**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

###### **FORM 10-Q**

######  

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

 

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

**THESECURITIES EXCHANGE ACT OF 1934**

**FOR THEQUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**

 

**OR**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF**

###### **THESECURITIES EXCHANGE ACT OF 1934**

######  

##### **Commission file number: 333-100029**

#####  

**ALLSTATELIFE INSURANCE COMPANY OF NEW YORK**

(Exactname of registrant as specified in its charter)

 

| **New York**             | ** ** | **36-2608394**                        |
|--------------------------|------------|---------------------------------------|
| (State of Incorporation) |       | (I.R.S.  Employer Identification No.) |

 

| **100 Motor Parkway, Suite 132**     |       |        |
|-------------------------------------------|------------|-------------|
| **Hauppauge, New York**                   | ** ** | **11788**   |
| (Address  of principal executive offices) |       | (Zip  code) |

 

Registrant’stelephone number, including area code:**631-357-8920**

 

**Indicate bycheck mark whether the registrant: (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.**
| **Yes****x****    No****o** |
|--------------------------------------------|

 

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

 
| **Large  accelerated filer****o** | ** ** | **Accelerated filer****o** | ** ** | **Non-accelerated filer****x** | ** ** | **Smaller Reporting company****o** |
|-----------------------------------|------------|----------------------------|------------|--------------------------------|------------|------------------------------------|

**(Do not check if a smaller reporting company)**

 

**Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).**
| **Yes****o****    No****x** |
|--------------------------------------------|

 

**As of November 20,2008, the registrant had 100,000 common shares, $25 par value, outstanding, allof which are held by Allstate Life Insurance Company.**

 

 

 

----

 

##### **ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK**

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

##### **September 30, 2008**

 
| **PART 1.**  | **FINANCIAL  INFORMATION**                                                                                                         | ** ** |
|-------------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                                               |       |
| Item 1.           | Financial Statements                                                                                                               |       |
|              |                                                                                                                               |       |
|              | Condensed Statements of  Operations for the Three-Month and Nine-Month Periods Ended  September 30, 2008 and 2007 (unaudited) | 1          |
|              |                                                                                                                               |       |
|              | Condensed Statements of  Financial Position as of September 30, 2008 (unaudited) and  December 31, 2007                  | 2          |
|              |                                                                                                                               |       |
|              | Condensed Statements of  Cash Flows for the Nine-Month Periods EndedSeptember 30, 2008 and 2007  (unaudited)                  | 3          |
|              |                                                                                                                               |       |
|              | Notes to Condensed  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                                                                                                            | 53         |
|              |                                                                                                                               |       |
| **PART II.** | **OTHER  INFORMATION**                                                                                                             | ** ** |
|              |                                                                                                                               |       |
| Item 1.           | Legal Proceedings                                                                                                                  | 54         |
|              |                                                                                                                               |       |
| Item 1A.          | Risk Factors                                                                                                                       | 54         |
|              |                                                                                                                               |       |
| Item 5.           | Other Information                                                                                                                  | 54         |
|              |                                                                                                                               |       |
| Item 6.           | Exhibits                                                                                                                           | 54         |

 

----

 

#### **PART 1. FINANCIAL INFORMATION**

####  

#### **ITEM 1.   FINANCIALSTATEMENTS**

####  

#### **ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK**

####  

**CONDENSED STATEMENTS OF OPERATIONS**

 
| ** **                                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                        | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                            | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)**                                     | ** ** |
| **Revenues**                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums                                              |       | $                                                    | 12,881     |                                                | $          | 17,720 |   | $ | 39,086 |   | $ | 54,135 |   |
| Contract charges                                      |       | 15,318                                               |       | 14,677                                              |       | 45,156 |   | 43,816 |   |
| Net investment income                                 |       | 102,633                                              |       | 96,994                                              |       | 302,597 |   | 287,901 |   |
| Realized capital gains and losses                     |       | 2,530                                                |       | 681                                                 |       | (55,862 | ) | (2,063 | ) |
|                                                  |       | 133,362                                              |       | 130,072                                             |       | 330,977 |   | 383,789 |   |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                                |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                                     |       | 48,933                                               |       | 45,297                                              |       | 134,092 |   | 136,835 |   |
| Interest credited to contractholder funds             |       | 48,506                                               |       | 44,572                                              |       | 136,385 |   | 131,470 |   |
| Amortization of deferred policy acquisition  costs    |       | 3,946                                                |       | 12,049                                              |       | 6,564 |   | 41,022 |   |
| Operating costs and expenses                          |       | 10,945                                               |       | 9,335                                               |       | 30,948 |   | 26,889 |   |
|                                                  |       | 112,330                                              |       | 111,253                                             |       | 307,989 |   | 336,216 |   |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Loss on disposition of operations                     |       | —                                               |       | —                                              |       | (358 | ) | (132 | ) |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| **Income from operations before income tax  expense** |       | 21,032                                               |       | 18,819                                              |       | 22,630 |   | 47,441 |   |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Income tax expense                                    |       | 6,574                                                |       | 6,434                                               |       | 7,154 |   | 16,679 |   |
|                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| **Net income**                                        |       | $                                                    | 14,458     |                                                | $          | 12,385 |   | $ | 15,476 |   | $ | 30,762 |   |

 

See notes to condensed financial statements.

 

1

----

 

**ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK**

 

**CONDENSED STATEMENTS OF FINANCIAL POSITION**

 
| ** **                                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **($ in thousands, except par value data)**          | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                         |       |                   |       |                  |       |
| Investments                                                                        |       |                   |       |                  |       |
| Fixed income securities, at fair value (amortized  cost $5,845,566 and $5,928,899) |       | $                      | 5,802,640  |                  | $          | 6,271,128 |   |
| Mortgage loans                                                                     |       | 711,933                |       | 725,301               |       |
| Short-term                                                                         |       | 398,296                |       | 22,688                |       |
| Policy loans                                                                       |       | 39,114                 |       | 38,509                |       |
| Other                                                                              |       | 2,162                  |       | 3                     |       |
| Total investments                                                                  |       | 6,954,145              |       | 7,057,629             |       |
|                                                                               |       |                   |       |                  |       |
| Cash                                                                               |       | 3,926                  |       | 7,356                 |       |
| Deferred policy acquisition costs                                                  |       | 443,318                |       | 278,664               |       |
| Accrued investment income                                                          |       | 63,977                 |       | 64,514                |       |
| Reinsurance recoverables                                                           |       | 353,343                |       | 381,431               |       |
| Deferred income taxes                                                              |       | 15,768                 |       | —                |       |
| Current income taxes receivable                                                    |       | 2,058                  |       | 146                   |       |
| Other assets                                                                       |       | 119,960                |       | 47,079                |       |
| Separate Accounts                                                                  |       | 697,363                |       | 948,358               |       |
| **Total assets**                                                                   |       | $                      | 8,653,858  |                  | $          | 8,785,177 |   |
|                                                                               |       |                   |       |                  |       |
| **Liabilities**                                                                    |       |                   |       |                  |       |
| Contractholder funds                                                               |       | $                      | 5,085,823  |                  | $          | 4,848,461 |   |
| Reserve for life-contingent contract  benefits                                     |       | 1,970,361              |       | 2,016,971             |       |
| Deferred income taxes                                                              |       | —                 |       | 39,737                |       |
| Other liabilities and accrued expenses                                             |       | 293,375                |       | 241,756               |       |
| Payable to affiliates, net                                                         |       | 3,849                  |       | 8,035                 |       |
| Reinsurance payable to parent                                                      |       | 9,657                  |       | 987                   |       |
| Separate Accounts                                                                  |       | 697,363                |       | 948,358               |       |
| **Total liabilities**                                                              |       | 8,060,428              |       | 8,104,305             |       |
| **Commitments and Contingent Liabilities  (Note 6)**                               |       |                   |       |                  |       |
|                                                                               |       |                   |       |                  |       |
| **Shareholder’s equity**                                                      |       |                   |       |                  |       |
| Common stock, $25 par value, 100 thousand  shares authorized and outstanding       |       | 2,500                  |       | 2,500                 |       |
| Additional capital paid-in                                                         |       | 140,000                |       | 140,000               |       |
| Retained income                                                                    |       | 490,635                |       | 473,184               |       |
| Accumulated other comprehensive (loss)  income:                                    |       |                   |       |                  |       |
| Unrealized net capital gains and losses                                            |       | (39,705                | )          | 65,188                |       |
| **Total accumulated other comprehensive  (loss) income**                           |       | (39,705                | )          | 65,188                |       |
| **Total shareholder’s equity**                                                |       | 593,430                |       | 680,872               |       |
| **Total liabilities and shareholder’s equity**                                |       | $                      | 8,653,858  |                  | $          | 8,785,177 |   |

 

See notes to condensed financial statements.

 

2

----

 

#### **ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK**

####  

**CONDENSED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                                                     | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                                     | ** ** |
| **Cash flows from operating activities**                                           |       |                                                |       |   |   |
| Net income                                                                         |       | $                                                   | 15,476     |   | $ | 30,762 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                                |       |   |   |
| Amortization and other non-cash items                                              |       | (60,998                                             | )          | (57,080 | ) |
| Realized capital gains and losses                                                  |       | 55,862                                              |       | 2,063 |   |
| Loss on disposition of operations                                                  |       | 358                                                 |       | 132 |   |
| Interest credited to contractholder funds                                          |       | 136,385                                             |       | 131,470 |   |
| Changes in:                                                                        |       |                                                |       |   |   |
| Life-contingent contract benefits and  contractholder funds                        |       | (14,203                                             | )          | 9,981 |   |
| Deferred policy acquisition costs                                                  |       | (34,550                                             | )          | 6,891 |   |
| Income taxes                                                                       |       | (1,999                                              | )          | (1,797 | ) |
| Other operating assets and liabilities                                             |       | 25,707                                              |       | (36,249 | ) |
| Net cash provided by operating activities                                          |       | 122,038                                             |       | 86,173 |   |
|                                                                               |       |                                                |       |   |   |
| **Cash flows from investing activities**                                           |       |                                                |       |   |   |
| Proceeds from sales of fixed income  securities                                    |       | 395,081                                             |       | 339,309 |   |
| Proceeds from sales of mortgage loans                                              |       | 12,175                                              |       | — |   |
| Investment collections                                                             |       |                                                |       |   |   |
| Fixed income securities                                                            |       | 114,927                                             |       | 84,197 |   |
| Mortgage loans                                                                     |       | 40,791                                              |       | 54,838 |   |
| Investment purchases                                                               |       |                                                |       |   |   |
| Fixed income securities                                                            |       | (499,623                                            | )          | (598,494 | ) |
| Mortgage loans                                                                     |       | (40,692                                             | )          | (54,542 | ) |
| Change in short-term investments, net                                              |       | (309,944                                            | )          | 45,495 |   |
| Change in other investments, net                                                   |       | (1,376                                              | )          | (547 | ) |
| Net cash used in investing activities                                              |       | (288,661                                            | )          | (129,744 | ) |
|                                                                               |       |                                                |       |   |   |
| **Cash flows from financing activities**                                           |       |                                                |       |   |   |
| Contractholder fund deposits                                                       |       | 528,337                                             |       | 377,809 |   |
| Contractholder fund withdrawals                                                    |       | (365,144                                            | )          | (336,408 | ) |
| Net cash provided by financing activities                                          |       | 163,193                                             |       | 41,401 |   |
|                                                                               |       |                                                |       |   |   |
| **Net decrease in cash**                                                           |       | (3,430                                              | )          | (2,170 | ) |
| **Cash at beginning of period**                                                    |       | 7,356                                               |       | 7,090 |   |
| **Cash at end of period**                                                          |       | $                                                   | 3,926      |   | $ | 4,920 |   |

 

See notes to condensed financial statements.

 

3

----

 

**ALLSTATE LIFE INSURANCE COMPANY OF NEW YORK**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(unaudited)**

 

### **1.  General**

###  

### **Basis of presentation**

 

The accompanying condensedfinancial statements include the accounts of Allstate Life Insurance Company ofNew York (the “Company”), a wholly owned subsidiary of Allstate Life InsuranceCompany (“ALIC”), which is wholly owned by Allstate Insurance Company (“AIC”),a wholly owned subsidiary of The Allstate Corporation (the “Corporation”).

 

The condensed financialstatements and notes as of September 30, 2008 and for the three-month andnine-month periods ended September 30, 2008 and 2007 are unaudited.  The condensed financial statements reflectall adjustments (consisting only of normal recurring accruals) which are, inthe opinion of management, necessary for the fair presentation of the financialposition, results of operations and cash flows for the interim periods.  These condensed financial statements andnotes should be read in conjunction with the financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2007.  Theresults of operations for the interim periods should not be consideredindicative of results to be expected for the full year.

 

**Premiumsand Contract Charges**

 

The following tablesummarizes premiums and contract charges by product.

 
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**              | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Premiums**                                |       |                                                 |       |                                                |       |   |   |   |   |
| Traditional life insurance (1)              |       | $                                                    | 7,335      |                                                | $          | 6,575 |   | $ | 21,433 |   | $ | 18,937 |   |
| Immediate annuities with life contingencies |       | 3,480                                                |       | 9,395                                               |       | 11,652 |   | 30,382 |   |
| Accident and health and other               |       | 2,066                                                |       | 1,750                                               |       | 6,001 |   | 4,816 |   |
| Total premiums                              |       | 12,881                                               |       | 17,720                                              |       | 39,086 |   | 54,135 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Contract charges**                        |       |                                                 |       |                                                |       |   |   |   |   |
| Interest-sensitive life insurance (1)       |       | 13,896                                               |       | 12,985                                              |       | 40,485 |   | 37,821 |   |
| Fixed annuities                             |       | 1,422                                                |       | 1,692                                               |       | 4,671 |   | 5,995 |   |
| Total contract charges                      |       | 15,318                                               |       | 14,677                                              |       | 45,156 |   | 43,816 |   |
| Total premiums and contract charges         |       | $                                                    | 28,199     |                                                | $          | 32,397 |   | $ | 84,242 |   | $ | 97,951 |   |

 

----

(1)   Beginning in 2008, certain ceded reinsurancepremiums previously included as a component of traditional life insurancepremiums were reclassified prospectively to be reported as a component ofinterest-sensitive life insurance contract charges.  In the third quarter and first nine months of2007, these ceded reinsurance premiums were $624 thousand and $1.8 million,respectively.

----

 

4

----

 

### **Adopted accounting standards**

 

*Statement of Position 05-1, Accounting by InsuranceEnterprises for Deferred Acquisition Costs in Connection with Modifications orExchanges of Insurance Contracts (“SOP 05-1”)*

 

In October 2005, theAmerican 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 SOP05-1 on January 1, 2007 for internal replacements occurring in fiscalyears beginning after December 15, 2006. The adoption resulted in a $1.2 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 qualify for deferral under SOP 05-1 and a reduction of DAC anddeferred sales inducement balances of $1.8 million pre-tax as of January 1,2007.

 

*SFAS No. 155, Accounting for Certain HybridFinancial Instruments – an amendment of FASB Statements No. 133 and 140 (“SFASNo. 155”)*

 

In February 2006, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 155, whichpermits fair value remeasurement at the date of adoption of any hybridfinancial instrument containing an embedded derivative that otherwise wouldrequire bifurcation under paragraph 12 or 13 of SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (“SFAS No. 133”);clarifies which interest-only strips and principal-only strips are not subjectto the requirements of SFAS No. 133; establishes a requirement to evaluateinterests in securitized financial assets to identify interests that arefreestanding derivatives or hybrid financial instruments that contain embeddedderivatives requiring bifurcation; and clarifies that concentrations of creditrisk in the form of subordination are not embedded derivatives. The Companyadopted the provisions of SFAS No. 155 on January 1, 2007, which wereeffective for all financial instruments acquired, issued or subject to aremeasurement event occurring after the beginning of the first fiscal yearafter September 15, 2006.  TheCompany elected not to remeasure existing hybrid financial instruments thatcontained embedded derivatives requiring bifurcation at the date of adoptionpursuant 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, Accounting forUncertainty in Income Taxes- an interpretation of FASB Statement No. 109  and FASB Staff Position No. FIN 48-1,Definition of Settlement in FASB Interpretation No. 48 (collectively “FIN48”)*

 

The FASB issued theinterpretation in July 2006 and the related staff position in May 2007.  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an entity’s financial statements inaccordance with SFAS No. 109, “Accounting for Income Taxes”.  FIN 48 requires 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, the Company adoptedthe provisions of FIN 48, which were effective for fiscal years beginning afterDecember 15, 2006.  No cumulativeeffect of a change in accounting principle or adjustment to the liability forunrecognized tax benefits was recognized as a result of the adoption of FIN48.  Accordingly, the adoption of FIN 48did not have an effect on the results of operations or financial position ofthe Company.

 

5

----

 

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

 

In September 2006, theFASB issued SFAS No. 157, which redefines fair value as the price thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in accounting principlesgenerally accepted in the United States of America (“GAAP”), and expandsdisclosures about fair value measurements. SFAS No. 157 establishes a three-level hierarchy for fair valuemeasurements based upon the nature of the inputs to the valuation of an assetor liability.  SFAS No. 157 applieswhere other accounting pronouncements require or permit fair valuemeasurements.  In February 2008, theFASB issued FASB Staff Position No. 157-2, “Effective Date of FASBStatement No. 157” (“FSP FAS 157-2”), which permits the deferral of theeffective date of SFAS No. 157 to fiscal years beginning after November 15,2008 for all non-financial assets and liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis.  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 FAS 157-2, the Company decided to defer the adoption of SFAS No. 157for non-financial assets and liabilities measured at fair value on anon-recurring basis until January 1, 2009. In October 2008, the FASB issued FASB Staff Position No. FAS157–3, “Determining the Fair Value of a Financial Asset When the Market forThat Asset Is Not Active” (“FSP FAS 157–3”), which clarifies the application ofSFAS 157 in a market that is not active. The Company adopted the provisions of FSP FAS 157–3 as of September 30,2008.  The adoption of SFAS No. 157and FSP FAS 157-3 did not have a material effect on the Company’s results ofoperations or financial position (see Note 4).

