** **

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**The Registrant meets the conditions set forth inGeneral Instruction H (1)(a) and (b) of Form 10-Q and istherefore filing this Form with the reduced disclosure format.**

 

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

**THESECURITIES EXCHANGE ACT OF 1934**

**FOR THEQUARTERLY PERIOD ENDED JUNE 30, 2009**

 

**OR**

 

**o        TRANSITION REPORT PURSUANT TO SECTION 13OR 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 by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.**

** **

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

 

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

 

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

 

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

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

 

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

** **

**Yes  **o   No x

** **

**As of August 11, 2009, the registrant had 23,800common shares, $227 par value, outstanding, all of which are held by AllstateInsurance Company.**

 

 

 

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**ALLSTATE LIFE INSURANCE COMPANY**

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

##### **June 30, 2009**

 
| ** **       | ** **                                                                                                                                | **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, 2009 and 2008 (unaudited) | 1          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Financial Position as of June 30, 2009  (unaudited) and  December 31, 2008                | 2          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Cash Flows for the Six-Month Periods Ended  June 30, 2009  and 2008 (unaudited)                | 3          |
|             |                                                                                                                                      |       |
|             | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                         | 4          |
|             |                                                                                                                                      |       |
|             | Report  of Independent Registered Public Accounting Firm                                                                                  | 39         |
|             |                                                                                                                                      |       |
| Item  2.         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                               | 40         |
|             |                                                                                                                                      |       |
| Item  4.         | Controls  and Procedures                                                                                                                  | 81         |
|             |                                                                                                                                      |       |
| **PART II** | **OTHER  INFORMATION**                                                                                                                    | ** ** |
|             |                                                                                                                                      |       |
| Item  1.         | Legal  Proceedings                                                                                                                        | 82         |
|             |                                                                                                                                      |       |
| Item  1A.        | Risk  Factors                                                                                                                             | 82         |
|             |                                                                                                                                      |       |
| Item  6.         | Exhibits                                                                                                                                  | 83         |

 

----

 

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

##### ** **

**ITEM 1. FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| **($ in millions)**                                           | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                         | ** ** | **(Unaudited)**                             | ** ** | **(Unaudited)**                           | ** ** |
| **Revenues**                                                       |       |                                        |       |                                      |       |   |   |   |   |
| Premiums                                                           | $          |                                        | 154        | $                                         |       | 147 | $ |   | 306 | $ |   | 287 |   |
| Contract charges                                                   |       | 237                                         |       | 225                                       |       | 465 |   | 437 |   |
| Net investment income                                              |       | 741                                         |       | 922                                       |       | 1,538 |   | 1,914 |   |
| Realized capital gains and losses:                                 |       |                                        |       |                                      |       |   |   |   |   |
| Total other-than-temporary impairment losses                       |       | (332                                        | )          | (929                                      | )          | (716 | ) | (1,157 | ) |
| Portion of loss recognized in other comprehensive  income          |       | 104                                         |       | —                                    |       | 104 |   | — |   |
| Net other-than-temporary impairment losses  recognized in earnings |       | (228                                        | )          | (929                                      | )          | (612 | ) | (1,157 | ) |
| Sales and other realized capital gains and losses                  |       | 350                                         |       | (3                                        | )          | 696 |   | (203 | ) |
| Total realized capital gains and losses                            |       | 122                                         |       | (932                                      | )          | 84 |   | (1,360 | ) |
|                                                               |       | 1,254                                       |       | 362                                       |       | 2,393 |   | 1,278 |   |
|                                                               |       |                                        |       |                                      |       |   |   |   |   |
| **Costs and expenses**                                             |       |                                        |       |                                      |       |   |   |   |   |
| Contract benefits                                                  |       | 357                                         |       | 343                                       |       | 691 |   | 684 |   |
| Interest credited to contractholder funds                          |       | 548                                         |       | 549                                       |       | 1,113 |   | 1,159 |   |
| Amortization of deferred policy acquisition costs                  |       | 268                                         |       | (56                                       | )          | 697 |   | (6 | ) |
| Operating costs and expenses                                       |       | 81                                          |       | 98                                        |       | 170 |   | 185 |   |
| Restructuring and related charges                                  |       | 2                                           |       | —                                    |       | 19 |   | — |   |
| Interest expense                                                   |       | 10                                          |       | 3                                         |       | 21 |   | 6 |   |
|                                                               |       | 1,266                                       |       | 937                                       |       | 2,711 |   | 2,028 |   |
| Gain (loss) on disposition of operations                           |       | 1                                           |       | —                                    |       | 4 |   | (9 | ) |
|                                                               |       |                                        |       |                                      |       |   |   |   |   |
| **Loss from operations before income  tax (benefit) expense**      |       | (11                                         | )          | (575                                      | )          | (314 | ) | (759 | ) |
|                                                               |       |                                        |       |                                      |       |   |   |   |   |
| Income tax (benefit) expense                                       |       | (11                                         | )          | (207                                      | )          | 22 |   | (276 | ) |
|                                                               |       |                                        |       |                                      |       |   |   |   |   |
| **Net loss**                                                       | $          |                                        | —     | $                                         |       | (368 | ) | $ |   | (336 | ) | $ |   | (483 | ) |
|                                                                    |            |                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

See notes to condensed consolidated financial statements.

 

1

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF FINANCIALPOSITION**

** **
| **($ in millions, except par value  data)**                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                        |       | **(Unaudited)**   |       |                  |       |
| **Assets**                                                                                        |       |              |       |                  |       |
| Investments                                                                                       |       |              |       |                  |       |
| Fixed  income securities, at fair value (amortized cost $49,168 and $49,136)                      | $          |              | 43,433     | $                     |       | 42,446 |   |
| Mortgage  loans                                                                                   |       | 9,203             |       | 10,012                |       |
| Equity  securities, at fair value (cost $182 and $106)                                            |       | 178               |       | 82                    |       |
| Limited  partnership interests                                                                    |       | 1,036             |       | 1,187                 |       |
| Short-term,  at fair value (amortized cost $2,125 and $3,855)                                     |       | 2,125             |       | 3,858                 |       |
| Policy  loans                                                                                     |       | 805               |       | 813                   |       |
| Other                                                                                             |       | 1,177             |       | 1,374                 |       |
| Total  investments                                                                                |       | 57,957            |       | 59,772                |       |
| Cash                                                                                              |       | 249               |       | 93                    |       |
| Deferred  policy acquisition costs                                                                |       | 6,440             |       | 6,701                 |       |
| Reinsurance  recoverables                                                                         |       | 4,246             |       | 3,923                 |       |
| Accrued  investment income                                                                        |       | 513               |       | 542                   |       |
| Deferred  income taxes                                                                            |       | 646               |       | 1,382                 |       |
| Other  assets                                                                                     |       | 801               |       | 1,294                 |       |
| Separate  Accounts                                                                                |       | 8,193             |       | 8,239                 |       |
| **Total assets**                                                                                  | $          |              | 79,045     | $                     |       | 81,946 |   |
|                                                                                              |       |              |       |                  |       |
| **Liabilities**                                                                                   |       |              |       |                  |       |
| Contractholder  funds                                                                             | $          |              | 52,298     | $                     |       | 56,780 |   |
| Reserve  for life-contingent contract benefits                                                    |       | 12,208            |       | 12,256                |       |
| Unearned  premiums                                                                                |       | 31                |       | 32                    |       |
| Payable  to affiliates, net                                                                       |       | 97                |       | 142                   |       |
| Other  liabilities and accrued expenses                                                           |       | 1,730             |       | 1,638                 |       |
| Surplus  notes due to related parties                                                             |       | 650               |       | 650                   |       |
| Separate  Accounts                                                                                |       | 8,193             |       | 8,239                 |       |
| **Total liabilities**                                                                             |       | 75,207            |       | 79,737                |       |
|                                                                                              |       |              |       |                  |       |
| **Commitments and Contingent Liabilities (Note 8)**                                               |       |              |       |                  |       |
|                                                                                              |       |              |       |                  |       |
| **Shareholder’s Equity**                                                                     |       |              |       |                  |       |
| Redeemable  preferred stock - series A, $100 par value, 1,500,000 shares authorized, none  issued |       | —            |       | —                |       |
| Redeemable  preferred stock - series B, $100 par value, 1,500,000 shares authorized, none  issued |       | —            |       | —                |       |
| Common  stock, $227 par value, 23,800 shares authorized and outstanding                           |       | 5                 |       | 5                     |       |
| Additional  capital paid-in                                                                       |       | 2,725             |       | 2,475                 |       |
| Retained  income                                                                                  |       | 2,211             |       | 2,066                 |       |
| Accumulated  other comprehensive income:                                                          |       |              |       |                  |       |
| Unrealized  net capital gains and losses:                                                         |       |              |       |                  |       |
| Unrealized  net capital losses on fixed income securities with OTTI                               |       | (249              | )          | —                |       |
| Other  unrealized net capital gains and losses                                                    |       | (3,493            | )          | (4,362                | )          |
| Unrealized  adjustment to DAC, DSI and insurance reserves                                         |       | 2,639             |       | 2,025                 |       |
| Total  unrealized net capital gains and losses                                                    |       | (1,103            | )          | (2,337                | )          |
| Total accumulated other comprehensive loss                                                        |       | (1,103            | )          | (2,337                | )          |
|                                                                                              |       |              |       |                  |       |
| Total shareholder’s equity                                                                   |       | 3,838             |       | 2,209                 |       |
|                                                                                              |       |              |       |                  |       |
| **Total liabilities and shareholder’s equity**                                               | $          |              | 79,045     | $                     |       | 81,946 |   |

 

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

 

2

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** ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| **($ in millions)**                                                         | ** ** | **Six months ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**    | ** ** |
| ** **                                                                       | ** ** | **2009**             | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **(Unaudited)**      | ** ** |
| **Cash flows from operating  activities**                                        |       |                 |       |   |   |
| Net loss                                                                         | $          |                 | (336       | ) | $ |   | (483 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                 |       |   |   |
| Amortization and other non-cash items                                            |       | (164                 | )          | (183 | ) |
| Realized capital gains and losses                                                |       | (84                  | )          | 1,360 |   |
| (Gain) loss on disposition of operations                                         |       | (4                   | )          | 9 |   |
| Interest credited to contractholder funds                                        |       | 1,113                |       | 1,159 |   |
| Changes in:                                                                      |       |                 |       |   |   |
| Policy benefits and other insurance reserves                                     |       | (52                  | )          | (323 | ) |
| Unearned premiums                                                                |       | (1                   | )          | (2 | ) |
| Deferred policy acquisition costs                                                |       | 501                  |       | (309 | ) |
| Reinsurance recoverables, net                                                    |       | (240                 | )          | 2 |   |
| Income taxes                                                                     |       | 425                  |       | (249 | ) |
| Other operating assets and liabilities                                           |       | 109                  |       | (54 | ) |
| Net cash provided by operating activities                                        |       | 1,267                |       | 927 |   |
|                                                                             |       |                 |       |   |   |
| **Cash flows from investing  activities**                                        |       |                 |       |   |   |
| Proceeds from sales:                                                             |       |                 |       |   |   |
| Fixed income securities                                                          |       | 5,516                |       | 6,755 |   |
| Equity securities                                                                |       | 7                    |       | 63 |   |
| Limited partnership interests                                                    |       | 19                   |       | 52 |   |
| Mortgage loans                                                                   |       | 139                  |       | 191 |   |
| Other investments                                                                |       | 251                  |       | 127 |   |
| Investment collections:                                                          |       |                 |       |   |   |
| Fixed income securities                                                          |       | 1,817                |       | 1,229 |   |
| Mortgage loans                                                                   |       | 584                  |       | 372 |   |
| Other investments                                                                |       | 57                   |       | 67 |   |
| Investment purchases:                                                            |       |                 |       |   |   |
| Fixed income securities                                                          |       | (6,048               | )          | (3,853 | ) |
| Equity securities                                                                |       | (101                 | )          | (106 | ) |
| Limited partnership interests                                                    |       | (96                  | )          | (219 | ) |
| Mortgage loans                                                                   |       | (13                  | )          | (436 | ) |
| Other investments                                                                |       | (7                   | )          | (64 | ) |
| Change in short-term investments, net                                            |       | 1,893                |       | (4,658 | ) |
| Change in other investments, net                                                 |       | (162                 | )          | (220 | ) |
| Net cash provided by (used in) investing activities                              |       | 3,856                |       | (700 | ) |
|                                                                             |       |                 |       |   |   |
| **Cash flows from financing  activities**                                        |       |                 |       |   |   |
| Capital contribution                                                             |       | 250                  |       | — |   |
| Contractholder fund deposits                                                     |       | 1,943                |       | 6,844 |   |
| Contractholder fund withdrawals                                                  |       | (7,160               | )          | (7,032 | ) |
| Net cash used in financing activities                                            |       | (4,967               | )          | (188 | ) |
| **Net increase in cash**                                                         |       | 156                  |       | 39 |   |
| **Cash at beginning of the period**                                              |       | 93                   |       | 185 |   |
| **Cash at end of period**                                                        | $          |                 | 249        | $ |   | 224 |   |
|                                                                                  |            |                      |            |  |  |  |  |  |

 

See notes to condensed consolidated financial statements.

 

3

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.   General**

 

**Basis of presentation**

 

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

 

The condensedconsolidated financial statements and notes as of June 30, 2009, and forthe three-month and six-month periods ended June 30, 2009 and 2008 areunaudited.  The condensed consolidatedfinancial statements reflect all adjustments (consisting only of normalrecurring accruals), which are, in the opinion of management, necessary for thefair presentation of the financial position, results of operations and cashflows for the interim periods.  Thesecondensed consolidated financial statements and notes should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2008.  The results of operations for theinterim periods should not be considered indicative of results to be expectedfor the full year.

 

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

 

Subsequent events were evaluated through August 11,2009, the date the consolidated financial statements were issued.

 

**Premiums and Contract Charges**

 

The following table summarizes premiums and contract charges byproduct.

 
| **($ in millions)**                     | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                   | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                   | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums**                                 |       |                   |       |                 |       |   |   |   |   |
| Traditional  life insurance                  | $          | 97                     | $          | 92                   | $          | 193 | $ | 181 |   |
| Immediate  annuities with life contingencies |       | 34                     |       | 36                   |       | 68 |   | 66 |   |
| Accident,  health and other                  |       | 23                     |       | 19                   |       | 45 |   | 40 |   |
| Total  premiums                              |       | 154                    |       | 147                  |       | 306 |   | 287 |   |
|                                         |       |                   |       |                 |       |   |   |   |   |
| **Contract charges**                         |       |                   |       |                 |       |   |   |   |   |
| Interest-sensitive  life insurance           |       | 226                    |       | 211                  |       | 442 |   | 410 |   |
| Fixed  annuities                             |       | 11                     |       | 13                   |       | 23 |   | 26 |   |
| Variable  annuities                          |       | —                 |       | 1                    |       | — |   | 1 |   |
| Total  contract charges                      |       | 237                    |       | 225                  |       | 465 |   | 437 |   |
| Total  premiums and contract charges         | $          | 391                    | $          | 372                  | $          | 771 | $ | 724 |   |

 

**Adopted accounting standards**

 

*Financial Accounting StandardsBoard (“FASB”) Staff Position No. FAS 115-2 and FAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS115-2”)*

 

In April 2009, the FASB issued FSPFAS 115-2 which amends Statement of Financial Accounting Standards No. 115,*Accounting for Certain Investments in Debt andEquity Securities* (“SFAS No. 115”), to provide recognitionguidance for debt securities classified as available-for-sale and subject toother-than-temporary impairment (“OTTI”) guidance.  If the fair value of a debt security is lessthan its amortized cost basis at the reporting date, an entity shall assesswhether the impairment is an OTTI.  Whenan entity intends to sell an impaired security or more likely than not will berequired to sell an impaired security before recovery of its amortized costbasis, an OTTI is recognized in earnings. If the entity does not expect to recover the entire amortized cost basisof an impaired security, even if it does not intend to sell the security and itis not more likely than not that it would be required to sell the securitybefore recovery of its amortized cost basis, the entity must consider, basedupon an 

 

4

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estimate of the present value of cash flowsexpected to be collected on the debt security as compared to its amortized costbasis, whether a credit loss exists.  Theportion of the total OTTI related to a credit loss shall be recognized inearnings while the portion of the total OTTI related to factors other thancredit shall be recognized in other comprehensive income (“OCI”).  The statement of operations is required topresent the total OTTI with an offset for the amount of the total OTTI that isrecognized in OCI.  The statementdisclosing accumulated other comprehensive income (“AOCI”) is required toseparately present amounts recognized for debt securities for which a portionof an OTTI has been recognized in earnings.

 

FSP FAS 115-2 expands the disclosurerequirements of SFAS No. 115 (for both debt and equity securities) andrequires a more detailed, risk-oriented breakdown of security types and relatedinformation, and requires that the annual disclosures be made for interimperiods.  In addition, new disclosuresare required about significant inputs used in determining credit losses as wellas a rollforward of credit losses each period. FSP FAS 115-2 is effective for interim periods ending after June 15,2009.  The disclosures are not requiredfor earlier periods presented for comparative purposes.  FSP FAS 115-2 applies to existing andnew investments held as of the beginning of the interim period of adoption.

 

The Company adopted the provisions of FSPFAS 115-2 as of April 1, 2009. The adoption resulted in the reclassification of $733 million ofpreviously recorded OTTI write-downs from retained income to unrealized capitallosses.  The cumulative effect ofadoption, net of related deferred policy acquisition costs (“DAC”), deferredsales inducements (“DSI”) and tax adjustments, was an increase in retainedincome of $481 million and a decrease in unrealized net capital gains andlosses of $339 million, with a net benefit to equity of $142 million.  The benefit to equity resulted from adecrease in the deferred tax asset valuation allowance.  The adoption did not have an impact on theCompany’s Condensed Consolidated Statement of Operations.

 

*FSP FAS 157-4**, Determining Fair Value When theVolume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly (“FSPFAS 157-4”)*

 

In April 2009, the FASB issued FSPFAS 157-4, which amends SFAS No. 157, *Fair ValueMeasurements* (“SFAS No. 157”), to provide additional guidancefor estimating fair value when the volume and level of activity for an asset orliability have significantly decreased. Guidance on identifying circumstances that indicate a transaction is notorderly is also provided.  If it is concludedthat there has been a significant decrease in the volume and level of marketactivity for an asset or liability in relation to normal market activity,transaction or quoted prices may not be determinative of fair value and furtheranalysis of transaction or quoted prices may be necessary.  A significant adjustment to transaction orquoted prices may be necessary to estimate fair value under the current marketconditions.  Determination of whether atransaction is orderly is based on the weight of relevant evidence.

 

The disclosure requirements of SFAS No. 157are expanded to include the inputs and valuation techniques used to measurefair value and a discussion of changes in valuation techniques and relatedinputs during the quarterly reporting period. Disclosures of assets and liabilities measured at fair value are to bepresented by major security type.  FSPFAS 157-4 does not require disclosures for earlier periods presented forcomparative purposes.  FSP FAS 157-4is effective for interim periods ending after June 15, 2009.  Revisions resulting from a change invaluation technique or its application shall be accounted for as a change inaccounting estimate and disclosed, along with the total effect of the change invaluation technique and related inputs, if practicable, by major category.  The Company adopted the provisions of FSPFAS 157-4 as of April 1, 2009. The adoption of FSP FAS 157-4 had no effect on the Company’s results ofoperations or financial position.

 

*FSP No. FAS 107-1 andAPB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSPFAS 107-1 and APB 28-1”)*

 

In April 2009, the FASB issued FSPFAS 107-1 and APB 28-1 which amends FASB Statement No. 107, *Disclosures about Fair Value of Financial Instruments*, torequire disclosures about fair value of financial instruments for interimreporting periods as well as in annual financial statements; and amendsAccounting Principles Board Opinion No. 28, *InterimFinancial Reporting*, to require those disclosures in summarized financialinformation for interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim periodsending after June 15, 2009.  Thedisclosures are not required for earlier periods presented for comparativepurposes.  The Company adopted the provisionsof FSP FAS 107-1 and APB 28-1 for second quarter 2009 with required 

 

5

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disclosures in Note 5.  FSP FAS 107-1 and APB 28-1 affectsdisclosures only and therefore the adoption had no impact on the Company’sresults of operations or financial position.

 

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

 

In December 2007, the FASB issued SFAS No. 141Rwhich replaces SFAS No. 141, *Business Combinations*(“SFAS No. 141”).  In April 2009,the FASB issued FSP No. FAS 141(R)-1, *Accountingfor Assets Acquired and Liabilities Assumed in a Business Combination ThatArise from Contingencies* (“FSP FAS 141(R)-1”), which clarifiesSFAS No. 141R by addressing application issues raised by preparers,auditors and the legal profession.  Amongother things, SFAS No. 141R and the related FSP broaden the scope of SFAS No. 141to include all transactions where an acquirer obtains control of one or moreother businesses; retains the guidance to recognize intangible assetsseparately from goodwill; requires, with limited exceptions, that all assetsacquired and liabilities assumed, including certain of those that arise fromcontingencies, be measured at their acquisition date fair values; requires mostacquisition and restructuring-related costs to be expensed as incurred;requires that step acquisitions, once control is acquired, be recorded at thefull amounts of the fair values of the identifiable assets, liabilities and thenoncontrolling interest in the acquiree; and replaces the reduction of assetvalues and recognition of negative goodwill with a requirement to recognize again in earnings.  The provisions of SFASNo. 141R and FSP FAS 141(R)-1 are effective for fiscal yearsbeginning after December 15, 2008 and are to be applied prospectivelyonly.  Early adoption is notpermitted.  The Company will apply theprovisions of SFAS No. 141R to any business combinations effectivesubsequent to January 1, 2009.

 

*SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements - an amendment ofARB No. 51 (“SFAS No. 160”)*

 

In December 2007, the FASB issued SFAS No. 160which clarifies that a noncontrolling interest in a subsidiary is that portionof the subsidiary’s equity that is attributable to owners of the subsidiaryother than its parent or parent’s affiliates. Noncontrolling interests are required to be reported as equity in theconsolidated financial statements and as such, net income will include amountsattributable to both the parent and the noncontrolling interest with disclosureof the amounts attributable to each on the face of the consolidated statementsof operations, if material.  SFAS No. 160requires that all changes in a parent’s ownership interest in a subsidiary whencontrol of the subsidiary is retained, be accounted for as equitytransactions.  In contrast, when controlover a subsidiary is relinquished and the subsidiary is deconsolidated, SFAS No. 160requires a parent to recognize a gain or loss in net income as well as providecertain associated expanded disclosures. SFAS No. 160 is effective as of the beginning of a reporting entity’sfirst fiscal year beginning after December 15, 2008.  SFAS No. 160 requires prospectiveapplication as of the beginning of the fiscal year in which the standard isinitially applied, except for the presentation and disclosure requirementswhich are to be applied retrospectively for all periods presented.  The adoption of SFAS No. 160 did nothave an effect on the Company’s results of operations or financial position.

 

*SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities - an amendmentof FASB Statement No. 133 (“SFAS No. 161”)*

 

In March 2008, the FASB issued SFAS No. 161,which amends and expands the disclosure requirements for derivatives currentlyaccounted for in accordance with SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities* (“SFAS No. 133”).  The new disclosures are designed to enhancethe understanding of how and why an entity uses derivative instruments and howderivative instruments affect an entity’s financial position, results ofoperations, and cash flows.  The standardrequires, on a quarterly basis, quantitative disclosures about the potentialcash outflows associated with the triggering of credit-risk-contingentfeatures, if any; tabular disclosures about the classification and fair valueamounts of derivative instruments reported in the statement of financialposition; disclosure of the location and amount of gains and losses onderivative instruments reported in the statement of operations; and qualitativeinformation about how and why an entity uses derivative instruments and howderivative instruments and related hedged items affect the entity’s financialstatements.  SFAS No. 161 iseffective for fiscal periods beginning after November 15, 2008, and is tobe applied on a prospective basis only. SFAS No. 161 affects disclosures only and therefore the adoptionhad no impact on the Company’s results of operations or financial position (seeNote 6).

 

6

----

 

**Pending accounting standard**

 

*SFAS No. FAS 167, Amendmentsto FASB Interpretation No. 46(R) (“SFAS No. 167”)*

 

In June 2009, the FASB issued SFAS No. 167which amends FASB Interpretation No. 46(R), *Consolidationof Variable Interest Entitie*s (“FIN 46R”), to require an entity toperform a qualitative analysis to determine whether the entity holds acontrolling financial interest (i.e., primary beneficiary (“PB”)) in a variableinterest entity (“VIE”). The analysis identifies the PB of a VIE as the entitythat has both the power to direct the activities of the VIE that mostsignificantly impact the economic performance of the VIE and the obligation toabsorb losses or the right to receive benefits that could potentially besignificant to the VIE.  Additionalamendments include the requirement to perform ongoing reassessments of FIN 46Rto determine whether the entity is the PB of a VIE and the elimination of thequantitative approach for determining the PB of a VIE.  SFAS No. 167 is effective for fiscalyears ending after December 15, 2009 with early applicationprohibited.  The Company is in theprocess of evaluating the impact of adoption on the Company’s results ofoperations or financial position.

 

**2.    Related Party Transactions**

 

**Capitalcontributions**

 

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

 

**3.    Supplemental Cash Flow Information**

 

Non-cash investment exchanges, includingmodifications of certain fixed income securities, mortgage loans and otherinvestments, as well as mergers completed with equity securities and limitedpartnerships, totaled $141 million and $9 million for the six-month periodsended June 30, 2009 and 2008, respectively.

 

Liabilities for collateral received inconjunction with the Company’s securities lending and over-the-counter (“OTC”)derivatives and for funds received from the Company’s security repurchasebusiness activities are reported in other liabilities and accrued expenses orother investments in the Condensed Consolidated Statements of FinancialPosition.

 

The accompanying cash flows are included incash flows from operating activities in the Condensed Consolidated Statementsof Cash Flows along with the activities resulting from management of theproceeds, which are as follows:

 
| **($ in millions)**                                               | ** ** | ** ** | **Six months ended   June 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------|--------------------------------------|------------|
| ** **                                                             | ** ** | ** ** | **2009**                             | ** ** | ** ** | **2008** | ** ** |
| **Net change in proceeds managed**                                     | ** ** | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** |
| Net  change in fixed income securities                                 |       | $          | —                               |       | $ | 236 |   |
| Net  change in short-term investments                                  |       |       | (350                                 | )          |   | (527 | ) |
| Operating  cash flow used                                              |       | $          | (350                                 | )          | $ | (291 | ) |
|                                                                   |       |       |                                 |       |   |   |   |
| **Net change in liabilities**                                          |       |       |                                 |       |   |   |   |
| Liabilities  for collateral and security repurchase, beginning of year |       | $          | (340                                 | )          | $ | (1,817 | ) |
| Liabilities  for collateral and security repurchase, end of period     |       |       | (690                                 | )          |   | (2,108 | ) |
| Operating  cash flow provided                                          |       | $          | 350                                  |       | $ | 291 |   |

 

7

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**4.  Investments**

 

**Fairvalues**

 

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

 
| **($ in millions)**                                   | ** ** | ** ** | **Amortized** | ** ** | ** ** | **Gross unrealized** | ** ** | ** ** | **Fair**   | ** ** |
|------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|------------|------------|
| ** **                                                 | ** ** | ** ** | **cost**      | ** ** | ** ** | **Gains**            | ** ** | ** ** | **Losses** | ** ** | ** ** | **value** | ** ** |
| **At June 30, 2009**                                  |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| U.S.  government and agencies                              |       | $          | 3,124         |       | $          | 221                  |       | $          | (8         | )          | $ | 3,337 |   |
| Municipal                                                  |       |       | 4,712         |       |       | 60                   |       |       | (549       | )          |   | 4,223 |   |
| Corporate                                                  |       |       | 26,602        |       |       | 555                  |       |       | (2,013     | )          |   | 25,144 |   |
| Foreign  government                                        |       |       | 1,565         |       |       | 241                  |       |       | (19        | )          |   | 1,787 |   |
| Residential  mortgage-backed securities (“RMBS”) |       |       | 5,886         |       |       | 66                   |       |       | (1,441     | )          |   | 4,511 |   |
| Commercial  mortgage-backed securities (“CMBS”)  |       |       | 4,848         |       |       | 18                   |       |       | (1,755     | )          |   | 3,111 |   |
| Asset-backed  securities (“ABS”)                 |       |       | 2,416         |       |       | 10                   |       |       | (1,117     | )          |   | 1,309 |   |
| Redeemable  preferred stock                                |       |       | 15            |       |       | —               |       |       | (4         | )          |   | 11 |   |
| Total  fixed income securities                             |       | $          | 49,168        |       | $          | 1,171                |       | $          | (6,906     | )          | $ | 43,433 |   |
|                                                       |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| **At December 31, 2008**                              |       |       |          |       |       |                 |       |       |       |       |   |   |   |
| U.S.  government and agencies                              |       | $          | 2,792         |       | $          | 895                  |       | $          | —     |       | $ | 3,687 |   |
| Municipal                                                  |       |       | 3,976         |       |       | 28                   |       |       | (696       | )          |   | 3,308 |   |
| Corporate                                                  |       |       | 27,416        |       |       | 408                  |       |       | (3,555     | )          |   | 24,269 |   |
| Foreign  government                                        |       |       | 1,652         |       |       | 513                  |       |       | (65        | )          |   | 2,100 |   |
| RMBS                                                       |       |       | 4,933         |       |       | 62                   |       |       | (1,022     | )          |   | 3,973 |   |
| CMBS                                                       |       |       | 5,712         |       |       | 10                   |       |       | (1,992     | )          |   | 3,730 |   |
| ABS                                                        |       |       | 2,639         |       |       | 5                    |       |       | (1,275     | )          |   | 1,369 |   |
| Redeemable  preferred stock                                |       |       | 16            |       |       | —               |       |       | (6         | )          |   | 10 |   |
| Total  fixed income securities                             |       | $          | 49,136        |       | $          | 1,921                |       | $          | (8,611     | )          | $ | 42,446 |   |

 

**Scheduledmaturities**

 

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

 
| **($ in millions)**                          | ** ** | **Amortized** | ** ** | **Fair**  | ** ** |
|---------------------------------------------------|------------|---------------|------------|-----------|------------|
| ** **                                        | ** ** | **cost**      | ** ** | **value** | ** ** |
| Due in one year or less                           | $          |          | 1,898      | $         |       | 1,901 |   |
| Due after one year through five years             |       | 11,784        |       | 11,699    |       |
| Due after five years through ten years            |       | 10,095        |       | 9,922     |       |
| Due after ten years                               |       | 17,089        |       | 14,091    |       |
|                                              |       | 40,866        |       | 37,613    |       |
| Residential mortgage- and asset-backed securities |       | 8,302         |       | 5,820     |       |
| Total                                             | $          |          | 49,168     | $         |       | 43,433 |   |

 

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

 

8

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**Netinvestment income**

 

Netinvestment income is as follows:

 
| **($ in millions)**          | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          |                                        | 639        | $                                         |       | 772 | $ |   | 1,320 | $ |   | 1,598 |   |
| Mortgage loans                    |       | 129                                         |       | 145                                       |       | 263 |   | 291 |   |
| Equity securities                 |       | 1                                           |       | 3                                         |       | 2 |   | 4 |   |
| Limited partnership interests     |       | 2                                           |       | 13                                        |       | 4 |   | 37 |   |
| Other                             |       | (7                                          | )          | 25                                        |       | (6 | ) | 61 |   |
| Investment income, before expense |       | 764                                         |       | 958                                       |       | 1,583 |   | 1,991 |   |
| Investment expense                |       | (23                                         | )          | (36                                       | )          | (45 | ) | (77 | ) |
| Net investment income             | $          |                                        | 741        | $                                         |       | 922 | $ |   | 1,538 | $ |   | 1,914 |   |

 

**Realized capital gains and losses**

 

Realizedcapital gains and losses by security type are as follows:

 
| **($ in millions)**          | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          |                                        | 4          | $                                         |       | (876 | ) | $ |   | 148 | $ |   | (1,107 | ) |
| Mortgage loans                    |       | (16                                         | )          | (37                                       | )          | (48 | ) | (36 | ) |
| Equity securities                 |       | 1                                           |       | (20                                       | )          | (24 | ) | (23 | ) |
| Limited partnership interests     |       | (53                                         | )          | (4                                        | )          | (224 | ) | (3 | ) |
| Derivatives                       |       | 221                                         |       | 12                                        |       | 290 |   | (176 | ) |
| Other                             |       | (35                                         | )          | (7                                        | )          | (58 | ) | (15 | ) |
| Realized capital gains and losses | $          |                                        | 122        | $                                         |       | (932 | ) | $ |   | 84 | $ |   | (1,360 | ) |
|                                   |            |                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

Realizedcapital gains and losses by transaction type are as follows:

 
| **($ in millions)**               | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Impairment write-downs (1)             | $          |                                        | (203       | )                                         | $          |   | (199 | ) | $ |   | (555 | ) | $ |   | (403 | ) |
| Change in intent write-downs (2)       |       | (25                                         | )          | (730                                      | )          |   | (57 | ) |   | (754 | ) |
| Net OTTI losses recognized in earnings |       | (228                                        | )          | (929                                      | )          |   | (612 | ) |   | (1,157 | ) |
| Sales                                  |       | 163                                         |       | (13                                       | )          |   | 521 |   |   | (56 | ) |
| Valuation of derivative instruments    |       | 179                                         |       | 8                                         |       |   | 262 |   |   | (194 | ) |
| Settlements of derivative instruments  |       | 41                                          |       | 2                                         |       |   | 23 |   |   | 47 |   |
| EMA  LP income (3)                     |       | (33                                         | )          | —                                    |       |   | (110 | ) |   | — |   |
| Realized capital gains and losses      | $          |                                        | 122        | $                                         |       | (932 | ) | $ |   | 84 |   | $ |   | (1,360 | ) |
|                                        |            |                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

 

9

----

 

Grossgains of $227 million and $58 million and gross losses of $51 million and $74million were realized on sales of fixed income securities during the threemonths ended June 30, 2009 and 2008, respectively.  Gross gains of $791 million and $128 millionand gross losses of $277 million and $160 million were realized on sales offixed income securities during the six months ended June 30, 2009 and2008, respectively.

