** **

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

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

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008**

 

**OR**

 

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

**OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission file number: 000-31248**

 

**ALLSTATE LIFE INSURANCE COMPANY**

(Exact name of registrant asspecified in its charter)

 

| **Illinois**                              | ** ** | **36-2554642**                        |
|-------------------------------------------|------------|---------------------------------------|
| (State of Incorporation)                  |       | (I.R.S. Employer Identification  No.) |
|                                      |       |                                  |
| **3100 Sanders Road**                     | ** ** |                                  |
| **Northbrook, Illinois**                  | ** ** | **60062**                             |
| (Address of principal executive  offices) |       | (Zip code)                            |

 

**Registrant’s telephone number, including areacode:  (847) 402-5000**

 

**Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.**

| **Yes****x** | **No****o** |
|--------------|-------------|

 

**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 “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):**
| **Large  accelerated filer****o**                  | **Accelerated  filer****o** | **Non-accelerated  filer  ****x** | **Smaller  reporting company****o** |
|----------------------------------------------------|-----------------------------|----------------------------------------|-------------------------------------|
| **(Do not check if a smaller  reporting company)** |

 

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

| **Yes****o** | **No****x** |
|--------------|-------------|

 

**As of August 8, 2008, the registrant had 23,800 commonshares, $227 par value, outstanding, all of which are held by AllstateInsurance Company.**

 

 

 

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**ALLSTATE LIFE INSURANCE COMPANY**

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

##### **June 30, 2008**

 
| ** **       | ** **                                                                                                                                | **PAGE**   |
|------------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART I**  | **FINANCIAL INFORMATION**                                                                                                                 | ** ** |
|             |                                                                                                                                      |       |
| Item 1.          | Financial Statements                                                                                                                      |       |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Operations for the Three-Month and Six-Month  Periods Ended June 30, 2008 and 2007 (unaudited) | 1          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Financial Position as of June 30, 2008  (unaudited) and December 31, 2007                 | 2          |
|             |                                                                                                                                      |       |
|             | Condensed  Consolidated Statements of Cash Flows for the Six-Month Periods Ended  June 30, 2008 and 2007 (unaudited)                 | 3          |
|             |                                                                                                                                      |       |
|             | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                          | 4          |
|             |                                                                                                                                      |       |
|             | Report of Independent Registered Public Accounting Firm                                                                                   | 19         |
|             |                                                                                                                                      |       |
| Item 2.          | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                               | 20         |
|             |                                                                                                                                      |       |
| Item 4.          | Controls and Procedures                                                                                                                   | 52         |
|             |                                                                                                                                      |       |
| **PART II** | **OTHER INFORMATION**                                                                                                                     | ** ** |
|             |                                                                                                                                      |       |
| Item 1.          | Legal Proceedings                                                                                                                         | 53         |
|             |                                                                                                                                      |       |
| Item 1A.         | Risk Factors                                                                                                                              | 53         |
|             |                                                                                                                                      |       |
| Item 6.          | Exhibits                                                                                                                                  | 53         |

 

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##### ** **

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

**ITEM1. FINANCIAL STATEMENTS**

 

**ALLSTATE LIFE INSURANCE COMPANY ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                                          | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                             | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                               | ** ** |
| **Revenues**                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Premiums                                                               |       | $                                               | 126        |                                          | $          | 122 |   | $ | 237 |   | $ | 277 |   |
| Contract charges                                                       |       | 246                                             |       | 230                                           |       | 487 |   | 458 |   |
| Net investment income                                                  |       | 922                                             |       | 1,053                                         |       | 1,914 |   | 2,083 |   |
| Realized capital gains and losses                                      |       | (932                                            | )          | 104                                           |       | (1,360 | ) | 126 |   |
|                                                                   |       | 362                                             |       | 1,509                                         |       | 1,278 |   | 2,944 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Costs and expenses**                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Contract benefits                                                      |       | 343                                             |       | 331                                           |       | 684 |   | 705 |   |
| Interest credited to contractholder funds                              |       | 549                                             |       | 660                                           |       | 1,159 |   | 1,295 |   |
| Amortization of deferred policy acquisition  costs                     |       | (56                                             | )          | 166                                           |       | (6 | ) | 281 |   |
| Operating costs and expenses                                           |       | 101                                             |       | 73                                            |       | 191 |   | 160 |   |
| Restructuring and related charges                                      |       | —                                          |       | (1                                            | )          | — |   | (1 | ) |
|                                                                   |       | 937                                             |       | 1,229                                         |       | 2,028 |   | 2,440 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Gain (loss) on disposition of operations                               |       | —                                          |       | 2                                             |       | (9 | ) | 3 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **(Loss) income from operations before income  tax (benefit) expense** |       | (575                                            | )          | 282                                           |       | (759 | ) | 507 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Income tax (benefit) expense                                           |       | (207                                            | )          | 95                                            |       | (276 | ) | 171 |   |
|                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Net (loss) income**                                                  |       | $                                               | (368       | )                                             | $          | 187 |   | $ | (483 | ) | $ | 336 |   |

 

See notes to condensed consolidated financialstatements.

 

1

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**ALLSTATE LIFE INSURANCE COMPANY ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF FINANCIAL POSITION**

** **
| ** **                                                                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **($ in millions, except par value data)**                              | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                            | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
|                                                                                                  |       |              |       |                  |       |
| **Assets**                                                                                            |       |              |       |                  |       |
| Investments                                                                                           |       |              |       |                  |       |
| Fixed income securities, at fair value  (amortized cost $52,885 and $58,020)                          |       | $                 | 51,873     |                  | $          | 58,469 |   |
| Mortgage loans                                                                                        |       | 9,739             |       | 9,901                 |       |
| Equity securities, at fair value (cost $150  and $102)                                                |       | 150               |       | 102                   |       |
| Limited partnership interests                                                                         |       | 1,150             |       | 994                   |       |
| Short-term                                                                                            |       | 5,599             |       | 386                   |       |
| Policy loans                                                                                          |       | 773               |       | 770                   |       |
| Other                                                                                                 |       | 1,471             |       | 1,792                 |       |
|                                                                                                  |       |              |       |                  |       |
| Total investments                                                                                     |       | 70,755            |       | 72,414                |       |
|                                                                                                  |       |              |       |                  |       |
| Cash                                                                                                  |       | 224               |       | 185                   |       |
| Deferred policy acquisition costs                                                                     |       | 4,738             |       | 3,905                 |       |
| Reinsurance recoverables                                                                              |       | 3,445             |       | 3,410                 |       |
| Accrued investment income                                                                             |       | 598               |       | 652                   |       |
| Other assets                                                                                          |       | 957               |       | 622                   |       |
| Deferred income taxes                                                                                 |       | 149               |       | —                |       |
| Separate Accounts                                                                                     |       | 12,438            |       | 14,929                |       |
|                                                                                                  |       |              |       |                  |       |
| **Total assets**                                                                                      |       | $                 | 93,304     |                  | $          | 96,117 |   |
|                                                                                                  |       |              |       |                  |       |
| **Liabilities**                                                                                       |       |              |       |                  |       |
| Contractholder funds                                                                                  |       | $                 | 60,886     |                  | $          | 60,464 |   |
| Reserve for life-contingent contract  benefits                                                        |       | 12,348            |       | 12,598                |       |
| Unearned premiums                                                                                     |       | 32                |       | 33                    |       |
| Payable to affiliates, net                                                                            |       | 136               |       | 206                   |       |
| Other liabilities and accrued expenses                                                                |       | 2,929             |       | 2,823                 |       |
| Deferred income taxes                                                                                 |       | —            |       | 101                   |       |
| Long-term debt                                                                                        |       | 250               |       | 200                   |       |
| Separate Accounts                                                                                     |       | 12,438            |       | 14,929                |       |
|                                                                                                  |       |              |       |                  |       |
| **Total liabilities**                                                                                 |       | 89,019            |       | 91,354                |       |
|                                                                                                  |       |              |       |                  |       |
| **Commitments and Contingent Liabilities  (Note 6)**                                                  |       |              |       |                  |       |
|                                                                                                  |       |              |       |                  |       |
| **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                                                                            |       | 1,475             |       | 1,108                 |       |
| Retained income                                                                                       |       | 3,251             |       | 3,734                 |       |
| Accumulated other comprehensive income:                                                               |       |              |       |                  |       |
| Unrealized net capital gains and losses                                                               |       | (446              | )          | (84                   | )          |
|                                                                                                  |       |              |       |                  |       |
| **Total accumulated other comprehensive loss**                                                        |       | (446              | )          | (84                   | )          |
|                                                                                                  |       |              |       |                  |       |
| **Total shareholder’s equity**                                                                   |       | 4,285             |       | 4,763                 |       |
|                                                                                                  |       |              |       |                  |       |
| **Total liabilities and shareholder’s equity**                                                   |       | $                 | 93,304     |                  | $          | 96,117 |   |

 

See notes to condensed consolidated financialstatements.****

 

2

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**ALLSTATE LIFE INSURANCE COMPANY ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** |
| **($ in millions)**                                                      | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited)**                | ** ** |
| **Cash flows from operating activities**                                           |       |                           |       |   |   |
| Net (loss) income                                                                  |       | $                              | (483       | ) | $ | 336 |   |
|                                                                               |       |                           |       |   |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                           |       |   |   |
| Amortization and other non-cash items                                              |       | (183                           | )          | (145 | ) |
| Realized capital gains and losses                                                  |       | 1,360                          |       | (126 | ) |
| Loss (gain) on disposition of operations                                           |       | 9                              |       | (3 | ) |
| Interest credited to contractholder funds                                          |       | 1,159                          |       | 1,295 |   |
| Changes in:                                                                        |       |                           |       |   |   |
| Contract benefit and other insurance  reserves                                     |       | (323                           | )          | (105 | ) |
| Unearned premiums                                                                  |       | (2                             | )          | (1 | ) |
| Deferred policy acquisition costs                                                  |       | (309                           | )          | 27 |   |
| Reinsurance recoverables, net                                                      |       | 2                              |       | (145 | ) |
| Income taxes                                                                       |       | (249                           | )          | 29 |   |
| Other operating assets and liabilities                                             |       | (54                            | )          | (60 | ) |
| Net cash provided by operating activities                                          |       | 927                            |       | 1,102 |   |
|                                                                               |       |                           |       |   |   |
| **Cash flows from investing activities**                                           |       |                           |       |   |   |
| Proceeds from sales:                                                               |       |                           |       |   |   |
| Fixed income securities                                                            |       | 6,755                          |       | 5,695 |   |
| Equity securities                                                                  |       | 63                             |       | 41 |   |
| Limited partnerships                                                               |       | 52                             |       | 135 |   |
| Mortgage loans                                                                     |       | 191                            |       | — |   |
| Other investments                                                                  |       | 127                            |       | 79 |   |
| Investment collections:                                                            |       |                           |       |   |   |
| Fixed income securities                                                            |       | 1,229                          |       | 1,597 |   |
| Mortgage loans                                                                     |       | 372                            |       | 892 |   |
| Other investments                                                                  |       | 67                             |       | 260 |   |
| Investment purchases:                                                              |       |                           |       |   |   |
| Fixed income securities                                                            |       | (3,853                         | )          | (7,149 | ) |
| Equity securities                                                                  |       | (106                           | )          | (44 | ) |
| Limited partnerships                                                               |       | (219                           | )          | (372 | ) |
| Mortgage loans                                                                     |       | (436                           | )          | (1,314 | ) |
| Other investments                                                                  |       | (64                            | )          | (459 | ) |
| Change in short-term investments, net                                              |       | (4,658                         | )          | 74 |   |
| Change in other investments, net                                                   |       | (220                           | )          | 83 |   |
| Net cash used in investing activities                                              |       | (700                           | )          | (482 | ) |
|                                                                               |       |                           |       |   |   |
| **Cash flows from financing activities**                                           |       |                           |       |   |   |
| Note payable to parent                                                             |       | —                         |       | (500 | ) |
| Redemption of redeemable preferred stock                                           |       | —                         |       | (11 | ) |
| Contractholder fund deposits                                                       |       | 6,844                          |       | 4,722 |   |
| Contractholder fund withdrawals                                                    |       | (7,032                         | )          | (4,933 | ) |
| Net cash used in financing activities                                              |       | (188                           | )          | (722 | ) |
| **Net increase (decrease) in cash**                                                |       | 39                             |       | (102 | ) |
| **Cash at beginning of the period**                                                |       | 185                            |       | 273 |   |
| **Cash at end of period**                                                          |       | $                              | 224        |   | $ | 171 |   |

 

See notes to condensed consolidated financialstatements.

 

3

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** **

**ALLSTATE LIFE INSURANCE COMPANY ANDSUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1.  General**

 

**Basis of presentation**

 

The accompanying condensed consolidatedfinancial statements include the accounts of Allstate Life Insurance Company (“ALIC”)and its wholly owned subsidiaries (collectively referred to as the “Company”).ALIC is wholly owned by Allstate Insurance Company (“AIC”), a wholly ownedsubsidiary of The Allstate Corporation (the “Corporation”).

 

The condensedconsolidated financial statements and notes as of June 30, 2008, and forthe three-month and six-month periods ended June 30, 2008 and 2007 areunaudited.  The condensed consolidatedfinancial statements reflect all adjustments (consisting only of normal recurringaccruals), which are, in the opinion of management, necessary for the fairpresentation of the financial position, results of operations and cash flowsfor the interim periods.  These condensedconsolidated financial statements and notes should be read in conjunction withthe consolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007.  The results of operations for the interimperiods should not be considered indicative of results to be expected for thefull year.

 

To conform to the 2008 presentation, certainamounts in the prior year condensed consolidated financial statements and noteshave been reclassified.

 

**Premiums and Contract Charges**

 

The following table summarizes premiums andcontract charges by product.

 
| ** **                                  | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **($ in millions)**               | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Premiums**                                |       |                             |       |                           |       |   |   |   |   |
| Traditional life insurance                  |       | $                                | 71         |                           | $          | 61 |   | $ | 131 |   | $ | 130 |   |
| Immediate annuities with life contingencies |       | 36                               |       | 52                             |       | 66 |   | 129 |   |
| Other                                       |       | 19                               |       | 9                              |       | 40 |   | 18 |   |
| Total premiums                              |       | 126                              |       | 122                            |       | 237 |   | 277 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| **Contract charges**                        |       |                             |       |                           |       |   |   |   |   |
| Interest-sensitive life insurance           |       | 232                              |       | 210                            |       | 460 |   | 420 |   |
| Fixed annuities                             |       | 13                               |       | 19                             |       | 26 |   | 37 |   |
| Variable annuities                          |       | 1                                |       | 1                              |       | 1 |   | 1 |   |
| Total contract charges                      |       | 246                              |       | 230                            |       | 487 |   | 458 |   |
| Total premiums and contract charges         |       | $                                | 372        |                           |       | $ | 352 |   |   | $ | 724 |   |   | $ | 735 |   |   |
|                                             |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Adopted accounting standards**

 

*Statement of Position 05-1, Accounting by Insurance Enterprises forDeferred Acquisition Costs in Connection with Modifications or Exchanges ofInsurance Contracts (“SOP 05-1”)*

 

In October 2005,the American Institute of Certified Public Accountants (“AICPA”) issued SOP05-1.  SOP 05-1 provides accountingguidance for deferred policy acquisition costs (“DAC”) associated with internalreplacements of insurance and investment contracts other than those set forthin Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accountingand Reporting by Insurance Enterprises for Certain Long-Duration Contracts andfor Realized Gains and Losses from the Sale of Investments”.  SOP 05-1 defines an internal replacement as amodification in product benefits, features, rights or coverages that occursthrough the exchange of an existing contract for a new contract, or byamendment, endorsement or rider to an existing contract, or by the election ofa feature or coverage within an existing contract.  The Company adopted the provisions of SOP 05-1on January 1, 2007 for internal replacements occurring in fiscal yearsbeginning after December 15, 2006. The adoption resulted in an $8 million after-tax reduction to retainedincome to reflect the impact on estimated future gross profits (“EGP”) from thechanges in accounting for certain costs associated with contract continuationsthat no longer

 

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qualify for deferralunder SOP 05-1 and a reduction of DAC and deferred sales inducement balances of$13 million pre-tax as of January 1, 2007.

 

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

 

In February 2006, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 155, which permitsfair value remeasurement at the date of adoption of any hybrid financial instrumentcontaining an embedded derivative that otherwise would require bifurcationunder paragraph 12 or 13 of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities*”***(“SFASNo. 133”); clarifies which interest-only strips and principal-only stripsare not subject to the requirements of SFAS No. 133; establishes arequirement to evaluate interests in securitized financial assets to identifyinterests that are freestanding derivatives or hybrid financialinstruments that contain embedded derivatives requiring bifurcation; andclarifies that concentrations ofcredit risk in the form of subordination are not embedded derivatives.  The Company adopted the provisions of SFAS No. 155on January 1, 2007, which were effective for all financial instrumentsacquired, issued or subject to a remeasurement event occurring after thebeginning of the first fiscal year after September 15, 2006.  The Company elected not to remeasure existinghybrid financial instruments that contained embedded derivatives requiringbifurcation at the date of adoption pursuant to paragraph 12 or 13 of SFAS No. 133.  The adoption of SFAS No. 155 did nothave a material effect on the results of operations or financial position ofthe Company.

 

*FASB Interpretation No. 48, Accountingfor Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109and FASB Staff Position No. FIN 48-1, Definition of Settlement in FASBInterpretation No. 48 (“FIN 48”)*

 

The FASB issued FIN 48 in July 2006 and the related staff positionin May 2007.  FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an entity’s financialstatements in accordance with SFAS No. 109, “Accounting for Income Taxes”.  FIN 48 requires an entity to recognize thetax benefit of uncertain tax positions only when it is more likely than not,based on the position’s technical merits, that the position would be sustainedupon examination by the respective taxing authorities.  The tax benefit is measured as the largestbenefit that is more than fifty-percent likely of being realized upon finalsettlement with the respective taxing authorities. On January 1, 2007, theCompany adopted the provisions of FIN 48, which were effective for fiscal yearsbeginning after December 15, 2006. No cumulative effect of a change in accounting principle or adjustmentto the liability for unrecognized tax benefits was recognized as a result ofthe adoption of FIN 48.  Accordingly, theadoption of FIN 48 did not have an effect on the results of operations orfinancial position of the Company.

 

*SEC Staff Accounting Bulletin No. 109, Written Loan CommitmentsThat are Recorded At Fair Value Through Earnings (“SAB 109”)*

 

InOctober 2007, the SEC issued SAB 109, a replacement of SAB 105, “Applicationof Accounting Principles to Loan Commitments”. SAB 109 is applicable to both loan commitments accounted for under SFAS No. 133,and other loan commitments for which the issuer elects fair value accountingunder SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities”.  SAB 109 statesthat the expected net future cash flows related to the servicing of a loanshould be included in the fair value measurement of a loan commitment accountedfor at fair value through earnings.  Theexpected net future cash flows associated with loan servicing should bedetermined in accordance with the guidance in SFAS No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”,as amended by SFAS No. 156, “Accounting for Servicing of Financial Assets”.  SAB 109 should be applied on a prospectivebasis to loan commitments accounted for under SFAS No. 133 that wereissued or modified in fiscal quarters beginning after December 15,2007.  Earlier adoption was notpermitted.  The adoption of SAB 109 didnot have a material impact on the Company’s results of operations or financialposition.

 

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

 

In September 2006, the FASB issued SFAS No. 157, whichredefines fair value as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date, establishes a framework for measuring fairvalue in accounting principles generally accepted in the United States ofAmerica (“GAAP”), and expands disclosures about fair value measurements.  SFAS No. 157 establishes a three-levelhierarchy for fair value measurements based upon the nature of the inputs tothe valuation of an asset or liability. SFAS No. 157 applies where other accounting pronouncements requireor permit fair value measurements.  InFebruary 2008, the FASB issued FASB Staff Position No. 157-2, “EffectiveDate of FASB

 

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Statement No. 157” (“FSP 157-2”), which permits the deferral ofthe effective date of SFAS No. 157 to fiscal years beginning after November 15,2008 for all non-financial assets and liabilities, except those that are recognizedor disclosed at fair value in the financial statements on a recurringbasis.  The Company adopted theprovisions of SFAS No. 157 for financial assets and liabilities recognizedor disclosed at fair value on a recurring and non-recurring basis as of January 1,2008.  Consistent with the provisions ofFSP 157-2, the Company decided to defer the adoption of SFAS No. 157 fornon-financial assets and liabilities measured at fair value on a non-recurringbasis until January 1, 2009.  Theadoption of SFAS No. 157 did not have a material effect on the Company’sresults of operations or financial position (see Note 4).

 

*SFAS No. 159, The Fair Value Option for Financial Assets andFinancial Liabilities – Including an amendment of FASB Statement No. 115 (“SFASNo. 159”)*

 

InFebruary 2007, the FASB issued SFAS No. 159 which provides reportingentities, on an ongoing basis, an option to report selected financial assets,including investment securities, and financial liabilities, including mostinsurance contracts, at fair value through earnings.  SFAS No. 159 establishes presentationand disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement alternatives for similar types offinancial assets and liabilities.  Thestandard also requires additional information to aid financial statement users’understanding of the impacts of a reporting entity’s decision to use fair valueon its earnings and requires entities to display, on the face of the statementof financial position, the fair value of those assets and liabilities for whichthe reporting entity has chosen to measure at fair value.  SFAS No. 159 was effective as of thebeginning of a reporting entity’s first fiscal year beginning after November 15,2007.  The Company did not apply the fair value option to any existingfinancial assets or liabilities as of January 1, 2008.  Consequently, the initial adoption of SFAS No. 159had no impact on the Company’s results of operations or financial position.

 

*FASB Staff Position No. FIN 39-1, Amendment of FASB InterpretationNo. 39 (“FSP FIN 39-1”)*

 

InApril 2007, the FASB issued FSP FIN 39-1, which amends FASB InterpretationNo. 39, “Offsetting of Amounts Related to Certain Contracts”.  FSP FIN 39-1 replaces the terms “conditionalcontracts” and “exchange contracts” with the term “derivative instruments” andrequires a reporting entity to offset fair value amounts recognized for theright to reclaim cash collateral or the obligation to return cash collateralagainst fair value amounts recognized for derivative instruments executed withthe same counterparty under the same master netting arrangement that have beenoffset in the statement of financial position. FSP FIN 39-1 was effective forfiscal years beginning after November 15, 2007, with early adoptionpermitted.  The adoption of FSP FIN 39-1did not have a material impact on the Company’s results of operations orfinancial position.

 

## **Pending accounting standards**

## ** **

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

 

InDecember 2007, the FASB issued SFAS No. 141R which replaces SFAS No. 141,“Business Combinations” (“SFAS No. 141”). Among other things, SFAS No. 141R broadens the scope of SFAS No. 141to include all transactions where an acquirer obtains control of one or moreother businesses; retains the guidance to recognize intangible assetsseparately from goodwill; requires, with limited exceptions, that all assetsacquired and liabilities assumed, including certain of those that arise fromcontractual contingencies, be measured at their acquisition date fair values;requires most acquisition and restructuring-related costs to be expensed asincurred; requires that step acquisitions, once control is acquired, to berecorded at the full amounts of the fair values of the identifiable assets,liabilities and the noncontrolling interest in the acquiree; and replaces thereduction of asset values and recognition of negative goodwill with arequirement to recognize a gain in earnings. The provisions of SFAS No. 141R are effective for fiscal yearsbeginning after December 15, 2008 and are to be applied prospectivelyonly.  Early adoption is not permitted.The Company will apply the provisions of SFAS 141R as required when effective.

 

*SFAS No. 160, Noncontrolling Interests in Consolidated FinancialStatements – an amendment of ARB No. 51 (“SFAS No. 160”)*

 

InDecember 2007, the FASB issued SFAS No. 160 which clarifies that anoncontrolling interest in a subsidiary is that portion of the subsidiary’sequity that is attributable to owners of the subsidiary other than its parentor parent’s affiliates.  Noncontrollinginterests are required to be reported as equity in the consolidated financialstatements and as such net income will include amounts attributable to both theparent and the noncontrolling interest with disclosure of the amountsattributable to each on the face of the consolidated statement ofoperations.  SFAS No. 160 requiresthat all changes in a parent’s ownership interest in a subsidiary when controlof the

 

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subsidiaryis retained, be accounted for as equity transactions.  In contrast, SFAS No. 160 requires aparent to recognize a gain or loss in net income when control over a subsidiaryis relinquished and the subsidiary is deconsolidated, as well as providecertain associated expanded disclosures. SFAS No. 160 is effective as of the beginning of a reporting entity’sfirst fiscal year beginning after December 15, 2008.  Early adoption is prohibited.  SFAS No. 160 requires prospectiveapplication as of the beginning of the fiscal year in which the standard isinitially applied, except for the presentation and disclosure requirementswhich are to be applied retrospectively for all periods presented.  The adoption of SFAS No. 160 is notexpected to have a material effect on the Company’s results of operations orfinancial position.

 

*SFAS No. 161, Disclosures about Derivative Instruments and HedgingActivities – an amendment of FASB Statement No. 133 (“SFAS No. 161”)*

 

InMarch 2008, the FASB issued SFAS No. 161, which amends and expandsthe disclosure requirements for derivatives currently accounted for inaccordance with SFAS No. 133.  The new disclosures are designed toenhance the understanding of how and why an entity uses derivative instrumentsand how derivative instruments affect an entity’s financial position, resultsof operations, and cash flows.  The standard requires, on a quarterlybasis, quantitative disclosures about the potential cash outflows associatedwith the triggering of credit-related contingent features, if any; tabulardisclosures about the classification and fair value amounts of derivativeinstruments reported in the statement of financial position; disclosure of thelocation and amount of gains and losses on derivative instruments reported inthe statement of operations; and qualitative information about how and why anentity uses derivative instruments and how derivative instruments and relatedhedged items affect the entity’s financial statements.  SFAS No. 161is effective for fiscal periods beginning after November 15, 2008, and isto be applied on a prospective basis only.  SFAS No. 161 affectsdisclosures and therefore will not impact the Company’s results of operationsor financial position.

 

**2.    Related Party Transactions**

 

**Capital contributions**

 

In June 2008, the Company received a capital contribution from itsparent AIC of $349 million, which was recorded as additional capital paid-in onthe Condensed Consolidated Statements of Financial Position.  The capital contribution included fixedincome securities of $337 million, accrued investment income of $5 million andcash of $7 million.  Additionally, in June 2008,the Board of Directors of AIC authorized AIC to make up to $400 million infunds available to the Company on or before September 1, 2008 through oneor any combination of the following methods: by making one or more capital contributions in cash or securities, byproviding a guaranty or guaranties, or by purchasing one or more surplus notesor other securities.

 

  The Company and AIC have aCapital Support Agreement that went into effect in 2007.  Under the terms of this agreement, AIC agreesto provide capital to maintain the amount of statutory capital and surplusnecessary to maintain a company action level risk-based capital (“RBC”) ratioof at least 150%.  AIC’s obligation toprovide capital to the Company under the agreement is limited to an aggregateamount of $1 billion.  Discretionarycapital contributions made by AIC outside of the terms of this agreement,including the $349 million contribution made in June 2008, do not reduceAIC’s $1 billion obligation.  In exchangefor providing this capital, the Company will pay AIC an annual commitment feeof 1% of the amount of the Capital and Surplus maximum that remains availableon January 1 of such year.  TheCompany or AIC have the right to terminate this agreement when: 1) the Companyqualifies for a financial strength rating from Standard and Poor’s, Moody’s or A.M.Best, without giving weight to the existence of this agreement, that is thesame or better than its rating with such support; or 2) the Company’s RBC ratiois at least 300% or 3) AIC no longer directly or indirectly owns at least 50%of the voting stock of the Company.  At June 30,2008, no capital had been provided by AIC under this agreement.