 

*SFAS No. 159, The Fair Value Option forFinancial Assets and Financial Liabilities – Including an amendment of FASBStatement No. 115 (“SFAS No. 159”)*

 

In February 2007, theFASB issued SFAS No. 159 which provides reporting entities, on an ongoingbasis, an option to report selected financial assets, including investment securities,and financial liabilities, including most insurance contracts, at fair valuethrough earnings.  SFAS No. 159establishes presentation and disclosure requirements designed to facilitatecomparisons between companies that choose different measurement alternativesfor similar types of financial assets and liabilities.  The standard also requires additionalinformation to aid financial statement users’ understanding of the impacts of areporting entity’s decision to use fair value on its earnings and requiresentities to display, on the face of the statement of financial position, thefair value of those assets and liabilities for which the reporting entity haschosen to measure at fair value.  SFAS No. 159was effective as of the beginning of a reporting entity’s first fiscal yearbeginning after November 15, 2007.  The Company did not apply thefair value option to any existing financial assets or liabilities as of January 1,2008.  Consequently, the initial adoptionof SFAS No. 159 had no impact on the Company’s results of operations orfinancial position.

 

*FASB StaffPosition No. FIN 39–1, Amendment of FASB Interpretation No. 39 (“FSPFIN 39–1”)*

 

In April 2007, the FASBissued FSP FIN 39–1, which amends FASB Interpretation No. 39, “Offsettingof Amounts Related to Certain Contracts”. FSP FIN 39–1 replaces the terms “conditional contracts” and “exchangecontracts” with the term “derivative instruments” and requires a reportingentity to offset fair value amounts recognized for the right to reclaim cashcollateral or the obligation to return cash collateral against fair valueamounts recognized for derivative instruments executed with the samecounterparty under the same master netting arrangement that have been offset inthe statement of financial position. FSP FIN 39–1 was effective for fiscalyears 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.

 

6

----

 

### **Pending accounting standards**

###  

*SFAS No. 161, Disclosures about DerivativeInstruments and Hedging Activities – an amendment of FASB Statement No. 133(“SFAS No. 161”)*

 

In March 2008, the FASBissued SFAS No. 161, which amends and expands the disclosure requirementsfor derivatives currently accounted for in accordance with SFAS No. 133. The new disclosures are designed to enhance the understanding of how and why anentity uses derivative instruments and how derivative instruments affect anentity’s financial position, results of operations, and cash flows.  Thestandard requires, on a quarterly basis, quantitative disclosures about thepotential cash outflows associated with the triggering of credit-relatedcontingent features, if any; tabular disclosures about the classification andfair value amounts of derivative instruments reported in the statement offinancial position; disclosure of the location and amount of gains and losseson derivative instruments reported in the statement of operations; andqualitative information about how and why an entity uses derivative instrumentsand how derivative instruments and related hedged items affect the entity’sfinancial statements.  SFAS No. 161 is effective for fiscal periodsbeginning after November 15, 2008, and is to be applied on a prospectivebasis only.  SFAS No. 161 affects disclosures and therefore will notimpact the Company’s results of operations or financial position.

 

*FASB StaffPosition No. FAS 133–1 and FIN 45–4, Disclosures about CreditDerivatives and Certain Guarantees: An Amendment of FASB Statement No. 133and FASB Interpretation No. 45; and Clarification of the Effective Date ofFASB Statement No. 161 (“FSP FAS 133–1 and FIN 45–4”)*

 

In September 2008, theFASB issued FSP FAS 133–1 and FIN 45–4, which amends SFAS No. 133, and FIN45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), toboth enhance and synchronize the disclosure requirements of the two statementswith respect to the potential for adverse effects of changes in credit risk onthe financial statements of the sellers of credit derivatives and certainguarantees.  SFAS No. 133 wasamended to require disclosures by sellers of credit derivatives, includingcredit derivatives embedded in a hybrid instrument.  FIN 45 was amended to require an additionaldisclosure about the current status of the payment/performance risk of a guarantee.  The FSP clarifies the FASB’s intent that thedisclosures required by SFAS No. 161 should be provided for any reportingperiod (annual or quarterly interim) beginning after November 15,2008.  The provisions of this FASB staffposition that amend SFAS No. 133 and FIN 45 are effective for reportingperiods ending after November 15, 2008; therefore, the disclosurerequirements, which have no impact to the Company’s results of operations orfinancial position, will be adopted at December 31, 2008.

 

### **2.  Related Party Transaction**

###  

**InvestmentPurchases**

 

In September 2008, theCompany purchased investments from its parent ALIC.  The Company paid $199.1 million in cash forthe investments, which included fixed income securities with a fair value onthe date of sale of $197.5 million and $1.6 million of accrued investmentincome.  Since the transaction wasbetween affiliates under common control, the fixed income securities wererecorded at the amortized cost basis on the date of sale of $200.5 million.  The difference between the fair value and theamortized cost basis of these investments on the date of sale was recorded asan increase to retained income of $2.0 million after-tax ($3.0 million pretax).

 

7

----

 

### **3.  Supplemental Cash Flow Information**

###  

Liabilities for collateralreceived in conjunction with the Company’s securities lending activities arereported in other liabilities and accrued expenses in the Condensed Statementsof Financial Position.  The accompanyingcash flows are included in cash flows from operating activities in theCondensed Statements of Cash Flows along with the activities resulting frommanagement of the proceeds, which are as follows:

 
| ** **                                     | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net change in fixed income securities          |       | $                                                   | 32,515     |   | $ | (131,643 | ) |
| Net change in short-term investments           |       | (58,301                                             | )          | (12,218 | ) |
| Operating cash flow used                       |       | $                                                   | (25,786    | ) | $ | (143,861 | ) |
|                                           |       |                                                |       |   |   |
| Liabilities for collateral, beginning of  year |       | $                                                   | (198,138   | ) | $ | (199,486 | ) |
| Liabilities for collateral, end of period      |       | (223,924                                            | )          | (343,347 | ) |
| Operating cash flow provided                   |       | $                                                   | 25,786     |   | $ | 143,861 |   |

 

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

 

The measurement basis for asignificant amount of the Company’s financial assets is fair value. Financialinstruments measured at fair value on a recurring basis include:

 

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

 

*Financial Liabilities* Primarily free-standing derivatives(exchange listed and OTC) and derivatives embedded in certain contractholderliabilities.

 

Financial instrumentsmeasured at fair value on a non-recurring basis include:

 

*Financial Assets*: Primarily mortgage loans written-down to fair value in connectionwith recognizing other-than-temporary impairments.

 

The Company adopted theprovisions of SFAS No. 157 as of January 1, 2008 for its financialassets and financial liabilities that are measured at fair value.  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.

 

In determining fair value,the Company principally uses the market approach which generally utilizesmarket transaction data for the same or similar instruments.  To a lesser extent, the Company uses theincome approach which involves determining fair values from discounted cashflow methodologies.  SFAS No. 157establishes a hierarchy for inputs used in determining fair value that maximizethe use of observable inputs and minimizes the use of unobservable inputs byrequiring that observable inputs be used when available.

 

Observable inputs are thoseused by market participants in valuing financial instruments that are developedbased on market data obtained from independent sources.  In the absence of sufficient observableinputs, unobservable inputs reflect the Company’s estimates of the assumptionsmarket participants would use in valuing financial assets and financialliabilities and are developed based on the best information available in thecircumstances.  The Company uses pricesand inputs that are current as of the measurement date, including duringperiods of market disruption.  In periodsof market disruption, the ability to observe prices and inputs may be reducedfor many instruments.  This conditioncould cause an instrument to be reclassified from Level 1 to Level 2, or fromLevel 2 to Level 3.

 

8

----

 

Financial assets andfinancial liabilities recorded on the Condensed Statements of FinancialPosition at fair value as of September 30, 2008 are categorized in thefair value hierarchy based on the reliability of inputs to the valuationtechniques 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:

 

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

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

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

 

*Level 3:*  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 reflect theCompany’s estimates of the assumptions that market participants would use invaluing the financial assets and financial liabilities.

 

The availability ofobservable inputs varies by instrument. In situations where fair value is basedon internally developed pricing models or inputs that are unobservable in themarket, the determination of fair value requires more judgment.  The degree of judgment exercised by theCompany in determining fair value is typically greatest for instrumentscategorized in Level 3. In many instances, valuation inputs used to measurefair value fall into different levels of the fair value hierarchy. The category level in the fair value hierarchy is determined based on thelowest level input that is significant to the fair value measurement inits entirety.

 

Certain financial assets arenot carried at fair value on a recurring basis, including investments such asmortgage loans and policy loans. Accordingly, such investments are onlyincluded in the fair value hierarchy disclosure when the investment is subjectto remeasurement at fair value after initial recognition and the resultingmeasurement is reflected in the condensed financial statements.

 

**Summary ofSignificant Valuation Techniques for Financial Assets and Financial Liabilitieson a Recurring Basis**

 

**Level 1Measurements**

 

Fixed income securities: U.S. treasuries are in Level 1 and valuationis based on unadjusted quoted prices for identical assets in active marketsthat the Company can access.

 

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

 

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

 

**Level 2Measurements**

 

Fixed income securities:

 

*Corporate,including privately placed*:  Valued based on inputsincluding quoted prices for identical or similar assets in markets that are notactive.  Also includes privately placedsecurities totaling $301.2 million which have market-observable externalratings from independent third party rating agencies.

 

*Municipal:* Externally rated municipals are valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

*U.S.government and agencies:*  Valued based on inputs including quotedprices for identical or similar assets in markets that are not active.

 

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

 

9

----

 

*Preferred stock; MBS; Foreign government:* Valued based on inputs including quoted prices for identical or similarassets in markets that are not active.

 

Short-term: Commercial paper and other short-terminvestments are valued based on quoted prices for identical or similar assetsin markets that are not active or amortized cost.

 

**Level 3 Measurements**

** **

Fixedincome securities:

 

*Corporate privately placed securities:* Valued based on non-binding broker quotes and models that are widelyaccepted in the financial services industry and use internally assigned creditratings as inputs and instrument specific inputs.  Instrument specific inputs used in internalfair value determinations include coupon rate, weighted average life, sector ofthe issuer and call provisions. Privately placed securities are categorized as Level 3 as a result ofthe significance of non-market observable inputs. The $1.1 billion of privatelyplaced fixed income securities included in Level 3 comprise $951 million valuedusing an internal model and $148 thousand valued using non-binding brokerquotes.  The internally modeledsecurities are valued based on internal ratings, which are not observable inthe market.  Multiple internal ratingscomprise a National Association of Insurance Commissioners (“NAIC”) ratingcategory and when used in the internal model provide a more refineddetermination of fair value.  The Company’sinternal ratings are primarily consistent with the NAIC ratings which aregenerally updated annually.

 

*ABS residential mortgage-securities (“ABS RMBS”); Alt-Aresidential mortgage-backed securities (“Alt-A”):*  ABSRMBS and Alt-A are principally valued based on inputs including quoted pricesfor identical or similar assets in markets that exhibit less liquidity relativeto those markets supporting Level 2 fair value measurements.  Certain ABS RMBS and Alt-A are valued basedon non-binding broker quotes.  Due to thereduced availability of actual market prices or relevant observable inputs as aresult of the decrease in liquidity that has been experienced in the market forthese securities, all ABS RMBS and Alt-A are categorized as Level 3.

 

*Other collateralized debt obligations (“CDO”):* Valued based on non—binding broker quotes received from brokers who arefamiliar with the investments.  Due tothe reduced availability of actual market prices or relevant observable inputsas a result of the decrease in liquidity that has been experienced in themarket for these securities, all collateralized loan obligations (“CLO”) andother CDO are categorized as Level 3.

 

*CMBS;  Commercial realestate collateralized debt obligations (“CRE CDO”):* CRE CDO, which are reported as CMBS, andother CMBS, are valued based on non-binding broker quotes and are categorizedas Level 3.

 

*Municipal:*  Auction rate securities (“ARS”)  backed by student loans totaling $109 millionthat have become illiquid due to failures in the auction market are included inLevel 3.  ARS backed by student loans arevalued based on a discounted cash flow model with certain inputs to thevaluation model that are significant to the valuation, but are not marketobservable, including estimates of future coupon rates if auction failurescontinue, maturity assumptions, and illiquidity premium.

 

Otherinvestments:* *Certain free-standing OTC derivatives, suchas caps, 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 best estimate of fair value for the embeddedderivatives within a block of contractholder liabilities.  The models use stochastically determined cashflows based on the contractual elements of embedded derivatives and otherapplicable market data.  These arecategorized as Level 3 as a result of the significance of non-market observableinputs.

 

Otherassets:  Includes a structured settlement annuityreinsurance agreement accounted for as a derivative instrument pursuant to therequirements of SFAS No. 133. Valued internally utilizing a model that uses interest rate and volatilityassumptions to generate stochastically determined cash flows. This item iscategorized as Level 3 as a result of the significance of non-market observableinputs.

 

10

----

 

**Financial Assets on a Non-Recurring Basis**

** **

Mortgageloans written-down to fair value in connection with recognizingother-than-temporary impairments are primarily valued using valuation modelsthat are widely accepted in the financial services industry.  Inputs include non-market observable inputssuch as credit spreads.  At September 30,2008, mortgage loans with a fair value of $5.5 million were included in thefair value hierarchy in Level 3 since they were subject to remeasurement atfair value during the third quarter of 2008.

 

Thefollowing table summarizes the Company’s financial assets and financialliabilities measured at fair value on a recurring and non-recurring basis as ofSeptember 30, 2008:

 
| **($ in thousands)**            | ** ** | **Quoted  prices in  active  markets for  identical  Assets** | ** **  | **Significant  other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** | **Other  valuations** | ** **    | **Balance as of  September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------------------|-------------|--------------------------------------------|------------|---------------------------------------|------------|-----------------------|---------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **(Level 1)**                                                      | ** **  | **(Level 2)**                         | ** ** | **(Level 3)**                    | ** ** | **and netting**  | ** **    | **2008**                                        | ** ** |
| **Financial assets**                      |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Fixed income securities                   |       | $                                                                       | 165,200     |                                       | $          | 4,280,974                             |       | $                     | 1,356,466     |                                            |       |   | $ | 5,802,640 |   |
| Short-term investments                    |       | 2,075                                                                   |        | 396,221                                    |       | —                                |       |                  |          | 398,296                                         |       |
| Other investments:                        |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Free-standing derivatives                 |       | —                                                                  |        | 226                                        |       | 1,936                                 |       |                  |          | 2,162                                           |       |
| **Total recurring basis assets**          | ** ** | **167,275**                                                             | ** **  | **4,677,421**                              | ** ** | **1,358,402**                         | ** ** | ** **            | ** **    | **6,203,098**                                   | ** ** |
|                                      |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Non-recurring basis                       | ** ** | **—**                                                              | ** **  | **—**                                 |       | 5,520                                 |       |                  |          | 5,520                                           |       |
| Valued at cost or amortized cost          |       |                                                                    |        |                                       |       |                                  |       | $                     | 745,527       |                                            | 745,527    |   |
| **Total investments**                     | ** ** | **167,275**                                                             | ** **  | **4,677,421**                              | ** ** | **1,363,922**                         | ** ** | **745,527**           | ** **    | **6,954,145**                                   | ** ** |
|                                      |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Separate account assets                   |       | 697,363                                                                 |        | —                                     |       | —                                |       | —                |          | 697,363                                         |       |
| Other assets                              |       | (1,356                                                                  | )           | —                                     |       | (472                                  | )          | —                |          | (1,828                                          | )          |
|                                      |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| **Total financial assets**                | ** ** | **$**                                                                   | **863,282** | ** **                                 | **$**      | **4,677,421**                         | ** ** | **$**                 | **1,363,450** | ** **                                      | **$**      | **745,527** | ** ** | **$** | **7,649,680** | ** ** |
| % of Total financial assets               |       | 11.3                                                                    | %           | 61.1                                       | %          | 17.8                                  | %          | 9.8                   | %             | 100.0                                           | %          |
|                                      |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| **Financial liabilities**                 |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Contractholder funds:                     |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Derivatives embedded in annuity contracts |       | $                                                                       | —      |                                       | $          | —                                |       | $                     | (5,238        | )                                               |       |   | $ | (5,238 | ) |
| Other liabilities:                        |       |                                                                    |        |                                       |       |                                  |       |                  |          |                                            |       |
| Free-standing derivatives                 |       | —                                                                  |        | —                                     |       | (3,883                                | )          |                  |          | (3,883                                          | )          |
| **Total financial liabilities**           | ** ** | **$**                                                                   | **—**  | ** **                                 | **$**      | **—**                            | ** ** | **$**                 | **(9,121**    | **)**                                           | ** ** | ** ** | **$** | **(9,121** | **)** |
| **% of Total financial liabilities**      | ** ** | **—**                                                              | %           | **—**                                 | %          | 100.0                                 | %          |                  |          | 100.0                                           | %          |

 

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). Net transfers in and/or out of Level 3 arereported as having occurred at the beginning of the period; therefore, allrealized and unrealized gains and losses on these securities for the period arereflected in the table below. Further, it should be noted that the followingtable does not take into consideration the effect of offsetting Level 1 andLevel 2 financial instruments entered into that economically hedge certainexposures to the Level 3 positions.

