**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

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

 

**OR**

 

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

 

**For the transition period from             to             **

 

**Commission file number: 000-31248**

 

**ALLSTATE LIFE INSURANCE COMPANY**

(Exact name of registrant as specified in itscharter)

 

| **Illinois**                                                    | ** ** | **36-2554642**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

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

(Address of principal executive offices)         (Zip code)

 

**(847) 402-5000**

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

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

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     Nox

 

As of November 3, 2010, the registrant had23,800 common shares, $227 par value, outstanding, all of which are held byAllstate Insurance Company.

 

 

 

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**ALLSTATE LIFE INSURANCE COMPANY**

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

**September 30,2010**

 
| ** **       | ** **                                                                                                                                      | **PAGE**   |
|------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                                       | ** ** |
|             |                                                                                                                                            |       |
| Item 1.          | Financial Statements                                                                                                                            |       |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Operations for the Three-Month and Nine-Month  Periods Ended September 30, 2010 and 2009 (unaudited) | 1          |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Financial Position as of September 30, 2010  (unaudited) and December 31, 2009                  | 2          |
|             |                                                                                                                                            |       |
|             | Condensed  Consolidated Statements of Cash Flows for the Nine-Month Periods Ended  September 30, 2010 and 2009 (unaudited)                 | 3          |
|             |                                                                                                                                            |       |
|             | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                               | 4          |
|             |                                                                                                                                            |       |
|             | Report of Independent Registered Public Accounting  Firm                                                                                        | 42         |
|             |                                                                                                                                            |       |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                     |       |
|             |                                                                                                                                            |       |
|             | Operations  Highlights                                                                                                                          | 43         |
|             | Operations                                                                                                                                      | 43         |
|             | Investments  Highlights                                                                                                                         | 49         |
|             | Investments                                                                                                                                     | 49         |
|             | Capital Resources and Liquidity Highlights                                                                                                      | 73         |
|             | Capital Resources and Liquidity                                                                                                                 | 74         |
|             |                                                                                                                                            |       |
| Item 4.          | Controls and  Procedures                                                                                                                        | 76         |
|             |                                                                                                                                            |       |
| **PART II** | **OTHER INFORMATION**                                                                                                                           | ** ** |
|             |                                                                                                                                            |       |
| Item 1.          | Legal Proceedings                                                                                                                               | 77         |
|             |                                                                                                                                            |       |
| Item 1A.         | Risk Factors                                                                                                                                    | 77         |
|             |                                                                                                                                            |       |
| Item 5.          | Other Information                                                                                                                               | 77         |
|             |                                                                                                                                            |       |
| Item 6.          | Exhibits                                                                                                                                        | 77         |

 

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**PART I.FINANCIAL INFORMATION**

 

**ITEM 1.FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                          | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                             | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)**                                     | ** ** |
| **Revenues**                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                                               |       | $                                                    | 151        |                                                | $          | 134 |   | $ | 458 |   | $ | 440 |   |
| Contract charges                                                       |       | 249                                                  |       | 241                                                 |       | 743 |   | 706 |   |
| Net investment income                                                  |       | 683                                                  |       | 722                                                 |       | 2,090 |   | 2,260 |   |
| Realized capital gains and losses:                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Total other-than-temporary impairment losses                           |       | (43                                                  | )          | (404                                                | )          | (396 | ) | (1,120 | ) |
| Portion of loss recognized in other comprehensive  income              |       | (55                                                  | )          | 125                                                 |       | (65 | ) | 229 |   |
| Net other-than-temporary impairment losses  recognized in earnings     |       | (98                                                  | )          | (279                                                | )          | (461 | ) | (891 | ) |
| Sales and other realized capital gains and losses                      |       | 61                                                   |       | 47                                                  |       | (89 | ) | 743 |   |
| Total realized capital gains and losses                                |       | (37                                                  | )          | (232                                                | )          | (550 | ) | (148 | ) |
|                                                                   |       | 1,046                                                |       | 865                                                 |       | 2,741 |   | 3,258 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                                                      |       | 365                                                  |       | 327                                                 |       | 1,135 |   | 1,018 |   |
| Interest credited to contractholder funds                              |       | 435                                                  |       | 485                                                 |       | 1,326 |   | 1,598 |   |
| Amortization of deferred policy acquisition costs                      |       | 69                                                   |       | 61                                                  |       | 150 |   | 758 |   |
| Operating costs and expenses                                           |       | 85                                                   |       | 74                                                  |       | 254 |   | 244 |   |
| Restructuring and related charges                                      |       | —                                               |       | 4                                                   |       | (1 | ) | 23 |   |
| Interest expense                                                       |       | 11                                                   |       | 11                                                  |       | 33 |   | 32 |   |
|                                                                   |       | 965                                                  |       | 962                                                 |       | 2,897 |   | 3,673 |   |
| Gain on disposition of operations                                      |       | 4                                                    |       | 2                                                   |       | 7 |   | 6 |   |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **Income (loss) from operations  before income tax expense (benefit)** |       | 85                                                   |       | (95                                                 | )          | (149 | ) | (409 | ) |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Income tax expense (benefit)                                           |       | 25                                                   |       | (38                                                 | )          | (64 | ) | (16 | ) |
|                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| **Net income (loss)**                                                  |       | $                                                    | 60         |                                                | $          | (57 | ) | $ | (85 | ) | $ | (393 | ) |

 

See notes to condensed consolidated financial statements.

 

1

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

** **
| ** **                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in millions, except par value data)**                         | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                       | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                       |       |                   |       |                  |       |
| Investments                                                                                      |       |                   |       |                  |       |
| Fixed income securities, at fair value (amortized  cost $48,145 and $49,842)                     |       | $                      | 49,781     |                  | $          | 47,658 |   |
| Mortgage loans                                                                                   |       | 6,833                  |       | 7,780                 |       |
| Equity securities, at fair value (cost $160 and  $159)                                           |       | 186                    |       | 183                   |       |
| Limited partnership interests                                                                    |       | 1,127                  |       | 1,028                 |       |
| Short-term, at fair value (amortized cost $1,003  and $1,669)                                    |       | 1,003                  |       | 1,669                 |       |
| Policy loans                                                                                     |       | 837                    |       | 823                   |       |
| Other                                                                                            |       | 980                    |       | 1,076                 |       |
| Total investments                                                                                |       | 60,747                 |       | 60,217                |       |
| Cash                                                                                             |       | 109                    |       | 145                   |       |
| Deferred policy acquisition costs                                                                |       | 2,863                  |       | 3,664                 |       |
| Reinsurance recoverables                                                                         |       | 4,303                  |       | 4,016                 |       |
| Accrued investment income                                                                        |       | 555                    |       | 540                   |       |
| Deferred income taxes                                                                            |       | —                 |       | 203                   |       |
| Other assets                                                                                     |       | 521                    |       | 963                   |       |
| Separate Accounts                                                                                |       | 8,459                  |       | 9,072                 |       |
| **Total assets**                                                                                 |       | $                      | 77,557     |                  | $          | 78,820 |   |
|                                                                                             |       |                   |       |                  |       |
| **Liabilities**                                                                                  |       |                   |       |                  |       |
| Contractholder funds                                                                             |       | $                      | 47,177     |                  | $          | 50,850 |   |
| Reserve for life-contingent contract benefits                                                    |       | 13,242                 |       | 12,256                |       |
| Unearned premiums                                                                                |       | 27                     |       | 30                    |       |
| Payable to affiliates, net                                                                       |       | 97                     |       | 119                   |       |
| Other liabilities and accrued expenses                                                           |       | 1,561                  |       | 1,432                 |       |
| Deferred income taxes                                                                            |       | 624                    |       | —                |       |
| Notes due to related parties                                                                     |       | 677                    |       | 675                   |       |
| Separate Accounts                                                                                |       | 8,459                  |       | 9,072                 |       |
| **Total liabilities**                                                                            |       | 71,864                 |       | 74,434                |       |
|                                                                                             |       |                   |       |                  |       |
| **Commitments and Contingent  Liabilities (Note 8)**                                             |       |                   |       |                  |       |
|                                                                                             |       |                   |       |                  |       |
| **Shareholder’s Equity**                                                                    |       |                   |       |                  |       |
| Redeemable preferred stock - series A, $100 par  value, 1,500,000 shares authorized, none issued |       | —                 |       | —                |       |
| Redeemable preferred stock - series B, $100 par  value, 1,500,000 shares authorized, none issued |       | —                 |       | —                |       |
| Common stock, $227 par value, 23,800 shares  authorized and outstanding                          |       | 5                      |       | 5                     |       |
| Additional capital paid-in                                                                       |       | 3,189                  |       | 3,189                 |       |
| Retained income                                                                                  |       | 1,856                  |       | 1,969                 |       |
| Accumulated other comprehensive income:                                                          |       |                   |       |                  |       |
| Unrealized net capital gains and losses:                                                         |       |                   |       |                  |       |
| Unrealized net capital losses on fixed income  securities with OTTI                              |       | (106                   | )          | (274                  | )          |
| Other unrealized net capital gains and losses                                                    |       | 1,174                  |       | (1,146                | )          |
| Unrealized adjustment to DAC, DSI and insurance  reserves                                        |       | (425                   | )          | 643                   |       |
| Total unrealized net capital gains and losses                                                    |       | 643                    |       | (777                  | )          |
| Total accumulated other  comprehensive income (loss)                                             |       | 643                    |       | (777                  | )          |
| Total shareholder’s  equity                                                                 |       | 5,693                  |       | 4,386                 |       |
| **Total liabilities and  shareholder’s equity**                                             |       | $                      | 77,557     |                  | $          | 78,820 |   |

 

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

 

2

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**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                       | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                       | ** ** | **September 30,**          | ** ** |
| **($ in millions)**                                                    | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| ** **                                                                       | ** ** | **(unaudited)**                 | ** ** |
| **Cash flows from operating  activities**                                        |       |                            |       |   |   |
| Net loss                                                                         |       | $                               | (85        | ) | $ | (393 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                            |       |   |   |
| Amortization and other non-cash items                                            |       | (117                            | )          | (219 | ) |
| Realized capital gains and losses                                                |       | 550                             |       | 148 |   |
| Gain on disposition of operations                                                |       | (7                              | )          | (6 | ) |
| Interest credited to contractholder funds                                        |       | 1,326                           |       | 1,598 |   |
| Changes in:                                                                      |       |                            |       |   |   |
| Policy benefits and other insurance reserves                                     |       | (216                            | )          | (268 | ) |
| Unearned premiums                                                                |       | (3                              | )          | (2 | ) |
| Deferred policy acquisition costs                                                |       | (131                            | )          | 471 |   |
| Reinsurance recoverables, net                                                    |       | (308                            | )          | (241 | ) |
| Income taxes                                                                     |       | 566                             |       | 360 |   |
| Other operating assets and liabilities                                           |       | 12                              |       | 134 |   |
| Net cash provided by operating activities                                        |       | 1,587                           |       | 1,582 |   |
|                                                                             |       |                            |       |   |   |
| **Cash flows from investing  activities**                                        |       |                            |       |   |   |
| Proceeds from sales                                                              |       |                            |       |   |   |
| Fixed income securities                                                          |       | 8,478                           |       | 10,111 |   |
| Equity securities                                                                |       | 90                              |       | 28 |   |
| Limited partnership interests                                                    |       | 78                              |       | 58 |   |
| Mortgage loans                                                                   |       | 110                             |       | 138 |   |
| Other investments                                                                |       | 71                              |       | 401 |   |
| Investment collections                                                           |       |                            |       |   |   |
| Fixed income securities                                                          |       | 1,933                           |       | 2,572 |   |
| Mortgage loans                                                                   |       | 767                             |       | 1,049 |   |
| Other investments                                                                |       | 76                              |       | 88 |   |
| Investment purchases                                                             |       |                            |       |   |   |
| Fixed income securities                                                          |       | (8,949                          | )          | (11,593 | ) |
| Equity securities                                                                |       | (51                             | )          | (101 | ) |
| Limited partnership interests                                                    |       | (173                            | )          | (149 | ) |
| Mortgage loans                                                                   |       | (45                             | )          | (15 | ) |
| Other investments                                                                |       | (88                             | )          | (18 | ) |
| Change in short-term investments, net                                            |       | 522                             |       | 2,091 |   |
| Change in other investments, net                                                 |       | (173                            | )          | (223 | ) |
| Net cash provided by investing activities                                        |       | 2,646                           |       | 4,437 |   |
|                                                                             |       |                            |       |   |   |
| **Cash flows from financing  activities**                                        |       |                            |       |   |   |
| Repayment of note due to related party                                           |       | (4                              | )          | — |   |
| Capital contribution                                                             |       | —                          |       | 250 |   |
| Contractholder fund deposits                                                     |       | 1,823                           |       | 2,621 |   |
| Contractholder fund withdrawals                                                  |       | (6,088                          | )          | (8,720 | ) |
| Net cash used in financing activities                                            |       | (4,269                          | )          | (5,849 | ) |
| **Net (decrease) increase in cash**                                              |       | (36                             | )          | 170 |   |
| **Cash at beginning of period**                                                  |       | 145                             |       | 93 |   |
| **Cash at end of period**                                                        |       | $                               | 109        |   | $ | 263 |   |

 

See notes to condensed consolidated financial statements.

 

3

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**ALLSTATELIFE 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 condensed consolidated financial statements and notes as of September 30,2010, and for the three-month and nine-month periods ended September 30,2010 and 2009 are unaudited.  Thecondensed consolidated financial statements reflect all adjustments (consistingonly of normal recurring accruals), which are, in the opinion of management,necessary for the fair presentation of the financial position, results ofoperations and cash flows for the interim periods.  These condensed consolidated financialstatements and notes should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2009.  The results of operations for the interimperiods should not be considered indicative of results to be expected for thefull year.

 

**Premiums and contract charges**

 

The following table summarizes premiums and contract charges byproduct.

 
| ** **                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **($ in millions)**               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Premiums**                                |       |                             |       |                            |       |   |   |   |   |
| Traditional life insurance                  |       | $                                | 100        |                            | $          | 96 |   | $ | 302 |   | $ | 289 |   |
| Immediate annuities with life contingencies |       | 26                               |       | 15                              |       | 84 |   | 83 |   |
| Accident and health insurance               |       | 25                               |       | 23                              |       | 72 |   | 68 |   |
| **Total premiums**                          |       | 151                              |       | 134                             |       | 458 |   | 440 |   |
|                                        |       |                             |       |                            |       |   |   |   |   |
| **Contract charges**                        |       |                             |       |                            |       |   |   |   |   |
| Interest-sensitive life insurance           |       | 240                              |       | 229                             |       | 711 |   | 671 |   |
| Fixed annuities                             |       | 9                                |       | 12                              |       | 32 |   | 35 |   |
| **Total contract charges**                  |       | 249                              |       | 241                             |       | 743 |   | 706 |   |
| **Total premiums and contract  charges**    |       | $                                | 400        |                            | $          | 375 |   | $ | 1,201 |   | $ | 1,146 |   |

 

**Adopted accounting standards**

 

*Disclosuresabout Fair Value Measurements*

 

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

 

*Consolidation of Variable Interest Entities*

 

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

 

4

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

todirect the activities of the VIE that most significantly impact the economicperformance of the VIE and the obligation to absorb losses, or the right toreceive benefits, that could potentially be significant to the VIE.  The Company adopted the new guidance as of January 1,2010.  The adoption had no impact on theCompany’s results of operations or financial position.

 

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

 

*Embedded Credit Derivatives Scope Exception*

 

InMarch 2010, the FASB issued accounting guidance clarifying the scopeexception for embedded credit derivative features, including those in certaincollateralized debt obligations and synthetic collateralized debtobligations.  Embedded credit derivativefeatures related to the transfer of credit risk that is only in the form ofsubordination of one financial instrument to another continue to qualify forthe scope exception.  Other embeddedcredit derivative features must be analyzed for potential bifurcation andseparate accounting as a derivative, with periodic changes in fair valuerecorded in net income.  The adoption ofthe new guidance as of July 1, 2010 resulted in the bifurcation of thecredit default swaps embedded in synthetic collateralized debt obligationspurchased after January 1, 2007, and the related net unrealized capitallosses were reclassified from accumulated other comprehensive income toretained income.  The cumulative effectof adoption, net of related deferred policy acquisition costs (“DAC”), deferredsales inducement costs (“DSI”) and tax adjustments, was a $19 million increasein unrealized net capital gains and losses, a $9 million decrease in totalassets and a $28 million decrease in retained income.

 

**Pending accounting standards**

 

*Consolidation Analysis Considering Investments Held throughSeparate Accounts*

 

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

 

*Disclosures about the Credit Quality of FinancingReceivables and the Allowance for Credit Losses*

 

In July 2010, the FASBissued guidance requiring expanded disclosures relating to the credit qualityof financing receivables and the related allowances for credit losses.  The new guidance requires a greater level ofdisaggregated information, as well as additional disclosures about creditquality indicators, past due information and modifications of its financingreceivables.  The new guidance iseffective for reporting periods ending after December 15, 2010.  The new guidance affects disclosures only;and therefore, the adoption will have no impact on the Company’s results ofoperations or financial position.

 

*Accounting for Costs Associatedwith Acquiring or Renewing Insurance Contracts*

 

In October 2010, theFASB issued guidance modifying the definition of the types of costs incurred byinsurance entities that can be capitalized in the acquisition of new andrenewal contracts.  The guidancespecifies that incremental direct costs of contract acquisition attributable tosuccessful efforts should be included as deferred acquisition costs.  The guidance also specifies that deferredacquisition costs include advertising costs only when the direct-responseadvertising accounting criteria are met. The new guidance is effective for reporting periods beginning after December 15,2011 and should be applied prospectively, with retrospective applicationpermitted.  If application of theguidance would result in the capitalization of acquisition costs that had notpreviously been capitalized prior to adoption, the entity may elect not tocapitalize those additional costs.  TheCompany is in process of evaluating the impact of adoption on the Company’sresults of operations and financial position.

 

5

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**2.  Related PartyTransaction**

 

In March 2010, in accordance with anasset purchase agreement between Road Bay Investments, LLC (“RBI”), aconsolidated subsidiary of ALIC, and American Heritage LifeInsurance Company (“AHL”), an unconsolidated affiliate of ALIC, AHL sold to RBI mortgage loans with acarrying value of $6 million on the date of sale.  As payment, RBI issued a 7.00% note due March 26,2017 to AHL for the same amount.  Assecurity for the performance of RBI’s obligations under the agreement and note,RBI granted a pledge of and security interest in RBI’s right, title andinterest in the mortgage loans and their proceeds.  In August 2010, RBI repaid $4 million ofprincipal on the outstanding note.  Thenote due from RBI to AHL is classified as notes due to related parties in theCondensed Consolidated Statements of Financial Position.

 

**3.  Supplemental CashFlow Information**

 

Non-cashinvestment exchanges, including modifications of certain mortgage loans, fixedincome securities, limited partnerships and other investments, as well asmergers completed with equity securities, totaled $506 million and $277 millionfor the nine months ended September 30, 2010 and 2009, respectively.

 

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

 
| ** **                                    | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                 | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Net change in proceeds managed**            |       |                                                |       |   |   |
| Net change in short-term investments          |       | $                                                   | 148        |   | $ | (155 | ) |
| Operating cash flow provided (used)           |       | $                                                   | 148        |   | $ | (155 | ) |
|                                          |       |                                                |       |   |   |
| **Net change in liabilities**                 |       |                                                |       |   |   |
| Liabilities for collateral, beginning of year |       | $                                                   | (617       | ) | $ | (340 | ) |
| Liabilities for collateral, end of period     |       | (469                                                | )          | (495 | ) |
| Operating cash flow (used) provided           |       | $                                                   | (148       | ) | $ | 155 |   |

 

6

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**4.  Investments**

 

**Fair values**

 

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

 
| ** **                                                | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Fair**   | ** ** |
|-----------------------------------------------------------|------------|---------------|------------|---------------------------|------------|------------|------------|
| **($ in millions)**                             | ** ** | **cost**      | ** ** | **Gains**                 | ** ** | **Losses** | ** ** | **value** | ** ** |
| **At September 30, 2010**                            |       |          |       |                      |       |       |       |   |   |
| U.S. government and agencies                              |       | $             | 3,948      |                      | $          | 359        |       | $ | — |   | $ | 4,307 |   |
| Municipal                                                 |       | 4,858         |       | 259                       |       | (212       | )          | 4,905 |   |
| Corporate                                                 |       | 27,009        |       | 2,186                     |       | (271       | )          | 28,924 |   |
| Foreign government                                        |       | 2,056         |       | 415                       |       | —     |       | 2,471 |   |
| Residential mortgage-backed securities (“RMBS”) |       | 5,108         |       | 151                       |       | (570       | )          | 4,689 |   |
| Commercial mortgage-backed securities (“CMBS”)  |       | 2,275         |       | 56                        |       | (438       | )          | 1,893 |   |
| Asset-backed securities (“ABS”)                 |       | 2,876         |       | 72                        |       | (371       | )          | 2,577 |   |
| Redeemable preferred stock                                |       | 15            |       | —                    |       | —     |       | 15 |   |
| Total fixed income securities                             |       | $             | 48,145     |                      | $          | 3,498      |       | $ | (1,862 | ) | $ | 49,781 |   |
|                                                      |       |          |       |                      |       |       |       |   |   |
| **At December 31, 2009**                             |       |          |       |                      |       |       |       |   |   |
| U.S. government and agencies                              |       | $             | 3,426      |                      | $          | 168        |       | $ | (13 | ) | $ | 3,581 |   |
| Municipal                                                 |       | 5,578         |       | 50                        |       | (519       | )          | 5,109 |   |
| Corporate                                                 |       | 27,314        |       | 1,015                     |       | (790       | )          | 27,539 |   |
| Foreign government                                        |       | 1,906         |       | 258                       |       | (11        | )          | 2,153 |   |
| RMBS                                                      |       | 5,596         |       | 76                        |       | (1,006     | )          | 4,666 |   |
| CMBS                                                      |       | 3,390         |       | 30                        |       | (952       | )          | 2,468 |   |
| ABS                                                       |       | 2,616         |       | 48                        |       | (537       | )          | 2,127 |   |
| Redeemable preferred stock                                |       | 16            |       | —                    |       | (1         | )          | 15 |   |
| Total fixed income securities                             |       | $             | 49,842     |                      | $          | 1,645      |       | $ | (3,829 | ) | $ | 47,658 |   |

 

**Scheduled maturities**

 

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

 
| **($ in millions)**          | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|
| Due in one year or less                |       | $                   | 1,827      |            | $          | 1,861 |   |
| Due after one year through five years  |       | 13,611              |       | 14,338          |       |
| Due after five years through ten years |       | 11,002              |       | 12,253          |       |
| Due after ten years                    |       | 13,721              |       | 14,063          |       |
|                                   |       | 40,161              |       | 42,515          |       |
| RMBS and ABS                           |       | 7,984               |       | 7,266           |       |
| Total                                  |       | $                   | 48,145     |            | $          | 49,781 |   |

 

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

 

7

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Net investment income**

 

Netinvestment income is as follows:

 
| ** **                        | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **($ in millions)**     | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities           |       | $                                                          | 615        |                                                      | $          | 635 |   | $ | 1,879 |   | $ | 1,955 |   |
| Mortgage loans                    |       | 90                                                         |       | 118                                                       |       | 289 |   | 381 |   |
| Equity securities                 |       | 1                                                          |       | 2                                                         |       | 3 |   | 4 |   |
| Limited partnership interests     |       | 3                                                          |       | 2                                                         |       | 10 |   | 6 |   |
| Short-term investments            |       | 1                                                          |       | 2                                                         |       | 3 |   | 12 |   |
| Other                             |       | (3                                                         | )          | (12                                                       | )          | (16 | ) | (28 | ) |
| Investment income, before expense |       | 707                                                        |       | 747                                                       |       | 2,168 |   | 2,330 |   |
| Investment expense                |       | (24                                                        | )          | (25                                                       | )          | (78 | ) | (70 | ) |
| Net investment income             |       | $                                                          | 683        |                                                      | $          | 722 |   | $ | 2,090 |   | $ | 2,260 |   |

 

**Realized capital gains and losses**

 

Realizedcapital gains and losses by security type are as follows:

 
| ** **                        | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **($ in millions)**     | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities           |       | $                                                          | (18        | )                                                         | $          | (62 | ) | $ | (285 | ) | $ | 86 |   |
| Mortgage loans                    |       | (1                                                         | )          | (65                                                       | )          | (54 | ) | (113 | ) |
| Equity securities                 |       | 15                                                         |       | 1                                                         |       | 35 |   | (23 | ) |
| Limited partnership interests     |       | (6                                                         | )          | (33                                                       | )          | (12 | ) | (257 | ) |
| Derivatives                       |       | (25                                                        | )          | (56                                                       | )          | (237 | ) | 234 |   |
| Other                             |       | (2                                                         | )          | (17                                                       | )          | 3 |   | (75 | ) |
| Realized capital gains and losses |       | $                                                          | (37        | )                                                         | $          | (232 | ) | $ | (550 | ) | $ | (148 | ) |

 

Realizedcapital gains and losses by transaction type are as follows:

 
| ** **                                                         | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **($ in millions)**                                      | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Impairment write-downs                                             |       | $                                                          | (78        | )                                                         | $          | (278 | ) | $ | (361 | ) | $ | (833 | ) |
| Change in intent write-downs                                       |       | (20                                                        | )          | (1                                                        | )          | (100 | ) | (58 | ) |
| Net other-than-temporary impairment losses  recognized in earnings |       | (98                                                        | )          | (279                                                      | )          | (461 | ) | (891 | ) |
| Sales                                                              |       | 88                                                         |       | 106                                                       |       | 148 |   | 627 |   |
| Valuation of derivative instruments                                |       | 10                                                         |       | (60                                                       | )          | (193 | ) | 202 |   |
| Settlements of derivative instruments                              |       | (34                                                        | )          | 7                                                         |       | (45 | ) | 30 |   |
| EMA limited partnership income                                     |       | (3                                                         | )          | (6                                                        | )          | 1 |   | (116 | ) |
| Realized capital gains and losses                                  |       | $                                                          | (37        | )                                                         | $          | (232 | ) | $ | (550 | ) | $ | (148 | ) |

 

Grossgains of $204 million and $250 million and gross losses of $139 million and$101 million were realized on sales of fixed income securities during the threemonths ended September 30, 2010 and 2009, respectively.  Gross gains of $370 million and $879 millionand gross losses of $282 million and $216 million were realized on sales offixed income securities during the nine months ended September 30, 2010and 2009, respectively.

 

8

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                              | ** ** | **Three months ended********September 30, 2010** | ** ** | **Nine months ended******** September 30, 2010** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| **($ in millions)**           | ** ** | **Gross**                                                            | ** ** | **Included  in OCI**                                                 | ** ** | **Net** | ** ** | **Gross** | ** ** | **Included  in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Municipal                               |       | $                                                                    | (1         | )                                                                         | $          | — |   | $ | (1 | ) | $ | (49 | ) | $ | — |   | $ | (49 | ) |
| Corporate                               |       | (9                                                                   | )          | (1                                                                        | )          | (10 | ) | (51 | ) | 1 |   | (50 | ) |
| RMBS                                    |       | (25                                                                  | )          | (28                                                                       | )          | (53 | ) | (174 | ) | (13 | ) | (187 | ) |
| CMBS                                    |       | (1                                                                   | )          | (26                                                                       | )          | (27 | ) | (44 | ) | (37 | ) | (81 | ) |
| ABS                                     |       | —                                                               |       | —                                                                    |       | — |   | (8 | ) | (16 | ) | (24 | ) |
| Total fixed income securities           |       | (36                                                                  | )          | (55                                                                       | )          | (91 | ) | (326 | ) | (65 | ) | (391 | ) |
| Mortgage loans                          |       | (3                                                                   | )          | —                                                                    |       | (3 | ) | (50 | ) | — |   | (50 | ) |
| Limited partnership interests           |       | (4                                                                   | )          | —                                                                    |       | (4 | ) | (20 | ) | — |   | (20 | ) |
| Other-than-temporary  impairment losses |       | $                                                                    | (43        | )                                                                         | $          | (55 | ) | $ | (98 | ) | $ | (396 | ) | $ | (65 | ) | $ | (461 | ) |
| ** **                              | ** ** | ** **                                                           | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Three months ended  September 30, 2009**       | ** ** | **Nine months ended  September 30, 2009**             | ** ** |
| ** **                              | ** ** | **Gross**                                                            | ** ** | **Included  in OCI**                                                 | ** ** | **Net** | ** ** | **Gross** | ** ** | **Included  in OCI** | ** ** | **Net** | ** ** |
| Fixed income securities:                |       |                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Municipal                               |       | $                                                                    | —     |                                                                      | $          | — |   | $ | — |   | $ | (16 | ) | $ | — |   | $ | (16 | ) |
| Corporate                               |       | (110                                                                 | )          | —                                                                    |       | (110 | ) | (180 | ) | (9 | ) | (189 | ) |
| Foreign government                      |       | —                                                               |       | —                                                                    |       | — |   | (17 | ) | — |   | (17 | ) |
| RMBS                                    |       | (139                                                                 | )          | 96                                                                        |       | (43 | ) | (307 | ) | 200 |   | (107 | ) |
| CMBS                                    |       | (89                                                                  | )          | 61                                                                        |       | (28 | ) | (142 | ) | 61 |   | (81 | ) |
| ABS                                     |       | (8                                                                   | )          | (32                                                                       | )          | (40 | ) | (175 | ) | (23 | ) | (198 | ) |
| Total fixed income securities           |       | (346                                                                 | )          | 125                                                                       |       | (221 | ) | (837 | ) | 229 |   | (608 | ) |
| Mortgage loans                          |       | (30                                                                  | )          | —                                                                    |       | (30 | ) | (79 | ) | — |   | (79 | ) |
| Equity securities                       |       | —                                                               |       | —                                                                    |       | — |   | (26 | ) | — |   | (26 | ) |
| Limited partnership interests           |       | (27                                                                  | )          | —                                                                    |       | (27 | ) | (142 | ) | — |   | (142 | ) |
| Other                                   |       | (1                                                                   | )          | —                                                                    |       | (1 | ) | (36 | ) | — |   | (36 | ) |
| Other-than-temporary  impairment losses |       | $                                                                    | (404       | )                                                                         | $          | 125 |   | $ | (279 | ) | $ | (1,120 | ) | $ | 229 |   | $ | (891 | ) |

 

The total amount of other-than-temporary impairment losses included inaccumulated other comprehensive income for fixed income securities, which werenot included in earnings, are presented in the following table.  The amount excludes $221 million and $136million as of September 30, 2010 and December 31, 2009, respectively,of net unrealized gains related to changes in valuation of the fixed incomesecurities subsequent to the impairment measurement date.

 
| **($ in millions)** | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Corporate                     |       | $                            | (18        | )                           | $          | (18 | ) |
| RMBS                          |       | (268                         | )          | (323                        | )          |
| CMBS                          |       | (58                          | )          | (127                        | )          |
| ABS                           |       | (40                          | )          | (90                         | )          |
| Total                         |       | $                            | (384       | )                           | $          | (558 | ) |

 

9

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                                                                                                                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                                                                                                             | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Beginning balance                                                                                                                                         |       | $                                                    | (864       | )                                                   | $          | (1,193 | ) | $ | (808 | ) | $ | — |   |
| Beginning balance of cumulative credit loss for  securities held at April 1, 2009                                                                    |       | —                                               |       | —                                              |       | — |   | (1,059 | ) |
| Cumulative effect of change in accounting principle                                                                                                       |       | 81                                                   |       | —                                              |       | 81 |   | — |   |
| Additional credit loss for securities previously  other-than-temporarily impaired                                                                         |       | (67                                                  | )          | (72                                                 | )          | (180 | ) | (101 | ) |
| Additional credit loss for securities not  previously other-than-temporarily impaired                                                                     |       | (4                                                   | )          | (149                                                | )          | (118 | ) | (278 | ) |
| Reduction in credit loss for securities disposed  or collected                                                                                            |       | 42                                                   |       | 365                                                 |       | 210 |   | 389 |   |
| Reduction in credit loss for securities  other-than-temporarily impaired to fair value                                                                    |       | 26                                                   |       | —                                              |       | 27 |   | — |   |
| 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 |       | 1                                                    |       | —                                              |       | 3 |   | — |   |
| Ending balance                                                                                                                                            |       | $                                                    | (785       | )                                                   | $          | (1,049 | ) | $ | (785 | ) | $ | (1,049 | ) |

 

TheCompany uses its best estimate of future cash flows expected to be collectedfrom the fixed income security, discounted at the security’s original orcurrent effective rate, as appropriate, to calculate a recovery value anddetermine whether a credit loss exists. The determination of cash flow estimates is inherently subjective andmethodologies may vary depending on facts and circumstances specific to thesecurity.  All reasonably availableinformation relevant to the collectability of the security, including pastevents, current conditions, and reasonable and supportable assumptions andforecasts, are considered when developing the estimate of cash flows expectedto be collected.  That informationgenerally includes, but is not limited to, the remaining payment terms of thesecurity, prepayment speeds, foreign exchange rates, the financial conditionand future earnings potential of the issue or issuer, expected defaults,expected recoveries, the value of underlying collateral, vintage, geographicconcentration, available reserves or escrows, current subordination levels,third party guarantees and other credit enhancements.  Other information, such as industry analystreports and forecasts, sector credit ratings, financial condition of the bondinsurer for insured fixed income securities, and other market data relevant tothe realizability of contractual cash flows, may also be considered.  The estimated fair value of collateral willbe used to estimate recovery value if the Company determines that the securityis dependent on the liquidation of collateral for ultimate settlement.  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.  The portion of the unrealized loss related tofactors other than credit remains classified in accumulated other comprehensiveincome.  If the Company determines thatthe fixed income security does not have sufficient cash flow or otherinformation to estimate a recovery value for the security, the Company mayconclude that the entire decline in fair value is deemed to be credit relatedand the loss is recorded in earnings.