 

**Reinsurance transactions**

 

Effective January 1,2008, the Company’s coinsurance reinsurance agreement with its unconsolidatedaffiliate American Heritage Life Insurance Company (“AHL”), which went intoeffect in 2004, was amended to include the assumption by the Company of certainaccident and health insurance policies. In accordance with this amendment, the Company recorded cash of $16million, a premium installment receivable of $5 million, DAC of $32 million,reserves for life-contingent contract benefits of $24 million and accruedliabilities of $2 million.  Since theCompany received assets in excess of net liabilities from an affiliate undercommon control, the Company recognized a gain of

 

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$27 million($18 million after-tax), which was recorded as a non-cash capital contributionresulting in an increase to additional capital paid-in on the Company’sCondensed Consolidated Statements of Financial Position.

 

**Debt**

 

On May 28, 2008, under an existingagreement with Kennett Capital, Inc. (“Kennett”), an unconsolidatedaffiliate of ALIC, ALIC sold Kennett a $50 million redeemable surplus noteissued by ALIC Reinsurance Company (“ALIC Re”), a wholly owned subsidiary ofALIC.  The surplus note is due June 1,2038 with an initial rate of 5.93% that will reset every ten years to the thencurrent ten year Constant Maturity Treasury yield (“CMT”), plus 2.09%.   As payment, Kennett issued a full recoursenote due June 1, 2038 to ALIC for the same amount with an initial interestrate of 5.73% that will reset every ten years to the then current ten year CMT,plus 1.89%.  The note due from Kennett isclassified as other investments and the related surplus note is classified aslong-term debt in the Condensed Consolidated Statements of Financial Position.

 

Effective May 8, 2008, the Company, AIC and the Corporationentered into a one-year Amended and Restated Intercompany Liquidity Agreement (“LiquidityAgreement”) replacing the Intercompany Liquidity Agreement between the Companyand AIC, dated January 1, 2008.  Theagreement allows for short-term advances of funds to be made between partiesfor liquidity and other general corporate purposes. It shall be automaticallyrenewed for subsequent one-year terms unless terminated by the parties.  The Liquidity Agreement does not establish acommitment to advance funds on the part of either party.  The Company and AIC each serve as a lenderand borrower and the Corporation serves only as a lender.  The maximum amount of advances each party maymake or receive is limited to $1 billion. Netting or offsetting of advances made and received is notpermitted.  Advances between the partiesare required to have specified due dates less than or equal to 364 days fromthe date of the advance and be payable upon demand by written request from thelender at least ten business days prior to the demand date.  The borrower may make prepayments of theoutstanding principal balance of an advance without penalty. Advances will bearinterest equal to or greater than the rate applicable to 30-day commercialpaper issued by the Corporation on the date the advance is made with anadjustment on the first day of each month thereafter.

 

**3.    Supplemental Cash FlowInformation**

 

Non-cash investment exchanges andmodifications, which primarily reflect refinancings of fixed income securitiesand mergers completed with equity securities and limited partnerships, totaled$9 million and $29 million for the six-month periods ended June 30, 2008and 2007, respectively.

 

Liabilities for collateral received inconjunction with the Company’s securities lending and other business activitiesand for funds received from the Company’s security repurchase businessactivities are reported in either other liabilities and accrued expenses orother invested assets as permitted under FSP FIN 39-1 in the CondensedConsolidated Statements of Financial Position. The accompanying cash flows areincluded in cash flows from operating activities in the Condensed ConsolidatedStatements of Cash Flows along with the activities resulting from management ofthe proceeds, which are as follows:

 
| ** **                                                             | ** ** | **Six months ended** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                             | ** ** | **June 30,**              | ** ** |
| **($ in millions)**                                          | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| Net change in fixed income securities                                  |       | $                              | 236        |   | $ | (732 | ) |
| Net change in short-term investments                                   |       | (527                           | )          | (446 | ) |
| Operating cash flow used                                               |       | $                              | (291       | ) | $ | (1,178 | ) |
|                                                                   |       |                           |       |   |   |
| Liabilities for collateral and security  repurchase, beginning of year |       | $                              | (1,817     | ) | $ | (2,294 | ) |
| Liabilities for collateral and security  repurchase, end of period     |       | (2,108                         | )          | (3,472 | ) |
| Operating cash flow provided                                           |       | $                              | 291        |   |   | $ | 1,178 |   |   |
|                                                                        |            |                                |            |  |  |  |  |  |  |

 

**4. Fair Value of Financial Assets and Financial Liabilities**

 

Themeasurement basis for a significant amount of the Company’s financial assets isfair value. Financial instruments measured at fair value on a recurring basisinclude:

 

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*Financial Assets*   Primarily investments including U.S.treasuries, U.S. equities, international equities, money market funds,corporates, municipals, U.S. government and agencies, commercialmortgage-backed securities (“CMBS”), preferred stock,  mortgage-backed securities (“MBS”), foreigngovernments, asset-backed securities (“ABS”), commercial paper, derivatives(exchange traded and over-the-counter (“OTC”)), and separate account assets.

 

*Financial Liabilities*   Primarily free-standingderivatives (exchange listed and OTC) and derivatives embedded in certaincontractholder liabilities.

 

Financialinstruments measured at fair value on a non–recurring basis include:

 

*Financial Assets*   Primarily mortgage loans and otherinvestments written-down to fair value in connection with recognizing other–than–temporaryimpairments.

 

*Financial Liabilities*   Includes certain reserves on aclosed block of policies expected to be transferred through a futurereinsurance agreement to an unrelated third party.

 

SFASNo. 157 is effective for fiscal years beginning after November 15,2007. The Company adopted the provisions of SFAS No. 157 as of January 1,2008 for its financial assets and financial liabilities that are measured atfair value.  SFAS No. 157:

 

·                 Defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date, andestablishes a framework for measuring fair value;

 

·                 Establishes a three-level hierarchy for fairvalue measurements based upon the transparency of inputs to the valuation as ofthe measurement date;

 

·                 Expands disclosures about financialinstruments measured at fair value.

 

In determining fair value, the Company principallyuses the market approach which generally utilizes market data for the same orsimilar instruments.  To a lesser extent,the Company uses the income approach which involves determining fair valuesfrom discounted cash flow methodologies. SFAS No. 157 establishes a hierarchy for inputs used in determiningfair value that maximize the use of observable inputs and minimizes the use ofunobservable inputs by requiring that observable inputs be used whenavailable.  Certain financial assets arenot carried at fair value on a recurring basis, including investments such asmortgage loans, limited partnership interests, bank loans and policy loans, andthus are only categorized in the fair value hierarchy when held at fair valueon a non-recurring basis.  In addition,equity options embedded in fixed income securities are not disclosed in thehierarchy with free-standing derivatives as the embedded derivatives arepresented as combined instruments in fixed income securities.

 

 Observable inputs are those used by marketparticipants in valuing financial instruments that are developed based onmarket data obtained from independent sources. In the absence of sufficient observable inputs, unobservable inputsreflect the Company’s estimates of the assumptions market participants woulduse in valuing financial assets and financial liabilities and are developedbased on the best information available in the circumstances.

 

Pursuantto SFAS No. 157, fair value is a market-based measure, considered from theperspective of a market participant who owns an asset or owes a liability.  Accordingly, when market observable data isnot readily available, the Company’s own assumptions are set to reflect thosethat market participants would be presumed to use in pricing the asset orliability at the measurement date.  TheCompany uses prices and inputs that are current as of the measurement date,including during periods of market disruption. In periods of market disruption, the ability to observe prices andinputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1to Level 2, or from Level 2 to Level 3.

 

Financialassets and financial liabilities recorded on the Condensed ConsolidatedStatements of Financial Position at fair value are categorized based on thereliability of inputs to the valuation techniques as follows:

 

*Level 1**        *Financial assets and financial liabilitieswhose values are based on unadjusted quoted prices for identical assets orliabilities in an active market that the Company can access.

 

*Level 2***        **Financial assets and financial liabilitieswhose values are based on the following:

 

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

b)  Quotedprices for identical or similar assets or liabilities in non-active markets; or

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

 

*Level 3**        *Financial assets and financial liabilitieswhose values are based on prices or valuation techniques that require inputsthat are both unobservable and significant to the overall fair valuemeasurement.  These inputs may reflectthe Company’s estimates of the assumptions that market participants would usein valuing the financial assets and financial liabilities.

 

Theavailability of observable inputs varies by instrument. In situations wherefair value is based on internally developed pricing models or inputs that areunobservable in the market, the determination of fair value requires morejudgment.  The degree of judgmentexercised by the Company in determining fair value is typically greatest forinstruments categorized in Level 3. In many instances, inputs used to measurefair value fall into different levels of the fair value hierarchy. In those instances, for disclosure purposes, the level in the fair valuehierarchy within which the fair value measurement is categorized is determinedbased on the lowest level input that is significant to the fair valuemeasurement in its entirety.

 

**Summaryof Significant Valuation Techniques for Financial Assets and FinancialLiabilities on a Recurring Basis**

 

**Level 1 Measurements**

 

FixedIncome Securities:  U.S. treasuries are in Level 1 and valuation isbased on unadjusted quoted prices for identical assets in active markets thatthe Company can access.

 

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

 

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

 

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

 

**Level 2 Measurements**

 

FixedIncome Securities:

 

*Corporate, including privately placed*: Valued based on inputs including quoted prices for identical or similarassets in markets that are not active. Also includes privately placed securities totaling $3.8 billion that arevalued based on market-observable external ratings from independent third partyrating agencies.

 

*Municipal:*  Externally rated municipals are valued basedon inputs including quoted prices for identical or similar assets in marketsthat are not active.  Included inmunicipals are $8 million of auction rate securities (“ARS”) other than thosebacked by student loans.  ARS backed bystudent loans are included in Level 3.

 

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

 

*CMBS*:  Valuation is principally based on inputsincluding quoted prices for identical or similar assets in markets that are notactive and are categorized as Level 2.

 

*Preferred Stock; MBS; Foreign Government; ABS – credit card and autoloans*:  Valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

Short-term: Commercial paper and other short-term are valued based on inputsincluding amortized cost, which approximates fair value, and quoted prices foridentical or similar assets in markets that are not active.

 

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

 

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OTCderivatives including interest rate swaps, foreign currency swaps, foreignexchange forward contracts, certain credit default swaps, and commodity swapsare valued using models that rely on inputs such as interest rate yield curves,currency rates, counterparty credit risk, and commodity prices that areobservable for substantially the full term of the contract.  The valuation techniques underlying themodels are widely accepted in the financial services industry and do notinvolve significant judgment.

 

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

 

**Level 3 Measurements**

 

FixedIncome Securities

 

*Corporate:*  Valued based on non–binding broker quotes andare categorized as Level 3.

 

*Corporate Privately Placed Securities:* Valued based on non-binding broker quotes and models that are widely accepted in the financialservices industry and use internally assigned credit ratings as inputs andinstrument specific inputs.  Instrumentspecific inputs used in internal fair value determinations include: couponrate, weighted average life, sector of the issuer and call provisions.  Privately placed securities are categorizedas Level 3 as a result of thesignificance of non-market observable inputs. The $10.8 billion of privately placed fixed income securities includedin Level 3 comprise $9.3 billion valued using an internal model and $1.5billion valued using non-binding broker quotes. The internally modeled securities are valued based on internal ratings,which are not observable in the market. Multiple internal ratings comprise a National Association of InsuranceCommissioners (“NAIC”) rating category and when used in the internal modelprovide a more refined determination of fair value.  The Company’s internal ratings are primarilyconsistent with the NAIC ratings which are generally updated annually.

 

*ABS RMBS; Alt–A**Residential Mortgage-backed Securities (“Alt-A”):* ABS RMBS and Alt-A are principally valuedbased on inputs including quoted prices for identical or similar assets inmarkets that exhibit less liquidity relative to those markets supporting Level2 fair value measurements.  Certain ABSRMBS and Alt-A 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, all ABSRMBS and Alt-A are categorized as Level 3.

 

*Other CDO; ABS 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, allCLO, ABS CDO, and Synthetic CDO are categorized as Level 3.

 

*CMBS;Commercial Real Estate Collateralized Debt Obligations (“CRE CDO”):* CRECDO, which are reported as CMBS, and other CMBS, are valued based onnon-binding broker quotes and are categorized as Level 3.

 

*Municipals:* Certain distressed municipal securities for which valuation is based onvaluation models that are widely accepted in the financial services industryand require projections of future cash flows that are not market–observable areincluded in Level 3.  Included in thiscategory are $745 million of ARS that are backed by student loans.  ARS backed by student loans are valued basedon a discounted cash flow model with certain inputs to the valuation model thatare significant to the valuation, butare not market observable, including estimates of future coupon rates ifauction failures continue, maturity assumptions, and illiquidity premium.

 

OtherInvestments:  Certain free-standing OTC derivatives, suchas caps, floors, certain credit default swaps and OTC options (includingswaptions), are valued using valuation models that are widely accepted in thefinancial services industry.  Inputsinclude non-market observable inputs such as volatility assumptions that aresignificant to the valuation of the instruments.

 

ContractholderFunds:  Derivatives embedded in annuity contracts arevalued internally using models widely accepted in the financial servicesindustry that determine a single bestestimate of fair value for a block of contractholder liabilities that containcertain embedded derivatives.  The modelsuse stochastically determined cash flows based on the contractual elements ofembedded derivatives and other applicable market data.  These are categorized as Level 3 as a result of the significance of non-marketobservable inputs.

 

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**FinancialAssets and Financial Liabilities on a Non-recurring Basis**

 

Mortgageloans, limited partnerships and other investments written–down to fair value inconnection with recognizing other–than–temporary impairments are primarilyvalued using valuation models that are widely accepted in the financialservices industry.  Inputs include non–marketobservable inputs such as credit spreads. At June 30, 2008, the fair value of mortgage loans, limitedpartnerships and other investments totaled $254 million and were categorized asLevel 3.

 

Reserves on a closed block of policies expected tobe transferred through a future reinsurance agreement to an unrelated thirdparty are valued based on significant non–observable inputs.  At June 30, 2008, the fair value ofReserves for life–contingent contract benefits on a closed block of policiestotaled $89 million and were categorized as Level 3.

 

The following table summarizes the Company’sfinancial assets and financial liabilities measured at fair value on arecurring and non-recurring basis as of June 30, 2008:

 
| ** **                                                 | ** ** | **Quoted  Prices in  Active  Markets for  Identical  Assets** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** | **Other  Valuations  and** | ** ** | **Balance as of** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| **($ in millions)**                              | ** ** | **(Level 1)**                                                      | ** ** | **(Level 2)**                         | ** ** | **(Level 3)**                    | ** ** | **Netting**                | ** ** | **June 30, 2008** | ** ** |
| **Financial assets:**                                      | ** ** | ** **                                                              | ** ** | ** **                                 | ** ** | ** **                            | ** ** | ** **                 | ** ** | ** **                  | ** ** |
| Fixed income securities                                    |       | $                                                                       | 463        |                                       | $          | 34,050                                |       | $                          | 17,360     |                        |       |   | $ | 51,873 |   |
| Equity securities                                          |       | 16                                                                      |       | 107                                        |       | 27                                    |       |                       |       | 150                         |       |
| Short–term investments                                |       | 396                                                                     |       | 4,609                                      |       | —                                |       |                       |       | 5,005                       |       |
| Other investments:                                         |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| Free-standing derivatives                                  |       | —                                                                  |       | 581                                        |       | 44                                    |       |                       |       | 625                         |       |
| **Total recurring basis assets**                           |       | 875                                                                     |       | 39,347                                     |       | 17,431                                |       |                       |       | 57,653                      |       |
| Non-recurring basis                                        |       | —                                                                  |       | —                                     |       | 254                                   |       |                       |       | 254                         |       |
| Valued at cost, amortized cost or using the  equity method |       |                                                                    |       |                                       |       |                                  |       | $                          | 13,242     |                        | 13,242     |   |
| Counterparty and cash collateral netting (1)               |       |                                                                    |       |                                       |       |                                  |       | (394                       | )          | (394                        | )          |
| **Total investments**                                      | ** ** | **875**                                                                 | ** ** | **39,347**                                 | ** ** | **17,685**                            | ** ** | **12,848**                 | ** ** | **70,755**                  | ** ** |
| Separate account assets                                    |       | 12,438                                                                  |       | —                                     |       | —                                |       | —                     |       | 12,438                      |       |
| Other assets                                               |       | 1                                                                       |       | —                                     |       | 2                                     |       | —                     |       | 3                           |       |
|                                                       |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| **Total financial assets**                                 | ** ** | **$**                                                                   | **13,314** | ** **                                 | **$**      | **39,347**                            | ** ** | **$**                      | **17,687** | ** **                  | **$**      | **12,848** | ** ** | **$** | **83,196** | ** ** |
| % of Total financial assets                                |       | 16.0                                                                    | %          | 47.3                                       | %          | 21.3                                  | %          | 15.4                       | %          | 100.0                       | %          |
|                                                       |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| **Financial liabilities:**                                 |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| Contractholder funds:                                      |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| Derivatives embedded in annuity contracts                  |       | $                                                                       | —     |                                       | $          | (50                                   | )          | $                          | (20        | )                           |       |   | $ | (70 | ) |
| Other liabilities:                                         |       |                                                                    |       |                                       |       |                                  |       |                       |       |                        |       |
| Free-standing derivatives                                  |       | —                                                                  |       | (398                                       | )          | (69                                   | )          |                       |       | (467                        | )          |
| Non-recurring basis                                        |       | —                                                                  |       | —                                     |       | (89                                   | )          |                       |       | (89                         | )          |
| Counterparty and cash collateral netting (1)               |       |                                                                    |       |                                       |       |                                  |       | $                          | 243        |                        | 243        |   |
| **Total financial liabilities**                            | ** ** | **$**                                                                   | **—** | ** **                                 | **$**      | **(448**                              | **)**      | **$**                      | **(178**   | **)**                       | **$**      | **243** | ** ** | **$** | **(383** | **)** |
| % of Total financial liabilities                           |       | 0.0                                                                     | %          | 117.0                                      | %          | 46.5                                  | %          | (63.5                      | )%         | 100.0                       | %          |

 

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(1)          In accordance with FSP FIN 39-1, the Company nets all fair value amountsrecognized for derivative instruments and fair value amounts recognized for theright to reclaim cash collateral or the obligation to return cashcollateral executed with the same counterparty under a master nettingagreement.  At June 30, 2008, the right to reclaim cash collateralwas offset by securities held, and the obligation to return collateral was $151million.

 

Asrequired by SFAS No. 157, when the inputs used to measure fair value fallwithin different levels of the hierarchy, the level within which the fair valuemeasurement is categorized is based on the lowest level input that issignificant to the fair value measurement in its entirety.  Thus, a Level 3 fair value measurement mayinclude inputs that are observable (Level 1 or Level 2) and unobservable (Level3).  Gains and losses for such assets andliabilities categorized within the Level 3 table may include changes in fairvalue that are attributable to both observable inputs (Level 1 and Level 2) andunobservable inputs (Level 3).  Nettransfers in and/or out of Level 3 are reported as having occurred at thebeginning of the period; therefore, all realized and unrealized gains andlosses on these securities for the period are reflected in the tablebelow.  Further, it should be noted thatthe following table does not take into consideration the effect of offsettingLevel 1 and Level 2 financial instruments entered into that economically hedgecertain exposures to the Level 3 positions.

 

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

 
| ** **                                         | ** ** | ** **                                        | ** ** | ** **                                                                                   | ** ** | ** **                                              | ** ** | ** **                                                        | ** ** | ** **                                                 | ** ** | ** **                                           | ** ** | **Total  Gains (Losses)**                                             | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | ** **                                        | ** ** | **Total realized and unrealized  Gains (Losses) included in:** | ** ** | ** **                                              | ** ** | **Net**                                                           | ** ** | ** **                                                 | ** ** | **included in  Net Income for**       | ** ** |
| **($ in millions)**                      | ** ** | **Balance as of  March 31,  2008** | ** ** | **Net  Income ****(1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  Sales, Issuances  and  Settlements, net** | ** ** | **Transfers  In and/or  (Out) of  Level 3** | ** ** | **Balance as of  June 30, 2008** | ** ** | **Instruments  Still Held at  June 30,  2008 ****(4)** | ** ** |
| **Financial  assets**                              |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                 |       |                                                                       |       |
| Fixed income  securities                           |       | $                                                 | 17,737     |                                                                                         | $          | (669                                                    | )          | $                                                                 | 196        |                                                       | $          | (501                                                 | )          | $                                                                          | 597        |   | $ | 17,360 |   | $ | (664 | ) |
| Equity securities                                  |       | 57                                                |       | (1                                                                                           | )          | (3                                                      | )          | 13                                                                |       | (39                                                        | )          | 27                                                   |       | (1                                                                         | )          |
| Other  investments:                                |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                 |       |                                                                       |       |
| Free-standing  derivatives, net                    |       | (35                                               | )          | —                                                                                       |       | —                                                  |       | 10                                                                |       | —                                                     |       | (25                                                  | )(2)       | 32                                                                         |       |
| **Total  investments**                             |       | 17,759                                            |       | (670                                                                                         | )          | 193                                                     |       | (478                                                              | )          | 558                                                        |       | 17,362                                               | (3)        | (633                                                                       | )          |
| Other assets                                       |       | 2                                                 |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                     |       | 2                                                    |       | —                                                                     |       |
| **Total  recurring Level 3 financial assets**      |       | $                                                 | 17,761     |                                                                                         | $          | (670                                                    | )          | $                                                                 | 193        |                                                       | $          | (478                                                 | )          | $                                                                          | 558        |   | $ | 17,364 |   | $ | (633 | ) |
|                                               |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                 |       |                                                                       |       |
| **Financial  liabilities**                         |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                 |       |                                                                       |       |
| Contractholder  funds:                             |       |                                              |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                 |       |                                                                       |       |
| Derivatives  embedded in annuity contracts         |       | $                                                 | (10        | )                                                                                            | $          | (11                                                     | )          | $                                                                 | —     |                                                       | $          | 1                                                    |       | $                                                                          | —     |   | $ | (20 | ) | $ | (11 | ) |
| **Total  recurring Level 3 financial liabilities** |       | $                                                 | (10        | )                                                                                            | $          | (11                                                     | )          | $                                                                 | —     |                                                       | $          | 1                                                    |       | $                                                                          | —     |   | $ | (20 | ) | $ | (11 | ) |

 

----

| (1) |   | The amounts above total $(681) million and  are reported in the Condensed Consolidated Statements of Operations as  follows: $(682) million in Realized capital gains and losses; $13 million in Net investment  income; $(1) million in Interest credited to contractholder funds; and  $(11) million in contract benefits.                                                                                                                                 |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Comprises $44 million of financial assets  and $(69) million of financial liabilities.                                                                                                                                                                                                                                                                                                                                                                            |
| (3) |   | Comprises $17.43 billion of investments and  $(69) million of free-standing derivatives included in financial liabilities.                                                                                                                                                                                                                                                                                                                                        |
| (4) |   | The amounts above represent gains and  losses included in net income for the period of time that the financial asset  or financial liability was determined to be in Level 3.  These gains and losses total $(644) million  and are reported in the Condensed Consolidated Statements of Operations as  follows:  $(646) million in Realized  capital gains and losses; $13 million in Net inve stment income; and $(11)  million in contract benefits. |

 

Thefollowing table provides a summary of changes in fair value during the six–monthperiod ended June 30, 2008 of Level 3 financial assets and financialliabilities held at fair value on a recurring basis at June 30, 2008.

 
| ** **                                         | ** ** | ** **                                         | ** ** | **Total realized and unrealized  Gains (Losses) included in:** | ** ** | ** **                                              | ** ** | **Net**                                                           | ** ** | ** **                                                 | ** ** | **Total  Gains (Losses)  included in  Net Income for** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in millions)**                      | ** ** | **Balance as of  January 1,  2008** | ** ** | **Net  Income ****(1)**                                                                 | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  Sales, Issuances  and  Settlements, net** | ** ** | **Transfers  In and/or  (Out) of  Level 3** | ** ** | **Balance as of  June 30, 2008**                       | ** ** | **Instruments  Still Held at  June 30,  2008 ****(4)** | ** ** |
| **Financial  assets**                              |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                                       |       |   |   |
| Fixed income  securities                           |       | $                                                  | 18,830     |                                                                                         | $          | (828                                                    | )          | $                                                                 | (545       | )                                                          | $          | (858                                                                       | )          | $ | 761 |   | $ | 17,360 |   | $ | (819 | ) |
| Equity securities                                  |       | 61                                                 |       | (2                                                                                           | )          | (6                                                      | )          | 13                                                                |       | (39                                                        | )          | 27                                                                         |       | (2 | ) |
| Other  investments:                                |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                                       |       |   |   |
| Free-standing  derivatives, net                    |       | (6                                                 | )          | (31                                                                                          | )          | —                                                  |       | 12                                                                |       | —                                                     |       | (25                                                                        | )(2)       | 14 |   |
| **Total  investments**                             |       | 18,885                                             |       | (861                                                                                         | )          | (551                                                    | )          | (833                                                              | )          | 722                                                        |       | 17,362                                                                     | (3)        | (807 | ) |
| Other assets                                       |       | 2                                                  |       | —                                                                                       |       | —                                                  |       | —                                                            |       | —                                                     |       | 2                                                                          |       | — |   |
| **Total  recurring Level 3 financial assets**      |       | $                                                  | 18,887     |                                                                                         | $          | (861                                                    | )          | $                                                                 | (551       | )                                                          | $          | (833                                                                       | )          | $ | 722 |   | $ | 17,364 |   | $ | (807 | ) |
|                                               |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                                       |       |   |   |
| **Financial  liabilities**                         |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                                       |       |   |   |
| Contractholder  funds:                             |       |                                               |       |                                                                                         |       |                                                    |       |                                                              |       |                                                       |       |                                                                       |       |   |   |
| Derivatives  embedded in annuity contracts         |       | $                                                  | 4          |                                                                                         | $          | (25                                                     | )          | $                                                                 | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (20 | ) | $ | (25 | ) |
| **Total  recurring Level 3 financial liabilities** |       | $                                                  | 4          |                                                                                         | $          | (25                                                     | )          | $                                                                 | —     |                                                       | $          | 1                                                                          |       | $ | — |   | $ | (20 | ) | $ | (25 | ) |

 

----

| (1) |   | The amounts above total $(886) million and  are reported in the Condensed Consolidated Statements of Operations as  follows: $(882) million in Realized capital gains and losses; $25 million in Net investment  income; $(4) million in Interest credited to contractholder funds and;  $(25) million in contract benefits. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Comprises $44 million of financial assets  and $(69) million of financial liabilities.                                                                                                                                                                                                                                            |
| (3) |   | Comprises $17.43 billion of investments and  $(69) million of free-standing derivatives included in financial liabilities.                                                                                                                                                                                                        |
| (4) |   | The amounts above represent gains and  losses included in net income for the period of time that the financial asset  or financial liability was determined to be in Level 3.  These gains and losses total $(832) million  and are reported in the Condensed Consolidated Statements of Operations                          |

 

13

----

 

asfollows:  $(831) million in Realizedcapital gains and losses; $25 million in Net investment income; $(1) millionin Interest credited to contractholder funds; and $(25) million in contractbenefits.