 

11

----

 

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

 
|                                               |       |                                                 |          | **Total realized and unrealized  gains (losses) included in:** |       |                                                    |       |                                                              |        |                                                                |       | **Total  gains (losses)  included in  Net income for** |       |
|----------------------------------------------------|------------|------------------------------------------------------|---------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|-------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in thousands)**                     | ** ** | **Balance as of  June 30, 2008** | ** **    | **Net income ****(1)**                                                             | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales, issuances  and settlements,  net** | ** **  | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  September 30,  2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial  assets**                              |       |                                                 |          |                                                                                         |       |                                                    |       |                                                              |        |                                                                |       |                                                                       |       |   |   |
| Fixed income  securities                           |       | $                                                    | 1,502,815     |                                                                                         | $          | (407                                                    | )          | $                                                                 | (66,613     | )                                                                   | $          | (95,312                                                                    | )          | $ | 15,983 |   | $ | 1,356,466 |   | $ | (3,824 | ) |
| Other  investments:                                |       |                                                 |          |                                                                                         |       |                                                    |       |                                                              |        |                                                                |       |                                                                       |       |   |   |
| Free-standing  derivatives, net                    |       | (2,749                                               | )             | (1,609                                                                                       | )          | —                                                  |       | 2,411                                                             |        | —                                                              |       | (1,947                                                                     | )(2)       | (460 | ) |
| **Total  investments**                             |       | 1,500,066                                            |          | (2,016                                                                                       | )          | (66,613                                                 | )          | (92,901                                                           | )           | 15,983                                                              |       | 1,354,519                                                                  | (3)        | (4,284 | ) |
| Other assets                                       |       | (2,067                                               | )             | 1,595                                                                                        |       | —                                                  |       | —                                                            |        | —                                                              |       | (472                                                                       | )          | 1,595 |   |
| **Total  recurring Level 3 financial assets**      | ** ** | **$**                                                | **1,497,999** | ** **                                                                                   | **$**      | **(421**                                                | **)**      | **$**                                                             | **(66,613** | **)**                                                               | **$**      | **(92,901**                                                                | **)**      | **$** | **15,983** | ** ** | **$** | **1,354,047** | ** ** | **$** | **(2,689** | **)** |
|                                               |       |                                                 |          |                                                                                         |       |                                                    |       |                                                              |        |                                                                |       |                                                                       |       |   |   |
| **Financial  liabilities**                         |       |                                                 |          |                                                                                         |       |                                                    |       |                                                              |        |                                                                |       |                                                                       |       |   |   |
| Contractholder  funds:                             |       |                                                 |          |                                                                                         |       |                                                    |       |                                                              |        |                                                                |       |                                                                       |       |   |   |
| Derivatives  embedded in annuity contracts         |       | $                                                    | (1,896        | )                                                                                            | $          | (3,379                                                  | )          | $                                                                 | —      |                                                                | $          | 37                                                                         |       | $ | — |   | $ | (5,238 | ) | $ | (3,379 | ) |
| **Total  recurring Level 3 financial liabilities** | ** ** | **$**                                                | **(1,896**    | **)**                                                                                        | **$**      | **(3,379**                                              | **)**      | **$**                                                             | **—**  | ** **                                                          | **$**      | **37**                                                                     | ** ** | **$** | **—** | ** ** | **$** | **(5,238** | **)** | **$** | **(3,379** | **)** |

 

----

(1)          The amounts above total $(3.8) million and are reported in the CondensedStatements of Operations as follows: $(2.6) million in realized capital gainsand losses, $2.2 million in net investment income, and $(3.4) million incontract benefits.

(2)          Comprises $1.9 million of financial assets and $(3.9) million offinancial liabilities.

(3)          Comprises $1.36 billion of investments and $(3.9) million of free–standingderivatives included in financial liabilities.

(4)          The amounts above represent gains and losses included in net income forthe period of time that the financial asset or financial liability wasdetermined to be in Level 3.  These gainsand losses total $(6.1) million and are reported in the Condensed Statements ofOperations as follows: $(4.9) million in realized capital gains and losses,$2.2 million in net investment income, and $(3.4) million in contract benefits.

----

 

12

----

 

The following table providesa summary of changes in fair value during the nine–month period ended September 30,2008 of Level 3 financial assets and financial liabilities held at fair valueon a recurring basis at September 30, 2008.

 
| ** **                                         | ** ** | ** **                                         | ** **    | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** **   | ** **                                                          | ** ** | **Total  gains (losses)  included in  Net income for** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|---------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|--------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in thousands)**                     | ** ** | **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  September 30,  2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial  assets**                              |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Fixed income  securities                           |       | $                                                  | 1,469,898     |                                                                                         | $          | (10,800                                                 | )          | $                                                                 | (112,804     | )                                                                   | $          | (109,457                                                                   | )          | $ | 119,629 |   | $ | 1,356,466 |   | $ | (14,970 | ) |
| Other  investments:                                |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Free-standing  derivatives, net                    |       | (980                                               | )             | (3,945                                                                                       | )          | —                                                  |       | 2,978                                                             |         | —                                                              |       | (1,947                                                                     | )(2)       | 1,142 |   |
| **Total  investments**                             |       | 1,468,918                                          |          | (14,745                                                                                      | )          | (112,804                                                | )          | (106,479                                                          | )            | 119,629                                                             |       | 1,354,519                                                                  | (3)        | (13,828 | ) |
| Other assets                                       |       | (1,733                                             | )             | 1,261                                                                                        |       | —                                                  |       | —                                                            |         | —                                                              |       | (472                                                                       | )          | 1,261 |   |
| **Total  recurring Level 3 financial assets**      | ** ** | **$**                                              | **1,467,185** | ** **                                                                                   | **$**      | **(13,484**                                             | **)**      | **$**                                                             | **(112,804** | **)**                                                               | **$**      | **(106,479**                                                               | **)**      | **$** | **119,629** | ** ** | **$** | **1,354,047** | ** ** | **$** | **(12,567** | **)** |
|                                               |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| **Financial  liabilities**                         |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Contractholder  funds:                             |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Derivatives  embedded in annuity contracts         |       | $                                                  | 174           |                                                                                         | $          | (5,482                                                  | )          | $                                                                 | —       |                                                                | $          | 70                                                                         |       | $ | — |   | $ | (5,238 | ) | $ | (5,482 | ) |
| **Total  recurring Level 3 financial liabilities** | ** ** | **$**                                              | **174**       | ** **                                                                                   | **$**      | **(5,482**                                              | **)**      | **$**                                                             | **—**   | ** **                                                          | **$**      | **70**                                                                     | ** ** | **$** | **—** | ** ** | **$** | **(5,238** | **)** | **$** | **(5,482** | **)** |

 

----

(1)          Theamounts above total $(19.0) million and are reported in the CondensedStatements of Operations as follows: $(18.7) million in realized capital gainsand losses, $5.2 million in net investment income, and $(5.5) million incontract benefits.

(2)          Comprises$1.9 million of financial assets and $(3.9) million of financial liabilities.

(3)          Comprises$1.36 billion of investments and $(3.9) million of free–standing derivativesincluded in financial liabilities.

(4)          Theamounts above represent gains and losses included in net income for the periodof time that the financial asset or financial liability was determined to be inLevel 3.  These gains and losses total$(18.0) million and are reported in the Condensed Statements of Operations asfollows: $(17.7) million in realized capital gains and losses, $5.2 million innet investment income, and $(5.5) million in contract benefits.

----

 

**5.  Reinsurance**

** **

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

 
| **($ in thousands)**                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Premiums and contract charges**                  |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                             |       | $                                                    | 37,592     |                                                | $          | 42,381 |   | $ | 111,813 |   | $ | 128,443 |   |
| Assumed – non-affiliate                       |       | 240                                                  |       | 220                                                 |       | 753 |   | 905 |   |
| Ceded                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate                                          |       | (985                                                 | )          | (997                                                | )          | (2,961 | ) | (2,981 | ) |
| Non-affiliate                                      |       | (8,648                                               | )          | (9,207                                              | )          | (25,363 | ) | (28,416 | ) |
| Premiums and contract charges, net of  reinsurance |       | $                                                    | 28,199     |                                                | $          | 32,397 |   | $ | 84,242 |   | $ | 97,951 |   |

 

13

----

 

The effects of reinsurance on contract benefits are asfollows:

 
| **($ in thousands)**        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Contract benefits**                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                |       | $                                                    | 49,074     |                                                | $          | 49,025 |   | $ | 145,005 |   | $ | 147,418 |   |
| Assumed – non-affiliate          |       | 134                                                  |       | 119                                                 |       | 513 |   | 608 |   |
| Ceded                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Affiliate (1)                         |       | 8,204                                                |       | (346                                                | )          | 6,044 |   | (1,618 | ) |
| Non-affiliate                         |       | (8,479                                               | )          | (3,501                                              | )          | (17,470 | ) | (9,573 | ) |
| Contract benefits, net of reinsurance |       | $                                                    | 48,933     |                                                | $          | 45,297 |   | $ | 134,092 |   | $ | 136,835 |   |

 

(1)   The Company accrued contract benefits in thethird quarter of 2008 relating to the rescission of reinsurance coverage forcertain traditional and interest-sensitive life insurance policies provided inaccordance with an agreement between the Company and ALIC.  This accrual is reflected as a component ofcontract benefits ceded to affiliate and for the three months and nine monthsended September 30, 2008 was $8.3 million and $7.1 million, respectively.  See below for further details.

----

 

The effects of reinsurance on interest credited tocontractholder funds are as follows:

 
| **($ in thousands)**                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Interest credited to contractholder funds**                 |       |                                                 |       |                                                |       |   |   |   |   |
| Direct                                                        |       | $                                                    | 50,907     |                                                | $          | 47,974 |   | $ | 144,683 |   | $ | 141,855 |   |
| Assumed – non-affiliate                                  |       | 1                                                    |       | 8                                                   |       | 15 |   | 23 |   |
| Ceded– non-affiliate                                     |       | (2,402                                               | )          | (3,410                                              | )          | (8,313 | ) | (10,408 | ) |
| Interest credited to contractholder funds, net of reinsurance |       | $                                                    | 48,506     |                                                | $          | 44,572 |   | $ | 136,385 |   | $ | 131,470 |   |

###  

In addition to amounts included in the tables aboveare reinsurance premiums ceded to ALIC of $834 thousand and $814 thousand forthe third quarter of September 30, 2008 and 2007, respectively, and $2.48million and $2.39 million for the first nine months of 2008 and 2007,respectively, under the terms of the structured settlement annuity reinsuranceagreement.  These amounts are reflectedas a component of realized capital gains and losses on the Condensed Statementsof Operations as the treaty is recorded as a derivative instrument pursuant tothe requirements of SFAS No. 133.

 

The Company accruedadditional expenses for contract benefits of $8.3 million in the third quarterof 2008 relating to the rescission of reinsurance coverage due to the nonpaymentof premium for certain traditional and interest-sensitive life insurancepolicies provided in accordance with an agreement between the Company andALIC.  The accrual resulted in areduction to net income for the third quarter of 2008 of $4.7 million, whichincluded contract benefits of $8.3 million, accretion of DAC of $1.1 millionand an income tax benefit of $2.5 million. For the nine months ended September 30, 2008, the accrual, net ofcontract benefits ceded in the six months ended June 30, 2008, resulted in areduction to net income of $4.1 million, which included contract benefits of$7.1 million, accretion of DAC of $876 thousand and an income tax benefit of$2.2 million.  As of September 30, 2008,reinsurance payable to parent on the Condensed Statements of Financial Positionincludes $8.7 million due to ALIC for the Company’s obligation to returnamounts received from ALIC for ceded contract benefits on policies subject tothe rescission of coverage.

 

14

----

 

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

###  

**Guaranty funds**

 

Under state insurance guaranty fund laws, insurersdoing business in a state can be assessed, up to prescribed limits, for certainobligations of insolvent insurance companies to policyholders andclaimants.  Amounts assessed to eachcompany are typically related to its proportion of business written in eachstate.

 

The New York Liquidation Bureau (the “Bureau”) haspublicly reported that Executive Life Insurance Company of New York (“ExecutiveLife”), currently under its jurisdiction as part of a 1992 court-orderedrehabilitation plan, may only be able to meet future obligations of its annuitycontracts for the next fifteen years. The shortfall is currently estimated to be $1.27 billion.  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 outcomeof this situation is uncertain at this time.  The Bureau may eventually take actions toaddress this situation that may lead to guaranty fund assessments or othercosts to the Company.  Under current law,the Company may be allowed to recoup a portion of the amount of any additionalguaranty fund assessment in periods subsequent to the recognition of theassessment by offsetting future premium taxes. The Company’s market share in New York was approximately 5.5% in 2006based on industry annuity premium.

 

**Guarantees**

 

Related to the disposal through reinsurance of ourvariable annuity business to Prudential Financial, Inc. and its subsidiary(“Prudential”) in 2006, the Company and ALIC have agreed to indemnifyPrudential for certain pre–closing contingent liabilities (including extra–contractualliabilities of the Company and ALIC, and liabilities specifically excluded fromthe transaction) that the Company and ALIC have agreed to retain.  In addition, the Company and ALIC willindemnify Prudential for certain post–closing liabilities that may arise fromthe acts of the Company, ALIC and its agents, including in connection with theCompany’s and ALIC’s provision of transition services. The reinsuranceagreements contain no limitations or indemnifications with regard to insurancerisk transfer, and transferred all of the future risks and responsibilities forperformance on the underlying variable annuity contracts to Prudential,including those related to benefit guarantees, in accordance with theprovisions of SFAS No. 113 “Accounting and Reporting for Reinsurance ofShort–Duration and Long–Duration Contracts”. Management does not believe thisagreement will have a material adverse effect on results of operations, cashflows or the financial position of the Company.

 

In the normal course of business, the Company providesstandard indemnifications to contractual counterparties in connection withnumerous transactions, including acquisitions and divestures.  The types of indemnifications typicallyprovided include indemnifications for breaches of representations andwarranties, taxes and certain other liabilities, such as third partylawsuits.  The indemnification clausesare often standard contractual terms and are entered into in the normal courseof business based on an assessment that the risk of loss would be remote.  The terms of the indemnifications vary induration and nature.  In many cases, themaximum obligation is not explicitly stated and the contingencies triggeringthe obligation to indemnify have not occurred and are not expected tooccur.  Consequently, the maximum amountof the obligation under such indemnifications is not determinable.Historically, the Company has not made any material payments pursuant to theseobligations.

 

The aggregate liability balance related to allguarantees was not material as of September 30, 2008.

 

**Regulation**

 

The Company is subject to changing social, economicand regulatory conditions.  From time totime, regulatory authorities or legislative bodies seek to impose additionalregulations regarding agent and broker compensation and otherwise expandoverall regulation of insurance products and the insurance industry.  The ultimate changes and eventual effects ofthese initiatives on the Company’s business, if any, are uncertain.

 

15

----

 

**Legal and regulatory proceedings andinquiries**

 

***Background***

 

The Company and certain affiliates are involved in anumber of lawsuits, regulatory inquiries, and other legal proceedings arisingout of various aspects of its business. As background to the “Proceedings” subsection below, please note thefollowing:

 

·                  These matters raise difficult and complicated factualand legal issues and are subject to many uncertainties and complexities,including the underlying facts of each matter; novel legal issues; variationsbetween jurisdictions in which matters are being litigated, heard orinvestigated; differences in applicable laws and judicial interpretations; thelength of time before many of these matters might be resolved by settlement,through litigation or otherwise; the fact that some of the lawsuits are putativeclass actions in which a class has not been certified and in which thepurported class may not be clearly defined; the fact that some of the lawsuitsinvolve multi-state class actions in which the applicable law(s) for theclaims 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 be affected bydecisions, 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 insurers,or other entities.

 

·                  In the lawsuits, plaintiffs seek a variety of remediesincluding equitable relief in the form of injunctive and other remedies andmonetary relief in the form of contractual and extra-contractual damages.  In some cases, the monetary damages soughtinclude punitive damages.  Often specificinformation about the relief sought, such as the amount of damages, is notavailable because plaintiffs have not requested specific relief in theirpleadings.  In the Company’s experience,when specific monetary demands are made in pleadings, they bear little relationto the ultimate loss, if any, to the Company.

 

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

 

·                  For the reasons specified above, it is often notpossible to make meaningful estimates of the amount or range of loss that couldresult from the matters described below in the “Proceedings” subsection.  The Company reviews these matters on anongoing 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.

 

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

 

**Proceedings**

 

Legal proceedings involving Allstate agencies and AICmay impact the Company, even when the Company is not directly involved, becausethe Company sells its products through a variety of distribution channelsincluding Allstate agencies. Consequently, information about the more significant of theseproceedings is provided in the following paragraph.

 

16

----

 

AIC is defending certain matters relating to itsagency program reorganization announced in 1999.  These matters are in various stages of development.

 

·                  These matters include a lawsuit filed in 2001 by theU.S. Equal Employment Opportunity Commission (“EEOC”) alleging retaliationunder federal civil rights laws (the “EEOC I” suit) and a class action filed in2001 by former employee agents alleging retaliation and age discriminationunder the Age Discrimination in Employment Act (“ADEA”), breach of contract andERISA violations (the “Romero I” suit).  In2004, in the consolidated EEOC I and Romero I litigation, the trial courtissued a memorandum and order that, among other things, certified classes ofagents, including a mandatory class of agents who had signed a release, forpurposes of effecting the court’s declaratory judgment that the release isvoidable at the option of the release signer. The court also ordered that an agent who voids the release must returnto AIC “any and all benefits received by the [agent] in exchange for signingthe release.”  The court also statedthat, “on the undisputed facts of record, there is no basis for claims of agediscrimination.”  The EEOC and plaintiffshave asked the court to clarify and/or reconsider its memorandum and order andin January 2007, the judge denied their request.  In June 2007, the court granted AIC’smotions for summary judgment.  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 themeaning of the federal law and thus not appealable at this time.  In March 2008, the Third Circuit decidedthat the appeal should not summarily be dismissed and that the question ofwhether the matter is appealable at this time will be addressed by the Courtalong with the merits of the appeal.

 

·                  The EEOC also filed another lawsuit in 2004 allegingage discrimination with respect to a policy limiting the rehire of agentsaffected by the agency program reorganization (the “EEOC II” suit).  In EEOC II, in 2006, the court grantedpartial summary judgment to the EEOC. Although the court did not determine that AIC was liable for agediscrimination under the ADEA, it determined that the rehire policy resulted ina disparate impact, reserving for trial the determination on whether AIC hadreasonable factors other than age to support the rehire policy.  In June 2008, the Eighth Circuit Courtof Appeals affirmed summary judgment in the EEOC’s favor.  In September 2008, the Court of Appealsgranted AIC’s petition for rehearing *en banc*and vacated its earlier decision affirming the trial court’s grant of summaryjudgment in favor of the EEOC.  The Courtof Appeals then dismissed the appeal, determining that it lacked jurisdictionto consider the appeal at this stage in the litigation.

 

·                  AIC is also defending a certified class action filedby former employee agents who terminated their employment prior to the agencyprogram reorganization.  Plaintiffsallege that they were constructively discharged so that AIC could avoid payingERISA and other benefits offered under the reorganization.  They claim that the constructive dischargeresulted from the implementation of agency standards, including mandatoryoffice hours and a requirement to have licensed staff available during businesshours.  The court approved the form ofclass notice which was sent to approximately 1,800 potential class members in November 2007.  Fifteen individuals opted out.  AIC’s motions for judgment on the pleadingswere 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. In August 2008, the court denied plaintiffs’ motion to reconsiderand to decertify the class.