 

10

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Unrealizednet capital gains and losses**

 

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

 
| ** **                                         | ** ** | **Fair**  | ** ** | **Gross unrealized** | ** ** | **Unrealized net** | ** ** |
|----------------------------------------------------|------------|-----------|------------|---------------------------|------------|-------------------------|------------|
| **($ in millions)**                      | ** ** | **value** | ** ** | **Gains**                 | ** ** | **Losses**              | ** ** | **gains (losses)** | ** ** |
| **At September 30, 2010**                          |       |      |       |                      |       |                    |       |   |   |
| Fixed income securities (1)                        |       | $         | 49,781     |                      | $          | 3,498                   |       | $ | (1,862 | ) | $ | 1,636 |   |
| Equity securities                                  |       | 186       |       | 30                        |       | (4                      | )          | 26 |   |
| Short-term investments                             |       | 1,003     |       | —                    |       | —                  |       | — |   |
| Derivative instruments (2)                         |       | (12       | )          | 2                         |       | (14                     | )          | (12 | ) |
| Unrealized net capital gains and losses, pre-tax   |       |      |       |                      |       |                    |       | 1,650 |   |
| Amounts recognized for:                            |       |      |       |                      |       |                    |       |   |   |
| Insurance reserves (3)                             |       |      |       |                      |       |                    |       | (608 | ) |
| DAC and DSI (4)                                    |       |      |       |                      |       |                    |       | (45 | ) |
| Amounts recognized                                 |       |      |       |                      |       |                    |       | (653 | ) |
| Deferred income taxes                              |       |      |       |                      |       |                    |       | (354 | ) |
| Unrealized net capital gains and losses, after-tax |       |      |       |                      |       |                    |       | $ | 643 |   |
|                                                    |            |           |            |                           |            |                         |            |  |  |  |  |  |  |

 

----

| (1)    | Unrealized  net capital gains and losses for fixed income securities as of  September 30, 2010 comprises $(163) million related to unrealized net  capital losses on fixed income securities with OTTI and $1,799 million  related to other unrealized net capital gains and losses.                                                                                                                                                                                                                                                                                                                           |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (2)    | Included  in the fair value of derivative instruments are $2 million classified as  assets and $14 million classified as liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (3)    | The  insurance reserves adjustment represents the amount by which the reserve  balance would increase if the net unrealized gains in the applicable product  portfolios were realized and reinvested at current lower interest rates,  resulting in a premium deficiency. Although the Company evaluates premium  deficiencies on the combined performance of life insurance and immediate  annuities with life contingencies, the adjustment primarily relates to  structured settlement annuities with life contingencies, in addition to  annuity buy-outs and certain payout annuities with life contingencies. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| (4)    | The  DAC and DSI adjustment balance represents the amount by which the  amortization of DAC and DSI would increase or decrease if the unrealized  gains or losses in the respective product portfolios were realized.                                                                                                                                                                                                                                                                                                                                                                                               |

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

 

----

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

 

11

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 
| **($ in millions)**                        | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| Fixed income securities                              |       | $          | 3,820      |   |
| Equity securities                                    |       | 2          |       |
| Derivative instruments                               |       | 6          |       |
| Total                                                |       | 3,828      |       |
|                                                 |       |       |       |
| Amounts recognized for:                              |       |       |       |
| Insurance reserves                                   |       | (608       | )          |
| DAC and DSI                                          |       | (1,035     | )          |
| Decrease in amounts recognized                       |       | (1,643     | )          |
| Deferred income taxes                                |       | (765       | )          |
| Increase in unrealized net capital gains and  losses |       | $          | 1,420      |   |

 

**Portfolio monitoring**

 

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

 

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

 

Ifthe Company has not made the decision to sell the fixed income security and itis not more likely than not the Company will be required to sell the fixedincome security before recovery of its amortized cost basis, the Companyevaluates whether it expects to receive cash flows sufficient to recover theentire amortized cost basis of the security.  The Company calculates the estimated recovery value by discounting thebest estimate of future cash flows at the security’s original or currenteffective rate, as appropriate, and compares this to the amortized cost of thesecurity.  If the Company does not expectto receive cash flows sufficient to recover the entire amortized cost basis ofthe fixed income security, the credit loss component of the impairment isrecorded in earnings, with the remaining amount of the unrealized loss relatedto other factors recognized in other comprehensive income.

 

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

 

TheCompany’s portfolio monitoring process includes a quarterly review of allsecurities to identify instances where the fair value of a security compared toits amortized cost (for fixed income securities) or cost (for equitysecurities) is below established thresholds. The process also includes the monitoring of other impairment indicatorssuch as ratings, ratings downgrades and payment defaults.  The securities identified, in addition toother securities for which the Company may have a concern, are evaluated forpotential other-than-temporary impairment using all reasonably availableinformation relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation ofother-than-temporary impairment for these fixed income and equity securitiesare assumptions and estimates about the financial condition and future earningspotential of the issue or issuer.  Someof the factors considered in evaluating whether a decline in fair value isother than temporary are: 1) the financial condition, near-term and long-termprospects of the issue or issuer, including relevant industry specific marketconditions and trends, geographic location and implications of rating agency actionsand offering prices; 2) the specific reasons that a security is in anunrealized loss position, including overall market conditions which couldaffect liquidity; and 3) the length of time and extent to which the fair valuehas been less than amortized cost or cost.

 

12

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                     | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**      | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|----------------|------------|
| ** **                                     | ** ** | **Number**                             | ** ** | **Fair**                             | ** ** | **Unrealized** | ** ** | **Number** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **unrealized** | ** ** |
| **($ in millions)**                  | ** ** | **of issues**                     | ** ** | **value**                            | ** ** | **losses**     | ** ** | **of issues** | ** ** | **value** | ** ** | **losses** | ** ** | **losses** | ** ** |
| **At September 30, 2010**                 | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed income securities                        | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. government and agencies                   |       | 2                                      |       | $                                    | 32         |           | $          | — |   | — |   | $ | — |   | $ | — |   | $ | — |   |
| Municipal                                      |       | 6                                      |       | 32                                   |       | —         |       | 181 |   | 1,266 |   | (212 | ) | (212 | ) |
| Corporate                                      |       | 60                                     |       | 763                                  |       | (40            | )          | 183 |   | 2,455 |   | (231 | ) | (271 | ) |
| Foreign government                             |       | —                                 |       | —                               |       | —         |       | 2 |   | 11 |   | — |   | — |   |
| RMBS                                           |       | 88                                     |       | 115                                  |       | (2             | )          | 255 |   | 1,346 |   | (568 | ) | (570 | ) |
| CMBS                                           |       | 3                                      |       | 19                                   |       | —         |       | 141 |   | 1,012 |   | (438 | ) | (438 | ) |
| ABS                                            |       | 36                                     |       | 280                                  |       | (16            | )          | 134 |   | 1,225 |   | (355 | ) | (371 | ) |
| Redeemable preferred stock                     |       | —                                 |       | —                               |       | —         |       | 1 |   | — |   | — |   | — |   |
| Total fixed income securities (1)              |       | 195                                    |       | 1,241                                |       | (58            | )          | 897 |   | 7,315 |   | (1,804 | ) | (1,862 | ) |
| Equity securities                              |       | 3                                      |       | 48                                   |       | (2             | )          | 1 |   | 16 |   | (2 | ) | (4 | ) |
| Total fixed income and equity securities       |       | 198                                    |       | $                                    | 1,289      |           | $          | (60 | ) | 898 |   | $ | 7,331 |   | $ | (1,806 | ) | $ | (1,866 | ) |
|                                           |       |                                   |       |                                 |       |           |       |   |   |   |   |   |   |   |   |
| Investment grade fixed income securities       |       | 165                                    |       | $                                    | 1,051      |           | $          | (51 | ) | 629 |   | $ | 5,602 |   | $ | (978 | ) | $ | (1,029 | ) |
| Below investment grade fixed income securities |       | 30                                     |       | 190                                  |       | (7             | )          | 268 |   | 1,713 |   | (826 | ) | (833 | ) |
| Total fixed income securities                  |       | 195                                    |       | $                                    | 1,241      |           | $          | (58 | ) | 897 |   | $ | 7,315 |   | $ | (1,804 | ) | $ | (1,862 | ) |
|                                           |       |                                   |       |                                 |       |           |       |   |   |   |   |   |   |   |   |
| **At December 31, 2009**                  | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed income securities                        | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U.S. government and agencies                   |       | 27                                     |       | $                                    | 1,952      |           | $          | (13 | ) | — |   | $ | — |   | $ | — |   | $ | (13 | ) |
| Municipal                                      |       | 144                                    |       | 1,634                                |       | (62            | )          | 280 |   | 1,912 |   | (457 | ) | (519 | ) |
| Corporate                                      |       | 300                                    |       | 3,979                                |       | (131           | )          | 398 |   | 5,155 |   | (659 | ) | (790 | ) |
| Foreign government                             |       | 10                                     |       | 360                                  |       | (11            | )          | 1 |   | 1 |   | — |   | (11 | ) |
| RMBS                                           |       | 162                                    |       | 604                                  |       | (14            | )          | 310 |   | 1,727 |   | (992 | ) | (1,006 | ) |
| CMBS                                           |       | 19                                     |       | 186                                  |       | (3             | )          | 257 |   | 1,796 |   | (949 | ) | (952 | ) |
| ABS                                            |       | 21                                     |       | 203                                  |       | (19            | )          | 163 |   | 1,363 |   | (518 | ) | (537 | ) |
| Redeemable preferred stock                     |       | 1                                      |       | —                               |       | —         |       | 1 |   | 13 |   | (1 | ) | (1 | ) |
| Total fixed income securities (1)              |       | 684                                    |       | 8,918                                |       | (253           | )          | 1,410 |   | 11,967 |   | (3,576 | ) | (3,829 | ) |
| Equity securities                              |       | 7                                      |       | 11                                   |       | (2             | )          | 1 |   | 13 |   | (5 | ) | (7 | ) |
| Total fixed income and equity securities       |       | 691                                    |       | $                                    | 8,929      |           | $          | (255 | ) | 1,411 |   | $ | 11,980 |   | $ | (3,581 | ) | $ | (3,836 | ) |
|                                           |       |                                   |       |                                 |       |           |       |   |   |   |   |   |   |   |   |
| Investment grade fixed income securities       |       | 650                                    |       | $                                    | 8,667      |           | $          | (191 | ) | 1,119 |   | $ | 10,260 |   | $ | (2,467 | ) | $ | (2,658 | ) |
| Below investment grade fixed income securities |       | 34                                     |       | 251                                  |       | (62            | )          | 291 |   | 1,707 |   | (1,109 | ) | (1,171 | ) |
| Total fixed income securities                  |       | 684                                    |       | $                                    | 8,918      |           | $          | (253 | ) | 1,410 |   | $ | 11,967 |   | $ | (3,576 | ) | $ | (3,829 | ) |

 

----

| (1) | Gross  unrealized losses resulting from factors other than credit on fixed income  securities with other-than-temporary impairments for which the Company has  recorded a credit loss in earnings total $1 million for the less than 12  month category and $261 million for the 12 months or greater category as of  September 30, 2010 and $16 million for the less than 12 month category  and $468 million for the 12 months or greater category as of  December 31, 2009. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Asof September 30, 2010, $496 million of unrealized losses are related tosecurities with an unrealized loss position less than 20% of amortized cost orcost, the degree of which suggests that these securities do not pose a highrisk of being other-than-temporarily impaired. Of the $496 million, $396 million are related to unrealized losses oninvestment grade fixed income securities. Investment grade is defined as a security having a rating of Aaa, Aa, Aor Baa from Moody’s, a rating of AAA, AA, A or BBB from Standard &Poor’s (“S&P”), Fitch, Dominion or Realpoint, a rating of aaa, aa, a or bbbfrom A.M. Best, or a comparable internal rating if an externally providedrating is not available.  Unrealizedlosses on investment grade securities are principally related to wideningcredit spreads, or in some instances, rising interest rates since the time ofinitial purchase.

 

Asof September 30, 2010, the remaining $1.37 billion of unrealized lossesare related to securities in unrealized loss positions greater than or equal to20% of amortized cost or cost. Investment grade securities comprising $633 million of these unrealizedlosses were evaluated based on factors such as expected cash flows and thefinancial condition and near-term and long-term prospects of the issue orissuer and were determined to have adequate resources to fulfill contractualobligations.  Of the $1.37 billion, $737million are related to below investment grade fixed income securities.  Of these amounts, $712 million of the belowinvestment grade fixed income securities had been in an unrealized lossposition for a period of twelve or more consecutive months as of September 30,2010.  Unrealized losses on below investmentgrade securities are principally related to RMBS, CMBS and ABS and were theresult of wider credit spreads resulting from larger risk premiums since thetime of initial purchase, largely due 

 

13

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

tomacroeconomic conditions and credit market deterioration, including the impactof declining residential and commercial real estate valuations.

 

RMBS,CMBS and ABS securities in an unrealized loss position were evaluated based onactual and projected collateral losses relative to the securities’ positions inthe respective securitization trusts, security specific expectations of cashflows, and credit ratings.  Thisevaluation also takes into consideration credit enhancement, measured in termsof (i) subordination from other classes of securities in the trust thatare contractually obligated to absorb losses before the class of security theCompany owns, (ii) the expected impact of other structural featuresembedded in the securitization trust beneficial to the class of securities theCompany owns, such as overcollateralization and excess spread, and (iii) forRMBS and ABS in an unrealized loss position, credit enhancements from reliablebond insurers, where applicable. Municipal bonds in an unrealized loss position were evaluated based onthe quality of the underlying securities, taking into consideration credit enhancementsfrom reliable bond insurers, where applicable. Unrealized losses on equity securities are primarily related to equitymarket fluctuations.

 

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

 

**Limitedpartnership impairment**

 

Asof September 30, 2010 and December 31, 2009, the carrying value ofequity method limited partnership interests totaled $507 million and $495million, respectively.  The Companyrecognizes an impairment loss 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 a level ofearnings that would justify the carrying amount of the investment.  The Company had no write-downs related toequity method limited partnership interests for the three months ended September 30,2010 and 2009.  The Company hadwrite-downs related to equity-method limited partnership interests of $1million and $5 million for the nine months ended September 30, 2010 and2009, respectively.

 

Asof September 30, 2010 and December 31, 2009, the carrying value forcost method limited partnership interests was $620 million and $533 million,respectively.  To determine if another-than-temporary impairment has occurred, the Company evaluates whether animpairment indicator has occurred in the period that may have a significantadverse effect on the carrying value of the investment.  Impairment indicators may include:significantly reduced valuations of the investments held by limitedpartnerships; actual recent cash flows received being significantly less thanexpected cash flows; reduced valuations based on financing completed at a lowervalue; completed sale of a material underlying investment at a pricesignificantly lower than expected; or any other adverse events since the lastfinancial statements received that might affect the fair value of the investee’scapital.  Additionally, the Company’sportfolio monitoring process includes a quarterly review of all cost methodlimited partnerships to identify instances where the net asset value is belowestablished thresholds for certain periods of time, as well as investments thatare performing below expectations, for further impairment consideration.  If a cost method limited partnership isother-than-temporarily impaired, the carrying value is written down to fairvalue, generally estimated to be equivalent to the reported net asset value ofthe underlying funds.  The Company hadwrite-downs related to cost method investments of $4 million and $27 millionfor the three months ended September 30, 2010 and 2009, respectively, and$19 million and $137 million for the nine months ended September 30, 2010and 2009, respectively.

 

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

 

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

 

14

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Level 1:**    *Assets and liabilities whosevalues are based on unadjusted quoted prices for identical assets orliabilities in an active market that the Company can access.

 

*Level 2:***    **Assets and liabilities whosevalues are based on the following:

 

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

 

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

 

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

 

*Level 3:**    *Assets and liabilities whosevalues are based on prices or valuation techniques that require inputs that areboth unobservable and significant to the overall fair value measurement.  Unobservable inputs reflect the Company’sestimates of the assumptions that market participants would use in valuing theassets and liabilities.

 

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

 

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

 

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

 

Certainassets are not carried at fair value on a recurring basis, includinginvestments such as mortgage loans, limited partnership interests, bank loansand policy loans.  Accordingly, suchinvestments are only included in the fair value hierarchy disclosure when theinvestment is subject to remeasurement at fair value after initial recognitionand the resulting remeasurement is reflected in the condensed consolidatedfinancial statements.  In addition,derivatives embedded in fixed income securities are not disclosed in thehierarchy as free-standing derivatives since they are presented with the hostcontracts in fixed income securities.  Asof September 30, 2010, 77.1% of total assets are measured at fair valueand 0.9% of total liabilities are measured at fair value.

 

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

 

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

 

Level1 measurements

 

·                  Fixed incomesecurities:  CompriseU.S. Treasuries.  Valuation is based onunadjusted quoted prices for identical assets in active markets that theCompany can access.

 

15

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

·                  Equitysecurities:  Compriseactively traded, exchange-listed U.S. and international equity securities.Valuation is based on unadjusted quoted prices for identical assets in activemarkets that the Company can access.

 

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

 

·                  Separateaccount assets:  Compriseactively traded mutual funds that have daily quoted net asset values foridentical assets that the Company can access. Net asset values for the actively traded mutual funds in which theseparate account assets are invested are obtained daily from the fund managers.

 

Level2 measurements

 

·                  Fixed incomesecurities:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·                  Equitysecurities:  The primaryinputs to the valuation include quoted prices for identical or similar assetsin markets that are not active.

 

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

 

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

 

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

 

16

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

Level3 measurements

 

·                  Fixed incomesecurities:

 

*Municipal: *ARS primarilybacked by student loans that have become illiquid due to failures in theauction market are valued using a discounted cash flow model that is widelyaccepted in the financial services industry and uses significant non-marketobservable inputs, including estimates of future coupon rates if auctionfailures continue, maturity assumptions and illiquidity premium.  Also included are municipal bonds that arenot rated by third party credit rating agencies but are rated by the NationalAssociation of Insurance Commissioners (“NAIC”), and other high-yield municipalbonds.  The primary inputs to thevaluation of these municipal bonds include quoted prices for identical orsimilar assets in markets that exhibit less liquidity relative to those marketssupporting Level 2 fair value measurements, contractual cash flows, benchmarkyields and credit spreads.

 

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

 

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

 

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

 

*CMBS:*  The primaryinputs to the valuation include quoted prices for identical or similar assetsin markets that exhibit less liquidity relative to those markets supportingLevel 2 fair value measurements, contractual cash flows, benchmark yields,collateral performance and credit spreads. Also included are CMBS that are valued based on non-binding brokerquotes.  Due to the reduced availabilityof actual market prices or relevant observable inputs as a result of thedecrease in liquidity that has been experienced in the market for thesesecurities, certain CMBS are categorized as Level 3.

 

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

 

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

 

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

 

17

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

observable inputs such as volatility. Other primary inputs include interest rate yield curves and creditspreads.

 

·      Contractholder funds:  Derivatives embedded in certain annuitycontracts are valued internally using models widely accepted in the financialservices industry that determine asingle best estimate of fair value for the embedded derivatives within a blockof contractholder liabilities.  Themodels use stochastically determined cash flows based on the contractualelements of embedded derivatives and other applicable market data.  These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

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

 

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

 

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

 
| **($ in millions)**             | ** ** | **Quoted prices  in active  markets for  identical assets  (Level 1)** | ** ** | **Significant  other  observable  inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** | **Counterparty  and cash  collateral  netting** | ** ** | **Balance as of  September 30,  2010** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **Assets**                                | ** ** | ** **                                                                                      | ** ** | ** **                                                 | ** ** | ** **                                            | ** ** | ** **                                           | ** ** | ** **                                            | ** ** |
| Fixed income securities:                  |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| U.S. government and agencies              |       | $                                                                                               | 1,496      |                                                       | $          | 2,811                                                 |       | $                                                    | —     |                                                  |       |   | $ | 4,307 |   |
| Municipal                                 |       | —                                                                                          |       | 4,273                                                      |       | 632                                                   |       |                                                 |       | 4,905                                                 |       |
| Corporate                                 |       | —                                                                                          |       | 26,939                                                     |       | 1,985                                                 |       |                                                 |       | 28,924                                                |       |
| Foreign government                        |       | —                                                                                          |       | 2,471                                                      |       | —                                                |       |                                                 |       | 2,471                                                 |       |
| RMBS                                      |       | —                                                                                          |       | 3,421                                                      |       | 1,268                                                 |       |                                                 |       | 4,689                                                 |       |
| CMBS                                      |       | —                                                                                          |       | 1,119                                                      |       | 774                                                   |       |                                                 |       | 1,893                                                 |       |
| ABS                                       |       | —                                                                                          |       | 689                                                        |       | 1,888                                                 |       |                                                 |       | 2,577                                                 |       |
| Redeemable preferred stock                |       | —                                                                                          |       | 14                                                         |       | 1                                                     |       |                                                 |       | 15                                                    |       |
| Total fixed income securities             |       | 1,496                                                                                           |       | 41,737                                                     |       | 6,548                                                 |       |                                                 |       | 49,781                                                |       |
| Equity securities                         |       | 121                                                                                             |       | 36                                                         |       | 29                                                    |       |                                                 |       | 186                                                   |       |
| Short-term investments                    |       | 132                                                                                             |       | 871                                                        |       | —                                                |       |                                                 |       | 1,003                                                 |       |
| Other investments:                        |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| Free-standing derivatives                 |       | —                                                                                          |       | 544                                                        |       | 4                                                     |       | $                                                    | (247       | )                                                     | 301        |   |
| Separate account assets                   |       | 8,459                                                                                           |       | —                                                     |       | —                                                |       |                                                 |       | 8,459                                                 |       |
| Other assets                              |       | —                                                                                          |       | —                                                     |       | 2                                                     |       |                                                 |       | 2                                                     |       |
| **Total recurring basis assets**          |       | 10,208                                                                                          |       | 43,188                                                     |       | 6,583                                                 |       | (247                                                 | )          | 59,732                                                |       |
| Non-recurring basis (1)                   |       | —                                                                                          |       | —                                                     |       | 72                                                    |       |                                                 |       | 72                                                    |       |
| **Total assets at fair value**            |       | $                                                                                               | 10,208     |                                                       | $          | 43,188                                                |       | $                                                    | 6,655      |                                                  | $          | (247 | ) | $ | 59,804 |   |
| % of total assets at fair value           |       | 17.1                                                                                            | %          | 72.2                                                       | %          | 11.1                                                  | %          | (0.4                                                 | )%         | 100.0                                                 | %          |
|                                      |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| **Liabilities**                           |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| Contractholder funds:                     |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| Derivatives embedded in annuity contracts |       | $                                                                                               | —     |                                                       | $          | (145                                                  | )          | $                                                    | (142       | )                                                     |       |   | $ | (287 | ) |
| Other liabilities:                        |       |                                                                                            |       |                                                       |       |                                                  |       |                                                 |       |                                                  |       |
| Free-standing derivatives                 |       | (1                                                                                              | )          | (535                                                       | )          | (97                                                   | )          | $                                                    | 243        |                                                  | (390       | ) |
| **Total liabilities at fair value**       |       | $                                                                                               | (1         | )                                                          | $          | (680                                                  | )          | $                                                    | (239       | )                                                     | $          | 243 |   | $ | (677 | ) |
| % of total liabilities at fair value      |       | 0.2                                                                                             | %          | 100.4                                                      | %          | 35.3                                                  | %          | (35.9                                                | )%         | 100.0                                                 | %          |

 

----

(1)   Includes $55 million ofmortgage loans, $13 million of limited partnership interests and $4 million ofother investments written-down to fair value in connection with recognizingother-than-temporary impairments.

 

18

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

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

 

----

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

 

19

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                 | ** ** | ** **                                       | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                            | ** ** | ** **                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|
| **($ in millions)**              | ** ** | **Balance as of  June 30,  2010** | ** ** | **Net  income (1)**                                                                     | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** ** | **Transfers  into Level 3** | ** ** | **Transfers out  of Level 3** | ** ** | **Balance as of  September 30,  2010** | ** ** |
| **Assets**                                 |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Fixed  income securities:                  |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Municipal                                  |       | $                                                | 603        |                                                                                         | $          | —                                                  |       | $                                                                 | (1         | )                                     | $          | 28                                           |       | $ | 2 |   | $ | — |   | $ | 632 |   |
| Corporate                                  |       | 2,018                                            |       | 14                                                                                           |       | 67                                                      |       | (127                                                              | )          | 164                                   |       | (151                                         | )          | 1,985 |   |
| RMBS                                       |       | 1,362                                            |       | (51                                                                                          | )          | 118                                                     |       | (161                                                              | )          | —                                |       | —                                       |       | 1,268 |   |
| CMBS                                       |       | 792                                              |       | (68                                                                                          | )          | 131                                                     |       | (119                                                              | )          | 38                                    |       | —                                       |       | 774 |   |
| ABS                                        |       | 1,880                                            |       | 27                                                                                           |       | 56                                                      |       | 48                                                                |       | —                                |       | (123                                         | )          | 1,888 |   |
| Redeemable  preferred stock                |       | 1                                                |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 1 |   |
| Total  fixed income securities             |       | 6,656                                            |       | (78                                                                                          | )          | 371                                                     |       | (331                                                              | )          | 204                                   |       | (274                                         | )          | 6,548 |   |
| Equity  securities                         |       | 29                                               |       | 15                                                                                           |       | —                                                  |       | (15                                                               | )          | —                                |       | —                                       |       | 29 |   |
| Other  investments:                        |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Free-standing  derivatives, net            |       | (108                                             | )          | 10                                                                                           |       | —                                                  |       | 5                                                                 |       | —                                |       | —                                       |       | (93 | )(2) |
| Other  assets                              |       | 2                                                |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 2 |   |
| **Total recurring****Level 3 assets**      |       | $                                                | 6,579      |                                                                                         | $          | (53                                                     | )          | $                                                                 | 371        |                                  | $          | (341                                         | )          | $ | 204 |   | $ | (274 | ) | $ | 6,486 |   |
|                                       |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| **Liabilities**                            |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Contractholder  funds:                     |       |                                             |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Derivatives  embedded in annuity contracts |       | $                                                | (119       | )                                                                                            | $          | (23                                                     | )          | $                                                                 | —     |                                  | $          | —                                       |       | $ | — |   | $ | — |   | $ | (142 | ) |
| **Total recurring****Level 3 liabilities** |       | $                                                | (119       | )                                                                                            | $          | (23                                                     | )          | $                                                                 | —     |                                  | $          | —                                       |       | $ | — |   | $ | — |   | $ | (142 | ) |

 

----

(1)   The effect to net incometotals $(76) million and is reported in the Condensed Consolidated Statementsof Operations as follows: $(63) million in realized capital gains and losses,$10 million in net investment income and $23 million in contract benefits.

 

(2)   Comprises $4 million ofassets and $97 million of liabilities.

 

20

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                 | ** ** | ** **                                           | ** ** | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                            | ** ** | ** **                                   | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|
| **($ in millions)**              | ** ** | **Balance as of  December 31,  2009** | ** ** | **Net  income (1)**                                                                     | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** ** | **Transfers  into Level 3** | ** ** | **Transfers out  of Level 3** | ** ** | **Balance as of  September 30,  2010** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Fixed  income securities:                  |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Municipal                                  |       | $                                                    | 746        |                                                                                         | $          | (10                                                     | )          | $                                                                 | 9          |                                  | $          | (88                                          | )          | $ | 2 |   | $ | (27 | ) | $ | 632 |   |
| Corporate                                  |       | 2,020                                                |       | (8                                                                                           | )          | 187                                                     |       | (188                                                              | )          | 336                                   |       | (362                                         | )          | 1,985 |   |
| Foreign  government                        |       | 20                                                   |       | —                                                                                       |       | —                                                  |       | (20                                                               | )          | —                                |       | —                                       |       | — |   |
| RMBS                                       |       | 1,052                                                |       | (179                                                                                         | )          | 366                                                     |       | 35                                                                |       | —                                |       | (6                                           | )          | 1,268 |   |
| CMBS                                       |       | 1,322                                                |       | (176                                                                                         | )          | 432                                                     |       | (453                                                              | )          | 62                                    |       | (413                                         | )          | 774 |   |
| ABS                                        |       | 1,710                                                |       | 43                                                                                           |       | 133                                                     |       | 202                                                               |       | —                                |       | (200                                         | )          | 1,888 |   |
| Redeemable  preferred stock                |       | 1                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 1 |   |
| Total  fixed income securities             |       | 6,871                                                |       | (330                                                                                         | )          | 1,127                                                   |       | (512                                                              | )          | 400                                   |       | (1,008                                       | )          | 6,548 |   |
| Equity  securities                         |       | 27                                                   |       | 15                                                                                           |       | 1                                                       |       | (14                                                               | )          | —                                |       | —                                       |       | 29 |   |
| Other  investments:                        |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Free-standing  derivatives, net            |       | (53                                                  | )          | (55                                                                                          | )          | —                                                  |       | 15                                                                |       | —                                |       | —                                       |       | (93 | )(2) |
| Other  assets                              |       | 2                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                |       | —                                       |       | 2 |   |
| **Total recurring****Level 3 assets**      |       | $                                                    | 6,847      |                                                                                         | $          | (370                                                    | )          | $                                                                 | 1,128      |                                  | $          | (511                                         | )          | $ | 400 |   | $ | (1,008 | ) | $ | 6,486 |   |
|                                       |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| **Liabilities**                            |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Contractholder  funds:                     |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                  |       |                                         |       |   |   |
| Derivatives  embedded in annuity contracts |       | $                                                    | (110       | )                                                                                            | $          | (35                                                     | )          | $                                                                 | —     |                                  | $          | 3                                            |       | $ | — |   | $ | — |   | $ | (142 | ) |
| **Total recurring****Level 3 liabilities** |       | $                                                    | (110       | )                                                                                            | $          | (35                                                     | )          | $                                                                 | —     |                                  | $          | 3                                            |       | $ | — |   | $ | — |   | $ | (142 | ) |

 

----

(1)   The effect to net incometotals $(405) million and is reported in the Condensed Consolidated Statementsof Operations as follows: $(424) million in realized capital gains and losses,$57 million in net investment income, $3 million in interest credited tocontractholder funds and $35 million in contract benefits.