 

**5. ****Reinsurance**

 

The effects of reinsurance on premiums and contract charges are asfollows:

 
| ** **                                         | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                      | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums and contract charges**                  |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                             |       | $                                               | 569        |                                          | $          | 580 |   | $ | 1,128 |   | $ | 1,178 |   |
| Assumed                                            |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                                          |       | 15                                              |       | 4                                             |       | 30 |   | 8 |   |
| Non-affiliate                                      |       | 6                                               |       | 6                                             |       | 12 |   | 13 |   |
| Ceded—non-affiliate                           |       | (218                                            | )          | (238                                          | )          | (446 | ) | (464 | ) |
|                                               |       |                                            |       |                                          |       |   |   |   |   |
| Premiums and contract charges, net of  reinsurance |       | $                                               | 372        |                                          | $          | 352 |   | $ | 724 |   | $ | 735 |   |

 

The effects ofreinsurance on contract benefits are as follows:

 
| ** **                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**         | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contract benefits**                 |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                |       | $                                               | 488        |                                          | $          | 494 |   | $ | 983 |   | $ | 993 |   |
| Assumed                               |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                             |       | 9                                               |       | 1                                             |       | 18 |   | 5 |   |
| Non-affiliate                         |       | 8                                               |       | 6                                             |       | 14 |   | 14 |   |
| Ceded—non-affiliate              |       | (162                                            | )          | (170                                          | )          | (331 | ) | (307 | ) |
|                                  |       |                                            |       |                                          |       |   |   |   |   |
| Contract benefits, net of reinsurance |       | $                                               | 343        |                                          | $          | 331 |   | $ | 684 |   | $ | 705 |   |

 

The effects ofreinsurance on interest credited to contractholder funds are as follows:

 
| ** **                                                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                     | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest credited to contractholder funds**                  |       |                                            |       |                                          |       |   |   |   |   |
| Direct                                                         |       | $                                               | 551        |                                          | $          | 662 |   | $ | 1,164 |   | $ | 1,303 |   |
| Assumed                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Affiliate                                                      |       | 3                                               |       | 4                                             |       | 6 |   | 7 |   |
| Non-affiliate                                                  |       | 3                                               |       | 5                                             |       | 7 |   | 9 |   |
| Ceded—non-affiliate                                       |       | (8                                              | )          | (11                                           | )          | (18 | ) | (24 | ) |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Interest credited to contractholder funds,  net of reinsurance |       | $                                               | 549        |                                          | $          | 660 |   | $ | 1,159 |   | $ | 1,295 |   |

 

**6.   ****Guarantees and Contingent Liabilities**

** Guaranty funds**

 

Under state insurance guaranty fund laws, insurers doing business in astate can be assessed, up to prescribed limits, for certain obligations ofinsolvent insurance companies to policyholders and claimants.  Amounts assessed to each company aretypically related to its proportion of business written in each state.

 

The New York Liquidation Bureau (the “Bureau”) has publicly reportedthat Executive Life Insurance Company of New York (“Executive Life”), currentlyunder its jurisdiction as part of a 1992 court-ordered

 

14

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rehabilitation plan, may only be able to meet futureobligations of its annuity contacts for the next fifteen years. The shortfallis estimated to be in the range of $650 million to $750 million.  If Executive Life were to be declaredinsolvent in the future, the Company would likely have exposure to guarantyfund assessments or other costs.

 

Based on currently available information, the outcome of this situationis uncertain at this time.  The Bureaumay eventually take actions to address this situation that may lead to guarantyfund assessments or other costs to the Company. Under current law, the Company may be allowed to recoup a portion of theamount of any additional guaranty fund assessment in periods subsequent to therecognition of the assessment by offsetting future premium taxes.  The Company’s market share in New York wasapproximately 5.5% in 2006 based on industry annuity premium.

 

**Guarantees**

 

The Company owns certain fixedincome securities that obligate the Company to exchange credit risk or toforfeit principal due, depending on the nature or occurrence of specifiedcredit events for the referenced entities. In the event all such specified credit events were to occur, the Company’smaximum amount at risk on these fixed income securities, as measured by theamount of the aggregate initial investment, was $196 million at June 30,2008.  The obligations associated withthese fixed income securities expire at various times during the next sixyears.

 

Relatedto the disposal through reinsurance of substantially all of our variableannuity business to Prudential Financial, Inc. and its subsidiary in 2006,the Company has agreed to indemnify Prudential for certain pre–closingcontingent liabilities (including extra–contractual liabilities of the Companyand liabilities specifically excluded from the transaction) that the Companyhas agreed to retain.  In addition, theCompany will indemnify Prudential for certain post–closing liabilities that mayarise from the acts of the Company and its agents, including in connection withthe Company’s provision of transition services. The Reinsurance Agreements contain no limitations or indemnificationswith regard to insurance risk transfer, and transferred all of the future risksand responsibilities for performance on the underlying variable annuitycontracts to Prudential, including those related to benefit guarantees, inaccordance with the provisions of SFAS No. 113 “Accounting and Reportingfor Reinsurance of Short–Duration and Long–Duration Contracts”.  Management does not believe this agreementwill have a material adverse effect on results of operations, cash flows or thefinancial position of the Company.

 

In the normal course of business, the Companyprovides standard indemnifications to contractual counterparties in connectionwith numerous transactions, including acquisitions and divestitures.  The types of indemnifications typicallyprovided include indemnifications for breaches of representations and warranties,taxes and certain other liabilities, such as third party lawsuits.  The indemnification clauses are oftenstandard contractual terms and are entered into in the normal course ofbusiness based on an assessment that the risk of loss would be remote.  The terms of the indemnifications vary in durationand nature.  In many cases, the maximumobligation is not explicitly stated and the contingencies triggering theobligation to indemnify have not occurred and are not expected to occur.  Consequently, the maximum amount of theobligation under such indemnifications is not determinable.  Historically, the Company has not made anymaterial payments pursuant to these obligations.

 

The aggregate liability balance related toall guarantees was not material as of June 30, 2008.

 

**Regulation**

 

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

 

**Legal and regulatory proceedings and inquiries**

 

***Background***

 

The Company and certain affiliates are involved in a number oflawsuits, regulatory inquiries, and other legal proceedings arising out ofvarious aspects of its business.  Asbackground to the “Proceedings” sub-section below, please note the following:

 

15

----

 

·                  These matters raise difficult andcomplicated factual and legal issues and are subject to many uncertainties andcomplexities, including the underlying facts of each matter; novel legalissues; variations between jurisdictions in which matters are being litigated,heard, or investigated; differences in applicable laws and judicialinterpretations; the length of time before many of these matters might beresolved by settlement, through litigation or otherwise; 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 on these matters may also beaffected by decisions, verdicts, and settlements, and the timing of such decisions,verdicts and settlements, in other individual and class action lawsuits thatinvolve the Company, other insurers, or other entities and by other legal,governmental, and regulatory actions that involve the Company, other insurersor other entities.

 

·                  In the lawsuits, plaintiffs seek avariety of remedies including equitable relief in the form of injunctive andother remedies and monetary relief in the form of contractual andextra-contractual damages.  In some cases,the monetary damages sought include punitive damages.  Often specific information about the reliefsought, such as the amount of damages, is not available because plaintiffs havenot requested specific relief in their pleadings.  In Allstate’s experience, when specificmonetary demands are made in pleadings, they bear little relation to theultimate loss, if any, to the Company.

 

·                  In connection with regulatoryexaminations and proceedings, government authorities may seek various forms ofrelief, including penalties, restitution and changes in businesspractices.  The Company may not beadvised of the nature and extent of relief sought until the final stages of theexamination or proceeding.

 

·                  Forthe reasons specified above, it is often not possible to make meaningfulestimates of the amount or range of loss that could result from the mattersdescribed below in the “Proceedings” subsection.  The Company reviews these matters on anon-going basis and follows the provisions of SFAS No. 5, “Accounting forContingencies”, when making accrual and disclosure decisions.  When assessing reasonably possible andprobable outcomes, the Company bases its decisions on its assessment of theultimate outcome following all appeals.

 

·                  Dueto the complexity and scope of the matters disclosed in the “Proceedings”subsection below and the many uncertainties that exist, the ultimate outcome ofthese matters cannot be reasonably predicted. In the event of an unfavorable outcome in one or more of these matters,the ultimate liability may be in excess of amounts currently reserved and maybe material to the Company’s operating results or cash flows for a particularquarterly or annual period.  However,based on information currently known to it, management believes that theultimate outcome of all matters described below as they are resolved over timeis not likely to have a material adverse effect on the financial position ofthe Company.

 

**Proceedings**

 

Legal proceedings involving Allstate agencies andAIC may impact the Company, even when the Company is not directly involved,because the Company sells its products through a variety of distributionchannels including Allstate agencies. Consequently, information about the moresignificant of these proceedings is provided in the following paragraph.

 

AIC is defending certain matters relating toits agency program reorganization announced in 1999. These matters are invarious stages of development.

 

·                  Thesematters include a lawsuit filed in 2001 by the U.S. Equal EmploymentOpportunity Commission (“EEOC”) alleging retaliation under federal civil rightslaws (the “EEOC I” suit) and a class action filed in 2001 by former employeeagents alleging retaliation and age discrimination under the Age Discriminationin Employment Act (“ADEA”), breach of contract and ERISA violations (the “RomeroI” suit).  In 2004, in the

 

16

----

 

consolidatedEEOC I and Romero I litigation, the trial court issued a memorandum and orderthat, among other things, certified classes of agents, including a mandatoryclass of agents who had signed a release, for purposes of effecting the court’sdeclaratory judgment that the release is voidable at the option of the releasesigner.  The court also ordered that anagent who voids the release must return to AIC “any and all benefits receivedby the [agent] in exchange for signing the release.”  The court also stated that, “on theundisputed facts of record, there is no basis for claims of age discrimination.”  The EEOC and plaintiffs have asked the courtto clarify and/or reconsider its memorandum and order and in January 2007,the judge denied their request.  In June 2007,the court granted AIC’s motions for summary judgment.  Following plaintiffs’ filing of a notice ofappeal, the Third Circuit issued an order in December 2007 stating thatthe notice of appeal was not taken from a final order within the meaning of thefederal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the Courtalong with the merits of the appeal.

 

·                  TheEEOC also filed another lawsuit in 2004 alleging age discrimination withrespect to a policy limiting the rehire of agents affected by the agencyprogram reorganization (the “EEOC II” suit). In EEOC II, in 2006, the court granted partial summary judgment to theEEOC.  Although the court did notdetermine that AIC was liable for age discrimination under the ADEA, itdetermined that the rehire policy resulted in a disparate impact, reserving fortrial the determination on whether AIC had reasonable factors other than age tosupport the rehire policy.  In June 2008,the Eight Circuit Court of Appeals affirmed summary judgment in the EEOC’sfavor.  AIC filed a petition forrehearing *en banc*.

 

·                  AIC is also defending a certifiedclass action filed by former employee agents who terminated their employmentprior to the agency program reorganization. Plaintiffs allege that they were constructively discharged so thatAllstate could avoid paying ERISA and other benefits offered under thereorganization.  They claim that theconstructive discharge resulted from the implementation of agency standards,including mandatory office hours and a requirement to have licensed staffavailable during business hours.  Thecourt approved the form of class notice which was sent to approximately 1,800potential class members in November 2007. Fifteen individuals opted out. AIC’s motions for judgment on the pleadings were partially granted.  In May 2008,the Court granted summary judgment in AIC’s favor on all class claims.  Plaintiffs moved for reconsideration and inthe alternative to decertify the class. AIC opposed this motion and filed a motion for summary judgment withrespect to the remaining non–class claim.

 

·                  Aputative nationwide class action has also been filed by former employee agentsalleging various violations of ERISA,including a worker classification issue. These plaintiffs are challenging certain amendments to the AgentsPension Plan and are seeking to have exclusive agent independent contractorstreated as employees for benefit purposes.  This matter was dismissed with prejudice bythe trial court, was the subject of further proceedings on appeal, and wasreversed and remanded to the trial court in 2005.  In June 2007, the court granted AIC’smotion to dismiss the case.  Followingplaintiffs’ filing of a notice of appeal, the Third Circuit issued an order in December 2007stating that the notice of appeal was not taken from a final order within the meaningof the federal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the Courtalong with the merits of the appeal.

 

In all of these variousmatters, plaintiffs seek compensatory and punitive damages, and equitablerelief.  AIC has been vigorouslydefending these lawsuits and other matters related to its agency programreorganization.

 

**Other Matters**

** **

Various other legal,governmental, and regulatory actions, including state market conduct exams, andother governmental and regulatory inquiries are currently pending that involvethe Company and specific aspects of its conduct of business. Like other membersof the insurance industry, the Company is the target of a number of classaction lawsuits and other types of proceedings, some of which involve claimsfor substantial 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.

 

One or more ofthese matters could have an adverse effect on the Company’s operating resultsor cash flows for a particular quarterly or annual period.  However, based on information currently knownto it, management believes

 

17

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that the ultimate outcome ofall matters described in this “Other Matters” subsection, in excess of amountscurrently reserved, as they are resolved over time is not likely to have amaterial effect on the operating results, cash flows or financial position ofthe Company.

 

**7.   Other Comprehensive Income**

 

The componentsof other comprehensive (loss) income on a pre-tax and after-tax basis are asfollows:

 
| ** **                                                                   | ** ** | **Three months ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **($ in millions)**                                                | ** ** | **Pre-tax**                                         | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                         |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding losses arising during  the period, net of related offsets |       | $                                                   | (843       | ) | $ | 296 |   | $ | (547 | ) | $ | (437 | ) | $ | 153 |   | $ | (284 | ) |
| Less: reclassification adjustment of  realized capital gains and losses      |       | (902                                                | )          | 316 |   | (586 | ) | (42 | ) | 15 |   | (27 | ) |
| Unrealized net capital gains and losses                                      |       | 59                                                  |       | (20 | ) | 39 |   | (395 | ) | 138 |   | (257 | ) |
| Other comprehensive income (loss)                                            |       | $                                                   | 59         |   | $ | (20 | ) | 39 |   | $ | (395 | ) | $ | 138 |   | (257 | ) |
|                                                                         |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                                            |       |                                                |       |   |   | (368 | ) |   |   |   |   | 187 |   |
| Comprehensive loss                                                           |       |                                                |       |   |   | $ | (329 | ) |   |   |   |   | $ | (70 | ) |

 
| ** **                                                                       | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| **($ in millions)**                                                    | ** ** | **Pre-tax**                                       | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising  during the period, net of related offsets |       | $                                                 | (1,678     | ) | $ | 587 |   | $ | (1,091 | ) | $ | (286 | ) | $ | 100 |   | $ | (186 | ) |
| Less: reclassification adjustment of  realized capital gains and losses          |       | (1,121                                            | )          | 392 |   | (729 | ) | (4 | ) | 1 |   | (3 | ) |
| Unrealized net capital gains and losses                                          |       | (557                                              | )          | 195 |   | (362 | ) | (282 | ) | 99 |   | (183 | ) |
| Other comprehensive loss                                                         |       | $                                                 | (557       | ) | $ | 195 |   | (362 | ) | $ | (282 | ) | $ | 99 |   | (183 | ) |
|                                                                             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                |       |                                              |       |   |   | (483 | ) |   |   |   |   | 336 |   |
| Comprehensive (loss) income                                                      |       |                                              |       |   |   | $ | (845 | ) |   |   |   |   | $ | 153 |   |

 

18

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Shareholder of

Allstate Life Insurance Company:

 

We have reviewed theaccompanying condensed consolidated statement of financial position of AllstateLife Insurance Company and subsidiaries (the “Company”, an affiliate of TheAllstate Corporation) as of June 30, 2008, and the related condensedconsolidated statements of operations for the three-month and six-month periodsended June 30, 2008 and 2007, and the condensed consolidated statements ofcash flows for the six-month periods ended June 30, 2008 and 2007.  These interim financial statements are theresponsibility of the Company’s management.

 

We conducted our reviews in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  A review of interim financial informationconsists principally of applying analytical procedures and making inquiries ofpersons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the objective of which is theexpression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such anopinion.

 

Based on our reviews, we are not aware of any material modificationsthat should be made to such condensed consolidated interim financial statementsfor them to be in conformity with accounting principles generally accepted inthe United States of America.

 

We have previously audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), the consolidatedstatement of financial position of Allstate Life Insurance Company and subsidiariesas of December 31, 2007, and the related consolidated statements ofoperations and comprehensive income, shareholder’s equity, and cash flows forthe year then ended (not presented herein); and in our report dated March 13,2008, which report includes an explanatory paragraph relating to a change inthe Company’s method of accounting for uncertainty in income taxes andaccounting for deferred acquisition costs associated with internal replacementsin 2007, we expressed an unqualified opinion on those consolidated financialstatements.  In our opinion, theinformation set forth in the accompanying condensed consolidated statement offinancial position as of December 31, 2007 is fairly stated, in allmaterial respects, in relation to the consolidated statement of financialposition from which it has been derived.

 

 

/s/ Deloitte & Touche LLP

 

Chicago, Illinois

August 7, 2008

 

19

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**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2008 AND 2007**

 

**OVERVIEW**

 

The following discussion highlightssignificant factors influencing the condensed consolidated financial positionand results of operations of Allstate Life Insurance Company (referred to inthis document as “we”, “our”, “us”, or the “Company”). It should be read inconjunction with the condensed consolidated financial statements and notesthereto found under Part I. Item 1. contained herein, and with thediscussion, analysis, consolidated financial statements and notes thereto in Part I.Item 1. and Part II. Item 7. and Item 8. of the Allstate Life InsuranceCompany Annual Report on Form 10-K for 2007.  We operate as a single segment entity basedon the manner in which we use financial information to evaluate businessperformance and determine the allocation of resources.

 

**HIGHLIGHTS**

 

·                  Net loss of $368 million and $483 million inthe second quarter and first six months of 2008, respectively, driven byrealized capital losses, compared to net income of $187 million and $336million in the second quarter and first six months of 2007, respectively.

 

·                  Net realized capital losses of $932 millionand $1.36 billion in the second quarter and first six months of 2008, respectively,compared to net realized capital gains of $104 million and $126 million in thesecond quarter and first six months of 2007, respectively.

 

·                  Contractholderfund deposits totaled $4.06 billion and $6.75 billion for the second quarterand first six months of 2008, respectively, compared to $2.50 billion and $4.73billion for the second quarter and first six months of 2007, respectively.

 

·                  Investments asof June 30, 2008 decreased 2.3% from December 31, 2007 and netinvestment income decreased 12.4% and 8.1% in the second quarter and first sixmonths of 2008, respectively, compared to the same periods of 2007.

 

**OPERATIONS**

** **

Summarized financial data ispresented in the following table.

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**             | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                              |       |                                            |       |                                          |       |   |   |   |   |
| Premiums                                  |       | $                                               | 126        |                                          | $          | 122 |   | $ | 237 |   | $ | 277 |   |
| Contract charges                          |       | 246                                             |       | 230                                           |       | 487 |   | 458 |   |
| Net investment income                     |       | 922                                             |       | 1,053                                         |       | 1,914 |   | 2,083 |   |
| Realized capital gains and losses         |       | (932                                            | )          | 104                                           |       | (1,360 | ) | 126 |   |
| Total revenues                            |       | 362                                             |       | 1,509                                         |       | 1,278 |   | 2,944 |   |
|                                      |       |                                            |       |                                          |       |   |   |   |   |
| **Costs and expenses**                    |       |                                            |       |                                          |       |   |   |   |   |
| Contract benefits                         |       | (343                                            | )          | (331                                          | )          | (684 | ) | (705 | ) |
| Interest credited to contractholder funds |       | (549                                            | )          | (660                                          | )          | (1,159 | ) | (1,295 | ) |
| Amortization of DAC                       |       | 56                                              |       | (166                                          | )          | 6 |   | (281 | ) |
| Operating costs and expenses              |       | (101                                            | )          | (73                                           | )          | (191 | ) | (160 | ) |
| Restructuring and related charges         |       | —                                          |       | 1                                             |       | — |   | 1 |   |
| Total costs and expenses                  |       | (937                                            | )          | (1,229                                        | )          | (2,028 | ) | (2,440 | ) |
|                                      |       |                                            |       |                                          |       |   |   |   |   |
| Gain (loss) on disposition of operations  |       | —                                          |       | 2                                             |       | (9 | ) | 3 |   |
| Income tax benefit (expense)              |       | 207                                             |       | (95                                           | )          | 276 |   | (171 | ) |
| Net (loss) income                         |       | $                                               | (368       | )                                             | $          | 187 |   | $ | (483 | ) | $ | 336 |   |
|                                      |       |                                            |       |                                          |       |   |   |   |   |
| Investments  at June 30              |       |                                            |       |                                          |       | $ | 70,755 |   | $ | 75,343 |   |

 

*Net loss* inthe second quarter of 2008 of $368 million compared to net income of $187million in the same period of 2007, and a net loss of $483 million in the firstsix months of 2008, compared to net income of $336 million in the first sixmonths of 2007.  The change was the resultof the recognition of net realized capital losses in 2008 compared to netrealized capital gains in 2007.

 

20

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**Analysis of Revenues**Totalrevenues decreased 76.0% or $1.15 billion in the second quarter of 2008 anddecreased 56.6% or $1.67 billion in the first six months of 2008, compared tothe same periods of 2007, due mostly to the recognition of net realized capitallosses in the current year periods compared to net realized capital gains inthe prior year periods, and, to a much lesser extent, lower net investmentincome in the current year periods compared to the prior year periods.  Premiums and contract charges increased inthe second quarter of 2008 but declined in the first six months of 2008.

 

*Premiums*****representrevenues generated from traditional life insurance, immediate annuities withlife contingencies and other insurance products that have significant mortalityor morbidity risk.

 

*Contract charges* arerevenues generated from interest-sensitive and variable life insurance, fixed annuitiesand institutional products for which deposits are classified as contractholderfunds or separate accounts liabilities. Contract charges are assessed against the contractholder account valuesfor maintenance, administration, cost of insurance and surrender prior tocontractually specified dates.  As aresult, changes in contractholder funds are considered in the evaluation ofgrowth and as indicators of future levels of revenues.

 

The following table summarizes premiums andcontract charges by product.

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**               | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Premiums**                                |       |                                            |       |                                          |       |   |   |   |   |
| Traditional life insurance                  |       | $                                               | 71         |                                          | $          | 61 |   | $ | 131 |   | $ | 130 |   |
| Immediate annuities with life contingencies |       | 36                                              |       | 52                                            |       | 66 |   | 129 |   |
| Other                                       |       | 19                                              |       | 9                                             |       | 40 |   | 18 |   |
| **Total premiums**                          |       | 126                                             |       | 122                                           |       | 237 |   | 277 |   |
|                                        |       |                                            |       |                                          |       |   |   |   |   |
| **Contract charges**                        |       |                                            |       |                                          |       |   |   |   |   |
| Interest-sensitive life insurance           |       | 232                                             |       | 210                                           |       | 460 |   | 420 |   |
| Fixed annuities                             |       | 13                                              |       | 19                                            |       | 26 |   | 37 |   |
| Variable annuities                          |       | 1                                               |       | 1                                             |       | 1 |   | 1 |   |
| **Total contract charges (1)**              |       | 246                                             |       | 230                                           |       | 487 |   | 458 |   |
|                                        |       |                                            |       |                                          |       |   |   |   |   |
| **Total premiums and contract charges**     |       | $                                               | 372        |                                          | $          | 352 |   | $ | 724 |   | $ | 735 |   |

 

----

(1)          Totalcontract charges for the second quarter of 2008 and 2007 include contractcharges related to the cost of insurance of $164 million and $150 million,respectively.  Total contract charges forthe first six months of 2008 and 2007 include contract charges related to thecost of insurance of $327 million and $300 million, respectively.

 

Total premiums increased 3.3% and decreased14.4% in the second quarter and first six months of 2008, respectively,compared to the same periods of 2007.  Inthe second quarter of 2008, higher sales of traditional life insurance and increasedpremium assumed from a reinsurance agreement with an unconsolidated affiliatewere partially offset by a decline in sales of life contingent immediateannuities due to competitive market conditions. In the first six months of 2008, a decline in sales of life contingentimmediate annuities and higher reinsurance premiums on life insurance werepartially offset by increased premium assumed from a reinsurance agreement withan unconsolidated affiliate.

 

Contract charges increased 7.0% and 6.3% inthe second quarter and first six months of 2008, respectively, compared to thesame periods of 2007 due primarily to higher contract charges oninterest-sensitive life insurance policies resulting from increased contractcharge rates and growth in business in force, partially offset by decreased contractcharges on fixed annuities resulting primarily from lower surrender charges.

 

21

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

 

The following table shows thechanges in contractholder funds.

 
| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Contractholder funds, beginning balance**                    |       | $                                               | 60,191     |                                          | $          | 61,014 |   | $ | 60,464 |   | $ | 60,565 |   |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| **Deposits**                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Fixed annuities                                                |       | 1,237                                           |       | 879                                           |       | 1,923 |   | 1,575 |   |
| Institutional products (funding agreements)                    |       | 2,498                                           |       | 1,300                                         |       | 4,158 |   | 2,500 |   |
| Interest-sensitive life insurance                              |       | 325                                             |       | 323                                           |       | 665 |   | 655 |   |
| Other                                                          |       | 1                                               |       | 1                                             |       | 1 |   | 1 |   |
| Total deposits                                                 |       | 4,061                                           |       | 2,503                                         |       | 6,747 |   | 4,731 |   |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| **Interest credited**                                          |       | 586                                             |       | 659                                           |       | 1,197 |   | 1,304 |   |
|                                                           |       |                                            |       |                                          |       |   |   |   |   |
| **Maturities, benefits, withdrawals and other  adjustments**   |       |                                            |       |                                          |       |   |   |   |   |
| Maturities and retirements of institutional  products          |       | (2,243                                          | )          | (1,243                                        | )          | (4,130 | ) | (1,995 | ) |
| Benefits                                                       |       | (419                                            | )          | (416                                          | )          | (880 | ) | (831 | ) |
| Surrenders and partial withdrawals                             |       | (1,051                                          | )          | (1,120                                        | )          | (2,034 | ) | (2,111 | ) |
| Contract charges                                               |       | (202                                            | )          | (183                                          | )          | (399 | ) | (365 | ) |
| Net transfers from separate accounts                           |       | 7                                               |       | 3                                             |       | 12 |   | 6 |   |
| Fair value hedge adjustments for  institutional products       |       | (67                                             | )          | (17                                           | )          | (1 | ) | (34 | ) |
| Other adjustments (1)                                          |       | 23                                              |       | (27                                           | )          | (90 | ) | (97 | ) |
| Total maturities, benefits, withdrawals and  other adjustments |       | (3,952                                          | )          | (3,003                                        | )          | (7,522 | ) | (5,427 | ) |
| **Contractholder funds, ending balance**                       |       | $                                               | 60,886     |                                          | $          | 61,173 |   | $ | 60,886 |   | $ | 61,173 |   |

 

----

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

 

Contractholder funds increased 1.2% in the second quarter of 2008,compared to an increase of 0.3% in the second quarter of 2007, and increased0.7% in the first six months of 2008, compared to an increase of 1.0% in thesame period in the prior year.  Averagecontractholder funds decreased 0.9% and 0.3% in the second quarter and firstsix months of 2008, respectively, compared to the same periods of 2007.

 

Contractholder deposits increased 62.2% and 42.6% in the second quarterand first six months of 2008, respectively, compared to the same periods of2007.  These increases were primarily dueto higher deposits on institutional products and, to a lesser extent, higherdeposits on fixed annuities.  Deposits oninstitutional products increased 92.2% and 66.3% in the second quarter andfirst six months of 2008, respectively, compared to the same periods of2007.  Sales of our institutionalproducts vary from period to period based on management’s assessment of marketconditions, investor demand and operational priorities. Deposits on fixedannuities increased 40.7% and 22.1% in the second quarter and first six monthsof 2008, respectively, compared to the same periods of 2007, due primarily toan improved sales environment for fixed annuities relative to competingproducts resulting from a steeper interest rate yield curve.

 

22

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Maturities andretirements of institutional products increased 80.5% and 107.0% in the secondquarter and first six months of 2008, respectively, compared to the sameperiods in the prior year.  During thesecond quarter and first six months of 2008, we acquired in the secondarymarket and retired $1.14 billion and $2.39 billion, respectively, ofinstitutional market deposits for which investors had elected to non-extendtheir maturity.  In addition, $986 millionhave been called and will be retired in July 2008.  Total non-extended institutional marketdeposits were $3.12 billion as of June 30, 2008, all of which become dueno later than the end of the first quarter of 2009.  We have accumulated, and expect to maintain,short-term investments to retire these obligations. We expect reduced futureearnings on our institutional products, because the crediting rate on contractsissued during 2008 is higher than the crediting rate on contracts that havebeen or will be retired during the year.