 

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

 
| **($ in millions)**                | ** ** | **Three months ended********June 30, 2009** | ** ** | **Six months ended******** June 30, 2009** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                              | ** ** | **Gross**                                        | ** ** | **Included   in OCI**                                | ** ** | **Net** | ** ** | **Gross** | ** ** | **Included   in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                             |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |
| Municipal                               | $          |                                             | (16        | )                                                    | $          |   | — |   | $ |   | (16 | ) | $ |   | (16 | ) | $ |   | — |   | $ |   | (16 | ) |
| Corporate                               |       | (37                                              | )          |                                                 | (9         | ) |   | (46 | ) |   | (70 | ) |   | (9 | ) |   | (79 | ) |
| Foreign  government                     |       | —                                           |       |                                                 | —     |   |   | — |   |   | (17 | ) |   | — |   |   | (17 | ) |
| RMBS                                    |       | (148                                             | )          |                                                 | 104        |   |   | (44 | ) |   | (168 | ) |   | 104 |   |   | (64 | ) |
| CMBS                                    |       | (44                                              | )          |                                                 | —     |   |   | (44 | ) |   | (53 | ) |   | — |   |   | (53 | ) |
| ABS                                     |       | (37                                              | )          |                                                 | 9          |   |   | (28 | ) |   | (167 | ) |   | 9 |   |   | (158 | ) |
| Total fixed income securities           |       | (282                                             | )          |                                                 | 104        |   |   | (178 | ) |   | (491 | ) |   | 104 |   |   | (387 | ) |
| Mortgage loans                          |       | (15                                              | )          |                                                 | —     |   |   | (15 | ) |   | (49 | ) |   | — |   |   | (49 | ) |
| Equity securities                       |       | (1                                               | )          |                                                 | —     |   |   | (1 | ) |   | (26 | ) |   | — |   |   | (26 | ) |
| Limited partnership interests           |       | (21                                              | )          |                                                 | —     |   |   | (21 | ) |   | (115 | ) |   | — |   |   | (115 | ) |
| Other                                   |       | (13                                              | )          |                                                 | —     |   |   | (13 | ) |   | (35 | ) |   | — |   |   | (35 | ) |
| Other-than-temporary impairment  losses | $          |                                             | (332       | )                                                    | $          |   | 104 |   | $ |   | (228 | ) | $ |   | (716 | ) | $ |   | 104 |   | $ |   | (612 | ) |

 

The total amount of other-than-temporary impairment losses included inaccumulated other comprehensive income for fixed income securities at June 30,2009, which were not included in earnings, are presented in the followingtable.  The amount excludes $72 millionof net unrealized gains related to changes in valuation of the fixed incomesecurities subsequent to the impairment measurement date.

 
| **($ in millions)** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| Corporate                | $          |       | (58        | ) |
| RMBS                     |       | (210       | )          |
| CMBS                     |       | (63        | )          |
| ABS                      |       | (125       | )          |
| Total                    | $          |       | (456       | ) |

 

10

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Arollforward of the amount related to credit losses for fixed income securitiesrecognized in earnings is presented in the following table.

 
| **($ in millions)**                                                                                                                                  | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| Beginning  balance of cumulative credit loss for securities held at April 1, 2009                                                                    | $          |       | (1,059     | ) |
| Additional  credit loss for securities previously other-than-temporarily impaired                                                                         |       | (39        | )          |
| Additional  credit loss for securities not previously other-than-temporarily impaired                                                                     |       | (119       | )          |
| Reduction  in credit loss for securities disposed or collected                                                                                            |       | 24         |       |
| Reduction  in credit loss for securities other-than-temporarily impaired to fair value                                                                    |       | —     |       |
| Change  in credit loss due to accretion of increase in cash flows and time value of  cash flows for securities previously other-than-temporarily impaired |       | —     |       |
| Ending  balance at June 30, 2009                                                                                                                     | $          |       | (1,193     | ) |

 

TheCompany uses its best estimate of future cash flows expected to be collectedfrom the fixed income security discounted at the security’s effective rateprior to impairment to calculate a recovery value and determine whether acredit loss exists.  The determination ofcash flow estimates is inherently subjective and methodologies may varydepending on circumstances specific to the security.  All reasonably available information relevantto the collectability of the security, including past events, current conditions, and reasonableand supportable assumptions and forecasts, are considered when developing theestimate of cash flows expected to be collected.  That information generally includes, but maynot be limited to, the remaining payment terms of the security, prepaymentspeeds, foreign exchange rates, the financial condition of the issuer(s),expected defaults, expected recoveries, the value of the underlying collateraland current subordination levels, vintage, geographic concentration, availablereserves or escrows, third party guarantees and other credit enhancements.  Additionally, other information, such asindustry analyst reports and forecasts, sector credit ratings, financialcondition of the bond insurer for insured fixed income securities, and othermarket data relevant to the collectability of the security may also beconsidered.  The estimated fair value ofcollateral may be used to estimate recovery value if the Company determinesthat the security is dependent on the liquidation of collateral forrecovery.  If the estimated recoveryvalue is less than the amortized cost of the security, a credit loss exists andan other-than-temporary impairment for the difference between the estimatedrecovery value and amortized cost is recorded in earnings.  If the Company determines that the fixedincome security does not have sufficient cash flow or other information todetermine a recovery value for the security, the Company may conclude that theentire decline in fair value is deemed to be credit related and is recorded inearnings.   The unrealized loss deemed tobe related to factors other than credit remains classified in OCI.

 

11

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**Unrealized net capital gains and losses**

 

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

 
| **($ in millions)**                            | ** ** | **Fair**  | ** ** | **Gross unrealized** | ** ** | ** ** | **Unrealized net** | ** ** |
|-----------------------------------------------------|------------|-----------|------------|----------------------|------------|------------|--------------------|------------|
| ** **                                          | ** ** | **value** | ** ** | **Gains**            | ** ** | **Losses** | ** **         | ** ** | **gains (losses)** | ** ** |
| **At June 30, 2009**                                |       |      |       |                 |       |       |               |       |   |   |
| Fixed  income securities (1)                        | $          |      | 44,433     | $                    |       | 1,171      | $                  |       | (6,906 | ) | $ |   | (5,735 | ) |
| Equity  securities                                  |       | 178       |       | 7                    |       | (11        | )                  |       | (4 | ) |
| Short-term  investments                             |       | 2,125     |       | —               |       | —     |               |       | — |   |
| Derivative  instruments (2)                         |       | (13       | )          | 4                    |       | (15        | )                  |       | (11 | ) |
| Unrealized  net capital gains and losses, pre-tax   |       |      |       |                 |       |       |               |       | (5,750 | ) |
| Amounts  recognized for:                            |       |      |       |                 |       |       |               |       |   |   |
| Insurance  reserves (3)                             |       |      |       |                 |       |       |               |       | — |   |
| DAC  and DSI (4)                                    |       |      |       |                 |       |       |               |       | 4,061 |   |
| Amounts  recognized                                 |       |      |       |                 |       |       |               |       | 4,061 |   |
| Deferred  income taxes                              |       |      |       |                 |       |       |               |       | 586 |   |
| Unrealized  net capital gains and losses, after-tax |       |      |       |                 |       |       |               | $          |   | (1,103 | ) |
|                                                     |            |           |            |                      |            |            |                    |            |  |  |  |  |  |  |

 

----

| (1)    | Unrealized  net capital gains and losses for fixed income securities comprise $(384)  million related to unrealized net capital losses on fixed income securities  with OTTI and $(5,351) million related to other unrealized net capital gains  and losses.                                                                                                                                                                                                                                                                                                                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (2)    | Included  in the fair value of derivative securities are $(5) million classified  as assets and $8 million classified as liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (3)    | The  insurance reserves adjustment represents the amount by which the reserve  balance would increase if the net unrealized gains in the applicable product  portfolios were realized and reinvested at current lower interest rates,  resulting in a premium deficiency. Although the Company evaluates premium  deficiencies on the combined performance of our life insurance and immediate  annuities with life contingencies, the adjustment primarily relates to  structured settlement annuities with life contingencies, in addition to  annuity buy-outs and certain payout annuities with life contingencies. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (4)    | The  DAC and DSI adjustment represents the amount by which the amortization of DAC  and DSI would increase or decrease if the unrealized gains or losses in the  respective product portfolios were realized.                                                                                                                                                                                                                                                                                                                                                                                                           |

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

 

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(1)   Included in the fair value ofderivative securities are $4 million classified as assets and $(12) millionclassified as liabilities.

 

12

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

 

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

 
| **($ in millions)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| Fixed income securities                              | $          |       | 955        |   |
| Equity securities                                    |       | 20         |       |
| Short-term investments                               |       | (3         | )          |
| Derivative instruments                               |       | (25        | )          |
| Total                                                |       | 947        |       |
| Amounts recognized for:                              |       |       |       |
| Insurance reserves                                   |       | 378        |       |
| DAC and DSI                                          |       | 568        |       |
| Increase in amounts recognized                       |       | 946        |       |
| Deferred income taxes                                |       | (659       | )          |
| Increase in unrealized net capital gains and  losses | $          |       | 1,234      |   |

 

**Portfolio monitoring**

 

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

 

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

 

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

 

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

 

Our portfolio monitoringprocess includes a quarterly review of all securities using a screening processto identify situations where the fair value, compared to amortized cost forfixed income securities and cost for equity securities, is below establishedthresholds for certain time periods, or which are identified through othermonitoring criteria such as ratings, ratings downgrades or paymentdefaults.  The securities identified, aswell as others for which the Company may have a concern, are evaluated forpotential other-than-temporary impairment using all reasonably availableinformation relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation ofother-than-temporary impairment for these fixed income and equity securitiesare assumptions and estimates about the financial condition of the issue or issuerand its future earnings potential.  Someof the factors considered in evaluating whether a decline in fair value isother than temporary are: 1) the length of time and extent to which the fairvalue has been less than amortized cost for fixed income securities, or costfor equity securities; 2) the financial condition, near-term and long-termprospects of the issue or issuer, including relevant industry conditions andtrends, geographic location and implications of rating agency actions andoffering prices; and 3) the specific reasons that a security is in asignificant unrealized loss position, including market conditions which couldaffect liquidity.

 

13

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

 
| **($ in millions)**                      | ** ** | **Less than 12 months****(1)** | ** ** | ** ** | **12 months or more****(1)** | ** ** | ** ** | **Total**      | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|------------|------------------------------|------------|------------|----------------|------------|
| ** **                                    | ** ** | **Number**                     | ** ** | ** ** | **Fair**                     | ** ** | ** ** | **Unrealized** | ** ** | ** ** | **Number** | ** ** | ** ** | **Fair** | ** ** | ** ** | **Unrealized** | ** ** | ** ** | **unrealized** | ** ** |
| ** **                                    | ** ** | **of issues**                  | ** ** | ** ** | **value**                    | ** ** | ** ** | **losses**     | ** ** | ** ** | **of issues** | ** ** | ** ** | **value** | ** ** | ** ** | **losses** | ** ** | ** ** | **losses** | ** ** |
| **At June 30, 2009**                     |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed income securities                       |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. government and agencies                  |       | 7                              |       | $          | 581                          |       | $          | (8             | )          |   | — |   | $ | — |   | $ | — |   | $ | (8 | ) |
| Municipal                                     |       | 202                            |       |       | 1,856                        |       |       | (236           | )          |   | 163 |   |   | 749 |   |   | (313 | ) |   | (549 | ) |
| Corporate                                     |       | 452                            |       |       | 5,430                        |       |       | (527           | )          |   | 721 |   |   | 7,462 |   |   | (1,486 | ) |   | (2,013 | ) |
| Foreign government                            |       | 20                             |       |       | 278                          |       |       | (13            | )          |   | 11 |   |   | 94 |   |   | (6 | ) |   | (19 | ) |
| RMBS                                          |       | 275                            |       |       | 805                          |       |       | (56            | )          |   | 324 |   |   | 1,720 |   |   | (1,385 | ) |   | (1,441 | ) |
| CMBS                                          |       | 102                            |       |       | 878                          |       |       | (306           | )          |   | 322 |   |   | 2,045 |   |   | (1,449 | ) |   | (1,755 | ) |
| ABS                                           |       | 20                             |       |       | 104                          |       |       | (53            | )          |   | 188 |   |   | 1,104 |   |   | (1,064 | ) |   | (1,117 | ) |
| Redeemable preferred stock                    |       | 1                              |       |       | 1                            |       |       | —         |       |   | 1 |   |   | 10 |   |   | (4 | ) |   | (4 | ) |
| Total fixed income securities (2)             |       | 1,079                          |       |       | 9,933                        |       |       | (1,199         | )          |   | 1,730 |   |   | 13,184 |   |   | (5,707 | ) |   | (6,906 | ) |
| Equity securities                             |       | 13                             |       |       | 99                           |       |       | (9             | )          |   | 2 |   |   | 16 |   |   | (2 | ) |   | (11 | ) |
| Total fixed income and equitysecurities       |       | 1,092                          |       | $          | 10,032                       |       | $          | (1,208         | )          |   | 1,732 |   | $ | 13,200 |   | $ | (5,709 | ) | $ | (6,917 | ) |
|                                          |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment grade fixed incomesecurities       |       | 987                            |       | $          | 9,376                        |       | $          | (1,014         | )          |   | 1,380 |   | $ | 11,519 |   | $ | (4,110 | ) | $ | (5,124 | ) |
| Below investment grade fixed incomesecurities |       | 92                             |       |       | 557                          |       |       | (185           | )          |   | 350 |   |   | 1,665 |   |   | (1,597 | ) |   | (1,782 | ) |
| Total fixed income securities                 |       | 1,079                          |       | $          | 9,933                        |       | $          | (1,199         | )          |   | 1,730 |   | $ | 13,184 |   | $ | (5,707 | ) | $ | (6,906 | ) |
|                                          |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **At December 31, 2008**                 |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed income securities                       |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Municipal                                     |       | 400                            |       | $          | 2,460                        |       | $          | (653           | )          |   | 26 |   | $ | 199 |   | $ | (43 | ) | $ | (696 | ) |
| Corporate                                     |       | 1,282                          |       |       | 12,781                       |       |       | (1,779         | )          |   | 446 |   |   | 4,344 |   |   | (1,776 | ) |   | (3,555 | ) |
| Foreign government                            |       | 43                             |       |       | 304                          |       |       | (53            | )          |   | 2 |   |   | 13 |   |   | (12 | ) |   | (65 | ) |
| RMBS                                          |       | 209                            |       |       | 1,154                        |       |       | (293           | )          |   | 226 |   |   | 973 |   |   | (729 | ) |   | (1,022 | ) |
| CMBS                                          |       | 289                            |       |       | 2,646                        |       |       | (786           | )          |   | 176 |   |   | 901 |   |   | (1,206 | ) |   | (1,992 | ) |
| ABS                                           |       | 61                             |       |       | 348                          |       |       | (100           | )          |   | 166 |   |   | 926 |   |   | (1,175 | ) |   | (1,275 | ) |
| Redeemable preferred stock                    |       | 3                              |       |       | 9                            |       |       | (6             | )          |   | — |   |   | — |   |   | — |   |   | (6 | ) |
| Total fixed income securities                 |       | 2,287                          |       |       | 19,702                       |       |       | (3,670         | )          |   | 1,042 |   |   | 7,356 |   |   | (4,941 | ) |   | (8,611 | ) |
| Equity securities                             |       | 39                             |       |       | 55                           |       |       | (25            | )          |   | — |   |   | — |   |   | — |   |   | (25 | ) |
| Total fixed income and equitysecurities       |       | 2,326                          |       | $          | 19,757                       |       | $          | (3,695         | )          |   | 1,042 |   | $ | 7,356 |   | $ | (4,941 | ) | $ | (8,636 | ) |
|                                          |       |                           |       |       |                         |       |       |           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment grade fixed incomesecurities       |       | 2,104                          |       | $          | 18,791                       |       | $          | (3,343         | )          |   | 906 |   | $ | 6,757 |   | $ | (4,481 | ) | $ | (7,824 | ) |
| Below investment grade fixed incomesecurities |       | 183                            |       |       | 911                          |       |       | (327           | )          |   | 136 |   |   | 599 |   |   | (460 | ) |   | (787 | ) |
| Total fixed income securities                 |       | 2,287                          |       | $          | 19,702                       |       | $          | (3,670         | )          |   | 1,042 |   | $ | 7,356 |   | $ | (4,941 | ) | $ | (8,611 | ) |

 

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(1)     The aging of unrealizedlosses, and therefore the time period category of aging, as of June 30,2009 was reset to the historical point of impairment for securities impacted bythe adoption of FSP FAS 115-2.  December 31,2008 balances have not been restated.

 

(2)     Unrealizedlosses resulting from factors other than credit on fixed income securities withother-than-temporary impairments for which the Company has recorded a creditloss in earnings total $75 million for the less than 12 month category and $330million for the 12 months or greater category.

 

As of June 30, 2009, $1.33 billion ofunrealized losses are related to securities with an unrealized loss positionless than 20% of cost or amortized cost, the degree of which suggests thatthese securities do not pose a high risk of being other-than-temporarilyimpaired.  Of the $1.33 billion, $1.21billion are related to unrealized losses on investment grade fixed incomesecurities.  Investment grade is definedas a security having a rating from the NAIC of 1 or 2; a rating of Aaa, Aa, Aor Baa from Moody’s, a rating of AAA, AA, A or BBB from Standard &Poor’s (“S&P”), Fitch or Dominion, or aaa, aa, a or bbb from A.M.Best; or a comparable internal rating if an externally provided rating is notavailable.  Unrealized losses oninvestment grade securities are principally related to rising interest rates orchanges in credit spreads since the securities were acquired.

 

As of June 30, 2009, the remaining $5.59billion of unrealized losses are related to securities in unrealized losspositions greater than or equal to 20% of cost or amortized cost.  Of the $5.59 billion, $1.67 billion arerelated to below investment grade fixed income securities and $10 million arerelated to equity securities.  Of theseamounts, 

 

14

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$1.01 billion of the below investment grade fixed income securities hadbeen in an unrealized loss position for a period of twelve or more consecutivemonths as of June 30, 2009. Unrealized losses on below investment grade securities are principallyrelated to rising interest rates or changes in credit spreads.  Unrealized losses on equity securities areprimarily related to equity market fluctuations.  The other securities comprising the $3.91billion of unrealized losses were evaluated based on factors such as thefinancial condition and near-term and long-term prospects of the issuer andwere determined to have adequate resources to fulfill contractual obligations,such as recent financings or bank loans, cash flows from operations, collateralor the position of a subsidiary with respect to its parent’s bankruptcy.

 

Unrealized losses on residentialmortgage-backed, asset-backed and commercial mortgage-backed holdings wereevaluated based on credit ratings, as well as the performance of the underlyingcollateral relative to the securities’ positions in the securities’ respectivecapital structure.  The unrealized losseson residential mortgage-backed and asset-backed securities were evaluated withcredit enhancements from bond insurers where applicable.   The unrealized losses on municipal bondsthat had credit enhancements from bond insurers were evaluated on the qualityof the underlying security.  Theseinvestments were determined to have adequate resources to fulfill contractualobligations.

 

As of June 30, 2009, the Company did nothave the intent to sell and it is not more likely than not the Company will berequired to sell fixed income securities with unrealized losses before recoveryof the amortized cost basis.  As of June 30,2009, the Company had the intent and ability to hold the equity securities withunrealized losses for a period of time sufficient for them to recover.

 

**Limited partnership impairment**

 

As of June 30, 2009 and December 31,2008, equity-method limited partnership interests totaled $535 million and $627million, respectively.  The Companyrecognizes a loss in value for equity-method investments when evidencedemonstrates that it is other-than-temporarily impaired.  Evidence of a loss in value that is otherthan temporary may include the absence of an ability to recover the carryingamount of the investment or the inability of the investee to sustain anearnings capacity that would justify the carrying amount of theinvestment.  The Company did not have anywrite-downs for the three months ended June 30, 2009 and 2008 or the sixmonths ended June 30, 2008 related to equity-method limited partnershipinterests.  The Company had write-downsof $5 million for the six months ended June 30, 2009 related toequity-method limited partnership interests.

 

As of June 30, 2009 and December 31,2008, the carrying value for cost-method limited partnership interests was $501million and $560 million, respectively, which primarily included limitedpartnership interests in fund investments. The fair value for cost-method investments is estimated to be equivalent to the reported netasset value of the underlying funds.  Todetermine if an other-than-temporary impairment has occurred, the Companyevaluates whether an impairment indicator has occurred in the period that mayhave a significant adverse effect on the carrying value of the investment.  Impairment indicators may include: actualrecent cash flows received being significantly less than expected cash flows;reduced valuations based on financing completed at a lower value; completedsale of a material underlying investment at a price significantly lower thanexpected; significantly reduced valuations of the investments held by limitedpartnerships; or any other recent adverse events since the last financialstatements received that might affect the fair value of the investee’scapital.  Additionally, the Company usesa screening process to identify those investments whose net asset value isbelow established thresholds for certain periods of time, and investments thatare performing below expectations for consideration for inclusion on its watch-list. The Company had write-downs of $21 million and $4 million for the threemonths ended June 30, 2009 and 2008, respectively, and write-downs of $110million and $7 million for the six months ended June 30, 2009 and 2008,respectively, related to cost method investments that wereother-than-temporarily impaired.

 

**5.  Fair Value ofAssets and Liabilities**

 

The hierarchy for inputs used in determiningfair value maximizes the use of observable inputs and minimizes the use of unobservableinputs by requiring that observable inputs be used when available.  Assets and liabilities recorded on theCondensed Consolidated Statements of Financial Position at fair value arecategorized in the fair value hierarchy based on the observability of inputs tothe valuation techniques as follows:

 

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

 

15

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

 

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

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

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

 

*Level 3:**    *Assets and liabilities whose values are based onprices or valuation techniques that require inputs that are both unobservableand significant to the overall fair value measurement.  These inputs reflect the Company’s estimatesof the assumptions that market participants would use in valuing the assets andliabilities.

 

The availability ofobservable inputs varies by instrument. In situations where fair value is based on internally developed pricingmodels or inputs that are unobservable in the market, the determination of fairvalue requires more judgment.  The degreeof judgment exercised by the Company in determining fair value is typicallygreatest for instruments categorized in Level 3.  In many instances, valuation inputs used tomeasure fair value fall into different levels of the fair valuehierarchy.  The category level in the fair value hierarchy is determinedbased on the lowest level input that is significant to the fair valuemeasurement in its entirety.  TheCompany uses prices and inputs that are current as of the measurement date,including during periods of market disruption. In periods of market disruption, the ability to observe prices andinputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1to Level 2, or from Level 2 to Level 3.

 

Certain assets are not carried at fair value on arecurring basis, including investments such as mortgage loans, limitedpartnership interests, bank loans and policy loans.  Accordingly, such investments are onlyincluded in the fair value hierarchy disclosure when the investment is subjectto remeasurement at fair value after initial recognition and the resultingremeasurement is reflected in the condensed consolidated financialstatements.  In addition, equity optionsembedded in fixed income securities are not disclosed in the hierarchy withfree-standing derivatives as the embedded derivatives are presented with thehost contract in fixed income securities.  As of June 30, 2009, 68.9% of totalassets are measured at fair value and 0.8% of total liabilities are measured atfair value.

 

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

 

Level 1 measurements

 

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

 

·                  Equity securities: Comprise actively traded, exchange-listed U.S. and international equitysecurities. Valuation is based on unadjusted quoted prices for identical assetsin active markets that the Company can access.

 

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

 

·                  Separate account assets: Comprise actively traded mutual funds that have daily quoted net assetvalues for identical assets that the Company can access.  Net asset values for the actively tradedmutual funds in which the separate account assets are invested are obtaineddaily from the fund managers.

 

Level 2 measurements

 

·                  Fixed income securities:

 

*Corporate,including privately placed:*  Valued basedon inputs including quoted prices for identical or similar assets in marketsthat are not active.  Also includesprivately placed securities which have market-observable external ratings fromindependent third party rating agencies.

 

*Municipal:* Externally rated municipals are valued based on inputs including quotedprices for identical or similar assets in markets that are not active.  Included in municipals are auction ratesecurities (“ARS”) other than those backed by student loans.  ARS backed by student loans are included inLevel 3.

 

*U.S.government and agencies:*  Valued based on inputsincluding quoted prices for identical or similar assets in markets that are notactive.

 

16

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*CMBS:* Valuation is principally based on inputs including quoted prices foridentical or similar assets in markets that are not active.

 

*Redeemablepreferred stock; U.S. government sponsored entities (“U.S. Agency”); Primeresidential mortgage-backed securities (“Prime”); Foreign government; ABS -credit card, auto and student loans:*  Valued basedon inputs including quoted prices for identical or similar assets in marketsthat are not active.

 

·                  Equity securities: Valued based on inputs including quoted prices for identical or similarassets in markets that are not active.

 

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

 

·                  Other investments: Free-standing exchange listed derivatives that are not actively tradedare valued based on quoted prices for identical instruments in markets that arenot active.

 

OTC derivatives,including interest rate swaps, foreign currency swaps, foreign exchange forwardcontracts and certain credit default swaps, are valued using models that relyon inputs such as interest rate yield curves, currency rates and adjustment forcounterparty credit risks that are observable for substantially the full termof the contract.  The valuationtechniques underlying the models are widely accepted in the financial servicesindustry and do not involve significant judgment.

 

·                  Contractholder funds: Derivatives embedded in certain annuity contracts are valued based oninternal models that rely on inputs such as interest rate yield curves andequity index volatility assumptions that are market observable forsubstantially the full term of the contract. The valuation techniques are widely accepted in the financial servicesindustry and do not include significant judgment.

 

Level 3 measurements

 

·                  Fixed income securities:

 

*Corporate:* Valued based on non-binding broker quotes.

 

*Corporateprivately placed:*  Valued based on non-binding broker quotes andmodels that are widely accepted in thefinancial services industry and use internally assigned credit ratings as inputsand instrument specific inputs.  Instrumentspecific inputs used in internal fair value determinations include coupon rate,coupon type, weighted average life, sector of the issuer and callprovisions.  Privately placed securitiesare categorized as Level 3 as a resultof the significance of non-marketobservable inputs.  The internallymodeled securities are valued based on internal ratings, which are notobservable in the market.  Multipleinternal ratings comprise a National Association of InsuranceCommissioners (“NAIC”) rating categoryand when used in the internal model provide a more refined determination offair value.  The Company’s internalratings are primarily consistent with the NAIC ratings which are generallyupdated annually.

 

*Municipal:* ARS primarily backed by student loans that have become illiquid due tofailures in the auction market and municipal bonds that are not rated by thirdparty credit rating agencies but are generally rated by the NAIC are includedin Level 3.  ARS backed by student loansare valued based on a discounted cash flow model with certain inputs to thevaluation model that are significant tothe valuation, but are not market observable, including estimates offuture coupon rates if auction failures continue, maturity assumptions, andilliquidity premium.  Non-rated municipalbonds are valued based on valuation models that are widely accepted in thefinancial services industry and are categorized as Level 3 as a result of thesignificance of non-market observable inputs, which may include projections offuture cash flows.

 

*Subprime residentialmortgage-backed securities (“Subprime”); Alt-A residential mortgage-backedsecurities (“Alt-A”):*  Subprime and Alt-A areprincipally valued based on inputs including quoted prices for identical orsimilar assets in markets that exhibit less liquidity relative to those marketssupporting Level 2 fair value measurements. Certain Subprime and Alt-A are valued based on non-binding brokerquotes.  Due to the reduced availabilityof actual market prices or relevant observable inputs as a result of thedecrease in liquidity that has been experienced in the market for thesesecurities, all Subprime and Alt-A are categorized as Level 3.

 

17

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*Othercollateralized debt obligations (“CDO”):*  Valued basedon non-binding broker quotes received from brokers who are familiar with theinvestments.  Due to the reducedavailability of actual market prices or relevant observable inputs as a resultof the decrease in liquidity that has been experienced in the market for thesesecurities, all collateralized loan obligations (“CLO”), including syntheticcollateralized debt obligations are categorized as Level 3.

 

*CMBS;Commercial real estate collateralized debt obligations (“CRE CDO”):* CRE CDO, which are reported as CMBS, and other CMBS, are either valuedbased on non-binding broker quotes or based on inputs including quoted pricesfor identical or similar assets in markets that exhibit less liquidity relativeto those markets supporting Level 2 fair value measurements.  Due to the reduced availability of actualmarket prices or relevant observable inputs as a result of the decrease inliquidity that has been experienced in the market for these securities, certainCMBS are categorized as Level 3.

 

*ABS -credit card, auto, student loans and other:*  Valued basedon inputs including quoted prices for identical or similar assets in marketsthat are not active.  Due to the reducedavailability of actual market prices or relevant observable inputs as a resultof the decrease in liquidity that has been experienced in the market for thesesecurities, certain ABS are categorized as Level 3.

 

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

 

·                  Contractholder funds:  Derivativesembedded in annuity contracts are valued internally using models widelyaccepted in the financial services industry that determine a single best estimate of fair value for the embeddedderivatives within a block of contractholder liabilities.  The models use stochastically determined cashflows based on the contractual elements of embedded derivatives and otherapplicable market data.  These are categorizedas Level 3 as a result of thesignificance of non-marketobservable inputs.

 

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

 

Mortgage loans and otherinvestments written-down to fair value in connection with recognizingother-than-temporary impairments are valued using valuation models that arewidely accepted in the financial services industry.  Inputs to the valuation models includenon-market observable inputs such as credit spreads.  Limited partnership interests written-down tofair value in connection with recognizing other-than-temporary impairments arevalued using net asset values and other sources.

 

18

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

 
| **($ in millions)**                  | ** ** | **Quoted prices  in active  markets for  identical assets** | ** ** | **Significant  other  observable  inputs** | ** ** | ** ** | **Significant  unobservable  inputs** | ** ** | ** ** | **Counterparty  and cash  collateral** | ** ** | ** ** | **Balance as of  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------|------------|------------|---------------------------------------|------------|------------|----------------------------------------|------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **(Level 1)**                                               | ** ** | **(Level 2)**                              | ** ** | ** ** | **(Level 3)**                         | ** ** | ** ** | **netting****(1)**                     | ** ** | ** ** | **2009**                         | ** ** |
| **Assets:**                               | ** ** | ** **                                                  | ** ** | ** **                                 | ** ** | ** ** | ** **                            | ** ** | ** ** | ** **                             | ** ** | ** ** | ** **                       | ** ** |
| Fixed income securities:                  |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| U.S. government and agencies              | $          | 662                                                         |       | $                                          | 2,675      |       | $                                     | —     |       |                                   |       |       | $                                | 3,337      |   |
| Municipal                                 |       | —                                                      |       |                                       | 3,536      |       |                                  | 687        |       |                                   |       |       |                             | 4,223      |   |
| Corporate                                 |       | —                                                      |       |                                       | 15,640     |       |                                  | 9,504      |       |                                   |       |       |                             | 25,144     |   |
| Foreign government                        |       | —                                                      |       |                                       | 1,787      |       |                                  | —     |       |                                   |       |       |                             | 1,787      |   |
| RMBS                                      |       | —                                                      |       |                                       | 3,100      |       |                                  | 1,411      |       |                                   |       |       |                             | 4,511      |   |
| CMBS                                      |       | —                                                      |       |                                       | 2,224      |       |                                  | 887        |       |                                   |       |       |                             | 3,111      |   |
| ABS                                       |       | —                                                      |       |                                       | 52         |       |                                  | 1,257      |       |                                   |       |       |                             | 1,309      |   |
| Redeemable preferred stock                |       | —                                                      |       |                                       | 10         |       |                                  | 1          |       |                                   |       |       |                             | 11         |   |
| Total fixed income securities             |       | 662                                                         |       |                                       | 29,024     |       |                                  | 13,747     |       |                                   |       |       |                             | 43,433     |   |
| Equity securities                         |       | 113                                                         |       |                                       | 39         |       |                                  | 26         |       |                                   |       |       |                             | 178        |   |
| Short-term investments                    |       | 235                                                         |       |                                       | 1,890      |       |                                  | —     |       |                                   |       |       |                             | 2,125      |   |
| Other investments:                        |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| Free-standing derivatives                 |       | —                                                      |       |                                       | 627        |       |                                  | 30         |       | $                                      | (380       | )          |                             | 277        |   |
| Separate account assets                   |       | 8,193                                                       |       |                                       | —     |       |                                  | —     |       |                                   |       |       |                             | 8,193      |   |
| Other assets                              |       | —                                                      |       |                                       | —     |       |                                  | 2          |       |                                   |       |       |                             | 2          |   |
| **Total recurring basis assets**          |       | 9,203                                                       |       |                                       | 31,580     |       |                                  | 13,805     |       |                                   | (380       | )          |                             | 54,208     |   |
| Non-recurring basis **(2)**               |       | —                                                      |       |                                       | —     |       |                                  | 225        |       |                                   |       |       |                             | 225        |   |
| **Total assets at fair value**            | $          | 9,203                                                       |       | $                                          | 31,580     |       | $                                     | 14,030     |       | $                                      | (380       | )          | $                                | 54,433     |   |
| % of total assets at fair value           |       | 16.9                                                        | %          |                                       | 58.0       | %          |                                  | 25.8       | %          |                                   | (0.7       | )%         |                             | 100.0      | % |
| ** **                                |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| **Liabilities:**                          |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| Contractholder funds:                     |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| Derivatives embedded in annuity contracts | $          | —                                                      |       | $                                          | (120       | )          | $                                     | (155       | )          |                                   |       |       | $                                | (275       | ) |
| Other liabilities:                        |       |                                                        |       |                                       |       |       |                                  |       |       |                                   |       |       |                             |       |   |
| Free-standing derivatives                 |       | —                                                      |       |                                       | (507       | )          |                                  | (129       | )          | $                                      | 316        |       |                             | (320       | ) |
| **Total liabilities at fair value**       | $          | —                                                      |       | $                                          | (627       | )          | $                                     | (284       | )          | $                                      | 316        |       | $                                | (595       | ) |
| % of total liabilities at fair value      |       | —                                                      | %          |                                       | 105.4      | %          |                                  | 47.7       | %          |                                   | (53.1      | )%         |                             | 100.0      | % |

 

----

| (1)    | The  Company nets all fair value amounts recognized for derivative instruments and  fair value amounts recognized for the right to reclaim cash  collateral or the obligation to return cash collateral executed with the  same counterparty under a master netting agreement.  At  June 30, 2009, the right to reclaim cash collateral was offset by  securities held, and the obligation to return collateral was $64 million. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (2)    | Includes  $144 million of mortgage loans, $37 million of limited partnership interests  and $44 million of other investments written-down to fair value in connection  with recognizing other-than-temporary impairments.                                                                                                                                                                                                                            |

 

19

----

 

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

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

 

----

| (1)    | The  Company nets all fair value amounts recognized for derivative instruments and  fair value amounts recognized for the right to reclaim cash  collateral or the obligation to return cash collateral executed with the  same counterparty under a master netting agreement. At December 31,  2008, the right to reclaim cash collateral was offset by securities held, and  the obligation to return collateral was $20 million. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (2)    | Includes  $164 million of mortgage loans, $70 million of limited partnership interests  and $10 million of other investments written-down to fair value in connection  with recognizing other-than-temporary impairments.                                                                                                                                                                                                                          |

 

When the inputs used tomeasure fair value fall within different levels of the hierarchy, the levelwithin which the fair value measurement is categorized is based on the lowestlevel input that is significant to the fair value measurement in itsentirety.  Thus, a Level 3 fair valuemeasurement may include inputs that are observable (Level 1 or Level 2) andunobservable (Level 3).

 

20

----

 

The following tableprovides a summary of changes in fair value during the three-month period endedJune 30, 2009 of Level 3 assets and liabilities held at fair value on arecurring basis.  Net transfers in and/orout of Level 3 are reported as having occurred at the beginning of the quarterthe transfer occurred; therefore, for all transfers into Level 3, all realizedand changes in unrealized gains and losses in the quarter of transfer arereflected in the table below.