 

(2)   Comprises $4 million ofassets and $97 million of liabilities.

 

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

 

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

 

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

 

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

 

21

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

wasnot available as of the prior period, and any gains or losses related to thechange in valuation source for individual securities were not significant.

 

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

 
| **($ in millions)**                  | ** ** | **Three  months ended  September 30, 2010** | ** ** | **Nine  months ended  September 30, 2010** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
|                                      |       |                                                       |       |                                                      |       |
| **Assets**                                |       |                                                       |       |                                                      |       |
| Fixed income securities:                  |       |                                                       |       |                                                      |       |
| Municipal                                 |       | $                                                          | —     |                                                      | $          | (8 | ) |
| Corporate                                 |       | 5                                                          |       | (27                                                       | )          |
| RMBS                                      |       | (49                                                        | )          | (141                                                      | )          |
| CMBS                                      |       | (22                                                        | )          | (42                                                       | )          |
| ABS                                       |       | 26                                                         |       | 49                                                        |       |
| Total fixed income securities             |       | (40                                                        | )          | (169                                                      | )          |
| Other investments:                        |       |                                                       |       |                                                      |       |
| Free-standing derivatives, net            |       | 13                                                         |       | (44                                                       | )          |
| **Total recurring Level 3 assets**        |       | $                                                          | (27        | )                                                         | $          | (213 | ) |
|                                      |       |                                                       |       |                                                      |       |
| **Liabilities**                           |       |                                                       |       |                                                      |       |
| Contractholder funds:                     |       |                                                       |       |                                                      |       |
| Derivatives embedded in annuity contracts |       | $                                                          | (23        | )                                                         | $          | (35 | ) |
| **Total recurring Level 3  liabilities**  |       | $                                                          | (23        | )                                                         | $          | (35 | ) |

 

Theamounts in the table above represent gains and losses included in net incomeduring the period presented for the period of time that the asset or liabilitywas determined to be in Level 3.  Thesegains and losses total $(50) million for the three months ended September 30,2010 and are reported in the Condensed Consolidated Statements of Operations asfollows: $(33) million in realized capital gains and losses,$5 million in net investment income, $(1) million in interestcredited to contractholder funds and $23 million in contractbenefits.  These gains and losses total$(248) million for the nine months ended September 30, 2010 and arereported in the Condensed Consolidated Statements of Operations as follows:$(243) million in realized capital gains and losses, $35 million innet investment income, $5 million in interest credited to contractholder fundsand $35 million in contract benefits.

 

22

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table presents the rollforward ofLevel 3 assets and liabilities held at fair value on a recurring basis duringthe three months ended September 30, 2009.

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

 

----

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

 

23

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table presents the rollforward ofLevel 3 assets and liabilities held at fair value on a recurring basis duringthe nine months ended September 30, 2009.

 
| ** **                                 | ** ** | ** **                                           | ** ** | **Total realized and unrealized gains  (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                          | ** ** | **Total  gains (losses)  included in net  income for  financial** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| **($ in millions)**              | ** ** | **Balance as of  December 31,  2008** | ** ** | **Net income (1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** ** | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  September 30,  2009**                                 | ** ** | **instruments  still held at  September 30,  2009 (3)** | ** ** |
| **Assets**                                 |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Fixed income securities:                   |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Municipal                                  |       | $                                                    | 703        |                                                                                         | $          | (1                                                      | )          | $                                                                 | 28         |                                                                | $          | (27                                                                                   | )          | $ | (16 | ) | $ | 687 |   | $ | — |   |
| Corporate                                  |       | 9,867                                                |       | (9                                                                                           | )          | 1,119                                                   |       | (1,405                                                            | )          | (109                                                                | )          | 9,463                                                                                 |       | (5 | ) |
| Foreign government                         |       | —                                               |       | —                                                                                       |       | —                                                  |       | 10                                                                |       | —                                                              |       | 10                                                                                    |       | — |   |
| RMBS                                       |       | 1,811                                                |       | (69                                                                                          | )          | 54                                                      |       | (162                                                              | )          | (577                                                                | )          | 1,057                                                                                 |       | (67 | ) |
| CMBS                                       |       | 410                                                  |       | (162                                                                                         | )          | 591                                                     |       | (74                                                               | )          | 561                                                                 |       | 1,326                                                                                 |       | (131 | ) |
| ABS                                        |       | 1,341                                                |       | (164                                                                                         | )          | 617                                                     |       | (126                                                              | )          | (169                                                                | )          | 1,499                                                                                 |       | (169 | ) |
| Redeemable preferred stock                 |       | 1                                                    |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 1                                                                                     |       | — |   |
| Total fixed income securities              |       | 14,133                                               |       | (405                                                                                         | )          | 2,409                                                   |       | (1,784                                                            | )          | (310                                                                | )          | 14,043                                                                                |       | (372 | ) |
| Equity securities                          |       | 27                                                   |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                              |       | 27                                                                                    |       | — |   |
| Other investments:                         |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Free-standing derivatives, net             |       | (93                                                  | )          | 55                                                                                           |       | —                                                  |       | (37                                                               | )          | —                                                              |       | (75                                                                                   | )(2)       | 68 |   |
| Other assets                               |       | 1                                                    |       | 1                                                                                            |       | —                                                  |       | —                                                            |       | —                                                              |       | 2                                                                                     |       | 1 |   |
| **Total recurring Level 3 assets**         |       | $                                                    | 14,068     |                                                                                         | $          | (349                                                    | )          | $                                                                 | 2,409      |                                                                | $          | (1,821                                                                                | )          | $ | (310 | ) | $ | 13,997 |   | $ | (303 | ) |
|                                       |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| **Liabilities**                            |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Contractholder funds:                      |       |                                                 |       |                                                                                         |       |                                                    |       |                                                              |       |                                                                |       |                                                                                  |       |   |   |
| Derivatives embedded in annuity contracts  |       | $                                                    | (265       | )                                                                                            | $          | 141                                                     |       | $                                                                 | —     |                                                                | $          | 4                                                                                     |       | $ | — |   | $ | (120 | ) | $ | 141 |   |
| **Total recurring Level 3****liabilities** |       | $                                                    | (265       | )                                                                                            | $          | 141                                                     |       | $                                                                 | —     |                                                                | $          | 4                                                                                     |       | $ | — |   | $ | (120 | ) | $ | 141 |   |

 

----

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

 

Presented below are the carrying values and fairvalue estimates of financial instruments not carried at fair value on arecurring basis.

 

**Financial assets**

 
| ** **                                  | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **($ in millions)**               | ** ** | **Carrying  value**              | ** ** | **Fair  value**                 | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Mortgage  loans                             |       | $                                | 6,833      |                            | $          | 6,247 |   | $ | 7,780 |   | $ | 6,220 |   |
| Limited  partnership interests - cost basis |       | 620                              |       | 649                             |       | 533 |   | 521 |   |
| Bank  loans                                 |       | 313                              |       | 297                             |       | 359 |   | 329 |   |
| Notes  due from related party               |       | 275                              |       | 249                             |       | 275 |   | 233 |   |
|                                             |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

The fair value of mortgage loans is based ondiscounted contractual cash flows or, if the loans are impaired due to creditreasons, the fair value of collateral less costs to sell.  Risk adjusted discount rates are selectedusing current rates at which similar loans would be made to borrowers withsimilar characteristics, using similar types of properties as collateral.  The fair value of limited partnershipinterests accounted for on the cost basis is determined using reported netasset values of the underlying funds. The fair value of bank loans, which are reported in other investments onthe Condensed Consolidated Statements of Financial Position, are valued basedon broker quotes

 

24

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

frombrokers familiar with the loans and current market conditions.  The fair value of notes due from relatedparty is based on discounted cash flow calculations using current interestrates for instruments with comparable terms.

 

**Financial liabilities**

 
| ** **                                    | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **($ in millions)**                 | ** ** | **Carrying  value**              | ** ** | **Fair  value**                 | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| Contractholder  funds on investment contracts |       | $                                | 35,792     |                            | $          | 35,742 |   | $ | 39,824 |   | $ | 38,196 |   |
| Notes  due to related parties                 |       | 677                              |       | 653                             |       | 675 |   | 611 |   |
| Liability  for collateral                     |       | 469                              |       | 469                             |       | 617 |   | 617 |   |
|                                               |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

The fair value of contractholder funds on investmentcontracts is based on the terms of the underlying contracts utilizingprevailing market rates for similar contracts adjusted for the Company’s owncredit risk.  Deferred annuities includedin contractholder 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 notes due to related parties isbased on discounted cash flow calculations using current interest rates forinstruments with comparable terms and considers the Company’s own creditrisk.  The liability for collateral isvalued at carrying value due to its short-term nature.

 

**6.  Derivative FinancialInstruments**

 

The Company primarily uses derivatives for riskmanagement and asset replication.  Inaddition, the Company has derivatives embedded in non-derivative host contractsthat are required to be separated from the host contracts and accounted for atfair value.  With the exception ofnon-hedge derivatives used for asset replication and non-hedge embeddedderivatives, all of the Company’s derivatives are evaluated for their ongoingeffectiveness as either accounting hedge or non-hedge derivative financialinstruments on at least a quarterly basis. The Company does not use derivatives for trading purposes.  Non-hedge accounting is generally used for “portfolio”level hedging strategies where the terms of the individual hedged items do notmeet the strict homogeneity requirements to permit the application of hedgeaccounting.

 

The Company uses derivatives to partially mitigatepotential adverse impacts from increases in credit spreads.  Credit default swaps are typically used tomitigate the credit risk within the Company’s fixed income portfolio.  The Company uses foreign currency swapsprimarily to reduce the foreign currency risk associated with issuing foreigncurrency denominated funding agreements and holding foreign currencydenominated investments.

 

Asset-liability management is a risk managementstrategy that is principally employed to balance the respective interest-ratesensitivities of the Company’s assets and liabilities.  Depending upon the attributes of the assetsacquired and liabilities issued, derivative instruments such as interest rateswaps, caps, floors, swaptions and futures are utilized to change the interestrate characteristics of existing assets and liabilities to ensure therelationship is maintained within specified ranges and to reduce exposure torising or falling interest rates.  TheCompany uses financial futures and interest rate swaps to hedge anticipatedasset purchases and liability issuances and futures and options for hedging theequity exposure contained in equity indexed annuity product contracts thatoffer equity returns to contractholders. In addition, the Company uses interest rate swaps to hedge interest raterisk inherent in funding agreements.

 

When derivatives meet specific criteria, they may bedesignated as accounting hedges and accounted for as fair value, cash flow,foreign currency fair value or foreign currency cash flow hedges.  The Company designates certain of itsinterest rate and foreign currency swap contracts and certain investment risktransfer reinsurance agreements as fair value hedges when the hedginginstrument is highly effective in offsetting the risk of changes in the fairvalue of the hedged item.  The Companydesignates certain of its foreign currency swap contracts as cash flow hedgeswhen the hedging instrument is highly effective in offsetting the exposure ofvariations in cash flows for the hedged risk that could affect net income.  Amounts are reclassified to net investmentincome or realized capital gains and losses as the hedged item affects netincome.

 

25

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Asset replication refers tothe “synthetic” creation of assets through the use of derivatives and primarilyinvestment grade host bonds to replicate securities that are either unavailablein the cash markets or more economical to acquire in synthetic form.  The Company replicates fixed incomesecurities using a combination of a credit default swap and one or more highlyrated fixed income securities to synthetically replicate the economic characteristicsof one or more cash market securities.

 

The Company’s primary embedded derivatives areconversion options in fixed income securities, which provide the Company withthe right to convert the instrument into a predetermined number of shares ofcommon stock; equity options in annuity product contracts, which provide equityreturns to contractholders; equity-indexed notes containing equity calloptions, which provide a coupon payout that is determined using one or moreequity-based indices; and credit default swaps in synthetic collateralized debtobligations, which provide enhanced coupon rates as a result of selling creditprotection.

 

The notional amounts specified in the contracts areused to calculate the exchange of contractual payments under the agreements andare generally not representative of the potential for gain or loss on theseagreements.  However, the notionalamounts specified in credit default swaps where the Company has sold creditprotection represent the maximum amount of potential loss, assuming norecoveries.

 

Fair value, which is equal to the carrying value, isthe estimated amount that the Company would receive or pay to terminate thederivative contracts at the reporting date. The carrying value amounts for OTC derivatives are further adjusted forthe effects, if any, of legally enforceable master netting agreements and arepresented on a net basis, by counterparty agreement, in the CondensedConsolidated Statements of Financial Position. For certain exchange traded derivatives, the exchange requires margindeposits as well as daily cash settlements of margin accounts.  As of September 30, 2010, the Companypledged $24 million of securities and cash in the form of margin deposits.

 

For those derivatives which qualify for fair valuehedge accounting, net income includes the changes in the fair value of both thederivative instrument and the hedged risk, and therefore reflects any hedgingineffectiveness.  For cash flow hedges,gains and losses are amortized from accumulated other comprehensive income andare reported in net income in the same period the forecasted transactions beinghedged impact net income.  For embeddedderivatives in fixed income securities, net income includes the change in fairvalue of the embedded derivative and accretion income related to the hostinstrument.  For non-hedge derivatives,net income includes changes in fair value and accrued periodic settlements,when applicable.

 

26

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table provides a summary of the volumeand fair value positions of derivative instruments as well as their reportinglocation in the Condensed Consolidated Statements of Financial Position atSeptember 30, 2010.

 
| ** **                                                                    | ** ** | **Asset derivatives**           | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                    | ** ** | ** **                           | ** ** | **Volume (1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in millions, except number of contracts)** | ** ** | **Balance sheet location** | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as accounting hedging  instruments**                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                                 |       | Other investments                    |       | $ | 35 |   | n/a |   | $ | (2 | ) | $ | — |   | $ | (2 | ) |
| Foreign currency swap agreements                                              |       | Other investments                    |       | 41 |   | n/a |   | 2 |   | 3 |   | (1 | ) |
| Total                                                                         |       |                                 |       | $ | 76 |   | n/a |   | $ | — |   | $ | 3 |   | $ | (3 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments**             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                                 |       | Other investments                    |       | $ | 574 |   | n/a |   | $ | 58 |   | $ | 60 |   | $ | (2 | ) |
| Interest rate cap and floor agreements                                        |       | Other investments                    |       | 61 |   | n/a |   | — |   | — |   | — |   |
| Financial futures contracts and options                                       |       | Other assets                         |       | n/a |   | 1,040 |   | — |   | — |   | — |   |
| **Equity and index contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Options, futures and warrants (2)                                             |       | Other investments                    |       | 66 |   | 23,750 |   | 243 |   | 243 |   | — |   |
| Options, futures and warrants                                                 |       | Other assets                         |       | n/a |   | 1,456 |   | — |   | — |   | — |   |
| **Foreign currency contracts**                                                |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency swap agreements                                              |       | Other investments                    |       | 40 |   | n/a |   | — |   | — |   | — |   |
| **Embedded derivative financial instruments**                                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Conversion options                                                            |       | Fixed income securities              |       | 309 |   | n/a |   | 76 |   | 76 |   | — |   |
| Equity-indexed call options                                                   |       | Fixed income securities              |       | 325 |   | n/a |   | 47 |   | 47 |   | — |   |
| Credit default swaps                                                          |       | Fixed income securities              |       | 179 |   | n/a |   | (101 | ) | — |   | (101 | ) |
| **Credit default contracts**                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Credit default swaps - buying protection                                      |       | Other investments                    |       | 31 |   | n/a |   | — |   | — |   | — |   |
| **Other contracts**                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other contracts                                                               |       | Other investments                    |       | 13 |   | n/a |   | — |   | — |   | — |   |
| Other contracts                                                               |       | Other assets                         |       | 5 |   | n/a |   | 2 |   | 2 |   | — |   |
| Total                                                                         |       |                                 |       | $ | 1,603 |   | 26,246 |   | $ | 325 |   | $ | 428 |   | $ | (103 | ) |
|                                                                          |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative assets**                                                   |       |                                 |       | $ | 1,679 |   | 26,246 |   | $ | 325 |   | $ | 431 |   | $ | (106 | ) |

 

----

| (1) | Volume for OTC derivative contracts is represented by their notional  amounts. Volume for exchange traded derivatives is represented by the number  of contracts, which is the basis on which they are traded. (n/a = not  applicable) |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | In addition to the number of contracts presented in the table, the  Company held 837,100 stock warrants. Stock warrants can be converted to cash  upon sale of those instruments or exercised for shares of common stock.              |

 

27

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                        | ** ** | **Liability derivatives**           | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                               | ** ** | **Volume (1)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **Balance sheet location**     | ** ** | **Notional  amount** | ** ** | **Number  of  contracts** | ** ** | **Fair  value,  net** | ** ** | **Gross  asset** | ** ** | **Gross  liability** | ** ** |
| **Derivatives designated as accounting hedging  instruments**     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other liabilities & accrued expenses |       | $ | 3,621 |   | n/a |   | $ | (255 | ) | $ | 26 |   | $ | (281 | ) |
| Interest rate swap agreements                                     |       | Contractholder funds                     |       | n/a |   | n/a |   | 7 |   | 7 |   | — |   |
| Foreign currency swap agreements                                  |       | Other liabilities & accrued expenses |       | 161 |   | n/a |   | (14 | ) | 1 |   | (15 | ) |
| Foreign currency and interest rate swap agreements                |       | Other liabilities & accrued expenses |       | 435 |   | n/a |   | 44 |   | 44 |   | — |   |
| Foreign currency and interest rate swap agreements                |       | Contractholder funds                     |       | n/a |   | n/a |   | 20 |   | 20 |   | — |   |
| Total                                                             |       |                                     |       | $ | 4,217 |   | n/a |   | $ | (198 | ) | $ | 98 |   | $ | (296 | ) |
|                                                              |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **Derivatives not designated as accounting hedging  instruments** |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **Interest rate contracts**                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate swap agreements                                     |       | Other liabilities & accrued expenses |       | $ | 4,494 |   | n/a |   | $ | 18 |   | $ | 131 |   | $ | (113 | ) |
| Interest rate swaption agreements                                 |       | Other liabilities & accrued expenses |       | 750 |   | n/a |   | 2 |   | 2 |   | — |   |
| Interest rate cap and floor agreements                            |       | Other liabilities & accrued expenses |       | 3,514 |   | n/a |   | (32 | ) | 1 |   | (33 | ) |
| Financial futures contracts and options                           |       | Other liabilities & accrued expenses |       | n/a |   | 1,130 |   | — |   | — |   | — |   |
| **Equity and index contracts**                                    |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Options and futures                                               |       | Other liabilities & accrued expenses |       | 57 |   | 24,118 |   | (109 | ) | 1 |   | (110 | ) |
| **Foreign currency contracts**                                    |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency swap agreements                                  |       | Other liabilities & accrued expenses |       | 50 |   | n/a |   | 3 |   | 3 |   | — |   |
| **Embedded derivative financial instruments**                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Guaranteed accumulation benefits                                  |       | Contractholder funds                     |       | 1,019 |   | n/a |   | (87 | ) | — |   | (87 | ) |
| Guaranteed withdrawal benefits                                    |       | Contractholder funds                     |       | 720 |   | n/a |   | (51 | ) | — |   | (51 | ) |
| Equity-indexed options in life and annuity product  contracts     |       | Contractholder funds                     |       | 4,165 |   | n/a |   | (145 | ) | — |   | (145 | ) |
| Other embedded derivative financial instruments                   |       | Contractholder funds                     |       | 85 |   | n/a |   | (4 | ) | — |   | (4 | ) |
| **Credit default contracts**                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Credit default swaps - buying protection                          |       | Other liabilities & accrued expenses |       | 512 |   | n/a |   | (3 | ) | 4 |   | (7 | ) |
| Credit default swaps - selling protection                         |       | Other liabilities & accrued expenses |       | 344 |   | n/a |   | (67 | ) | 2 |   | (69 | ) |
| Total                                                             |       |                                     |       | $ | 15,710 |   | 25,248 |   | $ | (475 | ) | $ | 144 |   | $ | (619 | ) |
|                                                              |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivative liabilities**                                  |       |                                     |       | $ | 19,927 |   | 25,248 |   | $ | (673 | ) | $ | 242 |   | $ | (915 | ) |
|                                                              |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **Total derivatives**                                             |       |                                     |       | $ | 21,606 |   | 51,494 |   | $ | (348 | ) |   |   |   |   |

 

----

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

 

 

28

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table providesa summary of the volume and fair value positions of derivative instruments aswell as their reporting location in the Consolidated Statements of FinancialPosition at December 31, 2009.

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

 

----

| (1) | Volume for OTC derivative contracts is represented by their notional  amounts. Volume for exchange traded derivatives is represented by the number  of contracts, which is the basis on which they are traded. (n/a = not  applicable) |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | In addition to the number of contracts presented in the table, the  Company held 837,100 stock warrants. Stock warrants can be converted to cash  upon sale of those instruments or exercised for shares of common stock.              |

 

29

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

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

 

----

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

 

The following table providesa summary of the impacts of the Company’s foreign currency contracts in cashflow hedging relationships in the Condensed Consolidated Statements ofOperations and the Condensed Consolidated Statements of FinancialPosition.  Amortization of net gains fromaccumulated other comprehensive income related to cash flow hedges is expectedto be $2 million during the next twelve months.

 
| ** **                                                                          | ** ** | **Three months  ended********September 30,** | ** ** | **Nine months********ended********September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **($ in millions)**                                                       | ** ** | **2010**                                               | ** ** | **2009**                                                    | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Effective portion**                                                               |       |                                                   |       |                                                        |       |   |   |   |   |
| (Loss) gain recognized in  OCI on derivatives during the period                     |       | $                                                      | (19        | )                                                           | $          | (12 | ) | $ | 9 |   | $ | (36 | ) |
| Loss recognized in OCI on  derivatives during the term of the hedging relationship  |       | (12                                                    | )          | (20                                                         | )          | (12 | ) | (20 | ) |
| Gain reclassified from  AOCI into income (net investment income)                    |       | —                                                 |       | —                                                      |       | 1 |   | 1 |   |
| (Loss) gain reclassified  from AOCI into income (realized capital gains and losses) |       | —                                                 |       | (2                                                          | )          | 2 |   | (1 | ) |
| **Ineffective portion and amount  excluded from effectiveness**                     |       |                                                   |       |                                                        |       |   |   |   |   |
| Gain recognized in income  on derivatives (realized capital gains and losses)       |       | —                                                 |       | —                                                      |       | — |   | — |   |
|                                                                                     |            |                                                        |            |                                                             |            |  |  |  |  |  |  |  |  |

 

30

----

 

**ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following tables present gains and losses fromvaluation, settlements and hedge ineffectiveness reported on derivatives usedin fair value hedging relationships and derivatives not designated asaccounting hedging instruments in the Condensed Consolidated Statements ofOperations.

 
| ** **                                                        | ** ** | **Three months ended September 30, 2010** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **($ in millions)**                                     | ** ** | **Net  investment  income**                                        | ** ** | **Realized  capital  gains and  losses** | ** ** | **Contract  benefits** | ** ** | **Interest  credited to  contractholder  funds** | ** ** | **Total gain  (loss)  recognized  in net  income on  derivatives** | ** ** |
| **Derivatives in fair value  accounting hedging relationships**   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | $                                                                  | (57        | ) | $ | 2 |   | $ | — |   | $ | 9 |   | $ | (46 | ) |
| Foreign currency and  interest rate contracts                     |       | —                                                             |       | — |   | — |   | 25 |   | 25 |   |
| Subtotal                                                          |       | (57                                                                | )          | 2 |   | — |   | 34 |   | (21 | ) |
|                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                             |       | (65 | ) | — |   | — |   | (65 | ) |
| Equity and index contracts                                        |       | —                                                             |       | — |   | — |   | 70 |   | 70 |   |
| Embedded derivative  financial instruments                        |       | —                                                             |       | 29 |   | (22 | ) | (39 | ) | (32 | ) |
| Credit default contracts                                          |       | —                                                             |       | 10 |   | — |   | — |   | 10 |   |
| Other contracts                                                   |       | —                                                             |       | — |   | — |   | 1 |   | 1 |   |
| Subtotal                                                          |       | —                                                             |       | (26 | ) | (22 | ) | 32 |   | (16 | ) |
| Total                                                             |       | $                                                                  | (57        | ) | $ | (24 | ) | $ | (22 | ) | $ | 66 |   | $ | (37 | ) |
|                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| ** **                                                        | ** ** | **Nine months ended September 30, 2010**  | ** ** |
| ** **                                                        | ** ** | **Net  investment  income**                                        | ** ** | **Realized  capital  gains and  losses** | ** ** | **Contract  benefits** | ** ** | **Interest  credited to  contractholder  funds** | ** ** | **Total gain  (loss)  recognized  in net  income on  derivatives** | ** ** |
| **Derivatives in fair value  accounting hedging relationships**   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | $                                                                  | (170       | ) | $ | 4 |   | $ | — |   | $ | 21 |   | $ | (145 | ) |
| Foreign currency and  interest rate contracts                     |       | —                                                             |       | (1 | ) | — |   | (15 | ) | (16 | ) |
| Subtotal                                                          |       | (170                                                               | )          | 3 |   | — |   | 6 |   | (161 | ) |
|                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Derivatives not designated as  accounting hedging instruments** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate contracts                                           |       | —                                                             |       | (212 | ) | — |   | — |   | (212 | ) |
| Equity and index contracts                                        |       | —                                                             |       | — |   | — |   | 34 |   | 34 |   |
| Embedded derivative  financial instruments                        |       | —                                                             |       | (27 | ) | (30 | ) | 71 |   | 14 |   |
| Foreign currency contracts                                        |       | —                                                             |       | 4 |   | — |   | — |   | 4 |   |
| Credit default contracts                                          |       | —                                                             |       | (6 | ) | — |   | — |   | (6 | ) |
| Other contracts                                                   |       | —                                                             |       | — |   | — |   | 3 |   | 3 |   |
| Subtotal                                                          |       | —                                                             |       | (241 | ) | (30 | ) | 108 |   | (163 | ) |
| Total                                                             |       | $                                                                  | (170       | ) | $ | (238 | ) | $ | (30 | ) | $ | 114 |   | $ | (324 | ) |

 

31

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

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

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

 

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

 
| **($ in millions)**                                                                                             | ** ** | **Three months ended September 30, 2010** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **Gain (loss) on derivatives**                      | ** ** | **Gain (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**                                      | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | **Contractholder  funds** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                                                                            |       | $                                                                  | 6          |   | $ | 18 |   | $ | (24 | ) | $ | — |   |
| Net investment income                                                                                                |       | (32                                                                | )          | — |   | — |   | 32 |   |
| Realized capital gains and losses                                                                                    |       | 2                                                                  |       | — |   | — |   | — |   |
| Total                                                                                                                |       | $                                                                  | (24        | ) | $ | 18 |   | $ | (24 | ) | $ | 32 |   |

 

32

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                                                                                                           | ** ** | **Nine months ended September 30, 2010** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **Gain (loss) on derivatives**                     | ** ** | **Gain (loss) on hedged risk** | ** ** |
| **Location of gain or (loss) recognized  in net income on derivatives** | ** ** | **Interest  rate  contracts**                                     | ** ** | **Foreign  currency &  interest rate  contracts** | ** ** | **Contractholder  funds** | ** ** | **Investments** | ** ** |
| Interest credited to contractholder funds                                                                            |       | $                                                                 | 14         |   | $ | (39 | ) | $ | 25 |   | $ | — |   |
| Net investment income                                                                                                |       | (88                                                               | )          | — |   | — |   | 88 |   |
| Realized capital gains and losses                                                                                    |       | 4                                                                 |       | (1 | ) | — |   | — |   |
| Total                                                                                                                |       | $                                                                 | (70        | ) | $ | (40 | ) | $ | 25 |   | $ | 88 |   |

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

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

 

TheCompany manages its exposure to credit risk by utilizing highly ratedcounterparties, establishing risk control limits, executing legally enforceablemaster netting agreements (“MNAs”) and obtaining collateral whereappropriate.  The Company uses MNAs forOTC derivative transactions, including interest rate swap, foreign currencyswap, interest rate cap, interest rate floor, credit default swap, forward andcertain option agreements (including swaptions).  These agreements permit either party to netpayments due for transactions covered by the agreements.  Under the provisions of the agreements,collateral is either pledged or obtained when certain predetermined exposurelimits are exceeded.  As of September 30,2010, counterparties pledged $4 million in cash and $13 million in securitiesto the Company, and the Company pledged $287 million in securities tocounterparties which includes $200 million of collateral posted under MNAs forcontracts containing credit-risk-contingent provisions that are in a liabilityposition and $87 million of collateral posted under MNAs for contracts withoutcredit-risk-contingent liabilities.  TheCompany has not incurred any losses on derivative financial instruments due tocounterparty nonperformance.  Otherderivatives, including futures and certain option contracts, are traded onorganized exchanges which require margin deposits and guarantee the executionof trades, thereby mitigating any potential credit risk.

 

Counterpartycredit exposure represents the Company’s potential loss if all of thecounterparties concurrently fail to perform under the contractual terms of thecontracts and all collateral, if any, becomes worthless.  This exposure is measured by the fair valueof OTC derivative contracts with a positive fair value at the reporting datereduced by the effect, if any, of legally enforceable master nettingagreements.

 

33

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| **($ in  millions)** | ** ** | **September 30, 2010**      | ** ** | **December 31, 2009** | ** ** |
|---------------------------|------------|---------------------------------------|------------|---------------------------------|------------|
| **Rating (1)**       | ** ** | **Number of  counter-  parties** | ** ** | **Notional  amount**            | ** ** | **Credit  exposure (2)** | ** ** | **Exposure,  net of  collateral (2)** | ** ** | **Number of  counter-  parties** | ** ** | **Notional  amount** | ** ** | **Credit  exposure (2)** | ** ** | **Exposure,  net of  collateral (2)** | ** ** |
| AA-                       |       | 1                                     |       | $                               | 672        |   | $ | 23 |   | $ | 11 |   | — |   | $ | — |   | $ | — |   | $ | — |   |
| A+                        |       | 1                                     |       | 113                             |       | 3 |   | — |   | 3 |   | 6,666 |   | 151 |   | 18 |   |
| A                         |       | 2                                     |       | 817                             |       | 5 |   | 5 |   | 2 |   | 1,041 |   | 48 |   | 17 |   |
| A-                        |       | 1                                     |       | 89                              |       | 34 |   | 34 |   | 1 |   | 145 |   | 23 |   | 23 |   |
| Total                     |       | 5                                     |       | $                               | 1,691      |   | $ | 65 |   | $ | 50 |   | 6 |   | $ | 7,852 |   | $ | 222 |   | $ | 58 |   |

 

----

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

(2) Only OTC derivatives with a net positive fair value are includedfor each counterparty.

 

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

 

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

 

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

 
| **($ in millions)**                                                                                                          | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Gross liability fair  value of contracts containing credit-risk-contingent features                                                    |       | $                            | 445        |                        | $          | 386 |   |
| Gross asset fair value  of contracts containing credit-risk-contingent features and subject to MNAs                                    |       | (235                         | )          | (233                        | )          |
| Collateral posted under  MNAs for contracts containing credit-risk-contingent features                                                 |       | (200                         | )          | (122                        | )          |
| Maximum amount of  additional exposure for contracts with credit-risk-contingent features if all  features were triggered concurrently |       | $                            | 10         |                        | $          | 31 |   |

 

**Credit derivatives - selling protection**

 

Free-standing credit default swaps (“CDS”) are utilizedfor selling credit protection against a specified credit event.  A credit default swap is a derivativeinstrument, representing an agreement between two parties to exchange thecredit risk of a specified entity (or a group of entities), or an index basedon the credit risk of a group of entities (all commonly referred to as the “referenceentity” or a portfolio of “reference entities”), in return for a periodicpremium.  In selling protection, CDS areused to replicate fixed income securities and to complement the cash marketwhen credit exposure to certain issuers is not available or when the derivativealternative is less expensive than the cash market alternative.  CDS typically have a five-year term.