 

Surrenders andpartial withdrawals decreased 6.2% and 3.6% in the second quarter and first sixmonths of 2008, respectively, compared to the same periods of 2007.  These declines were mostly due to lowersurrenders and partial withdrawals on fixed annuities, partially offset byhigher surrenders and partial withdrawals on interest-sensitive lifeproducts.  The annualized surrender andpartial withdrawal rate on deferred fixed annuities and interest-sensitive lifeinsurance products, based on the beginning of period contractholder funds, was9.7% and 9.9% for the first six months of 2008 and 2007, respectively.

 

*Net investment income* decreased 12.4%and 8.1% in the second quarter and first six months of 2008, respectively,compared to the same periods of 2007. The declines were primarily due to lower investment yields on floatingrate assets, lower yields on increased short-term investment balances held tooffset reduced liquidity in some asset classes and the maturity ofinstitutional markets funding agreements, and lower investment balancesreflecting dividends paid to our parent Allstate Insurance Company (“AIC”) in2007.

 

*Realizedcapital gains and losses* reflected net losses of $932million and $1.36 billion in the second quarter and first six months of 2008,respectively, compared with net gains of $104 million and $126 million in thesecond quarter and first six months of 2007, respectively.  For further discussion of realized capitalgains and losses, see the Investments section of MD&A.

 

**Analysis of Costs and Expenses** Total costs and expenses decreased 23.8% and16.9% in the second quarter and first six months of 2008, respectively,compared with the same periods of 2007, due mostly to lower amortization of deferredpolicy acquisition costs (“DAC”) andinterest credited to contractholder funds partially offset by higher operatingcosts and expenses.

 

*Contract benefits* increased 3.6% or $12 million in the secondquarter of 2008 compared to the second quarter of 2007 and decreased 3.0% or$21 million in the first six months of 2008 compared to the same period in2007.  The increase in the second quarterof 2008 was due to higher contract benefits on life insurance productsresulting primarily from increased insurance in-force and slightly unfavorablemortality experience, partially offset by lower contract benefits on annuitiesdue primarily to the impact of lower sales of immediate annuities with lifecontingencies on reserve changes partly offset by unfavorable mortalityexperience.  The decrease in the firstsix months of 2008 was due to lower contract benefits on annuities resultingprimarily from the impact of lower sales of immediate annuities with lifecontingencies on reserve changes, partially offset by higher contract benefitson life insurance products due primarily to increased insurance in-force andslightly unfavorable mortality experience, partially offset by the recognitionin the prior year of litigation related costs in the form of additional policybenefits.

 

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 $137 millionand $138 million in the second quarter of 2008 and 2007, respectively, andtotaled $276 million and $275 million in the first six months of 2008 and 2007,respectively.  The benefit spread byproduct group is disclosed in the following table.

 
| ** **                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)** | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Life insurance                |       | $                                               | 92         |                                          | $          | 85 |   | $ | 182 |   | $ | 161 |   |
| Annuities                     |       | (8                                              | )          | (6                                            | )          | (26 | ) | (14 | ) |
| Total benefit spread          |       | $                                               | 84         |                                          | $          | 79 |   | $ | 156 |   | $ | 147 |   |

 

23

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*Interest credited tocontractholder funds*decreased 16.8% or $111 million in the second quarter of 2008 compared to thesecond quarter of 2007 and 10.5% or $136 million in the first six months of2008 compared to the same period of 2007. These decreases were due primarily to a decline in averagecontractholder funds and lower weighted average interest crediting rates oninstitutional products due to declines in market interest rates on floatingrate obligations.  Amortization ofdeferred sales inducements (“DSI”) reflected a credit to income of $24 millionand $15 million in the second quarter and first six months of 2008,respectively, compared to a charge to income of $18 million and $29 million inthe second quarter and first six months of 2007, respectively. The changes of$42 million and $44 million in the second quarter and first six months of 2008,respectively, compared to the same periods in the prior year, werepredominantly the result of realized capital losses recorded in the currentyear periods on assets that support fixed annuities. We expect an increasedrate of DSI amortization in future periods as a result of the deceleration ofamortization recorded in the second quarter of 2008.

 

In order to analyze theimpact of net investment income and interest credited to policyholders on netincome, we review the difference between net investment income and the sum ofinterest credited to contractholder funds and the implied interest on immediateannuities with life contingencies, which is included as a component of contractbenefits on the Condensed Consolidated Statements of Operations (“investmentspread”).

 

The investment spread byproduct group is shown in the following table.

 
| ** **                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                            | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Annuities                                                |       | $                                               | 132        |                                          | $          | 129 |   | $ | 247 |   | $ | 258 |   |
| Life insurance                                           |       | 14                                              |       | 12                                            |       | 29 |   | 29 |   |
| Institutional products                                   |       | 16                                              |       | 20                                            |       | 43 |   | 45 |   |
| Net investment income on investments  supporting capital |       | 74                                              |       | 94                                            |       | 160 |   | 181 |   |
| Total investment spread                                  |       | $                                               | 236        |                                          | $          | 255 |   | $ | 479 |   | $ | 513 |   |

 

To further analyze investment spreads, thefollowing table summarizes the weighted average investment yield on assetssupporting product liabilities and capital, interest crediting rates oninvestment type products and investment spreads on investment type products forthe three months ended June 30.

** **
| ** **                                                           | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 6.1                                              | %          | 6.2                                                          | %          | 4.6                                                | %          | 4.7 | % | 1.5 | % | 1.5 | % |
| Deferred fixed annuities                                             |       | 5.5                                              |       | 5.8                                                          |       | 3.8                                                |       | 3.7 |   | 1.7 |   | 2.1 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 6.9                                              |       | 7.2                                                          |       | 6.5                                                |       | 6.6 |   | 0.4 |   | 0.6 |   |
| Institutional products                                               |       | 3.9                                              |       | 6.0                                                          |       | 3.2                                                |       | 5.1 |   | 0.7 |   | 0.9 |   |
| Investments supporting capital, traditional  life and other products |       | 5.5                                              |       | 6.3                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

The following table summarizes the weightedaverage investment yield on assets supporting product liabilities and capital,interest crediting rates on investment type products and investment spreads oninvestment type products for the six months ended June 30.

 
| ** **                                                           | ** ** | **Weighted Average  Investment Yield** | ** ** | **Weighted Average  Interest Crediting Rate** | ** ** | **Weighted Average  Investment Spreads** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 6.1                                              | %          | 6.2                                                          | %          | 4.6                                                | %          | 4.6 | % | 1.5 | % | 1.6 | % |
| Deferred fixed annuities                                             |       | 5.6                                              |       | 5.8                                                          |       | 3.7                                                |       | 3.7 |   | 1.9 |   | 2.1 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 6.9                                              |       | 7.1                                                          |       | 6.5                                                |       | 6.6 |   | 0.4 |   | 0.5 |   |
| Institutional products                                               |       | 4.5                                              |       | 6.0                                                          |       | 3.7                                                |       | 5.1 |   | 0.8 |   | 0.9 |   |
| Investments supporting capital, traditional  life and other products |       | 5.8                                              |       | 5.9                                                          |       | N/A                                                |       | N/A |   | N/A |   | N/A |   |

 

24

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The following table summarizes our productliabilities as of June 30 and indicates the account value of thosecontracts and policies in which an investment spread is generated.

 
| ** **                                                     | ** ** | **As of June 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|
| **($ in millions)**                                  | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Immediate fixed annuities with life  contingencies             |       | $                                 | 8,328      |   | $ | 8,241 |   |
| Other life contingent contracts and other                      |       | 4,020                             |       | 3,840 |   |
| Reserve for life-contingent contract  benefits                 |       | $                                 | 12,348     |   | $ | 12,081 |   |
|                                                           |       |                              |       |   |   |
| Interest-sensitive life                                        |       | $                                 | 9,117      |   | $ | 8,668 |   |
| Deferred fixed annuities                                       |       | 34,049                            |       | 35,003 |   |
| Immediate fixed annuities without life  contingencies          |       | 3,864                             |       | 3,818 |   |
| Institutional products                                         |       | 13,266                            |       | 13,301 |   |
| Fair value adjustments related to fair  value hedges and other |       | 590                               |       | 383 |   |
| Contractholder funds                                           |       | $                                 | 60,886     |   | $ | 61,173 |   |

 

*Amortization of DAC*reflected a credit to income of $56 millionin the second quarter of 2008 compared to a charge to income of $166 million inthe second quarter of 2007.  For thefirst six months of 2008 and 2007, amortization of DAC reflected a credit toincome of $6 million and a charge to income of $281 million, respectively.  The changes of $222 million and $287 millionin the second quarter and first six months of 2008, respectively, compared tothe same periods in the prior year, were predominantly the result of reducedactual gross profits for fixed annuities and interest-sensitive life insuranceproducts due to realized capital losses recorded in the current yearperiods.  For the six month period, thechange was also impacted by an increase in amortization deceleration (credit toincome) of $11 million due to our annual comprehensive review of DACassumptions (commonly referred to as “DAC unlocking”). We expect an increasedrate of DAC amortization in future periods as a result of the deceleration ofamortization recorded in the second quarter of 2008.

 

Accretion in the current year periods andamortization in the prior year periods of DAC related to realized capital gainsand losses increased income by $171 million and $224 million, pre-tax, in thesecond quarter and first six months of 2008, respectively, compared to adecrease to income of $20 million, pre-tax, in both the second quarter andfirst six months of 2007.  The impact ofrealized capital gains and losses on amortization of DAC is dependent upon therelationship between the assets that give rise to the gain or loss and theproduct liability supported by the assets. Fluctuations result from changes in the impact of realized capital gainsand losses on actual and expected gross profits.

 

In accordance with our annual comprehensivereview of DAC assumptions, in the first six months of 2008, the Companyrecognized net amortization deceleration totaling $23 million, including $17million for fixed annuities and $6 million for interest-sensitive lifeinsurance products.  In the first sixmonths of 2007, net amortization deceleration totaled $12 million and includednet amortization deceleration of $17 million for interest-sensitive lifeinsurance products and net amortization acceleration of $5 million for fixedannuities.  The first six months of 2008net amortization deceleration of $17 million on fixed annuities was dueprimarily to higher than expected investment spreads partially offset byincreased expenses.  The first six monthsof 2008 net amortization deceleration of $6 million on interest-sensitive lifeinsurance products was due to higher than expected benefit spreads partiallyoffset by increased expenses.

 

*Operating costs and expenses*increased 38.4% and 19.4% in the second quarter and first six months of 2008,respectively, compared to the same periods of 2007.   The following table summarizes operatingcosts and expenses.

 
| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**      | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                               |       |                                            |       |                                          |       |   |   |   |   |
| Non-deferrable acquisition costs   |       | $                                               | 19         |                                          | $          | 22 |   | $ | 40 |   | $ | 48 |   |
| Other operating costs and expenses |       | 82                                              |       | 51                                            |       | 151 |   | 112 |   |
| Total operating costs and expenses |       | $                                               | 101        |                                          | $          | 73 |   | $ | 191 |   | $ | 160 |   |

 

25

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Non-deferrable acquisition costs decreased13.6% or $3 million in the second quarter and decreased 16.7% or $8 million inthe first six months of 2008, compared to the same periods of 2007, primarilydue to lower non-deferrable commissions. Other operating costs and expenses increased 60.8% or $31 million in thesecond quarter and 34.8% or $39 million in the first six months of 2008,compared to the same periods of 2007, due primarily to increased spending onconsumer research, product development, marketing and technology related to theeffort to reinvent retirement for consumers.

 

*Loss on disposition of operations*for the first six months of 2008 totaled $9 million and was comprised primarilyof losses associated with the anticipated disposition of our direct responselong-term care business that is currently held for sale.  In the second quarter and first six months of2007, a gain on disposition of operations of $2 million and $3 million, respectively,was recognized that primarily included amortization of a deferred reinsurancegain associated with a prior period disposition.

 

*Income tax benefit*of $207 million and $276 million was recognized for the second quarter andfirst six months of 2008, respectively, compared to income tax expense of $95million and $171 million in the second quarter and first six months of 2007,respectively.  The change reflects theshift from net pre-tax income in the prior year to a net pre-tax loss in thecurrent year.

 

**INVESTMENTS**

 

Wedeveloped additional risk mitigation and return optimization programs in thesecond quarter of 2008 in response to an altered outlook for continued weaknessin the U.S. financial markets and economy including continued volatility in thefinancial markets, continued reduced liquidity in certain asset classes andfurther unfavorable economic trends.  Inaddition, the potential for systemic investment supply and demand imbalanceshas remained above normal due to the deteriorating credit strength of financialinstitutions.  The risk mitigation andreturn optimization programs are designed to protect certain portions of ourinvestment portfolio from significant decreases in value. They consist ofpotential future reductions in certain real estate and financial-related marketsectors.  These actions will position usto take advantage of market opportunities and also will help protect ourinvestment portfolio from the continued turmoil in the financial markets. Wewill monitor the progress of these programs as market and economic conditionscontinue to develop and will adapt our decisions as appropriate.

 

Therisk mitigation and return optimization programs were designed to reduce TheAllstate Corporation’s exposure to residential and commercial real estate andfinancial related markets including approximately $3 billion of amortized costheld by the Company, prior to change in intent write-downs.  A comprehensive review identified specificinvestments that could be significantly impacted by continued deterioration inthe economy including certain real estate and financial-related market sectorsthat may be sold. This includes a portion of our residential and commercialreal estate securities including securities collateralized by residential andcommercial mortgage loans, mortgage loans and securities issued by financialinstitutions.   As a result, we havechange in intent write-downs on securities with a fair value of approximately$2.64 billion at June 30, 2008. Approximately $714 million of realizedcapital losses were recognized in the second quarter of 2008 related to ourchange in intent write-downs, with minimal net impact on shareholder’s equityas these investments were carried at fair value with unrealized lossesreflected within accumulated other comprehensive income at March 31, 2008.

 

AtJune 30, 2008, our exposure to residential and commercial real estate isapproximately $21.8 billion, comprised primarily of mortgage-backed securities(“MBS”), commercial mortgage-backed securities (“CMBS”), asset-backedresidential mortgage-backed securities (“ABS RMBS”), asset-backedcollateralized debt obligations (“ABS CDO”) and mortgage loans.  Our exposure to financial-related market sectorstotaled approximately $9 billion at June 30, 2008, and includes fixedincome and equity holdings in banks, brokerages, finance companies andinsurance.

 

Anyfunds raised from the eventual disposition of these securities will be investedin accordance with our asset-liability management strategies and the initialstage of our enhanced enterprise-wide asset allocation (“EAA”) strategy. Thesestrategies identify risks and return needs across the Company and considercross-correlation impacts in determining an efficient mix of assets for theenterprise as a whole.  The workassociated with these strategies is ongoing, and implementation will occur asmarket opportunities arise.  To theextent markets remain unstable, we will invest in high quality, lower riskinvestments over the short-term.  Netinvestment income from potential reinvested funds may be lower as proceedsinvested at current yields could be lower than the yields on the investmentswritten-down.

 

26

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An important component of our financial results is the return on ourinvestment portfolio.  The composition ofthe investment portfolio at June 30, 2008 is presented in the table below.

 
| **($ in millions)**     | ** ** | **Investments** | ** ** | **Percent to  total** | ** ** |
|-----------------------------------|------------|-----------------|------------|----------------------------|------------|
| Fixed income securities (1)       |       | $               | 51,873     |                       | 73.3       | % |
| Mortgage loans                    |       | 9,739           |       | 13.8                       |       |
| Equity securities (2)             |       | 150             |       | 0.2                        |       |
| Limited partnership interests (3) |       | 1,150           |       | 1.6                        |       |
| Short-term                        |       | 5,599           |       | 7.9                        |       |
| Policy loans                      |       | 773             |       | 1.1                        |       |
| Other                             |       | 1,471           |       | 2.1                        |       |
| Total                             |       | $               | 70,755     |                       | 100.0      | % |

 

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(1)          Fixed income securitiesare carried at fair value.  Amortizedcost basis for these securities was $52.89 billion.

(2)          Equity securities arecarried at fair value.  Cost basis forthese securities was $150 million.

(3)          We have commitments toinvest in additional limited partnerships totaling $1.11 billion at June 30,2008.

 

Totalinvestments decreased to $70.76 billion at June 30, 2008 from $72.41billion at December 31, 2007, due to unrealized net capital losses and netrealized capital losses, partially offset by increased funds associated withcollateral received in conjunction with securities lending.

 

Totalinvestments at amortized cost related to collateral received in connection withsecurities lending business activities and collateral posted by counterpartiesrelated to derivative transactions increased to $2.11 billion at June 30,2008, from $1.82 billion at December 31, 2007.  As of June 30, 2008 and December 31,2007, these investments arecarried at fair value and classified in fixed income securities totaling $1.27billion and $1.57 billion, respectively, and short-term investments totaling$758 million and $219 million, respectively.

 

Fixed incomesecurities by type are listed in the table below.

 
| **($ in millions)** | ** ** | **June 30,  2008** | ** ** | **% to Total  Investments** | ** ** | **December 31,  2007** | ** ** | **% to Total  Investments** | ** ** |
|-------------------------------|------------|-------------------------|------------|---------------------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| U.S. government and agencies  |       | $                       | 3,643      |                                  | 5.2        | %                           | $          | 3,728                                 |       | 5.2 | % |
| Municipal                     |       | 4,055                   |       | 5.7                                   |       | 4,311                       |       | 6.0                                   |       |
| Corporate                     |       | 28,758                  |       | 40.6                                  |       | 31,735                      |       | 43.8                                  |       |
| Foreign government            |       | 2,002                   |       | 2.8                                   |       | 2,185                       |       | 3.0                                   |       |
| MBS                           |       | 3,150                   |       | 4.5                                   |       | 3,490                       |       | 4.8                                   |       |
| CMBS                          |       | 5,918                   |       | 8.4                                   |       | 7,388                       |       | 10.2                                  |       |
| ABS                           |       | 4,333                   |       | 6.1                                   |       | 5,603                       |       | 7.7                                   |       |
| Redeemable preferred stock    |       | 14                      |       | —                                |       | 29                          |       | —                                |       |
| Total fixed income securities |       | $                       | 51,873     |                                  | 73.3       |                        | $          | 58,469                                |       | 80.7 | % |

 

At June 30, 2008, 95.5% of the fixed income securities portfoliowas rated investment grade, which is defined as a security having a rating fromthe National Association of Insurance Commissioners (“NAIC”) of 1or 2; a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBBfrom Standard and Poor’s (“S&P’s”), Fitch or Dominion or a rating of aaa,aa, a or bbb from A.M. Best; or a comparable internal rating if anexternally provided rating is not available.

 

Duringthe second quarter of 2008, certain financial markets continued to experienceprice declines due to market and liquidity disruptions.   We experienced this illiquidity anddisruption particularly in our prime residential mortgage-backed securities (“Prime”),Alt-A residential mortgage-backed securities (“Alt-A”), commercial real estatecollateralized debt obligations (“CRE CDO”), ABS RMBS and ABS CDOportfolios.  These portfolios totaled$3.39 billion, or less than 5.0% of our total investments at June 30,2008.  Certain other asset-backed andreal estate-backed securities markets experienced illiquidity, but to a lesserdegree.

 

Wedetermine the fair values of securities comprising the illiquid portfolios byobtaining information from an independent third-party valuation serviceprovider and brokers. We confirmed the reasonableness of the fair value ofthese portfolios as of June 30, 2008 by analyzing available marketinformation including, but not limited to,

 

27

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collateralquality, anticipated cash flows, credit enhancements, default rates, lossseverities, securities’ relative position within their respective capitalstructures, and credit ratings from statistical rating agencies.

 

Investment write-downs during the second quarter of2008 were recorded on our Alt-A, CRE CDO, ABS RMBS and ABS CDO totaling $2million, $39 million, $125 million and $3 million, respectively.  Investment write-downs during the first sixmonths of 2008 were recorded on our Prime, Alt-A, CRE CDO, ABS RMBS and ABS CDOtotaling $9 million, $41 million, $39 million, $146 million and $63 million,respectively.  Change in intentwrite-downs included losses on our Prime totaling $8 million, Alt-A totaling$29 million, CRE CDO totaling $248 million and ABS RMBS totaling $132 millionfor the three months ended June 30, 2008. We continue to believe that the unrealized losses on these securitiesare not necessarily predictive of the ultimate performance of the underlyingcollateral.  In the absence of furtherdeterioration in the collateral relative to our positions in the securities’respective capital structures, which could be other-than-temporary, theunrealized losses should reverse over the remaining lives of the securities.

 

The cash flows of the underlyingmortgages or collateral for MBS, CRE CDO and ABS are generally applied in apre-determined order and are designed so that each security issued qualifiesfor a specific original rating.  Thesecurity issue is typically referred to as the “class”.  For example, the “senior” portion or “top” ofthe capital structure which would originally qualify for a rating of Aaa isreferred to as the “Aaa class” and typically has priority in receiving theprincipal repayments on the underlying mortgages.  In addition, the portion of the capitalstructure originally rated Aaa may further be divided into multiplesub-classes, “super senior”, “senior” ,”senior support” for Prime and Alt-Aissues, and  “first”, “second”, “third”for ABS RMBS issues where the principal repayments are typically paidsequentially (i.e., all of the underlying mortgage principal repayments arereceived by the first originally rated Aaa class in the structure until it ispaid in full, then all of the underlying mortgage principal repayments arereceived by the second originally rated Aaa class in the structure until it ispaid in full).  Although securitieswithin the various Aaa classes are paid sequentially, they typically share anylosses on a pro-rata basis after losses are absorbed by classes with lower originalratings or what may be referred to as more “junior” or “subordinate” securitiesin the capital structure.  The underlyingmortgages have fixed interest rates, variable interest rates (such asadjustable rate mortgages (“ARM”)) or are hybrid, meaning that they containfeatures of both fixed and variable rate mortgages.

 

*MBS*totaled $3.15 billion and 99.9% were rated investment grade at June 30,2008.  The MBS portfolio is subject tointerest rate risk since price volatility and the ultimate realized yield areaffected by the rate of prepayment of the underlying mortgages.  The credit risk associated with our MBS ismitigated due to the fact that 61.9% of the portfolio consists of securitiesthat were issued by, or have underlying collateral that is guaranteed by U.S.government agencies or U.S. government sponsored entities (“U.S. Agency”).

 

The followingtable shows MBS by type and Moody’s equivalent rating.

 
| **($ in millions)** | ** ** | **Fair value at  June 30, 2008** | ** ** | **% to Total  Investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Ba or  lower** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|---------|------------|--------|------------|--------|------------|-----------------------|------------|
| **MBS**                       |       |                                                 |       |                                  |       |    |       |   |       |   |       |                  |       |
| U.S. Agency                   |       | $                                                    | 1,950      |                                  | 2.8        | %       | 100.0      | %      | —     | %      | —     | %                     | —     | % |
| Prime                         |       | 732                                                  |       | 1.0                                   |       | 85.1    |       | 14.9   |       | — |       | —                |       |
| Alt-A                         |       | 468                                                  |       | 0.7                                   |       | 92.5    |       | 7.3    |       | — |       | 0.2                   |       |
| Total MBS                     |       | $                                                    | 3,150      |                                  | 4.5        | %       |       |   |       |   |       |                  |       |   |

 

Prime are collateralized by residential mortgage loans issued to primeborrowers.  As of June 30, 2008,fair value represents 94.7% of amortized cost of these securities.  During both the second quarter and first sixmonths of 2008, we sold $100 million of Prime, recognizing a gain of $2million.  We also collected $22 millionand $40 million of principal repayments consistent with the expected cash flowsduring the second quarter and first six months of 2008, respectively.  Investment write-downs during the first sixmonths of 2008 were recorded on our Prime totaling $9 million.  In addition, $8 million of change inintent write-downs were recorded during the second quarter of 2008 on Prime.

 

28

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Our Prime positions comprised 82.8% fixed rate mortgages, and 85.1% ofthe portfolio is in the Aaa class of the capital structure. The following tableshows our Prime portfolio of June 30, 2008 by vintage year, based upon ourparticipation in the capital structure.

 
| ** **                                                                | ** ** | **Vintage Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| **($ in millions)  Capital structure classification** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  value** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain/Loss** | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Aaa – Fixed rate**                                                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Super Senior                                                              |       | $                     | —     |       | $          | 39         |       | $ | — |   | $ | 48 |   | $ | 87 |   | $ | 89 |   | $ | (2 | ) |
| Senior                                                                    |       | 37                    |       | 47         |       | 91         |       | 235 |   | 410 |   | 434 |   | (24 | ) |
|                                                                      |       | 37                    |       | 86         |       | 91         |       | 283 |   | 497 |   | 523 |   | (26 | ) |
| **Aaa – Hybrid**                                                     |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Super Senior                                                              |       | —                |       | —     |       | 63         |       | 10 |   | 73 |   | 78 |   | (5 | ) |
| Senior                                                                    |       | 10                    |       | —     |       | —     |       | 34 |   | 44 |   | 46 |   | (2 | ) |
| Senior Support                                                            |       | —                |       | —     |       | 9          |       | — |   | 9 |   | 11 |   | (2 | ) |
|                                                                      |       | 10                    |       | —     |       | 72         |       | 44 |   | 126 |   | 135 |   | (9 | ) |
| **Aa – Fixed rate**                                                  |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Senior                                                                    |       | 102                   |       | —     |       | —     |       | — |   | 102 |   | 107 |   | (5 | ) |
| Senior Support                                                            |       | —                |       | —     |       | —     |       | 7 |   | 7 |   | 8 |   | (1 | ) |
|                                                                      |       | 102                   |       | —     |       | —     |       | 7 |   | 109 |   | 115 |   | (6 | ) |
| Total                                                                     |       | $                     | 149        |       | $          | 86         |       | $ | 163 |   | $ | 334 |   | $ | 732 |   | $ | 773 |   | $ | (41 | ) |

 

Includedin our mortgage-backed fixed income securities are Alt-A at fixed or variablerates.  The following table presentsinformation about the collateral in our Alt-A holdings.

 
| **($ in millions)** | ** ** | **Fair value at  June 30, 2008** | ** ** | **% to Total  Investments** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                    |       |                                                 |       |                                  |       |
| **Alt-A**                     |       |                                                 |       |                                  |       |
| Fixed rate                    |       | $                                                    | 354        |                                  | 0.5        | % |
| Variable rate                 |       | 114                                                  |       | 0.2                                   |       |
| Total Alt-A                   |       | $                                                    | 468        |                                  | 0.7        | % |

 

Alt-A can be issued by trusts backed by pools of residential mortgageswith either fixed or variable interest rates. The mortgage pools can include residential mortgage loans issued toborrowers with stronger credit profiles than sub-prime borrowers, but who donot qualify for prime financing terms due to high loan-to-value ratios orlimited supporting documentation.  As of June 30,2008, fair value represents 91.6% of the amortized cost of thesesecurities.  There were no Alt-Asecurities with a fair value less than 70% of amortized cost.  During both the second quarter and first sixmonths of 2008, we sold$1 million of Alt-A.  We also collected$16 million and $32 million of principal repayments consistent with the expectedcash flows during the second quarter and first six months of 2008,respectively.  Investment write-downsduring the second quarter and first six months of 2008 were recorded on ourAlt-A totaling $2 million and $41 million, respectively.  In addition, $29 million of change in intentwrite-downs were recorded during the second quarter of 2008 on Alt-A.