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

 

----

| (1)    | The  effect to net income totals $34 million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(110) million in realized  capital gains and losses, $13 million in net investment income and $(131)  million in contract benefits.                                                                                                                                                                                                                     |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (2)    | Comprises  $30 million of assets and $(129) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (3)    | The amounts represent gains and losses  included in net income for the period of time that the asset or liability was  determined to be in Level 3. These gains and losses total $24 million and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(122) million in realized  capital gains and losses, $14 million in net investment income,  $(1) million in interest credited to contractholder funds, and $(131)  million in contract benefits. |

 

21

----

 

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

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

 

----

| (1)    | The  effect to net income totals $(206) million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(359) million in realized  capital gains and losses, $49 million in net investment income, $1 million in  interest credited to contractholder funds, and $(105) million in  contract benefits.                                                                                                                                                              |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (2)    | Comprises  $30 million of assets and $(129) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (3)    | The amounts represent gains and losses included in  net income for the period of time that the asset or liability was determined  to be in Level 3. These gains and losses total $(203) million and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(357) million in realized capital gains and losses, $48 million in net  investment income, $(1) million in interest credited to contractholder  funds, and $(105) million in contract benefits. |

 

22

----

 

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

 
| **($ in millions)**                   | ** ** | ** **                              | ** ** | **Total  realized and unrealized   gains (losses) included in:** | ** **            | ** ** | ** ** | ** **                                       | ** ** | ** ** | ** **                                                    | **Total  gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------------|-----------------------|------------|------------|--------------------------------------------------|------------|------------|---------------------------------------------------------------|-------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Balance  as of  March 31, 2008** | ** ** | ** **                                                       | **Net income****(1)** | ** ** | ** ** | **OCI on   Statement of   Financial   Position** | ** ** | ** ** | **Purchases,  sales, issuances  and settlements,   net** | ** **                                                        | ** ** | **Net   transfers in  and/or (out)  of Level 3** | ** ** | ** ** | **Balance  as of  June 30, 2008** | ** ** | ** ** | **instruments  still held at  June 30,  2008****(3)** | ** ** |
| **Assets**                                 |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| Fixed  income securities:                  |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| Municipal                                  | $          | 213                                     |       | $                                                                | —                |       | $          | (20                                              | )          | $          | —                                                        |                                                              | $          | 611 |   | $ | 804 |   | $ | — |   |
| Corporate                                  |       | 11,889                                  |       |                                                             | (41                   | )          |       | (177                                             | )          |       | (262                                                          | )                                                                 |       | (65 | ) |   | 11,344 |   |   | (62 | ) |
| RMBS                                       |       | 2,516                                   |       |                                                             | (277                  | )          |       | 160                                              |       |       | (107                                                          | )                                                                 |       | — |   |   | 2,292 |   |   | (277 | ) |
| CMBS                                       |       | 627                                     |       |                                                             | (348                  | )          |       | 307                                              |       |       | (47                                                           | )                                                                 |       | 4 |   |   | 543 |   |   | (323 | ) |
| ABS                                        |       | 2,492                                   |       |                                                             | (3                    | )          |       | (74                                              | )          |       | (85                                                           | )                                                                 |       | 47 |   |   | 2,377 |   |   | (2 | ) |
| Total  fixed income securities             |       | 17,737                                  |       |                                                             | (669                  | )          |       | 196                                              |       |       | (501                                                          | )                                                                 |       | 597 |   |   | 17,360 |   |   | (664 | ) |
| Equity  securities                         |       | 57                                      |       |                                                             | (1                    | )          |       | (3                                               | )          |       | 13                                                            |                                                              |       | (39 | ) |   | 27 |   |   | (1 | ) |
| Other  investments:                        |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| Free-standing  derivatives, net            |       | (35                                     | )          |                                                             | —                |       |       | —                                           |       |       | 10                                                            |                                                              |       | — |   |   | (25 | )(2) |   | 32 |   |
| Other  assets                              |       | 2                                       |       |                                                             | —                |       |       | —                                           |       |       | —                                                        |                                                              |       | — |   |   | 2 |   |   | — |   |
| **Total recurring Level 3****assets**      | $          | 17,761                                  |       | $                                                                | (670                  | )          | $          | 193                                              |       | $          | (478                                                          | )                                                                 | $          | 558 |   | $ | 17,364 |   | $ | (633 | ) |
|                                       |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| **Liabilities**                            |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| Contractholder  funds:                     |       |                                    |       |                                                             |                  |       |       |                                             |       |       |                                                          |                                                              |       |   |   |   |   |   |   |   |   |
| Derivatives  embedded in annuity contracts | $          | (10                                     | )          | $                                                                | (11                   | )          | $          | —                                           |       | $          | 1                                                             |                                                              | $          | — |   | $ | (20 | ) | $ | (11 | ) |
| **Total recurring Level 3****liabilities** | $          | (10                                     | )          | $                                                                | (11                   | )          | $          | —                                           |       | $          | 1                                                             |                                                              | $          | — |   | $ | (20 | ) | $ | (11 | ) |

 

----

| (1)    | The  effect to net income totals $(681) million and is reported in the Condensed  Consolidated Statements of Operations as follows: $(682) million in realized  capital gains and losses, $13 million in net investment income, $1 million in  interest credited to contractholder funds, and $11 million in contract  benefits.                                                                                        |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (2)    | Comprises  $44 million of assets and $(69) million of liabilities.                                                                                                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                    |
| (3)    | The amounts represent gains and losses  included in net income for the period of time that the asset or liability was  determined to be in Level 3. These gains and losses total $(644) million and  are reported in the Condensed Consolidated Statements of Operations as  follows: $(646) million in realized capital gains and losses, $13 million in net investment  income, and $11 million in contract benefits. |

 

23

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

 
| **($ in millions)**                   | ** ** | ** **                                  | ** ** | **Total  realized and unrealized gains  (losses) included in:** | ** **             | ** ** | ** ** | ** **                                       | ** ** | ** ** | ** **                                               | **Total  gains (losses)  included in net  income for   financial** | ** **                                      |
|--------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------|------------------------|------------|------------|--------------------------------------------------|------------|------------|----------------------------------------------------------|--------------------------------------------------------------------|-------------------------------------------------|
| ** **                                 | ** ** | **Balance  as of   January 1,   2008** | ** ** | ** **                                                           | **Net  income****(1)** | ** ** | ** ** | **OCI on   Statement of   Financial   Position** | ** ** | ** ** | **Purchases,  sales, issuances  and   settlements, net** | ** **                                                         | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance  as   of June 30,  2008** | ** ** | **instruments  still held at  June 30,  2008****(3)** | ** ** |
| **Assets**                                 |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |
| Fixed  income securities:                  |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |
| Municipal                                  | $          | 231                                         |       | $                                                                    | —                 |       | $          | (21                                              | )          | $          | (11                                                      | )                                                                  | $                                               | 605 |   | $ | 804 |   | $ | — |   |
| Corporate                                  |       | 11,845                                      |       |                                                                 | (54                    | )          |       | (207                                             | )          |       | (345                                                     | )                                                                  |                                            | 105 |   |   | 11,344 |   |   | (89 | ) |
| RMBS                                       |       | 3,034                                       |       |                                                                 | (415                   | )          |       | (107                                             | )          |       | (220                                                     | )                                                                  |                                            | — |   |   | 2,292 |   |   | (397 | ) |
| CMBS                                       |       | 790                                         |       |                                                                 | (346                   | )          |       | 155                                              |       |       | (60                                                      | )                                                                  |                                            | 4 |   |   | 543 |   |   | (318 | ) |
| ABS                                        |       | 2,930                                       |       |                                                                 | (13                    | )          |       | (365                                             | )          |       | (222                                                     | )                                                                  |                                            | 47 |   |   | 2,377 |   |   | (15 | ) |
| Total  fixed income securities             |       | 18,830                                      |       |                                                                 | (828                   | )          |       | (545                                             | )          |       | (858                                                     | )                                                                  |                                            | 761 |   |   | 17,360 |   |   | (819 | ) |
| Equity  securities                         |       | 61                                          |       |                                                                 | (2                     | )          |       | (6                                               | )          |       | 13                                                       |                                                               |                                            | (39 | ) |   | 27 |   |   | (2 | ) |
| Other  investments:                        |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |   |   |   |
| Free-standing  derivatives, net            |       | (6                                          | )          |                                                                 | (31                    | )          |       | —                                           |       |       | 12                                                       |                                                               |                                            | — |   |   | (25 | )(2) |   | 14 |   |
| Other  assets                              |       | 2                                           |       |                                                                 | —                 |       |       | —                                           |       |       | —                                                   |                                                               |                                            | — |   |   | 2 |   |   | — |   |
| **Total recurring Level 3 assets**         | $          | 18,887                                      |       | $                                                                    | (861                   | )          | $          | (551                                             | )          | $          | (833                                                     | )                                                                  | $                                               | 722 |   | $ | 17,364 |   | $ | (807 | ) |
|                                       |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |   |   |   |
| **Liabilities**                            |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |   |   |   |
| Contractholder  funds:                     |       |                                        |       |                                                                 |                   |       |       |                                             |       |       |                                                     |                                                               |                                            |   |   |   |   |   |   |   |   |
| Derivatives  embedded in annuity contracts | $          | 4                                           |       | $                                                                    | (25                    | )          | $          | —                                           |       | $          | 1                                                        |                                                               | $                                               | — |   | $ | (20 | ) | $ | (25 | ) |
| **Total recurring Level 3 liabilities**    | $          | 4                                           |       | $                                                                    | (25                    | )          | $          | —                                           |       | $          | 1                                                        |                                                               | $                                               | — |   | $ | (20 | ) | $ | (25 | ) |

 

----

| (1)    | The  effect to net income totals $(886) million and is reported in the  Condensed Consolidated Statements of Operations as follows:  $(882) million in realized capital gains and losses,  $25 million in net investment income, $4 million in interest  credited to contractholder funds and $25 million in contract benefits.                                                                                                                                                  |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (2)    | Comprises  $44 million of assets and $(69) million of liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (3)    | The amounts represent gains and losses included in  net income for the period of time that the asset or liability was determined  to be in Level 3. These gains and losses total $(832) million and are  reported in the Condensed Consolidated Statements of Operations as follows:  $(831) million in realized capital gains and losses, $25 million in  net investment income, $1 million in interest credited to contractholder  funds and $25 million in contract benefits. |

 

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

 

**Financial assets**

 
| **($ in millions)**                   | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|--------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | **Carrying   value**   | ** ** | **Fair   value**           | ** ** | **Carrying  value** | ** ** | **Fair   value** | ** ** |
| Mortgage loans                             | $          |                   | 9,203      | $                          |       | 7,546 | $ |   | 10,012 | $ |   | 8,700 |   |
| Limited partnership interests - cost basis |       | 501                    |       | 445                        |       | 560 |   | 541 |   |
| Bank loans                                 |       | 625                    |       | 533                        |       | 981 |   | 675 |   |
| Intercompany notes                         |       | 250                    |       | 210                        |       | 250 |   | 185 |   |
|                                            |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

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

 

24

----

 

 

 

**Financial liabilities**

 
| **($ in millions)**                     | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **Carrying  value**    | ** ** | **Fair  value**            | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Contractholder funds on investment contracts | $          |                   | 41,241     | $                          |       | 38,644 | $ |   | 45,989 | $ |   | 42,484 |   |
| Surplus notes due to related parties         |       | 650                    |       | 594                        |       | 650 |   | 566 |   |
| Liability for collateral                     |       | 690                    |       | 690                        |       | 340 |   | 340 |   |
|                                              |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

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

 

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

 

**6.  DerivativeFinancial Instruments**

 

The Company primarily uses derivatives forrisk management and asset replication. In addition, the Company has derivatives embedded in non-derivative “host”contracts, which are required to be separated from the host contracts andaccounted for at fair value as derivative instruments.  With the exception of non-hedge derivativesused for asset replication and non-hedge embedded derivatives, all of theCompany’s derivatives are evaluated for their ongoing effectiveness as eitheraccounting hedge or non-hedge derivative financial instruments on at least aquarterly basis.  The Company does notuse derivatives for trading purposes. Non-hedge accounting is generally used for “portfolio” level hedgingstrategies where the terms of the individual hedged items do not meet thestrict homogeneity requirements prescribed in SFAS No. 133 to permit theapplication of SFAS No. 133’s hedge accounting model.

 

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

 

Asset-liability management is a risk management strategy thatis principally employed to balance the respective interest-rate sensitivitiesof the Company’s assets and liabilities. Depending upon the attributes of theassets acquired and liabilities issued, derivative instruments such as interestrate swaps, caps, floors and futures are acquired to change the interest ratecharacteristics of existing assets and liabilities to ensure the relationshipis maintained within specified ranges and to reduce exposure to rising orfalling interest rates.  The Company usesfinancial futures and interest rate swaps to hedge anticipated assetpurchases and liability issuances andfinancial futures and options for hedging the Company’s equity exposurecontained in equity indexed annuity product contracts that offer equity returnsto contractholders.  In addition, the Company uses interest rateswaps to hedge interest rate risk inherent in funding agreements.

 

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

 

25

----

 

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

 

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

 

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

 

Fair value, which is equal to the carrying value, is the estimatedamount that the Company would receive (pay) to terminate the derivativecontracts at the reporting date.  Thecarrying value amounts for OTC free-standing derivatives have been furtheradjusted for the effects, if any, of legally enforceable master nettingagreements and are presented on a net basis in the Condensed ConsolidatedStatements of Financial Position.  For certain exchange traded derivatives, theexchange requires margin deposits as well as daily cash settlements of marginaccounts.  As of June 30, 2009, theCompany pledged $14 million of securities in the form of margin deposits.

 

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

 

26

----

 

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

 
| **($ in millions, except number of contracts)**              | ** ** | **Asset derivatives**      | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                        | ** ** | ** **                 | ** ** | **Volume****(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **Balance sheet location** | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as  accounting hedging instruments**     |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other investments          | $          | 1,054 |   | n/a | $ | (104 | ) | $ | — | $ | (104 | ) |
| Foreign currency swap agreements                                  |       | Other investments          |       | 38 |   | n/a |   | (4 | ) |   | — |   | (4 | ) |
| Foreign currency and interest rate swap agreements                |       | Other investments          |       | 723 |   | n/a |   | 212 |   |   | 212 |   | — |   |
| Total                                                             |       |                       | $          | 1,815 |   | n/a | $ | 104 |   | $ | 212 | $ | (108 | ) |
|                                                              |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other investments          | $          | 2,481 |   | n/a | $ | 74 |   | $ | 98 | $ | (24 | ) |
| Interest rate cap and floor agreements                            |       | Other investments          |       | 2,619 |   | n/a |   | — |   |   | 13 |   | (13 | ) |
| Financial futures contracts and options                           |       | Other assets               |       | n/a |   | 2,727 |   | — |   |   | — |   | — |   |
| **Equity and index contracts**                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Options, financial futures and warrants                           |       | Other investments          |       | 79 |   | 21,450 |   | 201 |   |   | 201 |   | — |   |
| Options, financial futures and warrants                           |       | Other assets               |       | n/a |   | 232 |   | — |   |   | — |   | — |   |
| **Foreign currency contracts**                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency swap agreements                                  |       | Other investments          |       | 75 |   | n/a |   | 2 |   |   | 3 |   | (1 | ) |
| **Embedded derivative financial  instruments**                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Conversion options in fixed income securities                     |       | Fixed income securities    |       | 345 |   | n/a |   | 102 |   |   | 104 |   | (2 | ) |
| Equity-indexed call options in fixed income  securities           |       | Fixed income securities    |       | 665 |   | n/a |   | 77 |   |   | 77 |   | — |   |
| **Credit default contracts**                                      |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Credit Default Swaps — Buying Protection                     |       | Other investments          |       | 118 |   | n/a |   | — |   |   | 3 |   | (3 | ) |
| Credit Default Swaps — Selling Protection                    |       | Other investments          |       | 176 |   | n/a |   | (40 | ) |   | — |   | (40 | ) |
| **Other contracts**                                               |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| Other contracts                                                   |       | Other investments          |       | 75 |   | n/a |   | — |   |   | — |   | — |   |
| Other contracts                                                   |       | Other assets               |       | 6 |   | n/a |   | 2 |   |   | 2 |   | — |   |
| Total                                                             |       |                       | $          | 6,639 |   | 24,409 | $ | 418 |   | $ | 501 | $ | (83 | ) |
|                                                              |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivative assets**                                       |       |                       | $          | 8,454 |   | 24,409 | $ | 522 |   | $ | 713 | $ | (191 | ) |

 

----

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

 

27

----

 
| **($ in millions, except number of  contracts)**             | ** ** | **Liability derivatives**                 | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                | ** ** | **Volume****(1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **Balance sheet location**                | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as accounting hedging instruments**      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                    |       | Other liabilities  & accrued expenses | $          | 2,099 |   | n/a | $ | (205 | ) | $ | — | $ | (205 | ) |
| Foreign  currency swap agreements                                 |       | Other liabilities  & accrued expenses |       | 189 |   | n/a |   | (8 | ) |   | 5 |   | (13 | ) |
| Foreign  currency and interest rate swap agreements               |       | Other liabilities  & accrued expenses |       | 147 |   | n/a |   | 29 |   |   | 29 |   | — |   |
| Foreign  currency and interest rate swap agreements               |       | Contractholder  funds                     |       | n/a |   | n/a |   | 18 |   |   | 18 |   | — |   |
| Total                                                             |       |                                      | $          | 2,435 |   | n/a | $ | (166 | ) | $ | 52 | $ | (218 | ) |
| ** **                                                        |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments** |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Interest  rate swap agreements                                    |       | Other liabilities  & accrued expenses | $          | 1,925 |   | n/a | $ | 13 |   | $ | 52 | $ | (39 | ) |
| Interest  rate cap and floor agreements                           |       | Other liabilities  & accrued expenses |       | 3,091 |   | n/a |   | (5 | ) |   | 16 |   | (21 | ) |
| Financial  futures contracts and options                          |       | Other liabilities  & accrued expenses |       | n/a |   | 500 |   | — |   |   | — |   | — |   |
| **Equity and index contracts**                                    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Options,  financial futures and warrants                          |       | Other liabilities  & accrued expenses |       | 24 |   | 21,465 |   | (87 | ) |   | — |   | (87 | ) |
| **Foreign currency contracts**                                    |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Foreign  currency swap agreements                                 |       | Other liabilities  & accrued expenses |       | 40 |   | n/a |   | — |   |   | — |   | — |   |
| **Embedded derivative financial instruments**                     |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Guaranteed  accumulation benefits                                 |       | Contractholder  funds                     |       | 1,000 |   | n/a |   | (93 | ) |   | — |   | (93 | ) |
| Guaranteed  withdrawal benefits                                   |       | Contractholder  funds                     |       | 744 |   | n/a |   | (62 | ) |   | — |   | (62 | ) |
| Other  embedded derivative financial instruments                  |       | Contractholder  funds                     |       | 4,264 |   | n/a |   | (121 | ) |   | — |   | (121 | ) |
| **Credit default contracts**                                      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| Credit  Default Swaps — Buying Protection                    |       | Other liabilities  & accrued expenses |       | 590 |   | n/a |   | (13 | ) |   | 7 |   | (20 | ) |
| Credit  Default Swaps — Selling Protection                   |       | Other liabilities  & accrued expenses |       | 310 |   | n/a |   | (62 | ) |   | — |   | (62 | ) |
| Total                                                             |       |                                      | $          | 11,988 |   | 21,965 | $ | (430 | ) | $ | 75 | $ | (505 | ) |
| ** **                                                        |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivative liabilities**                                  |       |                                      | $          | 14,423 |   | 21,965 | $ | (596 | ) | $ | 127 | $ | (723 | ) |
| ** **                                                        |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |
| **Total derivatives**                                             |       |                                      | $          | 22,877 |   | 46,374 | $ | (74 | ) |   |   |   |   |   |

 

----

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

 

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

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

 

28

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

 
| **($ in millions)**                                          |   | **Three months ended June 30, 2009** |   |
|-------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                              |   | **Net  investment  income**               |   | **Realized  capital  gains and  losses** |   |   | **Contract  benefits** |   |   | **Interest  credited to  contractholder  funds** |   |   | **Total gain  (loss)  recognized  in net  income on  derivatives** |   |
| **Derivatives in fair value  accounting hedging relationships**   |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           | $      | 71                                        | $      | 6 |   | $ | — |   | $ | (1 | ) | $ | 76 |   |
| Foreign currency and interest rate contracts                      |   | —                                    |   | (2 | ) |   | — |   |   | 90 |   |   | 88 |   |
| Subtotal                                                          |   | 71                                        |   | 4 |   |   | — |   |   | 89 |   |   | 164 |   |
|                                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |   | —                                    |   | 218 |   |   | — |   |   | — |   |   | 218 |   |
| Equity and index contracts                                        |   | —                                    |   | (3 | ) |   | — |   |   | 32 |   |   | 29 |   |
| Embedded derivative financial instruments                         |   | —                                    |   | 25 |   |   | 133 |   |   | (68 | ) |   | 90 |   |
| Foreign currency contracts                                        |   | —                                    |   | (1 | ) |   |   |   |   | — |   |   | (1 | ) |
| Credit default contracts                                          |   | —                                    |   | (23 | ) |   | — |   |   | — |   |   | (23 | ) |
| Other contracts                                                   |   | —                                    |   | — |   |   | — |   |   | (4 | ) |   | (4 | ) |
| Subtotal                                                          |   | —                                    |   | 216 |   |   | 133 |   |   | (40 | ) |   | 309 |   |
| Total                                                             | $      | 71                                        | $      | 220 |   | $ | 133 |   | $ | 49 |   | $ | 473 |   |

 
|                                                              |   | **Six  months ended June 30, 2009** |   |
|-------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                              |   | **Net  investment  income**              |   | **Realized  capital  gains and  losses** |   |   | **Contract  benefits** |   |   | **Interest  credited to  contractholder  funds** |   |   | **Total gain  (loss)  recognized  in net  income on  derivatives** |   |
| **Derivatives in fair value  accounting hedging relationships**   |   |                                     |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           | $      | 78                                       | $      | 10 |   | $ | — |   | $ | (13 | ) | $ | 75 |   |
| Foreign currency and interest rate contracts                      |   | —                                   |   | (3 | ) |   | — |   |   | 60 |   |   | 57 |   |
| Subtotal                                                          |   | 78                                       |   | 7 |   |   | — |   |   | 47 |   |   | 132 |   |
|                                                              |   |                                     |   |   |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |   |                                     |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |   | —                                   |   | 274 |   |   | — |   |   | — |   |   | 274 |   |
| Equity and index contracts                                        |   | —                                   |   | — |   |   | — |   |   | 9 |   |   | 9 |   |
| Embedded derivative financial instruments                         |   | —                                   |   | 2 |   |   | 110 |   |   | (85 | ) |   | 27 |   |
| Credit default contracts                                          |   | —                                   |   | 6 |   |   | — |   |   | — |   |   | 6 |   |
| Other contracts                                                   |   | —                                   |   | — |   |   | — |   |   | (1 | ) |   | (1 | ) |
| Subtotal                                                          |   | —                                   |   | 282 |   |   | 110 |   |   | (77 | ) |   | 315 |   |
| Total                                                             | $      | 78                                       | $      | 289 |   | $ | 110 |   | $ | (30 | ) | $ | 447 |   |

 

29

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The following table provides a summary of the changes in fair value ofthe Company’s fair value hedging relationships in the Condensed ConsolidatedStatements of Operations.

 
| **($ in millions)**                                                | ** ** | **Three  months ended June 30, 2009** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **Gain  (loss) on derivatives**            | ** ** | **Gain  (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**              | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | ** ** | **Contractholder    funds** | ** ** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                               | $          | —                                     | $          | 79 |   | $ | (79 | ) | $ | — |   |
| Net investment income                                                   |       | 105                                        |       | — |   |   | — |   |   | (105 | ) |
| Realized capital gains and losses                                       |       | 6                                          |       | (2 | ) |   | — |   |   | — |   |
| Total                                                                   | $          | 111                                        | $          | 77 |   | $ | (79 | ) | $ | (105 | ) |

 
| ** **                                                              | ** ** | **Six  months ended June 30, 2009** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                              | ** ** | **Gain  (loss) on derivatives**          | ** ** | **Gain  (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**            | ** ** | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | ** ** | **Contractholder    funds** | ** ** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                               | $          | (26                                      | )          | $ | 44 |   | $ | (18 | ) | $ | — |   |
| Net investment income                                                   |       | 145                                      |       |   | — |   |   | — |   |   | (145 | ) |
| Realized capital gains and losses                                       |       | 10                                       |       |   | (3 | ) |   | — |   |   | — |   |
| Total                                                                   | $          | 129                                      |       | $ | 41 |   | $ | (18 | ) | $ | (145 | ) |

 

The Company manages its exposure to creditrisk by utilizing highly rated counterparties, establishing risk controllimits, executing legally enforceable master netting agreements (“MNAs”) andobtaining collateral where appropriate. The Company uses MNAs for OTC derivative transactions, includinginterest rate swap, foreign currency swap, interest rate cap, interest ratefloor, credit default swap, forward and certain option agreements (includingswaptions).  These agreements permiteither party to net payments due for transactions covered by theagreements.  Under the provisions of theagreements, collateral is either pledged or obtained when certain predeterminedexposure limits are exceeded.  As of June 30,2009, counterparties pledged $64 million in cash and $29 million in securitiesto the Company, and the Company pledged $182 million in securities tocounterparties which includes $136 million of collateral posted under MNAs forcontracts containing credit-risk-contingent provisions that are in a liabilityposition and $46 million of collateral posted under MNAs for contracts withoutcredit-risk-contingent liabilities.  TheCompany has not incurred any losses on derivative financial instruments due tocounterparty nonperformance.  Otherderivatives including futures and certain option contracts are traded on organizedexchanges, which require margin deposits and guarantee the execution of trades,thereby mitigating any potential credit risk associated with transactionsexecuted on organized exchanges.

 

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

 

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

 
| **($ in millions)** | ** ** | **June 30, 2009**            | ** ** | **December 31, 2008**  | ** ** |
|--------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
| **Rating****(1)**        | ** ** | **Number  of  counter-  parties** | ** ** | **Notional  amount****(2)** | ** ** | **Credit  exposure****(2)** | ** ** | **Exposure,  net of  collateral****(2)** | ** ** | **Number   of  counter-  parties** | ** ** | **Notional  amount****(2)** | ** ** | **Credit  exposure****(2)** | ** ** | **Exposure,  net of  collateral****(2)** | ** ** |
| AA-                      |       | 1                                 | $          | 331                         | $          | 8 | $ | 1 |   | 1 | $ | 236 | $ | 5 | $ | 5 |   |
| A+                       |       | 4                                 |       | 5,581                       |       | 85 |   | 24 |   | 2 |   | 242 |   | 8 |   | 8 |   |
| A                        |       | 2                                 |       | 1,285                       |       | 40 |   | 15 |   | 2 |   | 1,730 |   | 35 |   | 15 |   |
| A-                       |       | 1                                 |       | 166                         |       | 21 |   | 21 |   | 1 |   | 216 |   | 25 |   | 25 |   |
| Total                    |       | 8                                 | $          | 7,363                       | $          | 154 | $ | 61 |   | 6 | $ | 2,424 | $ | 73 | $ | 53 |   |

 

----

(1)  Rating is thelower of Standard & Poor’s (“S&P”) or Moody’s ratings.

(2)  Only OTC derivatives with a net positive fair value areincluded for each counterparty.

 

30

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

 

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

 

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

 
| **($ in millions)**                                                                                                              | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                                                            | ** ** | ** ** | ** ** |
| Gross liability fair value of contracts containing  credit-risk-contingent features                                                   | $          |       | 498        |   |
| Gross asset fair value of contracts containing  credit-risk-contingent features and subject to MNAs                                   |       | (300       | )          |
| Collateral posted under MNAs for contracts  containing credit-risk-contingent features                                                |       | (136       | )          |
| Maximum amount of additional exposure for  contracts with credit-risk-contingent featuresif all  features were triggered concurrently | $          |       | 62         |   |

 

**Credit derivatives — selling protection**

 

Credit default swaps (“CDS”)are utilized for selling credit protection against a specified creditevent.  A credit default swap is aderivative instrument, representing an agreement between two parties toexchange the credit risk of a specified entity (or a group of entities), or anindex based on the credit risk of a group of entities (all commonly referred toas the “reference entity” or a portfolio of “reference entities”), for aperiodic premium.  In selling protection,CDS are used to replicate fixed income securities and to complement the cashmarket when credit exposure to certain issuers is not available or when thederivative alternative is less expensive than the cash market alternative.  CDS typically have a five-year term.

 

31

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

 
| **($ in millions)**       | ** ** | **Notional  amount********credit rating underlying notional** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|------------|------------|
| ** **                     | ** ** | **AAA**                                                       | ** ** | **AA**     | ** ** | **A** | ** ** | **BBB** | ** ** | **BB  and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                |       |                                                          |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt | $          |                                                          | —     | $          |       | 10 | $ |   | 55 | $ |   | 71 | $ |   | 15 | $ |   | 151 | $ |   | (8 | ) |
| Municipal                      |       | —                                                        |       | 25         |       | — |   | — |   | — |   | 25 |   | (8 | ) |
| Subtotal                       |       | —                                                        |       | 35         |       | 55 |   | 71 |   | 15 |   | 176 |   | (16 | ) |
| **First-to-default**           |       |                                                          |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt |       | —                                                        |       | —     |       | 45 |   | 45 |   | — |   | 90 |   | (3 | ) |
| Municipal                      |       | —                                                        |       | 20         |       | 135 |   | — |   | — |   | 155 |   | (40 | ) |
| Subtotal                       |       | —                                                        |       | 20         |       | 180 |   | 45 |   | — |   | 245 |   | (43 | ) |
| **Index**                      |       |                                                          |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Investment gradecorporate debt |       | 1                                                             |       | 5          |       | 21 |   | 25 |   | 13 |   | 65 |   | (43 | ) |
| **Total**                      | $          |                                                          | 1          | $          |       | 60 | $ |   | 256 | $ |   | 141 | $ |   | 28 | $ |   | 486 | $ |   | (102 | ) |

 

The following table shows the CDS notional amounts by credit rating andfair value of protection sold as of December 31, 2008:

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

 

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

 

32

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

 

**7.  Reinsurance**

 

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

 
| **($ in millions)**                           | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums and contract charges**                  |       |                                        |       |                                      |       |   |   |   |   |
| Direct                                             | $          |                                        | 555        |                                      | $          |   | 569 |   | $ |   | 1,100 |   | $ |   | 1,128 |   |
| Assumed                                            |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Affiliate                                          |       | 25                                          |       |                                      | 15         |   |   | 50 |   |   | 30 |   |
| Non-affiliate                                      |       | 6                                           |       |                                      | 6          |   |   | 11 |   |   | 12 |   |
| Ceded—non-affiliate                           |       | (195                                        | )          |                                      | (218       | ) |   | (390 | ) |   | (446 | ) |
|                                               |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Premiums  and contract charges, net of reinsurance | $          |                                        | 391        |                                      | $          |   | 372 |   | $ |   | 771 |   | $ |   | 724 |   |

 

The effects ofreinsurance on contract benefits are as follows:

 
| **($ in millions)**               | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Contract benefits**                  |       |                                        |       |                                      |       |   |   |   |   |
| Direct                                 | $          |                                        | 480        |                                      | $          |   | 488 | ) | $ |   | 1,239 | ) | $ |   | 983 |   |
| Assumed                                |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Affiliate                              |       | 18                                          |       |                                      | 9          |   |   | 33 |   |   | 18 |   |
| Non-affiliate                          |       | 6                                           |       |                                      | 8          |   |   | 14 |   |   | 14 |   |
| Ceded—non-affiliate               |       | (147                                        | )          |                                      | (162       |   |   | (595 |   |   | (331 | ) |
|                                   |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Contract  benefits, net of reinsurance | $          |                                        | 357        |                                      | $          |   | 343 |   | $ |   | 691 |   | $ |   | 684 |   |

 

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

 
| **($ in millions)**                                       | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Interest credited to contractholder funds**                  |       |                                        |       |                                      |       |   |   |   |   |
| Direct                                                         | $          |                                        | 551        |                                      | $          |   | 551 |   | $ |   | 1,117 |   | $ |   | 1,164 |   |
| Assumed                                                        |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Affiliate                                                      |       | 2                                           |       |                                      | 3          |   |   | 5 |   |   | 6 |   |
| Non-affiliate                                                  |       | 3                                           |       |                                      | 3          |   |   | 6 |   |   | 7 |   |
| Ceded—non-affiliate                                       |       | (8                                          | )          |                                      | (8         | ) |   | (15 | ) |   | (18 | ) |
|                                                           |       |                                        |       |                                      |       |   |   |   |   |   |   |   |
| Interest  credited to contractholder funds, net of reinsurance | $          |                                        | 548        |                                      | $          |   | 549 |   | $ |   | 1,113 |   | $ |   | 1,159 |   |

 

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

 

**Guarantyfunds**

 

Under state insurance guaranty fund laws, insurers doing business in astate can be assessed, up to prescribed limits, for certain obligations ofinsolvent insurance companies to policyholders and claimants.  Amounts assessed to each company aretypically related to its proportion of business written in each state.  The Company’s policy is to accrue a guarantyfund assessment when the entity for which the insolvency relates has beendeclared financially insolvent by a court of competent jurisdiction and, incertain states, that is also a final order of liquidation, and the amount ofloss is reasonably estimable.

 

33

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

 

If Executive Life were to be declared insolvent in the future, theCompany may have exposure to future guaranty fund assessments.  The Company’s exposure will ultimately dependon the level of guaranty fund system participation, as well as the viability ofa plan of the Bureau to obtain voluntary contributions, primarily from theoriginal insurance companies that acquired structured settlement annuity contractsfrom Executive Life.  Under current law,the Company may be allowed to recoup a portion of the amount of any additionalguaranty fund assessment in periods subsequent to the recognition of theassessment by offsetting future premium taxes. The Company’s New York market share was approximately 4.1% in 2007 basedon industry annuity premium.

 

**Guarantees**

 

The Companyowns certain fixed income securities that obligate the Company to exchangecredit risk or to forfeit principal due, depending on the nature or occurrenceof specified credit events for the referenced entities.  In the event all such specified credit eventswere to occur, the Company’s maximum amount at risk on these fixed incomesecurities, as measured by the amount of the aggregate initial investment, was$172 million at June 30, 2009.  Theobligations associated with these fixed income securities expire at variousdates during the next five years.

 

Related to the disposalthrough reinsurance of substantially all of the Company’s variable annuitybusiness to Prudential Financial, Inc. and its subsidiary in 2006, theCompany has agreed to indemnify Prudential for certain pre-closing contingentliabilities (including extra-contractual liabilities of the Company andliabilities specifically excluded from the transaction) that the Company hasagreed to retain.  In addition, theCompany will indemnify Prudential for certain post-closing liabilities that mayarise from the acts of the Company and its agents, including in connection withthe Company’s provision of transition services. The Reinsurance Agreements contain no limitations or indemnificationswith regard to insurance risk transfer, and transferred all of the future risksand responsibilities for performance on the underlying variable annuitycontracts to Prudential, including those related to benefit guarantees.  Management does not believe this agreementwill have a material adverse effect on results of operations, cash flows orfinancial position of the Company.

 

In the normal course of business, the Company provides standardindemnifications to contractual counterparties in connection with numeroustransactions, including acquisitions and divestitures.  The types of indemnifications typically providedinclude indemnifications for breaches of representations and warranties, taxesand certain other liabilities, such as third party lawsuits.  The indemnification clauses are oftenstandard contractual terms and are entered into in the normal course of businessbased on an assessment that the risk of loss would be remote.  The terms of the indemnifications vary induration and nature.  In many cases, themaximum obligation is not explicitly stated and the contingencies triggeringthe obligation to indemnify have not occurred and are not expected tooccur.  Consequently, the maximum amountof the obligation under such indemnifications is not determinable.  Historically, the Company has not made anymaterial payments pursuant to these obligations.

 

The aggregate liability balance related to all guarantees was notmaterial as of June 30, 2009.

 

**Regulation**

 

The Company issubject to changing social, economic and regulatory conditions.  From time to time, regulatory authorities orlegislative bodies seek to impose additional regulations regarding agent andbroker compensation and otherwise expand overall regulation of insuranceproducts and the insurance industry.  Theultimate changes and eventual effects of these initiatives on the Company’sbusiness, if any, are uncertain.

 

34

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**Legaland regulatory proceedings and inquiries**

 

***Background***

 

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

 

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

 

·      The outcome of these matters may also be affected by decisions,verdicts, and settlements, and the timing of such decisions, verdicts andsettlements, in other individual and class action lawsuits that involve theCompany, other insurers, or other entities and by other legal, governmental,and regulatory actions that involve the Company, other insurers, or otherentities.

 

·      Inthe lawsuits, plaintiffs seek a variety of remedies including equitable reliefin the form of injunctive and other remedies and monetary relief in the form ofcontractual and extra-contractual damages. In some cases, the monetary damages sought include punitivedamages.  Often specific informationabout the relief sought, such as the amount of damages, is not availablebecause plaintiffs have not requested specific relief in their pleadings.  In the Company’s experience, when specificmonetary demands are made in pleadings, they bear little relation to theultimate loss, if any, to the Company.

 

·      Inconnection with regulatory examinations and proceedings, government authoritiesmay seek various forms of relief, including penalties, restitution and changesin business practices.  The Company maynot be advised of the nature and extent of relief sought until the final stagesof the examination or proceeding.

 

·      For the reasons specifiedabove, it is often not possible to make meaningful estimates of the amount orrange of loss that could result from the matters described below in the “Proceedings”subsection.  The Company reviews thesematters on an ongoing basis and follows the provisions of SFAS No. 5, *Accounting for Contingencies*, when making accrual anddisclosure decisions.  When assessingreasonably possible and probable outcomes, the Company bases its decisions onits assessment of the ultimate outcome following all appeals.