 

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

 

17

----

 

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 regulatoryactions, including state market conduct exams, and other governmental andregulatory inquiries are currently pending that involve the Company andspecific aspects of its conduct of business. Like other members of the insurance industry, the Company is the targetof a number of lawsuits and proceedings, some of which involve claims forsubstantial or indeterminate amounts. These actions are based on a variety of issues and target a range of theCompany’s practices.  The outcome ofthese disputes is currently unpredictable.

 

One or more of these matters could have an adverseeffect on 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 in this “Other Matters” subsection,in excess of amounts currently reserved, as they are resolved over time is notlikely to have a material effect on the operating results, cash flows orfinancial position of the Company.

 

**7.   OtherComprehensive Income**

 

The components of other comprehensive (loss) income ona pre-tax and after-tax basis are as follows:

 
| ** **                                                              | ** ** | **Three months ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| **($ in thousands)**                                          | ** ** | **Pre-tax**                                              | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                    |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding (losses) gains arising during the period         |       | $                                                        | (96,654    | ) | $ | 33,829 |   | $ | (62,825 | ) | $ | 23,124 |   | $ | (8,094 | ) | $ | 15,030 |   |
| Less: reclassification adjustment of realized capital gains and  losses |       | (828                                                     | )          | 290 |   | (538 | ) | 3,025 |   | (1,059 | ) | 1,966 |   |
| Unrealized net capital gains and losses                                 |       | (95,826                                                  | )          | 33,539 |   | (62,287 | ) | 20,099 |   | (7,035 | ) | 13,064 |   |
| Other comprehensive (loss) income                                       |       | $                                                        | (95,826    | ) | $ | 33,539 |   | (62,287 | ) | $ | 20,099 |   | $ | (7,035 | ) | 13,064 |   |
|                                                                    |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                              |       |                                                     |       |   |   | 14,458 |   |   |   |   |   | 12,385 |   |
|                                                                    |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Comprehensive (loss) income                                             |       |                                                     |       |   |   | $ | (47,829 | ) |   |   |   |   | $ | 25,449 |   |

 
| ** **                                                              | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **($ in thousands)**                                          | ** ** | **Pre-tax**                                             | ** ** | **Tax** | ** ** | **After-  tax** | ** ** | **Pre-tax** | ** ** | **Tax** | ** ** | **After-  tax** | ** ** |
|                                                                    |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Unrealized net holding losses arising during the period                 |       | $                                                       | (213,804   | ) | $ | 74,831 |   | $ | (138,973 | ) | $ | (35,430 | ) | $ | 12,400 |   | $ | (23,030 | ) |
| Less: reclassification adjustment of realized capital gains and  losses |       | (52,431                                                 | )          | 18,351 |   | (34,080 | ) | 4,142 |   | (1,450 | ) | 2,692 |   |
| Unrealized net capital gains and losses                                 |       | (161,373                                                | )          | 56,480 |   | (104,893 | ) | (39,572 | ) | 13,850 |   | (25,722 | ) |
| Other comprehensive loss                                                |       | $                                                       | (161,373   | ) | $ | 56,480 |   | (104,893 | ) | $ | (39,572 | ) | $ | 13,850 |   | (25,722 | ) |
|                                                                    |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                              |       |                                                    |       |   |   | 15,476 |   |   |   |   |   | 30,762 |   |
|                                                                    |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Comprehensive (loss) income                                             |       |                                                    |       |   |   | $ | (89,417 | ) |   |   |   |   | $ | 5,040 |   |

 

18

----

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Shareholder of

Allstate Life Insurance Company of New York

Hauppauge, New York

 

We have reviewed the accompanying condensed statement of financialposition of Allstate Life Insurance Company of New York (the “Company”), anaffiliate of The Allstate Corporation, as of September 30, 2008, and therelated condensed statements of operations for the three-month and nine-monthperiods ended September 30, 2008 and 2007, and the condensed statements ofcash flows for the nine-month periods ended September 30, 2008 and2007.  These interim financial statementsare the responsibility 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 of personsresponsible 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 awhole.  Accordingly, we do not expresssuch an opinion.

 

Based on our reviews, we are not aware of any material modificationsthat should be made to such condensed interim financial statements for them tobe in conformity with accounting principles generally accepted in the UnitedStates of America.

 

We have previously audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), the statement offinancial position of Allstate Life Insurance Company of New York as of December 31,2007, and the related statements of operations and comprehensive income,shareholder’s equity, and cash flows for the year then ended (not presentedherein); and in our report dated March 13, 2008, which report includes anexplanatory paragraph relating to a change in the Company’s method ofaccounting for uncertainty in income taxes and accounting for deferredacquisition costs associated with internal replacements in 2007, we expressedan unqualified opinion on those financial statements.  In our opinion, the information set forth inthe accompanying condensed statement of financial position as of December 31,2007 is fairly stated, in all material respects, in relation to the statementof financial position from which it has been derived.

 

 
| /s/ Deloitte & Touche LLP |   |
|------------------------------------|--------|
|                               |
| Chicago, Illinois                  |
| November 20, 2008             |

 

19

----

 

**Item 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS FOR THE THREE-MONTH AND NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2008AND 2007**

 

### **OVERVIEW**

###  

The following discussion highlights significantfactors influencing the condensed financial position and results of operationsof Allstate Life Insurance Company of New York (referred to in this document as“we”, “ALNY”, “our”, “us” or the “Company”). It should be read in conjunction with the condensed financial statementsand notes thereto found under Part I. Item 1. contained herein, and with thediscussion, analysis, financial statements and notes thereto in Part I.Item 1. and Part II. Item 7. and Item 8. of the Allstate Life InsuranceCompany of New York 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.

 

### **OPERATIONS**

###  

Summarized financial data is presented in thefollowing table.

 
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                |       |                                                 |       |                                                |       |   |   |   |   |
| **Revenues**                              |       |                                                 |       |                                                |       |   |   |   |   |
| Premiums (1)                              |       | $                                                    | 12,881     |                                                | $          | 17,720 |   | $ | 39,086 |   | $ | 54,135 |   |
| Contract charges (1)                      |       | 15,318                                               |       | 14,677                                              |       | 45,156 |   | 43,816 |   |
| Net investment income                     |       | 102,633                                              |       | 96,994                                              |       | 302,597 |   | 287,901 |   |
| Realized capital gains and losses         |       | 2,530                                                |       | 681                                                 |       | (55,862 | ) | (2,063 | ) |
| Total revenues                            |       | 133,362                                              |       | 130,072                                             |       | 330,977 |   | 383,789 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| **Costs and expenses**                    |       |                                                 |       |                                                |       |   |   |   |   |
| Contract benefits                         |       | (48,933                                              | )          | (45,297                                             | )          | (134,092 | ) | (136,835 | ) |
| Interest credited to contractholder funds |       | (48,506                                              | )          | (44,572                                             | )          | (136,385 | ) | (131,470 | ) |
| Amortization of DAC                       |       | (3,946                                               | )          | (12,049                                             | )          | (6,564 | ) | (41,022 | ) |
| Operating costs and expenses              |       | (10,945                                              | )          | (9,335                                              | )          | (30,948 | ) | (26,889 | ) |
| Total costs and expenses                  |       | (112,330                                             | )          | (111,253                                            | )          | (307,989 | ) | (336,216 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Loss on disposition of operations         |       | —                                               |       | —                                              |       | (358 | ) | (132 | ) |
| Income tax expense                        |       | (6,574                                               | )          | (6,434                                              | )          | (7,154 | ) | (16,679 | ) |
| Net income                                |       | $                                                    | 14,458     |                                                | $          | 12,385 |   | $ | 15,476 |   | $ | 30,762 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Investments at September 30          |       |                                                 |       |                                                |       | $ | 6,954,145 |   | $ | 7,033,317 |   |

 

----

(1)          Beginning in 2008, certainceded reinsurance premiums previously included as a component of traditionallife insurance premiums were reclassified prospectively to be reported as acomponent of interest-sensitive life insurance contract charges.  In the third quarter and first nine months of2007, these ceded reinsurance premiums were $624 thousand and $1.8 million,respectively.

----

 

*Net income*increased 16.7%or $2.1 million in the third quarter of 2008 compared to the third quarter of2007 and decreased 49.7% or $15.3 million in the first nine months of 2008compared to the same period in the prior year. These changes include an accrual recorded in the third quarter of 2008relating to the rescission of reinsurance coverage for certain traditional andinterest-sensitive life insurance policies provided in accordance with anagreement between the Company and Allstate Life Insurance Company (“ALIC”) (the“rescission”).  Excluding the impact ofthis accrual, which reduced net income by $4.7 million and $4.1 million in thethird quarter and first nine months of 2008, respectively, net income increased54.7% or $6.8 million in the third quarter of 2008 compared to the thirdquarter of 2007 and decreased 36.5% or $11.2 million in the first nine monthsof 2008 compared to the same period in the prior year.  The increase in the third quarter of 2008 wasprimarily due to lower total costs and expenses.  The decrease in net income in the first ninemonths of 2008 was primarily the result of higher realized capital losses,partially offset by lower total costs and expenses.

 

20

----

**Analysis of Revenues**Total revenues increased 2.5% or $3.3 millionin the third quarter of 2008 and decreased 13.8% or $52.8 million in the firstnine months of 2008, compared to the same periods of 2007. The increase in thethird quarter of 2008 was primarily due to higher net investment income andincreased net realized capital gains, partially offset by lower premiums.  The decrease in the first nine months of 2008was due mostly to higher net realized capital losses and lower premiums,partially offset by increased net investment income.  

 

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

 

*Contract charges*****arerevenues generated from interest-sensitive and variable life insurance, andfixed annuities for which deposits are classified as contractholder funds orseparate accounts liabilities.  Contractcharges are assessed against the contractholder account values for maintenance,administration, cost of insurance and surrender prior to the contractuallyspecified dates.  As a result, changes incontractholder funds are considered in the evaluation of growth and asindicators of future levels of revenues.

 

Thefollowing table summarizes premiums and contract charges by product.

 
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**              | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Premiums**                                | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Traditional life insurance (1)              |       | $                                                    | 7,335      |                                                | $          | 6,575 |   | $ | 21,433 |   | $ | 18,937 |   |
| Immediate annuities with life contingencies |       | 3,480                                                |       | 9,395                                               |       | 11,652 |   | 30,382 |   |
| Accident, health and other                  |       | 2,066                                                |       | 1,750                                               |       | 6,001 |   | 4,816 |   |
| **Total premiums**                          |       | 12,881                                               |       | 17,720                                              |       | 39,086 |   | 54,135 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Contract charges**                        |       |                                                 |       |                                                |       |   |   |   |   |
| Interest-sensitive life insurance (1)       |       | 13,896                                               |       | 12,985                                              |       | 40,485 |   | 37,821 |   |
| Fixed annuities                             |       | 1,422                                                |       | 1,692                                               |       | 4,671 |   | 5,995 |   |
| **Total contract charges**(2)               |       | 15,318                                               |       | 14,677                                              |       | 45,156 |   | 43,816 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| **Premiums and contract charges**           |       | $                                                    | 28,199     |                                                | $          | 32,397 |   | $ | 84,242 |   | $ | 97,951 |   |

 

----

| (1) | Beginning  in 2008, certain ceded reinsurance premiums previously included as a  component of traditional life insurance premiums were reclassified  prospectively to be reported as a component of interest-sensitive life  insurance contract charges. In the third quarter and first nine months of  2007, these ceded reinsurance premiums were $624 thousand and $1.8 million,  respectively. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Total  contract charges for the third quarter of 2008 and 2007 include contract  charges related to the cost of insurance of $9.2 million.  Total contract charges for the first nine  months of 2008 and 2007 include contract charges related to the cost of  insurance of $27.3 million and $25.9 million, respectively.                                                                   |

----

 

21

----

 

Totalpremiums decreased 27.3% or $4.8 million and 27.8% or $15.0 million in thethird quarter and first nine months of 2008, respectively, compared to the sameperiods of 2007.  These declines includethe impact of a prospective reporting reclassification for certain cededreinsurance premiums.  Excluding theimpact of this reporting reclassification, total premiums decreased 29.8% or$5.5 million and 30.2% or $16.9 million in the third quarter and first ninemonths of 2008, respectively, compared to the same periods in the prioryear.  These declines were primarily theresult of lower sales of immediate annuities with life contingencies.

Totalcontract charges increased 4.4% or $641 thousand and 3.1% or $1.3 million inthe third quarter and first nine months of 2008, respectively, compared to thesame periods of 2007. These increases include the impact of the prospectivereporting reclassification for certain ceded reinsurance premiums.  Excluding the impact of this reportingreclassification, total contract charges increased 9.0% or $1.3 million and7.6% or $3.2 million in the third quarter and first nine months of 2008,respectively, compared to the same periods in the prior year.  The increase in both periods was primarilyattributable to higher contract charges on interest-sensitive life insurancepolicies resulting from increased contract charge rates and growth in businessin force, partially offset by decreased contract charges on fixed annuities.

 

*Contractholder funds* represent interest-bearing liabilitiesarising from the sale of fixed annuities, interest-sensitive life insurancepolicies and variable life deposits allocated to fixed accounts.  The balance of contractholder funds is equalto the cumulative deposits received and interest credited to the contractholderless cumulative contract benefits, surrenders, withdrawals and contract chargesfor mortality or administrative expenses.

 

 The following table shows the changes incontractholder funds.

 
| ** **                                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                      | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                          |       |                                                 |       |                                                |       |   |   |   |   |
| **Contractholder funds, beginning balance**         |       | $                                                    | 5,033,362  |                                                | $          | 4,711,868 |   | $ | 4,848,461 |   | $ | 4,708,428 |   |
| **Deposits**                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Fixed annuities                                     |       | 125,993                                              |       | 134,811                                             |       | 448,317 |   | 293,832 |   |
| Interest-sensitive life insurance                   |       | 25,070                                               |       | 25,922                                              |       | 77,905 |   | 76,196 |   |
| Variable life deposits allocated to fixed  accounts |       | 25                                                   |       | 13                                                  |       | 54 |   | 42 |   |
| Total deposits                                      |       | 151,088                                              |       | 160,746                                             |       | 526,276 |   | 370,070 |   |
|                                                |       |                                                 |       |                                                |       |   |   |   |   |
| **Interest credited**                               |       | 49,777                                               |       | 45,042                                              |       | 142,495 |   | 133,598 |   |
|                                                |       |                                                 |       |                                                |       |   |   |   |   |
| **Benefits, withdrawals and other adjustments**     |       |                                                 |       |                                                |       |   |   |   |   |
| Benefits                                            |       | (46,420                                              | )          | (35,329                                             | )          | (120,864 | ) | (110,496 | ) |
| Surrenders and partial withdrawals                  |       | (83,455                                              | )          | (65,248                                             | )          | (244,262 | ) | (225,911 | ) |
| Contract charges                                    |       | (13,767                                              | )          | (12,317                                             | )          | (39,896 | ) | (35,911 | ) |
| Net transfers to separate accounts                  |       | (11                                                  | )          | —                                              |       | (18 | ) | — |   |
| Other adjustments (1)                               |       | (4,751                                               | )          | (13,500                                             | )          | (26,369 | ) | (48,516 | ) |
| Total benefits, withdrawals and other  adjustments  |       | (148,404                                             | )          | (126,394                                            | )          | (431,409 | ) | (420,834 | ) |
|                                                |       |                                                 |       |                                                |       |   |   |   |   |
| **Contractholder funds, ending balance**            |       | $                                                    | 5,085,823  |                                                | $          | 4,791,262 |   | $ | 5,085,823 |   | $ | 4,791,262 |   |

 

----

(1)          The table above illustrates the changes incontractholder funds, which are presented gross of reinsurance recoverables onthe Condensed Statements of Financial Position. The table above is intended to supplement our discussion and analysis ofrevenues, which are presented net of reinsurance on the Condensed Statements ofOperations.  As a result, the net changein contractholder funds associated with products reinsured is reflected as acomponent of the other adjustments line.

----

 

22

----

 

Contractholderfunds increased 1.0% in the third quarter of 2008, compared to an increase of1.7% in the third quarter of 2007, and increased 4.9% in the first nine monthsof 2008, compared to an increase of 1.8% in the same period in the prioryear.  Average contractholder fundsincreased 6.5% and 4.6% in the third quarter and first nine months of 2008,respectively, compared to the same periods in 2007.

Contractholderdeposits decreased 6.0% in the third quarter and increased 42.2% in the firstnine months of 2008, compared to the same periods of 2007.  The decrease in the third quarter of 2008 wasprimarily due to a 6.5% decline in deposits on fixed annuities due toincreasingly competitive market conditions partially offset by improvements inthe attractiveness of fixed annuities relative to competing products.  Higher contractholder deposits in the firstnine months of 2008 was primarily due to a 52.6% increase in fixed annuitydeposits due to improvements in the attractiveness of fixed annuities relativeto competing products.

Surrendersand partial withdrawals increased 27.9% and 8.1% in the third quarter and firstnine months of 2008, respectively, compared to the same periods of 2007.  These increases were due to higher surrendersand partial withdrawals on fixed annuities. The annualized surrender and partial withdrawal rate on deferred fixedannuities and interest-sensitive life insurance products, based on thebeginning of period contractholder funds, was 8.3% and 8.1% in the first ninemonths of 2008 and 2007, respectively.

 

*Net investment income* increased 5.8% and 5.1% in the third quarterand first nine months of 2008, respectively, compared to the same periods of2007 due primarily to higher average investment balances.

 

*Net realized capital gains and losses* reflected net gains of $2.5 million and $681thousand in the third quarter of 2008 and 2007, respectively, and net losses of$55.9 million and $2.1 million in the first nine months of 2008 and 2007,respectively.  For further discussion ofrealized capital gains and losses, see the Investments section of MD&A.

 

**Analysis of Costs and Expenses**Total costs and expenses increased 1.0% or$1.1 million in the third quarter of 2008 compared to the third quarter of 2007and decreased 8.4% or $28.2 million in the first nine months of 2008 comparedwith the same period in the prior year. These changes include an accrualrecorded in the third quarter of 2008 relating to the rescission.  Excluding the impact of this accrual, whichincreased total costs and expenses by $7.2 million and $6.3 million in thethird quarter and first nine months of 2008, respectively, total costs andexpenses decreased 5.5% or $6.1 million in the third quarter of 2008 comparedto the third quarter of 2007 and 10.3% or $34.5 million in the first ninemonths of 2008 compared to the same period in the prior year.  The decline in both periods was primarily dueto lower amortization of DAC and decreased contract benefits.