 

29

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Thefollowing table shows our Alt-A portfolio at June 30, 2008 by vintageyear, based upon our participation in the capital structure.

 
| ** **                                                                | ** ** | **Vintage Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| **($ in millions)  Capital structure classification** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain/Loss** | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Aaa – Fixed rate**                                                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Super Senior                                                              |       | $                     | —     |       | $          | 10         |       | $ | 37 |   | $ | — |   | $ | 47 |   | $ | 57 |   | $ | (10 | ) |
| Senior                                                                    |       | 33                    |       | 32         |       | 74         |       | 137 |   | 276 |   | 303 |   | (27 | ) |
| Senior Support                                                            |       | 16                    |       | 3          |       | —     |       | — |   | 19 |   | 19 |   | — |   |
|                                                                      |       | 49                    |       | 45         |       | 111        |       | 137 |   | 342 |   | 379 |   | (37 | ) |
| **Aaa – Hybrid**                                                     |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Super Senior                                                              |       | —                |       | 24         |       | —     |       | — |   | 24 |   | 29 |   | (5 | ) |
| Senior                                                                    |       | —                |       | —     |       | 12         |       | 6 |   | 18 |   | 21 |   | (3 | ) |
| Senior Support                                                            |       | —                |       | —     |       | —     |       | 3 |   | 3 |   | 3 |   | — |   |
|                                                                      |       | —                |       | 24         |       | 12         |       | 9 |   | 45 |   | 53 |   | (8 | ) |
| **Aaa - Option Adjustable Rate Mortgage**                                 |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Super Senior                                                              |       | —                |       | —     |       | 26         |       | — |   | 26 |   | 26 |   | — |   |
| Senior Support                                                            |       | —                |       | —     |       | —     |       | 9 |   | 9 |   | 9 |   | — |   |
| Super Senior – Mid                                                   |       | —                |       | —     |       | 3          |       | 8 |   | 11 |   | 11 |   | — |   |
|                                                                      |       | —                |       | —     |       | 29         |       | 17 |   | 46 |   | 46 |   | — |   |
| **Aa - Option Adjustable Rate Mortgage**                                  |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Subordinate                                                               |       | —                |       | —     |       | 4          |       | 18 |   | 22 |   | 20 |   | 2 |   |
|                                                                      |       | —                |       | —     |       | 4          |       | 18 |   | 22 |   | 20 |   | 2 |   |
| **Aa – Fixed Rate**                                                  |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Senior Support                                                            |       | —                |       | 8          |       | 4          |       | — |   | 12 |   | 12 |   | — |   |
|                                                                      |       | —                |       | 8          |       | 4          |       | — |   | 12 |   | 12 |   | — |   |
|                                                                      |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| **Ba - Option Adjustable Rate Mortgage**                                  |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Subordinate                                                               |       | —                |       | —     |       | 1          |       | — |   | 1 |   | 1 |   | — |   |
|                                                                      |       | —                |       | —     |       | 1          |       | — |   | 1 |   | 1 |   | — |   |
| Total                                                                     |       | $                     | 49         |       | $          | 77         |       | $ | 161 |   | $ | 181 |   | $ | 468 |   | $ | 511 |   | $ | (43 | ) |

 

*CMBS* totaled $5.92billion, most of which were rated investment grade at June 30, 2008.  The CMBS portfolio is subject to credit risk,but unlike other structured securities, is generally not subject to prepaymentrisk due to protections within the underlying commercial mortgages wherebyborrowers are effectively restricted from prepaying their mortgages due tochanges in interest rates.  Approximately84.0% of the CMBS investments are pools of commercial mortgages, broadlydiversified across property types and geographical area.  The following table shows CMBS by type andMoody’s equivalent rating.

 
| **($ in millions)** | ** ** | **Fair value at  June 30, 2008** | ** ** | **% to Total  Investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Baa** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|---------|------------|--------|------------|--------|------------|---------|------------|
| **CMBS**                      |       |                                                 |       |                                  |       |    |       |   |       |   |       |    |       |
| CMBS                          |       | $                                                    | 5,543      |                                  | 7.9        | %       | 81.4       | %      | 13.5       | %      | 4.0        | %       | 1.1        | % |
| CRE CDO                       |       | 375                                                  |       | 0.5                                   |       | 38.2    |       | 28.5   |       | 24.5   |       | 8.8     |       |
| Total CMBS                    |       | $                                                    | 5,918      |                                  | 8.4        | %       |       |   |       |   |       |    |       |   |

 

CRE CDO are investments secured primarily by commercial mortgage-backedsecurities and other commercial mortgage debt obligations.  These securities are generally lessliquid and have a higher risk profile than other commercial mortgage-backedsecurities.  As of June 30,2008, fair value represents101.1% of the amortized cost of these securities.  During the second quarter and first sixmonths of 2008, we sold $27 million and $36 million of CRE CDO, respectively,recognizing a loss of $23 million and $24 million, respectively.  Wealso collected $2

 

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millionand $3 million of principal repayments consistent with the expected cash flowsduring the second quarter and first six months of 2008, respectively.  Investment write-downs during both the secondquarter and first six months of 2008 were recorded on our CRE CDO totaling $39million.  In addition, $248 million ofchange in intent write-downs were recorded during the second quarter of 2008 onCRE CDO.  The following table shows ourCRE CDO portfolio at June 30, 2008 by vintage year, based upon ourparticipation in the capital structure.

 
| ** **                                                                | ** ** | **Vintage Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| **($ in millions)  Capital structure/Current rating** | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain/Loss** | ** ** |
|                                                                      |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Aaa                                                                       |       | $                     | 18         |       | $          | 33         |       | $ | 42 |   | $ | 50 |   | $ | 143 |   | $ | 142 |   | $ | 1 |   |
| Aa                                                                        |       | 3                     |       | 69         |       | 10         |       | 25 |   | 107 |   | 105 |   | 2 |   |
| A                                                                         |       | 18                    |       | 27         |       | 14         |       | 33 |   | 92 |   | 91 |   | 1 |   |
| Baa                                                                       |       | 6                     |       | 19         |       | 8          |       | — |   | 33 |   | 33 |   | — |   |
| Total                                                                     |       | $                     | 45         |       | $          | 148        |       | $ | 74 |   | $ | 108 |   | $ | 375 |   | $ | 371 |   | $ | 4 |   |

 

*ABS* totaled $4.33billion and 96.9% were rated investment grade at June 30, 2008.  ABSby type are listed in the table below.

 
| **($ in millions)**                                                         | ** ** | **Fair value at  June 30, 2008** | ** ** | **% to Total  Investments** | ** ** | **Fair value as a  % of  Amortized cost** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Baa** | ** ** | **Ba or  lower** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------------------------------------|------------|---------|------------|--------|------------|--------|------------|---------|------------|-----------------------|------------|
| **ABS**                                                                               |       |                                                 |       |                                  |       |                                                               |       |    |       |   |       |   |       |    |       |                  |       |
| ABS RMBS non-insured                                                                  |       | $                                                    | 1,484      |                                  | 2.1        | %                                                                  | 84.7       | %       | 54.0       | %      | 35.0       | %      | 6.7        | %       | 2.4        | %                     | 1.9        | % |
| ABS RMBS insured                                                                      |       | 314                                                  |       | 0.4                                   |       | 60.4                                                               |       | 16.2    |       | 27.1   |       | 31.8   |       | 16.9    |       | 8.0                   |       |
| Total ABS RMBS                                                                        |       | 1,798                                                |       | 2.5                                   |       | 79.1                                                               |       | 47.5    |       | 33.6   |       | 11.1   |       | 4.9     |       | 2.9                   |       |
| ABS CDO                                                                               |       | 14                                                   |       | —                                |       | 116.7                                                              |       | —  |       | — |       | — |       | —  |       | 100.0                 |       |
| Total asset-backed securities  collateralized by sub-prime residential mortgage loans |       | 1,812                                                |       | 2.5                                   |       | 79.3                                                               |       |    |       |   |       |   |       |    |       |                  |       |
|                                                                                  |       |                                                 |       |                                  |       |                                                               |       |    |       |   |       |   |       |    |       |                  |       |
| Other collateralized debt obligations                                                 |       | 1,613                                                |       | 2.3                                   |       | 74.1                                                               |       | 35.3    |       | 27.0   |       | 27.3   |       | 8.2     |       | 2.2                   |       |
| Other asset-backed securities                                                         |       | 908                                                  |       | 1.3                                   |       | 92.1                                                               |       | 34.4    |       | 19.9   |       | 28.6   |       | 11.1    |       | 6.0                   |       |
| Total ABS                                                                             |       | $                                                    | 4,333      |                                  | 6.1        | %                                                                  | 79.5       |    |       |   |       |   |       |    |       |                  |       |   |

 

ABSRMBS portfolio includes securities that are collateralized by 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 following table presents additional information about our ABS RMBSportfolio including a summary by first and second lien collateral.

 
| **($ in millions)** | ** ** | **Fair value at  June 30, 2008** | ** ** | **% to Total  Investments** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| **ABS RMBS**                  |       |                                                 |       |                                  |       |
| First lien:                   |       |                                                 |       |                                  |       |
| Fixed rate (1)                |       | $                                                    | 583        |                                  | 0.8        | % |
| Variable rate (1)             |       | 924                                                  |       | 1.3                                   |       |
| Total first lien (2)          |       | 1,507                                                |       | 2.1                                   |       |
| Second lien:                  |       |                                                 |       |                                  |       |
| Insured                       |       | 216                                                  |       | 0.3                                   |       |
| Other                         |       | 75                                                   |       | 0.1                                   |       |
| Total second lien (3)         |       | 291                                                  |       | 0.4                                   |       |
| Total ABS RMBS                |       | $                                                    | 1,798      |                                  | 2.5        | % |

 

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(1)     Fixed rate and variable rate refer to the primary interest ratecharacteristics of the underlying mortgages at the time of issuance.

(2)     The credit ratings of the first lien ABS RMBS were 53.0% Aaa, 36.4% Aa,6.9% A, 1.8% Baa and 1.9% Ba or lower at June 30, 2008.

(3)     The credit ratings of the second lien ABS RMBS were 18.6% Aaa, 19.2% Aa,33.0% A, 21.3% Baa and 7.9% Ba or lower at June 30, 2008.

 

31

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Asof June 30, 2008, the ABS RMBS portfolio had unrealized losses of $474million.  Fair value represents 79.1% ofthe amortized cost of these securities. ABS RMBS securities with a fair value less than 70% of amortized costtotaled $316 million, with unrealized losses of $350 million.  During the first six months of 2008, we sold$19 million of ABS RMBS, recognizing a loss of $17 million.  We also collected $87 million and $152million of principal repayments consistent with the expected cash flows duringthe second quarter and first six months of 2008, respectively.  Investment write-downs during the secondquarter and first six months of 2008 were recorded on our ABS RMBS totaling$125 million and $146 million, respectively. In addition, $132 million of change in intent write-downs were recordedduring the second quarter of 2008 on ABS RMBS.

 

Whenbuying ABS RMBS securities from 2006 and 2007 vintages, we concentrated ourholdings in securities that were senior or at the top of the structure and thatwere generally within the first three Aaa sub-classes of the capital structure,as it was expected that, in the unlikely event of losses in the underlyingcollateral, these sub-classes within the Aaa class would likely either be paidin full or receive substantial principal repayments before underlying mortgagelosses would breach that level.  However,when the underlying mortgage product was fixed-rate in nature, which weassessed to have stronger underwriting origination standards than variable ratecollateral, we invested somewhat lower in the capital structure, such assecurities below the first three Aaa sub-classes.  The vast majority of our investment in eitherof these vintages was concentrated within originally rated Aaa or Aasecurities.

 

Thefollowing table includes first lien non-insured ABS RMBS by vintage, theinterest rate characteristics of the underlying mortgage product and ourparticipation in the capital structure. The information in this table, together with the second liennon-insured, comprise the $1.48 billion of non-insured ABS RMBS.

 
| ** **                                                                | ** ** | **2007**           | ** ** | **2006**        | ** ** | **2005**                   | ** ** |
|---------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|----------------------------|------------|
| **($ in millions)  Capital structure classification** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Total Fair  Value** | ** ** | **Total  Amortized****Cost** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Total Fair  Value** | ** ** | **Total  Amortized****Cost** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Total Fair  Value** | ** ** | **Total  Amortized****Cost** | ** ** |
|                                                                      |       |               |       |            |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| First or Second Aaa class                                                 |       | $                  | 83         |            | $          | 25                         |       | $ | 108 |   | $ | 114 |   | $ | 234 |   | $ | 9 |   | $ | 243 |   | $ | 256 |   | $ | 4 |   | $ | — |   | $ | 4 |   | $ | 4 |   |
| Third Aaa class                                                           |       | —             |       | —          |       | —                     |       | — |   | 61 |   | 36 |   | 97 |   | 107 |   | 2 |   | — |   | 2 |   | 2 |   |
| Fourth Aaa class                                                          |       | —             |       | —          |       | —                     |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Last cash flow Aaa class                                                  |       | —             |       | —          |       | —                     |       | — |   | — |   | 7 |   | 7 |   | 10 |   | 9 |   | 17 |   | 26 |   | 26 |   |
| Other Aaa (1)                                                             |       | 24                 |       | 121             |       | 145                        |       | 145 |   | — |   | 59 |   | 59 |   | 62 |   | 23 |   | 82 |   | 105 |   | 107 |   |
| Total Aaa                                                                 |       | 107                |       | 146             |       | 253                        |       | 259 |   | 295 |   | 111 |   | 406 |   | 435 |   | 38 |   | 99 |   | 137 |   | 139 |   |
| Aa                                                                        |       | 5                  |       | 79              |       | 84                         |       | 196 |   | 5 |   | 10 |   | 15 |   | 25 |   | 180 |   | 11 |   | 191 |   | 238 |   |
| A                                                                         |       | —             |       | 6               |       | 6                          |       | 10 |   | — |   | 5 |   | 5 |   | 7 |   | 2 |   | 2 |   | 4 |   | 5 |   |
| Baa                                                                       |       | —             |       | —          |       | —                     |       | — |   | — |   | 1 |   | 1 |   | 2 |   | — |   | — |   | — |   | — |   |
| Total First Lien                                                          |       |               |       |            |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-Insured ABS RMBS                                                      |       | $                  | 112        |            | $          | 231                        |       | $ | 343 |   | $ | 465 |   | $ | 300 |   | $ | 127 |   | $ | 427 |   | $ | 469 |   | $ | 220 |   | $ | 112 |   | $ | 332 |   | $ | 382 |   |

 
| ** **                                                                | ** ** | **Pre- 2005** | ** ** | **Total**       | ** ** |
|---------------------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|
| **($ in millions)  Capital structure classification** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Total Fair  Value** | ** ** | **Total  Amortized****Cost** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Total Fair  Value** | ** ** | **Total  Amortized****Cost** | ** ** | **Unrealized  Gain/Loss** | ** ** |
|                                                                      |       |               |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| First or Second Aaa class                                                 |       | $                  | —     |            | $          | — |   | $ | — |   | $ | — |   | $ | 321 |   | $ | 34 |   | $ | 355 |   | $ | 374 |   | $ | (19 | ) |
| Third Aaa class                                                           |       | 4                  |       | —          |       | 4 |   | 4 |   | 67 |   | 36 |   | 103 |   | 113 |   | (10 | ) |
| Fourth Aaa class                                                          |       | —             |       | —          |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Last cash flow Aaa class                                                  |       | 8                  |       | 6               |       | 14 |   | 15 |   | 17 |   | 30 |   | 47 |   | 51 |   | (4 | ) |
| Other Aaa (1)                                                             |       | —             |       | 23              |       | 23 |   | 23 |   | 47 |   | 285 |   | 332 |   | 337 |   | (5 | ) |
| Total Aaa                                                                 |       | 12                 |       | 29              |       | 41 |   | 42 |   | 452 |   | 385 |   | 837 |   | 875 |   | (38 | ) |
| Aa                                                                        |       | 208                |       | 16              |       | 224 |   | 246 |   | 398 |   | 116 |   | 514 |   | 705 |   | (191 | ) |
| A                                                                         |       | 41                 |       | 1               |       | 42 |   | 54 |   | 43 |   | 14 |   | 57 |   | 76 |   | (19 | ) |
| Baa                                                                       |       | —             |       | —          |       | — |   | — |   | — |   | 1 |   | 1 |   | 2 |   | (1 | ) |
| Total First Lien                                                          |       |               |       |            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-Insured ABS RMBS                                                      |       | $                  | 261        |            | $          | 46 |   | $ | 307 |   | $ | 342 |   | $ | 893 |   | $ | 516 |   | $ | 1,409 |   | $ | 1,658 |   | $ | (249 | ) |

 

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(1)     Includes primarily pass-through securities and “NAS” bonds.  NAS bonds are typically locked out fromreceiving principal prepayments for a specified period of time after which theyreceive prepayment allocations according to a specified formula.

 

Wealso own approximately $75 million of second lien ABS RMBS non-insuredsecurities, representing 79.8% of amortized cost.  Approximately $32 million, or 42.7%, of thisportfolio are 2006 and 2007 vintage years.

 

At June 30, 2008, $314 million or 17.5% of the total ABS RMBSsecurities are insured by 4 bond insurers and 92.0% were rated investmentgrade.  $1.42 billion or 79.1% of theportfolio consisted of securities that were issued during 2005, 2006 and2007.  At June 30, 2008, 55.0% ofsecurities issued during 2005, 2006 and 2007 were rated Aaa, 26.0% rated Aa,9.8% rated A, 6.2% rated Baa and 3.0% rated Ba or lower.

 

32

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Thefollowing table shows our insured ABS RMBS portfolio at June 30, 2008 bybond insurer and vintage year for the first lien and second lien collateral.

 
| ** **                                                | ** ** | **Vintage Year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| **($ in millions)**                             | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  Value** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gain/Loss** | ** ** |
| **First Lien:**                                           |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| Financial Guarantee Insurance Company  (“FGIC”) |       | $                     | 13         |       | $          | 6          |       | $ | 9 |   | $ | 8 |   | $ | 36 |   | $ | 48 |   | $ | (12 | ) |
| Ambac Financial Group, Inc. (“AMBAC”)      |       | —                |       | 3          |       | 20         |       | 4 |   | 27 |   | 38 |   | (11 | ) |
| MBIA, Inc. (“MBIA”)                        |       | —                |       | —     |       | 7          |       | — |   | 7 |   | 7 |   | — |   |
| Financial Security Assurance Inc. (“FSA”)       |       | 28                    |       | —     |       | —     |       | — |   | 28 |   | 28 |   | — |   |
| CIFG Holding (“CIFG”)                           |       | —                |       | —     |       | —     |       | — |   | — |   | — |   | — |   |
| Total First Lien                                          |       | 41                    |       | 9          |       | 36         |       | 12 |   | 98 |   | 121 |   | (23 | ) |
| **Second Lien:**                                          |       |                  |       |       |       |       |       |   |   |   |   |   |   |   |   |
| FGIC                                                      |       | 9                     |       | 43         |       | 4          |       | — |   | 56 |   | 128 |   | (72 | ) |
| AMBAC                                                     |       | 11                    |       | 14         |       | 2          |       | 23 |   | 50 |   | 73 |   | (23 | ) |
| MBIA                                                      |       | 88                    |       | 4          |       | —     |       | 2 |   | 94 |   | 161 |   | (67 | ) |
| FSA                                                       |       | 11                    |       | 5          |       | —     |       | — |   | 16 |   | 37 |   | (21 | ) |
| XL Capital Assurance Inc. (“XLCA”)              |       | —                |       | —     |       | —     |       | — |   | — |   | — |   | — |   |
| Total Second Lien                                         |       | 119                   |       | 66         |       | 6          |       | 25 |   | 216 |   | 399 |   | (183 | ) |
| Total Insured ABS RMBS                                    |       | $                     | 160        |       | $          | 75         |       | $ | 42 |   | $ | 37 |   | $ | 314 |   | $ | 520 |   | $ | (206 | ) |

 

ABSCDO are securities collateralized by a variety of residential mortgage-backedsecurities and other securities, which may include sub-prime RMBS.  Fair value represents 116.7% of the amortizedcost of these securities.  Duringboth the second quarter and first six months of 2008, we sold $1 million of ABSCDO.  Investment write-downs during thesecond quarter and first six months of 2008 were recorded on our ABS CDOtotaling $3 million and $63 million, respectively.  As of June 30, 2008, the ABS CDOportfolio had unrealized gains of $2 million.

 

*Othercollateralized debt obligations* totaled $1.61 billion and 97.8% are rated investment grade at June 30,2008.  Other collateralized debtobligations consist primarily of obligations secured by high yield andinvestment grade corporate credits including $998 million of collateralizedloan obligations; $193 million of synthetic CDOs; $158 million of primarilybank trust preferred CDOs; $99 million of market value CDOs; $44 million ofCDOs that invest in other CDOs (“CDO squared”); and $25 million of collateralizedbond obligations.  As of June 30,2008, net unrealized losses on the other CDOs were $564 million.  Other CDOs with a fair value less than 70% ofamortized cost totaled $377 million, or 23.4% of the total other CDOs at June 30,2008, with unrealized losses of $327 million.

 

*Other asset-backed securities* consist primarily of investments secured by portfolios of credit cardloans, auto loans, student loans and other consumer and corporate obligations.As of June 30, 2008, the net unrealized losses on these securities were$78 million. Additionally, all of the other asset-backed securities that arerated Aaa, Aa, A and Baa were insured by four bond insurers.  Duringthe second quarter and first six months of 2008, we sold $2 million and $20million of these securities, respectively, recognizing a gain of $1 million and$2 million, respectively.  In addition,we acquired $11 million of securities during the first six months of 2008.  We also collected $5 million and $10 millionof principal repayments consistent with the expected cash flows during thesecond quarter and first six months of 2008, respectively.

 

As of June 30, 2008, we hold $2.72 billion of fixed incomesecurities that are insured by bond insurers, including approximately $2.15billion or 52.9% of our municipal bond portfolio, $314 million of our ABS RMBSand $221 million of our other asset-backed securities.  Additionally, we hold $12 million ofcorporate bonds and credit default swaps that were directly issued by thesebond insurers.  52.9% of our municipalbond portfolio is insured by seven bond insurers and 40.6% have a Moody’sequivalent rating of Aaa or Aa.  Ourpractices for acquiring and monitoring municipal bonds are primarily based onthe quality of the underlying security. As of June 30, 2008, we believe the valuations already reflected adecline in the value of the insurance, and further such declines, if any, arenot expected to be material.  While thevaluation of these holdings may be temporarily impacted by negative and rapidlychanging market developments, we continue to have the intent and ability tohold the bonds and expect to receive all of the contractual cash flows.  As of June 30, 2008, 35.1% of ourinsured municipal bond portfolio was insured by MBIA, 15.3% by AMBAC, 17.1% byFSA and 22.1% by FGIC.

 

33

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Includedin our municipal bond portfolio at June 30, 2008 are $753 million ofauction rate securities (“ARS”) that have long-term stated maturities, with theinterest rate reset based on auctions that generally occur every 7, 28 or 35days depending on the specific security. This is compared to a balance of ARS at December 31, 2007 of $866million, with the decline representing primarily redemptions during the secondquarter of 2008.  Our holdings primarily have a Moody’sequivalent rating of Aaa.  We make ourinvestment decisions based on the underlying credit of each security.  Approximately $745 million of our holdingsare pools of student loans for which at least 85% of the collateral was insuredby the U.S. Department of Education at the time we purchased the security.  As of June 30, 2008, $511 million of ourARS backed by student loans was 100% insured by the U.S. Department ofEducation, $171 million was 90% to 99% insured and $63 million was 80% to 89%insured.  During the second quarter of2008, all of our ARS holdings experienced failed auctions and we received thefailed auction rate or, for those which contain maximum reset rate formulas, wereceived the contractual maximum rate. We anticipate that failed auctions may persist and most of our holdingswill continue to pay the failed auction rate or, for those that contain maximumrate reset formulas, the maximum rate, as described below.  Auctions continue to be conducted asscheduled for each of the securities.

 

We estimate that approximately one third of ourstudent loan backed ARS include maximum rate reset formulas whereby when thefailed auction rate exceeds an annual contractual maximum rate over a precedingstipulated period, the coupon interest rate is temporarily reset to the maximumrate, which can vary between zero and the failed auction rate.  This maximum rate formula causes the resetinterest rate on these securities to be lower than the failed auction rate inorder to reduce the annual interest rate so that it does not exceed the annualcontractual maximum rate.  Generally, theannual contractual maximum rate is higher than the historical rates paid onthese securities.  During the secondquarter of 2008, $131 million of our ARS reset using the maximum rate resetformula.

 

*Fannie Mae and Freddie Mac*direct fixed income and equity exposure investments totaled $421million as of June 30, 2008.  Thefollowing table shows our direct exposure to Fannie Mae and Freddie Mac at June 30,2008.

 
| **($ in millions)**         | ** ** | **Fannie Mae** | ** ** | **Freddie Mac** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------------------|------------|----------------------|------------|-----------|------------|
| Fixed Income Securities:              |       |                |       |                 |       |      |       |
| Fair Value                            |       | $                   | 327        |                 | $          | 87        |       | $ | 414 |   |
| Net Unrealized Capital Gains (Losses) |       | 24                  |       | 1                    |       | 25        |       |
|                                  |       |                |       |                 |       |      |       |
| Equity Securities:                    |       |                |       |                 |       |      |       |
| Fair Value                            |       | $                   | 7          |                 | $          | —    |       | $ | 7 |   |
| Net Unrealized Capital Gains (Losses) |       | 2                   |       | —               |       | 2         |       |

 

*Limited partnership interests* consist of investments in private equity/debt funds, real estate fundsand hedge funds.  The overall limitedpartnership interests portfolio is well diversified across a number of metricsincluding fund sponsors, vintage years, strategies, geography (includinginternational), and company/property types. At June 30, 2008, our limited partnership interests comprise:

 

Private equity/debt funds - Approximately 55% or $632 million of the limited partnershipinterests comprised private equity/debt funds diversified across the followingfund types: buyout, mezzanine, distressed security, and secondaryofferings.  Private/equity debt fundswere spread across 70 sponsors and 92 individual funds.  The largest exposure to any single privateequity/debt fund was $20 million.

 

Real estate funds - Approximately 38% or $438 million of the limited partnershipinterests comprised real estate funds diversified across a variety ofstrategies including opportunistic, value-add platforms, distressed property,and property/market specific.  Realestate funds were spread across 30 sponsors and 50 individual funds.  The largest exposure to any single realestate fund was $36 million.

 

Hedge funds -Approximately 7% or $80 million of the limited partnership interests comprisedhedge funds with the majority invested with fund of funds advisors.  Hedge funds were spread across 3 sponsors and176 individual funds. The largest exposure to any single hedge fund was $5million.

 

Ouraggregate limited partnership exposure represented 1.6% and 1.4% of totalinvested assets as of June 30, 2008 and December 31, 2007,respectively.  Income from limitedpartnership interest was $13 million and $37 million for the second quarter andfirst six months of 2008, respectively, versus $20 million and $32 million forthe same periods in 2007, respectively. The decline was primarily related to reduced income from both realestate funds and hedge funds as capital market deleveraging has slowed the paceat which portfolio holdings are being sold.