 

·      Dueto the complexity and scope of the matters disclosed in the “Proceedings”subsection below and the many uncertainties that exist, the ultimate outcome ofthese matters cannot be reasonably predicted. In the event of an unfavorable outcome in one or more of these matters,the ultimate liability may be in excess of amounts currently reserved, if any,and may be material to the Company’s operating results or cash flows for aparticular quarterly or annual period. However, based on information currently known to it, management believesthat the ultimate outcome of all matters described below as they are resolvedover time is not likely to have a material adverse effect on the financialposition of the Company.

 

***Proceedings***

 

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

 

35

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

 

·      Thesematters include a lawsuit filed in 2001 by the U.S. Equal EmploymentOpportunity Commission (“EEOC”) alleging retaliation under federal civil rightslaws (the “EEOC I” suit) and a class action filed in 2001 by former employeeagents alleging retaliation and age discrimination under the Age Discriminationin Employment Act (“ADEA”), breach of contract and ERISA violations (the “RomeroI” suit).  In 2004, in the consolidatedEEOC I and Romero I litigation, the trial court issued a memorandum and orderthat, among other things, certified classes of agents, including a mandatoryclass of agents who had signed a release, for purposes of effecting the court’sdeclaratory judgment that the release is voidable at the option of the releasesigner.  The court also ordered that anagent who voids the release must return to AIC “any and all benefits receivedby the [agent] in exchange for signing the release.”  The court also stated that, “on theundisputed facts of record, there is no basis for claims of age discrimination.”  The EEOC and plaintiffs have asked the courtto clarify and/or reconsider its memorandum and order and in January 2007,the judge denied their request.  In June 2007,the court granted AIC’s motions for summary judgment.  Following plaintiffs’ filing of a notice ofappeal, the U.S. Court of Appeals for the Third Circuit issued an order in December 2007stating that the notice of appeal was not taken from a final order within themeaning of the federal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the ThirdCircuit along with the merits of the appeal. In July 2009, the Third Circuit vacated the decision which grantedAIC’s summary judgment motions, remanded the cases to the trial court foradditional discovery, and directed that the cases be reassigned to anothertrial court judge.

 

·      The EEOC also filed another lawsuit in 2004 alleging age discriminationwith respect to a policy limiting the rehire of agents affected by the agencyprogram reorganization (the “EEOC II” suit). In EEOC II, in 2006, the court granted partial summary judgment to theEEOC.  Although the court did notdetermine that AIC was liable for age discrimination under the ADEA, itdetermined that the rehire policy resulted in a disparate impact, reserving fortrial the determination on whether AIC had reasonable factors other than age tosupport the rehire policy.  AIC’sinterlocutory appeal from the partial summary judgment was granted.  In June 2008, the U.S. Court of Appealsfor the Eighth Circuit affirmed summary judgment in the EEOC’s favor.  In September 2008, the Eighth Circuit grantedAIC’s petition for rehearing *en banc*andvacated its earlier decision affirming the trial court’s grant of summaryjudgment in favor of the EEOC.  TheEighth Circuit then dismissed AIC’s appeal, determining that it lackedjurisdiction to consider the appeal at this stage in the litigation.

 

·      Aputative nationwide class action has also been filed by former employee agentsalleging various violations of ERISA, including a worker classificationissue.  These plaintiffs are challengingcertain amendments to the Agents Pension Plan and are seeking to have exclusiveagent independent contractors treated as employees for benefit purposes.  This matter was dismissed with prejudice bythe trial court, was the subject of further proceedings on appeal, and was reversedand remanded to the trial court in 2005. In June 2007, the court granted AIC’s motion to dismiss thecase.  Following plaintiffs’ filing of anotice of appeal, the U.S. Court of Appeals for the Third Circuit issued anorder in December 2007 stating that the notice of appeal was not takenfrom a final order within the meaning of the federal law and thus notappealable at this time.   In March 2008,the Third Circuit decided that the appeal should not summarily be dismissed andthat the question of whether the matter is appealable at this time will beaddressed by the Third Circuit along with the merits of the appeal.  In July 2009, the Third Circuit vacatedthe decision which granted AIC’s motion to dismiss the case, remanded the caseto the trial court for additional discovery, and directed that the case bereassigned to another trial court judge.

 

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

 

***OtherMatters***

** **

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

 

36

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amounts.  These actions are based on a variety ofissues and target a range of the Company’s practices.  The outcome of these disputes is currentlyunpredictable.

 

One or more of these matters could have anadverse effect on the Company’s operating results or cash flows for aparticular quarterly or annual period.  However,based on information currently known to it, management believes that theultimate outcome of all matters describedin this “Other Matters” subsection, in excess of amounts currently reserved,if any, as they are resolved over timeis not likely to have a material effect on the operating results, cash flows orfinancial position of the Company.

 

**9.  Income Taxes**

 

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

 
| **($ in millions)**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |   |   |   |   |
| Statutory federal income tax rate - (benefit) | $          |     | (110       | )        | (35.0      | )% | $ |   | (265 | ) | (35.0 | )% |
| Dividends received deduction                  |       | (6       | )          | (1.9     | )          |   | (9 | ) | (1.1 | ) |
| Other                                         |       | 1        |       | 0.3      |       |   | (2 | ) | (0.3 | ) |
| Valuation allowance                           |       | 137      |       | 43.6     |       |   | — |   | — |   |
| Effective income tax rate - expense (benefit) | $          |     | 22         |     | 7.0        | % | $ |   | (276 | ) | (36.4 | )% |

 

The valuation allowancefor deferred tax assets of $9 million at December 31, 2008 was releasedduring the six-month period ended June 30, 2009, primarily due to areduction in capital losses that have not been recognized for tax purposes anda reduction in gross unrealized losses on equity securities.  Income tax expense for the six months ended June 30,2009 includes expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital lossesrecorded in the first quarter of 2009. This valuation allowance was released in connection with the adoption ofFSP FAS 115-2 on April 1, 2009; however, the release was recorded as anincrease to retained income and therefore did not reverse the amount recordedin income tax expense on a year-to-date basis. The release of the valuation allowance is related to the reversal ofpreviously recorded other-than-temporary impairment write-downs that would nothave been recorded under FSP FAS 115-2. Although realization is not assured, management believes it is morelikely than not that the deferred tax assets will be realized based on theCompany’s assessment that the deductions ultimately recognized for tax purposeswill be fully utilized.

 

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

 

37

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**10.    Other Comprehensive Income**

 

The components of other comprehensive income (loss) on a pre-tax and after-taxbasis are as follows:

 
| **($ in millions)**                                                                   | ** ** | **Three months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **Pre-tax**                          | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                                       |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding gains and losses arising  during the period, net of related offsets | $          |                                 | 2,625      |   | $ |   | (1,021 | ) | $ |   | 1,604 |   | $ |   | (843 | ) | $ |   | 296 |   | $ |   | (547 | ) |
| Less: reclassification adjustment of realized  capital gains and losses                    |       | (49                                  | )          |   | 17 |   |   | (32 | ) |   | (902 | ) |   | 316 |   |   | (586 | ) |
| Unrealized net capital gains and losses                                                    |       | 2,674                                |       |   | (1,038 | ) |   | 1,636 |   |   | 59 |   |   | (20 | ) |   | 39 |   |
| Other comprehensive income                                                                 | $          |                                 | 2,674      |   | $ |   | (1,038 | ) |   | 1,636 |   | $ |   | 59 |   | $ |   | (20 | ) |   | 39 |   |
| Net loss                                                                                   |       |                                 |       |   |   |   |   | — |   |   |   |   |   |   |   |   | (368 | ) |
| Comprehensive income (loss)                                                                |       |                                 |       |   |   |   | $ |   | 1,636 |   |   |   |   |   |   |   | $ |   | (329 | ) |

 
| ** **                                                                                 | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **Pre-tax**                        | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                                       |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding gains and losses arising  during the period, net of related offsets | $          |                               | 2,471      |   | $ |   | (964 | ) | $ |   | 1,507 |   | $ |   | (1,678 | ) | $ |   | 587 |   | $ |   | (1,091 | ) |
| Less: reclassification adjustment of realized  capital gains and losses                    |       | (102                               | )          |   | 36 |   |   | (66 | ) |   | (1,121 | ) |   | 392 |   |   | (729 | ) |
| Unrealized net capital gains and losses                                                    |       | 2,573                              |       |   | (1,000 | ) |   | 1,573 |   |   | (557 | ) |   | 195 |   |   | (362 | ) |
| Other comprehensive income (loss)                                                          | $          |                               | 2,573      |   | $ |   | (1,000 | ) |   | 1,573 |   | $ |   | (557 | ) | $ |   | 195 |   |   | (362 | ) |
| Net loss                                                                                   |       |                               |       |   |   |   |   | (336 | ) |   |   |   |   |   |   |   | (483 | ) |
| Comprehensive income (loss)                                                                |       |                               |       |   |   |   | $ |   | 1,237 |   |   |   |   |   |   |   | $ |   | (845 | ) |

 

38

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company

Northbrook,Illinois

 

We have reviewed the accompanying condensedconsolidated statement of financial position of Allstate Life Insurance Companyand subsidiaries (the “Company”), an affiliate of The Allstate Corporation, asof June 30, 2009, and the related condensed consolidated statements ofoperations for the three-month and six-month periods ended June 30, 2009and 2008, and condensed consolidated statements of cash flows for the six-monthperiods ended June 30, 2009 and 2008. These interim financial statements are the responsibility of the Company’smanagement.

 

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

 

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

 

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

 

Wehave previously audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated statement offinancial position of Allstate Life Insurance Company and subsidiaries as of December 31,2008, and the related consolidated statements of operations and comprehensiveincome, shareholder’s equity, and cash flows for the year then ended (notpresented herein); and in our report dated March 17, 2009, which reportincludes an explanatory paragraph relating to a change in the Company’s methodof accounting for uncertainty in income taxes and accounting for deferredacquisition costs associated with internal replacements in 2007, we expressedan unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth inthe accompanying condensed consolidated statement of financial position as of December 31,2008 is fairly stated, in all material respects, in relation to theconsolidated statement of financial position from which it has been derived.

 

 

/s/Deloitte & Touche LLP

 

Chicago,Illinois

August 11,2009

 

39

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**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND2008**

 

**OVERVIEW**

 

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

 

**HIGHLIGHTS**

 

·                  We broke even (nonet income or net loss) in the second quarter of 2009 compared to a net loss of$368 million in the second quarter of 2008. Net loss was $336 million and $483 million in the first six months of2009 and 2008, respectively.

·                  Net realizedcapital gains totaled $122 million in the second quarter of 2009 compared tonet realized capital losses of $932 million in the second quarter of 2008.  Net realized capital gains totaled $84million in the first six months of 2009 compared to net realized capital lossesof $1.36 billion in the first six months of 2008.

·                  Financial Accounting Standards Board (“FASB”) Staff Position No. FAS115-2 and FAS 124-2, *Recognition andPresentation of Other-Than-Temporary Impairments*(“FSP FAS 115-2”),was adopted April 1, 2009 resulting in the reclassification of $733million of previously recorded other-than-temporary impairment write-downs fromretained income to unrealized capital losses. The cumulative effect of adoption, net of related deferred policyacquisition costs (“DAC”), deferred sales inducements (“DSI”) and tax adjustments,was an increase in retained income of $481 million and a decrease in unrealizednet capital gains and losses of $339 million, with a net benefit to equity of$142 million.  The benefit to equityresulted from a decrease in the deferred tax asset valuation allowance.

·                  Income tax expensefor the first six months of 2009 includes expense of $142 million attributableto an increase in the valuation allowance relating to the deferred tax asset oncapital losses recorded in the first quarter of 2009.  This valuation allowance was released inconnection with the adoption of FSP FAS 115-2 on April 1, 2009; however,the release was recorded as an increase to retained income and therefore didnot reverse the amount recorded in income tax expense on a year-to-date basis.

·                  Investments as of June 30, 2009decreased 3.0% to $57.96 billion from $59.77 billion as of December 31,2008.  Net investment income decreased19.6% to $741 million in the second quarter and 19.6% to $1.54 billion in thefirst six months of 2009 from $922 million and $1.91 billion in the secondquarter and first six months of 2008, respectively.

·                  Contractholder fund deposits for the secondquarter and first six months of 2009 reflect deposits on individual products of$972 million and $1.93 billion, respectively, and no deposits on institutionalproducts compared to deposits on individual and institutional products of $1.56billion and $2.50 billion, respectively, in the second quarter of 2008, and$2.59 billion and $4.16 billion, respectively, in the first six months of 2008.

·                  Restructuring charges of $2 million and $19million in the second quarter and first six months of 2009, respectively, inconnection with our initiative to lower operating expenses, with targetedannual savings of $90 million beginning in 2011.

·                  Institutional product liabilities totaling$1.39 billion were redeemed in the second quarter of 2009 in connection withcash tender offers announced in May 2009. The purpose ofthe tender offers was to reduce the amount of outstanding obligations andrelated interest expense.  A pre-tax gainof $3 million was recognized in the second quarter of 2009 primarily as aresult of certain of the liabilities being settled at a discount.

 

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** **

**OPERATIONS**

 

Summarized financial data is presented in thefollowing table.

 
| **($ in millions)**                  | ** ** | **Three months ended  June 30,** | ** ** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2009**                              | ** ** | **2008**   | ** **                          | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| **Revenues**                              |       |                                  |       |       |                                |       |   |   |   |   |   |
| Premiums                                  | $          |                                  | 154        | $          |                                | 147        |   | $ |   | 306 |   | $ |   | 287 |   |
| Contract charges                          |       | 237                                   |       | 225        |                                |       | 465 |   |   | 437 |   |
| Net investment income                     |       | 741                                   |       | 922        |                                |       | 1,538 |   |   | 1,914 |   |
| Realized capital gains and losses         |       | 122                                   |       | (932       | )                                   |       | 84 |   |   | (1,360 | ) |
| Total revenues                            |       | 1,254                                 |       | 362        |                                |       | 2,393 |   |   | 1,278 |   |
|                                      |       |                                  |       |       |                                |       |   |   |   |   |   |
| **Costs and expenses**                    |       |                                  |       |       |                                |       |   |   |   |   |   |
| Contract benefits                         |       | (357                                  | )          | (343       | )                                   |       | (691 | ) |   | (684 | ) |
| Interest credited to contractholder funds |       | (548                                  | )          | (549       | )                                   |       | (1,113 | ) |   | (1,159 | ) |
| Amortization of DAC                       |       | (268                                  | )          | 56         |                                |       | (697 | ) |   | 6 |   |
| Operating costs and expenses              |       | (81                                   | )          | (98        | )                                   |       | (170 | ) |   | (185 | ) |
| Restructuring and related charges         |       | (2                                    | )          | —     |                                |       | (19 | ) |   | — |   |
| Interest expense                          |       | (10                                   | )          | (3         | )                                   |       | (21 | ) |   | (6 | ) |
| Total costs and expenses                  |       | (1,266                                | )          | (937       | )                                   |       | (2,711 | ) |   | (2,028 | ) |
|                                      |       |                                  |       |       |                                |       |   |   |   |   |   |
| Gain (loss) on disposition of operations  |       | 1                                     |       | —     |                                |       | 4 |   |   | (9 | ) |
| Income tax benefit (expense)              |       | 11                                    |       | 207        |                                |       | (22 | ) |   | 276 |   |
| Net  loss                                 | $          |                                  | —     | $          |                                | (368       | ) | $ |   | (336 | ) | $ |   | (483 | ) |
|                                      |       |                                  |       |       |                                |       |   |   |   |   |   |
| Investments at  June 30              |       |                                  |       |       |                                | $          |   | 57,957 |   | $ |   | 70,755 |   |

 

*Net loss* We broke even (no net income or loss) inthe second quarter of 2009 compared to a net loss of $368 million in the secondquarter of 2008.  Net loss was $336million and $483 million in the first six months of 2009 and 2008,respectively.  The improvements of $368million and $147 million in the second quarter and first six months of 2009,respectively, were primarily due to net realized capital gains in the currentyear periods compared to net realized capital losses in the prior year periods,partially offset by higher amortization of DAC and lower investmentincome.  A $142 million increase in thevaluation allowance relating to the deferred tax asset on capital losses thatwas recorded in the first quarter of 2009 also partially offset the favorablechange in realized capital gains and losses in the first six months of2009.  This valuation allowance wasreleased in connection with our adoption in the second quarter of 2009 of FSP FAS 115-2; however, the release was recorded as an increaseto retained income and therefore did not reverse the amount recorded in incometax expense on a year-to-date basis.

 

**Analysis of Revenues**Total revenues increased$892 million in the second quarter of 2009 and $1.12 billion in the first sixmonths of 2009, compared to the same periods of 2008, due primarily to netrealized capital gains in the current year periods compared to net realizedcapital losses in the prior year periods, partially offset by lower netinvestment income.

 

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

 

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

 

41

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The following table summarizes premiums and contract charges byproduct.

 
| **($ in millions)**                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Premiums**                                |       |                                  |       |                                |       |   |   |   |   |
| Traditional life insurance (1)              | $          |                                  | 97         | $                                   |       | 92 | $ |   | 193 | $ |   | 181 |   |
| Immediate annuities with life contingencies |       | 34                                    |       | 36                                  |       | 68 |   | 66 |   |
| Accident, health and other                  |       | 23                                    |       | 19                                  |       | 45 |   | 40 |   |
| **Total premiums**                          |       | 154                                   |       | 147                                 |       | 306 |   | 287 |   |
|                                        |       |                                  |       |                                |       |   |   |   |   |
| **Contract charges**                        |       |                                  |       |                                |       |   |   |   |   |
| Interest-sensitive life insurance (1)       |       | 226                                   |       | 211                                 |       | 442 |   | 410 |   |
| Fixed annuities                             |       | 11                                    |       | 13                                  |       | 23 |   | 26 |   |
| Variable annuities                          |       | —                                |       | 1                                   |       | — |   | 1 |   |
| **Total contract charges**(2)               |       | 237                                   |       | 225                                 |       | 465 |   | 437 |   |
| ** **                                  |       |                                  |       |                                |       |   |   |   |   |
| **Total premiums and contract  charges**    | $          |                                  | 391        | $                                   |       | 372 | $ |   | 771 | $ |   | 724 |   |

 

----

| (1)    | To  conform to the current period presentation, certain amounts in the prior  period have been reclassified.                                                                                                                                                                                                                                                         |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                 |
| (2)    | Total  contract charges for the second quarter of 2009 and 2008 include contract  charges related to the cost of insurance totaling $147 million and $143  million, respectively. Total contract charges for the first six months of  2009 and 2008 include contract charges related to the cost of insurance  totaling $297 million and $277 million, respectively. |

 

Total premiums increased 4.8% and 6.6% in the second quarter and firstsix months of 2009, respectively, compared to the same periods of 2008 dueprimarily to lower reinsurance on traditional life insurance and higher salesof accident and health insurance.

 

Total contract charges increased 5.3% and 6.4% in the second quarter andfirst six months of 2009, respectively, compared to the same periods of 2008due primarily to higher contract charges on interest-sensitive life insuranceproducts resulting from increases in certain policy administration fees.

 

42

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*Contractholder funds*representinterest-bearing liabilities arising from the sale of individual andinstitutional products, such as interest-sensitive life insurance, fixedannuities and funding agreements. The balance of contractholder funds is equalto the cumulative deposits received and interest credited to the contractholderless cumulative contract maturities, benefits, surrenders, withdrawals andcontract charges for mortality or administrative expenses.  The following table shows the changes incontractholder funds.

 
| **($ in millions)**                                       | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended   June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                              | ** ** | **2008**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Contractholder funds, beginning  balance**                   | $          |                                  | 54,876     | $                                    |       | 60,191 | $ |   | 56,780 | $ |   | 60,464 |   |
| ** **                                                     |       |                                  |       |                                 |       |   |   |   |   |
| **Deposits**                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Fixed annuities                                                |       | 635                                   |       | 1,237                                |       | 1,270 |   | 1,923 |   |
| Institutional products (funding agreements)                    |       | —                                |       | 2,498                                |       | — |   | 4,158 |   |
| Interest-sensitive life insurance                              |       | 337                                   |       | 326                                  |       | 659 |   | 666 |   |
| Total deposits                                                 |       | 972                                   |       | 4,061                                |       | 1,929 |   | 6,747 |   |
| ** **                                                     |       |                                  |       |                                 |       |   |   |   |   |
| **Interest credited**                                          |       | 502                                   |       | 586                                  |       | 1,020 |   | 1,197 |   |
| ** **                                                     |       |                                  |       |                                 |       |   |   |   |   |
| **Maturities, benefits, withdrawals  and other adjustments**   |       |                                  |       |                                 |       |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (2,552                                | )          | (2,243                               | )          | (4,503 | ) | (4,130 | ) |
| Benefits                                                       |       | (394                                  | )          | (419                                 | )          | (825 | ) | (880 | ) |
| Surrenders and partial withdrawals                             |       | (918                                  | )          | (1,051                               | )          | (1,839 | ) | (2,034 | ) |
| Contract charges                                               |       | (213                                  | )          | (202                                 | )          | (419 | ) | (399 | ) |
| Net transfers from separate accounts                           |       | 2                                     |       | 7                                    |       | 6 |   | 12 |   |
| Fair value hedge adjustments for institutional  products       |       | 78                                    |       | (67                                  | )          | 30 |   | (1 | ) |
| Other adjustments (1)                                          |       | (55                                   | )          | 23                                   |       | 119 |   | (90 | ) |
| Total maturities, benefits, withdrawals and other  adjustments |       | (4,052                                | )          | (3,952                               | )          | (7,431 | ) | (7,522 | ) |
| **Contractholder funds, ending  balance**                      | $          |                                  | 52,298     | $                                    |       | 60,886 | $ |   | 52,298 | $ |   | 60,886 |   |

 

----

(1)   The tableabove illustrates the changes in contractholder funds, which are presentedgross of reinsurance recoverables on the Condensed Consolidated Statements ofFinancial Position.  The table above isintended to supplement our discussion and analysis of revenues, which arepresented net of reinsurance on the Condensed Consolidated Statements ofOperations.  As a result, the net changein contractholder funds associated with products reinsured to third parties isreflected as a component of the other adjustments line.

 

Contractholderfunds decreased 4.7% in the second quarter of 2009 compared to an increase of1.2% in the second quarter of 2008, and decreased 7.9% in the first six monthsof 2009 compared to an increase of 0.7% in the first six months of 2008.  Average contractholder funds decreased 11.5%and 10.1% in the second quarter and first six months of 2009, respectively,compared to the same periods of 2008.

 

Contractholderdeposits decreased 76.1% and 71.4% in the second quarter and first six monthsof 2009, respectively, compared to the same periods of 2008 primarily becausethere were no issuances of institutional products in the second quarter andfirst six months of 2009 compared to $2.50 billion and $4.16 billion ofissuances in the second quarter and first six months of 2008, respectively.  Sales of our institutional products vary fromperiod to period based on management’s assessment of market conditions,investor demand and operational priorities such as our current focus onreducing our concentration in spread based products.  Deposits on fixed annuities decreased 48.7%and 34.0% in the second quarter and first six months of 2009, respectively,compared to the same periods of 2008 due to pricing actions relating to ourefforts to improve returns on new business and reduce our concentration inspread based products.

 

Maturities and retirementsof institutional products increased 13.8% or $309 million to $2.55 billion inthe second quarter of 2009 and 9.0% or $373 million to $4.50 billion in thefirst six months of 2009, from $2.24 billion in the second quarter of 2008 and$4.13 billion in the first six months of 2008. These increases were primarily due to the redemption of $1.39 billion ofinstitutional product liabilities in accordance with cash tender offersannounced in May 2009, partially offset by lower retirements of extendibleinstitutional market obligations.  Duringthe second quarter and first six months of 2009, we retired $80 million and$1.44 billion, respectively, of extendible institutional market obligations forwhich investors had elected to non-extend their maturity date.  This compares to retirements of extendibleinstitutional market obligations totaling $1.14 billion and $2.39 billion inthe second

 

43

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quarter and first six monthsof 2008, respectively.  All of ouroutstanding extendible institutional market contracts, which totaled $9 millionas of June 30, 2009, have non-extended and become due by July 31,2009.

 

Surrenders and partialwithdrawals on deferred fixed annuities and interest-sensitive life insuranceproducts decreased 12.7% to $918 million in the second quarter of 2009 and 9.6%to $1.84 billion in the first six months of 2009 from $1.05 billion and $2.03billion in the second quarter and first six months of 2008, respectively, due tolower surrenders and partial withdrawals on deferred fixed annuities partiallyoffset by higher surrenders and partial withdrawals on interest-sensitive lifeinsurance products.  The annualizedsurrender and partial withdrawal rate on deferred fixed annuities andinterest-sensitive life insurance products, based on the beginning of periodcontractholder funds, was 8.7% in the first six months of 2009 compared to 9.7%in the first six months of 2008.

 

*Net investment income* decreased19.6% or $181 million to $741 million in the second quarter of 2009 and 19.6%or $376 million to $1.54 billion in the first six months of 2009 from $922million and $1.91 billion in the second quarter and first six months of 2008,respectively.  For furtherdiscussion of net investment income, see the Investments section of theMD&A.

 

*Net realized capital gains andlosses* reflected net gains of $122 million and $84 million in the secondquarter and first six months of 2009, respectively, compared to net losses of$932 million and $1.36 billion in the same periods of 2008, respectively.  For further discussion of realized capitalgains and losses, see the Investments section of the MD&A.

 

**Analysis of Costs and Expenses** Total costs and expenses increased 35.1%or $329 million in the second quarter of 2009 and 33.7% or $683 million in thefirst six months of 2009, compared with the same periods of 2008, due to higheramortization of DAC and, to a lesser extent, increased contract benefits andrestructuring and related charges, partially offset by lower operating costsand expenses and interest credited to contractholder funds.

 

*Contract benefits* increased 4.1% or $14 million in the second quarterof 2009 and 1.0% or $7 million in the first six months of 2009, compared to thesame periods of 2008.  The increase inthe second quarter of 2009 was primarily due to unfavorable mortalityexperience on annuities and interest-sensitive life insurance, partially offsetby improved mortality experience on traditional life insurance products.  In the first six months of 2009, the increaseprimarily reflects unfavorable mortality experience on interest-sensitive lifeinsurance, partially offset by improved mortality experience on traditionallife insurance products and annuities.

 

We analyze ourmortality and morbidity results using the difference between premiums andcontract charges earned for the cost of insurance and contract benefitsexcluding the portion related to the implied interest on immediate annuitieswith life contingencies (“benefit spread”). This implied interest totaled $140 million and $279 million in thesecond quarter and first six months of 2009, respectively, compared to $137million and $276 million in the second quarter and first six months of 2008,respectively.  The benefit spread byproduct group is disclosed in the following table.

 
| **($ in millions)** | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Life insurance           | $          |                                  | 99         | $                                   |       | 92 | $ |   | 208 | $ |   | 182 |   |
| Annuities                |       | (15                                   | )          | (8                                  | )          | (17 | ) | (26 | ) |
| Total benefit spread     | $          |                                  | 84         | $                                   |       | 84 | $ |   | 191 | $ |   | 156 |   |

 

Benefit spread was consistent in the second quarter of2009 and increased 22.4% or $35 million in the first six months of 2009compared to the same periods of 2008.  Inthe second quarter of 2009, higher premiums on accident and health insurancebusiness, increased contract charges on interest-sensitive life insuranceproducts for the cost of insurance and improved mortality experience ontraditional life insurance products were offset by unfavorable mortalityexperience on annuities and interest-sensitive life insurance.  In the first six months of 2009, the increasewas primarily the result of increased contract charges on interest-sensitivelife insurance products for the cost of insurance and improved mortalityexperience on traditional life insurance products and annuities, partiallyoffset by unfavorable mortality experience on interest-sensitive lifeinsurance.

 

*Interest credited to contractholder funds* decreased 0.2% or $1 million in thesecond quarter of 2009 and 4.0% or $46 million in the first six months of 2009,compared to the same periods of 2008. These declines were due primarily to lower average contractholder funds,partially offset by unfavorable changes in amortization of DSI.

 

44

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Amortization of DSI for the second quarter and firstsix months of 2009 reflected a charge to income of $53 million and $110million, respectively, compared to a credit to income of $24 million and $15million for the second quarter and first six months of 2008, respectively.  The unfavorable changes of $77 million and$125 million in the second quarter and first six months of 2009, respectively,were predominately the result of unfavorable changes in amortization relatingto realized capital gains and losses.  Inaddition, the comparison of the first six months of 2009 to the same period of2008 was unfavorably impacted by the acceleration of amortization relating toour annual comprehensive review of assumptions in the first quarter.  The acceleration of amortization of DSI due tochanges in assumptions increased interest credited to contractholder funds by$38 million in the first quarter of 2009 compared to amortization decelerationwhich decreased interest credited to contractholder funds by $1 million in thefirst quarter of 2008.

 

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

 

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

 
| **($ in millions)**                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | **2009**                              | ** ** | ** **                          | **2008**   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Annuities                                               | $          |                                  | (3         | )                                   | $          |   | 132 | $ |   | 14 | $ |   | 247 |   |
| Life insurance                                          |       | 7                                     |       |                                | 14         |   | 6 |   | 29 |   |
| Institutional products                                  |       | 6                                     |       |                                | 16         |   | 23 |   | 43 |   |
| Net investment income on investments supporting capital |       | 43                                    |       |                                | 74         |   | 103 |   | 160 |   |
| Total investment spread                                 | $          |                                  | 53         |                                | $          |   | 236 | $ |   | 146 | $ |   | 479 |   |

 

Investment spreaddeclined 77.5% or $183 million in the second quarter of 2009 and 69.5% or $333million in the first six months of 2009, compared to the same periods of 2008.  These declines were due primarily to lowernet investment income and increased amortization of DSI.

 

To further analyze investment spreads, thefollowing tables summarize the weighted average investment yield on assetssupporting product liabilities and capital, interest crediting rates andinvestment spreads.

 
| ** **                                                           | ** ** | **Three months ended June 30,**   | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2009**                               | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.4                                    | %          | 6.1 | % | 4.5 | % | 4.6 | % | 0.9 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 4.7                                    |       | 5.5 |   | 3.7 |   | 3.8 |   | 1.0 |   | 1.7 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.3                                    |       | 6.9 |   | 6.5 |   | 6.5 |   | (0.2 | ) | 0.4 |   |
| Institutional products                                               |       | 3.0                                    |       | 3.9 |   | 2.2 |   | 3.2 |   | 0.8 |   | 0.7 |   |
| Investments supporting capital, traditional life  and other products |       | 2.6                                    |       | 5.5 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 
| ** **                                                           | ** ** | **Six months ended June 30,**     | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
|                                                                 | ** ** | **2009**                               | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.4                                    | %          | 6.1 | % | 4.6 | % | 4.6 | % | 0.8 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 4.9                                    |       | 5.6 |   | 3.7 |   | 3.7 |   | 1.2 |   | 1.9 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.3                                    |       | 6.9 |   | 6.5 |   | 6.5 |   | (0.2 | ) | 0.4 |   |
| Institutional products                                               |       | 3.2                                    |       | 4.5 |   | 2.2 |   | 3.7 |   | 1.0 |   | 0.8 |   |
| Investments supporting capital, traditional life  and other products |       | 3.3                                    |       | 5.8 |   | N/A |   | N/A |   | N/A |   | N/A |   |

 

45

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Thefollowing table summarizes our product liabilities and indicates the accountvalue of those contracts and policies in which an investment spread isgenerated.

 

| **($ in millions)**                                         | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                       | ** ** | **2009**          | ** ** | **2008** | ** ** |
| Immediate fixed annuities with life contingencies                | $          |              | 8,402      | $ |   | 8,328 |   |
| Other life contingent contracts and other                        |       | 3,806             |       | 4,020 |   |
| Reserve for life-contingent contract benefits                    | $          |              | 12,208     | $ |   | 12,348 |   |
|                                                             |       |              |       |   |   |
| Interest-sensitive life insurance                                | $          |              | 9,477      | $ |   | 9,117 |   |
| Deferred fixed annuities                                         |       | 33,382            |       | 34,049 |   |
| Immediate fixed annuities without life  contingencies            |       | 3,876             |       | 3,864 |   |
| Institutional products                                           |       | 4,570             |       | 13,266 |   |
| Market value adjustments related to fair value  hedges and other |       | 993               |       | 590 |   |
| Contractholder funds                                             | $          |              | 52,298     | $ |   | 60,886 |   |

 

*Amortization of DAC* increased $324 million inthe second quarter of 2009 and $703 million in the first six months of 2009,compared to the same periods of 2008, due primarily to an unfavorable change inamortization relating to realized capital gains and losses.  In addition, the comparison of the first sixmonths of 2009 to the same period of 2008 was unfavorably impacted by theacceleration of amortization relating to our annual comprehensive review ofassumptions in the first quarter.  Thecomponents of amortization of DAC are summarized in the following table.

 

| **($ in millions)**                                                                                           | ** ** | **Three months ended********June 30,** | ** ** | ** ** | **Six months ended********June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------|-------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **2009**                                    | ** ** | ** ** | **2008**                                  | ** ** | ** ** | **2009** | ** ** | ** ** | **2008** | ** ** |
| Amortization  of DAC before amortization relating to realized capital gains and losses and  changes in assumptions | $          |                                        | (109       | )          | $                                         |       | (115 | ) | $ |   | (233 | ) | $ |   | (241 | ) |
| (Amortization)  accretion relating to realized capital gains and losses (1)                                        |       | (159                                        | )          |       | 171                                       |       |   | (186 | ) |   | 224 |   |
| Amortization  (acceleration) deceleration for changes in assumptions (“DAC unlocking”)                   |       | —                                      |       |       | —                                    |       |   | (278 | ) |   | 23 |   |
| Total  amortization of DAC                                                                                         | $          |                                        | (268       | )          |                                      | 56         |   | $ |   | (697 | ) | $ |   | 6 |   |
|                                                                                                                    |            |                                             |            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Theimpact of realized capital gains and losses on amortization of DAC is dependentupon the relationship between the assets that give rise to the gain or loss andthe product liability supported by the assets. Fluctuations result from changes in the impact of realized capital gainsand losses on actual and expected gross profits.

 

During the first quarterof 2009, we completed our annual comprehensive review of the profitability ofinvestment products to determine DAC balances for our interest-sensitive life,annuities and other investment contracts. The review covered assumptions for investment returns, including capitalgains and losses, interest crediting rates to policyholders, the effect of anyhedges, persistency, mortality and expenses in all product lines.  This review resulted in an acceleration ofDAC amortization (charge to income) of $278 million pre-tax.  $289 million related to fixed annuities, ofwhich $210 million was attributable to market value adjusted annuities, and $18million related to variable life insurance. Partially offsetting these amounts was amortization deceleration (creditto income) for interest-sensitive life insurance of $29 million.  The principal assumption impacting estimatedfuture gross profits and the related DAC amortization was an increase in thelevel of expected realized capital losses in 2009 and 2010.  This resulted in the majority of the marketvalue adjusted annuity DAC balance being reduced to zero since the product isestimated to have no gross profits. Market value adjusted annuity DAC will not be recapitalized while thereare no estimated gross profits.  Reducedestimated future gross profits for traditional fixed annuities and variablelife insurance resulted in accelerated DAC amortization.  For our interest-sensitive life insuranceproducts, the amortization deceleration was due to higher estimated futuregross profits due to a favorable change in our mortality assumptions, partiallyoffset by increased expected capital losses

 

In the first quarter of2008, our annual comprehensive review of the profitability of investmentproducts resulted in the deceleration of DAC amortization (credit to income)for changes in assumptions of $23 million, of which $17 million related to fixedannuities and $6 million related to interest-sensitive and variable lifeinsurance.  The first quarter 2008 net amortizationdeceleration of $17 million on fixed annuities was due primarily to higher 

 

46

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than expected investmentspreads partially offset by increased expenses. The first quarter 2008 net amortization deceleration of $6 million oninterest-sensitive and variable life insurance products was due to higher thanexpected benefit spreads partially offset by increased expenses.