 

34

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                       | ** ** | **Notional amount** | ** ** | ** ** | ** ** |
|----------------------------------|------------|--------------------------|------------|------------|------------|
| **($ in millions)**    | ** ** | **AA**                   | ** ** | **A**      | ** ** | **BBB** | ** ** | **BB and  lower** | ** ** | **Total** | ** ** | **Fair  value** | ** ** |
| **Single name**                  |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | $                        | 40         |       | $          | 65 |   | $ | 30 |   | $ | 15 |   | $ | 150 |   | $ | (3 | ) |
| High yield debt                  |       | —                   |       | —     |       | — |   | 4 |   | 4 |   | — |   |
| Municipal                        |       | 25                       |       | —     |       | — |   | — |   | 25 |   | (6 | ) |
| Subtotal                         |       | 65                       |       | 65         |       | 30 |   | 19 |   | 179 |   | (9 | ) |
| **Baskets**                      |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| **Tranche**                      |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Investment grade  corporate debt |       | —                   |       | —     |       | — |   | 65 |   | 65 |   | (22 | ) |
| **First-to-default**             |       |                     |       |       |       |   |   |   |   |   |   |   |   |
| Municipal                        |       | —                   |       | 100        |       | — |   | — |   | 100 |   | (36 | ) |
| Subtotal                         |       | —                   |       | 100        |       | — |   | 65 |   | 165 |   | (58 | ) |
| **Total**                        |       | $                        | 65         |       | $          | 165 |   | $ | 30 |   | $ | 84 |   | $ | 344 |   | $ | (67 | ) |

 

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

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

 

Inselling protection with CDS, the Company sells credit protection on anidentified single name, a basket of names in a first-to-default (“FTD”) structureor a specific tranche of a basket, 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 reference entity’spublic fixed maturity cash instruments and swap rates at the time the agreementis executed.  With a FTD basket or atranche of a basket, because of the additional credit risk inherent in a basketof named reference entities, the premium generally corresponds to a highproportion of the sum of the credit spreads of the names in the basket and thecorrelation between the names.  CDX indexis utilized to take a position on multiple 

 

35

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

(generally125) reference entities.  Credit eventsare typically defined as bankruptcy, failure to pay, or restructuring,depending on the nature of the reference entities.  If a credit event occurs, the Company settleswith the counterparty, either through physical settlement or cash settlement.  In a physical settlement, a reference assetis delivered by the buyer of protection to the Company, in exchange for cashpayment at par, whereas in a cash settlement, the Company pays the differencebetween par and the prescribed value of the reference asset.  When a credit event occurs in a single nameor FTD basket (for FTD, the first credit event occurring for any one name inthe basket), the contract terminates at the time of settlement.  When a credit event occurs in a tranche of abasket, there is no immediate impact to the Company until cumulative losses inthe basket exceed the contractual subordination.  To date, realized losses have not exceededthe subordination.  For CDX index, thereference entity’s name incurring the credit event is removed from the indexwhile the contract continues until expiration. The maximum payout on a CDS is the contract notional amount.  A physical settlement may afford the Companywith recovery rights as the new owner of the asset.

 

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

 

Inaddition to the CDS described above, the Company’s synthetic collateralizeddebt obligations contain embedded credit default swaps which sell protection ona basket of reference entities.  Thesynthetic collateralized debt obligations are fully funded; therefore, theCompany is not obligated to contribute additional funds when credit eventsoccur related to the reference entities named in the embedded credit defaultswaps.  The Company’s maximum amount atrisk equals the amount of its aggregate initial investment in the syntheticcollateralized debt obligations.

 

**7.****          ****Reinsurance**

 

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

 
| ** **                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                     | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Direct                                            |       | $                                                    |  554  |                                                | $          |  542 |   | $ |  1,671 |   | $ |  1,642 |   |
| Assumed                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                         |       | 27                                                   |       | 26                                                  |       | 80 |   | 76 |   |
| Non-affiliate                                     |       | 5                                                    |       | 5                                                   |       | 16 |   | 16 |   |
| Ceded—non-affiliate                          |       | (186                                                 | )          | (198                                                | )          | (566 | ) | (588 | ) |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums and contract charges, net of reinsurance |       | $                                                    |  400  |                                                | $          |  375 |   | $ |  1,201 |   | $ |  1,146 |   |

 

The effects of reinsurance on contract benefits are as follows:

 
| ** **                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Direct                                |       | $                                                    | 602        |                                                | $          | 296 |   | $ | 1,660 |   | $ | 1,535 |   |
| Assumed                               |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                             |       | 18                                                   |       | 16                                                  |       | 53 |   | 49 |   |
| Non-affiliate                         |       | 6                                                    |       | 4                                                   |       | 18 |   | 18 |   |
| Ceded—non-affiliate (1)          |       | (261                                                 | )          | 11                                                  |       | (596 | ) | (584 | ) |
|                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits, net of reinsurance |       | $                                                    | 365        |                                                | $          | 327 |   | $ | 1,135 |   | $ | 1,018 |   |

 

----

(1)          The three months ended September 30,2009 include a $166 million decrease in the reinsurance recoverable related tothe ceded variable annuity contract guarantees as a result of improved equitymarket conditions during 2009.

 

36

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Direct                                                         |       | $                                                    | 438        |                                                | $          | 488 |   | $ | 1,333 |   | $ | 1,605 |   |
| Assumed                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                                      |       | 3                                                    |       | 3                                                   |       | 8 |   | 8 |   |
| Non-affiliate                                                  |       | 2                                                    |       | 3                                                   |       | 9 |   | 9 |   |
| Ceded—non-affiliate                                       |       | (8                                                   | )          | (9                                                  | )          | (24 | ) | (24 | ) |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Interest credited to contractholder funds, net of  reinsurance |       | $                                                    | 435        |                                                | $          | 485 |   | $ | 1,326 |   | $ | 1,598 |   |

 

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

 

**Guaranty funds**

 

Understate insurance guaranty fund laws, insurers doing business in a state can beassessed, up to prescribed limits, for certain obligations of insolventinsurance companies to policyholders and claimants.  Amounts assessed to each company aretypically related to its proportion of business written in each state.  The Company’s policy is to accrue a guarantyfund assessment when the entity for which the insolvency relates has met itsstate of domicile’s statutory definition of insolvency and the amount of theloss is reasonably estimable.  In moststates, the definition is met with a declaration of financial insolvency by acourt of competent jurisdiction.  Incertain states there must also be a final order of liquidation.

 

The New York Liquidation Bureau (the “Bureau”) haspublicly reported that Executive Life Insurance Company of New York (“ExecutiveLife”) is currently under its jurisdiction as part of a 1992 court-orderedrehabilitation plan. However, Executive Life does not have a liquidity problemat this time, and an order of liquidation has not been sought by theBureau.  The current publicly availableestimated shortfall from the Bureau is $1.27 billion.  If Executive Life were to be declaredinsolvent in the future, the Company may have exposure to future guaranty fundassessments.  The Company’s exposure willultimately depend on the level of guaranty fund system participation.  New York law currently contains an aggregatelimit on guaranty funds under the Life Insurance Corporation of New York of$500 million, of which approximately $40 million has been used.  Under current law, the Company may be allowedto recoup a portion of the amount of any additional guaranty fund assessment inperiods subsequent to the recognition of the assessment by offsetting futurepremium taxes.  The Company’s averagemarket share for New York, based on assessable premiums, was approximately 3.1%in 2009.

 

**Guarantees**

 

TheCompany owns certain fixed income securities that obligate the Company toexchange credit risk or to forfeit principal due, depending on the nature oroccurrence of specified credit events for the reference entities.  In the event all such specified credit eventswere to occur, the Company’s maximum amount at risk on these fixed incomesecurities, as measured by the amount of the aggregate initial investment, was$111 million at September 30, 2010. The obligations associated with these fixed income securities expire atvarious dates on or before July 26, 2016.

 

Relatedto the disposal through reinsurance of substantially all of the Company’svariable annuity business to The Prudential Insurance Company of America, asubsidiary of Prudential Financial, Inc. (collectively “Prudential”) in2006, the Company and the Corporation have agreed to indemnify Prudential forcertain pre-closing contingent liabilities (including extra-contractualliabilities of the Company and liabilities specifically excluded from thetransaction) that the Company has agreed to retain.  In addition, the Company and the Corporationwill each indemnify Prudential for certain post-closing liabilities that mayarise from the acts of the Company and its agents, including in connection withthe Company’s provision of transition services. The reinsurance agreements contain no limitations or indemnificationswith regard to insurance risk transfer, and transferred all of the future risksand responsibilities for performance on the underlying variable annuitycontracts to Prudential, including those related to benefit guarantees.  Management does not believe this agreementwill have a material adverse effect on results of operations, cash flows orfinancial position of the Company.

 

37

----

 

**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Inthe normal course of business, the Company provides standard indemnificationsto contractual counterparties in connection with numerous transactions,including acquisitions and divestitures. The types of indemnifications typically provided includeindemnifications for breaches of representations and warranties, taxes and certainother liabilities, such as third party lawsuits.  The indemnification clauses are oftenstandard contractual terms and are entered into in the normal course ofbusiness based on an assessment that the risk of loss would be remote.  The terms of the indemnifications vary induration and nature.  In many cases, themaximum obligation is not explicitly stated and the contingencies triggeringthe obligation to indemnify have not occurred and are not expected to occur.  Consequently, the maximum amount of theobligation under such indemnifications is not determinable.  Historically, the Company has not made anymaterial payments pursuant to these obligations.

 

The aggregate liability balance related to all guarantees was notmaterial as of September 30, 2010.

 

**Regulation and Compliance**

 

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

 

**Legaland regulatory proceedings and inquiries**

 

***Background***

 

TheCompany and certain affiliates are involved in a number of lawsuits, regulatoryinquiries, and other legal proceedings arising out of various aspects of itsbusiness.

 

Asbackground to the “Proceedings” subsection below, please note the following:

 

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

 

·      The outcome of these mattersmay be affected by decisions, verdicts, and settlements, and the timing of suchdecisions, verdicts, and settlements, in other individual and class actionlawsuits that involve the Company, other insurers, or other entities and byother legal, governmental, and regulatory actions that involve the Company,other insurers, or other entities.  Theoutcome may also be affected by future state or federal legislation, the timingor substance of which cannot be predicted.

 

·      In the lawsuits, plaintiffsseek a variety of remedies which may include equitable relief in the form ofinjunctive and other remedies and monetary relief in the form of contractualand extra-contractual damages.  In somecases, the monetary damages sought may include punitive or treble damages.  Often specific information about the reliefsought, such as the amount of damages, is not available because plaintiffs havenot requested specific relief in their pleadings.  When specific monetary demands are made, theyare often set just below a state court jurisdictional limit in order to seekthe maximum amount available in state court, regardless of the specifics of thecase, while still avoiding the risk of removal to federal court.  In the Company’s experience, monetary demandsin pleadings bear little relation to the ultimate loss, if any, to the Company.

 

38

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

***Proceedings***

 

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

 

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

 

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

 

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

 

39

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

matter is appealable at this time will be addressed by the ThirdCircuit along with the merits of the appeal. In July 2009, the Third Circuit vacated the decision which grantedAIC’s motion to dismiss the case, remanded the case to the trial court foradditional discovery, and directed that the case be reassigned to another trialcourt judge.  In January 2010, thecase was assigned to a new judge for further proceedings in the trial court.

 

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

 

***Other Matters***

 

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

 

Oneor more of these matters could have an adverse effect on the Company’soperating results or cash flows for a particular quarterly or annualperiod.  However, based on informationcurrently known to it, management believes that the ultimate outcome of allmatters described in this “Other Matters” subsection, in excess of amountscurrently reserved, if any, as they are resolved over time, is not likely tohave a material effect on the operating results, cash flows or financialposition of the Company.

 

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

 

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

 
| **($ in millions)**               | ** ** | **2010** | ** ** | **2009** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Statutory federal income tax rate - benefit |       | $        | (52        | )        | (35.0      | )% | $ | (143 | ) | (35.0 | )% |
| Dividends received deduction                |       | (8       | )          | (5.3     | )          | (8 | ) | (2.0 | ) |
| Other                                       |       | (4       | )          | (2.7     | )          | (2 | ) | (0.5 | ) |
| Valuation allowance                         |       | —   |       | —   |       | 137 |   | 33.5 |   |
| Effective income tax rate - benefit         |       | $        | (64        | )        | (43.0      | )% | $ | (16 | ) | (4.0 | )% |

 

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

 

40

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**ALLSTATELIFE INSURANCE COMPANY AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 
| ** **                                                                                 | ** ** | **Three months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| **($ in millions)**                                                              | ** ** | **Pre-tax**                                              | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
| Unrealized net holding gains and losses arising  during the period, net of related offsets |       | $                                                        | 651        |   | $ | (227 | ) | $ | 424 |   | $ | 1,526 |   | $ | (534 | ) | $ | 992 |   |
| Less: reclassification adjustment of realized  capital gains and losses                    |       | (13                                                      | )          | 5 |   | (8 | ) | (102 | ) | 36 |   | (66 | ) |
| Unrealized net capital gains and losses                                                    |       | 664                                                      |       | (232 | ) | 432 |   | 1,628 |   | (570 | ) | 1,058 |   |
| Other comprehensive income                                                                 |       | $                                                        | 664        |   | $ | (232 | ) | 432 |   | $ | 1,628 |   | $ | (570 | ) | 1,058 |   |
| Net income (loss)                                                                          |       |                                                     |       |   |   | 60 |   |   |   |   |   | (57 | ) |
| Comprehensive income                                                                       |       |                                                     |       |   |   | $ | 492 |   |   |   |   |   | $ | 1,001 |   |

 
| ** **                                                                                 | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                                                                 | ** ** | **Pre-tax**                                             | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
| Unrealized net holding gains and losses arising  during the period, net of related offsets |       | $                                                       | 1,866      |   | $ | (653 | ) | $ | 1,213 |   | $ | 3,794 |   | $ | (1,325 | ) | $ | 2,469 |   |
| Less: reclassification adjustment of realized capital  gains and losses                    |       | (290                                                    | )          | 102 |   | (188 | ) | (249 | ) | 87 |   | (162 | ) |
| Unrealized net capital gains and losses                                                    |       | 2,156                                                   |       | (755 | ) | 1,401 |   | 4,043 |   | (1,412 | ) | 2,631 |   |
| Other comprehensive income                                                                 |       | $                                                       | 2,156      |   | $ | (755 | ) | 1,401 |   | $ | 4,043 |   | $ | (1,412 | ) | 2,631 |   |
| Net loss                                                                                   |       |                                                    |       |   |   | (85 | ) |   |   |   |   | (393 | ) |
| Comprehensive income                                                                       |       |                                                    |       |   |   | $ | 1,316 |   |   |   |   |   | $ | 2,238 |   |

 

41

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholder of

AllstateLife Insurance Company

Northbrook, IL60062

 

Wehave reviewed the accompanying condensed consolidated statement of financialposition of Allstate Life Insurance Company and subsidiaries (the “Company”),an affiliate of The Allstate Corporation, as of September 30, 2010, andthe related condensed consolidated statements of operations for the three-monthand nine-month periods ended September 30, 2010 and 2009, and thecondensed consolidated statements of cash flows for the nine-month periodsended September 30, 2010 and 2009. These interim financial statements are the responsibility of the Company’smanagement.

 

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

 

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

 

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

 

 

/s/Deloitte & Touche LLP

 

Chicago, Illinois

November 3,2010

 

42

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**Item2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF**

**OPERATIONS FOR THETHREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009**

 

**OVERVIEW**

 

Thefollowing discussion highlights significant factors influencing theconsolidated financial position and results of operations of Allstate LifeInsurance Company (referred to in this document as “we”, “our”, “us”, or the “Company”).  It should be read in conjunction with thecondensed consolidated financial statements and notes thereto found under Part I.Item 1. contained herein, and with the discussion, analysis, consolidatedfinancial statements and notes thereto in Part I. Item 1. and Part II.Item 7. and Item 8. of the Allstate Life Insurance Company Annual Report on Form 10-Kfor 2009.  We operate as a single segmententity based on the manner in which we use financial information to evaluatebusiness performance and to determine the allocation of resources.

 

**OPERATIONS HIGHLIGHTS**

 

·                  Netincome of $60 million and net loss of $85 million in the third quarter andfirst nine months of 2010, respectively, compared to net losses of $57 millionand $393 million in the third quarter and first nine months of 2009,respectively.

·                  Premiums and contractcharges on underwritten products, including traditional life,interest-sensitive life and accident and health insurance, increased 4.9% or$17 million and 5.5% or $57 million in the third quarter and first nine monthsof 2010, respectively, compared to the same periods in 2009.

·                  Netrealized capital losses totaled $37 million and $550 million in the thirdquarter and first nine months of 2010, respectively, compared to $232 millionand $148 million in the third quarter and first nine months of 2009,respectively.

·                  Investments as of September 30,2010 totaled $60.75 billion, reflecting an increase in carrying value of $530million from $60.22 billion as of December 31, 2009.  Net investment income decreased 5.4% to $683million in the third quarter and 7.5% to $2.09 billion in the first nine monthsof 2010 from $722 million and $2.26 billion in the third quarter and first ninemonths of 2009, respectively.

·                  Contractholder funds as of September 30,2010 totaled $47.18 billion, reflecting a decrease of $3.67 billion from $50.85billion as of December 31, 2009.

 

**OPERATIONS**

 

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

 
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**             | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Revenues**                              |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                  |       | $                                                    | 151        |                                                | $          | 134 |   | $ | 458 |   | $ | 440 |   |
| Contract charges                          |       | 249                                                  |       | 241                                                 |       | 743 |   | 706 |   |
| Net investment income                     |       | 683                                                  |       | 722                                                 |       | 2,090 |   | 2,260 |   |
| Realized capital gains and losses         |       | (37                                                  | )          | (232                                                | )          | (550 | ) | (148 | ) |
| Total revenues                            |       | 1,046                                                |       | 865                                                 |       | 2,741 |   | 3,258 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                    |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                         |       | (365                                                 | )          | (327                                                | )          | (1,135 | ) | (1,018 | ) |
| Interest credited to contractholder funds |       | (435                                                 | )          | (485                                                | )          | (1,326 | ) | (1,598 | ) |
| Amortization of DAC                       |       | (69                                                  | )          | (61                                                 | )          | (150 | ) | (758 | ) |
| Operating costs and expenses              |       | (85                                                  | )          | (74                                                 | )          | (254 | ) | (244 | ) |
| Restructuring and related charges         |       | —                                               |       | (4                                                  | )          | 1 |   | (23 | ) |
| Interest expense                          |       | (11                                                  | )          | (11                                                 | )          | (33 | ) | (32 | ) |
| Total costs and expenses                  |       | (965                                                 | )          | (962                                                | )          | (2,897 | ) | (3,673 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Gain on disposition of operations         |       | 4                                                    |       | 2                                                   |       | 7 |   | 6 |   |
| Income tax (expense) benefit              |       | (25                                                  | )          | 38                                                  |       | 64 |   | 16 |   |
| Net income (loss)                         |       | $                                                    | 60         |                                                | $          | (57 | ) | $ | (85 | ) | $ | (393 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Investments at September 30          |       |                                                 |       |                                                |       | $ | 60,747 |   | $ | 59,926 |   |

 

43

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*Net income* in the third quarter of 2010 was $60 millioncompared to a net loss of $57 million in the same period of 2009.  The favorable change of $117 million wasprimarily due to lower net realized capital losses, lower interest credited tocontractholder funds and higher premiums and contract charges, partially offset by lower net investmentincome and higher contract benefits.

 

Netloss in the first nine months of 2010 was $85 million compared to $393 millionin the first nine months of 2009.  Theimprovement of $308 million was primarily due to lower amortization of deferredpolicy acquisition costs (“DAC”), decreased interest credited to contractholderfunds and higher premiums and contract charges, partially offset by increasednet realized capital losses, lower net investment income and higher contractbenefits.  Additionally, the first ninemonths of 2009 included expenses of $142 million attributable to an increase inthe valuation allowance relating to the deferred tax asset on capital losses.

 

**Analysis of revenues **Total revenuesincreased 20.9% or $181 million in the third quarter of 2010 compared to thethird quarter of 2009 due to lower net realized capital losses and higherpremiums and contract charges, partially offset by lower net investmentincome.  Total revenues decreased 15.9%or $517 million in the first nine months of 2010 compared to the same period in2009 due to higher net realized capital losses and lower net investment income,partially offset by higher premiums and contract charges.

 

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

 

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

 

The following table summarizes premiums and contract charges byproduct.

 
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**               | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Premiums**                                |       |                                                 |       |                                                |       |   |   |   |   |
| Traditional life  insurance                 |       | $                                                    | 100        |                                                | $          | 96 |   | $ | 302 |   | $ | 289 |   |
| Immediate annuities with life contingencies |       | 26                                                   |       | 15                                                  |       | 84 |   | 83 |   |
| Accident and health  insurance              |       | 25                                                   |       | 23                                                  |       | 72 |   | 68 |   |
| **Total premiums**                          |       | 151                                                  |       | 134                                                 |       | 458 |   | 440 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Contract charges**                        |       |                                                 |       |                                                |       |   |   |   |   |
| Interest-sensitive life  insurance          |       | 240                                                  |       | 229                                                 |       | 711 |   | 671 |   |
| Fixed annuities                             |       | 9                                                    |       | 12                                                  |       | 32 |   | 35 |   |
| **Total contract charges**(1)               |       | 249                                                  |       | 241                                                 |       | 743 |   | 706 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Total premiums and contract  charges**(2) |       | $                                                    | 400        |                                                | $          | 375 |   | $ | 1,201 |   | $ | 1,146 |   |

 

----

| (1)    |   | Total  contract charges include contract charges related to the cost of insurance totaling  $159 million and $153 million in the third quarter of 2010 and 2009,  respectively, and $469 million and $450 million in the first nine months of  2010 and 2009, respectively.                                                                 |   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                                                                                                                                                                                                                                                                                                                                        |   |
| (2)    |   | Premiums  and contract charges on underwritten products, including traditional life,  interest-sensitive life and accident and health insurance, totaled $365  million and $348 million in the third quarter of 2010 and 2009, respectively,  and $1.09 billion and $1.03 billion in the first nine months of 2010 and  2009, respectively. |   |

 

Total premiums increased 12.7% and 4.1% in the third quarter and firstnine months of 2010, respectively, compared to the same periods of 2009primarily due to higher sales of immediate annuities with life contingenciesand lower reinsurance premiums on traditional life insurance resulting fromhigher retention.

 

Total contract charges increased 3.3% and 5.2% in the third quarter andfirst nine months of 2010, respectively, compared to the same periods of 2009primarily due to higher cost of insurance and maintenance contract charges oninterest-sensitive life insurance products resulting from a shift in the mix ofpolicies in force.

 

44

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

 
| ** **                                                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Contractholder funds, beginning  balance**                   |       | $                                                    | 47,697     |                                                | $          | 52,298 |   | $ | 50,850 |   | $ | 56,780 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Deposits**                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Fixed annuities                                                |       | 223                                                  |       | 342                                                 |       | 751 |   | 1,612 |   |
| Interest-sensitive life insurance                              |       | 345                                                  |       | 337                                                 |       | 1,087 |   | 996 |   |
| Total deposits                                                 |       | 568                                                  |       | 679                                                 |       | 1,838 |   | 2,608 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest credited**                                          |       | 433                                                  |       | 486                                                 |       | 1,322 |   | 1,506 |   |
|                                                           |       |                                                 |       |                                                |       |   |   |   |   |
| **Maturities, benefits, withdrawals  and other adjustments**   |       |                                                 |       |                                                |       |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (3                                                   | )          | (212                                                | )          | (1,784 | ) | (4,715 | ) |
| Benefits                                                       |       | (393                                                 | )          | (377                                                | )          | (1,174 | ) | (1,202 | ) |
| Surrenders and partial withdrawals                             |       | (1,035                                               | )          | (973                                                | )          | (3,138 | ) | (2,812 | ) |
| Contract charges                                               |       | (231                                                 | )          | (218                                                | )          | (685 | ) | (637 | ) |
| Net transfers from separate accounts                           |       | 3                                                    |       | 2                                                   |       | 8 |   | 8 |   |
| Fair value hedge adjustments for institutional  products       |       | 24                                                   |       | 1                                                   |       | (173 | ) | 31 |   |
| Other adjustments (1)                                          |       | 114                                                  |       | (61                                                 | )          | 113 |   | 58 |   |
| Total maturities, benefits, withdrawals and other  adjustments |       | (1,521                                               | )          | (1,838                                              | )          | (6,833 | ) | 9,269 |   |
| **Contractholder funds, ending  balance**                      |       | $                                                    | 47,177     |                                                | $          | 51,625 |   | $ | 47,177 |   | $ | 51,625 |   |

 

----

(1) The table above illustrates the changes incontractholder funds, which are presented gross of reinsurance recoverables onthe Condensed Consolidated Statements of Financial Position.  The table above is intended to supplement ourdiscussion and analysis of revenues, which are presented net of reinsurance onthe Condensed Consolidated Statements of Operations.  As a result, the net change in contractholderfunds associated with products reinsured to third parties is reflected as acomponent of the other adjustments line.

 

Contractholderfunds decreased 1.1% and 7.2% in the third quarter and first nine months of2010, respectively, compared to a decrease of 1.3% and 9.1% in the thirdquarter and first nine months of 2009, respectively.  Average contractholder funds decreased 8.7%and 9.6% in the third quarter and first nine months of 2010, respectively,compared to the same periods of 2009.

 

Contractholderdeposits decreased 16.3% and 29.5% in the third quarter and first nine monthsof 2010, respectively, compared to the same periods of 2009 primarily due tolower deposits on fixed annuities. Deposits on fixed annuities decreased 34.8% and 53.4% in the thirdquarter and first nine months of 2010, respectively, compared to the sameperiods of 2009 due to our strategic decision to discontinue distributing fixedannuities through banks and broker-dealers and our goal to reduce ourconcentration in spread based products and improve returns on new business.

 

Maturitiesand retirements of institutional products decreased 98.6% to $3 million in thethird quarter of 2010 and 62.2% to $1.78 billion in the first nine months of2010 from $212 million and $4.72 billion in the third quarter and first ninemonths of 2009, respectively.  The thirdquarter and first nine months of 2009 included the retirement of $9 million and$1.45 billion, respectively, of extendible institutional market obligations,all of which were retired during 2009. In addition, the first nine months of 2009 included the redemption of$1.39 billion of institutional product liabilities in conjunction with cashtender offers.

 

Surrenders and partial withdrawals on deferred fixed annuities andinterest-sensitive life insurance products increased 6.4% to $1.04 billion inthe third quarter of 2010 and 11.6% to $3.14 billion in the first nine monthsof 2010 from $973 million and $2.81 billion in the third quarter and first ninemonths of 2009, respectively.  Theincreases in both the third quarter and first nine months of 2010 wereprimarily due to higher surrenders and partial withdrawals on fixedannuities.  The annualized surrender andpartial withdrawal rate on deferred fixed annuities and interest-sensitive lifeinsurance products, based on the beginning of period contractholder funds, was10.2% in the first nine months of 2010 compared to 8.9% in the first ninemonths of 2009.

 

45

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**Analysis of costs and expenses**  Total costs and expenses increased 0.3% or $3million in the third quarter of 2010 compared to the third quarter of 2009primarily due to higher contract benefits and operating costs and expenses,partially offset by lower interest credited to contractholder funds.  Total costs and expenses decreased 21.1% or$776 million in the first nine months of 2010 compared to the same period in2009 primarily due to lower amortization of DAC and interest credited tocontractholder funds, partially offset by higher contract benefits.

 

*Contract benefits* increased 11.6% or $38 million in the thirdquarter of 2010 and 11.5% or $117 million in the first nine months of 2010compared to the same periods of 2009.  Inthe third quarter of 2010, higher contract benefits were primarily due tofavorable mortality experience on immediate annuities in the third quarter of2009.

 

The increase in contract benefits in the first nine months of 2010primarily reflects higher contract benefits on interest-sensitive lifeinsurance due to the re-estimation of reserves for certain secondary guaranteeson universal life insurance policies and unfavorable mortality experience,partially offset by lower contract benefits on immediate annuities with lifecontingencies due to the re-estimation of reserves for benefits payable tocertain annuitants to reflect current contractholder information.

 

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

 

We analyze our mortality and morbidity results using the differencebetween premiums and contract charges earned for the cost of insurance andcontract benefits excluding the portion related to the implied interest onimmediate annuities with life contingencies (“benefit spread”).  This implied interest totaled $134 millionand $412 million in the third quarter and first nine months of 2010,respectively, compared to $138 million and $417 million in the third quarterand first nine months of 2009, respectively.

 

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

 
| ** **                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)** | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Life insurance                |       | $                                                    | 88         |                                                | $          | 92 |   | $ | 192 |   | $ | 286 |   |
| Accident and health insurance |       | 8                                                    |       | 7                                                   |       | 23 |   | 21 |   |
| Annuities                     |       | (17                                                  | )          | (1                                                  | )          | (11 | ) | (18 | ) |
| Total benefit spread          |       | $                                                    | 79         |                                                | $          | 98 |   | $ | 204 |   | $ | 289 |   |

 

Benefit spread decreased 19.4% or $19 million in the third quarter of2010 and 29.4% or $85 million in the first nine months of 2010 compared to thesame periods of 2009.  The decrease inthe third quarter of 2010 was primarily due to favorable mortality experienceon annuities in the third quarter of 2009. The decrease in the first nine months of 2010 was primarily due tore-estimations of reserves that increased contract benefits forinterest-sensitive life insurance and decreased contract benefits for immediateannuities and unfavorable mortality experience on interest-sensitive lifeinsurance and immediate annuities with life contingencies.

 

*Interest credited to contractholder funds* decreased10.3% or $50 million in the third quarter of 2010 and 17.0% or $272 million inthe first nine months of 2010 compared to the same periods of 2009 primarilydue to lower average contractholder funds and management actions to reduceinterest crediting rates on deferred fixed annuities.  In addition, the decline in the first ninemonths of 2010 also reflects lower amortization of deferred sales inducementcosts (“DSI”).

 

Amortization of DSI in the third quarter and first nine months of 2010was $3 million and $14 million, respectively, compared to $4 million and $114million in the third quarter and first nine months of 2009, respectively.  The decline in amortization of DSI in thefirst nine months of 2010 was primarily due to a $44 million decrease inamortization relating to realized capital gains and losses and a $38 millionreduction in amortization acceleration for changes in assumptions.

 

In order to analyze the impact of net investment income and interestcredited to contractholders on net income, we monitor the difference betweennet investment income and the sum of interest credited to contractholder funds

 

46

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andthe implied interest on immediate annuities with life contingencies, which isincluded as a component of contract benefits on the Condensed ConsolidatedStatements of Operations (“investment spread”).

 

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

 
| ** **                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                            | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Annuities and institutional products                     |       | $                                                    | 44         |                                                | $          | 44 |   | $ | 148 |   | $ | 81 |   |
| Life insurance                                           |       | 12                                                   |       | (1                                                  | )          | 26 |   | 1 |   |
| Accident and health insurance                            |       | 2                                                    |       | 2                                                   |       | 6 |   | 6 |   |
| Net investment income on investments supporting  capital |       | 56                                                   |       | 54                                                  |       | 172 |   | 157 |   |
| Total investment spread                                  |       | $                                                    | 114        |                                                | $          | 99 |   | $ | 352 |   | $ | 245 |   |

 

Investment spread increased 15.2% or $15 million in the third quarterof 2010 and 43.7% or $107 million in the first nine months of 2010 compared tothe same periods of 2009 as lower net investment income was more than offset bydecreased interest credited to contractholder funds, which includes loweramortization of DSI.  Excluding amortizationof DSI, investment spread increased 13.6% or $14 million in the third quarterof 2010 and 1.9% or $7 million in the first nine months of 2010 compared to thesame periods in 2009.