 

34

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*Unrealized net capital losses*totaled $1.05 billion as of June 30, 2008, compared to unrealized netcapital gains of $417 million at December 31, 2007.  The decline was primarily due to investmentgrade fixed income securities as the yields supporting fair values increased,resulting from widening credit spreads and relatively flat risk-free interestrates.  This increase in fixed incomeunrealized net capital losses more than offset the decline in unrealized netcapital losses resulting from the realization of capital losses on write-downs,change in intent to hold to recovery and sales. We continue to experience volatility in the balance of our unrealizednet capital gains and losses as we did between the years 2004/2005 and2006/2007.  The following table presentstotal unrealized gains and losses.

 
| ** **                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **($ in millions)**         | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| U.S. government and agencies          |       | $                 | 823        |                  | $          | 880 |   |
| Municipal                             |       | (105              | )          | 76                    |       |
| Corporate                             |       | (504              | )          | 111                   |       |
| Foreign government                    |       | 340               |       | 371                   |       |
| Mortgage-backed securities            |       | (67               | )          | (9                    | )          |
| Commercial mortgage-backed securities |       | (384              | )          | (310                  | )          |
| Asset-backed securities               |       | (1,114            | )          | (670                  | )          |
| Redeemable preferred stock            |       | (1                | )          | —                |       |
| Fixed income securities               |       | (1,012            | )          | 449                   |       |
| Equity securities                     |       | —            |       | —                |       |
| Derivatives                           |       | (41               | )          | (32                   | )          |
| **Unrealized net gains and losses**   |       | $                 | (1,053     | )                     | $          | 417 |   |

 

The net unrealized loss for the fixed incomeportfolio totaled $1.01 billion, comprised of $1.80 billion of unrealized gainsand $2.81 billion of unrealized losses at June 30, 2008.  This is compared to a net unrealized gain forthe fixed income portfolio totaling $449 million at December 31, 2007,comprised of $2.26 billion of unrealized gains and $1.81 billion of unrealizedlosses.  Included in grossunrealized losses at June 30, 2008 were $939 million of fixed incomesecurities with a fair value below 70% of amortized cost, or 1.8% of our fixedincome portfolio at June 30, 2008. The percentage of fair value to amortized cost for the remaining fixedincome gross unrealized losses at June 30, 2008 are shown in the followingtable.

 
| **($ in millions)**                                   | ** ** | **Unrealized  (loss) gain** | ** ** | **Fair value** | ** ** | **% to Total  Fixed  Income  Investments** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------------|------------|------------------------------------------------------|------------|
| > 80% of amortized cost                                      |       | $                                | (1,426     | )                   | $          | 25,020                                               |       | 48.2 | % |
| 70% to 80% of amortized cost                                    |       | (573                             | )          | 1,763               |       | 3.4                                                  |       |
| < 70% of amortized cost                                      |       | (817                             | )          | 939                 |       | 1.8                                                  |       |
| Gross unrealized losses on fixed income  securities             |       | (2,816                           | )          | 27,722              |       | 53.4                                                 |       |
| Gross unrealized gains on fixed income  securities              |       | 1,804                            |       | 24,151              |       | 46.6                                                 |       |
| **Net unrealized gains and losses on fixed  income securities** |       | $                                | (1,012     | )                   | $          | 51,873                                               |       | 100.0 | % |

 

73.8% of the fixed income securities with a fairvalue less than 70% of amortized cost were ABS RMBS, Alt-A and other CDOs witha fair value totaling $693 million.  Wecontinue to believe that the unrealized losses on these securities are notnecessarily predictive of the ultimate performance.  The unrealized losses should reverse over theremaining lives of the securities in the absence of further deterioration inthe collateral relative to our positions in the securities’ respective capitalstructures.

 

Of the grossunrealized losses in the fixed income portfolio at June 30, 2008, $2.61billion or 92.5% were related to investment grade securities and are primarilyinterest rate related.  Of the remaining$210 million of unrealized losses in the fixed income portfolio, $153 millionor 72.9% were in the corporate fixed income portfolio and primarily comprisedsecurities in the consumer goods, financial services, utilities, communicationsand banking sectors.  The gross unrealizedlosses in these sectors were primarily related to changes in interest rates andcredit spreads, and company specific conditions.

 

35

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The gross unrealized gains and losses for theequity portfolio each totaled $4 million at June 30, 2008.  This is compared to $5 million each for bothunrealized gains and losses at December 31, 2007.  Within the equity portfolio, the losses wereprimarily concentrated in the financial services and basic industrysectors.  The unrealized losses in thesesectors were company and sector specific.

 

We have acomprehensive portfolio monitoring process to identify and evaluate, on acase-by-case basis, fixed income and equity securities whose carrying value maybe other-than-temporarily impaired.  Theprocess includes a quarterly review of all securities using a screening processto identify situations where the fair value, compared to amortized cost forfixed income securities, and cost for equity securities is below establishedthresholds for certain time periods, or which are identified through othermonitoring criteria such as ratings, ratings downgrades or paymentdefaults.  The securities identified, inaddition to other securities for which we may have a concern, are evaluatedbased on facts and circumstances for inclusion on our watch-list.  All investments in an unrealized lossposition at June 30, 2008 were included in our portfolio monitoringprocess for determining whether declines in value wereother-than-temporary.  We alsoconduct a portfolio review to recognize impairment on securities in anunrealized loss position for which we do not have the intent and ability tohold until recovery as a result of approved programs involving the dispositionof investments for reasons such as changes in economic and market outlooks,duration, revisions to strategic asset allocations, unanticipated liquidityactions, investment risk mitigation actions and unanticipated federal incometax situations involving capital gain (loss) carryforwards and carrybacks withspecific expiration dates, as well as changes in intent to hold certaininvestments by portfolio managers.

 

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

 
| ** **                                                                                                                                                       | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                       | ** ** | **Fixed Income**       | ** ** | ** **                      | ** ** | ** ** | ** ** | **Fixed Income** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in millions, except number of  issues)**                                                                                           | ** ** | **Investment  Grade**       | ** ** | **Below  Investment  Grade**    | ** ** | **Equity** | ** ** | **Total** | ** ** | **Investment  Grade** | ** ** | **Below  Investment  Grade** | ** ** | **Equity** | ** ** | **Total** | ** ** |
|                                                                                                                                                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (I): Unrealized loss less  than 20% of cost(1)                                                                                                     |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 2,509                       |       | 229                             |       | 37 |   | 2,775 |   | 2,403 |   | 227 |   | 9 |   | 2,639 |   |
| Fair Value                                                                                                                                                       |       | $                           | 23,612     |                            | $          | 1,373 |   | $ | 62 |   | $ | 25,047 |   | $ | 22,615 |   | $ | 1,517 |   | $ | 64 |   | $ | 24,196 |   |
| Unrealized                                                                                                                                                       |       | $                           | (1,301     | )                               | $          | (116 | ) | $ | (3 | ) | $ | (1,420 | ) | $ | (1,129 | ) | $ | (106 | ) | $ | (5 | ) | $ | (1,240 | ) |
|                                                                                                                                                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (II): Unrealized loss greater than  or equal to 20% of cost for a period of less than 6 consecutive months(1)                                           |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 279                         |       | 35                              |       | 2 |   | 316 |   | 156 |   | 18 |   | — |   | 174 |   |
| Fair Value                                                                                                                                                       |       | $                           | 2,369      |                            | $          | 187 |   | $ | 3 |   | $ | 2,559 |   | $ | 945 |   | $ | 107 |   | $ | — |   | $ | 1,052 |   |
| Unrealized                                                                                                                                                       |       | $                           | (1,068     | )                               | $          | (83 | ) | $ | (1 | ) | $ | (1,152 | ) | $ | (514 | ) | $ | (62 | ) | $ | — |   | $ | (576 | ) |
|                                                                                                                                                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (III): Unrealized loss greater  than or equal to 20% of cost for a period of 6 or more consecutive months,  but less than 12 consecutive months(1) |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | 45                          |       | 4                               |       | — |   | 49 |   | — |   | — |   | — |   | — |   |
| Fair Value                                                                                                                                                       |       | $                           | 164        |                            | $          | 17 |   | $ | — |   | $ | 181 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Unrealized                                                                                                                                                       |       | $                           | (237       | )                               | $          | (11 | ) | $ | — |   | $ | (248 | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                                                                                                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Category (IV): Unrealized loss greater than  or equal to 20% of cost for 12 or more consecutive months(1)                                                        |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Number of Issues                                                                                                                                                 |       | —                      |       | —                          |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Fair Value                                                                                                                                                       |       | $                           | —     |                            | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Unrealized                                                                                                                                                       |       | $                           | —     |                            | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                                                                                                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Number of Issues                                                                                                                                           |       | 2,833                       |       | 268                             |       | 39 |   | 3,140 |   | 2,559 |   | 245 |   | 9 |   | 2,813 |   |
| Total Fair Value                                                                                                                                                 |       | $                           | 26,145     |                            | $          | 1,577 |   | $ | 65 |   | $ | 27,787 |   | $ | 23,560 |   | $ | 1,624 |   | $ | 64 |   | $ | 25,248 |   |
| Total Unrealized Losses                                                                                                                                          |       | $                           | (2,606     | )                               | $          | (210 | ) | $ | (4 | ) | $ | (2,820 | ) | $ | (1,643 | ) | $ | (168 | ) | $ | (5 | ) | $ | (1,816 | ) |

 

----

(1) For fixed income securities, cost represents amortized cost.

 

36

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The largest individual unrealized loss was$11 million for category (I), $31 million for category (II) and $22million for category (III) as of June 30, 2008.

 

Categories (I) and (II) havegenerally been adversely affected by overall economic conditions includinginterest rate increases and the market’s evaluation of certain sectors.  The degree to which and/or length of timethat the securities have been in an unrealized loss position does not suggestthat these securities pose a high risk of being other-than-temporarilyimpaired.  Categories (III) and (IV) haveprimarily been historically adversely affected by industry and issue specific,or issuer specific conditions.  All ofthe securities in these categories are monitored for other-than-temporaryimpairment.

 

We continue to believe that the unrealizedlosses on these securities are not necessarily predictive of the ultimateperformance.  The unrealized lossesshould reverse over the remaining lives of the securities, including in theabsence of further deterioration in the collateral relative to our positions inthe securities’ respective capital structures. We have the intent and ability to hold these securities until recovery.

 

Whenever our initial analysis indicates that a fixed income security’sunrealized loss of 20% or more for at least 36 months or any equity security’sunrealized loss of 20% or more for at least 12 months is temporary, additionalevaluations and management approvals are required to substantiate that awrite-down is not appropriate.  As of June 30,2008, no securities met these criteria.

 

We also monitor the quality of our fixedincome and bank loan portfolios by categorizing certain investments as “problem”,“restructured” or “potential problem.” Problem fixed income securities and bank loans are in default withrespect to principal or interest and/or are investments issued by companiesthat have gone into bankruptcy subsequent to our acquisition or loan.  Restructured fixed income and bank loaninvestments have rates and terms that are not consistent with market rates orterms prevailing at the time of the restructuring.  Potential problem fixed income or bank loaninvestments are current with respect to contractual principal and/or interest,but because of other facts and circumstances, we have concerns regarding theborrower’s ability to pay future principal and interest, which causes us tobelieve these investments may be classified as problem or restructured in thefuture.

 

The following table summarizes problem,restructured and potential problem fixed income securities and bank loans.

 
| ** **                            | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **($ in millions)**         | ** ** | **Amortized  cost**         | ** ** | **Fair  value**                 | ** ** | **Percent of  total Fixed  Income and  Bank Loan  portfolios** | ** ** | **Amortized  cost** | ** ** | **Fair  value** | ** ** | **Percent of  total Fixed  Income and  Bank Loan  portfolios** | ** ** |
| Problem                               |       | $                           | 42         |                            | $          | 44 |   | 0.1 | % | $ | 14 |   | $ | 14 |   | — | % |
| Restructured                          |       | 5                           |       | 5                               |       | — |   | 5 |   | 6 |   | — |   |
| Potential problem                     |       | 287                         |       | 283                             |       | 0.5 |   | 218 |   | 172 |   | 0.3 |   |
| Total net carrying value              |       | $                           | 334        |                            | $          | 332 |   | 0.6 | % | $ | 237 |   | $ | 192 |   | 0.3 | % |
| Cumulative write-downs recognized (1) |       | $                           | 564        |                            |       |   |   |   | $ | 261 |   |   |   |   |   |

 

----

(1) Cumulativewrite-downs recognized only reflects write-downs related to securities withinthe problem, potential problem and restructured categories.

 

We have experienced an increase in theamortized cost of investments categorized as problem and potential problem asof June 30, 2008 compared to December 31, 2007.  The increase was primarily due toadditions of certain residential mortgage-backed securities, including Alt-A,Prime and ABS RMBS.  Partly offsettingthe increase were write-downs of investments categorized as potential problemat December 31, 2007, including certain ABS CDOs.

 

We also evaluated each of these investmentsthrough our portfolio monitoring process at June 30, 2008 and recordedwrite-downs when appropriate.  We furtherconcluded that any remaining unrealized losses on these investments weretemporary in nature and that we have the intent and ability to hold thesecurities until recovery.  While thesebalances may increase in the future, particularly if economic conditions areunfavorable, management expects that****thetotal amount of investments in these categories will remain low relative to thetotal fixed income securities and bank loans portfolios.

 

37

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**Net Investment Income** The following table presents net investmentincome.

 
| ** **                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**     | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                              |       |                                            |       |                                          |       |   |   |   |   |
| Fixed income securities           |       | $                                               | 772        |                                          | $          | 905 |   | $ | 1,598 |   | $ | 1,793 |   |
| Equity securities                 |       | 3                                               |       | 1                                             |       | 4 |   | 2 |   |
| Mortgage loans                    |       | 145                                             |       | 134                                           |       | 291 |   | 266 |   |
| Limited partnership interests     |       | 13                                              |       | 20                                            |       | 37 |   | 32 |   |
| Short-term                        |       | 32                                              |       | 22                                            |       | 48 |   | 45 |   |
| Other                             |       | (7                                              | )          | 43                                            |       | 13 |   | 84 |   |
| Investment income, before expense |       | 958                                             |       | 1,125                                         |       | 1,991 |   | 2,222 |   |
| Investment expense                |       | 36                                              |       | 72                                            |       | 77 |   | 139 |   |
| Net investment income             |       | $                                               | 922        |                                          | $          | 1,053 |   | $ | 1,914 |   | $ | 2,083 |   |

 

**Net Realized Capital Gains and Losses**Thefollowing table presents the components of realized capital gains and lossesand the related tax effect.

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **($ in millions)**                 | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                    | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment write-downs (1)                    |       | $                                               | (199       | )                                             | $          | (4 | ) | $ | (403 | ) | $ | (5 | ) |
| Sales                                         |       | (13                                             | )          | (5                                            | )          | (56 | ) | 50 |   |
| Change in intent write-downs                  |       | (730                                            | )          | (44                                           | )          | (754 | ) | (65 | ) |
| Valuation of derivative instruments           |       | 8                                               |       | 135                                           |       | (194 | ) | 115 |   |
| Settlement of derivative instruments          |       | 2                                               |       | 22                                            |       | 47 |   | 31 |   |
| Realized capital gains and losses, pre-tax    |       | (932                                            | )          | 104                                           |       | (1,360 | ) | 126 |   |
| Income tax benefit (expense)                  |       | 326                                             |       | (37                                           | )          | 476 |   | (45 | ) |
| Realized capital gains and losses,  after-tax |       | $                                               | (606       | )                                             | $          | 67 |   | $ | (884 | ) | $ | 81 |   |

 

----

(1)               Investment write-downs include other-than-temporaryimpairments except for those related to changes in intent.

 

The above table includes realized capitalgains and losses as a result of sales, change in intent write-downs and othertransactions such as calls and prepayments. We may sell or change our assertion to hold a security until recoveryfor impaired fixed income or equity securities that were in an unrealized lossposition at the previous reporting date, or other investments where the fairvalue has declined below the carrying value, in situations where new facts andcircumstances emerge or increase in significance that are anticipated toadversely impact a security’s future valuation; including negative developmentsin a holding, subsequent credit deterioration of an issuer or holding, subsequentfurther deterioration in capital markets (i.e. debt and equity) and of domesticeconomic conditions to levels previously unanticipated, subsequent furtherdeterioration in the financial services and real estate industries,unanticipated liquidity needs and unanticipated federal income tax situationsinvolving capital gain (loss) carryforwards and carrybacks with specificexpiration dates, investment risk mitigation strategies, and other new factsand circumstances that would cause a change in our previous intent to hold asecurity to recovery or maturity.

 

Investment write-downs for the three months ended June 30, 2008comprised $189 million from fixed income securities, $5 million from equitysecurities, $4 million from limited partnership interests and $1 million fromother investments compared to $4 million from fixed income securities for thesame period of the prior year. Investment write-downs for the six months ended June 30, 2008comprised $386 million from fixed income securities, $6 million from equitysecurities, $7 million from limited partnership interests and $4 million fromother investments compared to $4 million from fixed income securities and $1million from short-term investments for the same period of the prior year.  $182 million, or 96.3% and $333 million, or86.3% of the fixed income security write-downs for the three months and sixmonths ended June 30, 2008, respectively, relate to impaired securitiesthat were

 

38

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performingin line with anticipated or contractual cash flows, but which were written downprimarily because of further expected deterioration in the performance of theunderlying collateral.  As of June 30,2008, for these securities, there have been no defaults or defaults thatoccurred in classes lower in the capital structure.  $7 million and $35 million of the fixedincome security write-downs for the three months and six months ended June 30,2008, respectively, primarily related to securities experiencing a significantdeparture from anticipated residual cash flows, however, we believe they retaineconomic value.

 

Investment write-downs and cash received on theseinvestments were as follows:

 
| ** **                                                                                                      | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Six Months Ended  June 30, 2008****(3)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| **($ in millions)**                                                                                   | ** ** | **Investment  write-downs**                               | ** ** | **Cash  received****(****4)**                                  | ** ** | **Investment  write-downs** | ** ** | **Cash  received** | ** ** |
| **Performing in accordance with anticipated or contractual cash flows** | ** ** | ** **                                                | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Prime*                                                                                                         |       | $                                                         | —     |                                                           | $          | — |   | $ | (9 | ) | $ | 64 |   |
| *Alt–A*                                                                                                    |       | (2                                                        | )          | —                                                         |       | (41 | ) | 8 |   |
| *ABS RMBS*                                                                                                      |       | (121                                                      | )          | 3                                                              |       | (142 | ) | 9 |   |
| *ABS CDO*                                                                                                       |       | (3                                                        | )          | —                                                         |       | (63 | ) | 2 |   |
| *CMBS/CRE CDO*                                                                                                  |       | (39                                                       | )          | 1                                                              |       | (39 | ) | 4 |   |
| *Corporate*                                                                                                     |       |                                                      |       |                                                           |       |   |   |   |   |
| Bond insurer                                                                                                    |       | (17                                                       | )          | —                                                         |       | (17 | ) | 1 |   |
| Bond reinsurer – convertible to perpetual  security                                                        |       | —                                                    |       | —                                                         |       | (20 | ) | 1 |   |
| *Other*                                                                                                         |       | —                                                    |       | 1                                                              |       | (2 | ) | 2 |   |
| **Subtotal****(1)**                                                                                             | ** ** | **(182**                                                  | **)**      | **5**                                                          | ** ** | **(333** | **)** | **91** | ** ** |
|                                                                                                            |       |                                                      |       |                                                           |       |   |   |   |   |
| **Departure from anticipated or contractual  cash flows**                                                       |       |                                                      |       |                                                           |       |   |   |   |   |
| Future cash flows expected –                                                                               |       |                                                      |       |                                                           |       |   |   |   |   |
| *Residual interest trust security*                                                                              |       | —                                                    |       | —                                                         |       | — |   | — |   |
| *Other*                                                                                                         |       | —                                                    |       | —                                                         |       | (1 | ) | — |   |
| **Subtotal****(2)**                                                                                             | ** ** | **—**                                                | ** ** | **—**                                                     | ** ** | **(1** | **)** | **—** | ** ** |
| Future cash flows very uncertain -                                                                              |       |                                                      |       |                                                           |       |   |   |   |   |
| *Collateralized loan obligation*                                                                                |       | —                                                    |       | —                                                         |       | (18 | ) | — |   |
| *ABS RMBS*                                                                                                      |       | (4                                                        | )          | —                                                         |       | (4 | ) | 1 |   |
| *Corporate*                                                                                                     |       |                                                      |       |                                                           |       |   |   |   |   |
| Food manufacturer                                                                                               |       | (3                                                        | )          | —                                                         |       | (3 | ) | — |   |
| Bond insurer                                                                                                    |       | —                                                    |       | —                                                         |       | (10 | ) | — |   |
| **Subtotal**                                                                                                    | ** ** | **(7**                                                    | **)**      | **—**                                                     | ** ** | **(35** | **)** | **1** | ** ** |
| Investments disposed during the quarter                                                                         |       | —                                                    |       | —                                                         |       | (17 | ) | 23 |   |
| **Total fixed income securities**                                                                               | ** ** | **$**                                                     | **(189**   | **)**                                                          | **$**      | **5** | ** ** | **$** | **(386** | **)** | **$** | **115** | ** ** |
| **Total equity securities**                                                                                     | ** ** | **$**                                                     | **(5**     | **)**                                                          | **$**      | **—** | ** ** | **$** | **(6** | **)** | **$** | **—** | ** ** |
| **Total limited partnership interests**                                                                         | ** ** | **$**                                                     | **(4**     | **)**                                                          | **$**      | **—** | ** ** | **$** | **(7** | **)** | **$** | **—** | ** ** |
| **Total other investments**                                                                                     | ** ** | **$**                                                     | **(1**     | **)**                                                          | **$**      | **—** | ** ** | **$** | **(4** | **)** | **$** | **1** | ** ** |

 

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(1)          Written down primarily because of expected deterioration in theperformance of the underlying collateral. As of June 30, 2008, for the securities with direct interestin the lender, there have been no defaults. For securities supported by collateral, there have been no defaults ordefaults that have occurred in classes lower in the capital structure.

(2)          While these fixed income security write-downs were valued at asignificant discount to cost, we believe these securities retain economicvalue.

(3)          During the second quarter of 2008, we sold our mortgage lendersecurities that were written down at March 31, 2008 recognizing anadditional gain of $2 million. Additionally, a bond insurer was reclassified from performing in thefirst quarter of 2008 to departure from anticipated cash flows in the secondquarter of 2008.

(4)          Cash received includes both income and principal collected during theperiod.

 

Notwithstanding our intent and ability to hold thesesecurities with investment write-downs, we concluded that we could notreasonably assert that the recovery period would be temporary.

 

Change in intent write-downs for the three monthsended June 30, 2008 totaled $730 million and comprised net realized losseson fixed income of $687 million, equity of $11 million and mortgage loans of$32 million, compared to realized losses on fixed income of $25 million andmortgage loans of $19 million for the same period of the prior

 

39

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year.  Change in intent write-downs for the sixmonths ended June 30, 2008 totaled $754 million comprised net realizedlosses on fixed income of $709 million, mortgage loans of $33 million andequity of $12 million compared to net realized losses on fixed income of $46million and mortgage loans of $19 million for the same period of the prioryear.

 

Change in intent write-downs for the threemonths ended June 30, 2008 are presented in the table below.

 
| ** **                                                                                                                                        | ** ** | ** **             | ** ** | **Financial  Accounting  Standards Board  Statement No. 157,*Fair Value*** | ** ** | ** **                                     | ** ** | **Net realized  capital loss**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|
| **($ in millions)  Criteria**                                                                                                           | ** ** | **Security Type** | ** ** | ***Measurements*****(“SFAS No. 157”)  Level**                              | ** ** | **Fair value at  June 30,2008** | ** ** | **Three Months  Ended  June 30,** | ** ** |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
| *Risk Mitigation*                                                                                                                                 |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
| Targeted  reductions in commercial real estate exposure                                                                                           |       | CRE CDO                |       | 3                                                                                              |       | $                                              | 375        |                                        | $          | (248 | ) |
| where it is  anticipated that future downside risk remains.                                                                                       |       | CMBS                   |       | 2                                                                                              |       | 235                                            |       | (95                                         | )          |
| Considerations  included position held in the capital structure, vintage year, illiquidity  and deteriorating                                     |       |                   |       | 3                                                                                              |       | 32                                             |       | (32                                         | )          |
| fundamentals.                                                                                                                                     |       | Mortgage  loans        |       | 3                                                                                              |       | 265                                            |       | (32                                         | )          |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
| Targeted  reductions in residential real estate where management believes there is a  risk of future material                                     |       | Prime                  |       | 2                                                                                              |       | 105                                            |       | (8                                          | )          |
| declines in  price in the event of continued deterioration in the economy. Considerations  included position held                                 |       | Alt-A                  |       | 3                                                                                              |       | 116                                            |       | (29                                         | )          |
| in the  capital structure, projected performance of the collateral, and expected  internal rates of return.                                       |       | ABS RMBS               |       | 3                                                                                              |       | 617                                            |       | (132                                        | )          |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
| Targeted  reductions in financial sector exposure included securities issued by certain  regional banks and certain large financial institutions. |       | Financial  Sector      |       | 1  2  3                                                                                        |       | 2  702  12                                     |       | —  (116  —                        | )          |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
|                                                                                                                                              |       | Other                  |       | 2                                                                                              |       | 152                                            |       | (20                                         | )          |
|                                                                                                                                              |       |                   |       | 3                                                                                              |       | 25                                             |       | (2                                          | )          |
| Total Risk Mitigation                                                                                                                             |       |                   |       |                                                                                           |       | 2,638                                          |       | (714                                        | )          |
| Individual Identification                                                                                                                         |       |                   |       |                                                                                           |       | 291                                            |       | (16                                         | )          |
| EAA                                                                                                                                               |       |                   |       |                                                                                           |       | —                                         |       | —                                      |       |
| Other                                                                                                                                             |       |                   |       |                                                                                           |       | 37                                             |       | —                                      |       |
|                                                                                                                                              |       |                   |       |                                                                                           |       |                                           |       |                                        |       |
| Total change in intent                                                                                                                            |       |                   |       |                                                                                           |       | $                                              | 2,966      |                                        | $          | (730 | ) |

 

Net realized capital gains on the valuation andsettlement of derivative instruments totaled $10 million for the second quarterof 2008, primarily comprised $27 million for risk reduction programs and $(16)million for the valuation of equity indexed notes and convertible fixed incomesecurities. Gains from the risk reduction programs, primarily in our durationmanagement programs, were related to changing interest rates and credit spreadsas rates declined during the period.  Netrealized capital losses on the valuation and settlement of derivative instrumentstotaled $147 million for the first six months of 2008, primarily comprised $127million for the valuation of equity indexed notes and convertible fixed incomesecurities.

 

At June 30, 2008, our securities with embeddedoptions totaled $1.32 billion and decreased in fair value from December 31,2007 by $183 million, comprising realized capital losses related to thevaluation of embedded options of $127 million, net sales activity of $66million in realized capital losses, and unrealized net capital losses reportedin other comprehensive income (“OCI”) of $10 million for the hostsecurity.  Unrealized capital losses werefurther increased by $13 million due to amortization of the host security.  The change in the fair value of embeddedoptions is bifurcated from the host securities, separately valued and reportedin realized capital gains and losses, while the change in value of the hostsecurities is reported in OCI.  Totalfair value exceeded total amortized cost by $9 million at June 30,2008.  Valuation gains and losses areconverted into cash for securities with embedded options upon our election tosell these securities.  In the event theeconomic value of the options is not realized, we will recover the par value ifheld to maturity.  Total fair valueexceeded par value by $55 million at June 30, 2008.

 

Losses from the previously established riskreduction programs, primarily in our duration management programs, were relatedto changing interest rates and credit spreads as rates declined during theperiod.

 

40

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A changing interest rate environment willdrive changes 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 portfolio view.  Tactical duration management is accomplishedthrough both cash market transactions including new purchases and derivativeactivities that generate realized gains and losses.  As a component of our approach to managingportfolio duration, realized gains and losses on certain derivative instrumentsare most appropriately considered in conjunction with the unrealized gains andlosses on the fixed income portfolio. This approach mitigates the impacts of general interest rate changes tothe overall financial condition of the Company.