 

*Contract benefits* increased 8.0% or $3.6 million in the thirdquarter of 2008 compared to the third quarter of 2007 and decreased 2.0% or$2.7 million in the first nine months of 2008 compared to the same period in2007.  These changes include an accrualrecorded in the third quarter of 2008 relating to the rescission.  Excluding the impact of this accrual, whichincreased contract benefits by $8.3 million and $7.1 million in the thirdquarter and first nine months of 2008, respectively, contract benefitsdecreased 10.3% or $4.7 million in the third quarter of 2008 compared to thethird quarter of 2007 and 7.2% or $9.8 million in the first nine months of 2008compared to the same period in the prior year. These declines mostly resultedfrom lower contract benefits on annuities due primarily to lower sales ofimmediate annuities with life contingencies. In the third quarter of 2008, the decrease was also impacted byfavorable mortality experience on immediate annuities with life contingencies,partially offset by unfavorable mortality experience on life insuranceproducts.  In the first nine months of2008, the impact of lower sales of immediate annuities with life contingencieswas partially offset by unfavorable mortality experience on annuities and lifeinsurance products.

 

23

----

 

Weanalyze our mortality and morbidity results using the difference betweenpremiums and contract charges earned for the cost of insurance and contractbenefits excluding the portion related to the implied interest on immediateannuities with life contingencies (“benefit spread”).  This implied interest totaled $26.3 millionand $27.1 million in the third quarter of 2008 and 2007, respectively, andtotaled $80.9 million and $80.5 million in the first nine months of 2008 and2007, respectively.  The benefit spreadby product group is disclosed in the following table.

 
| ** **                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)** | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Life insurance (1)             |       | $                                                    | (2,114     | )                                                   | $          | 8,863 |   | $ | 13,933 |   | $ | 21,226 |   |
| Annuities                      |       | 1,503                                                |       | (207                                                | )          | (755 | ) | 2,412 |   |
| Total benefit spread (1)       |       | $                                                    | (611       | )                                                   | $          | 8,656 |   | $ | 13,178 |   | $ | 23,638 |   |

 

----

(1)          The Company accrued contract benefits in the third quarter of 2008relating to the rescission.  The accrualresulted in a reduction to benefit spread in the third quarter and first ninemonths of 2008 of $8.3 million and $7.1 million, respectively.  See Note 5 to the Condensed FinancialStatements for further details.

----

 

*Interest credited to contractholder funds* increased 8.8% and 3.7% in the third quarterand first nine months of 2008****comparedto the same periods in the prior year due primarily to higher averagecontractholder funds.  In the first ninemonths of 2008, the impact of higher average contractholder funds was partiallyoffset by the impact of amortization of deferred sales inducements (“DSI”).  Amortization of DSI reflected a credit toincome of $297 thousand in the first nine months of 2008 compared to a chargeto income of $5.1 million in the first nine months of 2007.  The change of $5.4 million in the first ninemonths of 2008 compared to the same period in the prior year was predominantlythe result of increased realized capital losses recorded in the current yearperiod on assets that support fixed annuities.

Inorder to analyze the impact of net investment income and interest credited tocontractholders on net income, we review the difference between net investmentincome and the sum of interest credited to contractholder funds and the impliedinterest on immediate annuities with life contingencies which is included as acomponent of contract benefits on the Condensed Statements of Operations (“investmentspread”).  The investment spread byproduct group is shown in the following table.

 
| ** **                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                           | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Annuities                                                |       | $                                                    | 15,749     |                                                | $          | 14,577 |   | $ | 50,301 |   | $ | 45,554 |   |
| Life insurance                                           |       | 476                                                  |       | 809                                                 |       | 2,273 |   | 2,267 |   |
| Net investment income on investments  supporting capital |       | 11,645                                               |       | 9,953                                               |       | 32,758 |   | 28,142 |   |
| Total investment spread                                  |       | $                                                    | 27,870     |                                                | $          | 25,339 |   | $ | 85,332 |   | $ | 75,963 |   |

 

24

----

 

Tofurther analyze investment spreads, the following table summarizes the weightedaverage investment yield on assets supporting product liabilities and capital,interest crediting rates and investment spreads for the three months ended September 30.

 
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spread** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                          | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.6                                              | %          | 5.7                                                          | %          | 4.7                                               | %          | 4.6 | % | 0.9 | % | 1.1 | % |
| Deferred fixed annuities                                             |       | 5.5                                              |       | 5.7                                                          |       | 3.5                                               |       | 3.5 |   | 2.0 |   | 2.2 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 7.1                                              |       | 7.3                                                          |       | 6.5                                               |       | 6.6 |   | 0.6 |   | 0.7 |   |
| Investments supporting capital, traditional  life and other products |       | 6.9                                              |       | 6.1                                                          |       | N/A                                               |       | N/A |   | N/A |   | N/A |   |

 

Thefollowing table summarizes the weighted average investment yield on assetssupporting product liabilities and capital, interest crediting rates andinvestment spreads for the nine months ended September 30.

 
| ** **                                                           | ** ** | **Weighted average  investment yield** | ** ** | **Weighted average  interest crediting rate** | ** ** | **Weighted average  investment spread** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                         | ** ** | **2007**                                                     | ** ** | **2008**                                          | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest-sensitive life insurance                                    |       | 5.7                                              | %          | 5.7                                                          | %          | 4.6                                               | %          | 4.6 | % | 1.1 | % | 1.1 | % |
| Deferred fixed annuities                                             |       | 5.6                                              |       | 5.6                                                          |       | 3.5                                               |       | 3.4 |   | 2.1 |   | 2.2 |   |
| Immediate fixed annuities with and without  life contingencies       |       | 7.2                                              |       | 7.4                                                          |       | 6.5                                               |       | 6.6 |   | 0.7 |   | 0.8 |   |
| Investments supporting capital, traditional  life and other products |       | 6.4                                              |       | 5.9                                                          |       | N/A                                               |       | N/A |   | N/A |   | N/A |   |

 

Thefollowing table summarizes our product liabilities as of September 30 andindicates the account value of those contracts and policies in which aninvestment spread is generated.

 
| ** **                                                      | ** ** | **As of September 30,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| **($ in thousands)**                                  | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Immediate fixed annuities with life  contingencies              |       | $                                      | 1,634,851  |   | $ | 1,607,719 |   |
| Other life contingent contracts and other                       |       | 335,510                                |       | 350,044 |   |
| Reserve for life-contingent contract  benefits                  |       | $                                      | 1,970,361  |   | $ | 1,957,763 |   |
|                                                            |       |                                   |       |   |   |
| Interest-sensitive life insurance                               |       | $                                      | 566,558    |   | $ | 515,037 |   |
| Deferred fixed annuities                                        |       | 3,919,140                              |       | 3,705,304 |   |
| Immediate fixed annuities without life  contingencies and other |       | 600,125                                |       | 570,921 |   |
| Contractholder funds                                            |       | $                                      | 5,085,823  |   | $ | 4,791,262 |   |

 

*Amortization of DAC* decreased 67.3% or $8.1 million in the third quarter of 2008 comparedto the third quarter of 2007 and 84.0% or $34.5 million in the first ninemonths of 2008 compared to the same period in the prior year.  The decrease in amortization of DAC in thethird quarter of 2008 was primarily due to lower actual gross profits on fixedannuities.  The decrease in amortizationof DAC in the first nine months of 2008 was predominantly the result of reducedactual gross profits for fixed annuities due to realized capital losses recordedin the current year period, and the recognition in the current year period ofamortization deceleration (credit to income) of $8.8 million compared toamortization acceleration (charge to income) of $5.8 million in the prior yearperiod due to our annual comprehensive review of DAC assumptions (commonlyreferred to as “DAC unlocking”).

 

25

----

 

Accretionof DAC relating to realized capital gains and losses was $4.5 million and $15.3million in the third quarter and first nine months of 2008, respectively,compared to amortization of DAC of $91 thousand in the third quarter of 2007and accretion of DAC of $209 thousand in the first nine months of 2007.  The impact of realized capital gains andlosses on amortization of DAC is dependent upon the relationship between theassets that give rise to the gain or loss and the product liability supportedby the assets.  Fluctuations result fromchanges in the impact of realized capital gains and losses on actual and expectedgross profits.

 

Inaccordance with our annual comprehensive review of DAC assumptions, in thefirst quarter of 2008, the Company recognized net amortization decelerationtotaling $8.8 million, including $6.5 million for fixed annuities and $2.3million for interest-sensitive life insurance products.  In the first quarter of 2007, netamortization acceleration totaled $5.8 million and included net amortizationdeceleration of $1.5 million for interest-sensitive life insurance products andnet amortization acceleration of $7.3 million for fixed annuities.  The first quarter 2008 net amortizationdeceleration of $6.5 million on fixed annuities was due primarily to higherthan expected investment spreads partially offset by increased expenses and thenet amortization deceleration of $2.3 million on interest-sensitive lifeinsurance products was due to higher than expected benefit spreads partiallyoffset by increased expenses.

* *

*Operating costs and expenses* increased 17.2% and 15.1% in the thirdquarter and first nine months of 2008, respectively, compared to the sameperiods of 2007 due primarily to higher expenses related to growthinitiatives.  In addition, the prior yearperiods benefited from a servicing fee paid by Prudential Financial Inc. forour servicing of the variable annuity business that we ceded to them during atransition period beginning in 2006.

* *

*Loss on disposition of operations* for the first nine months of 2008 and 2007totaled $358 thousand and $132 thousand, respectively.  Losses in each period were related toadjustments associated with a previous period disposition.

* *

*Income tax expense* increased 2.2% or $140 thousand in third quarter of 2008 compared tothe third quarter of 2007 and decreased 57.1% or $9.5 million in the first ninemonths of 2008 compared to the same period in the prior year.  These changes include the tax effect of anaccrual recorded in the third quarter of 2008 relating to the rescission.Excluding the tax effect of the accrual, which decreased income tax expense by$2.5 million and $2.2 million in the third quarter and first nine months of2008, respectively, income tax expense increased 41.5% or $2.7 million in thethird quarter of 2008 compared to the third quarter of 2007 and decreased 44.0%or $7.3 million in the first nine months of 2008 compared to the same period inthe prior year.  These changes primarilyreflect changes in pre-tax income.

 

26

----

 

**INVESTMENTS**

 

During2008, we developed risk mitigation and return optimization programs as ouroutlook on the economy has experienced significant revisions as conditionsdeteriorated throughout the year.  By theend of the third quarter of 2008, we modified our outlook to a more severe andprolonged downturn in the global financial markets and economy.  This represents a significant change from ourassessment of the economy as of the end of the second quarter of 2008 where wehad an outlook for continued weakness in the global financial markets andeconomy including continued volatility in the financial markets, continuedreduced liquidity in certain asset classes and further unfavorable economictrends.  The risk mitigation and returnoptimization programs augment earlier actions to reduce investments in realestate and other market sectors as well as to mitigate exposures to risk-freeinterest rate spikes.  We expectcontinued volatility in the financial markets, significantly reduced liquidityin certain asset classes and unfavorable economic trends.  In addition, the potential for systemicinvestment supply and demand imbalances has remained above normal due to thedeteriorating credit strength of financial institutions and eroding investorconfidence.

Duringthe third quarter of 2008, reflecting decisions made and reported at the end ofthe second quarter of 2008, we pursued risk mitigation and return optimizationprograms to protect portfolio value.  Acomprehensive review identified specific investments that could besignificantly impacted by continued deterioration in the economy includingcertain real estate and financial-related market sectors that may be sold. Thisincluded a portion of our residential and commercial real estate securitiesincluding securities collateralized by residential and commercial mortgageloans, mortgage loans and securities issued by financial institutions.  The risk mitigation and return optimizationprograms as of the end of the second quarter of 2008, which resulted in changein intent write-downs, were designed to reduce our exposure to residential andcommercial real estate and financial related markets by approximately $276million of amortized cost, prior to change in intent write-downs.  As of June 30, 2008, we held $268.8million of investments for which we had changed our intent to hold torecovery.  These investments included$229.8 million that we believed to be vulnerable to significant additionalcredit and pricing pressures, and $39.0 million related to individualsecurities.  During the third quarter of2008, we sold $127.3 million of these securities.  Change in intent write-downs of $15.3 millionwere recorded in the third quarter of 2008 including $12.5 million related tosecurities for which we changed our intent to hold to recovery in the secondquarter of 2008 that we still held at September 30, 2008 and $2.8 millionrelated to $18.8 million of securities for which we changed our intent to holdto recovery in the third quarter of 2008 due to unanticipated changes in factsand circumstances.  Investments for whichwe changed our intent to hold to recovery totaled $130.3 million as of September 30,2008.

 

Asa part of our risk mitigation and return optimization activities, we have takenthe following actions:

·                  Developed a tactical positioning in liquidassets and assets that we can sell without significant loss.

·                  Continued to reduce exposure in assets otherthan those for which we have asserted an intent to hold until recovery where wehave credit concerns or where there has been a significant change in facts andcircumstances.

·                  Our exposure to financial-related marketsectors, which primarily includes fixed income holdings in banks, brokerages,finance companies and insurance, decreased to $877.2 million as of September 30,2008 from $1.02 billion as of December 31, 2007, primarily as a result oftargeted sales and declines in fair value.

·                  Our exposure to residential and commercialreal estate market sectors comprised primarily mortgage-backed securities (“MBS”),commercial mortgage-backed securities (“CMBS”), asset-backed residentialmortgage-backed securities (“ABS RMBS”), and mortgage loans decreased to $1.86billion as of September 30, 2008 from $2.07 billion as of December 31,2007 as a result of targeted sales and declines in fair value.

·                  Reduced overall counterparty exposurereplacing over-the-counter (“OTC”) derivatives transactions with exchangetraded instruments where available and, in one case, terminating a counterpartyrelationship.

·                  During the third quarter of 2008, we sold$66.7 million of government securities and recognized realized capital gains of$17.3 million.  In addition, through October 20,2008, we sold government securities with a carrying value of $112.2 million onwhich we realized capital gains of $26.7 million.

 

Wecontinue to monitor the progress of these programs as market and economicconditions develop and will adapt our decisions as appropriate.  Our continuing focus is to manage our risksand to position our portfolio to take advantage of market opportunities whileattempting to mitigate further adverse effects.

 

27

----

 

Fundsraised from the sales of securities will eventually be invested in accordancewith our asset-liability management strategies. To the extent markets remain unstable, we intendto deploy funds available for reinvestment in high quality, shorter term, andlower-risk investments.  Net investmentincome may be lower as a function of current yields available on theseinvestments as well as somewhat higher short term balances.

An important component of ourfinancial results is the return on our investment portfolio.  The composition of the investment portfolioat September 30, 2008 is presented in the table below.

 
| ** **                     | ** ** | ** **      | ** ** | **Percent**       | ** ** |
|--------------------------------|------------|-----------------|------------|-------------------|------------|
| **($ in thousands)** | ** ** | **Investments** | ** ** | **of total** | ** ** |
|                           |       |            |       |              |       |
| Fixed income securities (1)    |       | $               | 5,802,640  |              | 83.4       | % |
| Mortgage loans                 |       | 711,933         |       | 10.2              |       |
| Short-term                     |       | 398,296         |       | 5.7               |       |
| Policy loans                   |       | 39,114          |       | 0.6               |       |
| Other                          |       | 2,162           |       | 0.1               |       |
| Total                          |       | $               | 6,954,145  |              | 100.0      | % |

 

----

(1) Fixed income securities are carried at fair value.  Amortized cost basis for these securities was$5.85 billion.

----

 

Total investments decreased to$6.95 billion at September 30, 2008, from $7.06 billion at December 31,2007, due to unrealized net capital losses and net realized capital losses,partially offset by positive cash flows from operating and financingactivities, including increased funds associated with securities lending.

 

Total investments at amortizedcost related to collateral received in connection with securities lendingbusiness activities increased to $223.9 million at September 30, 2008,from $198.1 million at December 31, 2007.

 

Fixed income securities by typeare listed in the table below.

 
| **($ in thousands)**            | ** ** | **Fair value at  September 30,  2008** | ** ** | **% to Total  investments** | ** ** | **Fair value at  December 31,  2007** | ** ** | **% to Total  investments** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
|                                      |       |                                                  |       |                                  |       |                                                 |       |                                  |       |
| U.S. government and agencies              |       | $                                                     | 827,337    |                                  | 11.9       | %                                                    | $          | 797,191                               |       | 11.3 | % |
| Municipal                                 |       | 455,265                                               |       | 6.6                                   |       | 433,307                                              |       | 6.1                                   |       |
| Corporate                                 |       | 3,068,574                                             |       | 44.1                                  |       | 3,378,811                                            |       | 47.9                                  |       |
| Foreign government                        |       | 341,653                                               |       | 4.9                                   |       | 333,540                                              |       | 4.7                                   |       |
| MBS                                       |       | 389,819                                               |       | 5.6                                   |       | 419,617                                              |       | 6.0                                   |       |
| CMBS                                      |       | 635,951                                               |       | 9.1                                   |       | 791,941                                              |       | 11.2                                  |       |
| Asset-backed securities (“ABS”) |       | 75,536                                                |       | 1.1                                   |       | 106,877                                              |       | 1.5                                   |       |
| Redeemable preferred stock                |       | 8,505                                                 |       | 0.1                                   |       | 9,844                                                |       | 0.2                                   |       |
| Total fixed income securities             |       | $                                                     | 5,802,640  |                                  | 83.4       | %                                                    | $          | 6,271,128                             |       | 88.9 | % |

 

At September 30, 2008,97.4% of the fixed income securities portfolio was rated investment grade,which is defined as a security having a rating from the National Association ofInsurance Commissioners (“NAIC”) of 1 or 2; a rating of Aaa, Aa, A or Baa fromMoody’s, a rating of AAA, AA, A or BBB from Standard & Poor’s (“S&P”),Fitch or Dominion or a rating of aaa, aa, a, or bbb from A.M. Best; or acomparable internal rating if an externally provided rating is not available.