 

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

 
| ** **                                                           | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                           | ** ** | **Weighted average  investment yield**         | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spreads** | ** ** |
| ** **                                                           | ** ** | **2010**                                                 | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.5                                                      | %          | 5.4 | % | 4.4 | % | 4.7 | % | 1.1 | % | 0.7 | % |
| Deferred fixed annuities and institutional  products                 |       | 4.4                                                      |       | 4.3 |   | 3.3 |   | 3.4 |   | 1.1 |   | 0.9 |   |
| Immediate fixed annuities with and without life  contingencies       |       | 6.3                                                      |       | 6.4 |   | 6.3 |   | 6.4 |   | — |   | — |   |
| Investments supporting capital, traditional life  and other products |       | 3.8                                                      |       | 3.4 |   | n/a |   | n/a |   | n/a |   | n/a |   |

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

 

47

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

 
| ** **                                                       | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|
| **($ in millions)**                                    | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Immediate fixed annuities with life contingencies                |       | $                      | 8,646      |   | $ | 8,414 |   |
| Other life contingent contracts and other                        |       | 4,596                  |       | 3,795 |   |
| Reserve for life-contingent contract benefits                    |       | $                      | 13,242     |   | $ | 12,209 |   |
|                                                             |       |                   |       |   |   |
| Interest-sensitive life insurance                                |       | $                      | 9,953      |   | $ | 9,556 |   |
| Deferred fixed annuities                                         |       | 30,042                 |       | 32,946 |   |
| Immediate fixed annuities without life  contingencies            |       | 3,807                  |       | 3,853 |   |
| Institutional products                                           |       | 2,678                  |       | 4,394 |   |
| Market value adjustments related to fair value  hedges and other |       | 697                    |       | 876 |   |
| Contractholder funds                                             |       | $                      | 47,177     |   | $ | 51,625 |   |

 

*Amortization of DAC* increased 13.1% or $8million in the third quarter of 2010 and decreased 80.2% or $608 million in thefirst nine months of 2010 compared to the same periods of 2009.  The components of amortization of DAC aresummarized in the following table.

 
| ** **                                                                                                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                                                                     | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Amortization of DAC before amortization relating  to realized capital gains and losses and changes in assumptions |       | $                                                    | (80        | )                                                   | $          | (89 | ) | $ | (176 | ) | $ | (322 | ) |
| Accretion (amortization) relating to realized  capital gains and losses (1)                                       |       | 11                                                   |       | 28                                                  |       | 13 |   | (158 | ) |
| Amortization deceleration (acceleration) for  changes in assumptions (“DAC unlocking”)                  |       | —                                               |       | —                                              |       | 13 |   | (278 | ) |
| Total amortization of DAC                                                                                         |       | $                                                    | (69        | )                                                   | $          | (61 | ) | $ | (150 | ) | $ | (758 | ) |

 

----

(1)The impact of realized capital gainsand losses on amortization of DAC is dependent upon the relationship betweenthe assets that give rise to the gain or loss and the product liabilitysupported by the assets.  Fluctuationsresult from changes in the impact of realized capital gains and losses onactual and expected gross profits.

 

Theincrease of $8 million in the third quarter of 2010 was primarily due to adecline in accretion relating to realized capital gains and losses.  The decrease of $608 million in the firstnine months of 2010 was primarily due to a favorable change in amortizationacceleration/deceleration for changes in assumptions, a favorable change inamortization/accretion relating to realized capital gains and losses, adecreased amortization rate on fixed annuities and lower amortization fromdecreased benefit spread on interest-sensitive life insurance due to there-estimation of reserves.

 

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

 

Inthe first quarter of 2009, our annual comprehensive review resulted in theacceleration of DAC amortization (charge to income) of $278 million.  $289 million related to fixed annuities, ofwhich $210 million was attributable to market value adjusted annuities, and $18million related to variable life insurance. Partially offsetting these amounts was amortization deceleration (creditto income) for interest-sensitive life insurance of $29 million.  The principal assumption impacting fixedannuity amortization acceleration was an increase in the level of expected 

 

48

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realizedcapital losses in 2009 and 2010.  Forinterest-sensitive life insurance, the amortization deceleration was due to afavorable change in our mortality assumptions, partially offset by increasedexpected capital losses.

 

*Operating costs and expenses* increased14.9% and 4.1% in the third quarter and first nine months of 2010,respectively, compared to the same periods of 2009.  The following table summarizes operatingcosts and expenses.

 
| ** **                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**      | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Non-deferrable acquisition costs   |       | $                                                    | 22         |                                                | $          | 19 |   | $ | 64 |   | $ | 63 |   |
| Other operating costs and expenses |       | 63                                                   |       | 55                                                  |       | 190 |   | 181 |   |
| Total operating costs and expenses |       | $                                                    | 85         |                                                | $          | 74 |   | $ | 254 |   | $ | 244 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Restructuring and related charges  |       | $                                                    | —     |                                                | $          | 4 |   | $ | (1 | ) | $ | 23 |   |

 

Non-deferrable acquisitioncosts increased 15.8% or $3 million and 1.6% or $1 million in the third quarterand first nine months of 2010, respectively, compared to the same periods of2009 primarily due to higher premium taxes. Other operating costs and expenses increased 14.5% or $8 million and5.0% or $9 million in the third quarter and first nine months of 2010,respectively, compared to the same periods of 2009 due primarily to higherproduct distribution and marketing costs, and lower reinsurance expenseallowances resulting from higher retention. In the first nine months of 2010, these increased costs were partiallyoffset by our expense reduction actions, which resulted in lower employee,professional services and sales support expenses.  Through reductions in workforce positionscombined with other actions completed as of September 30, 2010, weanticipate that we will exceed our targeted annual savings of $90 millionbeginning in 2011.

 

*Income tax expense* of $25 million and benefitof $64 million were recognized for the third quarter and first nine months of2010, respectively, compared to an income tax benefit of $38 million and $16million in the third quarter and first nine months of 2009, respectively.  Income tax benefit for the first nine monthsof 2009 included expense of $142 million attributable to an increase in thevaluation allowance relating to the deferred tax asset on capital losses.

 

**INVESTMENTS HIGHLIGHTS**

 

·                  Investments as of September 30, 2010 totaled$60.75 billion, an increase of 0.9% from $60.22 billion as of December 31,2009.

·                Unrealized netcapital gains totaled $1.65 billion as of September 30, 2010, improvingfrom unrealized net capital losses of $2.18 billion as of December 31,2009.

·                  Net investment income was $683 million in thethird quarter of 2010, a decrease of 5.4% from $722 million in the thirdquarter of 2009, and $2.09 billion in the first nine months of 2010, a decreaseof 7.5% from $2.26 billion in the first nine months of 2009.

·                  Net realized capital losses were $37 millionin the third quarter of 2010 compared to net realized capital losses of $232million in the third quarter of 2009. Net realized capital losses were $550 million in the first nine monthsof 2010 compared to net realized capital losses of $148 million in the firstnine months of 2009.

·                  During the first nine months of 2010, ourfixed income and mortgage loan portfolio generated $4.70 billion of cash flowsfrom interest and maturities.

 

**INVESTMENTS**

 

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

 

·                  Reduced ourcommercial real estate exposure by 17.2% or $2.01 billion of amortized costprimarily through targeted dispositions and principal repayments fromborrowers.

·                  Reduced ourmunicipal bond exposure by 12.9% or $720 million of amortized cost primarilythrough scheduled maturities, prepayments and targeted dispositions.

 

49

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The composition of the investment portfolio at September 30, 2010is presented in the table below.

 
| **($ in millions)**     | ** ** | **Investments** | ** ** | **Percent  to total** | ** ** |
|-----------------------------------|------------|-----------------|------------|----------------------------|------------|
| Fixed income securities (1)       |       | $               | 49,781     |                       | 81.9       | % |
| Mortgage loans                    |       | 6,833           |       | 11.2                       |       |
| Equity securities (2)             |       | 186             |       | 0.3                        |       |
| Limited partnership interests (3) |       | 1,127           |       | 1.9                        |       |
| Short-term (4)                    |       | 1,003           |       | 1.7                        |       |
| Policy loans                      |       | 837             |       | 1.4                        |       |
| Other                             |       | 980             |       | 1.6                        |       |
| Total                             |       | $               | 60,747     |                       | 100.0      | % |

 

----

| (1) |   | Fixed  income securities are carried at fair value. Amortized cost basis for these  securities was $48.15 billion. |   |
|-----|--------|--------------------------------------------------------------------------------------------------------------------|--------|
| (2) |   | Equity  securities are carried at fair value. Cost basis for these securities was  $160 million.                   |   |
| (3) |   | We  have commitments to invest in additional limited partnership interests  totaling $668 million.                 |   |
| (4) |   | Short-term  investments are carried at fair value. Amortized cost basis for these  investments was $1.00 billion.  |   |

 

Total investments increased to $60.75 billion at September 30,2010, from $60.22 billion at December 31, 2009, primarily due to highervaluations for fixed income securities, partially offset by net reductions incontractholder obligations of $3.67 billion. Valuations of fixed income securities are typically driven by acombination of changes in relevant risk-free interest rates and credit spreadsover the period.  Risk-free interestrates are typically defined as the yield on U.S. Treasury securities, whereascredit spread is the additional yield on fixed income securities above therisk-free rate that market participants require to compensate them for assumingcredit, liquidity and/or prepayment risks. The increase in valuation for fixed income securities for the ninemonths ended September 30, 2010 was mainly due to declining risk-freeinterest rates, partially offset by widening credit spreads in certain sectors.

 

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

 
| **($ in millions)**                               | ** ** | **Fair value at  September 30, 2010** | ** ** | **Percent to  total  investments** | ** ** | **Fair value at  December 31, 2009** | ** ** | **Percent to  total  investments** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------|------------|
| U.S. government and  agencies                               |       | $                                                         | 4,307      |                                    | 7.1        | %                                                        | $          | 3,581                                   |       | 5.9 | % |
| Municipal                                                   |       | 4,905                                                     |       | 8.1                                     |       | 5,109                                                    |       | 8.5                                     |       |
| Corporate                                                   |       | 28,924                                                    |       | 47.6                                    |       | 27,539                                                   |       | 45.7                                    |       |
| Foreign government                                          |       | 2,471                                                     |       | 4.1                                     |       | 2,153                                                    |       | 3.6                                     |       |
| Residential  mortgage-backed securities  (“RMBS”) |       | 4,689                                                     |       | 7.7                                     |       | 4,666                                                    |       | 7.8                                     |       |
| Commercial  mortgage-backed securities (“CMBS”)   |       | 1,893                                                     |       | 3.1                                     |       | 2,468                                                    |       | 4.1                                     |       |
| Asset-backed securities  (“ABS”)                  |       | 2,577                                                     |       | 4.2                                     |       | 2,127                                                    |       | 3.5                                     |       |
| Redeemable preferred  stock                                 |       | 15                                                        |       | —                                  |       | 15                                                       |       | —                                  |       |
| Total fixed income  securities                              |       | $                                                         | 49,781     |                                    | 81.9       | %                                                        | $          | 47,658                                  |       | 79.1 | % |

 

At September 30, 2010, 92.7% of the fixed income securitiesportfolio was rated investment grade, which is defined as a security having arating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB fromStandard and Poor’s (“S&P”), Fitch, Dominion, or Realpoint, a rating ofaaa, aa, a or bbb from A.M. Best, or a comparable internal rating if anexternally provided rating is not available.

 

50

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

 
| ** **                                                                       | ** ** | **Aaa**             | ** ** | **Aa**                          | ** ** | **A**               | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------|------------|---------------------------------|------------|---------------------|------------|
| **($ in millions)**                                                    | ** ** | **Fair**

**value** | ** ** | **Unrealized**

**gain/(loss)** | ** ** | **Fair**

**value** | ** ** | **Unrealized**

**gain/(loss)** | ** ** | **Fair**

**value** | ** ** | **Unrealized**

**gain/(loss)** | ** ** |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| U.S. government and agencies                                                     |       | $                   | 4,307      |                            | $          | 359                 |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Municipal                                                                        |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Tax exempt                                                                       |       | —              |       | —                          |       | 29                  |       | 1 |   | 1 |   | — |   |
| Taxable                                                                          |       | 186                 |       | 12                              |       | 2,476               |       | 158 |   | 1,150 |   | 22 |   |
| Auction rate securities (“ARS”)                                        |       | 410                 |       | (25                             | )          | 26                  |       | (5 | ) | 39 |   | (5 | ) |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Corporate                                                                        |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Public                                                                           |       | 705                 |       | 37                              |       | 1,656               |       | 131 |   | 5,354 |   | 506 |   |
| Privately placed                                                                 |       | 865                 |       | 64                              |       | 1,395               |       | 93 |   | 3,235 |   | 249 |   |
| Hybrid                                                                           |       | 35                  |       | 5                               |       | 44                  |       | 5 |   | 393 |   | (48 | ) |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Foreign government                                                               |       | 1,619               |       | 327                             |       | 128                 |       | 10 |   | 408 |   | 49 |   |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| RMBS                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| U.S. government sponsored entities (“U.S. Agency”)                     |       | 2,413               |       | 118                             |       | —              |       | — |   | — |   | — |   |
| Prime residential mortgage-backed securities  (“Prime”)                |       | 418                 |       | 3                               |       | 65                  |       | (2 | ) | 168 |   | 3 |   |
| Alt-A residential mortgage-backed securities  (“Alt-A”)                |       | 36                  |       | —                          |       | 50                  |       | (6 | ) | 103 |   | (6 | ) |
| Subprime residential mortgage-backed securities  (“Subprime”)          |       | 51                  |       | (2                              | )          | 245                 |       | (88 | ) | 55 |   | (16 | ) |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| CMBS                                                                             |       | 1,120               |       | 31                              |       | 219                 |       | (27 | ) | 217 |   | (62 | ) |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| ABS                                                                              |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Collateralized debt obligations (“CDO”)                                |       | 12                  |       | —                          |       | 489                 |       | (22 | ) | 453 |   | (65 | ) |
| Consumer and other asset-backed securities  (“Consumer and other ABS”) |       | 390                 |       | 11                              |       | 179                 |       | 1 |   | 198 |   | (2 | ) |
|                                                                             |       |                |       |                            |       |                |       |   |   |   |   |   |   |
| Redeemable preferred stock                                                       |       | —              |       | —                          |       | 1                   |       | — |   | — |   | — |   |
| Total fixed income securities                                                    |       | $                   | 12,567     |                            | $          | 940                 |       | $ | 7,002 |   | $ | 249 |   | $ | 11,774 |   | $ | 625 |   |

 
| ** **                    | ** ** | **Baa**         | ** ** | **Ba or lower**       | ** ** | **Total**       | ** ** |
|-------------------------------|------------|-----------------|------------|---------------------------------|------------|-----------------|------------|
| ** **                    | ** ** | **Fair  value** | ** ** | **Unrealized**

**gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized   gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| U.S. government and agencies  |       | $               | —     |                            | $          | —          |       | $ | — |   | $ | — |   | $ | 4,307 |   | $ | 359 |   |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Municipal                     |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Tax exempt                    |       | 32              |       | 3                               |       | —          |       | — |   | 62 |   | 4 |   |
| Taxable                       |       | 439             |       | (49                             | )          | 75              |       | (55 | ) | 4,326 |   | 88 |   |
| ARS                           |       | 30              |       | (7                              | )          | 12              |       | (3 | ) | 517 |   | (45 | ) |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Corporate                     |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Public                        |       | 6,949           |       | 579                             |       | 838             |       | 17 |   | 15,502 |   | 1,270 |   |
| Privately placed              |       | 5,861           |       | 291                             |       | 1,022           |       | 40 |   | 12,378 |   | 737 |   |
| Hybrid                        |       | 449             |       | (64                             | )          | 123             |       | 10 |   | 1,044 |   | (92 | ) |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Foreign government            |       | 316             |       | 29                              |       | —          |       | — |   | 2,471 |   | 415 |   |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| RMBS                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| U.S. Agency                   |       | —          |       | —                          |       | —          |       | — |   | 2,413 |   | 118 |   |
| Prime                         |       | 7               |       | —                          |       | 256             |       | (7 | ) | 914 |   | (3 | ) |
| Alt-A                         |       | 23              |       | (6                              | )          | 213             |       | (42 | ) | 425 |   | (60 | ) |
| Subprime                      |       | 52              |       | (16                             | )          | 534             |       | (352 | ) | 937 |   | (474 | ) |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| CMBS                          |       | 217             |       | (182                            | )          | 120             |       | (142 | ) | 1,893 |   | (382 | ) |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| ABS                           |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| CDO                           |       | 236             |       | (92                             | )          | 429             |       | (123 | ) | 1,619 |   | (302 | ) |
| Consumer and other ABS        |       | 171             |       | (3                              | )          | 20              |       | (4 | ) | 958 |   | 3 |   |
|                          |       |            |       |                            |       |            |       |   |   |   |   |   |   |
| Redeemable preferred stock    |       | 14              |       | —                          |       | —          |       | — |   | 15 |   | — |   |
| Total fixed income securities |       | $               | 14,796     |                            | $          | 483             |       | $ | 3,642 |   | $ | (661 | ) | $ | 49,781 |   | $ | 1,636 |   |

 

51

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*Municipal Bonds,* including tax exempt, taxable and ARSsecurities, totaled $4.91 billion as of September 30, 2010 with anunrealized net capital gain of $47 million.

 

As of September 30, 2010, 35.1% or $1.72 billion of our municipalbond portfolio is insured by six bond insurers and 40.5% of these securitieshave a credit rating of Aaa or Aa.  59.8%of our insured municipal bond portfolio was insured by National Public FinanceGuarantee Corporation, Inc., 20.8% by Assured Guaranty MunicipalCorporation, 15.2% by Ambac Assurance Corporation and 1.9% by SyncoraHoldings.  Given the effects of theeconomic crisis on bond insurers, the value inherent in this insurance hasdeclined.  We believe the fair value of our insured municipal bondportfolio substantially reflects the decline in the value of the insurance, andfurther related valuation declines, if any, are not expected to bematerial.  We expect to receive all of the contractual cash flows becauseour practice for acquiring and monitoring municipal bonds are predominantlybased on the underlying credit quality of the primary obligor.

 

*Corporate bonds,* including publicly traded, privately placedand hybrid securities, totaled $28.92 billion as of September 30, 2010with an unrealized net capital gain of $1.92 billion.  Privately placed securities primarily consistof corporate issued senior debt securities that are in unregistered form or aredirectly negotiated with the borrower. 49.9% of the privately placed corporate securities in our portfolio arerated by an independent rating agency and substantially all are rated by theNational Association of Insurance Commissioners.

 

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

 
| ** **                      | ** ** | **Public**      | ** ** | **Privately placed**   | ** ** | **Total**       | ** ** |
|---------------------------------|------------|-----------------|------------|-----------------------------|------------|-----------------|------------|
| **($ in millions)**   | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| United Kingdom (“UK”) |       | $               | 80         |                        | $          | (1              | )          | $ | 36 |   | $ | 1 |   | $ | 116 |   | $ | — |   |
| Europe (non-UK)                 |       | 126             |       | 6                           |       | 246             |       | (18 | ) | 372 |   | (12 | ) |
| Asia/Australia                  |       | 11              |       | (1                          | )          | 51              |       | (3 | ) | 62 |   | (4 | ) |
| North America                   |       | 301             |       | (42                         | )          | 193             |       | (34 | ) | 494 |   | (76 | ) |
| Total                           |       | $               | 518        |                        | $          | (38             | )          | $ | 526 |   | $ | (54 | ) | $ | 1,044 |   | $ | (92 | ) |

 

Hybridsecurities have attributes most similar to those of fixed income securitiessuch as stated interest rates and mandatory redemption dates.  Additionally, some hybrids may have an interestrate step-up feature which is intended to incent the issuer to redeem thesecurity at a specified call date.  Whilehybrid securities are generally issued by investment grade-rated financialinstitutions, they have structural features, such as the ability to deferprincipal and interest payments, which make them more sensitive to creditmarket deterioration.  $881 million ofour hybrid securities with $90 million of unrealized net capital losses areTier 1 securities, and $163 million with $2 million of unrealized net capitallosses are Tier 2 securities.  Tier 1securities are lower in the capital structure than Tier 2 securities.

 

*RMBS*, *CMBS* and *ABS* are structured securities that are primarilycollateralized by residential and commercial real estate related loans andother consumer related borrowings.  Thecash flows from the underlying collateral paid to the securitization trust aregenerally applied in a pre-determined order and are designed so that eachsecurity issued by the trust, typically referred to as a “class”, qualifies fora specific original rating.  For example,the “senior” portion or “top” of the capital structure, or rating class, whichwould originally qualify for a rating of Aaa typically has priority inreceiving principal repayments on the underlying collateral and retains thispriority until the class is paid in full. In a sequential structure, underlying collateral principal repaymentsare directed to the most senior rated Aaa class in the structure until paid infull, after which principal repayments are directed to the next most senior Aaaclass in the structure until it is paid in full.  Senior Aaa classes generally share any lossesfrom the underlying collateral on a pro-rata basis after losses are absorbed byclasses with lower original ratings.  Thepayment priority and class subordination included in these securities serves ascredit enhancement for holders of the senior or top portions of thestructures.  These securities continue toretain the payment priority features that existed at the origination of thesecuritization trust.  Other forms ofcredit enhancement may include structural features embedded in thesecuritization trust, such as overcollateralization, excess spread and bond insurance.  The underlying collateral can have fixedinterest rates, variable interest rates (such as adjustable rate mortgages (“ARM”))or may contain features of both fixed and variable rate mortgages.

 

*RMBS*, including U.S. Agency, Prime, Alt-A and Subprime,totaled $4.69 billion, with 78.6% rated investment grade, at September 30,2010.  The RMBS portfolio is subject tointerest rate risk, but unlike other fixed income securities, is additionallysubject to significant prepayment risk from the underlying residential mortgageloans.  The credit risk associated withour RMBS portfolio is mitigated due to the fact that 51.5% of the portfolioconsists of

 

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securitiesthat were issued by or have underlying collateral guaranteed by U.S. governmentagencies.  The unrealized net capitalloss of $419 million at September 30, 2010 was the result of wider creditspreads than at initial purchase on the non-U.S. Agency portion of our RMBSportfolio, largely due to increased risk premiums caused by macroeconomicconditions and credit market deterioration, including the impact of real estatevaluations, which continue to persist. The following table shows our RMBS portfolio at September 30, 2010,based upon vintage year of the issuance of the securities.

 
| ** **                    | ** ** | **U.S. Agency** | ** ** | **Prime**                   | ** ** | **Alt-A**       | ** ** | **Subprime**                | ** ** | **Total RMBS** | ** ** |
|-------------------------------|------------|----------------------|------------|-----------------------------|------------|-----------------|------------|-----------------------------|------------|---------------------|------------|
| **($ in millions)** | ** ** | **Fair  value**      | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value**     | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
| 2010                          |       | $                    | —     |                        | $          | —          |       | $                           | 202        |                | $          | 6 |   | $ | 58 |   | $ | 1 |   | $ | — |   | $ | — |   | $ | 260 |   | $ | 7 |   |
| 2009                          |       | 485                  |       | 11                          |       | 55              |       | —                      |       | 9                   |       | — |   | — |   | — |   | 549 |   | 11 |   |
| 2008                          |       | 327                  |       | 11                          |       | —          |       | —                      |       | —              |       | — |   | — |   | — |   | 327 |   | 11 |   |
| 2007                          |       | 94                   |       | 3                           |       | 147             |       | 2                           |       | 35                  |       | (15 | ) | 255 |   | (198 | ) | 531 |   | (208 | ) |
| 2006                          |       | 121                  |       | 6                           |       | 109             |       | (4                          | )          | 102                 |       | (14 | ) | 214 |   | (114 | ) | 546 |   | (126 | ) |
| 2005                          |       | 347                  |       | 16                          |       | 138             |       | (9                          | )          | 96                  |       | (9 | ) | 271 |   | (103 | ) | 852 |   | (105 | ) |
| Pre-2005                      |       | 1,039                |       | 71                          |       | 263             |       | 2                           |       | 125                 |       | (23 | ) | 197 |   | (59 | ) | 1,624 |   | (9 | ) |
| Total                         |       | $                    | 2,413      |                        | $          | 118             |       | $                           | 914        |                | $          | (3 | ) | $ | 425 |   | $ | (60 | ) | $ | 937 |   | $ | (474 | ) | $ | 4,689 |   | $ | (419 | ) |

 

Prime are collateralized by residential mortgage loans issued to primeborrowers.  As of September 30,2010, $756 million of the Prime were fixed rate and $158 million were variablerate.

 

Alt-A includes securities collateralized by residential mortgage loansissued to borrowers who do not qualify for prime financing terms due to highloan-to-value ratios or limited supporting documentation, but have strongercredit profiles than subprime borrowers. As of September 30, 2010, $348 million of the Alt-A were fixed rateand $77 million were variable rate.

 

Subprimeincludes securities that are collateralized by residential mortgage loansissued to borrowers that cannot qualify for Prime or Alt-A financing terms duein part to weak or limited credit history. It also includes securities that are collateralized by certain secondlien mortgages regardless of the borrower’s credit history.  The Subprime portfolio consisted of $746million and $190 million of first lien and second lien securities,respectively.  Subprime included $460million of fixed rate and $477 million of variable rate securities.

 

*CMBS* totaled $1.89 billion, with 93.7% rated investmentgrade, at September 30, 2010.  TheCMBS portfolio is subject to credit risk, but unlike certain other structuredsecurities, is generally not subject to prepayment risk due to protectionswithin the underlying commercial mortgage loans.  Of the CMBS investments, 95.9% aretraditional conduit transactions collateralized by commercial mortgage loans,broadly diversified across property types and geographical area.  The remainder consists of non-traditionalCMBS such as small balance transactions, large loan pools and single borrowertransactions.

 

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

 
| **($ in millions)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/(loss)** | ** ** |
|-------------------------------|------------|-----------------|------------|-----------------------------|------------|
| 2007                          |       | $               | 277        |                        | $          | (43 | ) |
| 2006                          |       | 557             |       | (280                        | )          |
| 2005                          |       | 294             |       | (60                         | )          |
| Pre-2005                      |       | 765             |       | 1                           |       |
| Total CMBS                    |       | $               | 1,893      |                        | $          | (382 | ) |

 

Theunrealized net capital loss of $382 million at September 30, 2010 on ourCMBS portfolio was the result of wider credit spreads than at initial purchase,largely due to the macroeconomic conditions and credit market deterioration,including the impact of declining real estate valuations, which continue topersist.  While CMBS spreads tightenedduring 2009 and 2010, credit spreads in most rating classes remain wider thanat initial purchase, which is particularly evident in our 2005-2007 vintageyear CMBS.

 

*ABS,* including CDO and Consumer and other ABS, totaled$2.58 billion, with 82.6% rated investment grade, at September 30,2010.  Credit risk is managed bymonitoring the performance of the underlying collateral.  In addition, many of the securities in theABS portfolio have credit enhancement with features such asovercollateralization, subordinated structures, reserve funds, guaranteesand/or insurance.  The unrealized netcapital loss of $299 million at September 30, 2010 on our ABS portfoliowas the result of wider credit spreads than at initial purchase.

 

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CDOtotaled $1.62 billion, with 73.5% rated investment grade, at September 30,2010.  CDO consist primarily ofobligations collateralized by high yield and investment grade corporate creditsincluding $1.28 billion of cash flow collateralized loan obligations (“CLO”)with unrealized losses of $151 million. The remaining $337 million of securities consisted of synthetic CDO,trust preferred CDO, market value CDO, project finance CDO, collateralized bondobligations and other CLO with unrealized losses of $151 million.

 

Cash flow CLO are structures collateralized primarily by belowinvestment grade senior secured corporate loans.  Theunderlying collateral is actively managed by external managers that monitor thecollateral’s performance and is well diversified across industries and amongissuers.  A transaction willtypically issue notes with various capital structure classes (i.e. Aaa, Aa, A, etc.)as well as equity-like tranches.  Ingeneral, these securities are structured with overcollateralization ratios andperformance is impacted primarily by defaults and recoveries of the underlyingcollateral within the structures, which reduce overcollateralization ratiosover time.  A violation of the seniorovercollateralization test could result in an event of default of thestructure.

 

Consumer and other ABS totaled $958 million, with 97.9% ratedinvestment grade, at September 30, 2010. Consumer and other ABS consists of $552 million of auto and $406 millionof other ABS securities with unrealized gains of $6 million and unrealizedlosses of $3 million, respectively.

 

**Mortgage loans**  Our mortgageloan portfolio totaled $6.83 billion at September 30, 2010, comparedto $7.78 billion at December 31, 2009, and primarily comprise loanssecured by 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 highlydiversified, with the largest exposure not exceeding 10.2% of the portfolio.  The portfolio is also diversified acrossseveral property types, with the largest concentrations of 33.5% in officebuildings and 26.4% in retail property. Debt service coverage ratios represent the amount of cash flows from theproperty available to the borrower to meet principal and interest paymentobligations.  For fixed rate mortgageloans, which comprise 90.7% and 89.9% of the total portfolio at September 30,2010 and December 31, 2009, respectively, the average debt servicecoverage ratios as of September 30, 2010 and December 31, 2009 were1.6 and 1.7, respectively.  Mortgageloans with debt service coverage ratios below 1.0 generally have a higher levelof risk.  5.7% and 5.8% of the mortgageloan portfolio had a debt service coverage ratio under 1.0 as of September 30,2010 and December 31, 2009, respectively. As of September 30, 2010, 28.8% or $112 million of these mortgageloans are impaired and have valuation allowances totaling $50 million comparedto 18.7% or $85 million which had valuation allowances totaling $26 million asof December 31, 2009.  Mortgageloans with debt service coverage below 1.0 which are not impaired primarilyrelate to instances where the borrower has the financial capacity to fund therevenue shortfalls from the properties for the foreseeable term, the decreasein occupancy is considered temporary, or there are other risk mitigatingcircumstances such as additional collateral, escrow balances or borrowerguarantees.

 

Inthe first nine months of 2010, $793 million of mortgage loans werecontractually due.  Of these, 40% werepaid as due, 14% were extended, 43% were refinanced for an average of six yearsat market rates using our standard underwriting criteria and 3% were real estateacquired through foreclosure or deed in lieu of mortgage loans.  In addition, $387 million of mortgage loansthat were not contractually due in the first nine months of 2010 were paid infull.

 

Thenet carrying value of impaired mortgage loans at September 30, 2010 andDecember 31, 2009 was $229 million and $377 million,respectively.  Total valuation allowancesof $75 million were held on impaired mortgage loans at September 30, 2010,compared to $94 million at December 31, 2009.  We recognized $3 million and $44 millionof realized capital losses related to net increases in the valuation allowanceson impaired mortgage loans for the three months and nine months ended September 30,2010, respectively.  The net increases inboth periods were primarily due to deteriorating debt service coverageresulting from a decrease in occupancy and the risk associated with refinancingnear-term maturities due to declining underlying collateral valuations.  Realized capital losses recognized onmortgage loans held for sale totaled $6 million for the nine months ended September 30,2010.  There were no realized capitallosses recognized on mortgage loans held for sale for the three months ended September 30,2010.