 

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

 
| ** **                                             | ** ** | **Six months ended June 30,** | ** ** | ** **      | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------|------------|-----------------|------------|
| ** **                                             | ** ** | **2008**                                          | ** ** | **2007**        | ** ** | **YTD 2008 Explanations** | ** ** |
| **($ in millions)**                          | ** ** | **Valuation**                                     | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| ** **                                             |       |                                              |       |            |       |   |   |   |   |   |   |
| **Risk  Reduction**Duration gap management             |       | (29)                                              |       | 17              |       | (12) |   | 37 |   | Interest rate caps, floors and swaps are used to  align 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 change in valuation reflects the  changing value of expected future settlements, which may vary over the period  of the contracts. The loss should offset unrealized gain in OCI to the extent  it relates to changes in risk-free rates, however any offset was reduced by  the impact of widening credit spreads. The 2008 loss resulted from declining  interest rates. |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| Anticipatory hedging                                   |       | —                                            |       | 23              |       | 23 |   | 6 |   | Futures 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 contracts are cash  settled daily and can be exited at any time for a minimal additional cost. If  the cash flow mismatches are such that a positive net investment position is  being hedged, there is an offset for the related investments’ unrealized gain  or loss in OCI. The 2008 YTD amounts reflect decreases in risk-free interest  rates on a net long position as liability issuances exceeded asset  acquisitions. |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| Hedging of interest rate exposure in annuity contracts |       | (9)                                               |       | 6               |       | (3) |   | 8 |   | Interest rate caps used to hedge the effect of  changing crediting rates that are indexed to changes in treasury rates on  certain annuity contracts. The change in valuation reflects the changing  value of expected future settlements including the underlying cost to hedge  the treasury-rate index feature. The offset to the product hedging cost is  reflected in the base crediting rates on the underlying annuity policies,  which is reported in credited interest. The value of expected future  settlements and the associated value of future credited interest, which is  reportable in future periods when incurred, decreased in 2008 due to the  decline in interest rates. |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| Hedging unrealized gains on equity indexed notes       |       | —                                            |       | 2               |       | 2 |   | — |   |   |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| Hedge  ineffectiveness                                 |       | (9                                                | )          | (2              | )          | (11 | ) | 9 |   | The hedge ineffectiveness of $(9) million  includes $23 million in realized capital losses on swaps that were offset by  $14 million in realized capital gains on the hedged risk. |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| Foreign currency  contracts                            |       | —                                            |       | (3              | )          | (3 | ) | — |   |   |   |
| **Total  Risk reduction**                              |       | $                                                 | (47        | )               | $          | 43 |   | $ | (4 | ) | $ | 60 |   |   |   |
|                                                   |       |                                              |       |            |       |   |   |   |   |   |   |
| **Income  generation**                                 |       |                                              |       |            |       |   |   |   |   |   |   |
| Asset replication  – credit exposure              |       | $                                                 | (20        | )               | $          | 4 |   | $ | (16 | ) | $ | — |   | Credit default swaps are used to replicate fixed  income securities and to complement the cash market when credit exposure to  certain issuers is not available or when the derivative alternative is less  expensive than the cash market alternative. The credit default swaps  typically have five—year terms  for which we receive periodic premiums through expiration. Valuation gains  and losses will reverse if allowed to expire. The 2008 YTD changes in  valuation are due to widening credit spreads, and would only be converted to  cash upon disposition or a default on an underlying credit obligation. |   |

 

41

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| ** **                    | ** ** | **Six months ended June 30,** | ** ** | ** **      | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|-----------------|------------|
| ** **                    | ** ** | **2008**                                          | ** ** | **2007**        | ** ** | **YTD 2008 Explanations** | ** ** |
| **($ in millions)** | ** ** | **Valuation**                                     | ** ** | **Settlements** | ** ** | **Total** | ** ** | **Total** | ** ** | ** ** | ** ** |
| ** **                    |       |                                              |       |            |       |   |   |   |   |   |   |
| **Accounting**                |       |                                              |       |            |       |   |   |   |   |   |   |
| Equity indexed notes          |       | $                                                 | (105)      |            | $          | — |   | $ | (105) |   | $ | 58 |   | Equity–indexed  notes are fixed income securities that contain embedded equity 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. In the event the economic value of the options is not  realized, we will recover the par value if held to maturity. Fair value  exceeded par value by $28 million at June 30, 2008. The following table  compares the June 30, 2008 holdings and December 31, 2007 holdings. |   |
|                          |       |                                              |       |            |       |   |   |   |   |   |   |   |   |   |   |

 
| ** ** | **($ in millions)**                  | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** | **December 31,  2007** | ** ** |
|------------|------------------------------------------------|------------|-------------------------|------------|------------|------------|-----------------------------|------------|
|       | Par value                                      |       | $                       |  800  |       | $          |  —                |       | $ |  800 |   |
|       | Amortized cost of  host contract               |       | $                       | 507        |       | $          | 10                          |       | $ | 497 |   |
|       | Fair value of  equity–indexed call option |       | 317                     |       | (105       | )          | 422                         |       |
|       | Total amortized  cost                          |       | $                       | 824        |       | $          | (95                         | )          | $ | 919 |   |
|       | Total Fair value                               |       | $                       | 828        |       | $          | (96                         | )          | $ | 924 |   |
|       | Unrealized  gain/loss                          |       | $                       | 4          |       | $          | (1                          | )          | $ | 5 |   |

 
| Conversion options in fixed income securities |   | (22) |   | — |   | (22) |   | 28 |   | 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 equity indices. 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 if held to maturity. Fair value exceeded par value by $27 million at  June 30, 2008. The following table compares the June 30, 2008  holdings and December 31, 2007 holdings. |   |
|-----------------------------------------------|--------|------|--------|--------|--------|------|--------|----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|

 
| ** ** | **($ in millions)**    | ** ** | **June 30,  2008** | ** ** | **Change  in Fair  Value** | ** ** | **Change due  to Net Sale  Activity** | ** ** | **December 31,  2007** | ** ** |
|------------|----------------------------------|------------|-------------------------|------------|---------------------------------|------------|------------------------------------------------------|------------|-----------------------------|------------|
|       | Par value                        |       | $                       |  466  |                            | $          |  —                                         |       | $                           |  (93) |   | $ |  559 |   |
|       | Amortized cost of  host contract |       | $                       | 329        |                            | $          | 3                                                    |       | $                           | (61        | ) | $ | 387 |   |
|       | Fair value of  conversion option |       | 159                     |       | (22                             | )          | (9                                                   | )          | 190                         |       |
|       | Total amortized  cost            |       | $                       | 488        |                            | $          | (19                                                  | )          | $                           | (70        | ) | $ | 577 |   |
|       | Total Fair value                 |       | $                       | 493        |                            | $          | (21                                                  | )          | $                           | (66        | ) | $ | 580 |   |
|       | Unrealized  gain/loss            |       | $                       | 5          |                            | $          | (2                                                   | )          | $                           | 4          |   | $ | 3 |   |

 
| **Total  accounting** |   | $      | (127)  |   | $      | — |   | $      | (127)  |   | $      | 86  |   |   |   |
|-----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|-----|--------|--------|--------|
| ** **            |   |   |   |   |   |   |   |   |   |   |   |
| **Total**             |   | $      | (194)  |   | $      | 47     |   | $      | (147)  |   | $      | 146 |   |   |   |

 

**APPLICATIONOF CRITICAL ACCOUNTING ESTIMATES**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America (“GAAP”) requires management to adopt accountingpolicies and make estimates and assumptions that affect amounts reported in theconsolidated financial statements.

 

In applyingpolicies, management makes subjective and complex judgments that frequentlyrequire estimates about matters that are inherently uncertain. Many of thesepolicies, estimates and related judgments are common in the insurance andfinancial services industries; others are specific to our businesses andoperations.  It is reasonably likely thatchanges in these estimates could occur from period to period and result in amaterial impact on our consolidated financial statements.

 

Our criticalaccounting estimate for the fair value of financial assets and financialliabilities follows.  For a descriptionof critical accounting estimates not discussed below, see the Application ofCritical Accounting Estimates section of MD&A found under Part II.Item 7. of the Allstate Life Insurance Company Annual Report on Form 10-Kfor 2007.

 

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**Fair Value of Financial Assets and Financial Liabilities**SFAS No. 157is effective for fiscal years beginning after November 15, 2007. Weadopted the provisions of SFAS No. 157 as of January 1, 2008 forfinancial assets and financial liabilities that are measured at fairvalue.  SFAS No. 157:

 

·                 Defines fair value as the price that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date, and establishes a framework for measuringfair value;

 

·                 Establishes a three-level hierarchy for fair value measurements basedupon the transparency of inputs to the valuation as of the measurement date;

 

·                 Expands disclosures about financial instruments measured at fair value.

 

We categorizeour financial assets and financial liabilities measured at fair value based onthe priority of the inputs to the valuation technique, into a three-level fairvalue hierarchy. The fair value hierarchy gives the highest priority to quotedprices in active markets for identical assets or liabilities which we canaccess (Level 1); the second highest priority for similar assets or liabilitiesin active markets, quoted prices for identical or similar assets or liabilitiesin non-active markets, or valuation models whose inputs are observable (Level2); and the lowest priority to unobservable inputs (Level 3).  If inputs used to measure a financialinstrument fall within different levels of the fair value hierarchy, thecategorization is based on the lowest level input that is significant to the fairvalue measurement of the entire instrument. Certain financial assets are not carried at fair value on a recurringbasis, including investments such as mortgage loans, limited partnershipinterests, bank loans and policy loans, and thus are only categorized in thefair value hierarchy when held at fair value on a non-recurring basis.  In addition, equity options embedded in fixedincome securities are not disclosed in the hierarchy with free-standingderivatives as the embedded derivatives are presented as combined instrumentsin fixed income securities.

 

Theavailability of market observable information is the principal factor indetermining the level that financial instruments are assigned in thethree-level hierarchy. Observable inputs are those used by market participantsin valuing financial instruments that are developed based on market dataobtained from independent sources. In the absence of sufficient observableinputs, unobservable inputs reflect our estimates of the assumptions marketparticipants would use in valuing financial assets and financial liabilitiesand are developed based on the best information available in thecircumstances.  The degree of managementjudgment involved in determining fair values is inversely related to theavailability of market observable information.

 

Financial assets and financial liabilities recorded onthe Condensed Consolidated Statements of Financial Position at fair value arecategorized based on the reliability of inputs to the valuation techniques asfollows:

 
| *Level  1:* | Financial assets  and financial liabilities whose values are based on unadjusted quoted prices  for identical assets or liabilities in an active market that we can access.                                                                                                                                                                                            |
|-------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |                                                                                                                                                                                                                                                                                                                                                                   |
| *Level  2:* | Financial assets  and financial liabilities whose values are based on the following:                                                                                                                                                                                                                                                                                   |
|        |                                                                                                                                                                                                                                                                                                                                                                   |
|        | a)                                                                                                                                                                                                                                                                                                                                                                     | Quoted prices  for similar assets or liabilities in active markets; |
|        |                                                                                                                                                                                                                                                                                                                                                                   |   |
|        | b)                                                                                                                                                                                                                                                                                                                                                                     | Quoted prices  for identical or similar assets or liabilities in non-active markets; or |
|        |                                                                                                                                                                                                                                                                                                                                                                   |   |
|        | c)                                                                                                                                                                                                                                                                                                                                                                     | Valuation models  whose inputs are observable, directly or indirectly, for substantially the  full term of the asset or liability |
|        |                                                                                                                                                                                                                                                                                                                                                                   |
| *Level  3:* | Financial assets  and financial liabilities whose values are based on prices or valuation  techniques that require inputs that are both unobservable and significant to  the overall fair value measurement. These inputs may reflect our estimates of  the assumptions that market participants would use in valuing the financial  assets and financial liabilities. |

 

We utilize a combination of third partyvaluation service providers, brokers, and internal valuation models todetermine fair value.  We gain assurance on the overallreasonableness and consistent application of input assumptions, valuationmethodologies, and compliance with accounting standards for fair valuedetermination through the execution of various processes and controls designedto ensure that our financial assets and financial liabilities are appropriatelyvalued and our ongoing monitoring of the fair values received or derivedinternally.

 

We areresponsible for the determination of the value of the financial assets andfinancial liabilities carried at fair value and the supporting assumptions andmethodologies.  In certain situations, weemploy independent third-party valuation service providers to gather, analyze,and interpret market information and derive fair values based upon relevantassumptions and methodologies for individual instruments.  In situations where our valuation serviceproviders are unable to obtain sufficient market observable information uponwhich to estimate the fair value for a particular security, fair value isdetermined either by requesting brokers who are knowledgeable about thesesecurities to provide a quote or by employing internal valuation models thatare widely accepted in the financial 

 

43

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services industry.  Changing market conditions in the secondquarter of 2008 were incorporated into valuation assumptions and reflected inthe fair values, which were validated by calibration and other analyticaltechniques to available market observable data.

 

Valuationservice providers typically obtain data about market transactions and other keyvaluation model inputs from multiple sources and, through the use ofproprietary algorithms, produce valuation information in the form of a singlefair value for individual securities for which a fair value has been requestedunder the terms of our agreements.  Forcertain equity securities, valuation service providers provide marketquotations for completed transactions on the measurement date.  For other security types, fair values arederived from the valuation service providers’ proprietary valuationmodels.  The inputs used by the valuationservice providers include, but are not limited to, market prices from recentlycompleted transactions and transactions of comparable securities, interest rateyield curves, credit spreads, currency rates, and other market-observableinformation, as applicable. Valuation service providers also use proprietary discountedcash flow models that are widely accepted in the financial services industryand similar to those used by other market participants to value the samefinancial instruments.  The valuationmodels take into account, among other things, market observable information asof the measurement date, as described above, as well as the specific attributesof the security being valued including its term, interest rate, credit rating,industry sector, and where applicable, collateral quality and other issue orissuer specific information.  Executingvaluation models effectively requires seasoned professional judgment andexperience.  In cases where markettransactions or other market observable data is limited, the extent to whichjudgment is applied varies inversely with the availability of market observableinformation.

 

For certain of our financial assets carried at fairvalue, where our valuation service providers cannot provide fair valuedeterminations, we obtain non-binding price quotes from brokers familiar withthe security who, similar to our valuation service providers, may considertransactions or activity in similar securities, as applicable, among otherinformation.  The brokers providing pricequotes are generally from the brokerage divisions of leading financialinstitutions with market making, underwriting and distribution expertise.

 

The fair valueof financial assets and financial liabilities, including privately-placedsecurities and certain derivatives embedded in certain contractholder liabilities, where our valuation service providers orbrokers do not provide fair value determinations, is determined usingvaluation methods and models widely accepted in the financial servicesindustry.  Internally developed valuationmodels, which include inputs that may not be market observable and as suchinvolve some degree of judgment, are considered appropriate for each class ofsecurity to which they are applied.

 

Our internalpricing methods are primarily based on models using discounted cash flow methodologiesthat determine a single best estimate of fair value for individual financialinstruments.  In addition, our models useinternally assigned credit ratings as inputs (which are generally consistentwith any external ratings and those we use to report our holdings by creditrating) and stochastically determined cash flows for certain derivativesembedded in certain contractholder liabilities, both of which are difficult toindependently observe and verify.  Instrumentspecific inputs used in our internal fair value determinations include: couponrate, weighted average life, sector of the issuer, call provisions, and thecontractual elements of derivatives embedded in certain contractholderliabilities.  Market specific inputs usedin these fair values, which we believe are representative of inputs othermarket participants would use to determine fair value of the same instrumentsinclude: interest rate yield curves, quoted market prices of comparablesecurities, credit spreads, estimated liquidity premiums, and other applicablemarket data including lapse and anticipated market return estimates forderivatives embedded in certain contractholder liabilities.  As a result of the significance of non-marketobservable inputs, including internally assigned credit ratings and stochasticcash flow estimates as described above, judgment is required in developingthese fair values. The fair value of these financial assets and financialliabilities may differ from the amount received to sell an asset or the amountpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. Moreover, the use of different valuation assumptions may have a materialeffect on the financial assets’ and financial liabilities’ fair values.

 

Fair value of ourinvestments comprise an aggregation of numerous, single best estimates for eachsecurity in the Condensed Consolidated Statements of Financial Position.  Because of this detailed approach, there is nosingle set of assumptions that determine our fair value estimates at aconsolidated level.  Moreover, managementdoes not compile a range of estimates for items reported at fair value at theconsolidated level because we do not believe that a range would providemeaningful information.  Level 1 andLevel 2 measurements represent valuations where all significant inputs aremarket observable. Level 3 measurements have one or more significant inputsthat are not market observable and as a result these fair value determinationshave greater potential variability as it relates to their significantinputs.  The Level 3 principal componentsare privately placed securities valued using internal models, broker quotedsecurities, ABS RMBS, Alt-A, ARS backed by student loans and other CDO.  In general, the 

 

44

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greater the reliance onsignificant inputs that are not market observable, the greater potentialvariability of the fair value determinations. ABS RMBS and Alt-A reflected themost significant impacts to their respective fair value determinations, due tothe continued illiquidity that existed for these classes of securities. Forbroker quoted securities’ fair value determinations, we believe the brokersproviding the quotes may consider market observable transactions or activity insimilar securities, as applicable, and other information as calibrationpoints.  Privately placed securities’fair value determinations, which were based on internal ratings that are notmarket observable, are calibrated to market observable information in the formof external NAIC ratings and credit spreads. We believe our most significant exposure to changes in fair value is dueto market risk.  Our exposure to changesin market conditions is discussed fully in the Market Risk section of theMD&A included in our 2007 Form 10-K.

 

We employspecific control processes to determine the reasonableness of the fair valuesof our financial assets and financial liabilities.  Our processes are designed to ensure that thevalues received or internally estimated are accurately recorded and that thedata inputs and the valuation techniques utilized are appropriate, consistentlyapplied, and that the assumptions are reasonable and consistent with theobjective of determining fair value.  Forexample, on a continuing basis, we assess the reasonableness of individualsecurity values received from valuation service providers that exceed certainthresholds as compared to previous values received from those valuation serviceproviders. In addition, we may validate the reasonableness of fair values bycomparing information obtained from our valuation service providers to otherthird party valuation sources for selected financial assets. When fair valuedeterminations are expected to be more variable, we validate them throughreviews by members of management who have relevant expertise and who areindependent of those charged with executing investing transactions.

 

Thefollowing table identifies investments as of June 30, 2008 by source ofvalue determination:

 
| ** **                                                                                                                                                         | ** ** | **Investments** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| **($ in millions)**                                                                                                                                      | ** ** | **Fair  Value** | ** ** | **Percent  to total** | ** ** |
| Fair value based on internal sources (1)                                                                                                                           |       | $               | 14,441     |   | 20.4 | % |
| Fair value based on external sources (2)                                                                                                                           |       | 42,587          |       | 60.2 |   |
| Total fixed income, equity and certain short-term securities                                                                                                       |       | 57,028          |       | 80.6 |   |
| Fair value of derivatives                                                                                                                                          |       | 231             |       | 0.3 |   |
| Mortgage loans, policy loans, bank loans and certain limited  partnership, short-term and other investments, valued at cost, amortized cost  and the equity method |       | 13,496          |       | 19.1 |   |
| Total                                                                                                                                                              |       | $               | 70,755     |   | 100.0 | % |

 

----

(1)   Includesshort-term, commercial paper and other of $4.61 billion reported in Level 2.

(2)   Includes$4.88 billion that are valued using broker quotes.

 

For more detailedinformation on our accounting policy for the fair value of financial assets andfinancial liabilities and information on the financial assets and financialliabilities included in the Levels promulgated by SFAS No. 157, see Note 4to the Condensed Consolidated Financial Statements.

 

45

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Thefollowing table provides additional detail regarding Level 1, 2 and 3 financialassets and financial liabilities by their classification in the CondensedConsolidated Statement of Financial Position at June 30, 2008.

 
| ** **                                                | ** ** | **Quoted Prices   in Active   Markets for   Identical   Assets** | ** ** | **Significant   Other   Observable   Inputs** | ** ** | **Significant   Unobservable   Inputs** | ** ** | **Other   Valuations   and** | ** ** | **Balance as of** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| **($ in millions)**                             | ** ** | **(Level 1)**                                                                                  | ** ** | **(Level 2)**                                           | ** ** | **(Level 3)**                                | ** ** | **Netting**                            | ** ** | **June 30, 2008** | ** ** |
| **Financial assets**                                      |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Fixed income securities:                                  |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Corporate                                                 |       |                                                                                                |       | $                                                            | 13,574     |                                              | $          | 569                                    |       |                        |       | $ | 14,143 |   |
| Corporate privately placed securities                     |       |                                                                                                |       | 3,840                                                        |       | 10,775                                            |       |                                   |       | 14,615                      |       |
| Municipal                                                 |       |                                                                                                |       | 3,243                                                        |       | 59                                                |       |                                   |       | 3,302                       |       |
| Municipal – ARS                                      |       |                                                                                                |       | 8                                                            |       | 745                                               |       |                                   |       | 753                         |       |
| U.S. government and agencies                              |       | $                                                                                                   | 463        |                                                         | 3,180      |                                              | —     |                                   |       |                        | 3,643      |   |
| ABS RMBS                                                  |       | —                                                                                              |       | —                                                       |       | 1,798                                             |       |                                   |       | 1,798                       |       |
| Alt-A                                                     |       | —                                                                                              |       | —                                                       |       | 468                                               |       |                                   |       | 468                         |       |
| Other CDO                                                 |       | —                                                                                              |       | —                                                       |       | 560                                               |       |                                   |       | 560                         |       |
| Other ABS                                                 |       | —                                                                                              |       | —                                                       |       | 1,613                                             |       |                                   |       | 1,613                       |       |
| ABS CDO                                                   |       | —                                                                                              |       | —                                                       |       | 14                                                |       |                                   |       | 14                          |       |
| CRE CDO                                                   |       | —                                                                                              |       | —                                                       |       | 375                                               |       |                                   |       | 375                         |       |
| CMBS                                                      |       | —                                                                                              |       | 5,375                                                        |       | 168                                               |       |                                   |       | 5,543                       |       |
| Preferred stock                                           |       | —                                                                                              |       | 14                                                           |       | —                                            |       |                                   |       | 14                          |       |
| MBS                                                       |       | —                                                                                              |       | 2,670                                                        |       | 12                                                |       |                                   |       | 2,682                       |       |
| Foreign government                                        |       | —                                                                                              |       | 2,002                                                        |       | —                                            |       |                                   |       | 2,002                       |       |
| ABS – Credit card  and auto loans                    |       | —                                                                                              |       | 144                                                          |       | 204                                               |       |                                   |       | 348                         |       |
| Total fixed income securities                             |       | 463                                                                                                 |       | 34,050                                                       |       | 17,360                                            |       |                                   |       | 51,873                      |       |
| Equity securities:                                        |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| U.S equities                                              |       | 16                                                                                                  |       | —                                                       |       | 16                                                |       |                                   |       | 32                          |       |
| International equities                                    |       | —                                                                                              |       | 26                                                           |       | 10                                                |       |                                   |       | 36                          |       |
| Other                                                     |       | —                                                                                              |       | 81                                                           |       | 1                                                 |       |                                   |       | 82                          |       |
| Total equity securities                                   |       | 16                                                                                                  |       | 107                                                          |       | 27                                                |       |                                   |       | 150                         |       |
| Short-term investments:                                   |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Commercial paper and other                                |       | —                                                                                              |       | 4,609                                                        |       | —                                            |       |                                   |       | 4,609                       |       |
| Money market funds                                        |       | 396                                                                                                 |       | —                                                       |       | —                                            |       |                                   |       | 396                         |       |
| Total short–term  investments                        |       | 396                                                                                                 |       | 4,609                                                        |       | —                                            |       |                                   |       | 5,005                       |       |
| Other investments:                                        |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Free–standing  derivatives                           |       | —                                                                                              |       | 581                                                          |       | 44                                                |       |                                   |       | 625                         |       |
| Total other investments                                   |       | —                                                                                              |       | 581                                                          |       | 44                                                |       |                                   |       | 625                         |       |
| **Total recurring basis assets**                          |       | 875                                                                                                 |       | 39,347                                                       |       | 17,431                                            |       |                                   |       | 57,653                      |       |
| Non–recurring  basis                                 |       | —                                                                                              |       | —                                                       |       | 254                                               |       |                                   |       | 254                         |       |
| Valued at cost, amortized cost or using the equity method |       | —                                                                                              |       | —                                                       |       | —                                            |       | $                                      | 13,242     |                        | 13,242     |   |
| Counterparty and cash collateral netting (1)              |       | —                                                                                              |       | —                                                       |       | —                                            |       | (394                                   | )          | (394                        | )          |
| **Total investments**                                     | ** ** | **875**                                                                                             | ** ** | **39,347**                                                   | ** ** | **17,685**                                        | ** ** | **12,848**                             | ** ** | **70,755**                  | ** ** |
| Separate account assets                                   |       | 12,438                                                                                              |       | —                                                       |       | —                                            |       | —                                 |       | 12,438                      |       |
| Other assets                                              |       | 1                                                                                                   |       | —                                                       |       | 2                                                 |       | —                                 |       | 3                           |       |
| **Total financial assets**                                | ** ** | **$**                                                                                               | **13,314** | ** **                                                   | **$**      | **39,347**                                        | ** ** | **$**                                  | **17,687** | ** **                  | **$**      | **12,848** | ** ** | **$** | **83,196** | ** ** |
| % of total financial assets                               |       | 16.0                                                                                                | %          | 47.3                                                         | %          | 21.3                                              | %          | 15.4                                   | %          | 100.0                       | %          |
|                                                      |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| **Financial liabilities**                                 |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Contractholder funds:                                     |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Derivatives embedded in annuity contracts                 |       | $                                                                                                   | —     |                                                         | $          | (50                                               | )          | $                                      | (20        | )                           | —     |   | $ | (70 | ) |
| Other liabilities:                                        |       |                                                                                                |       |                                                         |       |                                              |       |                                   |       |                        |       |
| Free–standing  derivatives                           |       | —                                                                                              |       | (398                                                         | )          | (69                                               | )          | —                                 |       | (467                        | )          |
| Non–recurring  basis                                 |       | —                                                                                              |       | —                                                       |       | (89                                               | )          | —                                 |       | (89                         | )          |
| Counterparty and cash collateral netting (1)              |       | —                                                                                              |       | —                                                       |       | —                                            |       | $                                      | 243        |                        | 243        |   |
| **Total financial liabilities**                           | ** ** | **$**                                                                                               | **—** | ** **                                                   | **$**      | **(448**                                          | **)**      | **$**                                  | **(178**   | **)**                       | **$**      | **243** | ** ** | **$** | **(383** | **)** |
| % of total financial liabilities                          |       | 0.0                                                                                                 | %          | 117.0                                                        | %          | 46.5                                              | %          | (63.5                                  | )%         | 100.0                       | %          |

 

----

(1) In accordance with *Financial Accounting Standards Board (“FASB”) Staff Position No. FIN39-1, Amendment of FASB Interpretation No. 39*, we net all fairvalue amounts recognized for derivative instruments and fair value amountsrecognized for the right to reclaim cash collateral or the obligation toreturn cash collateral executed with the same counterparty under a masternetting agreement.  At June 30, 2008, the right to reclaim cashcollateral was offset by securities held, and the obligation to returncollateral was $151 million.