 

Duringthe third 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 other collateralizeddebt obligations (“other CDO”) portfolios. These portfolios totaled $146.5 million, or approximately 2.1% of ourtotal investments at September 30, 2008. Other securities markets, including certain other asset-backed and realestate-backed securities markets, experienced illiquidity, but to a lesserdegree.

 

Wedetermine the fair values of securities comprising these illiquid portfolios byobtaining information from an independent third-party valuation serviceprovider, brokers and other sources. We confirmed the reasonableness of thefair value of these portfolios as of September 30, 2008 by analyzingavailable market information including, but 

 

28

----

 

notlimited to, collateral quality, anticipated cash flows, credit enhancements,default rates, loss severities, securities’ relative position within theirrespective capital structures, and credit ratings from statistical ratingagencies.

 

Impairmentwrite-downs during the third quarter of 2008 were recorded on our ABS RMBS andCRE CDO totaling $305 thousand and $1.2 million, respectively, for a total of$1.5 million.  Impairment write-downsduring the first nine months of 2008 were recorded on our ABS RMBS and CRE CDOtotaling $938 thousand and $7.7 million, respectively, for a total of $8.6million.  Change in intent write-downsfor the third quarter of 2008 included losses on our ABS RMBS and CRE CDOtotaling $952 thousand and $326 thousand, respectively, for a total of $1.3million.  Change in intent write-downsduring the first nine months of 2008 included losses on our ABS RMBS and CRECDO totaling $5.1 million and $5.8 million, respectively, for a total of $10.9million.

 

Thepar value of our illiquid investment portfolios totaled $191.3 million andamortized cost totaled $176.0 million or 92.0% of par value at September 30,2008, which is primarily the result of write-downs of approximately $15.3million.  Fair value of these investmentstotaled $146.5 million or 76.6% of par value.

 

Theunrealized net capital losses as of September 30, 2008 on our illiquidportfolios are detailed in the following table.

 
| **($ in thousands)** | ** ** | **Par  value ****(2)** | ** ** | **Amortized  cost ****(1) (2)** | ** ** | **% Amortized  cost to  par value** | ** ** | **Fair  value** | ** ** | **% Fair  value to  par value** | ** ** | **Unrealized  gain/loss** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-------------------------------------------|------------|----------------------------------------------------|------------|-----------------|------------|------------------------------------------------|------------|---------------------------|------------|
| **MBS**                        |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| Prime                          |       | $                           | 47,165     |                                      | $          | 47,370                                             |       | 100.4           | %          | $                                              | 41,521     |                      | 88.0       | % | $ | (5,849 | ) |
| Alt-A                          |       | 30,000                      |       | 29,618                                    |       | 98.7                                               |       | 24,106          |       | 80.4                                           |       | (5,512                    | )          |
|                           |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| **CMBS**                       |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| CRE CDO                        |       | 14,929                      |       | 5,311                                     |       | 35.6                                               |       | 5,329           |       | 35.7                                           |       | 18                        |       |
|                           |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| **ABS**                        |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| ABS RMBS                       |       | 70,275                      |       | 64,793                                    |       | 92.2                                               |       | 52,877          |       | 75.2                                           |       | (11,916                   | )          |
| Other CDO                      |       | 28,939                      |       | 28,939                                    |       | 100.0                                              |       | 22,659          |       | 78.3                                           |       | (6,280                    | )          |
|                           |       |                        |       |                                      |       |                                               |       |            |       |                                           |       |                      |       |
| Total                          |       | $                           | 191,308    |                                      | $          | 176,031                                            |       | 92.0            |       | $                                              | 146,492    |                      | 76.6       |   | $ | (29,539 | ) |

 

----

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

(2) The difference between parvalue and amortized cost of $15.3 million is primarily attributable towrite-downs.  Par value has been reducedby principal payments.

----

 

Unrealizednet capital losses as of September 30, 2008 included $5.8 million onPrime, $5.5 million on Alt-A, $11.9 million on ABS RMBS, and $6.3 million onother CDO, for a total of $29.5 million. Unrealized net capital gains as of September 30, 2008 included $18thousand on CRE CDO.

 

Securitiesincluded in our illiquid portfolios with a fair value less than 70% ofamortized cost as of September 30, 2008 are shown in the following table.

 
| **($ in thousands)** | ** ** | **Fair  value** | ** ** | **Unrealized  gain/loss** | ** ** |
|--------------------------------|------------|-----------------|------------|---------------------------|------------|
| **ABS**                        |       |            |       |                      |       |
| ABS RMBS                       |       | $               | 7,381      |                      | $          | (9,169 | ) |
| Other CDO                      |       | 6,432           |       | (3,568                    | )          |
| Total                          |       | $               | 13,813     |                      | $          | (12,737 | ) |

 

Inaddition, as of September 30,2008, CMBS excluding CRE CDO parvalue totaled $753.8 million and amortized cost totaled $730.0 million or 96.8%of par value, which was primarily the result of write-downs.  Fair value totaled $630.6 million or 83.7% ofpar value.

 

Wecontinue to believe that the unrealized losses on these securities are notnecessarily 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.

 

29

----

 

The cash flows of the underlying mortgages or collateral for MBS, CRECDO and ABS are generally applied in a pre-determined order and are designed sothat each security issued qualifies for a specific original rating.  The security issue is typically referred toas the “class”.  For example, the “senior”portion or “top” of the capital structure which would originally qualify for arating of Aaa is referred to as the “Aaa class” and typically has priority inreceiving the principal 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. The sub-classes mayreceive principal repayments on a sequential or pro-rata payment basisdepending upon the structure.  In asequential structure, underlying collateral principal repayments are directedto the most senior rated Aaa class in the structure until paid in full, afterwhich principal repayments are directed to the next most senior Aaa class inthe structure until it is paid in full. Although the various Aaa classes may receive principal sequentially,they may share any losses from the underlying collateral on a pro-rata basisafter losses are absorbed by classes with lower original ratings or what may bereferred to as more “junior” or “subordinate” securities in the capitalstructure.  The underlying mortgages havefixed interest rates, variable interest rates (such as adjustable ratemortgages (“ARM”)) or are hybrid, meaning that they contain features of bothfixed and variable rate mortgages.

 

*MBS* totaled$389.8 million and 100.0% were rated investment grade at September 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 83.2% 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 following table shows MBS by type and Moody’s equivalent rating.

 
| **($ in thousands)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  Investments** | ** ** | **Aaa**    | ** ** |
|--------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|
| **MBS**                        | ** ** | ** **                                                | ** ** | ** **                            | ** ** | ** ** | ** ** |
| U.S. Agency                    |       | $                                                         | 324,192    |                                  | 4.7        | %          | 100.0      | % |
| Prime                          |       | 41,521                                                    |       | 0.6                                   |       | 100.0      |       |
| Alt-A                          |       | 24,106                                                    |       | 0.3                                   |       | 100.0      |       |
| Total MBS                      |       | $                                                         | 389,819    |                                  | 5.6        | %          |       |   |

 

Prime are collateralized by residential mortgage loans issued to primeborrowers.  As of September 30,2008, fair value represents 87.7% of amortized cost of these securities.  Wehave collected $479 thousand and $3.1 million of principal repaymentsconsistent with the expected cash flows during the third quarter and first ninemonths of 2008, respectively.  All of our Prime MBS positionscomprised fixed rate mortgages, and include securities issued before 2005 thatare in the Aaa class of the capital structure. The following table shows our Primeportfolio as of September 30, 2008 based upon our participation in thecapital structure.

 
| **($ in thousands)**       | ** ** | ** **      | ** ** | ** **                       | ** ** | ** **                | ** ** |
|--------------------------------------|------------|-----------------|------------|----------------------------------|------------|---------------------------|------------|
| ** **                           | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| **Capital structure classification** | ** ** | ** **      | ** ** | ** **                       | ** ** | ** **                | ** ** |
| **Aaa – Fixed rate**            | ** ** | ** **      | ** ** | ** **                       | ** ** | ** **                | ** ** |
| Super Senior                         |       | $               | 4,415      |                             | $          | 4,913                     |       | $ | (498 | ) |
| Senior                               |       | 37,106          |       | 42,457                           |       | (5,351                    | )          |
| Total                                |       | $               | 41,521     |                             | $          | 47,370                    |       | $ | (5,849 | ) |

 

----

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

----

 

Alt-Acan be issued by trusts backed by pools of residential mortgages with eitherfixed or variable interest rates.  Themortgage pools can include residential mortgage loans issued to borrowers withstronger credit profiles than sub-prime borrowers, but who do not qualify forprime financing terms due to high loan-to-value ratios or limited supportingdocumentation.  As of September 30,2008, all of our Alt-A portfolio are in the Aaa class and were issued prior to2005 at fixed rates and had net unrealized losses of $5.5 million.  Fair value represents 81.4% of the amortizedcost of these securities.

 

30

----

 

*CMBS* totaled $636.0million all of which were rated investment grade at September 30,2008.  The CMBS portfolio is subject tocredit risk, but unlike other structured securities, is generally not subjectto prepayment risk due to protections within the underlying commercialmortgages whereby borrowers are effectively restricted from prepaying theirmortgages due to changes in interest rates. Approximately 97.4% of the CMBS investments are pools of commercialmortgages, broadly diversified across property types and geographicalarea.  The following table shows CMBS bytype and Moody’s equivalent rating.

 
| **($ in thousands)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** | **Aaa** | ** ** | **Aa** | ** ** | **A**  | ** ** | **Baa** | ** ** |
|--------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|---------|------------|--------|------------|--------|------------|---------|------------|
|                           |       |                                                      |       |                                  |       |    |       |   |       |   |       |    |       |   |
| CMBS                           |       | $                                                         | 630,622    |                                  | 9.1        | %       | 81.2       | %      | 15.4       | %      | 3.4        | %       | —     | % |
| CRE CDO                        |       | 5,329                                                     |       | —                                |       | —  |       | — |       | 22.3   |       | 77.7    |       |
| Total CMBS                     |       | $                                                         | 635,951    |                                  | 9.1        | %       |       |   |       |   |       |    |       |   |

 

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 September 30,2008, fair value represents100.3% of the amortized cost of these securities.  During the third quarter of 2008, we sold$18.4 million of CRE CDO.  We also collected $682 thousand and $696thousand of principal repayments consistent with the expected cash flows duringthe third quarter and first nine months of 2008, respectively.  Impairment write-downs during the thirdquarter and first nine months of 2008 were recorded on our CRE CDO totaling$1.2 million and $7.7 million, respectively. In addition, $326 thousand and $5.8 million of change in intentwrite-downs were recorded during the third quarter and first nine months of2008, respectively, on CRE CDO.  Thefollowing table shows our CRE CDO portfolio at September 30, 2008 byvintage year, based upon our participation in the capital structure.

 
| **($ in thousands)**              | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** **      | ** ** | ** **                       | ** ** |
|---------------------------------------------|------------|-----------------------|------------|------------|------------|-----------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **2006**              | ** ** | **2005**   | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
|                                        |       |                  |       |       |       |            |       |                             |       |   |   |
| **Capital structure**** ****(2)** |       |                  |       |       |       |            |       |                             |       |   |   |   |   |   |   |   |
| Aa                                          |       | $                     | 2,857      |       | $          | —          |       | $                                | 2,857      |   | $ | 2,857 |   | $ | — |   |
| A                                           |       | —                |       | 1,190      |       | 1,190           |       | 1,190                            |       |   |   |
| Baa                                         |       | —                |       | 1,282      |       | 1,282           |       | 1,264                            |       | 18 |   |
| Total                                       |       | $                     | 2,857      |       | $          | 2,472           |       | $                                | 5,329      |   | $ | 5,311 |   | $ | 18 |   |

 

----

(1) Amortized cost includes other-than-temporary impairmentcharges, as applicable.

(2) May not be consistent with current ratings due todowngrades.

----

 

31

----

 

*ABS* totaled $75.5million and 97.3% were rated investment grade at September 30, 2008.  ABSby type are listed in the table below.

 
| **($ ****in thousands)**     | ** ** | **Fair value at  September  30, 2008** | ** ** | **% ****to Total  investments** | ** ** | **Fair value as a  % of amortized  cost** | ** ** | **A****aa** | ** ** | **A****a** | ** ** | **A**      | ** ** | **B****aa** | ** ** | **B****a or  lower** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------|------------|-------------|------------|---------------------------|------------|
| **ABS**                                | ** ** | ** **                                            | ** ** | ** **                                | ** ** | ** **                                                         | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **                | ** ** |
| ABS RMBS non-insured                   | ** ** | $                                                     | 42,615     |                                      | 0.6        | %                                                                  | 90.8       | %           | 85.5       | %          | 3.0        | %          | 0.7        | %           | 6.1        | %                         | 4.7        | % |
| ABS RMBS insured                       | ** ** | 10,262                                                |       | 0.2                                       |       | 57.4                                                               |       | 6.8         |       | 41.1       |       | 45.1       |       | —      |       | 7.0                       |       |
| Total ABS RMBS                         | ** ** | 52,877                                                |       | 0.8                                       |       | 81.6                                                               |       | 70.2        |       | 10.4       |       | 9.4        |       | 4.9         |       | 5.1                       |       |
| Other  collateralized debt obligations | ** ** | 22,659                                                |       | 0.3                                       |       | 78.3                                                               |       | 55.3        |       | 16.3       |       | 28.4       |       | —      |       | —                    |       |
| Total ABS                              | ** ** | $                                                     | 75,536     |                                      | 1.1        | %                                                                  | 80.6       |        |       |       |       |       |       |        |       |                      |       |   |

 

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.

Thefollowing table presents additional information about our ABS RMBS portfolioincluding a summary by first and second lien collateral.

 
| **($ ****in thousands)** | ** ** | **Fair value at  September 30, 2008** | ** ** | **% to Total  investments** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| **ABS RMBS**                       | ** ** | ** **                                                | ** ** | ** **                            | ** ** |
| First lien:                        |       |                                                      |       |                                  |       |
| Fixed rate(1)                      | ** ** | $                                                         | 12,230     |                                  | 0.2        | % |
| Variable rate(1)                   | ** ** | 26,605                                                    |       | 0.4                                   |       |
| Total first lien(2)                | ** ** | 38,835                                                    |       | 0.6                                   |       |
| Second lien :                      |       |                                                      |       |                                  |       |
| Insured                            | ** ** | 9,196                                                     |       | 0.1                                   |       |
| Other                              | ** ** | 4,846                                                     |       | 0.1                                   |       |
| Total second lien(3)               | ** ** | 14,042                                                    |       | 0.2                                   |       |
| Total ABS  RMBS                    | ** ** | $                                                         | 52,877     |                                  | 0.8        | % |

 

----

(1)          Fixed rate and variable rate refer to theprimary interest rate characteristics of the underlying mortgages at the timeof issuance.

(2)          The credit ratings of the first lien ABS RMBSwere 86.6% Aaa, 4.0% Aa, 1.0% A, 6.6% Baa and 1.8% Ba or lower atSeptember 30, 2008.

(3)          The credit ratings of the second lien ABS RMBSwere 25.2% Aaa, 28.1% Aa, 32.4% A and 14.3% Ba or lower at September 30,2008.

----

 

Asof September 30, 2008, the ABS RMBS portfolio had net unrealized losses of$11.9 million.  Fair value represents81.6% of the amortized cost of these securities.  ABS RMBS securities with a fair value lessthan 70% of amortized cost totaled $7.4 million, with unrealized losses of $9.2million.  During the third quarter andfirst nine months of 2008, we sold $311 thousand and $318 thousand of ABS RMBS,respectively, recognizing a loss of $52 thousand and $62 thousand,respectively.  We also collected $4.5million and $12.4 million of principal repayments consistent with the expectedcash flows during the third quarter and first nine months of 2008,respectively.  Impairment write-downsduring the third quarter and first nine months of 2008 were recorded on our ABSRMBS totaling $305 thousand and $938 thousand, respectively.  In addition, $952 thousand and $5.1 millionof change in intent write-downs were recorded during the third quarter andfirst nine months of 2008, respectively, 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

 

32

----

 

withinthe Aaa class would likely either be paid in full or receive substantialprincipal repayments before underlying mortgage losses would breach thatlevel.  However, when the underlyingmortgage product was fixed-rate in nature, which we assessed to have strongerunderwriting origination standards than variable rate collateral, we investedsomewhat lower in the capital structure, such as securities below the firstthree Aaa sub-classes.  The vast majorityof our ABS RMBS from 2006 and 2007 are concentrated within originally rated Aaaor Aa securities.

 

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, togetherwith the second lien non-insured, comprise the $42.6 million of non-insured ABSRMBS.

 
| **($ in thousands)**                                  | ** ** | **2007**           | ** ** | **2006**        | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|-----------------|------------|
| **Capital structure classification**** ****(3)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized****cost ****(1)** | ** ** | **Variable  rate** | ** ** | **Fixed  rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized****cost ****(1)** | ** ** |
| First or Second  Aaa class                                      |       | $                  | 4,875      |            | $          | 1,508 |   | $ | 6,383 |   | $ | 6,910 |   | $ | 16,616 |   | $ | 729 |   | $ | 17,345 |   | $ | 18,332 |   |
| Third Aaa class                                                 |       | —             |       | —          |       | — |   | — |   | 3,986 |   | 1,591 |   | 5,577 |   | 6,419 |   |
| Other Aaa (2)                                                   |       | —             |       | 8,402           |       | 8,402 |   | 8,121 |   | — |   | — |   | — |   | — |   |
| Total Aaa First  Lien  Non-Insured ABS RMBS                     |       | $                  | 4,875      |            | $          | 9,910 |   | $ | 14,785 |   | $ | 15,031 |   | $ | 20,602 |   | $ | 2,320 |   | $ | 22,922 |   | $ | 24,751 |   |

 
| **($ in thousands)**                             | ** ** | **2005**           | ** ** | **Total**           | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| **Capital structure Classification**** ****(3)** | ** ** | **Variable  rate** | ** ** | **Fixed rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized****cost ****(1)** | ** ** | **Variable  rate** | ** ** | **Fixed rate** | ** ** | **Total fair  value** | ** ** | **Total  amortized****cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| First or Second  Aaa class                                 |       | $                  | 62         |                | $          | — |   | $ | 62 |   | $ | 62 |   | $ | 21,553 |   | $ | 2,237 |   | $ | 23,790 |   | $ | 25,304 |   | $ | (1,514 | ) |
| Third Aaa class                                            |       | —             |       | —              |       | — |   | — |   | 3,986 |   | 1,591 |   | 5,577 |   | 6,419 |   | (842 | ) |
| Other Aaa (1)                                              |       | —             |       | —              |       | — |   | — |   | — |   | 8,402 |   | 8,402 |   | 8,121 |   | 281 |   |
| Total Aaa First  Lien  Non-Insured ABS RMBS                |       | $                  | 62         |                | $          | — |   | $ | 62 |   | $ | 62 |   | $ | 25,539 |   | $ | 12,230 |   | $ | 37,769 |   | $ | 39,844 |   | $ | (2,075 | ) |

 

----

(1)          Amortized costincludes other-than-temporary impairment charges, as applicable.