 

In total, we have seven mortgage loans totaling $64 million in theprocess of foreclosure, reflecting an increase from five mortgage loanstotaling $49 million as of December 31, 2009.  Real estate acquired through foreclosure ordeed in lieu of mortgage loans during the first nine months of 2010 totaled $82million and is included in other investments on the Condensed ConsolidatedStatement of Financial Position.  Werecognized $2 million of realized capital losses for both the three months andnine months ended September 30, 2010 related to sales of real estate

 

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assets with an active plan to sell. There were no impairment write-downs recognized on real estate foreither the three or nine month periods ended September 30, 2010.

 

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

 
| **($ in millions)**                  | ** ** | **Private  equity/debt  funds** | ** ** | **Real estate  funds** | ** ** | **Hedge  funds** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|------------------|------------|-----------|------------|
| Cost method of  accounting (“Cost”)  |       | $                               | 496        |                        | $          | 124              |       | $         | —     |   | $ | 620 |   |
| Equity method of  accounting (“EMA”) |       | 342                             |       | 157                         |       | 8                |       | 507       |       |
| Total                                          |       | $                               | 838        |                        | $          | 281              |       | $         | 8          |   | $ | 1,127 |   |
|                                           |       |                            |       |                        |       |             |       |      |       |
| Number of sponsors                             |       | 74                              |       | 32                          |       | 1                |       |      |       |
| Number of individual  funds                    |       | 111                             |       | 59                          |       | 2                |       |      |       |
| Largest exposure to  single fund               |       | $                               | 23         |                        | $          | 17               |       | $         | 7          |   |   |   |

 

Ouraggregate limited partnership exposure represented 1.9% and 1.7% of totalinvested assets as of September 30, 2010 and December 31, 2009,respectively.

 

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

 
| ** **                    | ** ** | **Three months ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|
| ** **                    | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| **($ in millions)** | ** ** | **Cost**                                             | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs **(1) | ** ** | **Cost** | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs **(1) | ** ** |
| Private equity/debt funds     |       | $                                                    | 3          |   | $ | 1 |   | $ | 4 |   | $ | — |   | $ | 2 |   | $ | 5 |   | $ | 7 |   | $ | (2 | ) |
| Real estate funds             |       | —                                               |       | (4 | ) | (4 | ) | (4 | ) | — |   | (12 | ) | (12 | ) | (25 | ) |
| Hedge funds                   |       | —                                               |       | — |   | — |   | — |   | — |   | 1 |   | 1 |   | — |   |
| Total                         |       | $                                                    | 3          |   | $ | (3 | ) | $ | — |   | $ | (4 | ) | $ | 2 |   | $ | (6 | ) | $ | (4 | ) | $ | (27 | ) |

 
| ** **                | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|
| ** **                | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| ** **                | ** ** | **Cost**                                            | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs **(1) | ** ** | **Cost** | ** ** | **EMA** | ** ** | **Total  income** | ** ** | **Impairment  write-downs **(1) | ** ** |
| Private equity/debt funds |       | $                                                   | 10         |   | $ | 20 |   | $ | 30 |   | $ | (2 | ) | $ | 6 |   | $ | (40 | ) | $ | (34 | ) | $ | (43 | ) |
| Real estate funds         |       | —                                              |       | (25 | ) | (25 | ) | (18 | ) | — |   | (78 | ) | (78 | ) | (99 | ) |
| Hedge funds               |       | —                                              |       | 6 |   | 6 |   | — |   | — |   | 2 |   | 2 |   | — |   |
| Total                     |       | $                                                   | 10         |   | $ | 1 |   | $ | 11 |   | $ | (20 | ) | $ | 6 |   | $ | (116 | ) | $ | (110 | ) | $ | (142 | ) |

 

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(1)   Impairment write-downsrelated to Cost limited partnerships were $4 million and $19 million in thethree months and nine months ended September 30, 2010, respectively,compared to $27 million and $137 million in the three months and nine monthsended September 30, 2009, respectively. There were no impairment write-downs related to EMA limited partnershipsin both the three months ended September 30, 2010 and 2009.  Impairment write-downs related to EMA limitedpartnerships were $1 million in the nine months ended September 30, 2010compared to $5 million in the nine months ended September 30, 2009.

 

Limited partnershipinterests, excluding impairment write-downs, produced no income or loss in thethird quarter of 2010 and income of $11 million in the nine months ended September 30,2010 compared to losses of $4 million and $110 million in the three months andnine months ended September 30, 2009, respectively.  Income on EMA limited partnerships 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.  Income on Cost limitedpartnerships is recognized only upon cash distributions by the partnership.

 

55

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**Unrealized net capital gains** totaled $1.65 billion as ofSeptember 30, 2010 compared to unrealized net capital losses of $2.18billion as of December 31, 2009. The improvement since December 31, 2009 for fixed income securitieswas primarily a result of declining risk-free interest rates, partially offsetby widening credit spreads in certain sectors. The following table presents unrealized net capital gains and losses,pre-tax and after-tax.

 
| **($ in millions)**                      | ** ** | **September 30,  2010** | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| U.S. government and  agencies                      |       | $                            | 359        |                    | $          | 334                      |       | $                           | 157        |   | $ | 155 |   |
| Municipal                                          |       | 47                           |       | (126                    | )          | (347                     | )          | (469                        | )          |
| Corporate                                          |       | 1,915                        |       | 1,184                   |       | 728                      |       | 225                         |       |
| Foreign government                                 |       | 415                          |       | 320                     |       | 263                      |       | 247                         |       |
| RMBS                                               |       | (419                         | )          | (580                    | )          | (770                     | )          | (930                        | )          |
| CMBS                                               |       | (382                         | )          | (553                    | )          | (766                     | )          | (922                        | )          |
| ABS                                                |       | (299                         | )          | (408                    | )          | (398                     | )          | (489                        | )          |
| Redeemable preferred stock                         |       | —                       |       | —                  |       | —                   |       | (1                          | )          |
| Fixed income securities (1)                        |       | 1,636                        |       | 171                     |       | (1,133                   | )          | (2,184                      | )          |
| Equity securities                                  |       | 26                           |       | 11                      |       | 44                       |       | 24                          |       |
| Short-term investments                             |       | —                       |       | —                  |       | —                   |       | —                      |       |
| Derivatives                                        |       | (12                          | )          | 7                       |       | (13                      | )          | (18                         | )          |
| Unrealized net capital gains and losses, pre-tax   |       | 1,650                        |       | 189                     |       | (1,102                   | )          | (2,178                      | )          |
| Amounts recognized for:                            |       |                         |       |                    |       |                     |       |                        |       |
| Insurance reserves (2)                             |       | (608                         | )          | (292                    | )          | —                   |       | —                      |       |
| DAC and DSI (3)                                    |       | (45                          | )          | 406                     |       | 727                      |       | 990                         |       |
| Amounts recognized                                 |       | (653                         | )          | 114                     |       | 727                      |       | 990                         |       |
| Deferred income taxes                              |       | (354                         | )          | (111                    | )          | 126                      |       | 411                         |       |
| Unrealized net capital gains and losses, after-tax |       | $                            | 643        |                    | $          | 192                      |       | $                           | (249       | ) | $ | (777 | ) |

 

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(1)     Unrealized net capital gainsand losses for fixed income securities as of September 30, 2010, June 30,2010, March 31, 2010 and December 31, 2009 comprise $(163) million,$(319) million, $(376) million and $(422) million, respectively, related tounrealized net capital losses on fixed income securities withother-than-temporary impairment and $1.80 billion, $490 million, $(757) millionand $(1.76) billion, respectively, related to other unrealized net capital gainsand losses.

 

(2)     The insurance reservesadjustment represents the amount by which the reserve balance would increase ifthe net unrealized gains in the applicable product portfolios were realized andreinvested at current lower interest rates, resulting in a premiumdeficiency.  Although we evaluate premiumdeficiencies on the combined performance of our life insurance and immediateannuities with life contingencies, the adjustment primarily relates tostructured settlement annuities with life contingencies, in addition to annuitybuy-outs and certain payout annuities with life contingencies.

 

(3)     The DAC and DSI adjustmentbalance represents the amount by which the amortization of DAC and DSI wouldincrease or decrease if the unrealized gains or losses in the respectiveproduct portfolios were realized.  Onlythe unrealized net capital gains and losses on the fixed annuity andinterest-sensitive life product portfolios are used in this calculation.  The reduction in unrealized net capitallosses in the first, second and third quarter of 2010 for these productportfolios was less than the reduction in unrealized net capital losses for thetotal portfolio.  The DAC and DSIadjustment balance, subject to limitations, is determined by applying the DACand DSI amortization rate to unrealized net capital gains or losses.  Recapitalization of the DAC and DSI balancesis limited to the originally deferred costs plus interest.

 

Theunrealized net capital gains for the fixed income portfolio totaled $1.64billion and comprised $3.50 billion of gross unrealized gains and $1.86 billionof gross unrealized losses at September 30, 2010.  This is compared to unrealized net capitallosses for the fixed income portfolio totaling $2.18 billion, comprised of$1.65 billion of gross unrealized gains and $3.83 billion of gross unrealizedlosses at December 31, 2009.

 

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Gross unrealized gains and losses as of September 30, 2010 onfixed income securities by type and sector are provided in the table below.

 
| ** **                                 | ** ** | **Par**            | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Fair**   | ** ** | **Amortized  cost as a  percent of** | ** ** | **Fair value  as a  percent of** | ** ** |
|--------------------------------------------|------------|--------------------|------------|---------------|------------|---------------------------|------------|------------|------------|-----------------------------------------------------|------------|-------------------------------------------------|------------|
| **($ in millions)**              | ** ** | **value **(1) | ** ** | **cost**      | ** ** | **Gains**                 | ** ** | **Losses** | ** ** | **value**                                           | ** ** | **par value **(2)                     | ** ** | **par value **(2) | ** ** |
| Corporate:                                 |       |               |       |          |       |                      |       |       |       |                                                |       |                                            |       |   |   |
| Banking                                    |       | $                  | 3,178      |          | $          | 3,073                     |       | $          | 143        |                                                | $          | (122                                            | )          | $ | 3,094 |   | 96.7 | % | 97.4 | % |
| Consumer goods (cyclical and non-cyclical) |       | 4,511              |       | 4,555         |       | 369                       |       | (28        | )          | 4,896                                               |       | 101.0                                           |       | 108.5 |   |
| Financial services                         |       | 2,512              |       | 2,494         |       | 152                       |       | (27        | )          | 2,619                                               |       | 99.3                                            |       | 104.3 |   |
| Utilities                                  |       | 5,447              |       | 5,460         |       | 570                       |       | (24        | )          | 6,006                                               |       | 100.2                                           |       | 110.3 |   |
| Transportation                             |       | 1,485              |       | 1,501         |       | 131                       |       | (21        | )          | 1,611                                               |       | 101.1                                           |       | 108.5 |   |
| Capital goods                              |       | 2,954              |       | 2,953         |       | 286                       |       | (18        | )          | 3,221                                               |       | 100.0                                           |       | 109.0 |   |
| Technology                                 |       | 993                |       | 1,008         |       | 73                        |       | (6         | )          | 1,075                                               |       | 101.5                                           |       | 108.3 |   |
| Basic industry                             |       | 1,301              |       | 1,316         |       | 101                       |       | (6         | )          | 1,411                                               |       | 101.2                                           |       | 108.5 |   |
| Energy                                     |       | 1,767              |       | 1,786         |       | 156                       |       | (4         | )          | 1,938                                               |       | 101.1                                           |       | 109.7 |   |
| Communications                             |       | 1,618              |       | 1,618         |       | 124                       |       | (4         | )          | 1,738                                               |       | 100.0                                           |       | 107.4 |   |
| FDIC guaranteed                            |       | 115                |       | 115           |       | 1                         |       | —     |       | 116                                                 |       | 100.0                                           |       | 100.9 |   |
| Other                                      |       | 1,252              |       | 1,130         |       | 80                        |       | (11        | )          | 1,199                                               |       | 90.3                                            |       | 95.8 |   |
| Total corporate fixed income portfolio     |       | 27,133             |       | 27,009        |       | 2,186                     |       | (271       | )          | 28,924                                              |       | 99.5                                            |       | 106.6 |   |
|                                       |       |               |       |          |       |                      |       |       |       |                                                |       |                                            |       |   |   |
| U.S. government and agencies               |       | 4,562              |       | 3,948         |       | 359                       |       | —     |       | 4,307                                               |       | 86.5                                            |       | 94.4 |   |
| Municipal                                  |       | 7,920              |       | 4,858         |       | 259                       |       | (212       | )          | 4,905                                               |       | 61.3                                            |       | 61.9 |   |
| Foreign government                         |       | 2,529              |       | 2,056         |       | 415                       |       | —     |       | 2,471                                               |       | 81.3                                            |       | 97.7 |   |
| RMBS                                       |       | 5,520              |       | 5,108         |       | 151                       |       | (570       | )          | 4,689                                               |       | 92.5                                            |       | 84.9 |   |
| CMBS                                       |       | 2,325              |       | 2,275         |       | 56                        |       | (438       | )          | 1,893                                               |       | 97.8                                            |       | 81.4 |   |
| ABS                                        |       | 3,280              |       | 2,876         |       | 72                        |       | (371       | )          | 2,577                                               |       | 87.7                                            |       | 78.6 |   |
| Redeemable preferred stock                 |       | 14                 |       | 15            |       | —                    |       | —     |       | 15                                                  |       | 107.1                                           |       | 107.1 |   |
| Total fixed income securities              |       | $                  | 53,283     |          | $          | 48,145                    |       | $          | 3,498      |                                                | $          | (1,862                                          | )          | $ | 49,781 |   | 90.4 |   | 93.4 |   |

 

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(1) Included in parvalue are zero-coupon securities that are generally purchased at a deepdiscount to the par value that is received at maturity.  These primarily included corporate, municipal,foreign government and U.S. government and agencies zero-coupon securities withpar value of $712 million, $4.07 billion, $1.33 billion and $1.67 billion,respectively.

 

(2) Excluding theimpact of zero-coupon securities, the percentage of amortized cost to par valuewould be 100.2% for corporates, 99.0% for municipals, 104.4% for foreigngovernments and 103.8% for U.S. government and agencies.  Similarly, excluding the impact ofzero-coupon securities, the percentage of fair value to par value would be 107.2%for corporates, 102.3% for municipals, 116.1% for foreign governments and107.3% for U.S. government and agencies.

 

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

 

The unrealized net capital gain for the equity portfolio totaled $26million and comprised $30 million of gross unrealized gains and $4 million ofgross unrealized losses at September 30, 2010.  This is compared to an unrealized net capitalgain for the equity portfolio totaling $24 million, comprised of $31 million ofgross unrealized gains and $7 million of gross unrealized losses at December 31,2009.  Within the equity portfolio, thelosses were primarily concentrated in the banking sector.  The unrealized losses in this sector werecompany and sector specific.  As of September 30,2010, we have the intent and ability to hold our equity securities withunrealized losses until recovery.

 

We have a comprehensive portfolio monitoring process to identify andevaluate each fixed income and equity security whose carrying value may beother-than-temporarily impaired.  Theprocess includes a quarterly review of all securities to identify instanceswhere the fair value of a security compared to its amortized cost (for fixedincome securities) and cost (for equity securities) is below establishedthresholds.  The process also includesthe monitoring of other impairment indicators such as ratings, ratingsdowngrades and payment defaults.  Thesecurities identified, in addition to other securities for which we may have aconcern, are evaluated based on facts and circumstances for inclusion on ourwatch-list.  All investments in anunrealized loss position at September 30, 2010 were included in ourportfolio monitoring process for determining whether declines in value wereother than temporary.

 

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

 

57

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declinein fair value is other than temporary has placed greater emphasis on ouranalysis of the underlying credit and collateral and related estimates offuture cash flows.

 

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

 
| ** **                    | ** ** | **Investment grade** | ** ** | **Below investment grade** | ** ** | **Total**       | ** ** |
|-------------------------------|------------|---------------------------|------------|--------------------------------------|------------|-----------------|------------|
| **($ in millions)** | ** ** | **Fair  value**           | ** ** | **Unrealized  losses**               | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** |
| U.S. government and agencies  |       | $                         | 32         |                                 | $          | —          |       | $ | — |   | $ | — |   | $ | 32 |   | $ | — |   |
| Municipal                     |       | 1,220                     |       | (154                                 | )          | 78              |       | (58 | ) | 1,298 |   | (212 | ) |
| Corporate                     |       | 2,606                     |       | (223                                 | )          | 612             |       | (48 | ) | 3,218 |   | (271 | ) |
| Foreign government            |       | 11                        |       | —                               |       | —          |       | — |   | 11 |   | — |   |
| RMBS                          |       | 729                       |       | (150                                 | )          | 732             |       | (420 | ) | 1,461 |   | (570 | ) |
| CMBS                          |       | 920                       |       | (295                                 | )          | 111             |       | (143 | ) | 1,031 |   | (438 | ) |
| ABS                           |       | 1,135                     |       | (207                                 | )          | 370             |       | (164 | ) | 1,505 |   | (371 | ) |
| Total                         |       | $                         | 6,653      |                                 | $          | (1,029          | )          | $ | 1,903 |   | $ | (833 | ) | $ | 8,556 |   | $ | (1,862 | ) |

 

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

 

Asof September 30, 2010, our below investment grade gross unrealized losseswere primarily concentrated in RMBS, specifically Alt-A and Subprime, CMBS andABS, specifically cash flow CLO.  Thefair value of these securities totaled $957 million, an increase of 19.8%,compared to $799 million as of December 31, 2009.  Gross unrealized losses on these securitiestotaled $625 million as of September 30, 2010, a decrease of 23.7%,compared to $819 million as of December 31, 2009.

 

Fairvalues for our structured securities are obtained from third-party valuationservice providers and are subject to review as disclosed in our Application ofCritical Accounting Estimates.  Inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”), when fair value is less than the amortized cost of asecurity and we have not made the decision to sell the security and it is notmore likely than not we will be required to sell the security before recoveryof its amortized cost basis, we evaluate if we expect to receive cash flowssufficient to recover the entire amortized cost basis of the security.  We calculate the estimated recovery value bydiscounting our best estimate of future cash flows at the security’s originalor current effective rate, as appropriate, and compare this to the amortizedcost of the security.  If we do notexpect to receive cash flows sufficient to recover the entire amortized costbasis of the security, the credit loss component of the impairment is recordedin earnings, with the remaining amount of the unrealized loss related to otherfactors (“non-credit-related”) recognized in other comprehensive income (“OCI”).

 

Thenon-credit-related unrealized losses for our structured securities, includingour below investment grade Alt-A, Subprime, CMBS and cash flow CLO, are heavilyinfluenced by risk factors other than those related to our best estimate offuture cash flows.  The differencebetween these securities’ original or current effective rates and the yieldsimplied by their fair value indicates that a larger risk premium is included inthe valuation of these securities than existed at initial issue orpurchase.  This risk premium representsthe return that a market participant requires as compensation to assume therisk associated with the uncertainties regarding the future performance of theunderlying commercial and residential real estate collateral.  The risk premium is comprised of: defaultrisk, which reflects the probability of default and the uncertainty related tocollection of contractual principal and interest; liquidity risk, whichreflects the risk associated with exiting the investment in an illiquid market,both in terms of timeliness and cost; and volatility risk, which reflects thepotential valuation volatility during an investor’s holding period.  Other factors reflected in the risk premiuminclude the costs associated with underwriting, monitoring and holding thesetypes of complex securities.  Certain aspectsof the default risk are included in the development of our best estimate offuture cash flows, as appropriate.  Otheraspects of the risk premium are considered to be temporary in nature and areexpected to reverse over the remaining lives of the securities as future cashflows are received.

 

58

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

 

Grossunrealized losses for our below investment grade Alt-A and Subprime portfoliostotaled $47 million and $356 million, respectively, while gross unrealized gainsfor these portfolios totaled $6 million and $4 million, respectively, as of September 30,2010.  For our below investment gradeAlt-A and Subprime securities with gross unrealized gains, we have recognizedcumulative write-downs in earnings totaling $7 million and $89 million,respectively, as of September 30, 2010. Gross unrealized losses for our below investment grade Alt-A andSubprime portfolios as of December 31, 2009 totaled $84 million and $514million, respectively.

 

Thecredit loss evaluation for Alt-A and Subprime securities with gross unrealizedlosses is performed in two phases.  Thefirst phase estimates the future cash flows of the entire securitization trustfrom which our security was issued.  Acritical part of this estimate involves forecasting default rates and lossseverities of the residential mortgage loans that collateralize thesecuritization trust.  The factors thataffect the default rates and loss severities include, but are not limited to,historical collateral performance, collateral type, transaction vintage year,geographic concentrations, borrower credit quality, origination practices ofthe transaction sponsor, and practices of the mortgage loan servicers.  Current loan-to-value ratios of underlying collateral are not consistentlyavailable and accordingly they are not a primary factor in our impairmentevaluation.** **While our projections are developed internally and customizedto our specific holdings, they are informed by and benchmarked against creditopinions obtained from third parties, such as industry analysts, nationallyrecognized credit rating agencies and an RMBS loss modeling advisory service.** **Thedefault rate and loss severity forecasts result in a trust-level projectedadditional collateral loss estimate.

 

Wethen analyze the actual cumulative collateral losses incurred to date by thesecuritization trust, our projected additional collateral losses expected to beincurred and the position of the class of securities we own in thesecuritization trust relative to the trust’s other classes to determine whetherany of the collateral losses will be applied to our class.  If our class has remaining credit enhancementsufficient to withstand the projected additional collateral losses, no collaterallosses will be realized by our class and we expect to collect all contractualprincipal and interest of the security we own. Remaining credit enhancement is measured in terms of (i) subordinationfrom other classes of securities in the trust that are contractually obligatedto absorb losses before the class of security we own and (ii) the expectedimpact of other structural features embedded in the securitization trustbeneficial to our class, such as overcollateralization and excess spread.

 

Forsecurities where there is insufficient remaining credit enhancement for theclass of securities we own, a recovery value is calculated based on our bestestimate of future cash flows specific to that security.  This estimate is based on the contractualprincipal payments and current interest payments of the securities we own,adjusted for actual cumulative collateral losses incurred to date and theprojected additional collateral losses expected to be incurred.  This estimate also takes into considerationadditional secondary sources of credit support, such as reliable bondinsurance.  For securities withoutsecondary sources of credit support or for which the secondary sources do notfully offset the actual and projected additional collateral losses applied tothem, a credit loss is recorded in earnings to the extent amortized costexceeds recovery value.

 

98.5%and 1.5% of the fair value of our below investment grade Alt-A securities withgross unrealized losses were issued with Aaa and Aa original ratings andcapital structure classifications, respectively.  83.7%, 13.9% and 1.7% of the fair value ofour below investment grade Subprime securities with gross unrealized losseswere issued with Aaa, Aa and A original ratings and capital structure classifications,respectively.  As described previously,Alt-A and Subprime securities with higher original ratings typically havepriority in receiving the principal repayments on the underlying collateralcompared to those with lower original ratings. While the projected cash flow assumptions for our below investment gradeAlt-A and Subprime securities with gross unrealized losses have deterioratedsince the securities were originated, as reflected by their current creditratings, these securities continue to retain the payment priority features thatexisted at the origination of the securitization trust.

 

59

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

 
| ** **                                                 | ** ** | **September 30, 2010**                                                    | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| **($ in millions)**                              | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date (1)  |       | 0.4                                                                                 | %          | 0.7 | % | 5.7 | % | 5.4 | % | 0.1 | % | 1.1 | % | 2.4 | % | 1.9 | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | 9.9                                                                                 | %          | 22.3 | % | 22.7 | % | 22.4 | % | 4.6 | % | 7.4 | % | 10.3 | % | 9.0 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | 11.2                                                                                | %          | 19.0 | % | 5.5 | % | 5.9 | % | 5.3 | % | 24.7 | % | 8.3 | % | 7.8 | % | n/a |   |
| Security-specific                                          | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Number of positions                                        |       | 1                                                                                   |       | 1 |   | 10 |   | 12 |   | 2 |   | 1 |   | 3 |   | 6 |   | 18 |   |
| Par value                                                  |       | $                                                                                   | 4          |   | $ | 3 |   | $ | 165 |   | $ | 172 |   | $ | 16 |   | $ | 1 |   | $ | 52 |   | $ | 69 |   | $ | 241 |   |
| Amortized cost                                             |       | $                                                                                   | 4          |   | $ | 2 |   | $ | 129 |   | $ | 135 |   | $ | 16 |   | $ | 1 |   | $ | 51 |   | $ | 68 |   | $ | 203 |   |
| Fair value                                                 |       | $                                                                                   | 1          |   | $ | 1 |   | $ | 97 |   | $ | 99 |   | $ | 13 |   | $ | 1 |   | $ | 43 |   | $ | 57 |   | $ | 156 |   |
| Gross unrealized losses                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                                                                   | (3         | ) | $ | (1 | ) | $ | (32 | ) | $ | (36 | ) | $ | (3 | ) | $ | — |   | $ | (8 | ) | $ | (11 | ) | $ | (47 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Over 24 months (5)                                         |       | $                                                                                   | (3         | ) | $ | (1 | ) | $ | (32 | ) | $ | (36 | ) | $ | (3 | ) | $ | — |   | $ | (8 | ) | $ | (11 | ) | $ | (47 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | —     |   | $ | (1 | ) | $ | (29 | ) | $ | (30 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (30 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | —     |   | $ | — |   | $ | 4 |   | $ | 4 |   | $ | 1 |   | $ | — |   | $ | 2 |   | $ | 3 |   | $ | 7 |   |

 
| ** **                                                 | ** ** | **December 31, 2009**                                                     | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date (1)  |       | 0.2                                                                                 | %          | 1.6 | % | 3.7 | % | 3.4 | % | 0.5 | % | 0.5 | % | 1.2 | % | 0.6 | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | 12.1                                                                                | %          | 11.7 | % | 20.3 | % | 19.2 | % | 3.8 | % | 17.5 | % | 10.9 | % | 5.6 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | 11.3                                                                                | %          | 8.9 | % | 7.7 | % | 7.9 | % | 7.4 | % | 19.2 | % | 4.1 | % | 7.1 | % | n/a |   |
| Security-specific                                          |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                                        |       | 1                                                                                   |       | 2 |   | 8 |   | 11 |   | 4 |   | 1 |   | 1 |   | 6 |   | 17 |   |
| Par value                                                  |       | $                                                                                   | 4          |   | $ | 19 |   | $ | 151 |   | $ | 174 |   | $ | 71 |   | $ | 3 |   | $ | 18 |   | $ | 92 |   | $ | 266 |   |
| Amortized cost                                             |       | $                                                                                   | 4          |   | $ | 19 |   | $ | 126 |   | $ | 149 |   | $ | 70 |   | $ | 4 |   | $ | 16 |   | $ | 90 |   | $ | 239 |   |
| Fair value                                                 |       | $                                                                                   | 1          |   | $ | 13 |   | $ | 82 |   | $ | 96 |   | $ | 45 |   | $ | 1 |   | $ | 13 |   | $ | 59 |   | $ | 155 |   |
| Gross unrealized losses                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                                                                   | (3         | ) | $ | (6 | ) | $ | (44 | ) | $ | (53 | ) | $ | (25 | ) | $ | (3 | ) | $ | (3 | ) | $ | (31 | ) | $ | (84 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | (3         | ) | $ | (2 | ) | $ | (16 | ) | $ | (21 | ) | $ | (18 | ) | $ | — |   | $ | (3 | ) | $ | (21 | ) | $ | (42 | ) |
| Over 24 months (5)                                         |       | $                                                                                   | —     |   | $ | (4 | ) | $ | (28 | ) | $ | (32 | ) | $ | (6 | ) | $ | (3 | ) | $ | — |   | $ | (9 | ) | $ | (41 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | —     |   | $ | (1 | ) | $ | (19 | ) | $ | (20 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (20 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | —     |   | $ | 3 |   | $ | 6 |   | $ | 9 |   | $ | 3 |   | $ | — |   | $ | 2 |   | $ | 5 |   | $ | 14 |   |

 

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(1) Weighted averageactual cumulative collateral losses incurred to date as of period end are basedon the actual principal losses incurred as a percentage of the remainingprincipal amount of the loans in the trust. The weighting calculation is based on the par value of eachsecurity.  Actual losses on thesecurities we hold are less than the losses on the underlying collateral aspresented in this table.  There were noactual cumulative realized principal losses on the below investment grade Alt-Asecurities we own, as reported by the trust servicers as of September 30,2010.

(2) Weighted averageprojected additional collateral losses to be incurred as of period end arebased on our projections of future losses to be incurred by the trust, takinginto consideration the actual cumulative collateral losses incurred to date, asa percentage of the remaining principal amount of the loans in the trust.  Our projections are developed internally andcustomized to our specific holdings and are informed by and benchmarked againstcredit opinions obtained from third parties, such as industry analysts,nationally recognized credit rating agencies and an RMBS loss modeling advisoryservice.  Projected additional collaterallosses to be incurred are compared to average remaining credit enhancement foreach security.  For securities where theprojected additional collateral losses exceed remaining credit enhancement, arecovery value is calculated to determine whether impairment losses should berecorded in earnings.  The weightingcalculation is based on the par value of each security.

 

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(3) Weighted averageremaining credit enhancement as of period end is based on structuralsubordination and the expected impact of other structural features existing inthe securitization trust beneficial to our class and reflects our projection offuture principal losses that can occur as a percentage of the remainingprincipal amount of the loans in the trust before the class of the security weown will incur its first dollar of principal loss.  The weighting calculation is based on the parvalue of each security.

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

(5) Includes total gross unrealized losses onsecurities in an unrealized loss position for a period more than 24 consecutivemonths.  As of September 30, 2010,$14 million of unrealized losses on securities with other-than-temporary impairmentsrecognized in earnings and $2 million of unrealized losses on securitieswithout other-than-temporary impairments recognized in earnings have beengreater than or equal to 20% of those securities’ amortized cost for a periodof more than 24 consecutive months.  Asof December 31, 2009, there were no Alt-A securities with gross unrealizedlosses greater than or equal to 20% for a period of more than 24 consecutivemonths.

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

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

 

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

 

Asof September 30, 2010, our below investment grade Alt-A securities withgross unrealized losses and without other-than-temporary impairments recordedin earnings had incurred actual cumulative collateral losses of 1.9%.  Our impairment evaluation forecasts moresevere assumptions than the trusts are actually experiencing, including aprojected weighted average underlying default rate of 25.5% and a projectedweighted average loss severity of 39.9%, which resulted in projected additionalcollateral losses of 9.0%.  As theaverage remaining credit enhancement for our Ba and B rated Alt-A securities of5.3% and 24.7%, respectively, exceeds the projected additional collaterallosses of 4.6% and 7.4%, respectively, these securities have not been impaired.

 

Forour three Alt-A securities rated Caa or lower, the projected additionalcollateral losses of 10.3% exceed the average remaining credit enhancement of8.3%.  This is due to one security withunrealized losses of $2 million which has projected additional collaterallosses that exceed its total remaining credit enhancement.  The amortized cost of this security is $15million, lower than its par value of $16 million.  Despite the excess of the projectedadditional collateral losses over remaining credit enhancement, our bestestimate of future cash flows indicates that trust-level collateral lossesimpacting the class of security we own will not effect this particularsecurity, given its lower amortized cost. Our best estimate of future cash flows results in a recovery value of$16 million which exceeds the security’s amortized cost of $15 million.  Accordingly, this security has not beenimpaired.  For the remaining twosecurities, the average remaining credit enhancement of 11.0% exceeds theprojected additional collateral losses of 10.3%.  Accordingly, these securities have not beenimpaired.

 

Asof September 30, 2010, our below investment grade Alt-A securities withgross unrealized losses and with other-than-temporary impairments recorded inearnings had incurred actual cumulative collateral losses of 5.4%.  Our impairment evaluation forecasts moresevere assumptions than the trusts are actually experiencing, including aprojected weighted average underlying default rate of 41.9% and a projectedweighted average loss severity of 51.3%, which resulted in projected additionalcollateral losses of 22.4%.  As theaverage remaining credit enhancement for these securities of 5.9% isinsufficient to withstand the projected additional collateral losses, we haverecognized cumulative write-downs in earnings on these securities as reflectedin the table above using our calculated recovery value at the time ofimpairment.  The current average recoveryvalue of these securities as a percentage of par was 79.1% and exceeded thesesecurities’ current average amortized cost as a percentage of par of 78.6%,which demonstrates our conclusion that the nature of the remaining unrealizedloss on these securities is temporary and will reverse over time.  The comparison indicates that recovery valueexceeds amortized cost based on a comprehensive evaluation of financial,economic and capital markets assumptions developed for this reporting period.