 

*Operating costs and expenses*decreased 17.3% and 8.1% in the second quarter and first six months of 2009,respectively, compared to the same periods of 2008.  The following table summarizes operatingcosts and expenses.

 

| **($ in millions)**           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Non-deferrable acquisition costs   | $          |                                  | 22         | $                                   |       | 19 | $ |   | 44 | $ |   | 40 |   |
| Other operating costs and expenses |       | 59                                    |       | 79                                  |       | 126 |   | 145 |   |
| Total operating costs and expenses | $          |                                  | 81         | $                                   |       | 98 | $ |   | 170 | $ |   | 185 |   |
|                               |       |                                  |       |                                |       |   |   |   |   |
| Restructuring  and related charges | $          |                                  | 2          | $                                   |       | — | $ |   | 19 | $ |   | — |   |

 

Non-deferrable acquisition costs increased 15.8% or $3million and 10.0% or $4 million in the second quarter and first six months of2009, respectively, compared to the same periods of 2008, due to highernon-deferrable commissions related to interest-sensitive life insuranceproducts and higher premium tax expense. Also reflected in the increase in the first six months of 2009 is anincrease in non-deferrable commissions related to structured settlementannuities.  Other operating costs andexpenses decreased 25.3% or $20 million and 13.1% or $19 million in the secondquarter and first six months of 2009, respectively, compared to the same periodsof 2008, due primarily to our expense reduction actions, which resulted inlower employee, professional services and sales support expenses.  In the first six months of 2009, thefavorable impact of our expense reduction strategies was partially offset bythe absence in the current year period of a servicing fee paid by PrudentialFinancial Inc. (“Prudential”) for our servicing of variable annuity businessthat we reinsured to them during a transition period that ended in the secondquarter of 2008.

 

During thesecond quarter and first six months of 2009, restructuring and related chargesof $2 million and $19 million, respectively, were recorded in connection withour previously announced plan to improve efficiency and narrow our focus ofproduct offerings.  In accordance withthis plan, among other actions, we continue to anticipate the reduction ofapproximately 1,000 workforce positions through a combination of attrition andposition elimination in 2009 and 2010. This reduction reflects approximately 30% of our work force at the timethe plan was initiated.  Reductions inworkforce positions combined with other actions completed as of June 30,2009 reflect approximately 70% of our targeted annual savings of $90 millionbeginning in 2011.

 

*Income tax benefit*of $11 million for the second quarter of 2009 compared to a benefit of $207million for the second quarter of 2008 and income tax expense of $22 millionfor the first six months of 2009 compared to a benefit of $276 million for thesame period in the prior year.  Thedecrease in the benefit of $196 million in the second quarter of 2009 wasmostly attributable to the decline in the pre-tax net loss in the secondquarter of 2009 compared to the second quarter of 2008.  The increase in expense of $298 million inthe first six months of 2009 was primarily the result of a reduction in thepre-tax net loss in the first six months of 2009 compared to the same period inthe prior year and an increase in the valuation allowance relating to thedeferred tax asset on capital losses. Income tax expense for the first six months of 2009 includes expense of$142 million attributable to an increase in the valuation allowance relating tothe deferred tax asset on capital losses recorded in the first quarter of 2009.  Thisvaluation allowance was released in connection with the adoption of FSP FAS115-2 on April 1, 2009; however, the release was recorded as an increaseto retained income and therefore did not reverse the amount recorded in incometax expense on a year-to-date basis.  Forfurther discussion of changes in this valuation allowance see the DeferredTaxes section of the MD&A.

 

47

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**INVESTMENT HIGHLIGHTS**

 

·                  Investments as of June 30, 2009totaled $57.96 billion, a decrease of 3.0% from $59.77 billion as of December 31,2008.

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

·                  Net investment income was $741 million inthe second quarter of 2009, a decrease of 19.6% from $922 million in the secondquarter of 2008, and $1.54 billion in the first six months of 2009, a decreaseof 19.6% from $1.91 billion in the first six months of 2008.

·                  Net realizedcapital gains were $122 million in the second quarter of 2009 compared to netrealized capital losses of $932 million in the second quarter of 2008, and netrealized capital gains of $84 million in the first six months of 2009 comparedto net realized capital losses of $1.36 billion in the first six months of2008.

·                  During the first six months of 2009, our fixed income and mortgage loanportfolio generated cash flows totaling $3.91 billion which are available totake advantage of market opportunities and manage liabilities.

·                  Adoption of FSP FAS 115-2 on April 1,2009 resulted in thereclassification of $733 million of previously recorded other-than-temporaryimpairment write-downs from retained income to unrealized capital losses.  Of this amount 58% relates to impairmentwrite-downs and 42% relates to intent write-downs.  The balance comprised4% from 2007 and prior, 91% from 2008, and 5% from 2009.  Of those from 2008, 70% and 12% of theinitial write-downs were recognized during the second and third quarters,respectively.

 

**INVESTMENTS**

 

We continuedto focus strategic risk mitigation efforts towards managing portfolio risk andoverall exposure to commercial real estate, while our return optimizationefforts focus on investing in new opportunities to generate income and capitalappreciation.

 

·                  Commercial real estate exposure was reduced by 12.1% or $2.03 billionas of June 30, 2009 compared to December 31, 2008 primarily throughtargeted dispositions and principal repayments from borrowers.

·                  Net investment income for the quarter and the six months ended June 30,2009 has been impacted by lower investment yields in short-term and variablerate securities, as well as decreased average investment balances.

·                  Increased market stability drove a morepositive market outlook and improved liquidity in the portfolios, which led usto deploy more than $2.50 billion of short-term investments and cash receiptsinto fixed income securities to generate income and capital appreciation.

 

The composition of the investment portfolio at June 30,2009 is presented in the table below.

 

| **($ in  millions)**         | ** ** | **Investments** | ** ** | **Percent  to total** | ** ** |
|-----------------------------------|------------|-----------------|------------|-----------------------|------------|
| Fixed income securities (1)       | $          |            | 43,433     |                  | 74.9       | % |
| Mortgage loans                    |       | 9,203           |       | 15.9                  |       |
| Equity securities (2)             |       | 178             |       | 0.3                   |       |
| Limited partnership interests (3) |       | 1,036           |       | 1.8                   |       |
| Short-term (4)                    |       | 2,125           |       | 3.7                   |       |
| Policy loans                      |       | 805             |       | 1.4                   |       |
| Other                             |       | 1,177           |       | 2.0                   |       |
| Total                             | $          |            | 57,957     |                  | 100.0      | % |

 

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(1)          Fixed income securities arecarried at fair value.  Amortized costbasis for these securities was $49.17 billion.

 

(2)          Equity securities arecarried at fair value.  Cost basis forthese securities was $182 million.

 

(3)          We have commitments toinvest in additional limited partnership interests totaling $937 million.

 

(4)          Short-term investments arecarried at fair value.  Amortized costbasis for these investments was $2.13 billion.

 

Total investments decreased to $57.96 billion at June 30,2009, from $59.77 billion at December 31, 2008, due to net reductions incontractholder obligations of $4.48 billion primarily from maturities andretirements of institutional products, partially offset by higher valuationsresulting from significant tightening in credit spreads for certain fixed income securities and the March 2009capital contribution of $250 million from Allstate Insurance Company (“AIC”).

 

48

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*Fixedincome securities* are listed in the table below.

 
| **($ in millions)**                                      | ** ** | **Fair  value at********June 30,  2009** | ** ** | **Percent  to   total********investments** | ** ** | ** ** | **Fair  value at********December 31,  2008** | ** ** | **Percent  to  total********investments** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------|------------|------------|---------------------------------------------------|------------|-------------------------------------------|------------|
| U.S. government and agencies                                  | $          |                                          | 3,337      |                                       | 5.7        | %          | $                                                 |       | 3,687                                     |       | 6.2 | % |
| Municipal                                                     |       | 4,223                                         |       | 7.3                                        |       |       | 3,308                                             |       | 5.5                                       |       |
| Corporate                                                     |       | 25,144                                        |       | 43.4                                       |       |       | 24,269                                            |       | 40.6                                      |       |
| Foreign government                                            |       | 1,787                                         |       | 3.1                                        |       |       | 2,100                                             |       | 3.5                                       |       |
| Residential mortgage-backed****securities  (“RMBS”) |       | 4,511                                         |       | 7.8                                        |       |       | 3,973                                             |       | 6.7                                       |       |
| Commercial mortgage-backed securities (“CMBS”)      |       | 3,111                                         |       | 5.4                                        |       |       | 3,730                                             |       | 6.2                                       |       |
| Asset-backed securities (“ABS”)                     |       | 1,309                                         |       | 2.2                                        |       |       | 1,369                                             |       | 2.3                                       |       |
| Redeemable preferred stock                                    |       | 11                                            |       | —                                     |       |       | 10                                                |       | —                                    |       |
| Total fixed income securities                                 | $          |                                          | 43,433     |                                       | 74.9       | %          | $                                                 |       | 42,446                                    |       | 71.0 | % |

 

At June 30, 2009, 94.2% of the fixed income securitiesportfolio was rated investment grade, which is defined as a security having arating from the NationalAssociation of Insurance Commissioners (“NAIC”) of 1 or 2; a ratingof Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from Standardand Poor’s (“S&P”), Fitch or Dominion or a rating of aaa, aa, a or bbb from A.M.Best; or a comparable internal rating if an externally provided rating is notavailable.

 

*MunicipalBonds* aresummarized in the table below by Moody’s equivalent rating as of June 30,2009.

 
| **($ in millions)** | ** ** | **Par********value** | ** ** | **Amortized   cost** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair value********as a percent of  amortized cost** | ** ** |
|--------------------------|------------|----------------------|------------|----------------------|------------|-----------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|
| Non - zero-coupon:       | ** ** | ** **           | ** ** | ** **           | ** ** | ** **      | ** ** | ** **                  | ** ** |                                                  | ** ** |
| Rating                   | ** ** | ** **           | ** ** | ** **           | ** ** | ** **      | ** ** | ** **                  | ** ** |                                                  | ** ** |
| Aaa                      | $          |                 | 683        | $                    |       | 686             | $          |                        | 645        | $                                                     |       | (41 | ) | 94.0 | % |
| Aa                       |       | 1,242                |       | 1,230                |       | 1,196           |       | (34                         | )          | 97.2                                                  |       |
| A                        |       | 877                  |       | 876                  |       | 848             |       | (28                         | )          | 96.8                                                  |       |
| Baa                      |       | 504                  |       | 503                  |       | 453             |       | (50                         | )          | 90.1                                                  |       |
| Ba or lower              |       | 71                   |       | 58                   |       | 42              |       | (16                         | )          | 72.4                                                  |       |
| Subtotal (1)             | $          |                 | 3,377      | $                    |       | 3,353           | $          |                        | 3,184      | $                                                     |       | (169 | ) | 95.0 |   |
|                     |       |                 |       |                 |       |            |       |                        |       |                                                  |       |
| Zero-coupon:             |       |                 |       |                 |       |            |       |                        |       |                                                  |       |
| Rating                   |       |                 |       |                 |       |            |       |                        |       |                                                  |       |
| Aaa                      | $          |                 | 8          | $                    |       | 6               | $          |                        | 7          | $                                                     |       | 1 |   | 116.7 |   |
| Aa                       |       | 884                  |       | 362                  |       | 325             |       | (37                         | )          | 89.8                                                  |       |
| A                        |       | 1,024                |       | 470                  |       | 394             |       | (76                         | )          | 83.8                                                  |       |
| Baa                      |       | 3,541                |       | 521                  |       | 313             |       | (208                        | )          | 60.1                                                  |       |
| Subtotal                 | $          |                 | 5,457      | $                    |       | 1,359           | $          |                        | 1,039      | $                                                     |       | (320 | ) | 76.4 |   |
| Total:                   | ** ** | ** **           | ** ** | ** **           | ** ** | ** **      | ** ** | ** **                  | ** ** |                                                  | ** ** |
| Aaa                      | $          |                 | 691        | $                    |       | 692             | $          |                        | 652        | $                                                     |       | (40 | ) | 94.2 |   |
| Aa                       |       | 2,126                |       | 1,592                |       | 1,521           |       | (71                         | )          | 95.5                                                  |       |
| A (2)                    |       | 1,901                |       | 1,346                |       | 1,242           |       | (104                        | )          | 92.3                                                  |       |
| Baa                      |       | 4,045                |       | 1,024                |       | 766             |       | (258                        | )          | 74.8                                                  |       |
| Ba or lower (2)          |       | 71                   |       | 58                   |       | 42              |       | (16                         | )          | 72.4                                                  |       |
| Total (3)                | $          |                 | 8,834      | $                    |       | 4,712           | $          |                        | 4,223      | $                                                     |       | (489 | ) | 89.6 |   |

 

----

(1) Includes auction rate securities (“ARS”)with par value of $710 million, amortized cost of $710 million, fair value of$643 million and unrealized capital losses of $67 million.  For a more detailed discussion on ARS, seethe Allstate Life Insurance Company Annual Report on Form 10-K for 2008.

 

(2) Includes pre-refunded municipals with fairvalues of $21 million of A and $3 million of Ba or lower at June 30,2009.  Pre-refunded municipals aregenerally escrowed by Aaa rated securities, such as U.S. government orgovernmental agency securities.

 

(3) Municipal bonds with a fair value of $1.86billion are insured by six bond insurers.

 

49

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The unrealized netcapital loss of $489 million at June 30, 2009 in our municipal bondportfolio was the result of higher yields and wider credit spreads since thetime of initial purchase, which were largely due to the macroeconomicconditions and credit market deterioration that has persisted into 2009.

 

Included in our municipalbond holdings at June 30, 2009 are $17 million of municipal securitieswhich are not rated by third party credit rating agencies, but are rated by theNAIC and also internally rated by us. Our initial investment decisions and ongoing monitoring procedures forthese securities are based on a thorough due diligence process which includes,among other things, an assessment of the credit quality, structure, andliquidity risks of the issue.

 

*Corporatebonds* as of June 30,2009, included $12.97 billion or 51.6% of publicly-traded corporate bonds and$12.17 billion or 48.4% of privately placed corporate bonds, compared to $11.91billion or 49.1% of publicly-traded corporate bonds and $12.36 billion or 50.9%of privately placed corporate bonds at December 31, 2008.  Privately placed securities primarily consistof corporate issued senior debt securities that are in unregistered form or aredirectly negotiated with the borrower. Privately placed corporate securities are rated by the NAIC in instanceswhen information is provided to them. Approximately 41.4% of the privately placed corporate securities in ourportfolio are rated by an independent rating agency.  Hybrid securities totaling $601 million areincluded in the publicly-traded corporate bonds and $875 million are includedin the privately placed corporate bonds. Hybrid securities have attributes most similar to those of fixed incomesecurities such as stated interest rates, mandatory redemption dates or aninterest rate step-up feature which may incent the issuer to redeem thesecurity at a specified call date.

 

The following tablesummarizes the corporate fixed income portfolio by Moody’s equivalent rating asof June 30, 2009.

 
| **($ in millions)** | ** ** | **Corporate-public**                      | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **Non-hybrid**                            | ** ** | **Hybrid** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **Fair********value**                     | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** |
| Rating                   |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Aaa                      | $          |                                      | 720        | $ |   | 10 | $ |   | — | $ |   | — | $ |   | 720 | $ |   | 10 |   |
| Aa                       |       | 685                                       |       | — |   | 25 |   | 2 |   | 710 |   | 2 |   |
| A                        |       | 3,935                                     |       | 35 |   | 127 |   | (47 | ) | 4,062 |   | (12 | ) |
| Baa                      |       | 6,237                                     |       | (127 | ) | 302 |   | (151 | ) | 6,539 |   | (278 | ) |
| Ba or lower              |       | 795                                       |       | (130 | ) | 147 |   | (93 | ) | 942 |   | (223 | ) |
| Total                    | $          |                                      | 12,372     | $ |   | (212 | ) | $ |   | 601 | $ |   | (289 | ) | $ |   | 12,973 | $ |   | (501 | ) |
| ** **               | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Corporate-privately placed securities** | ** ** |
| ** **               | ** ** | **Non-hybrid**                            | ** ** | **Hybrid** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **Fair********value**                     | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** |
| Rating                   | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Aaa                      | $          |                                      | 423        | $ |   | 14 | $ |   | — | $ |   | — | $ |   | 423 | $ |   | 14 |   |
| Aa                       |       | 854                                       |       | (1 | ) | 52 |   | — |   | 906 |   | (1 | ) |
| A                        |       | 2,975                                     |       | 7 |   | 440 |   | (152 | ) | 3,415 |   | (145 | ) |
| Baa                      |       | 5,814                                     |       | (354 | ) | 268 |   | (160 | ) | 6,082 |   | (514 | ) |
| Ba or lower              |       | 1,230                                     |       | (187 | ) | 115 |   | (124 | ) | 1,345 |   | (311 | ) |
| Total                    | $          |                                      | 11,296     | $ |   | (521 | ) | $ |   | 875 | $ |   | (436 | ) | $ |   | 12,171 | $ |   | (957 | ) |
| ** **               | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Total Corporate**                       | ** ** |
| ** **               | ** ** | **Non-hybrid**                            | ** ** | **Hybrid** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **Fair********value**                     | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** |
| Rating                   | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Aaa                      | $          |                                      | 1,143      | $ |   | 24 | $ |   | — | $ |   | — | $ |   | 1,143 | $ |   | 24 |   |
| Aa                       |       | 1,539                                     |       | (1 | ) | 77 |   | 2 |   | 1,616 |   | 1 |   |
| A                        |       | 6,910                                     |       | 42 |   | 567 |   | (199 | ) | 7,477 |   | (157 | ) |
| Baa                      |       | 12,051                                    |       | (481 | ) | 570 |   | (311 | ) | 12,621 |   | (792 | ) |
| Ba or lower              |       | 2,025                                     |       | (317 | ) | 262 |   | (217 | ) | 2,287 |   | (534 | ) |
| Total                    | $          |                                      | 23,668     | $ |   | (733 | ) | $ |   | 1,476 | $ |   | (725 | ) | $ |   | 25,144 | $ |   | (1,458 | ) |

 

50

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The unrealized netcapital loss of $1.46 billion at June 30, 2009 was driven primarily by themacroeconomic conditions and credit market deterioration that has persistedinto 2009.  While credit spreads havetightened in the second quarter of 2009 from the historically high levelsobserved in the prior two quarters, they remain wider than levels at initialpurchase in the lower rated sectors. This is particularly evident in our non-hybrid Baa and lower ratedholdings, which contributed $798 million of the unrealized net capitalloss.  The other significant driver ofunrealized net capital losses in our corporate bond portfolio was from hybridsecurities, which contributed $725 million of the unrealized loss.  While these securities are generally issuedby investment grade-rated financial institutions, they have structural featureswhich make them more sensitive to credit market deterioration.  Specifically, features allowing deferral ofpayment have severely impacted prices as the global financial system continuesto endure significant stress.  Hybridcorporate fixed income securities are assessed for other-than-temporaryimpairment as fixed income securities, when they are expected to perform like afixed income security.  However, whencredit-related reasons increase the risk of deferred payment, they may beassessed for other-than-temporary impairment in a manner similar to equitysecurities.  There were four hybridcorporate fixed income securities with a fair value of $12 million which wereassessed and written down in the second quarter of 2009 forother-than-temporary impairment as equity securities.

 

The following table showsadditional details of our hybrid securities reported in corporate fixed incomesecurities as of June 30, 2009.

 
| **($ in millions)**     | ** ** | **United  Kingdom   (“UK”)** | ** ** | ** **                  | **Europe  (non-UK)** | ** ** | ** **      | **Asia/Australia** | ** **                  | ** ** | **North  America** | ** **      | ** ** | **Total**                   | ** ** |
|------------------------------|------------|----------------------------------------|------------|-----------------------------|----------------------|------------|-----------------|--------------------|-----------------------------|------------|--------------------|-----------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **Fair  value**                        | ** ** | **Unrealized  gain/(loss)** | ** **           | ** ** | **Fair  value** | ** **         | **Unrealized  gain/(loss)** | ** ** | ** **         | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| Tier  2:                     | ** ** | ** **                             | ** ** | ** **                  | ** **           | ** ** | ** **      | ** **         | ** **                  | ** ** | ** **         | ** **      | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Public                       | $          |                                   | 31         | $                           |                 | (17        | )               | $                  |                        | 73         | $                  |            | (11        | )                           | $          |   | 10 | $ |   | (1 | ) | $ |   | — | $ |   | — |   | $ |   | 114 | $ |   | (29 | ) |
| Privately  placed securities |       | 4                                      |       | —                      |                 |       | 52              |               | (4                          | )          |               | 87              |       | (2                          | )          |   | — |   | — |   |   | 143 |   | (6 | ) |
| Subtotal                     |       | 35                                     |       | (17                         | )                    |       | 125             |               | (15                         | )          |               | 97              |       | (3                          | )          |   | — |   | — |   |   | 257 |   | (35 | ) |
| Tier  1:                     |       |                                   |       |                        |                 |       |            |               |                        |       |               |            |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Public                       |       | 64                                     |       | (45                         | )                    |       | 89              |               | (55                         | )          |               | 22              |       | (3                          | )          |   | 312 |   | (157 | ) |   | 487 |   | (260 | ) |
| Privately  placed securities |       | 66                                     |       | (77                         | )                    |       | 304             |               | (185                        | )          |               | 213             |       | (66                         | )          |   | 149 |   | (102 | ) |   | 732 |   | (430 | ) |
| Subtotal                     |       | 130                                    |       | (122                        | )                    |       | 393             |               | (240                        | )          |               | 235             |       | (69                         | )          |   | 461 |   | (259 | ) |   | 1,219 |   | (690 | ) |
| Total  hybrids:              |       |                                   |       |                        |                 |       |            |               |                        |       |               |            |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Public                       |       | 95                                     |       | (62                         | )                    |       | 162             |               | (66                         | )          |               | 32              |       | (4                          | )          |   | 312 |   | (157 | ) |   | 601 |   | (289 | ) |
| Privately  placed securities |       | 70                                     |       | (77                         | )                    |       | 356             |               | (189                        | )          |               | 300             |       | (68                         | )          |   | 149 |   | (102 | ) |   | 875 |   | (436 | ) |
| Total                        | $          |                                   | 165        | $                           |                 | (139       | )               | $                  |                        | 518        | $                  |            | (255       | )                           | $          |   | 332 | $ |   | (72 | ) | $ |   | 461 | $ |   | (259 | ) | $ |   | 1,476 | $ |   | (725 | ) |

 

51

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*Collateralized RMBS, CMBS and ABS securities*are detailed in the following table by Moody’s equivalent rating as of June 30,2009.

 
| **($ in millions)**                                                     | ** ** | **Fair  value** | ** ** | **Percent  to total  investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Baa** | ** ** | **Ba or********Lower** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------|------------|------------------------------------|------------|---------|------------|--------|------------|--------|------------|---------|------------|------------------------|------------|
| **RMBS**                                                                     |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| U.S. government sponsored entities                                           | $          |            | 2,703      |                               | 4.7        | %       | 100.0      | %      | —     |   | —     |    | —     |                   | —     |   |
| Subprime residential mortgage-backed securities  (“Subprime”) (1): |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| Subprime non-insured                                                         |       | 775             |       | 1.3                                |       | 17.0    |       | 38.3   | %          | 9.2    | %          | 8.3     | %          | 27.2                   | %          |
| Subprime insured                                                             |       | 203             |       | 0.4                                |       | —  |       | 16.3   |       | 0.5    |       | 7.9     |       | 75.3                   |       |
| Total Subprime                                                               |       | 978             |       | 1.7                                |       | 13.5    |       | 33.7   |       | 7.4    |       | 8.2     |       | 37.2                   |       |
| Prime residential mortgage-backed securities  (“Prime”)            |       | 520             |       | 0.9                                |       | 87.1    |       | 4.6    |       | 4.4    |       | —  |       | 3.9                    |       |
| Alt-A residential mortgage-backed securities  (“Alt-A”)            |       | 310             |       | 0.5                                |       | 34.8    |       | 4.5    |       | 6.5    |       | 16.5    |       | 37.7                   |       |
| Total RMBS                                                                   | $          |            | 4,511      |                               | 7.8        | %       |       |   |       |   |       |    |       |                   |       |   |
|                                                                         |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| **CMBS**                                                                     | $          |            | 3,111      |                               | 5.4        | %       | 79.7       |   | 8.6        |   | 9.1        |    | 1.9        |                   | 0.7        |   |
| ** **                                                                   |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| **ABS**                                                                      |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| Other collateralized debt obligations (“other  CDO”):              |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| Cash flow collateralized loan obligations (“CLO”)                  | $          |            | 551        |                               | 1.0        | %       | 42.3       |   | 26.1       |   | 9.1        |    | 10.0       |                   | 12.5       |   |
| Synthetic CDO                                                                |       | 49              |       | 0.1                                |       | 12.2    |       | — |       | 14.3   |       | 14.3    |       | 59.2                   |       |
| Trust preferred CDO                                                          |       | 56              |       | 0.1                                |       | —  |       | 1.8    |       | 19.6   |       | —  |       | 78.6                   |       |
| Market value CDO                                                             |       | 36              |       | —                             |       | —  |       | 33.3   |       | 8.3    |       | 2.8     |       | 55.6                   |       |
| Project finance CDO                                                          |       | 36              |       | —                             |       | —  |       | 27.8   |       | 52.8   |       | 19.4    |       | —                 |       |
| CDOs that invest in other CDOs (“CDO squared”)                     |       | 1               |       | —                             |       | —  |       | — |       | — |       | —  |       | 100.0                  |       |
| Collateralized bond obligations                                              |       | 18              |       | —                             |       | —  |       | — |       | — |       | 55.6    |       | 44.4                   |       |
| Other CLO                                                                    |       | 38              |       | 0.1                                |       | 100.0   |       | — |       | — |       | —  |       | —                 |       |
| Total other CDO                                                              |       | 785             |       | 1.3                                |       | 35.3    |       | 21.3   |       | 11.4   |       | 10.2    |       | 21.8                   |       |
|                                                                         |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| Other asset-backed securities (“other ABS”):                       |       |            |       |                               |       |    |       |   |       |   |       |    |       |                   |       |
| Auto                                                                         |       | 85              |       | 0.2                                |       | 22.3    |       | 36.5   |       | 9.4    |       | 31.8    |       | —                 |       |
| Credit card                                                                  |       | 81              |       | 0.1                                |       | 35.8    |       | — |       | 53.1   |       | 11.1    |       | —                 |       |
| Student loan                                                                 |       | 9               |       | —                             |       | 100.0   |       | — |       | — |       | —  |       | —                 |       |
| Other                                                                        |       | 349             |       | 0.6                                |       | 15.5    |       | 12.6   |       | 18.1   |       | 28.9    |       | 24.9                   |       |
| Total other ABS (2)                                                          |       | 524             |       | 0.9                                |       | 21.2    |       | 14.3   |       | 21.8   |       | 26.1    |       | 16.6                   |       |
| Total ABS                                                                    | $          |            | 1,309      |                               | 2.2        | %       |       |   |       |   |       |    |       |                   |       |   |

 

----

(1) Subprime was previously referred to asasset-backed residential mortgage-backed securities (“ABS RMBS”) and includedin the ABS category.

 

(2) 24.0% of other ABS that are rated Aa, A andBaa were insured by four bond insurers.

 

During the second quarterof 2009, certain financial sectors continued to experience depressed prices dueto continued market and liquidity disruptions. We experienced this illiquidity and disruption in certain of our RMBS,CMBS and ABS fixed income securities, particularly in our Subprime, Prime,Alt-A, CMBS and other CDO portfolios. These portfolios totaled $5.70 billion, or 9.8% of our total investmentsat June 30, 2009.  Other securitiesmarkets, including certain other asset-backed and real estate-backed securitiesmarkets, also experienced illiquidity, but to a lesser degree.

 

We determine the fairvalues of securities comprising these illiquid portfolios by obtaininginformation from an independent third-party valuation service provider andbrokers.  We confirmed the reasonablenessof the fair value of these portfolios as of June 30, 2009 by analyzingavailable market information including, but not limited to, collateral quality,anticipated cash flows, credit enhancements, default rates, loss severities,securities’ relative position within their respective capital structures, andcredit ratings from statistical rating agencies.

 

52

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Thefollowing table summarizes our illiquid portfolios as of June 30, 2009.

 
| **($ in millions)** | ** ** | **Par********value****(1)** | ** ** | **Amortized********cost****(1)** | ** ** | **Amortized  cost********as a  percent********of par  value** | ** ** | ** ** | **Fair********value** | ** ** | **Fair  value as a percent of********par  value** | ** ** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|--------------------------|------------|-----------------------------|------------|----------------------------------|------------|---------------------------------------------------------------|------------|------------|-----------------------|------------|---------------------------------------------------|------------|------------|-----------------------------|------------|
| **RMBS**                 |       |                        |       |                             |       |                                                          |       |       |                  |       |                                              |       |       |                        |       |
| Subprime                 | $          |  2,408                 | $          |  2,166                      |       | 89.9                                                          | %          | $          |  978             |       | 40.6                                              | %          | $          |  (1,188                | )          |
| Prime                    |       | 612                         |       | 605                              |       | 98.9                                                          |       |       | 520                   |       | 85.0                                              |       |       | (85                         | )          |
| Alt-A                    |       | 522                         |       | 471                              |       | 90.2                                                          |       |       | 310                   |       | 59.4                                              |       |       | (161                        | )          |
|                     |       |                        |       |                             |       |                                                          |       |       |                  |       |                                              |       |       |                        |       |
| **CMBS**                 |       | 4,996                       |       | 4,848                            |       | 97.0                                                          |       |       | 3,111                 |       | 62.3                                              |       |       | (1,737                      | )          |
|                     |       |                        |       |                             |       |                                                          |       |       |                  |       |                                              |       |       |                        |       |
| **ABS**                  |       |                        |       |                             |       |                                                          |       |       |                  |       |                                              |       |       |                        |       |
| Other CDO                |       | 2,187                       |       | 1,791                            |       | 81.9                                                          |       |       | 785                   |       | 35.9                                              |       |       | (1,006                      | )          |
| Total                    | $          | 10,725                      | $          | 9,881                            |       | 92.1                                                          |       | $          | 5,704                 |       | 53.2                                              |       | $          | (4,177                      | )          |

 

----

(1) The difference between parvalue and amortized cost of $844 million is primarily attributable towrite-downs.  Both amounts have beenreduced by principal payments.

 

Thefollowing table presents realized capital gains and losses and principaltransactions relating to our illiquid portfolios.

 
| **($ in millions)**                   | ** ** | **Realized  capital gains and losses** | ** ** | **Principal  transactions** | ** **                        |
|--------------------------------------------|------------|----------------------------------------|------------|-----------------------------|-----------------------------------|
| ** **                                 | ** ** | **Sales**                              | ** ** | ** **                  | **Impairment********write-downs** | ** ** | ** ** | **Change  in intent********write-downs** | ** ** | ** ** | **Sales** | ** ** | **Principal********received** | ** ** | **Acquired** | ** ** |
| **Three months ended  June 30, 2009** |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **RMBS**                                   |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| Subprime                                   | $          | 1                                      |       | $                           |  (41                         | ) | $ |  — |   | $ |  4 | $ |  53 | $ |  14 |   |
| Prime                                      |       | —                                 |       |                        | —                            |   |   | — |   |   | — |   | 44 |   | 9 |   |
| Alt-A                                      |       | —                                 |       |                        | (3                                | ) |   | — |   |   | 2 |   | 9 |   | 25 |   |
|                                       |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **CMBS**                                   |       | (16                                    | )          |                        | (44                               | ) |   | — |   |   | 709 |   | 28 |   | — |   |
|                                       |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **ABS**                                    |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| Other CDO                                  |       | —                                 |       |                        | (28                               | ) |   | — |   |   | 6 |   | 10 |   | 34 |   |
| Total                                      | $          |  (15                              | )          | $                           |  (116                        | ) | $ |  — |   | $ |  721 | $ |  144 | $ |  82 |   |
|                                       |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **Six months ended June 30,  2009**   |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **RMBS**                                   |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| Subprime                                   | $          |  1                                |       | $                           |  (46                         | ) | $ |  (6 | ) | $ |  7 | $ |  107 | $ |  14 |   |
| Prime                                      |       | —                                 |       |                        | —                            |   |   | — |   |   | 8 |   | 62 |   | 9 |   |
| Alt-A                                      |       | 3                                      |       |                        | (11                               | ) |   | (1 | ) |   | 14 |   | 16 |   | 25 |   |
|                                       |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **CMBS**                                   |       | (29                                    | )          |                        | (46                               | ) |   | (7 | ) |   | 787 |   | 54 |   | — |   |
|                                       |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| **ABS**                                    |       |                                   |       |                        |                              |   |   |   |   |   |   |   |   |   |   |   |
| Other CDO                                  |       | (3                                     | )          |                        | (158                              | ) |   | — |   |   | 8 |   | 12 |   | 34 |   |
| Total                                      | $          |  (28                              | )          | $                           |  (261                        | ) | $ |  (14 | ) | $ |  824 | $ |  251 | $ |  82 |   |

 

Securities included inour illiquid portfolios with a fair value less than 70% of amortized cost as ofJune 30, 2009 are shown in the following table.

 
| **($ in millions)** | ** ** | **Fair********value** | ** ** | **Unrealized gain/(loss)** | ** ** |
|--------------------------|------------|-----------------------|------------|----------------------------|------------|
| **RMBS**                 |       |                  |       |                       |       |
| Subprime                 | $          |                  | 680        | $                          |       | (1,119 | ) |
| Prime                    |       | 46                    |       | (36                        | )          |
| Alt-A                    |       | 136                   |       | (134                       | )          |
|                     |       |                  |       |                       |       |
| **CMBS**                 |       | 853                   |       | (1,501                     | )          |
|                     |       |                  |       |                       |       |
| **ABS**                  |       |                  |       |                       |       |
| Other  CDO               |       | 471                   |       | (964                       | )          |
| Total                    | $          |                  | 2,186      | $                          |       | (3,754 | ) |

 

53

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We continue to believethat the unrealized losses on these securities are not predictive of theultimate performance of the underlying collateral.  In the absence of further deterioration inthe collateral relative to our positions in the securities’ respective capitalstructures, which could be other than temporary, the unrealized losses shouldreverse over the remaining lives of the securities.

 

The cash flowsof the underlying mortgages or collateral for RMBS, CMBS and ABS are generallyapplied in a pre-determined order and are designed so that each security issuedqualifies for a specific original rating. The security issue is typically referred to as the “class”.  For example, the “senior” portion or “top” ofthe capital structure which would originally qualify for a rating of Aaa isreferred to as the “Aaa class” and typically has priority in receiving theprincipal repayments on the underlying mortgages.  In a sequential structure, underlyingcollateral principal repayments are directed to the most senior rated Aaa classin the structure until paid in full, after which principal repayments aredirected to the next most senior Aaa class in the structure until it is paid infull.  Senior Aaa classes generally shareany losses from the underlying collateral on a pro-rata basis after losses areabsorbed by classes with lower original ratings including other “junior” or “subordinate”Aaa securities.  For certain senior Aaaclasses of CMBS, the losses may be shared pro-rata.  The underlying mortgages have fixed interestrates, variable interest rates (such as adjustable rate mortgages (“ARM”)), orare hybrid, meaning that they contain features of both fixed and variable ratemortgages.

 

*RMBS*totaled $4.51 billion, with 88.9% rated investment grade, at June 30,2009.  The RMBS portfolio is subject tointerest rate risk since price volatility and the ultimate realized yield areaffected by the rate of prepayment of the underlying mortgages.  The credit risk associated with our RMBS ismitigated due to the fact that 59.9% of the portfolio consists of securitiesthat were issued by, or have underlying collateral that is guaranteed by U.S.government agencies.