(2)          Includes primarily pass-through securities and “NAS”bonds.  NAS bonds are typically lockedout from receiving principal prepayments for a specified period of time afterwhich they receive prepayment allocations according to a specified formula.

(3)          May not be consistent with currentratings due to downgrades.

----

 

Wealso own approximately $4.8 million of second lien ABS RMBS non-insuredsecurities, representing 68.5% of amortized cost.  Approximately $2.0 million or 41.3% of thisportfolio are 2006 and 2007 vintage years.

AtSeptember 30, 2008, $10.3 million or 19.4% of the total ABS RMBSsecurities are insured by 4 bond insurers and 93.0% of these insuredsecurities were rated investment grade. $46.2 million or 87.4% of the portfolioconsisted of securities that were issued during 2005, 2006 and 2007.  At September 30, 2008, 64.9% ofsecurities issued during 2005, 2006 and 2007 were rated Aaa, 3.2% rated Aa,9.4% rated A, 4.9% rated Baa and 5.2% rated Ba or lower.

 

33

----

 

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

 
| **($ in thousands)**                             | ** ** | **Vintage year** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                                                 | ** ** | **2007**              | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Pre-2005** | ** ** | **Fair  value** | ** ** | **Amortized  cost ****(1)** | ** ** | **Unrealized  gain/loss** | ** ** |
| **First  Lien:**                                           |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| Financial  Guarantee  Insurance Company (“FGIC”) |       | $                     | 718        |       | $          | 77         |       | $            | —     |   | $ | — |   | $ | 795 |   | $ | 924 |   | $ | (129 | ) |
| Ambac Financial  Group, Inc. (“AMBAC”)      |       | —                |       | 271        |       | —     |       | —       |       | 271 |   | 281 |   | (10 | ) |
| Total First Lien                                           |       | 718                   |       | 348        |       | —     |       | —       |       | 1,066 |   | 1,205 |   | (139 | ) |
| **Second  Lien:**                                          |       |                  |       |       |       |       |       |         |       |   |   |   |   |   |   |
| AMBAC                                                      |       | —                |       | —     |       | 124        |       | 3,822        |       | 3,946 |   | 4,512 |   | (566 | ) |
| MBIA, Inc  (“MBIA”)                              |       | 4,556                 |       | —     |       | —     |       | —       |       | 4,556 |   | 9,854 |   | (5,298 | ) |
| Financial  Security  Assurance, Inc.(“FSA”) |       | 694                   |       | —     |       | —     |       | —       |       | 694 |   | 2,303 |   | (1,609 | ) |
| Total Second Lien                                          |       | 5,250                 |       | —     |       | 124        |       | 3,822        |       | 9,196 |   | 16,669 |   | (7,473 | ) |
| Total Insured ABS  RMBS                                    |       | $                     | 5,968      |       | $          | 348        |       | $            | 124        |   | $ | 3,822 |   | $ | 10,262 |   | $ | 17,874 |   | $ | (7,612 | ) |

 

----

(1) Amortized cost includes other-than-temporary impairmentcharges, as applicable

----

OtherCDO totaled $22.7 million and all were rated investment grade at September 30,2008.  Other CDO consist primarily ofobligations secured by high yield and investment grade corporate credits.  As of September 30, 2008, the other CDOportfolio had net unrealized losses of $6.3 million.  As of September 30, 2008, fair valuerepresents 78.3% of the amortized cost of these securities. Other CDO securitieswith a fair value less than 70% of amortized cost totaled $6.4 million, withunrealized losses of $3.6 million.

*Insured Investments*As of September 30, 2008, we hold $258.7 million of fixed incomesecurities that are insured by bond insurers, including approximately $242.2million or 53.2% of our municipal bond portfolio and $10.3 million of our ABSRMBS.  53.2% of our municipal bondportfolio is insured by five bond insurers and 43.2% have a Moody’s equivalentrating of Aaa or Aa.  Our practices foracquiring and monitoring municipal bonds primarily are based on the quality ofthe primary obligor.  As of September 30,2008, we believe the valuations already reflected a decline in the value of theinsurance, and further such declines, if any, are not expected to bematerial.  While the valuation of theseholdings may be temporarily impacted by negative and rapidly changing marketdevelopments, we continue to have the intent and ability to hold the bonds andexpect to receive all of the contractual cash flows.  As of September 30, 2008, 45.7% of ourinsured municipal bond portfolio was insured by MBIA, 19.4% by AMBAC, 16.3% byFGIC and 13.3% by FSA.

*Municipal Bonds *Included in our municipal bond portfolio at September 30,2008 are $108.8 million of auction rate securities (“ARS”) that have long-termstated maturities, with the interest rate reset based on auctions thathistorically occured every 7, 28 or 35 days depending on the specificsecurity.  This is compared to a balanceof ARS at December 31, 2007 of $133.7 million, with the declinerepresenting primarily redemptions from calls or refunding proceeds since December 31,2007.  Our holdings primarily have a Moody’s equivalent rating of Aaa.  We make our investment decisions based on theunderlying credit of each security.  Allof our holdings are pools of student loans for which at least 85% of thecollateral was insured by the U.S. Department of Education at the time wepurchased the security.  As of September 30,2008, $85.4 million of our ARS backed by student loans was 100% insured by theU.S Department of Education and $23.4 million were 90-99% insured. During thethird quarter of 2008, all of our student loan ARS holdings experienced failedauctions and we received the failed auction rate or, for those which containmaximum reset rate formulas, we received the contractual maximum rate. Weanticipate that failed auctions may persist and most of our holdings willcontinue to pay the failed auction rate or, for those that contain maximum ratereset formulas, the maximum rate, as described below.  Auctions continue to be conducted asscheduled for each of the securities.

Weestimate that approximately one third of our student loan backed ARS includemaximum rate reset formulas whereby when the failed auction rate exceeds anannual contractual maximum rate over a preceding stipulated period, the couponinterest rate is temporarily reset to the maximum rate, which can vary betweenzero and the failed

 

34

----

 

auctionrate.  This maximum rate formula causesthe reset interest rate on these securities to be lower than the failed auctionrate in order to reduce the annual interest rate so that it does not exceed theannual contractual maximum rate. Generally, the annual contractual maximum rate is higher than thehistorical rates paid on these securities. During the third quarter of 2008, $2.8 million of our ARS reset usingthe maximum rate reset formula.

Duringthe third quarter of 2008, regulatory authorities announced preliminarysettlements in principle with some of the largest broker-dealers of ARSfollowing extensive investigations into the February 2008 ARS marketcollapse.  According to press releases,the settlements require broker-dealers to expeditiously provide liquiditysolutions to institutional customers within specified timeframes.  While the press release descriptions of thepreliminary settlement terms vary in details for institutional investors, atleast one description calls for liquidation at par, while other descriptionscall for a “best efforts” approach.

 

*Exposure to certain financial institutions *Our direct exposure to American International Group, Bank of AmericaCorporation (including Countrywide), Goldman Sachs Group, LLP, JP Morgan Chase &Company (including Bear Stearns and Washington Mutual), Merrill Lynch andCompany, Morgan Stanley, Wachovia Corporation and Fannie Mae totals $151.1million or 2.2% of our total investment portfolio as of September 30,2008.  On these names, we had $7.8million in impairment write-downs and $1.6 million in change in intentwrite-downs during the third quarter of 2008, and $7.8 million in impairmentwrite-downs and $7.6 million in change in intent write-downs during the firstnine months of 2008.

 

35

----

 

*Unrealized net capital losses* totaled $42.7 million as of September 30,2008, compared to unrealized net capital gains of $341.5 million at December 31,2007.  The decline was primarily due towidening credit spreads. Net unrealized capital losses increased despite therealization of capital losses on sales and impairments, including change inintent write-downs, during the third quarter and first nine months of2008.  We continue to experiencevolatility in the balance of our unrealized net capital gains and losses as wedid between the years 2004/2005 and 2006/2007. The following tables present total unrealized gains and losses, pre-taxand after-tax.

 
| **($ in thousands)**           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| U.S. government and agencies             |       | $                      | 202,059    |                  | $          | 220,299 |   |
| Municipal                                |       | (12,207                | )          | 11,552                |       |
| Corporate                                |       | (176,347               | )          | 63,866                |       |
| Foreign government                       |       | 73,897                 |       | 73,689                |       |
| MBS                                      |       | (12,023                | )          | (113                  | )          |
| CMBS                                     |       | (99,313                | )          | (19,250               | )          |
| ABS                                      |       | (18,196                | )          | (8,326                | )          |
| Redeemable preferred stock               |       | (796                   | )          | 512                   |       |
| Fixed income securities                  |       | (42,926                | )          | 342,229               |       |
| Derivatives                              |       | 234                    |       | (766                  | )          |
| Unrealized net gains and losses, pre-tax |       | $                      | (42,692    | )                     | $          | 341,463 |   |

* *
| **($ in thousands)**                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Fixed income securities                                     |       | $                      | (42,926    | )                     | $          | 342,229 |   |
| Derivative instruments                                      |       | 234                    |       | (766                  | )          |
| Unrealized net gains and losses, pre-tax                    |       | (42,692                | )          | 341,463               |       |
| Amounts recognized for:                                     |       |                   |       |                  |       |
| Insurance Reserves (1)                                      |       | (193,788               | )          | (261,846              | )          |
| Deferred policy acquisition and sales  inducement costs (2) |       | 175,395                |       | 20,672                |       |
| Total                                                       |       | (18,393                | )          | (241,174              | )          |
| Deferred income taxes                                       |       | 21,380                 |       | (35,101               | )          |
| Unrealized net capital gains and losses,  after-tax         |       | $                      | (39,705    | )                     | $          | 65,188 |   |

 

----

(1)          The insurance reserves adjustment representsthe amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolioswere realized.  Since these products havea long-term expected life, the proceeds from investments sold in an unrealizedgain position would be reinvested at current lower interest rates, resulting ina premium deficiency.  The adjustmentprimarily relates to structured settlement annuities with life contingencies,in addition to certain payout annuities with life contingencies.

(2)          The deferred policy acquisition and salesinducement costs adjustment represents the amount by which the amortization ofDAC and DSI would increase or decrease if the unrealized gains or losses in therespective product portfolios were realized.

----

 

The net unrealized loss for the fixed income portfolio totaled $42.9million, comprised of $329.3 million of unrealized gains and $372.2 million ofunrealized losses at September 30, 2008. This is compared to a net unrealized gain for the fixed income portfoliototaling $342.2 million at December 31, 2007, comprised of $437.5 millionof unrealized gains and $95.3 million of unrealized losses.

Of the gross unrealized losses in the fixed income portfolio at September 30,2008, $346.8 million or 93.2% were related to investment grade securities andare primarily related to widening credit spreads.  Most of the remaining $25.4 million of losseswere in the corporate fixed income portfolio and primarily comprised securitiesin the capital goods, consumer goods, financial services, utilities andcommunications sectors.  The grossunrealized losses in these sectors were primarily related to changes ininterest rates and credit spreads, and company specific conditions.

 

36

----

 

Included in gross unrealized losses at September 30, 2008 were$166.4 million of fixed income securities with a fair value below 70% ofamortized cost, or 2.8% of our fixed income portfolio at September 30,2008.  The percentage of fair value toamortized cost for the remaining fixed income gross unrealized losses at September 30,2008 are shown in the following table.

 
| **($ in thousands)**                              | ** ** | **Unrealized  (loss) gain** | ** ** | **Fair value** | ** ** | **% to Total  fixed income  investments** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------|------------|----------------------------------------------------------|------------|
| > 80% of amortized cost                                  |       | $                                | (211,124   | )                   | $          | 2,905,799                                                |       | 50.1 | **%** |
| 70% to 80% of amortized cost                                |       | (64,599                          | )          | 207,715             |       | 3.6                                                      | ** ** |
| < 70% of amortized cost                                  |       | (96,461                          | )          | 166,378             |       | 2.8                                                      | ** ** |
| Gross unrealized losses on fixed income  securities         |       | (372,184                         | )          | 3,279,892           |       | 56.5                                                     | ** ** |
| Gross unrealized gains on fixed income  securities          |       | 329,258                          |       | 2,522,748           |       | 43.5                                                     | ** ** |
| Net unrealized gains and losses on fixed  income securities |       | $                                | (42,926    | )                   | $          | 5,802,640                                                |       | 100.0 | % |

 

Included in the fixed income securities with a fairvalue less than 70% of amortized cost totaling $166.4 million were unrealizedlosses comprised of other CDO of $3.6 million,ABS RMBS of $9.2 million, corporate bonds of$43.2 million, and CMBS of $40.5 million. We continue to believe that the unrealized losses on these securitiesare not necessarily 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.

We have a comprehensive portfolio monitoring process to identify andevaluate, on a case-by-case basis, fixed income securities whose carrying valuemay be other-than-temporarily impaired. The process includes a quarterly review of all securities using ascreening process to identify situations where the fair value compared toamortized cost is below established thresholds for certain time periods, orwhich are identified through other monitoring criteria such as ratings, ratingsdowngrades or payment defaults.  Thesecurities identified, in addition to other securities for which we may have aconcern, are evaluated based on facts and circumstances for inclusion on ourwatch-list.  All investments in anunrealized loss position at September 30, 2008 were included in ourportfolio monitoring process 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 negative developments that would change theview of long term investors and their intent to continue to hold theinvestment, subsequent credit deterioration of an issuer or holding, subsequentfurther deterioration of capital markets (i.e. debt) and of economicconditions, subsequent further deterioration in the financial services and realestate industries, changes in duration, revisions to strategic asset allocations,liquidity needs, unanticipated federal income tax situations involving capitalgain and capital loss carrybacks and carryforwards with specific expirationdates, investment risk mitigation actions, and other new facts andcircumstances that would cause a change in our previous intent to hold asecurity to recovery or maturity.

 

37

----

 

The following table summarizes fixed income securities in a grossunrealized loss position according to significance, aging and investment gradeclassification.

 
| ** **                                                                                                                                                  | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **($ in thousands, except number  of issues)**                                                                                     | ** ** | **investment  grade**            | ** ** | **Below  investment  grade**    | ** ** | **Total** | ** ** | **Investment  grade** | ** ** | **Below  investment  grade** | ** ** | **Total** | ** ** |
| Category (I): Unrealized loss less than 20%  of cost (1)                                                                                                    |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| Number of issues                                                                                                                                            |       | 530                              |       | 52                              |       | 582 |   | 381 |   | 60 |   | 441 |   |
| Fair value                                                                                                                                                  |       | $                                | 2,805,525  |                            | $          | 93,125 |   | $ | 2,898,650 |   | $ | 2,014,259 |   | $ | 103,660 |   | $ | 2,117,919 |   |
| Unrealized                                                                                                                                                  |       | $                                | (201,147   | )                               | $          | (8,189 | ) | $ | (209,336 | ) | $ | (74,751 | ) | $ | (8,180 | ) | $ | (82,931 | ) |
|                                                                                                                                                        |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| 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                                                                                                                                            |       | 67                               |       | 11                              |       | 78 |   | 9 |   | 5 |   | 14 |   |
| Fair value                                                                                                                                                  |       | $                                | 310,549    |                            | $          | 30,875 |   | $ | 341,424 |   | $ | 22,380 |   | $ | 4,830 |   | $ | 27,210 |   |
| Unrealized                                                                                                                                                  |       | $                                | (123,193   | )                               | $          | (14,033 | ) | $ | (137,226 | ) | $ | (9,208 | ) | $ | (3,208 | ) | $ | (12,416 | ) |
|                                                                                                                                                        |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| 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                                                                                                                                            |       | 12                               |       | 5                               |       | 17 |   | — |   | — |   | — |   |
| Fair value                                                                                                                                                  |       | $                                | 37,558     |                            | $          | 2,260 |   | $ | 39,818 |   | $ | — |   | $ | — |   | $ | — |   |
| Unrealized                                                                                                                                                  |       | $                                | (22,415    | )                               | $          | (3,207 | ) | $ | (25,622 | ) | $ | — |   | $ | — |   | $ | — |   |
|                                                                                                                                                        |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| Total Number of issues                                                                                                                                      |       | 609                              |       | 68                              |       | 677 |   | 390 |   | 65 |   | 455 |   |
| Total Fair value                                                                                                                                            |       | $                                | 3,153,632  |                            | $          | 126,260 |   | $ | 3,279,892 |   | $ | 2,036,639 |   | $ | 108,490 |   | $ | 2,145,129 |   |
| Total Unrealized losses                                                                                                                                     |       | $                                | (346,755   | )                               | $          | (25,429 | ) | $ | (372,184 | ) | $ | (83,959 | ) | $ | (11,388 | ) | $ | (95,347 | ) |

 

----

(1)          Cost represents amortized cost.

----

 

The largest individual unrealized loss was $4.7 million for category(I), $6.1 million for category (II) and $3.6 million for category (III) asof September 30, 2008.

Categories (I) and (II) have generally been adverselyaffected by overall economic conditions including interest rate increases andthe market’s evaluation of certain sectors. The degree to which and/or length of time that the securities have beenin an unrealized loss position does not suggest that these securities pose ahigh risk of being other-than-temporarily impaired.  Category (III) has primarily beenhistorically adversely affected by industry and issue specific, or issuerspecific conditions.  All of thesecurities in these categories are monitored for other-than-temporaryimpairment.