 

Thefollowing table shows actual trust-level key metrics specific to the trustsfrom which our below investment grade Alt-A securities with gross unrealizedlosses were issued, as reported by the trust servicers.

 
| ** **                                            | ** ** | **September 30,  2010** | ** ** | **June 30,  2010** | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** | **September 30,  2009** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Trust-level statistics                                |       |                         |       |                    |       |                           |       |                        |       |                         |       |
| Delinquency rates                                     |       | 20.7                         | %          | 19.6                    | %          | 19.7                           | %          | 19.1                        | %          | 18.9                         | %          |
| Actual cumulative collateral losses incurred to  date |       | 4.4                          | %          | 3.5                     | %          | 3.1                            | %          | 2.4                         | %          | 2.1                          | %          |

 

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We believe the unrealized losses on our Alt-A securities, includingthose over 24 months, result from the current risk premium on these securities,which should reverse over the securities’ remaining lives.  We expect to receive our estimated share ofcontractual principal and interest collections used to determine the securities’recovery value.  As of September 30, 2010, we do not have the intentto sell and it is not more likely than not we will be required to sell thesesecurities before the recovery of their amortized cost basis.  We believe that our valuation and impairmentprocesses are comprehensive, employ the most current views about collateral andsecuritization trust financial positions, and demonstrate our recordedimpairments and that the remaining unrealized losses on these positions aretemporary in nature.

 

For our below investment grade Subprime securities with grossunrealized losses that are not reliably insured, by credit rating, thefollowing tables show trust-level, class level and security-specific detailedinformation.

 
| ** **                                                 | ** ** | **September 30, 2010**                                                    | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| **($ in millions)**                              | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date (1)  |       | —                                                                              | %          | 10.3 | % | 15.7 | % | 15.5 | % | 12.5 | % | 11.3 | % | 8.4 | % | 9.4 | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | —                                                                              | %          | 32.9 | % | 39.3 | % | 39.0 | % | 43.3 | % | 39.4 | % | 33.6 | % | 35.8 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | —                                                                              | %          | 26.2 | % | 24.0 | % | 24.1 | % | 56.5 | % | 57.6 | % | 41.2 | % | 45.6 | % | n/a |   |
| Security-specific                                          |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                                        |       | —                                                                              |       | 3 |   | 49 |   | 52 |   | 11 |   | 7 |   | 39 |   | 57 |   | 109 |   |
| Par value                                                  |       | $                                                                                   | —     |   | $ | 27 |   | $ | 562 |   | $ | 589 |   | $ | 55 |   | $ | 42 |   | $ | 247 |   | $ | 344 |   | $ | 933 |   |
| Amortized cost                                             |       | $                                                                                   | —     |   | $ | 24 |   | $ | 364 |   | $ | 388 |   | $ | 55 |   | $ | 42 |   | $ | 246 |   | $ | 343 |   | $ | 731 |   |
| Fair value                                                 |       | $                                                                                   | —     |   | $ | 16 |   | $ | 203 |   | $ | 219 |   | $ | 41 |   | $ | 28 |   | $ | 146 |   | $ | 215 |   | $ | 434 |   |
| Gross unrealized losses                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                                                                   | —     |   | $ | (8 | ) | $ | (161 | ) | $ | (169 | ) | $ | (14 | ) | $ | (14 | ) | $ | (100 | ) | $ | (128 | ) | $ | (297 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | —     |   | $ | — |   | $ | (7 | ) | $ | (7 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (7 | ) |
| Over 24 months (5)                                         |       | $                                                                                   | —     |   | $ | (8 | ) | $ | (153 | ) | $ | (161 | ) | $ | (14 | ) | $ | (14 | ) | $ | (100 | ) | $ | (128 | ) | $ | (289 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | —     |   | $ | (3 | ) | $ | (191 | ) | $ | (194 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (194 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | —     |   | $ | 2 |   | $ | 13 |   | $ | 15 |   | $ | 12 |   | $ | 1 |   | $ | 4 |   | $ | 17 |   | $ | 32 |   |

 
| ** **                                                 | ** ** | **December 31, 2009**                                                     | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date(1)   |       | 15.0                                                                                | %          | 15.8 | % | 16.2 | % | 16.1 | % | 6.8 | % | 7.4 | % | 8.5 | % | 7.8 | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | 41.2                                                                                | %          | 35.1 | % | 45.2 | % | 44.3 | % | 35.2 | % | 38.1 | % | 35.7 | % | 35.7 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | 38.1                                                                                | %          | 31.5 | % | 36.9 | % | 36.6 | % | 45.1 | % | 46.0 | % | 38.0 | % | 41.1 | % | n/a |   |
| Security-specific                                          |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                                        |       | 1                                                                                   |       | 3 |   | 38 |   | 42 |   | 12 |   | 7 |   | 24 |   | 43 |   | 85 |   |
| Par value                                                  |       | $                                                                                   | 30         |   | $ | 35 |   | $ | 464 |   | $ | 529 |   | $ | 103 |   | $ | 21 |   | $ | 169 |   | $ | 293 |   | $ | 822 |   |
| Amortized cost                                             |       | $                                                                                   | 24         |   | $ | 32 |   | $ | 315 |   | $ | 371 |   | $ | 103 |   | $ | 21 |   | $ | 168 |   | $ | 292 |   | $ | 663 |   |
| Fair value                                                 |       | $                                                                                   | 10         |   | $ | 15 |   | $ | 109 |   | $ | 134 |   | $ | 62 |   | $ | 10 |   | $ | 74 |   | $ | 146 |   | $ | 280 |   |
| Gross unrealized losses                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                                                                   | (14        | ) | $ | (17 | ) | $ | (206 | ) | $ | (237 | ) | $ | (41 | ) | $ | (11 | ) | $ | (94 | ) | $ | (146 | ) | $ | (383 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | —     |   | $ | (3 | ) | $ | (19 | ) | $ | (22 | ) | $ | — |   | $ | (1 | ) | $ | — |   | $ | (1 | ) | $ | (23 | ) |
| Over 24 months (5)                                         |       | $                                                                                   | (14        | ) | $ | (12 | ) | $ | (184 | ) | $ | (210 | ) | $ | (41 | ) | $ | (10 | ) | $ | (94 | ) | $ | (145 | ) | $ | (355 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | (6         | ) | $ | (4 | ) | $ | (146 | ) | $ | (156 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (156 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | —     |   | $ | 2 |   | $ | 16 |   | $ | 18 |   | $ | 9 |   | $ | 2 |   | $ | 11 |   | $ | 22 |   | $ | 40 |   |

 

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(1) Weighted averageactual cumulative collateral losses incurred to date as of period end are basedon the actual principal losses incurred as a percentage of the remainingprincipal amount of the loans in the trust. The weighting calculation is based on the par value of eachsecurity.  Actual losses on thesecurities we hold are less than the losses on the underlying collateral aspresented in this table.  Actualcumulative realized principal losses on the below investment grade Subprimesecurities we own, as reported by the trust servicers, were $10 million as of September 30,2010.

 

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(2) Weighted averageprojected additional collateral losses to be incurred as of period end arebased on our projections of future losses to be incurred by the trust, takinginto consideration the actual cumulative collateral losses incurred to date, asa percentage of the remaining principal amount of the loans in the trust.  Our projections are developed internally and customized to our specific holdings and areinformed by and benchmarked against credit opinions obtained from thirdparties, such as industry analysts, nationally recognized credit ratingagencies and an RMBS loss modeling advisory service. ** **Projected additionalcollateral losses to be incurred are compared to average remaining creditenhancement for each security.  Forsecurities where the projected additional collateral losses exceed remainingcredit enhancement, a recovery value is calculated to determine whetherimpairment losses should be recorded in earnings.  The weighting calculation is based on the parvalue of each security.

(3) Weighted averageremaining credit enhancement as of period end is based on structuralsubordination and the expected impact of other structural features existing inthe securitization trust beneficial to our class and reflects our projection offuture principal losses that can occur as a percentage of the remainingprincipal amount of the loans in the trust before the class of the security weown will incur its first dollar of principal loss.  The weighting calculation is based on the parvalue of each security.

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

(5) Includes totalgross unrealized losses on securities in an unrealized loss position for aperiod more than 24 consecutive months. As of September 30, 2010, $137 million of unrealized losses onsecurities with other-than-temporary impairments recognized in earnings and $99million of unrealized losses on securities without other-than-temporaryimpairments recognized in earnings have been greater than or equal to 20% ofthose securities’ amortized cost for a period of more than 24 consecutivemonths, and as of December 31, 2009, $63 million of unrealized losses onsecurities with other-than-temporary impairments recognized in earnings and $26million of unrealized losses on securities without other-than-temporaryimpairments recognized in earnings had been greater than or equal to 20% ofthose securities’ amortized cost for a period of more than 24 consecutivemonths.

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

(7)  Reflects principalpayments for the nine months ended September 30, 2010 or the year ended December 31,2009, respectively.

 

Theabove tables include information only about below investment grade Subprimesecurities with gross unrealized losses that are not reliably insured as ofeach period presented.  As such, the parvalue and composition of securities included can vary significantly from periodto period due to changes in variables such as credit ratings, purchases,principal payments, sales and realized principal losses.

 

Asof September 30, 2010, our Subprime securities that are reliably insuredinclude nine below investment grade Subprime securities with a total fair valueof $68 million and aggregate gross unrealized losses of $59 million, all ofwhich are rated B.  These securities areinsured by one bond insurer rated B that we estimate has sufficient claimspaying capacity to service its obligations on these securities.  The securitization trusts from which oursecurities were issued are currently receiving contractual payments from thebond insurer and considering the combination of expected future payments fromthe bond insurer and cash flows available from the underlying collateral, weexpect the trust to have adequate cash flows to make all contractual paymentsdue to the class of securities we own. As a result, our security-specific estimates of future cash flowsindicate that these securities’ estimated recovery values equal or exceed theiramortized cost.  Accordingly, noother-than-temporary impairments have been recognized on these securities.

 

Asof September 30, 2010, our below investment grade Subprime securities withgross unrealized losses that are not reliably insured and withoutother-than-temporary impairments recorded in earnings had incurred actualcumulative collateral losses of 9.4%. Our impairment evaluation forecasts more severe assumptions than thetrusts are actually experiencing, including a projected weighted averageunderlying default rate of 53.7% and a projected weighted average loss severityof 66.1%, which resulted in projected additional collateral losses of35.8%.  As the average remaining creditenhancement for these securities of 45.6% exceeds the projected additionalcollateral losses of 35.8%, these securities have not been impaired.

 

Asof September 30, 2010, our below investment grade Subprime securities withgross unrealized losses that are not reliably insured and withother-than-temporary impairments recorded in earnings had incurred actualcumulative collateral losses of 15.5%. Our impairment evaluation forecasts more severe assumptions than thetrusts are actually experiencing, including a projected weighted averageunderlying default rate of 51.9% and a projected weighted average loss severityof 77.6%, which resulted in projected additional collateral losses of39.0%.  As the average remaining creditenhancement for these securities of 24.1% is insufficient to withstand theprojected additional collateral losses, we have recognized cumulativewrite-downs in earnings on the securities as reflected in the table above usingour calculated recovery value at the time of impairment.  The current average recovery value of thesesecurities as a percentage of par was 68.7% and exceeded these securities’current average amortized cost as a percentage of par of 65.9%, whichdemonstrates our conclusion that the nature of the remaining unrealized loss onthese securities is temporary and will reverse over time.  The comparison indicates that recovery valueexceeds amortized cost based on a comprehensive evaluation of financial,economic and capital markets assumptions developed for this reporting period.

 

63

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The following table shows actual trust-level key metrics specific tothe trusts from which our below investment grade Subprime securities with grossunrealized losses were issued, as reported by the trust servicers.

 
| ** **                                            | ** ** | **September 30,  2010** | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,********2009** | ** ** | **September 30,  2009** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------------------|------------|
| Trust-level statistics                                |       |                         |       |                    |       |                     |       |                              |       |                         |       |
| Delinquency rates                                     |       | 25.9                         | %          | 25.8                    | %          | 28.5                     | %          | 27.5                              | %          | 26.6                         | %          |
| Actual cumulative collateral losses incurred to  date |       | 15.1                         | %          | 14.4                    | %          | 14.4                     | %          | 13.3                              | %          | 11.4                         | %          |

 

Webelieve the unrealized losses on our Subprime securities, including those over24 months, result from the current risk premium on these securities, whichshould reverse over the securities’ remaining lives.  We expect to receive our estimated share ofcontractual principal and interest collections used to determine the securities’recovery value.  As of September 30, 2010, we do not have the intent tosell and it is not more likely than not we will be required to sell thesesecurities before the recovery of their amortized cost basis.  We believe that our valuation and impairmentprocesses are comprehensive, employ the most current views about collateral andsecuritization trust financial positions, and demonstrate our recorded impairmentsand that the remaining unrealized losses on these positions are temporary innature.

 

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

 

Grossunrealized losses for our below investment grade CMBS portfolio totaled $143million, while gross unrealized gains for this portfolio were $1 million as ofSeptember 30, 2010.  Gross unrealizedlosses for our below investment grade CMBS portfolio totaled $122 million as ofDecember 31, 2009.  For our belowinvestment grade CMBS with gross unrealized gains, we have recognized cumulativewrite-downs in earnings totaling $18 million as of September 30, 2010.

 

The credit loss evaluationfor CMBS securities with gross unrealized losses is performed in twophases.  The first phase estimates thefuture cash flows of the entire securitization trust from which our securitywas issued.  A critical part of thisestimate involves forecasting the collateral losses of the commercial mortgageloans that collateralize the securitization trust.  Factors affecting these estimates include,but are not limited to, estimates of current and future property prices,current and projected rental incomes, the propensity of the commercial mortgageloans to default under these assumptions and loss severities in cases ofdefault.  Estimates of future propertyprices and rental incomes consider specific property-type and geographiceconomic trends such as employment, property vacancy and rental rates, andforecasts of new supply in the commercial real estate markets.  Estimates of default rates and loss severitiesconsider factors such as borrower payment history, the origination practices ofthe transaction sponsor, overall collateral quality and diversification,transaction vintage year, maturity date, overall transaction structure andother factors that may influence performance. Realized losses in the CMBS market have historically been low and, webelieve, are not predictive of future losses. Therefore, our projections of collateral performance rely onprobability-weighted scenarios informed by credit opinions obtained from thirdparties, such as nationally recognized credit rating agencies, industryanalysts and CMBS loss modeling advisory services.

 

We then analyze the actualcumulative collateral losses incurred to date by the securitization trust, our projectedadditional collateral losses expected to be incurred and the position of theclass of securities we own in the securitization trust relative to the trust’sother classes to determine whether any of the collateral losses will be appliedto our class.  If our class has remainingcredit enhancement sufficient to withstand the projected additional collaterallosses, no collateral losses will be realized by our class and we expect tocollect all contractual principal and interest of the security we own.  Remaining credit enhancement is measured interms of subordination from other classes of securities in the trust beingcontractually obligated to absorb losses before the class of security we own.

 

For securities where thereis insufficient remaining credit enhancement for the class of securities weown, a recovery value is calculated based on our best estimate of future cashflows specific to that security.  Thisestimate is based on the contractual principal payments and current interestpayments of the securities we own, adjusted for actual cumulative collaterallosses incurred to date and the projected additional collateral losses expectedto be incurred.  In instances where therecovery value of the security is less than its amortized cost, a credit lossis recorded in earnings.

 

40.6%,51.4% and 5.8% of the fair value of our below investment grade CMBS with grossunrealized losses were issued with Aaa, Aa and A original ratings and capitalstructure classifications, respectively. As described previously, CMBS with higher original ratings typicallyhave priority in receiving the principal repayments on the underlyingcollateral compared to those with lower original ratings.  Commercial property prices have deteriorated 

 

64

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substantiallyduring the last 24 months and property rental incomes are declining as thecommercial real estate sector adjusts to lower macroeconomic activity.  In addition, tight credit markets andconservative underwriting standards continue to stress commercial mortgageborrowers’ ability to refinance obligations. While the projected cash flow assumptions for our below investment gradeCMBS securities with gross unrealized losses have deteriorated since thesecurities were originated, as reflected by their current credit ratings, thesesecurities continue to retain the payment priority features that existed at theorigination of the securitization trust.

 

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

 
| ** **                                                 | ** ** | **September 30, 2010**                                                    | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| **($ in millions)**                              | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date (1)  |       | —                                                                              | %          | — | % | 5.7 | % | 5.4 | % | 0.7 | % | 1.7 | % | — | % | 0.8 | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | 4.3                                                                                 | %          | — | % | 23.9 | % | 22.9 | % | 5.6 | % | 5.4 | % | 5.9 | % | 5.6 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | 8.4                                                                                 | %          | — | % | 17.0 | % | 16.6 | % | 8.6 | % | 7.8 | % | 6.6 | % | 8.4 | % | n/a |   |
| Security-specific                                          |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                                        |       | 1                                                                                   |       | — |   | 6 |   | 7 |   | 14 |   | 3 |   | 1 |   | 18 |   | 25 |   |
| Par value                                                  |       | $                                                                                   | 7          |   | $ | — |   | $ | 139 |   | $ | 146 |   | $ | 139 |   | $ | 32 |   | $ | 6 |   | $ | 177 |   | $ | 323 |   |
| Amortized cost                                             |       | $                                                                                   | 7          |   | $ | — |   | $ | 64 |   | $ | 71 |   | $ | 143 |   | $ | 35 |   | $ | 5 |   | $ | 183 |   | $ | 254 |   |
| Fair value                                                 |       | $                                                                                   | 3          |   | $ | — |   | $ | 28 |   | $ | 31 |   | $ | 66 |   | $ | 13 |   | $ | 1 |   | $ | 80 |   | $ | 111 |   |
| Gross unrealized losses                                    | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total                                                      |       | $                                                                                   | (4         | ) | $ | — |   | $ | (36 | ) | $ | (40 | ) | $ | (77 | ) | $ | (22 | ) | $ | (4 | ) | $ | (103 | ) | $ | (143 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Over 24 months (5)                                         |       | $                                                                                   | (4         | ) | $ | — |   | $ | (36 | ) | $ | (40 | ) | $ | (77 | ) | $ | (22 | ) | $ | (4 | ) | $ | (103 | ) | $ | (143 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | (1         | ) | $ | — |   | $ | (80 | ) | $ | (81 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (81 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | —     |   | $ | — |   | $ | 3 |   | $ | 3 |   | $ | 1 |   | $ | — |   | $ | — |   | $ | 1 |   | $ | 4 |   |

 
| ** **                                                 | ** ** | **December 31, 2009**                                                     | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **With other-than-temporary  impairments recorded in earnings** | ** ** | **Without other-than-temporary  impairments recorded in earnings** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Ba**                                                                              | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Ba** | ** ** | **B** | ** ** | **Caa or  lower** | ** ** | **Total** | ** ** | **Total** | ** ** |
| Trust-level                                                | ** ** | ** **                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Actual cumulative collateral losses incurred to  date (1)  |       | 1.4                                                                                 | %          | 0.6 | % | — | % | 0.8 | % | — | % | — | % | — | % | — | % | n/a |   |
| Projected additional collateral losses to be  incurred (2) |       | 20.1                                                                                | %          | 13.5 | % | — | % | 15.0 | % | 6.1 | % | 7.7 | % | — | % | 6.7 | % | n/a |   |
| Class-level                                                |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining credit enhancement (3)                   |       | 17.4                                                                                | %          | 9.8 | % | — | % | 11.5 | % | 9.1 | % | 8.5 | % | — | % | 8.9 | % | n/a |   |
| Security-specific                                          |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of positions                                        |       | 1                                                                                   |       | 5 |   | — |   | 6 |   | 6 |   | 6 |   | — |   | 12 |   | 18 |   |
| Par value                                                  |       | $                                                                                   | 20         |   | $ | 69 |   | $ | — |   | $ | 89 |   | $ | 87 |   | $ | 49 |   | $ | — |   | $ | 136 |   | $ | 225 |   |
| Amortized cost                                             |       | $                                                                                   | 14         |   | $ | 41 |   | $ | — |   | $ | 55 |   | $ | 84 |   | $ | 50 |   | $ | — |   | $ | 134 |   | $ | 189 |   |
| Fair value                                                 |       | $                                                                                   | 9          |   | $ | 16 |   | $ | — |   | $ | 25 |   | $ | 29 |   | $ | 13 |   | $ | — |   | $ | 42 |   | $ | 67 |   |
| Gross unrealized losses                                    |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                      |       | $                                                                                   | (5         | ) | $ | (25 | ) | $ | — |   | $ | (30 | ) | $ | (55 | ) | $ | (37 | ) | $ | — |   | $ | (92 | ) | $ | (122 | ) |
| 12-24 months (4)                                           |       | $                                                                                   | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | (13 | ) | $ | — |   | $ | — |   | $ | (13 | ) | $ | (13 | ) |
| Over 24 months (5)                                         |       | $                                                                                   | (5         | ) | $ | (25 | ) | $ | — |   | $ | (30 | ) | $ | (42 | ) | $ | (37 | ) | $ | — |   | $ | (79 | ) | $ | (109 | ) |
| Cumulative write-downs recognized (6)                 |       | $                                                                                   | (7         | ) | $ | (34 | ) | $ | — |   | $ | (41 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | (41 | ) |
| Principal payments received during the period (7)          |       | $                                                                                   | 1          |   | $ | — |   | $ | — |   | $ | 1 |   | $ | 1 |   | $ | — |   | $ | — |   | $ | 1 |   | $ | 2 |   |

 

----

(1) Weighted average actual cumulative collaterallosses incurred to date as of period end are based on the actual principallosses incurred as a percentage of the remaining principal amount of the loansin the trust.  The weighting calculationis based on the par value of each security. Actual losses on the securities we hold are less than the losses on theunderlying collateral as presented in this table.  Actual cumulative realized principal losseson the below investment grade CMBS securities we own, as reported by the trustservicers, were $1 million as of September 30, 2010.

 

(2) Weighted average projected additional collaterallosses to be incurred as of period end are based on our projections of futurelosses to be incurred by the trust, taking into consideration the actualcumulative collateral losses incurred to date, as a percentage of the remainingprincipal amount of the loans in the trust. Our projections are developedinternally and customized to our specific holdings and are informed 

 

65

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by and benchmarked against credit opinions obtainedfrom third parties, such as industry analysts, nationally recognized creditrating agencies and CMBS loss modeling advisory services.** **Projectedadditional collateral losses to be incurred are compared to average remainingcredit enhancement for each security. For securities where the projected additional collateral losses exceedremaining credit enhancement, a recovery value is calculated to determinewhether impairment losses should be recorded in earnings.  The weighting calculation is based on the parvalue of each security.

 

(3) Weighted average remaining credit enhancement asof period end is based on structural subordination and reflects our projectionof future principal losses that can occur as a percentage of the remainingprincipal amount of the loans in the trust before the class of the security weown will incur its first dollar of principal loss.  The weighting calculation is based on the parvalue of each security.

 

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

 

(5) Includes total gross unrealized losses onsecurities in an unrealized loss position for a period more than 24 consecutivemonths.  As of September 30, 2010, $21million of unrealized losses on securities with other-than-temporaryimpairments recognized in earnings and $90 million of unrealized losses onsecurities without other-than-temporary impairments recognized in earnings havebeen greater than or equal to 20% of those securities’ amortized cost for aperiod of more than 24 consecutive months. As of December 31, 2009, there were no CMBS securities with grossunrealized losses greater than or equal to 20% for a period of more than 24consecutive months.

 

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

 

(7)  Reflectsprincipal payments for the nine months ended September 30, 2010 or the yearended December 31, 2009, respectively.

 

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

 

Our impairment evaluation for CMBS forecasts moresevere assumptions than the trusts are actually experiencing.  We assume that all loans delinquent 60 daysor more default and project default rates on otherwise performing loans.  Projected loss severities are then appliedagainst the resulting default rates, arriving at our projected additionalcollateral loss rates.  The projected additional collateral lossrates by vintage year of our CMBS portfolio range from a low of 2.0% forholdings with a vintage year of 2003 to a high of 10.6% for holdings with avintage year of 2007.

 

Asof September 30, 2010, our below investment grade CMBS securities with gross unrealizedlosses and without other-than-temporary impairments recorded in earnings hadincurred actual cumulative collateral losses of 0.8%, and the projectedadditional collateral loss rate for these securities at September 30, 2010 was5.6%.  As the average remaining creditenhancement for these securities of 8.4% exceeds the projected additionalcollateral losses of 5.6%, these securities have not been impaired.

 

Asof September 30, 2010, our below investment grade CMBS securities with grossunrealized losses and with other-than-temporary impairments recorded inearnings had incurred actual cumulative collateral losses of 5.4%.  The projectedadditional collateral loss rate for these securities at September 30, 2010 was22.9%.  As the average remaining creditenhancement for these securities of 16.6% is insufficient to withstand theprojected additional collateral losses, we have recognized cumulativewrite-downs in earnings on these securities as reflected in the table aboveusing our calculated recovery value at the time of impairment.  The current average recovery value of thesesecurities as a percentage of par was 48.5% and equaled these securities’current average amortized cost as a percentage of par, which demonstrates ourconclusion that the nature of the remaining unrealized loss on these securitiesis temporary and will reverse over time. The comparison indicates that recovery value is in line with amortizedcost as impairment write-downs were recorded in the reporting period and basedon a comprehensive evaluation of financial, economic and capital marketsassumptions developed for this reporting period.

 

The following table shows actual trust-level key metrics specific tothe trusts from which our below investment grade CMBS with gross unrealizedlosses were issued, as reported by the trust servicers.

 
| ** **                                            | ** ** | **September 30,  2010** | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** | **December 31,********2009** | ** ** | **September 30,  2009** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------------|------------|------------------------------|------------|
| Trust-level statistics                                |       |                         |       |                    |       |                     |       |                              |       |                         |       |
| Delinquency rates                                     |       | 8.3                          | %          | 8.5                     | %          | 8.6                      | %          | 5.2                               | %          | 4.9                          | %          |
| Actual cumulative collateral losses incurred to  date |       | 2.9                          | %          | 1.6                     | %          | 0.8                      | %          | 0.3                               | %          | 0.1                          | %          |

 

Webelieve the unrealized losses on our CMBS securities, including those over 24months, result from the current risk premium on these securities, which shouldreverse over the securities’ remaining lives. We expect to receive our estimated share of contractual principal andinterest collections used to determine the securities’ recovery value.  Asof September 30, 2010, we do not have the intent to sell and it is not morelikely than not we will be required to sell these securities before therecovery of their amortized cost basis. We believe that our valuation and impairment processes arecomprehensive, employ the most current views about collateral and 

 

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securitizationtrust financial positions, and demonstrate our recorded impairments and thatthe remaining unrealized losses on these positions are temporary in nature.

 

*Other-than-temporaryimpairment assessment for below investment grade cash flow CLO ABS*

 

Asof September 30, 2010, the fair value for our below investment grade cash flowCLO portfolio with gross unrealized losses totaled $189 million compared to$188 million as of December 31, 2009. The gross unrealized losses for these securities totaled $79 million asof September 30, 2010, a decrease of 20.2%, compared to $99 million as ofDecember 31, 2009.  Gross unrealizedgains for these securities were $36 million as of September 30, 2010.  For below investment grade cash flow CLO withgross unrealized gains, we have recognized cumulative write-downs in earningstotaling $84 million.

 

Asof September 30, 2010, our below investment grade cash flow CLO portfolio withgross unrealized losses and without other-than-temporary impairments recordedin earnings have a fair value of $186 million and gross unrealized losses of$79 million, all of which is aged over 24 months.  As of September 30, 2010, our belowinvestment grade cash flow CLO portfolio with gross unrealized losses and withother-than-temporary impairments recorded in earnings have a fair value of $3million, gross unrealized losses of less than $1 million, all of which is agedover 24 months, and cumulative write downs recorded in earnings of $1 million.

 

Cashflow CLO are collateralized primarily by below investment grade senior securedcorporate loans and are structured with overcollateralization which serves ascredit enhancement for the class of securities we own.  Overcollateralization ratios are based on thepar value of the collateral in the underlying portfolio as a percentage of thenotes issued as cash flow CLO securities. The performance of these securities is impacted primarily by defaultsand recoveries of the underlying collateral within the structures, which reduceovercollateralization ratios over time. A violation of the senior overcollateralization test could result in anevent of default of the structure which would give the controlling class,generally defined as the majority of the senior lenders, certain rights,including the ability to divert cash flows or liquidate the underlyingportfolio to pay off the senior liabilities.

 

Thecredit loss evaluation for cash flow CLO is performed in two phases.  The first phase evaluates theovercollateralization that exists for the class of securities we own.  A critical part of this estimate involvesprojections of future losses formulated through our assessment of the corporateloan markets, and considers opinions from third parties, such as industryanalysts and strategists, credit rating agencies, our own participation inthese markets, as well as our overall economic outlook for indicators such asunemployment and GDP.  The expectedperformance of each security considers anticipated collateral losses and creditenhancement levels, as well as factors including default rates, anticipatedrecoveries, prepayment rates, changes in interest rates and othercharacteristics.  In addition, theperformance of collateral underlying certain of our securities is activelymonitored by external managers, allowing for enhanced collateral managementactions which help mitigate the risk of loss. If the overcollateralization that exists for our class exceeds 100%, ourclass has remaining credit enhancement sufficient to withstand the projectedfuture losses, and we expect to collect all contractual principal and interestof the security we own.

 

Forsecurities where there is insufficient remaining credit enhancement for theclass of securities we own, a recovery value is calculated based on our bestestimate of future cash flows specific to that security.  This estimate is based on the contractualprincipal payments and current interest payments of the securities we own,adjusted for actual cumulative collateral losses incurred to date and theprojected future losses expected to be incurred.  If we do not expect to receive cash flowssufficient to recover the entire amortized cost basis of the security, a creditloss is recorded to the extent amortized cost exceeds recovery value.

 

Theovercollateralization ratios as reported by the trust servicers for our belowinvestment grade cash flow CLO securities with gross unrealized losses haveimproved over the past several periods and averaged 116.0% at September 30,2010, compared to 117.1% at original issuance. At December 31, 2009, the average overcollateralization ratio for ourbelow investment grade cash flow CLO securities was 113.6%.  As the average overcollateralization ratiosexceed 100%, this indicates that projected future collateral losses will beabsorbed by lower classes and we expect the structures to have adequate cashflows to make all contractual payments due to the class of securities weown.  Our comprehensive evaluation offinancial, economic and capital markets assumptions developed for thisreporting period, supported by the applicable overcollateralization ratios,indicates that the nature of the unrealized loss on these securities istemporary.

 

Webelieve the unrealized losses on our cash flow CLO securities, including thoseover 24 months result from the current risk premium on these securities, whichshould reverse over the securities’ remaining lives.  We expect 

 

67

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toreceive our estimated share of contractual principal and interest collectionsused to determine the securities’ recovery value.  As of September 30,2010, we do not have the intent to sell and it is not more likely than not wewill be required to sell these securities before the recovery of theiramortized cost basis.  We believe thatour valuation and impairment processes are comprehensive, employ the mostcurrent views about collateral and securitization trust financial positions,and demonstrate our recorded impairments and that the remaining unrealized losseson these positions are temporary in nature.