 

Subprime includessecurities that are collateralized by mortgage loans issued to borrowers thatcannot qualify for Prime or Alt-A financing terms due in part to weak orlimited credit history.  It also includessecurities that are collateralized by certain second lien mortgages regardlessof the borrower’s credit history.  $739million or 75.6% of the Subprime portfolio consisted of securities that wereissued during 2005, 2006 and 2007.  At June 30,2009, 11.8% of securities issued during 2005, 2006 and 2007 were rated Aaa,26.0% rated Aa, 7.2% rated A, 7.7% rated Baa and 47.3% rated Ba or lower.

 

The following tablepresents additional information about our Subprime portfolio including asummary by first and second lien collateral at June 30, 2009.

 
| **($ in millions)** | ** ** | **Fair value** | ** ** | **Percent to   total  investments** | ** ** |
|--------------------------|------------|----------------|------------|-------------------------------------|------------|
| First  lien:             |       |           |       |                                |       |
| Fixed  rate (1)          | $          |           | 312        |                                | 0.5        | % |
| Variable  rate (1)       |       | 493            |       | 0.9                                 |       |
| Total  first lien (2)    |       | 805            |       | 1.4                                 |       |
| Second  lien :           |       |           |       |                                |       |
| Insured                  |       | 133            |       | 0.2                                 |       |
| Other                    |       | 36             |       | 0.1                                 |       |
| Total  second lien (3)   |       | 169            |       | 0.3                                 |       |
| Other                    |       | 4              |       | —                              |       |
| Total Subprime           | $          |           | 978        |                                | 1.7        | % |

 

----

(1) Fixed rate andvariable rate refer to the primary interest rate characteristics of theunderlying mortgages at the time of issuance.

 

(2) The original creditratings of the first lien Subprime, which may not be consistent with currentratings due to downgrades, were 59.8% Aaa, 36.0% Aa and 4.2% A at June 30,2009.

 

(3) The original creditratings of the second lien Subprime, which may not be consistent with currentratings due to downgrades, were 97.5% Aaa and 2.5% Aa at June 30, 2009.

 

54

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The following table includesfirst lien non-insured Subprime by vintage year and the interest ratecharacteristics of the underlying mortgage product at June 30, 2009.

 
| **($ in millions)** | ** ** | **Fair value** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------|------------|----------------|------------|------------|------------|------------|------------|
| *** ***             | ** ** | **Variable**   | ** ** | **Fixed**  | ** ** | ** ** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
| ** **               | ** ** | **rate**       | ** ** | **rate**   | ** ** | **Total**  | ** ** | **cost****(1)** | ** ** | **gain/(loss)** | ** ** |
| 2007                     | $          |           |  57   | $          |       |  114  | $          |   |  171 | $ |   |  454 | $ |   |  (283 | ) |
| 2006                     |       | 130            |       | 80         |       | 210        |       | 417 |   | (207 | ) |
| 2005                     |       | 124            |       | 39         |       | 163        |       | 336 |   | (173 | ) |
| Pre-2005                 |       | 164            |       | 27         |       | 191        |       | 324 |   | (133 | ) |
| Total                    | $          |           |  475  | $          |       |  260  | $          |   |  735 | $ |   |  1,531 | $ |   |  (796 | ) |

 

----

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

 

We also own $36 millionof second lien Subprime non-insured securities, representing 39.1% of amortizedcost; $9 million, or 25.0%, of this portfolio are 2006 and 2007 vintage years.  Together with the first lien non-insuredSubprime in the table above, this comprises $771 million of non-insuredSubprime.

 

At June 30, 2009,$203 million or 20.8% of the total Subprime securities are insured by four bondinsurers and 24.7% of these insured securities were rated investmentgrade.  The following table shows ourinsured Subprime portfolio at June 30, 2009 by vintage year for the firstlien and second lien collateral.

 
| **($ in millions)**   | ** ** | **Vintage year** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
|----------------------------|------------|------------------|------------|----------|------------|---------------|------------|----------------|------------|
| ** **                 | ** ** | **2007**         | ** ** | **2006** | ** ** | **2005**      | ** ** | **Pre-2005**   | ** ** | **value** | ** ** | **cost****(1)** | ** ** | **gain/(loss)** | ** ** |
| First lien                 | $          |             |  23   | $        |       |  5       | $          |           |  33   | $ |   |  9 | $ |   |  70 | $ |   |  124 | $ |   |  (54 | ) |
| Second lien                |       | 65               |       | 48       |       | 4             |       | 16             |       | 133 |   | 405 |   | (272 | ) |
| Total insured Subprime (2) | $          |             |  88   | $        |       |  53      | $          |           |  37   | $ |   |  25 | $ |   |  203 | $ |   |  529 | $ |   |  (326 | ) |

 

----

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

 

(2) The evaluation for other-than-temporaryimpairment through our portfolio monitoring process considers the currentclaims paying resources of the individual bond insurers.

 

Prime arecollateralized by residential mortgage loans issued to prime borrowers.  The following table shows our Prime portfolioas of June 30, 2009 by vintage year, based upon our participation in thecapital structure.

 
| **($ in  millions)**               | ** ** | **Vintage year** | ** **   | ** ** | ** ** | ** **    | ** ** | ** **     | ** ** |
|-----------------------------------------|------------|------------------|--------------|------------|------------|---------------|------------|----------------|------------|
| **Capital structure**                   | ** ** | ** **       | ** **   | **Fair**   | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
| **classification ****(1)**         | ** ** | **2009**         | ** **   | **2007**   | ** ** | **2006**      | ** ** | **2005**       | ** ** | **Pre-2005** | ** ** | **value** | ** ** | **cost****(2)** | ** ** | **gain/(loss)** | ** ** |
| Aaa  — Fixed  rate            | $          |             |  — | $          |       |  77      | $          |           |  33   | $ |   |  70 | $ |   |  252 | $ |   |  432 | $ |   |  485 | $ |   |  (53 | ) |
| Aaa  — Hybrid                 |       | 4                |         | —     |       | —        |       | 41             |       | 31 |   | 76 |   | 102 |   | (26 | ) |
| Aa    — Fixed  rate |       | —           |         | —     |       | —        |       | —         |       | 7 |   | 7 |   | 8 |   | (1 | ) |
| A — Hybrid                         |       | —           |         | —     |       | —        |       | 2              |       | — |   | 2 |   | 7 |   | (5 | ) |
| Baa — Hybrid                       |       | —           |         | —     |       | —        |       | 3              |       | — |   | 3 |   | 3 |   | — |   |
| Total                                   | $          |             |  4      | $          |       |  77      | $          |           |  33   | $ |   |  116 | $ |   |  290 | $ |   |  520 | $ |   |  605 | $ |   |  (85 | ) |

 

----

(1) Capital structure classification reflects originalratings which may not be consistent with current ratings due to downgrades.

 

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

 

Alt-A can beissued by trusts backed by pools of residential mortgages with either fixed orvariable interest rates.  The mortgagepools include residential mortgage loans issued to borrowers with strongercredit profiles than subprime borrowers, but who do not qualify for primefinancing terms due to high loan-to-value ratios or limited supportingdocumentation.  As of June 30, 2009,$268 million of the Alt-A were fixed rate and $42 million were variable rate.

 

55

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The followingtable shows our Alt-A portfolio at June 30, 2009 by vintage year, based uponour participation in the capital structure.

 
| **($ in  millions)**                  | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------------|------------|------------|------------|------------|------------|------------|------------|
| **Capital  structure**                     | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **Pre-**   | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
| **classification****(1)**                  | ** ** | **2007**         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2005**   | ** ** | **value** | ** ** | **cost****(2)** | ** ** | **gain/(loss)** | ** ** |
| Aaa — Fixed rate                      | $          |             | 24         | $          |       | 16         | $          |       | 81         | $ |   | 129 | $ |   | 250 | $ |   | 366 | $ |   | (116 | ) |
| Aaa — Hybrid                          |       | —           |       | —     |       | —     |       | 6          |       | 6 |   | 9 |   | (3 | ) |
| Aaa — Option adjustable rate mortgage |       | —           |       | —     |       | —     |       | —     |       | — |   | 3 |   | (3 | ) |
| Aa — Fixed rate                       |       | —           |       | 3          |       | 2          |       | —     |       | 5 |   | 7 |   | (2 | ) |
| Aa — Hybrid                           |       | —           |       | —     |       | —     |       | —     |       | — |   | 1 |   | (1 | ) |
| Aa — Option adjustable rate mortgage  |       | —           |       | —     |       | 1          |       | 4          |       | 5 |   | 25 |   | (20 | ) |
| A — Hybrid                            |       | —           |       | —     |       | 7          |       | —     |       | 7 |   | 11 |   | (4 | ) |
| Baa — Hybrid                          |       | —           |       | 12         |       | —     |       | —     |       | 12 |   | 24 |   | (12 | ) |
| Ba or lower — Fixed                   |       | 13               |       | —     |       | —     |       | —     |       | 13 |   | 13 |   | — |   |
| Ba or lower — Hybrid                  |       | —           |       | —     |       | 12         |       | —     |       | 12 |   | 12 |   | — |   |
| Total                                      | $          |             | 37         | $          |       | 31         | $          |       | 103        | $ |   | 139 | $ |   | 310 | $ |   | 471 | $ |   | (161 | ) |

 

----

(1) Capital structure classification reflects originalratings which may not be consistent with current ratings due to downgrades.

 

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

 

*CMBS* totaled $3.11 billion, with 99.1% rated investmentgrade, at June 30, 2009.  The CMBSportfolio is subject to credit risk, but unlike certain other structuredsecurities, is generally not subject to prepayment risk due to protectionswithin the underlying commercial mortgages whereby borrowers are effectivelyrestricted from prepaying their mortgages due to changes in interestrates.  Of the CMBS investments, 94.2%are traditional conduit transactions collateralized by pools of commercialmortgages, broadly diversified across property types and geographicalarea.  The remainder consists ofnon-traditional CMBS such as large loan pools and single borrower transactions.

 

56

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The following table shows our CMBS portfolio at June 30, 2009based upon vintage year and our participation in the capital structure,excluding commercial real estate collateralized debt obligations (“CRE CDO”).

 
| **($ in  millions)****Capital structure** | ** ** | **Par**   | ** ** | **Amortized**   | ** ** | **Fair**  | ** ** | **Unrealized**        | ** ** |
|------------------------------------------------|------------|-----------|------------|-----------------|------------|-----------|------------|-----------------------|------------|
| **classification****(1)**                      | ** ** | **value** | ** ** | **cost****(2)** | ** ** | **value** | ** ** | ** gain/(loss)** | ** ** |
| Aaa                                            |       |      |       |            |       |      |       |                  |       |
| 2007:                                          |       |      |       |            |       |      |       |                  |       |
| Super  senior (3)                              | $          |      | 373        | $               |       | 369       | $          |                  | 285        | $ |   | (84 | ) |
| Mezzanine  senior (4)                          |       | 130       |       | 122             |       | 60        |       | (62                   | )          |
| Subordinated  senior (5)                       |       | 532       |       | 497             |       | 164       |       | (333                  | )          |
| Other  (6)                                     |       | 95        |       | 98              |       | 33        |       | (65                   | )          |
| Subtotal                                       |       | 1,130     |       | 1,086           |       | 542       |       | (544                  | )          |
| 2006:                                          |       |      |       |            |       |      |       |                  |       |
| Super  senior (3)                              |       | 78        |       | 78              |       | 63        |       | (15                   | )          |
| Mezzanine  senior (4)                          |       | 81        |       | 77              |       | 46        |       | (31                   | )          |
| Subordinated  senior (5)                       |       | 314       |       | 299             |       | 112       |       | (187                  | )          |
| Other  (6)                                     |       | 75        |       | 76              |       | 42        |       | (34                   | )          |
| Subtotal                                       |       | 548       |       | 530             |       | 263       |       | (267                  | )          |
| 2005:                                          |       |      |       |            |       |      |       |                  |       |
| Super  senior (3)                              |       | 282       |       | 284             |       | 257       |       | (27                   | )          |
| Mezzanine  senior (4)                          |       | 22        |       | 22              |       | 13        |       | (9                    | )          |
| Subordinated  senior (5)                       |       | 108       |       | 112             |       | 57        |       | (55                   | )          |
| Other  (6)                                     |       | 115       |       | 115             |       | 76        |       | (39                   | )          |
| Subtotal                                       |       | 527       |       | 533             |       | 403       |       | (130                  | )          |
| Pre-2005  (7)                                  |       | 1,290     |       | 1,299           |       | 1,201     |       | (98                   | )          |
| Aaa  total                                     |       | 3,495     |       | 3,448           |       | 2,409     |       | (1,039                | )          |
|                                           |       |      |       |            |       |      |       |                  |       |
| Aa                                             |       | 1,082     |       | 1,105           |       | 540       |       | (565                  | )          |
| A                                              |       | 330       |       | 272             |       | 157       |       | (115                  | )          |
| Baa                                            |       | 30        |       | 14              |       | 3         |       | (11                   | )          |
| Total  CMBS (8)                                | $          |      | 4,937      | $               |       | 4,839     | $          |                  | 3,109      | $ |   | (1,730 | ) |

 

----

(1) Capital structure classification reflectsoriginal ratings which may not be consistent with current ratings due toupgrades and downgrades.

 

(2) Amortized cost includesother-than-temporary impairment charges, as applicable.

 

(3) Most senior of the Aaa rated tranches,typically has a high level of credit enhancement of approximately 30%, meaningactual losses in the deal have to reach 30% before incurring a first dollarloss.

 

(4) MiddleAaa rated tranche, typically having credit enhancement of approximately 20%,are subordinate only to the Super senior bonds.

 

(5) Lowest Aaa rated tranche, typically with credit enhancement in the lowteens.  This bond is subordinate to theSuper senior and Mezzanine senior tranches, but still senior to all tranchesrated below Aaa.

 

(6) IncludesAaa bonds that were originated in 2005 through 2007 that do not fall into thecategories above.  These arenon-traditional CMBS bonds that did not have a Aaa Senior-type breakdown.

 

(7) Priorto 2005, the Aaa bonds in a transaction were generally not divided into Supersenior, Mezzanine senior, or Subordinated senior (with the exception of a fewdeals structured very late in 2004); therefore all 2004 and prior Aaa-ratedsecurities are grouped into this category.

 

(8) Excludes CRE CDOwith par value of $59 million, amortized cost of $9 million, fair value of $2million and unrealized capital losses of $7 million.

 

The unrealized netcapital loss of $1.73 billion at June 30, 2009 on our CMBS portfolio wasthe result of wider credit spreads, which was largely due to the macroeconomicconditions and credit market deterioration that has persisted into 2009.  While CMBS spreads have tightened during thesecond quarter of 2009, credit spreads in all rating classes remain wider thaninitial purchase levels, which is particularly evident in our subordinatedsenior Aaa and lower rated securities. These holdings accounted for $1.40 billion, or 81.2%, of the unrealizednet capital loss.  Our analysis suggeststhat the vast majority of our CMBS portfolio is well insulated from a severerise in commercial mortgage default rates.

 

57

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*ABS* totaled $1.31 billion, with 84.3% rated investmentgrade, at June 30, 2009.  Credit risk is managed by monitoring theperformance of the collateral.  Inaddition, many of the securities in the ABS portfolio are credit enhanced withfeatures such as over-collateralization, subordinated structures, reservefunds, guarantees and/or insurance.  Aportion of the ABS portfolio is also subject to interest rate risk sinceultimate realized yields are affected by the rate of prepayment of theunderlying assets.

 

Other CDO totaled $785million, with 78.2% rated investment grade, at June 30, 2009.  Other CDO consist primarily of obligationssecured by high yield and investment grade corporate credits including cashflow CLO, synthetic CDO, trust preferred CDO, market value CDO, project financeCDO, CDO squared, collateralized bond obligations and other CLO.

 

The following tablepresents realized and unrealized capital gains and losses on our other CDOportfolio.

 
| **($ in millions)**       | ** ** | **Realized  capital gains and losses**             | ** ** | ** **                                       | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **Three  months ended********June 30,  2009** | ** ** | **Six  months ended********June 30,  2009** | ** ** | **Unrealized** | ** ** |
| ** **                     | ** ** | **Sales**                                          | ** ** | **Impairment********write-downs**                | ** ** | **Sales** | ** ** | **Impairment********write-downs** | ** ** | **gain/(loss)  as of********June 30,  2009** | ** ** |
| **Other CDO**                  |       |                                               |       |                                             |       |   |   |   |   |   |   |
| Cash flow CLO                  | $          |                                               | —     | $                                                |       | (10 | ) | $ |   | — |   | $ |   | (38 | ) | $ |   | (633 | ) |
| Synthetic CDO                  |       | —                                             |       | (18                                              | )          |   | (4 | ) |   | (18 | ) |   | (186 | ) |
| Trust preferred CDO            |       | —                                             |       | —                                           |       |   | — |   |   | (17 | ) |   | (92 | ) |
| Market value CDO               |       | —                                             |       | —                                           |       |   | 1 |   |   | (11 | ) |   | (40 | ) |
| Project finance CDO            |       | —                                             |       | —                                           |       |   | — |   |   | — |   |   | (37 | ) |
| CDO squared                    |       | —                                             |       | —                                           |       |   | — |   |   | (74 | ) |   | (11 | ) |
| Collateralizedbond obligations |       | —                                             |       | —                                           |       |   | — |   |   | — |   |   | (7 | ) |
| Other CLO                      |       | —                                             |       | —                                           |       |   | — |   |   | — |   |   | — |   |
| Total                          | $          |                                               | —     | $                                                |       | (28 | ) | $ |   | (3 | ) | $ |   | (158 | ) | $ |   | (1,006 | ) |

 

Cash flow CLO arestructures where the underlying assets are primarily comprised of belowinvestment grade senior secured corporate loans.  Thecollateral is actively managed by external managers that monitor the collateralperformance.  The underlying investmentsare well diversified across industries and among issuers.  A transaction will typically issuenotes with various capital structure class (i.e. Aaa, Aa, A, etc.) as well asequity-like tranches.  In general, thesesecurities are structured with overcollaterization (“OC”) ratios andperformance is impacted by downgrades, defaults and recoveries of theunderlying assets within the structures. Downgrades of underlying assets, along with increased defaults reduce OCratios over time.  A violation of thesenior OC test, usually at the Aaa level, could result in an event of defaultof the structure.  This would give thecontrolling class certain rights which could include diverting cash flows orliquidating the underlying portfolio to pay off the senior liabilities.  The following table shows our cash flow CLOportfolio at June 30, 2009 by vintage year, based upon our participationin the capital structure.

 
| **($ in  millions)** | ** ** | **Vintage  year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------|------------|-------------------|------------|------------|------------|------------|------------|------------|------------|
| **Capital structure**     | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** |
| **classification****(1)** | ** ** | **2008**          | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **value** | ** ** | **cost****(2)** | ** ** | **gain/(loss)** | ** ** |
| Aaa                       | $          |              | —     | $          |       | —     | $          |       | 69         | $ |   | 60 | $ |   | 140 | $ |   | 269 | $ |   | 352 | $ |   | (83 | ) |
| Aa                        |       | 2                 |       | 56         |       | 69         |       | 10         |       | 18 |   | 155 |   | 308 |   | (153 | ) |
| A                         |       | 1                 |       | 24         |       | 20         |       | 20         |       | 29 |   | 94 |   | 459 |   | (365 | ) |
| Baa                       |       | —            |       | 2          |       | 2          |       | 12         |       | 16 |   | 32 |   | 65 |   | (33 | ) |
| Ba or below               |       | —            |       | 1          |       | —     |       | —     |       | — |   | 1 |   | — |   | 1 |   |
| Total                     | $          |              | 3          | $          |       | 83         | $          |       | 160        | $ |   | 102 | $ |   | 203 | $ |   | 551 | $ |   | 1,184 | $ |   | (633 | ) |

 

----

(1) Capitalstructure classification reflects original ratings which may not be consistent with current ratings due todowngrades.

 

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

 

58

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Synthetic CDO primarily consist of a portfolio ofcorporate credit default swaps (“CDS”) which are collateralized by Aaa ratedLIBOR-based securities (i.e. “fully funded” synthetic CDO).  Our synthetic CDO collateral primarilyis actively managed by an external manager monitoring the CDS selection andperformance.  The following table showsour synthetic CDO at June 30, 2009 by vintage year, based upon ourparticipation in the capital structure.

 
| **($ in millions)**  | ** ** | ** **        | ** ** | ** ** | ** ** | ** **    | ** ** | ** **      | ** ** | ** **            | ** ** |
|---------------------------|------------|-------------------|------------|------------|------------|---------------|------------|-----------------|------------|-----------------------|------------|
| **Capital structure**     | ** ** | **Vintage  year** |       | **Fair**   |       | **Amortized** |       | **Unrealized**  |       |
| **classification****(1)** | ** ** | **2007**          | ** ** | **2006**   | ** ** | **value**     | ** ** | **cost****(2)** | ** ** | ** gain/(loss)** | ** ** |
| Aaa                       | $          |              | 23         | $          |       | —        | $          |            | 23         | $                     |       | 88 | $ |   | (65 | ) |
| Aa                        |       | 4                 |       | 22         |       | 26            |       | 144             |       | (118                  | )          |
| A                         |       | —            |       | —     |       | —        |       | 3               |       | (3                    | )          |
| Total                     | $          |              | 27         | $          |       | 22            | $          |            | 49         | $                     |       | 235 | $ |   | (186 | ) |

 

----

(1) Capitalstructure classification reflects original ratings which may not be consistent with current ratings due todowngrades.

 

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

 

*Mortgage loans*    Our mortgage loan portfolio was$9.20 billion at June 30, 2009 and primarily comprised loans securedby first mortgages on developed commercial real estate.  Key considerations used to manage ourexposure include property type and geographic diversification.  Our exposure to any metropolitan area is alsohighly diversified, with the largest exposure not exceeding 9.2% of theportfolio.  The portfolio is alsodiversified across several property types, with the largest concentrations of32.2% in office and 25.1% in retail property types.  The average debt service coverage ratiorepresents the amount of cash flows from the property available by the borrowerto meet its principal and interest payment obligations.  The average debt service coverage ratio ofthe portfolio as of June 30, 2009 was 2.0, and only 4.5% of the mortgageloan portfolio had a debt service coverage ratio under 1.0.

 

In the first six monthsof 2009, $339 million of commercial mortgage loans were contractuallydue.  Of these, 46% were paid as due, 38%were extended generally for less than one year and 16% are in the process ofrefinancing or restructuring negotiations. In addition, $359 million that were not contractually due in the firstsix months of 2009 were paid in full.  Wecurrently have a $15 million loan in the process of foreclosure.  We are aggressively pursuing workoutsolutions for $72 million of delinquent loans, which includes refinancing,extensions and sales.

 

The net carrying value ofimpaired loans at June 30, 2009 and December 31, 2008 was$326 million and $159 million, respectively.  We recognized $15 million and $43million of realized capital losses related to valuation allowances on mortgageloans for the three months and six months ended June 30, 2009,respectively.  Total valuation allowancesof $41 million were held as of June 30, 2009.  Realized capital losses due to changes inintent to hold mortgage loans to maturity totaled $6 million for the sixmonths ended June 30, 2009.

 

*Limitedpartnership interests* consist of investments in private equity/debt funds, real estate fundsand hedge funds.  The overall limitedpartnership interests portfolio is well diversified across a number of metricsincluding fund sponsors, vintage years, strategies, geography (includinginternational), and company/property types. The following table presents information about our limited partnershipinterests as of June 30, 2009.

 
| **($ in millions)**                      | ** ** | **Private   equity/ debt   funds** | ** ** | **Real estate  funds** | ** ** | **Hedge  funds** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|------------------------------------|------------|------------------------|------------|------------------|------------|-----------|------------|
| Cost method of accounting (“Cost”)  | $          |                               | 370        | $                      |       | 131              | $          |      | —     | $ |   | 501 |   |
| Equity method of accounting (“EMA”) |       | 315                                |       | 163                    |       | 57               |       | 535       |       |
| Total                                         | $          |                               | 685        | $                      |       | 294              | $          |      | 57         | $ |   | 1,036 |   |
|                                          |       |                               |       |                   |       |             |       |      |       |
| Number of sponsors                            |       | 72                                 |       | 30                     |       | 1                |       |      |       |
| Number of individual funds                    |       | 113                                |       | 57                     |       | 2                |       |      |       |
| Largest exposure to single fund               | $          |                               | 22         | $                      |       | 21               | $          |      | 37         |   |   |   |

 

Our aggregate limitedpartnership exposure represented 1.8% and 2.0% of total invested assets as of June 30,2009 and December 31, 2008, respectively.

 

59

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Thefollowing table shows the results from our limited partnership interests byfund type and accounting classification.

 
| **($ in millions)**   | ** ** | **Three months ended********June 30,** | ** ** |
|----------------------------|------------|---------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
| ** **                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** | **Impairment** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** | **Impairment** | ** ** |
| ** **                 | ** ** | **Cost**                                    | ** ** | **EMA****(1)** | ** ** | ** ** | **income** | ** ** | **write-downs****(2)** | ** ** | **Cost** | ** ** | **EMA****(1)** | ** ** | **income** | ** ** | **write-downs****(2)** | ** ** |
| Private equity/ debt funds | $          |                                        |  2    | $ |   |  (12 | ) | $ |   |  (10 | ) | $ |   |  (4 | ) | $ |   |  3 | $ |   |  12 |   | $ |   |  15 |   | $ |   |  (1 | ) |
| Real estate funds          |       | —                                      |       | (23 | ) |   | (23 | ) |   | (17 | ) |   | 2 |   | (4 | ) |   | (2 | ) |   | (3 | ) |
| Hedge funds                |       | —                                      |       | 2 |   |   | 2 |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   |
| Total                      | $          |                                        |  2    | $ |   |  (33 | ) | $ |   |  (31 | ) | $ |   |  (21 | ) | $ |   |  5 | $ |   |  8 |   | $ |   |  13 |   | $ |   |  (4 | ) |

 
| ** **                 | ** ** | **Six months ended********June 30,** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** | **Impairment** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** | **Impairment** | ** ** |
| ** **                 | ** ** | **Cost**                                  | ** ** | **EMA****(1)** | ** ** | ** ** | **income** | ** ** | **write-downs****(2)** | ** ** | **Cost** | ** ** | **EMA****(1)** | ** ** | **income** | ** ** | **write-downs****(2)** | ** ** |
| Private equity/ debt funds | $          |                                      |  4    | $ |   |  (45 | ) | $ |   |  (41 | ) | $ |   |  (41 | ) | $ |   |  11 | $ |   |  26 |   | $ |   |  37 |   | $ |   |  (4 | ) |
| Real estate funds          |       | —                                    |       | (66 | ) |   | (66 | ) |   | (74 | ) |   | 3 |   | (1 | ) |   | 2 |   |   | (3 | ) |
| Hedge funds                |       | —                                    |       | 1 |   |   | 1 |   |   | — |   |   | — |   | (2 | ) |   | (2 | ) |   | — |   |
| Total                      | $          |                                      |  4    | $ |   |  (110 | ) | $ |   |  (106 | ) | $ |   |  (115 | ) | $ |   |  14 | $ |   |  23 |   | $ |   |  37 |   | $ |   |  (7 | ) |

 

----

(1) Beginning in the fourth quarter of 2008, income from EMA LP isreported in realized capital gains and losses. EMA LP income for periods prior to the fourth quarter of 2008 isreported in net investment income.

 

(2) Impairment write-downs related to Cost LP were $21 million and$110 million in the three months and six months ended June 30, 2009,respectively, compared to $4 million and $7 million in the three months and sixmonths ended June 30, 2008, respectively. Impairment write-downs related to EMA LP were $5 million in the sixmonths ended June 30, 2009 and there were no impairment write-downsrelated to EMA LP in the six months ended June 30, 2008.

 

Loss from limited partnership interests, excludingimpairment write-downs, was $31 million and $106 million in the three monthsand six months ended June 30, 2009, respectively, compared to income of$13 million and $37 million in the three months and six months ended June 30,2008.  The loss from limited partnershipinterests in the three months and six months ended June 30, 2009 comparedto income in the three months and six months ended June 30, 2008 isprimarily related to losses from partnerships accounted for under the equitymethod of accounting resulting from reduced valuations on the net asset valueof the partnerships.  Income on EMA LP isrecognized on a delay due to the availability of the related financialstatements.  The recognition of income onhedge funds is primarily on a one-month delay and the income recognition onprivate equity/debt funds and real estate funds are generally on a three-monthdelay.  Limited partnership interestsaccounted for under the cost method of accounting recognize income only uponcash distributions by the partnership.

 

To determine if an other-than-temporary impairment hasoccurred related to a cost LP, we evaluate whether an impairment indicator hasoccurred in the period that may have a significant adverse effect on thecarrying value of the investment. Impairment indicators may include: actual recent cash flows receivedbeing significantly less than expected cash flows; reduced valuations based onfinancing completed at a lower value; completed sale of a material underlyinginvestment at a price significantly lower than expected; significantly reducedvaluations of the investments held by the limited partnerships or any otherrecent adverse events since the last financial statements received that mightaffect the fair value of the investee’s capital.

 

*CDS* are utilized for both buying and sellingcredit protection against a specified credit event.  As of June 30, 2009, the notional amountand fair value of our buying protection CDS were $708 million and $(13)million, respectively.  For furtherdetails on our selling protection CDS balances, see Note 6 of the condensedconsolidated financial statements.

 

60

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**Unrealizednet capital losses**totaled $5.75 billion as of June 30, 2009, compared to unrealized netcapital losses of $7.46 billion as of March 31, 2009 and $6.70 billion asof December 31, 2008.  The decreasesince December 31, 2008 for fixed income securities was primarily a resultof tightening credit spreads on certain fixed income securities during thesecond quarter of 2009 that more than offset the rise in risk-free interestrates and the impact of the $733 million cumulative effect adjustment from theadoption of FSP FAS 115-2.  Theunrealized net capital losses for equity securities also declined as a resultof improvements in equity market valuations. The following table presents unrealized net capital gains and losses,pre-tax and after-tax.

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

 

----

(1) Unrealized net capital gains and losses for fixed incomesecurities as of June 30, 2009 comprises $(384) million related tounrealized net capital losses on fixed income securities withother-than-temporary impairment and $(5,351) million related to otherunrealized net capital gains and losses.

 

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

 

(3) The DAC and DSI adjustment represents the amount by which theamortization of DAC and DSI would increase or decrease if the unrealized gainsor losses in the respective product portfolios were realized.  Recapitalization of the DAC and DSI balancesis limited to the originally deferred costs plus interest.

 

The net unrealized loss for the fixed incomeportfolio totaled $5.74 billion, comprised of $1.17 billion of gross unrealizedgains and $6.91 billion of gross unrealized losses at June 30, 2009.  This is compared to a net unrealized loss forthe fixed income portfolio totaling $6.69 billion, comprised of $1.92 billionof gross unrealized gains and $8.61 billion of gross unrealized losses at December 31,2008.

 

61

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Grossunrealized gains and losses as of June 30, 2009 on fixed income securitiesby type and sector are provided in the table below.

 
| **($ in millions)**                   | ** ** | **Par**          | ** ** | **Amortized** | ** ** | **Gross  unrealized** | ** ** | **Fair**   | ** ** | **Amortized  cost as a  percent of** | ** ** | **Fair  value  as a percent of** | ** ** |
|--------------------------------------------|------------|------------------|------------|---------------|------------|-----------------------|------------|------------|------------|--------------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **value****(1)** | ** ** | **cost**      | ** ** | **Gains**             | ** ** | **Losses** | ** ** | **value**                            | ** ** | **par value ****(2)**  | ** ** | **par value****(2)** | ** ** |
| Corporate:                                 |       |             |       |          |       |                  |       |       |       |                                 |       |                             |       |   |   |
| Banking                                    | $          |             | 3,971      | $             |       | 3,759                 | $          |       | 16         | $                                    |       | (808                             | )          | $ |   | 2,967 |   | 94.7 |   | 74.7 | % |
| Financial services                         |       | 2,962            |       | 2,738         |       | 27                    |       | (272       | )          |                                 | 2,493      |                             | 92.4       |   | 84.2 |   |
| Utilities                                  |       | 4,982            |       | 4,969         |       | 203                   |       | (199       | )          |                                 | 4,973      |                             | 99.7       |   | 99.8 |   |
| Consumer goods (cyclical and non-cyclical) |       | 4,078            |       | 4,058         |       | 96                    |       | (183       | )          |                                 | 3,971      |                             | 99.5       |   | 97.4 |   |
| Capital goods                              |       | 2,749            |       | 2,747         |       | 51                    |       | (156       | )          |                                 | 2,642      |                             | 99.9       |   | 96.1 |   |
| Other                                      |       | 1,513            |       | 1,282         |       | 13                    |       | (111       | )          |                                 | 1,184      |                             | 84.7       |   | 78.3 |   |
| Transportation                             |       | 1,385            |       | 1,397         |       | 33                    |       | (92        | )          |                                 | 1,338      |                             | 100.9      |   | 96.6 |   |
| Basic industry                             |       | 1,395            |       | 1,389         |       | 21                    |       | (67        | )          |                                 | 1,343      |                             | 99.6       |   | 96.3 |   |
| Communications                             |       | 1,444            |       | 1,437         |       | 39                    |       | (53        | )          |                                 | 1,423      |                             | 99.5       |   | 98.5 |   |
| Energy                                     |       | 1,475            |       | 1,485         |       | 39                    |       | (39        | )          |                                 | 1,485      |                             | 100.7      |   | 100.7 |   |
| Technology                                 |       | 646              |       | 651           |       | 12                    |       | (33        | )          |                                 | 630        |                             | 100.8      |   | 97.5 |   |
| FDIC guaranteed                            |       | 688              |       | 690           |       | 5                     |       | —     |       |                                 | 695        |                             | 100.3      |   | 101.0 |   |
| Total corporate fixed income portfolio     |       | 27,288           |       | 26,602        |       | 555                   |       | (2,013     | )          |                                 | 25,144     |                             | 97.5       |   | 92.1 |   |
|                                       |       |             |       |          |       |                  |       |       |       |                                 |       |                             |       |   |   |   |
| U.S. government and agencies               |       | 4,331            |       | 3,124         |       | 221                   |       | (8         | )          |                                 | 3,337      |                             | 72.1       |   | 77.0 |   |
| Municipal                                  |       | 8,834            |       | 4,712         |       | 60                    |       | (549       | )          |                                 | 4,223      |                             | 53.3       |   | 47.8 |   |
| Foreign government                         |       | 2,154            |       | 1,565         |       | 241                   |       | (19        | )          |                                 | 1,787      |                             | 72.7       |   | 83.0 |   |
| RMBS                                       |       | 6,154            |       | 5,886         |       | 66                    |       | (1,441     | )          |                                 | 4,511      |                             | 95.6       |   | 73.3 |   |
| CMBS                                       |       | 4,996            |       | 4,848         |       | 18                    |       | (1,755     | )          |                                 | 3,111      |                             | 97.0       |   | 62.3 |   |
| ABS                                        |       | 2,921            |       | 2,416         |       | 10                    |       | (1,117     | )          |                                 | 1,309      |                             | 82.7       |   | 44.8 |   |
| Redeemable preferred stock                 |       | 15               |       | 15            |       | —                |       | (4         | )          |                                 | 11         |                             | 100.0      |   | 73.3 |   |
| Total fixed income securities              | $          |             | 56,693     | $             |       | 49,168                | $          |       | 1,171      | $                                    |       | (6,906                           | )          | $ |   | 43,433 |   | 86.7 |   | 76.6 |   |

 

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(1) Included in parvalue are zero-coupon securities that are generally purchased at a deepdiscount to the par value that is received at maturity.  These included corporate, municipal, foreigngovernment and U.S. government and agencies zero-coupon securities with parvalue of $1.12 billion, $5.46 billion, $1.39 billion and $3.32 billion,respectively.

 

(2) Excluding the impactof zero-coupon securities, the percentage of amortized cost to par value wouldbe 98.9% for corporates, 99.3% for municipals, 103.4% for foreign governments,and 104.6% for U.S. government and agencies.  Similarly, excluding the impact of zero-couponsecurities, the percentage of fair value to par value would be 93.4% forcorporates, 94.3% for municipals, 105.0% for foreign governments, and 106.3%for U.S. government and agencies.