 

46

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The following tableprovides a summary of changes in fair value during the three–month period endedJune 30, 2008 of Level 3 financial assets and financial liabilities heldat fair value on a recurring basis at June 30, 2008.

 
| ** **                                         | ** ** | ** **                                                  | ** ** | **Total realized and unrealized   Gains (Losses) included in:** | ** ** | ** **                                                                | ** ** | ** **                                                                    | ** ** | ** **                                                                            | ** ** | **Total   Gains (Losses)   included in** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **($ in millions)**                      | ** ** | **Balance as of   March 31, 2008** | ** ** | **Net Income ****(1)**                                                                   | ** ** | **OCI on   Statement of   Financial   Position** | ** ** | **Purchases, Sales,   Issuances and   Settlements,  net** | ** ** | **Net   Transfers In   and/or (Out)   of Level 3** | ** ** | **Balance as of   June 30, 2008**   | ** ** | **Net Income for   Instruments   Still Held at  June 30, 2008**** ****(4)** | ** ** |
| **Financial  assets**                              |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| Fixed income  securities:                          |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| Corporate                                          |       | $                                                           | 734        |                                                                                               | $          | (10                                                                       | )          | $                                                                             | (8         | )                                                                                     | $          | 16                                                           |       | $ | (163 | ) | $ | 569 |   | $ | (9 | ) |
| Corporate privately  placed securities             |       | 11,155                                                      |       | (31                                                                                                | )          | (169                                                                      | )          | (278                                                                          | )          | 98                                                                                    |       | 10,775                                                       |       | (53 | ) |
| Municipal                                          |       | 41                                                          |       | —                                                                                             |       | 1                                                                         |       | 21                                                                            |       | (4                                                                                    | )          | 59                                                           |       | — |   |
| Municipal – ARS                               |       | 172                                                         |       | —                                                                                             |       | (21                                                                       | )          | (21                                                                           | )          | 615                                                                                   |       | 745                                                          |       | — |   |
| ABS RMBS                                           |       | 2,000                                                       |       | (243                                                                                               | )          | 129                                                                       |       | (88                                                                           | )          | —                                                                                |       | 1,798                                                        |       | (243 | ) |
| Alt–A                                         |       | 486                                                         |       | (31                                                                                                | )          | 30                                                                        |       | (17                                                                           | )          | —                                                                                |       | 468                                                          |       | (31 | ) |
| Other CDO                                          |       | 1,696                                                       |       | 2                                                                                                  |       | (58                                                                       | )          | (7                                                                            | )          | (20                                                                                   | )          | 1,613                                                        |       | 2 |   |
| Other ABS                                          |       | 633                                                         |       | (5                                                                                                 | )          | (17                                                                       | )          | (71                                                                           | )          | 20                                                                                    |       | 560                                                          |       | (4 | ) |
| ABS CDO                                            |       | 17                                                          |       | (3                                                                                                 | )          | 1                                                                         |       | (1                                                                            | )          | —                                                                                |       | 14                                                           |       | (3 | ) |
| CRE CDO                                            |       | 436                                                         |       | (311                                                                                               | )          | 278                                                                       |       | (28                                                                           | )          | —                                                                                |       | 375                                                          |       | (288 | ) |
| CMBS                                               |       | 191                                                         |       | (37                                                                                                | )          | 29                                                                        |       | (19                                                                           | )          | 4                                                                                     |       | 168                                                          |       | (35 | ) |
| Preferred stock                                    |       | —                                                      |       | —                                                                                             |       | —                                                                    |       | —                                                                        |       | —                                                                                |       | —                                                       |       | — |   |
| MBS                                                |       | 13                                                          |       | —                                                                                             |       | —                                                                    |       | (1                                                                            | )          | —                                                                                |       | 12                                                           |       | — |   |
| Foreign  government                                |       | —                                                      |       | —                                                                                             |       | —                                                                    |       | —                                                                        |       | —                                                                                |       | —                                                       |       | — |   |
| ABS – Credit card  and auto loans             |       | 163                                                         |       | —                                                                                             |       | 1                                                                         |       | (7                                                                            | )          | 47                                                                                    |       | 204                                                          |       | — |   |
| Total fixed  income securities                     |       | 17,737                                                      |       | (669                                                                                               | )          | 196                                                                       |       | (501                                                                          | )          | 597                                                                                   |       | 17,360                                                       |       | (664 | ) |
| Equity securities                                  |       | 57                                                          |       | (1                                                                                                 | )          | (3                                                                        | )          | 13                                                                            |       | (39                                                                                   | )          | 27                                                           |       | (1 | ) |
| Other  investments:                                |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| Free-standing  derivatives, net                    |       | (35                                                         | )          | —                                                                                             |       | —                                                                    |       | 10                                                                            |       | —                                                                                |       | (25                                                          | )(2)       | 32 |   |
| Total other  investments                           |       | (35                                                         | )          | —                                                                                             |       | —                                                                    |       | 10                                                                            |       | —                                                                                |       | (25                                                          | )          | 32 |   |
| **Total  investments**                             |       | 17,759                                                      |       | (670                                                                                               | )          | 193                                                                       |       | (478                                                                          | )          | 558                                                                                   |       | 17,362                                                       | (3)        | (633 | ) |
| Other assets                                       |       | 2                                                           |       | —                                                                                             |       | —                                                                    |       | —                                                                        |       | —                                                                                |       | 2                                                            |       | — |   |
| **Total  recurring Level 3 financial assets**      |       | $                                                           | 17,761     |                                                                                               | $          | (670                                                                      | )          | $                                                                             | 193        |                                                                                  | $          | (478                                                         | )          | $ | 558 |   | $ | 17,364 |   | $ | (633 | ) |
|                                               |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| **Financial  liabilities**                         |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| Contractholder  funds:                             |       |                                                        |       |                                                                                               |       |                                                                      |       |                                                                          |       |                                                                                  |       |                                                         |       |   |   |
| Derivatives  embedded in annuity contracts         |       | $                                                           | (10        | )                                                                                                  | $          | (11                                                                       | )          | $                                                                             | —     |                                                                                  | $          | 1                                                            |       | $ | — |   | $ | (20 | ) | $ | (11 | ) |
| **Total  recurring Level 3 financial liabilities** |       | $                                                           | (10        | )                                                                                                  | $          | (11                                                                       | )          | $                                                                             | —     |                                                                                  | $          | 1                                                            |       | $ | — |   | $ | (20 | ) | $ | (11 | ) |

 

----

(1)   The amountsabove total $(681) million and are reported in the Condensed ConsolidatedStatements of Operations as follows: $(682) million in realized capital gainsand losses; $13 million in net investment income; $(1) million in interestcredited to contractholder funds, and; $(11) million in contract benefits.

(2)   Comprises$44 million of financial assets and $(69) million of financial liabilities.

(3)   Comprises$17.43 billion of investments and $(69) million of free–standing derivativesincluded in financial liabilities.

(4)   The amountsabove represent gains and losses included in net income for the period of timethat the financial asset or financial liability was determined to be in Level3. These gains and losses total $(644) million and are reported in theCondensed Consolidated Statements of Operations as follows: $(646) million inrealized capital gains and losses; $13 million in net investment income, and;$(11) million in contract benefits.

 

47

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The following tableprovides a summary of changes in fair value during the six–month period ended June 30, 2008 of Level 3financial assets and financial liabilities held at fair value on a recurringbasis at June 30, 2008.

 
| ** **                                         | ** ** | ** **                                                     | ** ** | **Total realized and unrealized   Gains (Losses) included in:** | ** ** | ** **                                                                | ** ** | ** **                                                                          | ** ** | ** **                                                                            | ** ** | **Total   Gains (Losses)   included in** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **($ in millions)**                      | ** ** | **Balance as of   January 1,   2008** | ** ** | **Net Income ****(1)**                                                                   | ** ** | **OCI on   Statement of   Financial   Position** | ** ** | **Purchases,   Sales, Issuances   and Settlements,   net** | ** ** | **Net   Transfers In   and/or (Out)   of Level 3** | ** ** | **Balance as of   June 30, 2008**   | ** ** | **Net Income for  Instruments   Still Held at   June 30, 2008 ****(4)** | ** ** |
| **Financial  assets**                              |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| Fixed income  securities:                          |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| Corporate                                          |       | $                                                              | 747        |                                                                                               | $          | (43                                                                       | )          | $                                                                                   | (7         | )                                                                                     | $          | 4                                                            |       | $ | (132 | ) | $ | 569 |   | $ | (50 | ) |
| Corporate  privately placed securities             |       | 11,098                                                         |       | (11                                                                                                | )          | (200                                                                      | )          | (349                                                                                | )          | 237                                                                                   |       | 10,775                                                       |       | (39 | ) |
| Municipal                                          |       | 68                                                             |       | —                                                                                             |       | —                                                                    |       | 1                                                                                   |       | (10                                                                                   | )          | 59                                                           |       | — |   |
| Municipal – ARS                               |       | 163                                                            |       | —                                                                                             |       | (21                                                                       | )          | (12                                                                                 | )          | 615                                                                                   |       | 745                                                          |       | — |   |
| ABS RMBS                                           |       | 2,382                                                          |       | (281                                                                                               | )          | (132                                                                      | )          | (171                                                                                | )          | —                                                                                |       | 1,798                                                        |       | (264 | ) |
| Alt–A                                         |       | 588                                                            |       | (70                                                                                                | )          | (17                                                                       | )          | (33                                                                                 | )          | —                                                                                |       | 468                                                          |       | (70 | ) |
| Other CDO                                          |       | 1,961                                                          |       | 2                                                                                                  |       | (313                                                                      | )          | (17                                                                                 | )          | (20                                                                                   | )          | 1,613                                                        |       | 1 |   |
| Other ABS                                          |       | 720                                                            |       | (15                                                                                                | )          | (45                                                                       | )          | (164                                                                                | )          | 64                                                                                    |       | 560                                                          |       | (16 | ) |
| ABS CDO                                            |       | 36                                                             |       | (63                                                                                                | )          | 42                                                                        |       | (1                                                                                  | )          | —                                                                                |       | 14                                                           |       | (63 | ) |
| CRE CDO                                            |       | 566                                                            |       | (311                                                                                               | )          | 158                                                                       |       | (38                                                                                 | )          | —                                                                                |       | 375                                                          |       | (285 | ) |
| CMBS                                               |       | 224                                                            |       | (35                                                                                                | )          | (3                                                                        | )          | (22                                                                                 | )          | 4                                                                                     |       | 168                                                          |       | (33 | ) |
| Preferred stock                                    |       | —                                                         |       | —                                                                                             |       | —                                                                    |       | —                                                                              |       | —                                                                                |       | —                                                       |       | — |   |
| MBS                                                |       | 28                                                             |       | (1                                                                                                 | )          | —                                                                    |       | (15                                                                                 | )          | —                                                                                |       | 12                                                           |       | — |   |
| Foreign  government                                |       | —                                                         |       | —                                                                                             |       | —                                                                    |       | —                                                                              |       | —                                                                                |       | —                                                       |       | — |   |
| ABS – Credit card  and auto loans             |       | 249                                                            |       | —                                                                                             |       | (7                                                                        | )          | (41                                                                                 | )          | 3                                                                                     |       | 204                                                          |       | — |   |
| Total fixed  income securities                     |       | 18,830                                                         |       | (828                                                                                               | )          | (545                                                                      | )          | (858                                                                                | )          | 761                                                                                   |       | 17,360                                                       |       | (819 | ) |
| Equity securities                                  |       | 61                                                             |       | (2                                                                                                 | )          | (6                                                                        | )          | 13                                                                                  |       | (39                                                                                   | )          | 27                                                           |       | (2 | ) |
| Other  investments:                                |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| Free-standing  derivatives, net                    |       | (6                                                             | )          | (31                                                                                                | )          | —                                                                    |       | 12                                                                                  |       | —                                                                                |       | (25                                                          | )(2)       | 14 |   |
| Total other  investments                           |       | (6                                                             | )          | (31                                                                                                | )          | —                                                                    |       | 12                                                                                  |       | —                                                                                |       | (25                                                          | )          | 14 |   |
| **Total  investments**                             |       | 18,885                                                         |       | (861                                                                                               | )          | (551                                                                      | )          | (833                                                                                | )          | 722                                                                                   |       | 17,362                                                       | (3)   | (807 | ) |
| Other assets                                       |       | 2                                                              |       | —                                                                                             |       | —                                                                    |       | —                                                                              |       | —                                                                                |       | 2                                                            |       | — |   |
| **Total  recurring Level 3 financial assets**      |       | $                                                              | 18,887     |                                                                                               | $          | (861                                                                      | )          | $                                                                                   | (551       | )                                                                                     | $          | (833                                                         | )          | $ | 722 |   | $ | 17,364 |   | $ | (807 | ) |
|                                               |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| **Financial  liabilities**                         |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| Contractholder  funds:                             |       |                                                           |       |                                                                                               |       |                                                                      |       |                                                                                |       |                                                                                  |       |                                                         |       |   |   |
| Derivatives  embedded in annuity contracts         |       | $                                                              | 4          |                                                                                               | $          | (25                                                                       | )          | $                                                                                   | —     |                                                                                  | $          | 1                                                            |       | $ | — |   | $ | (20 | ) | $ | (25 | ) |
| **Total  recurring Level 3 financial liabilities** |       | $                                                              | 4          |                                                                                               | $          | (25                                                                       | )          | $                                                                                   | —     |                                                                                  | $          | 1                                                            |       | $ | — |   | $ | (20 | ) | $ | (25 | ) |

 

----

(1)   The amountsabove total $(886) million and are reported in the Condensed ConsolidatedStatements of Operations as follows: $(882) million in realized capital gainsand losses; $25 million in net investment income; $(4) million in interestcredited to contractholder funds, and; $(25) million in contract benefits.

(2)   Comprises$44 million of financial assets and $(69) million of financial liabilities.

(3)   Comprises$17.43 billion of investments and $(69) million of free–standing derivativesincluded in financial liabilities.

(4)   The amountsabove represent gains and losses included in net income for the period of timethat the financial asset or financial liability was determined to be in Level3. These gains and losses total $(832) million and are reported in theCondensed Consolidated Statements of Operations as follows: $(831) million inrealized capital gains and losses; $25 million in net investment income;$(1) million in interest credited to contractholder funds, and; $(25)million in contract benefits.

 

Transfers into and out ofLevel 3 during the six months ended June 30, 2008 are attributable to achange in the availability of market observable information for individualsecurities within the respective categories. Due to a further deterioration in liquidity for the segment of the ARSmarket backed by student loans, certain market observable data utilized forvaluation purposes became unavailable during the second quarter of 2008.  As of June 30, 2008, $745 million or98.9% of our total ARS holdings were valued using a discounted cash flow model.  Certaininputs to the valuation model that are significant to the overall valuation andnot market observable included: estimates of future coupon rates if auctionfailures continue, maturity assumptions, and illiquidity premium.  As a result of the reliance on certainnon-market observable inputs, the portion of the ARS portfolio backed by studentloans have been transferred to Level 3 for the period ended June 30, 2008.These same securities were classified as Level 2 measurements for the periodended March 31, 2008.  Our ARSholdings that are not backed by student loans have a fair value equal to theircorresponding par value based on market observable inputs and, therefore,continue to have a Level 2 classification.

 

48

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        The following table presents fair value as a percent ofamortized cost for Level 3 investments at June 30, 2008.

 
| **($ in millions)**           | ** ** | **Fair value** | ** ** | **Fair value as a   % of   Amortized cost** | ** ** |
|-----------------------------------------|------------|---------------------|------------|--------------------------------------------------------------------------------|------------|
| Fixed income securities:                |       |                |       |                                                                           |       |
| Corporate                               |       | $                   | 569        |                                                                           | 100.7      | % |
| Corporate - privately placed securities |       | 10,775              |       | 99.8                                                                           |       |
| Municipal                               |       | 59                  |       | 100.0                                                                          |       |
| Municipal - ARS                         |       | 745                 |       | 97.3                                                                           |       |
| ABS RMBS                                |       | 1,798               |       | 79.1                                                                           |       |
| Alt-A                                   |       | 468                 |       | 91.6                                                                           |       |
| Other CDO                               |       | 1,613               |       | 74.1                                                                           |       |
| Other ABS                               |       | 560                 |       | 89.3                                                                           |       |
| ABS CDO                                 |       | 14                  |       | 116.7                                                                          |       |
| CRE CDO                                 |       | 375                 |       | 101.1                                                                          |       |
| CMBS                                    |       | 168                 |       | 82.8                                                                           |       |
| Preferred stock                         |       | —              |       | —                                                                         |       |
| MBS                                     |       | 12                  |       | 100.0                                                                          |       |
| Foreign government                      |       | —              |       | —                                                                         |       |
| ABS – Credit card  and auto loans  |       | 204                 |       | 95.3                                                                           |       |
| Total fixed income securities           |       | 17,360              |       | 93.4                                                                           |       |
| Equity securities:                      |       |                |       |                                                                           |       |
| U.S. equities                           |       | 16                  |       | 100.0                                                                          |       |
| International equities                  |       | 10                  |       | 100.0                                                                          |       |
| Other                                   |       | 1                   |       | 100.0                                                                          |       |
| Total equity securities                 |       | 27                  |       | 103.8                                                                          |       |
| Other investments:                      |       |                |       |                                                                           |       |
| Free-standing derivatives               |       | 44                  |       | 100.0                                                                          |       |
| Total other investments                 |       | 44                  |       | 100.0                                                                          |       |
| Sub-total recurring Level 3 investments |       | 17,431              |       | 93.4                                                                           |       |
| Non-recurring basis                     |       | 254                 |       | 100.0                                                                          |       |
| **Total Level 3 investments**           |       | $                   | 17,685     |                                                                           | 93.5       |   |

 

Non-recurring investmentsinclude certain mortgage loans, limited partnership interests and otherinvestments at fair value due to our change in intent write-downs andother-than-temporary impairments at June 30, 2008.

 

**CAPITAL RESOURCES AND LIQUIDITY**

 

**Capital Resources** consist of shareholder’sequity and debt, representing funds deployed or available to be deployed tosupport business operations.  Thefollowing table summarizes our capital resources.

 
| **($ in millions)**                                           | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Common stock, retained income and other shareholder’s equity items |       | $                           | 4,731      |                            | $          | 4,847 |   |
| Accumulated other comprehensive income                                  |       | (446                        | )          | (84                             | )          |
| Total shareholder’s equity                                         |       | 4,285                       |       | 4,763                           |       |
| Debt                                                                    |       | 250                         |       | 200                             |       |
| Total capital resources                                                 |       | $                           | 4,535      |                            | $          | 4,963 |   |

 

*Shareholder’s equity* decreased in the first six months of 2008 due to anet loss in the first six months of 2008 and higher unrealized net capitallosses on investments as June 30, 2008 compared to December 31, 2007,partially offset by capital contributions from AIC.

 

In the secondquarter of 2008, the Company received a capital contribution from its parentAIC of $349 million, which was recorded as additional capital paid-in on theCondensed Consolidated Statements of Financial Position.  The capital contribution included fixedincome securities with a fair value of $337 million, accrued investment incomeof $5 million and cash of $7 million. Additionally, in the first quarter of 2008, a non-cash capitalcontribution was recorded in connection with a reinsurance transaction with anunconsolidated affiliate.

 

49

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Inthe second quarter of 2008, the Board of Directors of AIC authorized AIC tomake up to $400 million in funds available to the Company on or before September 1,2008 through one or any combination of the following methods: by making one ormore capital contributions in cash or securities, by providing a guaranty orguarantees, or by purchasing one or more surplus notes or other securities.

 

*Debt* increased $50 million in the second quarter of 2008due to the issuance and transfer of a surplus note to an unconsolidatedaffiliate.  On May 28, 2008, under an existing agreement withKennett Capital, Inc. (“Kennett”), an unconsolidated affiliate of theCompany, the Company sold Kennett a $50 million redeemable surplus note issuedby ALIC Reinsurance Company (“ALIC Re”), a wholly owned subsidiary ofALIC.  The surplus note is due June 1,2038 with an initial rate of 5.93% that will reset every ten years to the thencurrent ten year Constant Maturity Treasury yield (“CMT”), plus 2.09%.   As payment, Kennett issued a full recoursenote due June 1, 2038 to ALIC for the same amount with an initial interestrate of 5.73% that will reset every ten years to the then current ten year CMT,plus 1.89.  The note due from Kennett isclassified as other investments and the related surplus note is classified aslong-term debt in the Condensed Consolidated Statements of Financial Position.

 

**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, AIC’s ratings and other factors.  There have been no changes to our insurancefinancial strength ratings since December 31, 2007.  S&P affirmed AIC’s and our ratings in July 2008.  Moody’s placed certain of our ratings underreview.

 

Effective May 8, 2008, the Company, AIC and TheAllstate Corporation (“the Corporation”) entered into a one-year Amended andRestated Intercompany Liquidity Agreement (“Liquidity Agreement”) replacing theIntercompany Liquidity Agreement between the Company and AIC, dated January 1,2008.  It shall be automatically renewedfor subsequent one-year terms unless terminated by the parties.  The Liquidity Agreement does not establish acommitment to advance funds on the part of any party.  ALIC and AIC each serve as a lender andborrower and the Corporation serves only as a lender. See Note 2 to theCondensed Consolidated Financial Statements for further details.

 

Additionally, the Company has a Capital SupportAgreement with AIC under which AIC is committed to provide capital to theCompany to allow for profitable growth while maintaining financial strengthratings at or above those of AIC.  SeeNote 2 to the Condensed Consolidated Financial Statements for further details.

 

**Liquidity Sources and Uses** Asreflected in our Condensed Consolidated Statements of Cash Flows,****loweroperating cash flows in the first six months of 2008, compared to the first sixmonths of 2007, were primarily related to a decrease in investment income andpremiums.

 

Cash flows used in investing activitiesincreased in the first six months of 2008, compared to the first six months of2007, primarily due to an increased investment in short-term securities,partially offset by a lower investment in and higher proceeds from sales offixed income securities.

 

# **Cash flows used in financing activities decreased primarily due toincreased contractholder fund deposits partially offset by highercontractholder fund withdrawals.  Forquantification of the changes in contractholder funds, see the Operationssection of the MD&A.**

# ** **

Atotal of $986 million of extendible medium-term notes backed by fundingagreements have been called and will be retired in July 2008.** **We have accumulated, and expect tomaintain, short-term investments to retire these obligations.  As of June 30, 2008, $3.12 billion of extendible fundingagreements have maturity dates prior to or on March 31, 2009.

 

In addition to theCapital Support Agreement and Liquidity Agreement, which provide a maximumamount of potential funding under each agreement of $1.00 billion, we also haveaccess to additional borrowing to support liquidity through The AllstateCorporation as follows:

 

·                   A commercialpaper program with a borrowing limit of $1.00 billion to cover short-term cashneeds.  As of June 30, 2008, therewere no balances outstanding and therefore the remaining borrowing capacity was$1.00 billion; however, the outstanding balance can fluctuate daily.

 

·                  A primarycredit facility that covers short-term liquidity requirements.  The $1.00 billion unsecured revolving creditfacility has an initial term of five years expiring in 2012 with two optionalone-year extensions that can be exercised at the end of any of the remainingfour years of the facility upon approval of existing or replacement lendersproviding more than two thirds of the commitments to lend.  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 

 

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later date among existing ornew lenders.  This facility has afinancial covenant requiring that The Allstate Corporation not exceed a 37.5%debt to capital resources ratio as defined in the agreement.  This ratio at June 30, 2008 was21.7%.  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 oursenior, unsecured, nonguaranteed long-term debt.  There were no borrowings under this line ofcredit during the first six months of 2008. The total amount outstanding at anypoint in time under the combination of the commercial paper program and thecredit facility cannot exceed the amount that can be borrowed under the creditfacility.

 

·                  A universal shelf registration statementwas filed by The Allstate Corporation with the Securities and ExchangeCommission in May 2006.  TheAllstate Corporation can use it to issue an unspecified amount of debtsecurities, common stock (including 354 million shares of treasury stock as of June 30,2008), preferred stock, depositary shares, warrants, stock purchase contracts,stock purchase units and securities of subsidiaries.  The specific terms of any securities TheAllstate Corporation issues under this registration statement will be providedin the applicable prospectus supplements.

 

As of June 30, 2008,we recorded a net deferred tax asset of $149 million, which included a netdeferred tax asset of $748 million relating to unrealized and realized tax netcapital losses that have not yet been recognized for tax purposes.  Although realization is not assured,management believes it is more likely than not that the deferred tax asset willbe realized based on our assumption that we will be able to fully utilize thedeductions that are ultimately recognized for tax purposes.

 

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**Item 4. Controls and Procedures**

** **

*Evaluationof Disclosure Controls and Procedures. *We maintaindisclosure controls and procedures as defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of1934.  Under the supervision and with theparticipation of our management, including our principalexecutive officer and principal financial officer, we conducted an evaluationof the effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this report.  Basedupon this evaluation, the principal executive officer and the principalfinancial officer concluded that our disclosure controls and procedures areeffective in providing reasonable assurance that material information requiredto be disclosed in our reports filed with or submitted to the Securities andExchange Commission under the Securities Exchange Act is made known tomanagement, including the principal executive officer and the principalfinancial officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

*Changes inInternal Control over Financial Reporting. *During the fiscal quarter ended June 30, 2008, there have been nochanges in our internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.    LegalProceedings**

 

Information required forthis Part II, Item 1 is incorporated by reference to the discussion underthe heading “Regulation” and under the heading “Legal and regulatoryproceedings and inquiries” in Note 6 of the Condensed Consolidated FinancialStatements in Part I, Item 1 of this Form 10-Q.

 

**Item 1A.  Risk Factors**

 

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

 

These forward-lookingstatements do not relate strictly to historical or current facts and may beidentified by their use of words like “plans,” “seeks,” “expects,” “will,” “should,”“anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets” andother words with similar meanings. These statements may address, among otherthings, our strategy for growth, product development, 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 the forward-looking statements prove inaccurateor if other risks or uncertainties arise, actual results could differ materiallyfrom those communicated in these forward-looking statements.  Risk factors which could cause actual resultsto differ materially from those suggested by such forward-looking statementsinclude but are not limited to those discussed or identified in this document(including the risks described below), in our public filings with theSecurities and Exchange Commission, and those incorporated by reference in Part I,Item 1A of Allstate Life Insurance Company Annual Report on Form 10-K for2007.

 

**The impact of our investmentstrategies may be adversely affected by developments in the investment markets**

 

The impact of our investment portfolio risk mitigationand return optimization programs may be adversely affected by unexpecteddevelopments in the investment markets.

 

**The realization of deferred taxassets is subject to uncertainty**

 

The realization ofour deferred tax assets is based on our assumption that we will be able tofully utilize the deductions that are ultimately recognized for taxpurposes.  However, actual results maydiffer from our assumptions if adequate levels of taxable income are notattained.

 

**Item6.  Exhibits**

 
| (a)    |   | Exhibits                                                                       |
|--------|--------|--------------------------------------------------------------------------------|
|   |   | An  Exhibit Index has been filed as part of this report on page E-1. |

 

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**SIGNATURE**

 

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

 
|                | Allstate Life Insurance Company    |
|---------------------|------------------------------------|
|                | (Registrant)                       |
|                |                               |
| August 8, 2008 |                               |
|                | 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                 |       | Letter  Agreement between Allstate Insurance Company, The Allstate Corporation and  certain affiliates, including Allstate Life Insurance Company, effective  December 1, 2007, incorporated herein by reference to Exhibit 10.1  to Allstate Life Insurance Company’s Current Report on Form 8-K filed  May 23, 2008. |
|                 |       |                                                                                                                                                                                                                                                                                                                                            |
| 10.2                 |       | Amendment  No. 1 to Credit Agreement dated as of May 22, 2008, incorporated  herein by reference to Exhibit 10.1 to Allstate Life Insurance Company’s  Current Report on Form 8-K filed May 27, 2008.                                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                                                                            |
| 15                   |       | Acknowledgment  of awareness from Deloitte & Touche LLP, datedAugust 7, 2008, concerning unaudited  interim financial information.                                                                                                                                                                                                |
|                 |       |                                                                                                                                                                                                                                                                                                                                            |
| 31.1                 |       | Rule 13a-14(a) Certification  of Principal Executive Officer                                                                                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                            |
| 31.2                 |       | Rule 13a-14(a) Certification  of Principal Financial Officer                                                                                                                                                                                                                                                                          |
|                 |       |                                                                                                                                                                                                                                                                                                                                            |
| 32                   |       | Section 1350  Certifications                                                                                                                                                                                                                                                                                                               |

 

E-1

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