 

*Problem,restructured, or potential problem securities*

 

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

 

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

 
| ** **                            | ** ** | **September 30, 2010** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| **($ in millions)**         | ** ** | **Par  value (1)**          | ** ** | **Amortized  cost (1)** | ** ** | **Amortized  cost as a  percent of  par value** | ** ** | **Fair********value (2)** | ** ** | **Fair value as a  percent of********par value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Restructured                          |       | $                                | 68         |   | $ | 52 |   | 76.5 | % | $ | 58 |   | 85.3 | % | 0.1 | % |
| Problem                               |       | 508                              |       | 121 |   | 23.8 |   | 97 |   | 19.1 |   | 0.2 |   |
| Potential problem                     |       | 1,398                            |       | 815 |   | 58.3 |   | 603 |   | 43.1 |   | 1.2 |   |
| Total                                 |       | $                                | 1,974      |   | $ | 988 |   | 50.1 |   | $ | 758 |   | 38.4 |   | 1.5 | % |
| Cumulative write-downs recognized (3) |       |                             |       | $ | 745 |   |   |   |   |   |   |   |   |   |

 
| ** **                            | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Par  value (1)**         | ** ** | **Amortized  cost (1)** | ** ** | **Amortized  cost as a  percent of  par value** | ** ** | **Fair********value (2)** | ** ** | **Fair value as a  percent of********par value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Restructured                          |       | $                               | 75         |   | $ | 53 |   | 70.7 | % | $ | 51 |   | 68.0 | % | 0.1 | % |
| Problem                               |       | 480                             |       | 165 |   | 34.4 |   | 100 |   | 20.8 |   | 0.2 |   |
| Potential problem                     |       | 1,735                           |       | 1,080 |   | 62.2 |   | 645 |   | 37.2 |   | 1.3 |   |
| Total                                 |       | $                               | 2,290      |   | $ | 1,298 |   | 56.7 |   | $ | 796 |   | 34.8 |   | 1.6 | % |
| Cumulative write-downs recognized (3) |       |                            |       | $ | 805 |   |   |   |   |   |   |   |   |   |

 

----

(1) Thedifference between par value and amortized cost of $986 million at September30, 2010 and $992 million at December 31, 2009 is primarily attributable towrite-downs.  Par value has been reducedby principal payments.

 

(2) Bank loans are reflectedat amortized cost.

 

(3) Cumulative write-downsrecognized only reflect impairment write-downs related to investments withinthe problem, potential problem and restructured categories.

 

At September 30, 2010, amortized cost for the problem category was $121million and comprised $49 million of Subprime, $17 million of Alt-A, $9 millionof CMBS, $4 million of other CDO, and $4 million of Consumer and other ABS.  Also included were $30 million of corporates(primarily privately placed), $7 million of municipal bonds and $1 million ofbank loans.  The amortized cost ofproblem investments with a fair value less than 80% of amortized cost totaled$61 million with unrealized losses of $31 million and fair value of $30million.

 

68

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At September 30, 2010, amortized cost for the potential problemcategory was $815 million and comprised $358 million of Subprime, $175 millionof Alt-A, $83 million of CMBS, $75 million of other CDO and $9 million ofConsumer and other ABS.  Also includedwere $69 million of Prime, $37 million of corporates (primarily privatelyplaced) and $9 million of bank loans. The amortized cost of potential problem investments with a fair valueless than 80% of amortized cost totaled $519 million with unrealized losses of$250 million and fair value of $269 million.

 

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

 
| ** **                        | ** ** | **Three months ended********September 30,** | ** ** | **Nine months ended********September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **($ in millions)**     | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities |       | $                                                          | 615        |                                                      | $          | 635 |   | $ | 1,879 |   | $ | 1,955 |   |
| Mortgage loans                    |       | 90                                                         |       | 118                                                       |       | 289 |   | 381 |   |
| Equity securities                 |       | 1                                                          |       | 2                                                         |       | 3 |   | 4 |   |
| Limited partnership interests     |       | 3                                                          |       | 2                                                         |       | 10 |   | 6 |   |
| Short-term                        |       | 1                                                          |       | 2                                                         |       | 3 |   | 12 |   |
| Other                             |       | (3                                                         | )          | (12                                                       | )          | (16 | ) | (28 | ) |
| Investment income, before expense |       | 707                                                        |       | 747                                                       |       | 2,168 |   | 2,330 |   |
| Investment expense                |       | (24                                                        | )          | (25                                                       | )          | (78 | ) | (70 | ) |
| Net investment income             |       | $                                                          | 683        |                                                      | $          | 722 |   | $ | 2,090 |   | $ | 2,260 |   |

 

Net investment income decreased5.4% or $39 million to $683 million in the third quarter of 2010 and 7.5% or$170 million to $2.09 billion in the first nine months of 2010 from $722million and $2.26 billion in the third quarter and first nine months of 2009,respectively, primarily due to reduced average asset balances, lower yields andactions to reduce the portfolio’s exposure to commercial real estate.  Net investment income was $707 millionand $700 million in the first quarter of 2010 and second quarter of 2010,respectively.

 

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

 
| ** **                                                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)**                                      | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Impairment write-downs                                             |       | $                                                    | (78        | )                                                   | $          | (278 | ) | $ | (361 | ) | $ | (833 | ) |
| Change in intent write-downs                                       |       | (20                                                  | )          | (1                                                  | )          | (100 | ) | (58 | ) |
| Net other-than-temporary impairment losses  recognized in earnings |       | (98                                                  | )          | (279                                                | )          | (461 | ) | (891 | ) |
| Sales                                                              |       | 88                                                   |       | 106                                                 |       | 148 |   | 627 |   |
| Valuation of derivative instruments                                |       | 10                                                   |       | (60                                                 | )          | (193 | ) | 202 |   |
| Settlements of derivative instruments                              |       | (34                                                  | )          | 7                                                   |       | (45 | ) | 30 |   |
| EMA limited partnership income                                     |       | (3                                                   | )          | (6                                                  | )          | 1 |   | (116 | ) |
| Realized capital gains and losses, pre-tax                         |       | (37                                                  | )          | (232                                                | )          | (550 | ) | (148 | ) |
| Income tax benefit (expense)                                       |       | 14                                                   |       | 82                                                  |       | 193 |   | (86 | ) |
| Realized capital gains  and losses, after-tax                      |       | $                                                    | (23        | )                                                   | $          | (150 | ) | $ | (357 | ) | $ | (234 | ) |

 

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

 
| ** **                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)** | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities       |       | $                                                    | (71        | )                                                   | $          | (221 | ) | $ | (297 | ) | $ | (568 | ) |
| Mortgage loans                |       | (3                                                   | )          | (30                                                 | )          | (44 | ) | (73 | ) |
| Equity securities             |       | —                                               |       | —                                              |       | — |   | (20 | ) |
| Limited partnership interests |       | (4                                                   | )          | (27                                                 | )          | (20 | ) | (142 | ) |
| Other investments             |       | —                                               |       | —                                              |       | — |   | (30 | ) |
| Impairment write-downs        |       | $                                                    | (78        | )                                                   | $          | (278 | ) | $ | (361 | ) | $ | (833 | ) |

 

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Impairmentwrite-downs for the three months and nine months ended September 30, 2010were primarily driven by RMBS, which experienced deterioration in expected cashflows; investments with commercial real estate exposure, including CMBS,limited partnership interests, and mortgage loans, which were impacted bydeclines in real estate valuations or experienced deterioration in expectedcash flows; and privately placed corporate bonds impacted by issuer specificcircumstances.  Impairment write-downsfor the nine months ended September 30, 2010 also included municipalbonds.  Impairment write-downs on belowinvestment grade RMBS and CMBS for the three months ended September 30,2010 were $35 million and $26 million, respectively.  There were no impairment write-downs relatedto below investment grade ABS for the three months ended September 30,2010.  Impairment write-downs on belowinvestment grade RMBS, CMBS and ABS for the nine months ended September 30,2010 were $139 million, $79 million and $24 million, respectively.

 

$54million or 76.1% and $194 million or 78.2% of the fixed income securitywrite-downs for the three months and nine months ended September 30, 2010,respectively, related to impaired securities that were performing in line withanticipated or contractual cash flows but were written down primarily becauseof expected deterioration in the performance of the underlying collateral orour assessment of the probability of future default.  For these securities, as of September 30,2010, there were either no defaults or defaults only impacted classes lowerthan our position in the capital structure. $17 million and $52 million of the fixed income security write-downs forthe three months and nine months ended September 30, 2010, respectively,related to securities experiencing a significant departure from anticipatedcash flows; however, we believe they retain economic value.  $2 million for the nine months ended September 30,2010 related to fixed income securities for which future cash flows are not anticipated.  $49 million of the fixed income securitywrite-downs for the nine months ended September 30, 2010 related tosecurities that were subsequently disposed and synthetic collateralized debtobligations that were no longer considered impaired upon the bifurcation oftheir embedded credit derivatives required by the Company’s adoption of newaccounting guidance.

 

Limited partnership impairment write-downs related to Cost limitedpartnerships, which experienced declines in portfolio valuations and we couldnot assert the recovery period would be temporary.  To determine if an other-than-temporaryimpairment has occurred related to a Cost limited partnership, we evaluatewhether an impairment indicator has occurred in the period that may have asignificant adverse effect on the carrying value of the investment.  Impairment indicators may include:significantly reduced valuations of the investments held by the limitedpartnerships; actual recent cash flows received being significantly less thanexpected cash flows; reduced valuations based on financing completed at a lowervalue; completed sale of a material underlying investment at a pricesignificantly lower than expected; or any other recent adverse events since thelast financial statements received that might affect the fair value of theinvestee’s capital.

 

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

 
| ** **                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in millions)** | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Fixed income securities       |       | $                                                    | (20        | )                                                   | $          | — |   | $ | (94 | ) | $ | (40 | ) |
| Mortgage loans                |       | —                                               |       | —                                              |       | (6 | ) | (6 | ) |
| Equity securities             |       | —                                               |       | —                                              |       | — |   | (6 | ) |
| Other investments             |       | —                                               |       | (1                                                  | )          | — |   | (6 | ) |
| Change in intent write-downs  |       | $                                                    | (20        | )                                                   | $          | (1 | ) | $ | (100 | ) | $ | (58 | ) |

 

The change in intent write-downs in the three monthsended September 30, 2010 related primarily to below investment gradeSubprime RMBS for which we have the intent to sell.  The change in intent write-downs in the ninemonths ended September 30, 2010 related primarily to below investmentgrade Subprime RMBS.

 

*Sales*generated $88 million and $148 million of netrealized gains for the three months and nine months ended September 30,2010, respectively.  Net realized gainsfor the three months ended September 30, 2010 primarily related to $159million of net gains on sales of corporate and U.S. and foreign governmentfixed income securities and $15 million of net gains on sales of equitysecurities, partially offset by $77 million of net losses on sales of CMBS andmunicipal bonds.  Net realized gains forthe nine months ended September 30, 2010 primarily related to $267 millionof net gains on sales of corporate and U.S. and foreign government fixed incomesecurities and $35 million of net gains on sales of equity securities,partially offset by $151 million of net losses on sales of CMBS and municipalbonds.

 

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*Valuation and settlement of derivative instruments*recorded as netrealized capital losses totaling $24 million for the three months ended September 30,2010 included $10 million of gains on the valuation of derivative instrumentsand $34 million of losses on the settlement of derivative instruments.  Valuation and settlement of derivativeinstruments recorded as net realized capital losses totaling $238 million forthe nine months ended September 30, 2010 included $193 million of losseson the valuation of derivative instruments and $45 million of losses on thesettlement of derivative instruments.

 

Net realized capital gains and losses from our riskmanagement derivative programs are primarily driven by changes in risk-freeinterest rates, equity market valuations, volatility and credit spreads duringa given period.  Net realized capitalgains and losses from our income generation derivative programs are primarilydriven by changes in the fair value of the reference entities or indicesunderlying the derivative instruments.

 

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

 

At September 30, 2010, our securities withembedded derivatives totaled $691 million, a decrease in fair value of $76million from December 31, 2009, comprising realized capital losses onvaluation of $27 million, net sales activity of $157 million, unrealized netcapital gains reported in OCI of $61 million for the host securities and anincrease of $47 million due to the adoption of new accounting guidance.  Unrealized net capital gains were furtherdecreased by $17 million due to amortization of the host securities.  The change in fair value of embedded derivativesis bifurcated from the host securities, separately valued and reported inrealized capital gains and losses, while the change in the difference betweenthe fair value and the amortized cost of the host securities is reported inOCI.  Total fair value exceeded totalamortized cost by $13 million at September 30, 2010.  Valuation gains and losses for securitieswith embedded derivatives are converted into cash upon our election to sellthese securities.  In the event theeconomic value of the embedded options is not realized, we will recover the parvalue if held to maturity unless the issuer of the security defaults.  In the event there are defaults by thereferenced credit entities of the embedded credit default swap, our loss islimited to the par value of the combined fixed income security, net ofapplicable recoveries.  Total par value exceeded fair value by $122million at September 30, 2010.

 

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

 
| ** **                                              | ** ** | **Nine months ended September 30,** | ** ** | ** **      | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **2010**                                                | ** ** | **2009**        | ** ** | **2010 Explanations** | ** ** |
| **($ in millions)**                           | ** ** | **Valuation**                                           | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **Risk reduction**                                      |       |                                                    |       |            |       |   |   |   |   |   |   |
| Duration gap management                                 |       | $                                                       | (171       | )               | $          | (55 | ) | $ | (226 | ) | $ | 175 |   | Interest  rate caps, floors, swaptions and swaps are used to balance interest-rate  sensitivities of assets and liabilities. The contracts settle based on  differences between current market rates and a contractually specified fixed  rate through expiration. The contracts can be terminated and settled at any  time with minimal additional cost. The maximum loss on caps, floors and  swaptions is limited to the amount of premiums paid. The change in valuation  reflects the changing value of expected future settlements from changing  interest rates, which may vary over the period of the contracts. The 2010  losses, resulting from decreasing interest rates, are offset in unrealized  capital gains and losses of our fixed income securities in OCI to the extent  it relates to changes in risk-free rates. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| Anticipatory hedging                                    |       | 26                                                      |       | 6               |       | 32 |   | (16 | ) | Futures  and interest rate swaps are used to protect investment spread from interest  rate changes during mismatches in the timing of cash flows between product  sales and the related investment activity. The futures contracts are exchange  traded, daily cash settled and can be exited at any time for minimal  additional cost. If the cash flow mismatches are such that a positive net  investment position is being hedged, there is an offset for the related  investment’s unrealized loss in OCI. The 2010 gains were caused by a decrease  in risk-free interest rates over the life of the net short position as  liability issuances exceeded asset acquisitions. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| Hedging of interest rate  exposure in annuity contracts |       | (18                                                     | )          | —          |       | (18 | ) | 6 |   | Value  of expected future settlements on interest rate caps and the associated value  of future credited interest, which is reportable in future periods when  incurred, decreased due to a decrease in interest rates. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| Hedge ineffectiveness                                   |       | 3                                                       |       | —          |       | 3 |   | 1 |   | The  hedge ineffectiveness of $3 million includes $110 million in realized capital  losses on swaps that were offset by $113 million in realized capital gains on  the hedged risk. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| Foreign currency contracts                              |       | (2                                                      | )          | 6               |       | 4 |   | 1 |   | Currency  forwards are used to protect our foreign bond portfolio from changes in  currency rates. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| Credit risk reduction                                   |       | 8                                                       |       | (10             | )          | (2 | ) | (41 | ) | Valuation  gain is the result of widening credit spreads on referenced credit entities. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| **Total Risk reduction**                                |       | (154                                                    | )          | (53             | )          | (207 | ) | 126 |   |   |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| **Income generation**                                   |       |                                                    |       |            |       |   |   |   |   |   |   |
| Asset replication - credit  exposure                    |       | (12                                                     | )          | 8               |       | (4 | ) | 50 |   | The  2010 changes in valuation are due to the widening credit spreads on  referenced credit entities. The losses are primarily on first-to-default credit default swaps (“CDS”) and  credit derivative index CDS. The changes in valuation would only be converted  to cash upon disposition, which can be done at any time, or if the credit  event specified in the contract occurs. For further discussion on CDS, see  Note 6 of the condensed consolidated financial statements. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
| **Accounting**                                          |       |                                                    |       |            |       |   |   |   |   |   |   |
| Equity indexed notes                                    |       | (20                                                     | )          | —          |       | (20 | ) | 19 |   | 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 $20 million at September 30, 2010.  Equity-indexed notes are subject to our comprehensive portfolio monitoring  and watchlist processes to identify and evaluate when the carrying value may  be other-than-temporarily impaired. The following table compares the  September 30, 2010 and December 31, 2009 holdings, respectively. |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   |   |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | **($ in  millions)** | ** ** | **September 30,  2010** | ** ** | **Change  in  fair value** | ** ** | **Change  due to  net sale  activity** | ** ** | **December 31,  2009** |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Par value |   | $ | 325 |   | $ | — |   | $ | (150 | ) | $ | 475 |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Amortized cost of host contract |   | $ | 240 |   | $ | 12 |   | $ | (116 | ) | $ | 344 |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Fair value of equity-indexed call option |   | 47 |   | (20 | ) | (22 | ) | 89 |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Total amortized cost |   | $ | 287 |   | $ | (8 | ) | $ | (138 | ) | $ | 433 |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Total fair value |   | $ | 305 |   | $ | 24 |   | $ | (149 | ) | $ | 430 |   |
|                                                    |       |                                                    |       |            |       |   |   |   |   | Unrealized gain/loss |   | $ | 18 |   | $ | 32 |   | $ | (11 | ) | $ | (3 | ) |
|                                                         |            |                                                         |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                                     | ** ** | **Nine months ended September 30,** | ** ** | ** **      | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **2010**                                                | ** ** | **2009**        | ** ** | **2010 Explanations** | ** ** |
| **($ in millions)**                  | ** ** | **Valuation**                                           | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| Conversion options in  fixed income securities |       | (29                                                     | )          | —          |       | (29 | ) | 37 |   | Convertible  bonds are fixed income securities that contain embedded options.  Changes in valuation of the embedded option  are reported in realized capital gains and losses.  The results generally track the performance  of underlying equities.  Valuation  gains and losses are converted into cash upon our election to sell these  securities.  In the event the economic  value of the options is not realized, we will recover the par value of the  host fixed income security if held to maturity unless the issuer of the note  defaults.  Fair value exceeded par  value by $23 million at September 30, 2010.  Convertible bonds are subject to our  comprehensive portfolio monitoring and watchlist processes to identify and  evaluate when the carrying value may be other-than-temporarily impaired.  The following table compares the September 30,  2010 and December 31, 2009 holdings, respectively. |   |
|                                           |       |                                                    |       |            |       |   |   |   |   |   |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | **($ in  millions)** | ** ** | **September 30,  2010** | ** ** | **Change  in  fair value** | ** ** | **Change  due  to net sale  activity** | ** ** | **December 31,  2009** |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Par value |   | $ | 309 |   | $ | — |   | $ | (6 | ) | $ | 315 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Amortized cost of host contract |   | $ | 237 |   | $ | 5 |   | $ | 8 |   | $ | 224 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Fair value of conversion option |   | 76 |   | (29 | ) | (12 | ) | 117 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Total amortized cost |   | $ | 313 |   | $ | (24 | ) | $ | (4 | ) | $ | 341 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Total fair value |   | $ | 332 |   | $ | 3 |   | $ | (8 | ) | $ | 337 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Unrealized gain/loss |   | $ | 19 |   | $ | 27 |   | $ | (4 | ) | $ | (4 | ) |
|                                           |       |                                                    |       |            |       |   |   |   |   |   |   |
| CDS in fixed income  securities

** **    |       | 22                                                      |       | —          |       | 22 |   | — |   | Synthetic  CDO’s are fixed income securities that contain embedded credit default  swaps.  Effective July 1, 2010,  when new accounting guidance requiring bifurcation of these derivatives was  adopted, changes in valuation of the embedded credit default swap are reported  in realized capital gains and losses.   The embedded credit default swap increases or decreases in value as  referenced credit entities’ credit spreads tighten or widen, respectively.  Credit events, changes in interest rates,  correlations of the referenced entities and assumed recovery rates are among  some of the other factors affecting the value of the embedded credit default  swap.  In the event a referenced credit  entity experiences a credit event, our loss is limited to the par value of  the fixed income security.  Losses on  credit events are net of recovery.  Par  value exceeded fair value by $125 million at September 30, 2010.  Synthetic CDO’s are subject to our  comprehensive portfolio monitoring and watchlist processes to identify and  evaluate when the carrying value may be other-than-temporarily impaired.  The following table compares the September 30,  2010 and July 1, 2010 holdings, respectively. |   |
|                                           |       |                                                    |       |            |       |   |   |   |   |   |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | **($ in  millions)** | ** ** | **September 30,  2010** | ** ** | **Change  in  fair value** | ** ** | **Change  due  to net sale  activity** | ** ** | **July 1,  2010** |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Par value |   | $ | 179 |   | $ | — |   | $ | — |   | $ | 179 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Amortized cost of host contract |   | $ | 179 |   | $ | — |   | $ | — |   | $ | 179 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Fair value of credit default swap |   | (101 | ) | 22 |   | — |   | (123 | ) |
|                                           |       |                                                    |       |            |       |   |   |   |   | Total amortized cost |   | $ | 78 |   | $ | 22 |   | $ | — |   | $ | 56 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Total fair value |   | $ | 54 |   | $ | 7 |   | $ | — |   | $ | 47 |   |
|                                           |       |                                                    |       |            |       |   |   |   |   | Unrealized gain/loss |   | $ | (24 | ) | $ | (15 | ) | $ | — |   | $ | (9 | ) |
|                                           |       |                                                    |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total Accounting**                           |       | (27                                                     | )          | —          |       | (27 | ) | 56 |   |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                                                    |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**                                      |       | $                                                       | (193       | )               | $          | (45 | ) | $ | (238 ) | (1) | $ | 232 |   |   |   |   |   |   |   |   |   |   |   |
|                                                |            |                                                         |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)         Does notinclude $1 million of derivative gains related to the termination of fair valueand cash flow hedges which are included in sales and reported with the hedgedrisk.

 

**CAPITAL RESOURCES AND LIQUIDITY HIGHLIGHTS**

 

·                  Shareholder’sequity as of September 30, 2010was $5.69 billion, an increase of 29.8% from $4.39 billion as of December 31,2009.

·                  The AllstateCorporation (the “Corporation”) has at the parent holding company level $3.53billion of deployable invested assets at September 30, 2010 compared to$3.07 billion at December 31, 2009.

·                  At September 30, 2010,we held 26.2% of our total cash and investment portfolio, or $15.94 billion, incash and liquid investments that are saleable within one quarter without significantadditional net realized capital losses.

 

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**CAPITAL RESOURCES AND LIQUIDITY**

 

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

 
| **($ in millions)**                                 | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Common stock, additional capital paid-in and  retained income |       | $                            | 5,050      |                        | $          | 5,163 |   |
| Accumulated other comprehensive income (loss)                 |       | 643                          |       | (777                        | )          |
| Total shareholder’s equity                               |       | 5,693                        |       | 4,386                       |       |
| Notes due to related parties                                  |       | 677                          |       | 675                         |       |
| Total capital resources                                       |       | $                            | 6,370      |                        | $          | 5,061 |   |

 

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

 

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

 

The Company, AIC and the Corporation are party to the Amended andRestated Intercompany Liquidity Agreement (“Liquidity Agreement”) which allowsfor short-term advances of funds to be made between parties for liquidity andother general corporate purposes.  TheLiquidity Agreement does not establish a commitment to advance funds on thepart of any party.  The Company and AICeach serve as a lender and borrower and the Corporation serves only as alender.  The Company also has a capitalsupport agreement with AIC.  Under thecapital support agreement, AIC is committed to provide capital to the Companyto maintain an adequate capital level. The maximum amount of potential funding under each of these agreementsis $1.00 billion.

 

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

 

**Liquidity sources and uses **We activelymanage our financial position and liquidity levels in light of changing market,economic, and business conditions. Liquidity is managed at both the entity and enterprise level across theCompany, and is assessed on both base and stressed level liquidity needs.  We believe we have sufficient liquidity to meetthese needs, with $15.94 billion of cash and liquid investments saleable within90 days without generating significant additional capital losses (26.2% of thetotal cash and investment portfolio).  Weexpect $6.91 billion of investment portfolio cash flows from maturities, calls,and interest receipts over the next 12 months. Additionally, we have existing intercompany agreements in place thatfacilitate liquidity management across the Company to enhance flexibility.

 

*Allstate parent holding company capital capacity*****The Corporationhas at the parent holding company level $3.53 billion of deployable investedassets as of September 30, 2010. These assets include investments that are generally saleable within onequarter totaling $3.21 billion.  Thisprovides funds for the parent company’s relatively low fixed charges.

 

TheCompany has access to additional borrowing to support liquidity through theCorporation as follows:

 

·                  A commercial paper facility with a borrowinglimit of $1.00 billion to cover short-term cash needs.  As of September 30, 2010, there were nobalances outstanding and therefore the remaining borrowing capacity was $1.00billion; however, the outstanding balance can fluctuate daily.

 

·                  A primarycredit facility is available for short-term liquidity requirements and backsthe commercial paper facility.  The $1.00billion unsecured revolving credit facility has an initial term of five yearsexpiring in 2012 with two optional one-year extensions that can be exercised atthe end of any of the remaining anniversary years of the facility upon approvalof existing or replacement lenders providing more than two-thirds of thecommitments to lend.  The program isfully subscribed among 11 lenders with the largest commitment being

 

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$185million.  The commitments of the lendersare several and no lender is responsible for any other lender’s commitment ifsuch lender fails to make a loan under the facility.  This facility contains an increase provisionthat would allow up to an additional $500 million of borrowing provided theincreased portion could be fully syndicated at a later date among existing ornew lenders.  This facility has afinancial covenant requiring that the Corporation not exceed a 37.5% debt tocapital resources ratio as defined in the agreement.  This ratio at September 30, 2010 was19.6%.  Although the right to borrowunder the facility is not subject to a minimum rating requirement, the costs ofmaintaining the facility and borrowing under it are based on the ratings of theCorporation’s senior, unsecured, nonguaranteed long-term debt.  There were no borrowings under the creditfacility during the third quarter and first nine months of 2010.  The total amount outstanding at any point intime under the combination of the commercial paper program and the creditfacility cannot exceed the amount that can be borrowed under the creditfacility.

 

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

 

*Liquidity Exposure*** **Contractholder funds as of September 30, 2010 were $47.18billion.  The following table summarizescontractholder funds by their contractual withdrawal provisions at September 30,2010.

 
| **($ in millions)**                                | ** ** | ** ** | ** ** | **Percent  to total** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------------------------|------------|
| Not subject to discretionary withdrawal                      |       | $          | 6,838      |                       | 14.5       | % |
| Subject to discretionary withdrawal with  adjustments:       |       |       |       |                       |       |
| Specified surrender charges (1)                              |       | 19,923     |       | 42.2                       |       |
| Market value adjustments (2)                                 |       | 8,068      |       | 17.1                       |       |
| Subject to discretionary withdrawal without adjustments  (3) |       | 12,348     |       | 26.2                       |       |
| Total contractholder funds (4)                               |       | $          | 47,177     |                       | 100.0      | % |

 

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(1)          Includes $9.40billion of liabilities with a contractual surrender charge of less than 5% ofthe account balance.

 

(2)          $6.71 billionof the contracts with market value adjusted surrenders have a 30-45 day periodat the end of their initial and subsequent interest rate guarantee periods(which are typically 5 or 6 years) during which there is no surrender charge ormarket value adjustment.

 

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

 

(4)          Includes $1.31billion of contractholder funds on variable annuities reinsured to ThePrudential Insurance Company of America, a subsidiary of Prudential Financial, Inc.effective September 1, 2006.

 

Whilewe are able to quantify remaining scheduled maturities for our institutionalproducts, anticipating retail product surrenders is less precise.  Retail life and annuity products may besurrendered by customers for a variety of reasons.  Reasons unique to individual customersinclude a current or unexpected need for cash or a change in life insurancecoverage needs.  Other key factors thatmay impact the likelihood of customer surrender include the level of thecontract surrender charge, the length of time the contract has been in force,distribution channel, market interest rates, equity market conditions andpotential tax implications.  In addition,the propensity for retail life insurance policies to lapse is lower than it isfor fixed annuities because of the need for the insured to be re-underwrittenupon policy replacement.  Surrenders andpartial withdrawals for our retail annuities increased 5.1% and 13.0% in thethird quarter and first nine months of 2010, respectively, compared to the sameperiods of 2009.  The annualizedsurrender and partial withdrawal rate on deferred annuities andinterest-sensitive life insurance, based on the beginning of yearcontractholder funds, was 10.2% and 8.9% for the first nine months of 2010 and2009, respectively.  We strive topromptly pay customers who request cash surrenders, however, statutoryregulations generally provide up to six months in most states to fulfillsurrender requests.

 

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

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

 

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

 

*Cash Flows*  As reflectedin our Condensed Consolidated Statements of Cash Flows, operating cash flows in the first nine months of 2010 wereconsistent with the same period in 2009 as higher premiums and tax refundsreceived were offset by higher contract benefits paid and lower investmentincome.

 

Lowercash flows provided by investing activities in the first nine months of 2010compared to the first nine months of 2009 were primarily related to lower netreductions in short-term investments to fund reductions in contractholderfunds.

 

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

 

**Item 4. Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures. *We maintaindisclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934.  Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of our disclosure controls and procedures as ofthe end of the period covered by this report. Based upon this evaluation, the principal executive officer and theprincipal financial officer concluded that our disclosure controls andprocedures are effective in providing reasonable assurance that materialinformation required to be disclosed in our reports filed with or submitted tothe Securities and Exchange Commission under the Securities Exchange Act ismade known to management, including the principal executive officer and theprincipal financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

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

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Informationrequired for Part II, Item 1 is incorporated by reference to the discussionunder the heading “Regulation and Compliance” 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.

 

**Item 1A.  Risk Factors**

 

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

 

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

 

**Item 5. Other Information**

 

OnOctober 28, 2010, Allstate Finance Company, LLC (“Allstate Finance”), asubsidiary of the Registrant, entered into a Marketing and AdministrationAgreement dated as of October 1, 2010 with Allstate Bank.  Allstate Finance was formed by the Registrantto originate, fund and retain certain business-purpose loans.  Pursuant to this agreement attached hereto asExhibit 10.1, Allstate Bank will provide certain administrative functionsfor these loans but will not originate, fund, or retain any investment in theseloans.  The Registrant is an indirect,wholly owned subsidiary of The Allstate Corporation.  Allstate Bank is a wholly owned subsidiary ofThe Allstate Corporation.

 

**Item6.  Exhibits**

 

(a)                                  Exhibits

 

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

 

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**SIGNATURE**

 

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

 
|                   | Allstate  Life Insurance Company |
|------------------------|----------------------------------|
|                   | (Registrant)                     |
|                   |                             |
|                   |                             |
| November 3,  2010 |                             |
|                   | By                               | /s/  Samuel H. Pilch |
|                   |                             | Samuel  H. Pilch |
|                   |                             | (chief  accounting officer and duly |
|                   |                             | authorized  officer of Registrant) |

 

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| **Exhibit No.** | ** ** | **Description**                                                                                                                                     |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                |
| 10.1                 |       | Marketing  and Administration Agreement between Allstate Finance Company, LLC and  Allstate Bank                                                    |
|                 |       |                                                                                                                                                |
| 15                   |       | Acknowledgment  of awareness from Deloitte & Touche LLP, dated November 3,  2010, concerning unaudited interim financial information. |
|                 |       |                                                                                                                                                |
| 31(i)                |       | Rule 13a-14(a) Certification  of Principal Executive Officer                                                                              |
|                 |       |                                                                                                                                                |
| 31(i)                |       | Rule 13a-14(a) Certification  of Principal Financial Officer                                                                              |
|                 |       |                                                                                                                                                |
| 32                   |       | Section 1350  Certifications                                                                                                                   |

 

E-1

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