 

The banking,financial services, utilities and consumer goods sectors had the highestconcentration of gross unrealized losses in our corporate fixed incomesecurities portfolio at June 30, 2009. While credit spreads have tightened in the second quarter from thehistorically high levels observed in the prior two quarters, they remain widerthan levels at initial purchase.  As of June 30,2009, $1.59 billion or 79.1% of the gross unrealized losses in the corporatefixed income portfolio and $3.53 billion or 72.2% of the gross unrealizedlosses in the remaining fixed income securities related to securities ratedinvestment grade.

 

62

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For fixed income securities, 71.9% of the grossunrealized losses at June 30, 2009 were from $3.72 billion of securitieswith a fair value below 70% of amortized cost, or 8.5% of our fixed incomeportfolio.  The percentage of fairvalue to amortized cost for fixed income securities with gross unrealizedlosses at June 30, 2009 are shown in the following table.

 
| **($ in millions)**                                    | ** ** | **Par********value****(1)** | ** ** | **Amortized********cost** | ** ** | **Unrealized********gain/(loss)** | ** ** | **Fair********value****(3)** | ** ** | **Percent  to********total  fixed********income********securities** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------------------------------|------------|------------------------------|------------|---------------------------------------------------------------------|------------|
| > 80% of amortized  cost                                 | $          |                        | 20,028     | $                         |       | 18,819                            | $          |                         | (1,329     | )                                                                   | $          |   | 17,490 |   | 40.3 | % |
| 70% to 80% of amortized  cost                               |       | 2,661                       |       | 2,520                     |       | (609                              | )          |                         | 1,911      |                                                                | 4.4        |   |
| < 70% of amortized  cost (2)                             |       | 13,626                      |       | 8,684                     |       | (4,968                            | )          |                         | 3,716      |                                                                | 8.5        |   |
| Gross unrealized losses on fixed income securities          |       | 36,315                      |       | 30,023                    |       | (6,906                            | )          |                         | 23,117     |                                                                | 53.2       |   |
| Gross unrealized gains on fixed income securities           |       | 20,378                      |       | 19,145                    |       | 1,171                             |       |                         | 20,316     |                                                                | 46.8       |   |
| Net unrealized gains and losses on fixed income  securities | $          |                        | 56,693     | $                         |       | 49,168                            | $          |                         | (5,735     | )                                                                   | $          |   | 43,433 |   | 100.0 | % |

 

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(1) Included in parvalue are $5.46 billion of zero-coupon securities as of June 30, 2009 thatare generally purchased at a deep discount to the par value that is received atmaturity.

 

(2) Illiquid portfolios represent $3.75 billion of net unrealizedlosses and $2.19 billion of fair value as of June 30, 2009.

 

(3) Illiquid portfolios represent $4.18 billion of net unrealizedlosses and $5.70 billion of fair value as of June 30, 2009.

 

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

 
| **($ in millions)**       | ** ** | **Fair value** | ** ** | **Gross unrealized  losses** | ** ** |
|--------------------------------|------------|----------------|------------|------------------------------|------------|
| Municipal                      | $          |           | 283        | $                            |       | (300 | ) |
| Corporate                      |       | 1,173          |       | (854                         | )          |
| RMBS                           |       | 862            |       | (1,289                       | )          |
| CMBS                           |       | 853            |       | (1,501                       | )          |
| ABS                            |       | 545            |       | (1,024                       | )          |
| Total  fixed income securities | $          |           | 3,716      | $                            |       | (4,968 | ) |

 

We continue tobelieve that the unrealized losses on these securities are not predictive ofthe ultimate performance.  The unrealizedlosses should reverse over the remaining lives of the securities.  As of June 30, 2009, we do not have theintent to sell and it is not more likely than not we will be required to sellthese securities before the recovery of their amortized cost basis.  Our evaluation of whether it is more likelythan not we will be required to sell a security before recovery of itsamortized cost basis is substantially enhanced by our liquidity position, whichcushions us from the need to liquidate securities with significant unrealizedlosses to meet cash obligations.  Duringthe first six months of 2009, our fixed income securities portfolio providedapproximately $3.01 billion in principal and interest cash flows, of whichsubstantially all have been received in accordance with the contractual terms.

 

The net unrealized loss for the equityportfolio totaled $4 million, comprised of $7 million of unrealized gains and$11 million of unrealized losses at June 30, 2009.  This is compared to a net unrealized loss forthe equity portfolio totaling $24 million, comprised of $1 million ofunrealized gains and $25 million of unrealized losses at December 31,2008.  Within the equity portfolio, thelosses were primarily concentrated in the banking, real estate and financialservices sectors.  The unrealized lossesin these sectors were company and sector specific.  As of June 30, 2009, we have theintent and ability to hold our equity securities with unrealized losses untilrecovery.

 

We have a comprehensiveportfolio monitoring process to identify and evaluate each fixed income andequity security whose carrying value may be other-than-temporarilyimpaired.  The process includes aquarterly review of all securities using a screening process to identifysituations where the fair value, compared to amortized cost for fixed incomesecurities and cost for equity securities, is below established thresholds forcertain time periods, or which are identified through other monitoring criteriasuch as ratings, ratings downgrades or payment defaults.  The securities identified, in addition toother securities for which we may have a concern, are evaluated based on factsand circumstances for inclusion on our watch-list.  All investments in an unrealized loss position at June 30,2009 were included in our portfolio monitoring process for determining whetherdeclines in value were other than temporary.

 

63

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

 
| **($ in millions, except number of issues)**                                                                                                                              | ** ** | **June 30,  2009** | ** ** | **December 31,  2008**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **Fixed  income**       | ** ** | ** **                   | ** ** | ** ** | ** ** | **Fixed  income** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                                          | ** ** | **Investment  grade**   | ** ** | **Below  investment  grade** | ** ** | **Equity** | ** ** | **Total** | ** ** | **Investment  grade** | ** ** | **Below  investment  grade** | ** ** | **Equity** | ** ** | **Total** | ** ** |
|                                                                                                                                                                                |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category  (I): Unrealized loss less than 20% of cost (1) (3)                                                                                                              |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                                   |       | 1,639                   |       |                         | 163        |   |   | 7 |   |   | 1,809 |   |   | 1,933 |   |   | 113 |   |   | 4 |   |   | 2,050 |   |
| Fair  value                                                                                                                                                                         | $          |                    | 16,374     |                         | $          |   | 1,116 |   | $ |   | 90 |   | $ |   | 17,580 |   | $ |   | 18,433 |   | $ |   | 622 |   | $ |   | 31 |   | $ |   | 19,086 |   |
| Unrealized                                                                                                                                                                          | $          |                    | (1,214     | )                            | $          |   | (115 | ) | $ |   | (1 | ) | $ |   | (1,330 | ) | $ |   | (1,627 | ) | $ |   | (82 | ) | $ |   | (3 | ) | $ |   | (1,712 | ) |
|                                                                                                                                                                                |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category  (II): Unrealized loss greater than or equal to 20% of cost for a period of  less than 6 consecutive months (1) (2) (3)                                          |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                                   |       | 162                     |       |                         | 49         |   |   | 7 |   |   | 218 |   |   | 853 |   |   | 183 |   |   | 35 |   |   | 1,071 |   |
| Fair  value                                                                                                                                                                         | $          |                    | 1,241      |                         | $          |   | 239 |   | $ |   | 23 |   | $ |   | 1,503 |   | $ |   | 6,346 |   | $ |   | 802 |   | $ |   | 24 |   | $ |   | 7,172 |   |
| Unrealized                                                                                                                                                                          | $          |                    | (552       | )                            | $          |   | (171 | ) | $ |   | (9 | ) | $ |   | (732 | ) | $ |   | (4,442 | ) | $ |   | (553 | ) | $ |   | (22 | ) | $ |   | (5,017 | ) |
|                                                                                                                                                                                |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category  (III): Unrealized loss greater than or equal to 20% of cost for a period of 6  or more consecutive months, but less than 12 consecutive months (1) (2) (3) |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                                   |       | 399                     |       |                         | 101        |   |   | 1 |   |   | 501 |   |   | 193 |   |   | 19 |   |   | — |   |   | 212 |   |
| Fair  value                                                                                                                                                                         | $          |                    | 2,671      |                         | $          |   | 465 |   | $ |   | 2 |   | $ |   | 3,138 |   | $ |   | 783 |   | $ |   | 79 |   | $ |   | — |   | $ |   | 862 |   |
| Unrealized                                                                                                                                                                          | $          |                    | (2,284     | )                            | $          |   | (482 | ) | $ |   | (1 | ) | $ |   | (2,767 | ) | $ |   | (1,579 | ) | $ |   | (139 | ) | $ |   | — |   | $ |   | (1,718 | ) |
|                                                                                                                                                                                |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Category  (IV): Unrealized loss greater than or equal to 20% of cost for 12 or more  consecutive months (1) (2) (3)                                                       |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number  of issues                                                                                                                                                                   |       | 167                     |       |                         | 129        |   |   | — |   |   | 296 |   |   | 33 |   |   | 4 |   |   | — |   |   | 37 |   |
| Fair  value                                                                                                                                                                         | $          |                    | 609        |                         | $          |   | 402 |   | $ |   | — |   | $ |   | 1,011 |   | $ |   | 66 |   | $ |   | 7 |   | $ |   | — |   | $ |   | 73 |   |
| Unrealized                                                                                                                                                                          | $          |                    | (1,074     | )                            | $          |   | (1,014 | ) | $ |   | — |   | $ |   | (2,088 | ) | $ |   | (176 | ) | $ |   | (13 | ) | $ |   | — |   | $ |   | (189 | ) |
|                                                                                                                                                                                |       |                    |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  number of issues                                                                                                                                                             |       | 2,367                   |       |                         | 442        |   |   | 15 |   |   | 2,824 |   |   | 3,012 |   |   | 319 |   |   | 39 |   |   | 3,370 |   |
| Total  fair value (3)                                                                                                                                                               | $          |                    | 20,895     |                         | $          |   | 2,222 |   | $ |   | 115 |   | $ |   | 23,232 |   | $ |   | 25,628 |   | $ |   | 1,510 |   | $ |   | 55 |   | $ |   | 27,193 |   |
| Total  unrealized losses                                                                                                                                                            | $          |                    | (5,124     | )                            | $          |   | (1,782 | ) | $ |   | (11 | ) | $ |   | (6,917 | ) | $ |   | (7,824 | ) | $ |   | (787 | ) | $ |   | (25 | ) | $ |   | (8,636 | ) |

 

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| (1)    | For  fixed income securities, cost represents amortized cost.                                                                                                                                                                                                                                                                                            |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                     |
| (2)    | The  aging of unrealized losses, and therefore the time period category of aging,  as of June 30, 2009 was reset to the historical point of impairment for  securities impacted by the adoption of FSP FAS 115-2. December 31, 2008  balances have not been restated.                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                     |
| (3)    | Categories  include unrealized losses resulting from factors other than credit on fixed  income securities with other-than-temporary impairments for which we have  recorded a credit loss in earnings as follows: Category (I) $7 million, Category (II) $20 million, Category  (III) $110 million, and Category (IV) $268 million. |

 

The largest individual unrealized loss was$14 million for category (I), $28 million for category (II), $67 million for category(III), and $34 million for category (IV) as of June 30, 2009.

 

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

 

Categories (III) and (IV) havehistorically been affected by industry and issue specific, or issuer specificconditions.  All of the securities inthese categories are monitored for other-than-temporary impairment.

 

64

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

 
| **($ in millions)**    | ** ** | **Category (III)**    | ** ** | **Category (IV)**           | ** ** |
|-----------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                  | ** ** | **Fair********value** | ** ** | **Unrealized  losses** | ** ** | **Fair********value** | ** ** | **Unrealized  losses** | ** ** |
| Municipal                   | $          |                  | 211        | $                           |       | (172 | ) | $ |   | 5 | $ |   | (5 | ) |
| Corporate                   |       | 1,387                 |       | (751                        | )          |   | 236 |   | (182 | ) |
| Foreign  government         |       | 3                     |       | (1                          | )          |   | — |   | — |   |
| CMBS                        |       | 803                   |       | (1,103                      | )          |   | 122 |   | (424 | ) |
| RMBS                        |       | 472                   |       | (461                        | )          |   | 318 |   | (735 | ) |
| ABS                         |       | 249                   |       | (274                        | )          |   | 330 |   | (742 | ) |
| Redeemable  preferred stock |       | 11                    |       | (4                          | )          |   | — |   | — |   |
|                        | $          |                  | 3,136      | $                           |       | (2,766 | ) | $ |   | 1,011 | $ |   | (2,088 | ) |

 

As a result of the adoption of FSP FAS 115-2on April 1, 2009, the following amounts changed into Categories (III) and(IV) as of June 30, 2009.

 
| **($ in millions)****Previous category as of March 31, 2009** | ** ** | **Securities reclassified as********Category (III)**       | ** ** | **Securities reclassified as********Category (IV)** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                              | ** ** | **Unrealized loss  impact from  cumulative effect****(1)** | ** ** | **Fair value****(1)**                               | ** ** | **Unrealized loss  impact from  cumulative effect****(1)** | ** ** | **Fair value****(1)** | ** ** |
| Unrealized gain                                                         | $          |                                                       | (66        | )                                                   | $          |   | 42 | $ |   | (125 | ) | $ |   | 28 |   |
| (I)                                                                     |       | (17                                                        | )          |                                                | 14         |   | (72 | ) |   | 24 |   |
| (II)                                                                    |       | (109                                                       | )          |                                                | 363        |   | (183 | ) |   | 76 |   |
|                                                                    | $          |                                                       | (192       | )                                                   | $          |   | 419 | $ |   | (380 | ) | $ |   | 128 |   |

 

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(1) Valuesare presented to reflect the impact to the respective categories.

 

Gross unrealized losses on fixed incomesecurities in Category (II) decreased $4.27 billion since December 31,2008.  This change was primarily theresult of $2.79 billion of losses shifting into Category (III) and (IV) dueto continued aging of losses in a continuous unrealized loss position ofgreater than or equal to 20% of amortized cost and the resetting of unrealizedlosses to the historical point of impairment for securities impacted by theadoption of FSP FAS 115-2.  The remainderof the reduction in Category (II) is a result of improved marketconditions resulting in higher valuations, which either caused a shift toCategory (I) or created an overall gross unrealized gain position andtherefore eliminated the securities from the population altogether.

 

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

 

Whenever ourinitial analysis indicates that a fixed income security’s unrealized loss of20% or more for at least 36 months or any equity security’s unrealized loss of20% or more for at least 12 months is temporary, additional evaluations andmanagement approvals are required to substantiate that the unrealized loss isrelated to other factors and recognition of a credit loss write-down is notappropriate.  As of June 30, 2009,one security with an unrealized loss of $7 million met this criteria.

 

We also monitor the quality of our fixed incomeand bank loan portfolios by categorizing certain investments as “problem”, “restructured”or “potential problem.”  Problem fixedincome securities and bank loans are in default with respect to principal orinterest and/or are investments issued by companies that have gone intobankruptcy subsequent to our acquisition or loan.  Fixed income and bank loan investments arecategorized as restructured when the debtor is in financial difficulty and wegrant a concession.  Potential problemfixed income or bank loan investments are current with respect to contractualprincipal and/or interest, but because of other facts and circumstances, wehave concerns regarding the borrower’s ability to pay future principal andinterest according to the original terms, which causes us to believe theseinvestments may be classified as problem or restructured in the future.

 

65

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

 
| **($ in millions)**              | ** ** | **June 30, 2009** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **Par  value****(1)**  | ** ** | **Amortized  cost ****(1)** | ** ** | **Amortized   cost as a  percent of  par value** | ** ** | **Fair  value** | ** ** | **Fair value as   a percent of  par value** | ** ** | **Percent of   total fixed   income and  bank loan  portfolios** | ** ** |
| Restructured                          | $          |                   | 93         | $ |   | 69 |   | 74.2 | % | $ |   | 57 |   | 61.3 | % | 0.2 | % |
| Problem                               |       | 949                    |       | 219 |   | 23.1 |   |   | 168 |   | 17.7 |   | 0.3 |   |
| Potential problem                     |       | 2,004                  |       | 1,448 |   | 72.3 |   |   | 593 |   | 29.6 |   | 1.2 |   |
| Total net carrying value              | $          |                   | 3,046      | $ |   | 1,736 |   | 57.0 |   | $ |   | 818 |   | 26.9 |   | 1.7 | % |
| Cumulative write-downs recognized (2) |       |                   | $          |   | 1,236 |   |   |   |   |   |   |   |   |   |   |

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

 

----

(1) Thedifference between par value and amortized cost of $1.31 billion at June 30,2009 and $1.43 billion at December 31, 2008 is primarily attributable towrite-downs.  Par value has been reducedby principal payments.

 

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

 

At June 30,2009, amortized cost for the problem category was $219 million and was comprisedof $104 million of corporates (primarily privately placed), $39 million ofSubprime and $29 million of bank loans. Also included were $25 million of other CDO, $12 million of municipalbonds, $9 million of other ABS and $1 million of Alt-A.  The increase of $31 million over December 31,2008 is primarily attributable to the addition of bank loans and Subprime.  The amortized cost of problem investmentswith a fair value less than 70% of amortized cost totaled $86 million, withunrealized losses of $50 million and fair value of $36 million.

 

At June 30,2009, amortized cost for the potential problem category was $1.45 billion andwas comprised of $596 million of Subprime, $304 million of corporates(primarily privately placed), $212 million of other CDO, $181 million of Alt-Aand $85 million of CMBS.  Also included were $31 million of bankloans, $23 million of municipal bonds and $15 million of other ABS.  The increase of $1.02 billion over December 31,2008 is primarily attributable to the additions of Subprime, corporates(primarily privately placed), Alt-A and CMBS. The amortized cost of potential problem investments with a fair valueless than 70% of amortized cost totaled $1.21 billion, with unrealized lossesof $829 million and fair value of $385 million.

 

We evaluated each of theseinvestments through our portfolio monitoring process at June 30, 2009 andrecorded write-downs reflecting the estimated credit loss whenappropriate.  We further concluded thatany remaining unrealized losses on these investments were due to factors otherthan credit loss and were temporary in nature. For fixed income securities, we have not made the decision to sell andit is not more likely than not we will be required to sell before recovery ofthe amortized cost basis.

 

66

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

 
| **($ in millions)**          | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed income securities           | $          |                                        | 639        |                                      | $          |   | 772 |   | $ |   | 1,320 |   | $ |   | 1,598 |   |
| Mortgage loans                    |       | 129                                         |       |                                      | 145        |   |   | 263 |   |   | 291 |   |
| Equity securities                 |       | 1                                           |       |                                      | 3          |   |   | 2 |   |   | 4 |   |
| Limited partnership interests     |       | 2                                           |       |                                      | 13         |   |   | 4 |   |   | 37 |   |
| Short-term                        |       | 3                                           |       |                                      | 32         |   |   | 10 |   |   | 48 |   |
| Other                             |       | (10                                         | )          |                                      | (7         | ) |   | (16 | ) |   | 13 |   |
| Investment income, before expense |       | 764                                         |       |                                      | 958        |   |   | 1,583 |   |   | 1,991 |   |
| Investment expense                |       | (23                                         | )          |                                      | (36        | ) |   | (45 | ) |   | (77 | ) |
| Net investment income (1)         | $          |                                        | 741        |                                      | $          |   | 922 |   | $ |   | 1,538 |   | $ |   | 1,914 |   |

 

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(1)   Beginning in the fourthquarter of 2008, income from EMA LP is reported in realized capital gains andlosses.  EMA LP income for periods priorto the fourth quarter of 2008 is reported in net investment income.  The amount of EMA LP income included in netinvestment income was $8 million and $23 million in the three months and sixmonths ended June 30, 2008, respectively.

 

Net investment income decreased 19.6% or $181 million in the second quarter of 2009 anddecreased 19.6% or $376 million in the first six months of 2009 compared to thesame periods of 2008.  These declineswere primarily due to lower investment yields on fixed and floating rate fixedincome securities as well as short-term investments, decreased investmentbalances due to net reductions in contractholder funds and lower income fromlimited partnership interests.

 

During the first sixmonths of 2009, our fixed income and mortgage loan portfolio continued togenerate significant cash flows from maturities, principal and interestreceipts totaling $3.91 billion which was consistent with amounts due.  These cash flows will be available to takeadvantage of market opportunities and manage liabilities.  Increasedmarket stability drove a more positive market outlook and improved liquidity inthe portfolios, which led us to deploy more than $2.50 billion of short-terminvestments and cash receipts into fixed income securities to generate incomeand capital appreciation.

 

67

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

 
| **($ in millions)**                                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **2009**                              | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Impairment  write-downs (1)                                        | $          |                                  | (203       | )                                         | $          |   | (199 | ) | $ |   | (555 | ) | $ |   | (403 | ) |
| Change in  intent write-downs (2)                                  |       | (25                                   | )          |                                      | (730       | ) |   | (57 | ) |   | (754 | ) |
| Net  other-than-temporary impairment losses recognized in earnings |       | (228                                  | )          |                                      | (929       | ) |   | (612 | ) |   | (1,157 | ) |
| Sales                                                              |       | 163                                   |       |                                      | (13        | ) |   | 521 |   |   | (56 | ) |
| Valuation  of derivative instruments                               |       | 179                                   |       |                                      | 8          |   |   | 262 |   |   | (194 | ) |
| Settlements  of derivative instruments                             |       | 41                                    |       |                                      | 2          |   |   | 23 |   |   | 47 |   |
| EMA LP  income (3)                                                 |       | (33                                   | )          |                                      | —     |   |   | (110 | ) |   | — |   |
| Realized  capital gains and losses, pre-tax                        |       | 122                                   |       |                                      | (932       | ) |   | 84 |   |   | (1,360 | ) |
| Income  tax (expense) benefit (4)                                  |       | (39                                   | )          |                                      | 326        |   |   | (168 | ) |   | 476 |   |
| Realized  capital gains and losses, after-tax                      | $          |                                  | 83         |                                      | $          |   | (606 | ) | $ |   | (84 | ) | $ |   | (884 | ) |

 

----

(1)   Beginning April 1,2009 for fixed income securities, impairment write-downs reflect the creditloss component of issue specific other-than-temporary declines in fair valuewhere the amortized cost basis is not expected to be entirely recovered.  For periods prior to April 1, 2009 forfixed income securities and all periods for equity securities, impairmentwrite-downs reflect issue specific other-than-temporary declines in fair value,including instances where we could not reasonably assert that the recoveryperiod would be temporary.  Impairmentwrite-downs on fixed income securities were $189 million in the first quarterof 2009.

 

(2)   Beginning April 1,2009 for fixed income securities, change in intent write-downs reflectinstances where we have made a decision to sell the security or it is morelikely than not we will be required to sell the security before recovery of itsamortized cost basis.  For periods priorto April 1, 2009 for fixed income securities and all periods for equitysecurities, change in intent write-downs reflect instances where we could notassert a positive intent to hold until recovery.  Change in intent write-downs on fixed incomesecurities were $20 million in the first quarter of 2009.

 

(3)   Beginning inthe fourth quarter of 2008, income from EMA LP is reported in realized capitalgains and losses.  EMA LP income forperiods prior to the fourth quarter of 2008 is reported in net investmentincome.

 

(4)   Income taxexpense for the six months ended June 30, 2009 includes expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital lossesrecorded in the first quarter of 2009. This valuation allowance was released in connection with the adoption ofFSP FAS 115-2 on April 1, 2009; however, the release was recorded as anincrease to retained income and therefore did not reverse the amount recordedin income tax expense on a year-to-date basis. For a further discussion of changes in this valuation allowance, see theDeferred Taxes section of the MD&A.

 

*Impairmentwrite-downs* are presentedin the following table.

 
| **($ in millions)**       | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2009**                              | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed  income securities       | $          |                                  | (158       | )                                         | $          |   | (189 | ) | $ |   | (347 | ) | $ |   | (386 | ) |
| Mortgage  loans                |       | (15                                   | )          |                                      | —     |   |   | (43 | ) |   | — |   |
| Equity  securities             |       | (1                                    | )          |                                      | (5         | ) |   | (20 | ) |   | (6 | ) |
| Limited  partnership interests |       | (21                                   | )          |                                      | (4         | ) |   | (115 | ) |   | (7 | ) |
| Other  investments             |       | (8                                    | )          |                                      | (1         | ) |   | (30 | ) |   | (4 | ) |
| Impairment  write-downs        | $          |                                  | (203       | )                                         | $          |   | (199 | ) | $ |   | (555 | ) | $ |   | (403 | ) |

 

$130 million or82.3% and $184 million or 53.0% of the fixed income security write-downs forthe three months and six months ended June 30, 2009, respectively, relatedto impaired securities that were performing in line with anticipated orcontractual cash flows but were written down primarily because of expected deteriorationin the performance of the underlying collateral or our assessment of theprobability of future default.  As of June 30,2009, there have either been no defaults or defaults have only impacted classeslower than our position in the capital structure.  $26 million and $84 million of the fixedincome security write-downs for the three months and six months ended June 30,2009, respectively, related to securities experiencing a significant departurefrom anticipated cash flows; however, we believe they retain economicvalue.  $2 million and $62 million forthe three months and six months ended June 30, 2009, respectively, relatedto securities for which future cash flows are very uncertain.

 

68

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Equity securities werewritten down primarily due to the length of time and extent fair value wasbelow cost, considering our assessment of the financial condition, near-termand long-term prospects of the issuer, including relevant industry conditionsand trends.  Hybrid corporate fixedincome securities are assessed for other-than-temporary impairment as fixedincome securities, when they are expected to perform like a fixed incomesecurity.  However, when credit-relatedreasons increase the risk of deferred payment, they may be assessed forother-than-temporary impairment in a manner similar to equity securities.  There were four hybrid corporate fixed incomesecurities with a fair value of $12 million which were assessed and writtendown in the second quarter of 2009 for other-than-temporary impairment asequity securities.

 

Limitedpartnership impairment write-downs related primarily to Cost LP whichexperienced significant declines in portfolio valuations and we could notassert the recovery period would be temporary.

 

Impairmentwrite-downs on fixed income securities are presented in the following table.

 
| **($ in millions)**                                                     | ** ** | **Three months ended********June 30, 2009** | ** ** | **Six months ended********June 30, 2009** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| **Performing in accordance with  anticipated or contractual cash flows**     | ** ** | ** **                                       | ** ** | ** **                                     | ** ** |
| Alt-A                                                                        |       |                                             |       |                                           |       |
| No defaults in underlying collateral                                         | $          |                                             | (3         | )                                              | $          |   | (10 | ) |
| Defaults lower in capital structure                                          |       | —                                           |       |                                           | (1         | ) |
|                                                                         |       | (3                                               | )          |                                           | (11        | ) |
| Subprime                                                                     |       | (41                                              | )          |                                           | (41        | ) |
| CMBS                                                                         |       | (44                                              | )          |                                           | (46        | ) |
| Other CDO                                                                    |       | (1                                               | )          |                                           | (18        | ) |
| Synthetic CDO                                                                |       | (18                                              | )          |                                           | (18        | ) |
| Corporate                                                                    |       |                                             |       |                                           |       |   |
| Entertainment                                                                |       | —                                           |       |                                           | (20        | ) |
| Hybrids                                                                      |       | (30                                              | )          |                                           | (30        | ) |
| Other                                                                        |       | 7                                                |       |                                           | —     |   |
| Subtotal                                                                     |       | (23                                              | )          |                                           | (50        | ) |
| Subtotal performing in accordance with anticipated  or actual cash flows (1) |       | (130                                             | )          |                                           | (184       | ) |
| ** **                                                                   |       |                                             |       |                                           |       |   |
| **Departure from anticipated or  contractual cash flows**                    |       |                                             |       |                                           |       |   |
| Future cash flows expected –                                            |       |                                             |       |                                           |       |   |
| Subprime                                                                     |       | —                                           |       |                                           | (5         | ) |
| Municipal Bonds                                                              |       | (16                                              | )          |                                           | (16        | ) |
| Other CDO                                                                    |       | (9                                               | )          |                                           | (62        | ) |
| Corporate                                                                    |       |                                             |       |                                           |       |   |
| Other                                                                        |       | (1                                               | )          |                                           | (1         | ) |
| Subtotal expected future cash flows****(2)                                   |       | (26                                              | )          |                                           | (84        | ) |
|                                                                         |       |                                             |       |                                           |       |   |
| Future cash flows very uncertain -                                           |       |                                             |       |                                           |       |   |
| Other CDO                                                                    |       | —                                           |       |                                           | (60        | ) |
| Corporate                                                                    |       |                                             |       |                                           |       |   |
| Financials                                                                   |       | (2                                               | )          |                                           | (2         | ) |
| Subtotal very uncertain future cash flows                                    |       | (2                                               | )          |                                           | (62        | ) |
| Investments disposed                                                         |       | —                                           |       |                                           | (17        | ) |
| **Total fixed income securities**(3)                                         | $          |                                             | (158       | )                                              | $          |   | (347 | ) |

 

----

(1)   Written down primarilybecause of expected deterioration in the performance of the underlyingcollateral or our assessment of the probability of future default.  As of June 30, 2009, forthe securities with direct interest in the lender, there have been nodefaults.  For securities supported bycollateral, there have been no defaults or defaults that have occurred inclasses lower in the capital structure.

 

(2)   Experienced a significantdeparture from anticipated residual cash flows. While these fixed income security write-downs were valued at asignificant discount to cost, we believe these securities retain economicvalue.

 

(3)   Impairment write-downs on ourilliquid portfolios were $116 million and $261 million for the three months andsix months ended June 30, 2009.

 

69

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

 

| **($ in millions)**      | ** ** | **Three months ended********June 30,** | ** ** | **Six months ended********June 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Fixed  income securities      | $          |                                        | (20        | )                                         | $          |   | (687 | ) | $ |   | (40 | ) | $ |   | (709 | ) |
| Mortgage  loans               |       | —                                      |       |                                      | (32        | ) |   | (6 | ) |   | (33 | ) |
| Equity  securities            |       | —                                      |       |                                      | (11        | ) |   | (6 | ) |   | (12 | ) |
| Other  investments            |       | (5                                          | )          |                                      | —     |   |   | (5 | ) |   | — |   |
| Change  in intent write-downs | $          |                                        | (25        | )                                         | $          |   | (730 | ) | $ |   | (57 | ) | $ |   | (754 | ) |

 

BeginningApril 1, 2009, change in intent write-downs for fixed income securitiesreflect instances where we have made the decision to sell the security or it ismore likely than not we will be required to sell the security before recoveryof its amortized cost basis.  For periodsprior to April 1, 2009 for fixed income securities and all periods forequity securities, change in intent write-downs reflect instances where wecould not assert a positive intent to hold until recovery.  Change in intent write-downs for mortgageloans and other investments reflect instances where the loans have beenclassified as held for sale.

 

The change inintent write-downs in the three months and six months ended June 30, 2009were a result of ongoing comprehensive reviews of our portfolios resulting inwrite-downs of individually identified investments.  At June 30, 2009, the fair value offixed income securities for which we have made the decision to sell totaled$101 million and the fair value of equity securities for which we do not havethe intent to hold until recovery totaled $4 million.

 

*Sales*generated $163 million and $521 millionof net realized gains for the three months and six months ended June 30,2009, respectively, and were primarily due to $187 million and $508 million ofgains on sales of U.S. and foreign governmental securities for the three monthsand six months ended June 30, 2009, respectively.

 

*Valuationand settlement of derivative instruments*net realized capital gains totaling $285 million forthe six months ended June 30, 2009 included $262 million of gains on thevaluation of derivative instruments and $23 million of gains on the settlementof derivative instruments.  For the sixmonths ended June 30, 2008, net realized capital losses on the valuationand settlement of derivative instruments totaled $147 million.

 

At June 30,2009, our securities with embedded options totaled $816 million and decreasedin fair value from December 31, 2008 by $156 million, comprised ofrealized capital gains on valuation of $2 million, net sales activity of $144million, and unrealized net capital losses reported in other comprehensiveincome (“OCI”) of $14 million for the host securities.  Net unrealized capital losses were furtherincreased by $14 million due to amortization and impairment write-downs on thehost securities.  The change in fairvalue of embedded options is bifurcated from the host securities, separatelyvalued and reported in realized capital gains and losses, while the change inthe difference between the fair value and the amortized cost of the hostsecurities is reported in OCI.  Total amortizedcost exceeded total fair value by $52 million at June 30, 2009.  Valuation gains and losses are converted intocash for securities with embedded options upon our election to sell thesesecurities.  In the event the economicvalue of the options is not realized, we will recover the par value if held tomaturity unless the issuer of the note defaults.  Total par value exceeded fair value by $194million at June 30, 2009.

 

Gainsfrom the risk reduction programs, primarily our portfolio duration gap managementprogram, were related to an increase in interest rates.  A changing interest rateenvironment will drive changes in our portfolio duration targets at a tacticallevel.  A duration target and range isestablished with an economic view of liabilities relative to a long-terminvestment portfolio view.  Tacticalduration management is accomplished through both cash market transactionsincluding new purchases and derivative activities that generate realized gainsand losses.  As a component of our approachto managing portfolio duration, realized gains and losses on certain derivativeinstruments are most appropriately considered in conjunction with theunrealized gains and losses on the fixed income portfolio.  This approach mitigates the impacts of generalinterest rate changes to the overall financial condition of the Company.

 

70

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

 
| **($ in millions)**                                | ** ** | **Six  months ended June 30,** | ** ** | ** **      | ** ** |
|---------------------------------------------------------|------------|--------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **2009**                       | ** ** | **2008**        | ** ** | **2009  Explanations** | ** ** |
| ** **                                              | ** ** | **Valuation**                  | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Risk  Reduction**                                     |       |                           |       | ** **      |       |   |   |   |   |   |   |
| Duration  gap management                                | $          |                           | 237        |            | $          |   | 40 |   | $ |   | 277 |   | $ |   | (12 | ) | Interest rate caps, floors and swaps are used to  balance interest-rate sensitivities of assets and liabilities.  The contracts settle based on differences  between current market rates and a contractually specified fixed rate through  expiration.  The contracts can be  terminated and settled at anytime with a minimal additional cost.  The maximum loss on caps and floors is  limited to the amount of premiums paid.   The change in valuation reflects the changing value of expected future  settlements from changing interest rates, which may vary over the period of  the contracts.  The 2009 YTD gains,  resulting from increasing interest rates, are offset in unrealized capital  gains and losses of our fixed income securities in OCI to the extent it  relates to changes in risk-free rates. |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Anticipatory  hedging                                   |       | (5                             | )          |            | (10        | ) |   | (15 | ) |   | 23 |   | Futures are used to protect investment spread from  interest rate changes during mismatches in the timing of cash flows between  product sales and the related investment activity.  The futures contracts are exchange traded,  daily cash settled and can be exited at any time for minimal additional  cost.  If the cash flow mismatches are such  that a positive net investment position is being hedged, there is an offset  for the related investments unrealized loss in OCI.  The 2009 YTD losses reflect increases in  risk-free interest rates over the life of the net long position as liability  issuances exceeded asset acquisitions. |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedging of  interest rate exposure in annuity contracts |       | 12                             |       |            | —     |   |   | 12 |   |   | (3 | ) | Value of expected future settlements on interest rate  caps and the associated value of future credited interest, which is  reportable in future periods when incurred, increased due to an increase in  interest rates. |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedging  unrealized gains on equity indexed notes       |       | —                         |       |            | —     |   |   | — |   |   | 2 |   |   |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Hedge  ineffectiveness                                  |       | 3                              |       |            | —     |   |   | 3 |   |   | (11 | ) | The hedge ineffectiveness of $3 million includes $166  million in realized capital gains on swaps that were offset by $163 million  in realized capital losses on the hedged risk. |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Foreign currency  contracts                             |       | —                         |       |            | —     |   |   | — |   |   | (3 | ) |   |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Credit risk  reduction                                  |       | (2                             | )          |            | (12        | ) |   | (14 | ) |   | — |   | Valuation loss is the results of tightening credit  spreads on referenced credit entities. |   |
| **Total  Risk reduction**                               | $          |                           | 245        |            | $          |   | 18 |   | $ |   | 263 |   | $ |   | (4 | ) |   |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| **Income  generation**                                  |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Asset replication  — credit exposure               | $          |                           | 15         |            | $          |   | 5 |   | $ |   | 20 |   | $ |   | (16 | ) | The 2009 YTD changes in  valuation are due to tightening credit spreads on referenced credit entities,  and would only be converted to cash upon disposition, which can be done at  any time, or if the credit event specified in the contract occurs. As of  June 30, 2009, we had $486 million of notional outstanding. For further  discussion on CDS, see Note 6 of the condensed consolidated financial  statements and the CDS section of the Investment section of MD&A. |   |
|                                                    |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| **Accounting**                                          |       |                           |       |            |       |   |   |   |   |   |   |   |   |   |
| Equity indexed  notes                                   | $          |                           | (11        | )               | $          |   | — |   | $ |   | (11 | ) | $ |   | (105 | ) | Equity-indexed notes are fixed income securities that  contain embedded options. The changes in valuation of the embedded equity  indexed call options are reported in realized capital gains and losses. The  results generally track the performance of underlying equity indices.  Valuation gains and losses are converted into cash upon sale or maturity. In  the event the economic value of the options is not realized, we will recover  the par value of the host fixed income security if held to maturity unless  the issuer of the note defaults. Par value exceeded fair value by $179  million at June 30, 2009. Equity-indexed notes are subject to our  comprehensive portfolio monitoring and watchlist processes to identify and  evaluate when the carrying value may be other-than-temporarily impaired. The  following table compares the June 30, 2009 and December 31, 2008  holdings, respectively. |   |

 
|   |                                           |       |                   |       |                                  |       |                                                 |       |                        |       |
|--------|------------------------------------------------|------------|------------------------|------------|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------|------------|
|   | **($ in millions)**                       | ** ** | **June 30****,  2009** | ** ** | **Change   in fair  value** | ** ** | **Change due  to net sale  activity** | ** ** | **December 31,  2008** | ** ** |
|   | Par value                                      | $          |                   | 665        |                                  | $          |                                                 | —     | $                           |       | (135 | ) | $ |   | 800 |   |
|   | Amortized cost of  host contract               | $          |                   | 446        |                                  | $          |                                                 | 11         |                        | $          |   | (51 | ) | $ |   | 486 |   |
|   | Fair value of  equity–indexed call option |       | 77                     |       |                                  | (11        | )                                                    |       | (44                         | )          |   | 132 |   |
|   | Total amortized  cost                          | $          |                   | 523        |                                  | $          |                                                 | —     |                        | $          |   | (95 | ) | $ |   | 618 |   |
|   | Total Fair value                               | $          |                   | 486        |                                  | $          |                                                 | (31        | )                           | $          |   | (116 | ) | $ |   | 633 |   |
|   | Unrealized  gain/(loss)                        | $          |                   | (37        | )                                     | $          |                                                 | (31        | )                           | $          |   | (21 | ) | $ |   | 15 |   |

 

71

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| **($ in millions)**                       | ** ** | **Six  months ended June 30,** | ** ** | ** **      | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2009**                       | ** ** | **2008**        | ** ** | **2009  Explanations** | ** ** |
| ** **                                     | ** ** | **Valuation**                  | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Conversion  options in fixed income securities |       | 13                             |       | —          |       | 13 |   | (22 | ) | Convertible bonds are fixed income securities that  contain embedded options. Changes in valuation of the embedded option are  reported in realized capital gains and losses. The results generally track  the performance of underlying equities. Valuation gains and losses are  converted into cash upon our election to sell these securities. In the event  the economic value of the options is not realized, we will recover the par  value of the host fixed income security if held to maturity unless the issuer  of the note defaults. Par value exceeded fair value by $15 million at  June 30, 2009. Convertible bonds are subject to our comprehensive  portfolio monitoring and watchlist processes to identify and evaluate when  the carrying value may be other-than-temporarily impaired. The following  table compares the June 30, 2009 and December 31, 2008 holdings,  respectively. |   |

 
|   |                             |       |                   |       |                                  |       |                                             |       |                        |       |   |
|--------|----------------------------------|------------|------------------------|------------|---------------------------------------|------------|--------------------------------------------------|------------|-----------------------------|------------|--------|
|   | **($ in millions)**    | ** ** | **June 30****,  2009** | ** ** | **Change   in fair  value** | ** ** | **Change due  to  net sale  activity** | ** ** | **December 31,  2008** | ** ** |
|   | Par value                        | $          |                   | 345        |                                  | $          |                                             | —     |                        | $          |   | (33 | ) | $ |   | 378 |   |
|   | Amortized cost of  host contract | $          |                   | 243        |                                  | $          |                                             | 3          |                        | $          |   | (7 | ) | $ |   | 247 |   |
|   | Fair value of  conversion option |       | 102                    |       |                                  | 13         |                                             |       | (1                          | )          |   | 90 |   |
|   | Total amortized  cost            | $          |                   | 345        |                                  | $          |                                             | 16         |                        | $          |   | (8 | ) | $ |   | 337 |   |
|   | Total Fair value                 | $          |                   | 330        |                                  | $          |                                             | 19         |                        | $          |   | (28 | ) | $ |   | 339 |   |
|   | Unrealized  gain/(loss)          | $          |                   | (15        | )                                     | $          |                                             | 3          |                        | $          |   | (20 | ) | $ |   | 2 |   |
|        |                                  |            |                        |            |                                       |            |                                                  |            |                             |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **Total  accounting** | $      |   | 2      | $      |   | — | $      |   | 2      |   | $      |   | (127 | ) |   |   |
|-----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|------|---|--------|--------|
| ** **            |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**             | $      |   | 262    | $      |   | 23     | $      |   | 285    | (1)    | $      |   | (147 | ) |   |   |

 

----

(1)   Does not include $5 million of derivative gains related to thetermination of fair value hedges and cash flow hedges which are included insales and reported with the hedged risk.

 

Included in the table above arenet realized capital losses on the valuation and settlement of derivativeinstruments related to credit spread risk hedging from our risk mitigation andreturn optimization programs totaling $5 million for the six months ended June 30,2009.

 

**Fair Value of Assets andLiabilities**

 

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

 

·      Levelof new issuances in the primary market;

·      Tradingvolume in the secondary market;

·      Levelof credit spreads over historical levels;

·      Bid-askspread, and

·      Priceconsensus among market participants and sources.

 

When transferring these securities into Level3 due to a significant decrease in the volume and level of activity, we do notchange the source of fair value estimates or modify the estimates received fromindependent third-party valuation service providers.  Accordingly, for securities included withinthis group, there was no change in fair value for a change in model resultingin a gain or loss.

 

The second situation where we have classifiedsecurities in Level 3 is where specific inputs to our fair value estimationmodels which are considered significant are not market observable.  This has occurred in three principal categories.  The first is for certain of our privatelyplaced securities for which we utilize internally developed ratings.  The second is broker quotes.  Privately placed securities valued usinginternally developed ratings and securities valued using broker quotes wereassigned to Level 3 when we initially assigned the hierarchy in the firstquarter of 2008.  The third is our ARSbacked by student loans for which a principal assumption, the anticipated dateliquidity will return to this market, is not market observable.

 

72

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Due to the reducedavailability of actual market prices or relevant market observable inputs as aresult of the decrease in liquidity that has been experienced in the market,all Subprime and Alt-A and certain ABS, certain ARS backed by student loans andcertain CMBS are categorized as Level 3. Transfers into and out of Level 3 during the six months ended June 30,2009 are attributable to a change in the availability of market observableinformation for individual securities within the respective categories.  This included situations where a fair valuequote is not provided by our independent third-party valuation service providerand as a result the price is stale or has been replaced with a broker quoteresulting in the security being classified as Level 3.  A quote utilizing the new pricing source isnot available as of the prior period, and any gains or losses related to thechange in valuation source for individual securities are not ascertainable andare not significant.

 

The following table presents fair value as a percent of par value andamortized cost for Level 3 investments at June 30, 2009.

 
| **($ in millions)**               | ** ** | **Fair  value** | ** ** | **Fair value********as a percent of********par value** | ** ** | **Fair value********as a percent of********amortized cost** | ** ** |
|----------------------------------------|------------|-----------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Fixed income securities:               |       |            |       |                                                   |       |                                                        |       |
| Municipal                              | $          |            | 687        |                                                   | 90.3       | %                                                           | 91.0       | % |
| Corporate                              |       | 9,504           |       | 91.9                                                   |       | 96.4                                                        |       |
| RMBS                                   |       | 1,411           |       | 45.8                                                   |       | 50.6                                                        |       |
| CMBS                                   |       | 887             |       | 34.9                                                   |       | 37.3                                                        |       |
| ABS                                    |       | 1,257           |       | 43.8                                                   |       | 53.2                                                        |       |
| Redeemable preferred stock             |       | 1               |       | 100.0                                                  |       | 100.0                                                       |       |
| Equity securities                      |       | 26              |       | N/A                                                    |       | 89.7                                                        |       |
| Other investments:                     |       |            |       |                                                   |       |                                                        |       |
| Free-standing derivatives              |       | 30              |       | N/A                                                    |       | 100.0                                                       |       |
| Subtotal recurring Level 3 investments |       | 13,803          |       | 70.5                                                   |       | 75.8                                                        |       |
| Non-recurring basis                    |       | 225             |       | N/A                                                    |       | 100.0                                                       |       |
| **Total Level 3 investments**          | $          |            | 14,028     |                                                   | 71.6       |                                                        | 76.1       |   |

 

Non-recurringinvestments include certain mortgage loans, limited partnership interests andother investments remeasured at fair value due to our change in intentwrite-downs and other-than-temporary impairments at June 30, 2009.

 

**APPLICATION OF CRITICAL ACCOUNTING ESTIMATES**

 

The preparation of financial statements in conformity with GAAPrequires management to adopt accounting policies and make estimates andassumptions that affect amounts reported in the consolidated financialstatements.

 

In applyingpolicies, management makes subjective and complex judgments that frequentlyrequire estimates about matters that are inherently uncertain.  Many of these policies, estimates and relatedjudgments are common in the insurance and financial services industries; othersare specific to our businesses and operations. It is reasonably likely that changes in these estimates could occur fromperiod to period and result in a material impact on our consolidated financialstatements.

 

Our critical accounting estimate for theimpairment of fixed income and equity securities follows.  For a description of critical accountingestimates not discussed below, see the Application of Critical AccountingEstimates section of the MD&A found under Part II. Item 7. of theAllstate Life Insurance Company Annual Report on Form 10-K for 2008.

 

**Impairmentof Fixed Income and Equity Securities **Forinvestments classified as available for sale, the difference between fair valueand amortized cost for fixed income securities and cost for equity securities,net of deferred income taxes, is reported as a component of accumulated othercomprehensive income on the Consolidated Statements of Financial Position andis not reflected in the operating results of any period until reclassified tonet income upon the consummation of a transaction with an unrelated third partyor when the decline in fair value is deemed other than temporary.  We have a comprehensive portfolio monitoringprocess to identify and evaluate each fixed income and equity security whosecarrying value may be other-than-temporarily impaired.

 

Foreach fixed income security in an unrealized loss position, we assess whethermanagement with the appropriate authority**has made adecision to sell or whether it is more likely than not we will be required tosell for

 

73

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reasonssuch as liquidity, contractual or regulatory purposes before recovery of theamortized cost basis.  If a securitymeets either of these criteria, the security’s decline in fair value is deemedother than temporary and is recorded in earnings.

 

If we have not made the decision to sell thefixed income security and it is not more likely than not we will be required tosell the fixed income security before recovery of its amortized cost basis, weevaluate whether we expect to receive cash flows sufficient to recover theentire amortized cost basis of the security. We use our best estimate of future cash flows expected to becollected from the fixed income security discounted at the security’s effectiverate prior to impairment to calculate a recovery value and determine whether acredit loss exists.  The determination ofcash flow estimates is inherently subjective and methodologies may varydepending on circumstances specific to the security.  All reasonably available information relevantto the collectability of thesecurity, including past events, current conditions, and reasonable andsupportable assumptions and forecasts, are considered when developing theestimate of cash flows expected to be collected.  That information generally includes, but maynot be limited to, the remaining payment terms of the security, prepaymentspeeds, foreign exchange rates, the financial condition of the issuer(s),expected defaults, expected recoveries, the value of the underlying collateraland current subordination levels, vintage, geographic concentration, availablereserves or escrows, third party guarantees and other credit enhancements.  Additionally, other information, such asindustry analyst reports and forecasts, sector credit ratings, financialcondition of the bond insurer for insured fixed income securities, and othermarket data relevant to the collectability of the security may also beconsidered.  The estimated fair value ofcollateral may be used to estimate recovery value if we determine that the securityis dependent on the liquidation of collateral for recovery.  If the estimated recovery value is less thanthe amortized cost of the security, a credit loss exists and another-than-temporary impairment for the difference between the estimatedrecovery value and amortized cost is recorded in earnings.  If we determine that the fixed incomesecurity does not have sufficient cash flow or other information to determine arecovery value for the security, we may conclude that the entire decline infair value is deemed to be credit related and is recorded in earnings.  The unrealized loss deemed to be related tofactors other than credit remains classified in other comprehensive income.

 

There are anumber of assumptions and estimates inherent in evaluating impairments ofequity securities and determining if they are other than temporary, including:1) our ability and intent to hold the investment for a period of timesufficient to allow for an anticipated recovery in value; 2) the length of timeand extent to which the fair value has been less than cost; 3) the financialcondition, near-term and long-term prospects of the issue or issuer, includingrelevant industry conditions and trends, geographic location and implicationsof rating agency actions and offering prices; and 4) the specific reasons thata security is in a significant unrealized loss position, including marketconditions which could affect liquidity.

 

Once assumptions and estimatesare made, any number of changes in facts and circumstances could cause us tosubsequently determine that an impairment is other than temporary, including:1) general economic conditions that are worse than previously forecasted orthat have a greater adverse effect on a particular issuer or industry sectorthan originally estimated; 2) changes in the facts and circumstances related toa particular issue or issuer’s ability to meet all of its contractualobligations; and 3) changes in facts and circumstances obtained that result inan intent to sell or result in our assessment that it is more likely than notwe will be required to sell before recovery of the amortized cost of a fixedincome security or causes a change in our ability or intent to hold an equitysecurity until it recovers in value. Changes in assumptions, facts and circumstances could result inadditional charges to earnings in future periods to the extent that losses arerealized.  The charge to earnings, whilepotentially significant to net income, would not have a significant effect onshareholder’s equity, since the majority of our portfolio is designated asavailable-for-sale and carried at fair value and as a result, any related netunrealized loss would already be reflected as a component of accumulated othercomprehensive income in shareholder’s equity.

 

Thedetermination of the amount of impairment is an inherently subjective processbased on periodic evaluation of the factors described above.  Such evaluations and assessments are revisedas conditions change and new information becomes available.  We update our evaluations regularly andreflect changes in other-than-temporary impairments in results of operations assuch evaluations are revised.  The use ofdifferent methodologies and assumptions in the determination of the amount ofimpairments may have a material effect on the amounts presented within theconsolidated financial statements.

 

Fixed income securities subject to other-than-temporary impairmentwrite-downs continue to earn investment income when future expected paymentsare both reasonably estimable and probable, and any discount or premium is

 

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recognized using the effective yield method over the expected life ofthe security; otherwise income recognition is discontinued.

 

**DEFERRED TAXES**

 

Weevaluate whether a valuation allowance for our deferred tax assets is requiredeach reporting period.  A valuationallowance is established if, based on the weight of available evidence, it ismore likely than not that some portion or all of the deferred income tax assetwill not be realized.  In determiningwhether a valuation allowance is needed, all available evidence isconsidered.  This includes the potentialfor capital and ordinary loss carryback, future reversals of existing taxabletemporary differences, tax planning strategies that we may employ to avoid atax benefit from expiring unused and future taxable income exclusive ofreversing temporary differences.

 

Withrespect to our evaluation of the need for a valuation allowance related to thedeferred tax asset on capital losses that have been realized but have not yetbeen recognized for tax purposes, we utilize prudent and feasible tax planningstrategies that optimize the ability to carry back capital losses as well asthe ability to offset future capital losses with unrealized capital gains thatcould be recognized for tax purposes.

 

With respect to our evaluation of the need for a valuation allowancerelated to the deferred tax asset on unrealized capital losses on fixed incomeand equity securities, our tax planning strategies first consider theavailability of unrealized capital gains to offset future capital losses andthen we rely on our assertion that we have the intent and ability to hold thesecurities with unrealized losses to recovery. As a result, the unrealized losses on these securities would not beexpected to materialize and no valuation allowance on the associated deferredtax asset is needed.

 

The total deferred tax valuation allowance was zero at June 30,2009 compared to $148 million at March 31, 2009 and $9 million at December 31,2008.  The following table shows howchanges in the valuation allowance were recorded in the condensed consolidatedfinancial statements in the first six months of 2009.

 
| ** ** | **($ in  millions)**                   | ** ** | **Adjustments  recorded in  the three months ended  March 31, 2009** | ** ** | **Adjustments  recorded in  the three months ended  June 30, 2009** | ** ** | ** **                                                         | ** ** |
|------------|---------------------------------------------|------------|---------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** ** | ** **                                  | ** ** | ** **                                                                | ** ** | ** **                                                               | ** ** | **Impact  of adoption of FSP  FAS 115-2 as of April 1, 2009** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** ** | **Balance  as of  December 31,  2008** | ** ** | **Decrease  to  income**                                                  | ** ** | **Increase  to other  comprehensive  income**                            | ** ** | **Increase  in retained  income**                                  | ** ** | **Increase  in other  comprehensive  income** | ** ** | **Increase  to  income** | ** ** | **Increase  to  other  comprehensive  income** | ** ** | **Balance  as of  June 30,  2009** | ** ** |
|       |                                        |       |                                                                      |       |                                                                     |       |                                                               |       |   |   |   |   |   |   |   |   |
| $          |  9                                     | $          |                                                                      | 142        | $                                                                        |       | (3                                                                 | )          | $ |   | (142 | ) | $ |   | — | $ |   | (5 | ) | $ |   | (1 | ) | $ |   | — |   |
|            |                                             |            |                                                                           |            |                                                                          |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Income tax expense for the six months ended June 30, 2009 includes expense of $142 million attributableto an increase in the valuation allowance relating to the deferred tax asset oncapital losses recorded in the first quarter of 2009, which were primarilyrelated to other-than-temporary impairment write-downs that were not deductiblefor tax purposes as of March 31, 2009. This valuation allowance was released in connection with the adoption ofFSP FAS 115-2 on April 1, 2009; however, the release was recorded as anincrease to retained income and therefore did not reverse the amount recordedin income tax expense on a year-to-date basis. The release of the valuation allowance is related to the reclassificationof previously recorded other-than-temporary impairment write-downs fromretained income to unrealized capital losses.

 

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**CAPITAL RESOURCES AND LIQUIDITY HIGHLIGHTS**

 

·                  Shareholder’s equity as of June 30, 2009 was $3.84 billion,an increase of 73.7% from $2.21 billion as of December 31, 2008.

·                  TheAllstate Corporation (the “Corporation”) has at the parent holding companylevel $3.38 billion of deployable invested assets at June 30, 2009compared to $3.64 billion at December 31, 2008.

·                  As of June 30, 2009, ALICstatutory surplus is approximately $3.4 billion compared to $3.2 billion at December 31,2008.

·                  At June 30, 2009, we held 17.1%of our total cash and investment portfolio, or $9.96 billion, in cash and otherliquid investments that are saleable within one quarter without significantadditional net realized capital losses.

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

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

 

**CAPITAL RESOURCES AND LIQUIDITY**

 

**Capital Resources**consist of shareholder’s equity and surplus notes due to related parties,representing funds deployed or available to be deployed to support businessoperations.  The following tablesummarizes our capital resources.

 
| **($ in millions)**                                      | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Common  stock, additional capital paid-in and retained income | $          |                   | 4,941      |                       | $          |   | 4,546 |   |
| Accumulated  other comprehensive loss                         |       | (1,103                 | )          |                       | (2,337     | ) |
| Total  shareholder’s equity                              |       | 3,838                  |       |                       | 2,209      |   |
| Surplus  notes                                                |       | 650                    |       |                       | 650        |   |
| Total  capital resources                                      | $          |                   | 4,488      |                       | $          |   | 2,859 |   |

 

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

 

**Financial Ratings andStrength **Ourratings are influenced by many factors including our operating and financialperformance, asset quality, liquidity, asset/liability management, overallportfolio mix, financial leverage (i.e., debt), exposure to risks, the currentlevel of operating leverage and AIC’s ratings.

 

On August 6, 2009, Moody’s affirmed our A1 financial strengthrating.  The outlook for the ratingremained stable.  On January 29,2009, Moody’s had downgraded our financial strength rating to A1 from Aa3 andthe outlook for the rating was revised from negative to stable.  On February 2, 2009, A.M. Bestaffirmed our A+ financial strength rating. The outlook for the rating remained stable.  On January 29, 2009, S&P downgradedour financial strength rating to AA- from AA. The outlook for the rating remained negative.

 

The Company, AIC and theCorporation are party to the Liquidity Agreement which allows for short-termadvances of funds to be made between parties for liquidity and other generalcorporate purposes.  The LiquidityAgreement does not establish a commitment to advance funds on the part of any party.  The Company and AIC each serve as a lenderand borrower and the Corporation serves only as a lender.  The Company also has a capital supportagreement with AIC.  Under the capitalsupport agreement, AIC is committed to provide capital to the Company tomaintain an adequate capital level.  Themaximum amount of potential funding under each of these agreements is $1.00billion.

 

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

 

ALIC and its life insurance subsidiariesprepare their statutory-basis financial statements in conformity withaccounting practices prescribed or permitted by the insurance department of theapplicable state of domicile.  Statutorysurplus is a measure that is often used as a basis for determining dividendpaying capacity, operating

 

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leverage and premium growth capacity, and it is also reviewed by ratingagencies in determining their ratings. As of June 30, 2009, ALIC’s statutory surplus is approximately $3.4billion compared to $3.2 billion at December 31, 2008.

 

**Liquidity Sources and Uses**

 

We actively manage our financial position andliquidity levels in light of changing market, economic, and businessconditions.  We continue to takeproactive measures to maintain or enhance our economic and liquidity positionpending a return to normal capital market conditions.  Actions include managing our gross exposureto our largest exposure, interest rate risk, through active management of ourinvestment and product portfolios as well as further mitigation throughhedging.

 

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

 

·                  Continuedretention of portfolio cash flows including approximately $6.10 billion ofexpected inflows from upcoming maturities, calls and prepayments on fixedincome securities, mortgage loans and bank loans, and interest receipts oninvestments over the next twelve months. Expected interest receipts include amounts related to floating rateinvestments for which the interest rate fluctuates in accordance with marketinterest rates.  Our expectation is basedon market interest rates as of June 30, 2009.  Further, these expected portfolio cash flowsare based on investments as of June 30, 2009 and were determined withoutregard to increases in the portfolio for reasons such as the reinvestment ofportfolio cash flows or decreases due to reductions in outstandingcontractholder funds obligations.

 

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

 

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

 
| **($ in millions)**                                                       | ** ** | **As of********June 30, 2009** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Cash and short-term positions convertible to cash  available same day/next day | $          |                                | 1,187      |   |
| Other highly liquid investments (1)                                            |       | 3,228                               |       |
| Other liquid investments (2)                                                   |       | 5,547                               |       |
| Total liquid (3)                                                               | $          |                                | 9,962      |   |
|                                                                           |       |                                |       |
| Percent of total cash and investments                                          |       | 17.1                                | %          |

 

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| (1)    | Other  highly liquid investments are defined as assets that are generally saleable  within one week, and primarily include U.S. government and agencies bonds of  $1.18 billion, foreign sovereign securities of $643 million, corporate bonds  of $615 million, agency pass through securities of $449 million and common  stocks of $122 million. The amounts shown in the table above represent the  amount of our holdings in these assets, excluding any holdings with  restrictions.               |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (2)    | Other  liquid investments are defined as assets that are saleable within one  quarter, and primarily include corporate bonds of $1.92 billion, U.S.  government and agencies bonds of $956 million, agency pass through securities  of $672 million, foreign sovereign securities of $643 million and municipals  of $537 million. The amounts shown in the table above represent the amount  that we believe could be sold during the third quarter of 2009, excluding any  holdings with restrictions. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (2)    | From period to period, we may revise our definition of what is  saleable within a quarter which may result in a variation from period to  period.                                                                                                                                                                                                                                                                                                                                                        |

 

The above analysis identifies our access tointernal sources of liquidity.  Webelieve we have sufficient liquidity to address current planned needs frominvestments other than fixed income securities in an unrealized loss positionfor which we have asserted that we do not have the intent to sell the securityand it is not more likely than not we will be required to sell the securitybefore recovery of its amortized cost basis, and equity securities for which we

 

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have asserted the intent to hold until recovery, combined with targetedsales of certain products.  Additionally,we have existing intercompany agreements in place that facilitate liquiditymanagement.

 

*Allstate Parent Company Capital Capacity*****The Corporation has at the parent holdingcompany level $3.38 billion of deployable cash and investments at June 30,2009.  These assets include highly liquidsecurities that are generally saleable within one week totaling $1.98 billion,additional liquid investments that are saleable within one quarter totaling$967 million, and $436 million of investments that would require more than onequarter to sell.  This provides funds forthe parent company’s relatively low fixed charges, estimated at $680 millionfor the next twelve months.

 

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

 

Inaddition to the Capital Support Agreement and Liquidity Agreement, whichprovide a maximum amount of potential funding under each agreement of $1.00billion, the Company also has access to additional borrowing to supportliquidity through the Corporation as follows:

 

·               A commercial paperfacility with a borrowing limit of $1.00 billion to cover short-term cashneeds.  As of June 30, 2009, therewere no balances outstanding and therefore the remaining borrowing capacity was$1.00 billion; however, the outstanding balance can fluctuate daily.

·                  Aprimary credit facility is available for short-term liquidity requirements andbacks the commercial paper facility.  The$1.00 billion unsecured revolving credit facility has an initial term of fiveyears expiring in 2012 with two optional one-year extensions that can beexercised at the end of any of the remaining anniversary years of the facilityupon approval of existing or replacement lenders providing more than two-thirdsof the commitments to lend.  The programis fully subscribed among 11 lenders with the largest commitment being $185million.  The commitments of the lendersare several and no lender is responsible for any other lender’s commitment ifsuch lender fails to make a loan under the facility.  This facility contains an increase provisionthat would allow up to an additional $500 million of borrowing provided theincreased portion could be fully syndicated at a later date among existing ornew lenders.  This facility has a financialcovenant requiring that the Corporation not exceed a 37.5% debt to capitalresources ratio as defined in the agreement. This ratio at June 30, 2009 was 23.0%.  Although the right to borrow under thefacility is not subject to a minimum rating requirement, the costs ofmaintaining the facility and borrowing under it are based on the ratings of theCorporation’s senior, unsecured, nonguaranteed long-term debt.  There were no borrowings under the creditfacility during the second quarter and first six months of 2009.  The total amount outstanding at any point intime under the combination of the commercial paper program and the creditfacility cannot exceed the amount that can be borrowed under the creditfacility.

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

 

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*Liquidity Exposure*** **Contractholder fundsas of June 30, 2009 were $52.30 billion. The following table summarizes contractholder funds by their contractualwithdrawal provisions at June 30, 2009.

 
| **($ in millions)**                                 | ** ** | ** ** | ** ** | **Percent to  Total** | ** ** |
|----------------------------------------------------------|------------|------------|------------|-----------------------|------------|
| Not subject to discretionary withdrawal                  | $          |       | 8,968      |                  | 17.1       | % |
| Subject to discretionary withdrawal with  adjustments:   |       |       |       |                  |       |
| Specified surrender charges (1)                          |       | 24,057     |       | 46.0                  |       |
| Market value adjustments (2)                             |       | 9,669      |       | 18.5                  |       |
| Subject to discretionary withdrawal without  adjustments |       | 9,604      |       | 18.4                  |       |
| Total contractholder funds (3)                           | $          |       | 52,298     |                  | 100.0      | % |

 

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| (1)    | Includes  $10.85 billion of liabilities with a contractual surrender charge of less  than 5% of the account balance.                                                                                                                                                                 |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                 |
| (2)    | $8.15  billion of the contracts with market value adjusted surrenders have a 30-45  day period at the end of their initial and subsequent interest rate guarantee  periods (which are typically 5 or 6 years) during which there is no surrender  charge or market value adjustment. |
|   |                                                                                                                                                                                                                                                                                 |
| (3)    | Includes $1.55 billion of  contractholder funds on variable annuities reinsured to Prudential effective  June 1, 2006.                                                                                                                                                          |

 

Whilewe are able to quantify remaining scheduled maturities for our institutionalproducts of $200 million in 2009, anticipating retail product surrenders isless precise.  Retail life and annuityproducts may be surrendered by customers for a variety of reasons.  Reasons unique to individual customersinclude a current or unexpected need for cash or a change in life insurancecoverage needs.  Other key factors thatmay impact the likelihood of customer surrender include the level of thecontract surrender charge, the length of time the contract has been in force,distribution channel, market interest rates, equity market conditions andpotential tax implications.  In addition,the propensity for retail life insurance policies to lapse is lower than it isfor fixed annuities because of the need for the insured to be re-underwrittenupon policy replacement.  Surrenders andpartial withdrawals for our retail annuities decreased 16.5% and 12.5% in thesecond quarter and first six months of 2009 compared to the same periods of2008.  The annualized surrender andpartial withdrawal rate on deferred annuities and interest-sensitive lifeinsurance, based on the beginning of year contractholder funds, was 8.7% and 9.7%for the first six months of 2009 and 2008, respectively.  We strive to promptly pay customers whorequest cash surrenders, however, statutory regulations generally provide up tosix months in most states to fulfill surrender requests.

 

Our institutionalproducts are primarily funding agreements backing medium-term notes.  As of June 30, 2009, total institutionalproducts outstanding were $4.55 billion. The following table presents the remaining scheduled maturities for ourinstitutional products outstanding as of June 30, 2009.

 
| **($ in millions)** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| ** **               |       |       |       |
| 2009                     | $          |       | 200        |   |
| 2010                     |       | 1,715      |       |
| 2011                     |       | 760        |       |
| 2012                     |       | 40         |       |
| 2013                     |       | 1,750      |       |
| 2016                     |       | 85         |       |
|                     | $          |       | 4,550      |   |

 

Ourasset-liability management practices limit the differences between the cashflows generated by our investment portfolio and the expected cash flow requirementsof our life insurance, annuity and institutional product obligations.

 

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

 

Cash flows provided by investing activitiesin the first six months of 2009 compared to cash flows used in investingactivities in the first six months of 2008 were primarily due to reductions ofshort-term investments to fund reductions in contractholder funds.

 

Higher cashflows used in financing activities in the first six months of 2009 compared tothe first six months of 2008 were primarily due to the absence of issuances ofinstitutional products in the first six months of 2009 compared to $4.16billion in the first six months of 2008.

 

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**Item 4. Controls and Procedures**

** **

*Evaluation of Disclosure Controls andProcedures. *Wemaintain disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934.  Under the supervision and with theparticipation of our management, including our principal executive officerand principal financial officer, we conducted an evaluation of theeffectiveness of our disclosure controls and procedures as of the end of theperiod covered by this report.  Basedupon this evaluation, the principal executive officer and the principalfinancial officer concluded that our disclosure controls and procedures areeffective in providing reasonable assurance that material information requiredto be disclosed in our reports filed with or submitted to the Securities 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 FinancialReporting. *Duringthe fiscal quarter ended June 30, 2009, there have been no changes in ourinternal control over financial reporting that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.    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 8 of the condensed consolidatedfinancial statements in Part I, Item 1 of this Form 10-Q.

 

**Item1A.  Risk Factors**

 

This document contains “forward-looking statements”that anticipate results based on our estimates, assumptions and plans that aresubject to uncertainty.  These statementsare made subject to the safe-harbor provisions of the Private SecuritiesLitigation Reform Act of 1995.  We assumeno obligation to update any forward-looking statements as a result of newinformation or future events or developments.

 

These forward-looking statements do not relatestrictly to historical or current facts and may be identified by their use ofwords like “plans,” “seeks,” “expects,” “will,” “should,” “anticipates,” “estimates,”“intends,” “believes,” “likely,” “targets” and other words with similarmeanings.  These statements may address,among other things, our strategy for growth, product development, regulatoryapprovals, market position, expenses, financial results, litigation andreserves.  We believe that thesestatements are based on reasonable estimates, assumptions and plans.  However, if the estimates, assumptions orplans underlying the forward-looking statements prove inaccurate or if other risksor uncertainties arise, actual results could differ materially from thosecommunicated in these forward-looking statements.  Risk factors which could cause actual resultsto differ materially from those suggested by such forward-looking statements includebut are not limited to those discussed or identified in this document(including the risks described below), in our public filings with theSecurities and Exchange Commission, and those incorporated by reference in Part I,Item 1A of the Allstate Life Insurance Company Annual Report on Form 10-Kfor 2008.

 

**A large scale pandemic, thecontinued threat of terrorism, and ongoing military actions may adverselyaffect the level of claim losses we incur and the value of our investmentportfolio**

 

A global pandemic and thecontinued threat of terrorism, both within the United States and abroad, andongoing military and other actions and heightened security measures in responseto these types of threats, may cause significant volatility and losses fromdeclines in the equity markets and from interest rate changes in the UnitedStates, Europe and elsewhere, and result in loss of life, disruptions tocommerce and reduced economic activity. Some of the assets in our investment portfolio may be adversely affectedby declines in the equity markets and reduced economic activity caused by aglobal pandemic or the continued threat of terrorism.  We seek to mitigate the potential impact ofterrorism on our commercial mortgage portfolio by limiting geographicalconcentrations in key metropolitan areas and by requiring terrorism insuranceto the extent that it is commercially available.  Additionally, in the event that a globalpandemic or a terrorist act occurs, we could be adversely affected, dependingon the nature of the event.

 

**Proposedregulatory reforms, and the more stringent application of existing regulations,may make it more expensive for us to conduct our business.**

 

The federal government has released a set ofproposed regulatory reforms with respect to financial services entities.  As part of a larger effort to strengthen theregulation of the financial services market, the proposal outlines certainreforms applicable to the insurance industry, including the establishment of anOffice of National Insurance within the Treasury Department and themodernization of insurance regulation in accordance with principles regardingrisk, capital, consumer protection, national regulatory uniformity, improvedand broadened regulatory scope, and coordination among international regulatoryauthorities.  The proposal would alsoincrease the regulation of large insurance conglomerates whose failure couldpose a systemic risk to the financial system.

 

Any additionallegislation or regulatory requirements imposed upon us in connection with thefederal government proposed regulatory reforms, and any more stringentenforcement of existing regulations by federal authorities, may make it moreexpensive for us to conduct our business.

 

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**Item6.  Exhibits**

 

(a)                                  Exhibits

 

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

 

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**SIGNATURE**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                 | Allstate Life Insurance Company                                      |
|----------------------|----------------------------------------------------------------------|
|                 | (Registrant)                                                         |
|                 |                                                                 |
|                 |                                                                 |
| August 11, 2009 |                                                                 |
|                 | By                                                                   | /s/ Samuel H. Pilch |
|                 | Samuel H. Pilch                                                      |
|                 | (chief accounting officer and dulyauthorized officer of  Registrant) |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                    |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                               |
| 15                   |       | Acknowledgment of awareness from  Deloitte & Touche LLP, dated August 11, 2009, concerning  unaudited interim financial information. |
|                 |       |                                                                                                                                               |
| 31(i)                |       | Rule 13a-14(a) Certification of  Principal Executive Officer                                                                             |
|                 |       |                                                                                                                                               |
| 31(i)                |       | Rule 13a-14(a) Certification of  Principal Financial Officer                                                                             |
|                 |       |                                                                                                                                               |
| 32                   |       | Section 1350 Certifications                                                                                                                   |

 

E-1

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