At September 30, 2008, Category (III) comprised primarily$6.4 million of other CDO, $2.5 million of ABS RMBS and $21.9 million of CMBSwith unrealized losses of $3.6 million, $3.7 million and $12.3 million,respectively, for a total of $19.6 million unrealized losses.  All of these unrealized losses includedsecurities with a fair value less than 70% of amortized cost.

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.

Whenever our initial analysis indicates that a fixedincome security’s unrealized loss of 20% or more for at least 36 months istemporary, additional evaluations and management approvals are required tosubstantiate that a write-down is not appropriate.  As of September 30, 2008, no securitiesmet these criteria.

 

38

----

 

We also monitor the quality of our fixed income portfolio by categorizingcertain investments as “problem”, “restructured” or “potential problem.”  Problem fixed income securities are indefault with respect to principal or interest and/or are investments issued bycompanies that have gone into bankruptcy subsequent to our acquisition.  Restructured fixed income investments haverates and terms that are not consistent with market rates or terms prevailingat the time of the restructuring.  Potentialproblem fixed income investments are current with respect to contractual principaland/or interest, but because of other facts and circumstances, we have concernsregarding the borrower’s ability to pay future principal and interest, whichcauses us to believe these investments may be classified as problem orrestructured in the future.

The following table summarizes problem, restructured and potentialproblem fixed income securities as of September 30, 2008.  We had no problem, restructured or potentialproblem fixed income securities as of December 31, 2007.

 
| **($ in thousands)**         | ** ** | **September 30, 2008** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **Par  value **(1)          | ** ** | **Amortized  cost **(1) | ** ** | **Fair  value** | ** ** | **Percent of  total fixed  income and  bank loan  portfolios** | ** ** |
| Problem                                |       | $                                | 14,679     |   | $ | 2,924 |   | $ | 2,923 |   | 0.1 | % |
| Restructured                           |       | —                           |       | — |   | — |   | — |   |
| Potential problem                      |       | 19,681                           |       | 8,767 |   | 8,471 |   | 0.1 |   |
| Total net carrying value               |       | $                                | 34,360     |   | $ | 11,691 |   | $ | 11,394 |   | 0.2 | % |
| Cumulative write- downs recognized (2) |       |                             |       | $ | 22,512 |   |   |   |   |   |

 

----

(1)          The difference betweenpar value and amortized cost of $22.7 million at September 30, 2008, isprimarily attributable to write-downs. Par value has been reduced by principal payments.

(2)          Cumulative write-downsrecognized only reflects write-downs related to investments within the problem,potential problem and restructured categories.

----

 

Forour problem category, par value totaled $14.7 million and amortized cost andfair value totaled $2.9 million, or 19.9% of par value at September 30,2008.  At September 30, 2008, theproblem category was comprised of CRE CDO. There were no problem investments with a fair value less than 70% ofamortized cost as of September 30, 2008.

Forour potential problem category, par value totaled $19.7 million and amortizedcost totaled $8.8 million, or 44.5% of par value at September 30,2008.  Fair value for this categorytotaled $8.5 million, or 43.0% of par value, at September 30, 2008.  At September 30, 2008, the potentialproblem category primarily included $3.7 million of market value CDO, $2.7million of financial sector related holdings and $1.3 million of CRE CDO.  There were no potential problem investmentswith a fair value less than 70% of amortized cost as of September 30,2008.

We also evaluated each of these investments through our portfoliomonitoring process at September 30, 2008 and recorded write-downs whenappropriate.  We further concluded thatany remaining unrealized losses on these investments were temporary in natureand that we have the intent and ability to hold the securities untilrecovery.  While these balances mayincrease in the future, particularly if economic conditions are unfavorable,management expects that****the totalamount of investments in these categories will remain low relative to the totalfixed income securities portfolio.

 

**Recent developments**Between September 30, 2008 and October 31,2008, the S&P 500 index has declined 17%, the Muni Bond buyer index yieldshave increased 12 basis points (“bps”) and while risk free interest rates haveincreased as illustrated by the increase of 16 bps in U.S. Treasury 10 yearyields, credit spreads have widened, as illustrated by the 42 bps spreadincrease in the Barclays Capital Aggregate index resulting in an overallincrease of 40 bps in the Barclays Capial Aggregate Yield.  This has resulted in an increase in ourunrealized losses on our fixed income securities.  Our unrealized gains and losses can varysignificantly between periods.  The U.S.government is seeking to reverse these economic trends and we believe that theywill be successful.

 

39

----

 

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

 
| ** **                        | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**    | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Fixed income securities           |       | $                                                    | 91,662     |                                                | $          | 90,369 |   | $ | 273,686 |   | $ | 266,657 |   |
| Mortgage loans                    |       | 10,527                                               |       | 10,317                                              |       | 31,495 |   | 30,370 |   |
| Short-term and other              |       | 3,955                                                |       | 3,444                                               |       | 9,886 |   | 11,722 |   |
| Investment income, before expense |       | 106,144                                              |       | 104,130                                             |       | 315,067 |   | 308,749 |   |
| Investment expense                |       | (3,511                                               | )          | (7,136                                              | )          | (12,470 | ) | (20,848 | ) |
| Net investment income             |       | $                                                    | 102,633    |                                                | $          | 96,994 |   | $ | 302,597 |   | $ | 287,901 |   |

 

**Net Realized Capital Gains and Losses **The following tablespresent the components of realized capital gains and losses and the related taxeffect.

 
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **($ in thousands)**                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Sales                                         |       | $                                                    | 24,312     |                                                | $          | 3,530 |   | $ | 29,664 |   | $ | 9,690 |   |
| Impairment write-downs (1)                    |       | (9,992                                               | )          | —                                              |       | (17,598 | ) | — |   |
| Change in intent write-downs (2)              |       | (15,261                                              | )          | (220                                                | )          | (66,016 | ) | (5,833 | ) |
| Valuation of derivative instruments           |       | (285                                                 | )          | (3,524                                              | )          | (3,356 | ) | (5,497 | ) |
| Settlement of derivative instruments          |       | 3,756                                                |       | 895                                                 |       | 1,444 |   | (423 | ) |
| Realized capital gains and losses, pre-tax    |       | 2,530                                                |       | 681                                                 |       | (55,862 | ) | (2,063 | ) |
| Income tax (expense) benefit                  |       | (885                                                 | )          | (257                                                | )          | 19,552 |   | 768 |   |
| Realized capital gains and losses,  after-tax |       | $                                                    | 1,645      |                                                | $          | 424 |   | $ | (36,310 | ) | $ | (1,295 | ) |

 

----

(1)          Impairment write-downs reflect issue specificother-than-temporary declines in fair value, including instances where we couldnot reasonably assert that therecovery period would be temporary.

(2)          Change in intent write-downs reflect instances where we cannot assert a positiveintent to hold until recovery.

----

We may sell or change our assertion to hold asecurity until recovery for impaired fixed income securities that were in anunrealized loss position at the previous reporting date, or other investmentswhere the fair value has declined below the carrying value, in situations wheresignificant unanticipated new facts and circumstances emerge or existing factsand circumstances increase in significance and are anticipated to adverselyimpact a security’s future valuations more than previously expected; includingnegative developments that would change the view of long term investors andtheir intent to continue to hold the investment, subsequent creditdeterioration of an issuer or holding, subsequent further deterioration incapital markets (i.e. debt) and of economic conditions, subsequent furtherdeterioration in the financial services and real estate industries, liquidity needs,unanticipated federal income tax situations involving capital gains and capitalloss carrybacks and carryforwards with specific expiration dates, investmentrisk mitigation actions, and other new facts and circumstances that would causea change in our previous intent to hold a security to recovery or maturity.

Upon approval of programsinvolving the expected disposition of investments, portfolio managers identifya population of suitable investments, typically larger than needed toaccomplish the objective, from which specific securities are selected tosell.  Due to our change in intent tohold until recovery, we recognize impairments on investments within thepopulation that are in an unrealized loss position. Further unrealized losspositions that develop subsequent to the original write-down are recognized inthe reporting period in which they occur through the date the program isclosed. The program is closed when the objectives of the program areaccomplished or a decision is made not to fully complete it, at which time anevaluation is performed of any remaining securities and where appropriate theyare redesignated as intent to hold to recovery. Reasons resulting in a decisionnot to complete an approved program include matters such as the mitigation ofconcerns that led to the initial decision, changes in priorities or newcomplications that emerge from significant unanticipated developments, such assubsequent significant deterioration which we view to be temporary in nature,to the point at which securities could only be sold at prices below our view oftheir intrinsic values, or subsequent favorable developments that support areturn to the intent to hold to recovery. Subsequent other-than-temporaryimpairment evaluations utilize the amortized cost or cost basis that reflectthe write-downs.  Fixed income securitiessubject to change in intent write–downs, and including those redesignated asintent to hold, continue to earn investment income and any discount or premiumfrom the amortized cost basis that reflects the write-downs is recognized usingthe effective yield method over the expected life of the security.

 

40

----

 

$7.4million or 74.5% and $14.6 million or 82.8% of the write-downs for the threemonths and nine months ended September 30, 2008, respectively, related toimpaired securities that were performing in line with anticipated orcontractual cash flows, but which were written down primarily because offurther expected deterioration in the performance of the underlyingcollateral.  As of September 30,2008, for these securities, there have been no defaults or defaults that haveoccurred in classes lower in the capital structure as of September 30,2008.  $2.5 million and $3.0 million ofwrite-downs for the three months and nine months ended September 30, 2008,respectively, primarily related to securities experiencing a significantdeparture from anticipated residual cash flows, however, we believe they retaineconomic value.

 

Impairmentwrite-downs and cash received, inclusive of sales, on these investments were asfollows:

 
| **($ in thousands)**                                                                              | ** ** | **Three months ended  September 30, 2008** | ** ** | **Nine months ended  September 30, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **Performing in accordance with anticipated  or contractual cash flows** | ** ** | **Impairment  write-downs**                                    | ** ** | **Cash  received ****(3)**                               | ** ** | **Impairment  write-downs** | ** ** | **Cash  received** | ** ** |
| ** **                                                                                                  | ** ** | ** **                                                     | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ABS RMBS                                                                                                    |       | $                                                              | (305       | )                                                             | $          | 28 |   | $ | (938 | ) | $ | 143 |   |
| CMBS/CRE CDO                                                                                                |       | (1,223                                                         | )          | 147                                                           |       | (7,716 | ) | 566 |   |
| Corporate                                                                                                   |       |                                                           |       |                                                          |       |   |   |   |   |
| Financials                                                                                                  |       | (5,250                                                         | )          | 300                                                           |       | (5,250 | ) | 600 |   |
| Other                                                                                                       |       | (670                                                           | )          | 33                                                            |       | (670 | ) | 65 |   |
| **Subtotal****(1)**                                                                                         | ** ** | **(7,448**                                                     | **)**      | **508**                                                       | ** ** | **(14,574** | **)** | **1,374** | ** ** |
|                                                                                                        |       |                                                           |       |                                                          |       |   |   |   |   |
| **Departure from anticipated or contractual cash flows**                      | ** ** | ** **                                                     | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Future cash flows expected -                                                                                |       |                                                           |       |                                                          |       |   |   |   |   |
| Corporate                                                                                                   |       |                                                           |       |                                                          |       |   |   |   |   |
| Food manufacturer                                                                                           |       | —                                                         |       | —                                                        |       | (480 | ) | 37 |   |
| **Subtotal****(2)**                                                                                         | ** ** | **—**                                                     | ** ** | **—**                                                    | ** ** | **(480** | **)** | **37** | ** ** |
| Future cash flows very uncertain -                                                                          |       |                                                           |       |                                                          |       |   |   |   |   |
| Corporate                                                                                                   |       |                                                           |       |                                                          |       |   |   |   |   |
| Financials                                                                                                  |       | (2,544                                                         | )          | 86                                                            |       | (2,544 | ) | 258 |   |
| **Subtotal**                                                                                                | ** ** | **(2,544**                                                     | **)**      | **86**                                                        | ** ** | **(2,544** | **)** | **258** | ** ** |
| **Total fixed income securities**                                                                           | ** ** | **$**                                                          | **(9,992** | **)**                                                         | **$**      | **594** | ** ** | **$** | **(17,598** | **)** | **$** | **1,669** | ** ** |

 

----

(1)          Writtendown primarily because of expected deterioration in the performance of theunderlying collateral.  As of September 30,2008, for the securities with direct interest in the lender, there have been nodefaults.  For securities supported bycollateral, there have been no defaults or defaults have occurred in classeslower in the capital structure.

(2)          Whilethese fixed income security write-downs were valued at a significant discountto cost, we believe these securities retain economic value.

(3)          Cashreceived includes both income and principal collected during the period.

----

 

Notwithstanding our intent and ability to hold thesesecurities with impairment 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 September 30, 2008 comprised net realized losses on fixed incomesecurities of $15.2 million and mortgage loans of $66 thousand, compared torealized losses on fixed income securities of $94 thousand and mortgage loansof $126 thousand for the same period of the prior year.  Change in intent write-downs for the ninemonths ended September 30, 2008 comprised net realized losses on fixedincome securities of $64.2 million and mortgage loans of $1.8 million, comparedto net realized losses on fixed income of $3.6 million and mortgage loans of$2.2 million, for the same period of the prior year.

 

41

----

 

Change in intent write-downs for the three months ended September 30,2008 are presented in the table below.

 
| **($ in thousands)**                                                                                                                                                                                                                                                                                                            | ** **      | ** **             | ** ** | **Financial  Accounting  Standards Board  Statement No. 157,**      | ** ** | **Fair value of  outstanding  change in** | ** ** | **Net realized  capital loss**               | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **Criteria**                                                                                                                                                                                                                                                                                                                              | ** **      | **Security type** | ** ** | ***Fair Value  Measurements*****(“SFAS No. 157”)  Level** | ** ** | **intent assets  at  September 30,  2008**     | ** ** | **Three months  ended  September 30,  2008** | ** ** | **Nine months  ended  September 30,  2008** | ** ** |
|                                                                                                                                                                                                                                                                                                                                      |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
| *Risk mitigation*                                                                                                                                                                                                                                                                                                                         |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
|                                                                                                                                                                                                                                                                                                                                      |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
| Targeted reductions in commercial real  estate exposure where it is anticipated that future downside risk remains.  Considerations included position held in the capital structure, vintage year,  illiquidity and deteriorating fundamentals.                                                                                            |            | CRE CDO                |       | 3                                                                                  |       | $                                                        | 5,329      |                                                   | $          | (326 | ) | $ | (5,846 | ) |
|                                                                                                                                                                                                                                                                                                                                      | CMBS            |                   | 2          |                                                                               | 21,553     |                                                     | (6,272     | )                                                      | (23,981    | ) |
|                                                                                                                                                                                                                                                                                                                                      |            |                   | 3          |                                                                               | —     |                                                     | —     |                                                   | (3,819     | ) |
|                                                                                                                                                                                                                                                                                                                                      | Mortgage  loans |                   | 3          |                                                                               | 9,474      |                                                     | (59        | )                                                      | (1,803     | ) |
|                                                                                                                                                                                                                                                                                                                                      |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
| Targeted reductions in residential real  estate where management believes there is a risk of future material declines  in price in the event of continued deterioration in the economy.  Considerations included position held in the capital structure, projected  performance of the collateral, and expected internal rates of return. |            | ABS RMBS               |       | 3                                                                                  |       | 13,984                                                   |       | (952                                                   | )          | (5,100 | ) |
|                                                                                                                                                                                                                                                                                                                                      |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
| Targeted reductions in financial sector  exposure included securities issued by certain regional banks and certain  large financial institutions.                                                                                                                                                                                         |            | Financial  sector      |       | 2                                                                                  |       | 41,901                                                   |       | (3,187                                                 | )          | (15,115 | ) |
|                                                                                                                                                                                                                                                                                                                                      |            |                   | 3          |                                                                               | 9,860      |                                                     | (1,210)    |                                                   | (2,117     | ) |
|                                                                                                                                                                                                                                                                                                                                      |            |                   |       |                                                                               |       |                                                     |       |                                                   |       |   |   |
|                                                                                                                                                                                                                                                                                                                                      |            | Other                  |       | 2                                                                                  |       | 926                                                      |       | (19                                                    | )          | (1,258 | ) |
| Total risk mitigation (1)                                                                                                                                                                                                                                                                                                                 |            |                   |       |                                                                               |       | 103,027                                                  |       | (12,025                                                | )          | (59,039 | ) |
| Individual identification (2)                                                                                                                                                                                                                                                                                                             |            |                   |       |                                                                               |       | 25,227                                                   |       | (3,228                                                 | )          | (5,768 | ) |
| Other                                                                                                                                                                                                                                                                                                                                     |            |                   |       |                                                                               |       | 2,010                                                    |       | (8                                                     | )          | (1,209 | ) |
| Total change in intent                                                                                                                                                                                                                                                                                                                    |            |                   |       |                                                                               |       | $                                                        | 130,264    |                                                   | $          | (15,261 | ) | $ | (66,016 | ) |

 

----

(1)          After changing our intent at June 30,2008 for our risk mitigation and return optimization programs, the mortgage andasset backed markets experienced significant deterioration, to the pointat which securities were trading at prices below our view of their intrinsicvalues.  As a result only approximatelyone half of the securities were sold during the third quarter of 2008.

(2)          During the third quarter of 2008, additionalsecurities with a fair value of $18.7 million had change in intent write-downsof $2.8 million related to individual identification.

----

 

42

----

 

The following table summarizes the third quarteractivity related to securities written down due to a change in intent.

 
| **($ in thousands)**                       | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| Carrying value as of June 30, 2008              |       | $          | 268,805    |   |
| Sales:                                               |       |       |       |
| Risk mitigation and return optimization  program (1) |       | (104,927   | )          |
| Individual identification and other  programs        |       | (22,379    | )          |
| Net realized capital gains and losses on  sales:     |       |       |       |
| Risk mitigation and return optimization  program (1) |       | 853        |       |
| Individual identification and other  programs        |       | (353       | )          |
| Additional change in intent designations             |       | 18,749     |       |
| Write-downs (2)                                      |       | (24,582    | )          |
| Other                                                |       | (5,902     | )          |
| Carrying value as of September 30,  2008        |       | $          | 130,264    |   |

 

----

(1)          Net proceeds from the sales of second quarterrisk mitigation and return optimization actions totaled $104.9 million with again of $853 thousand or 100.8% of fair values reported at June 30, 2008.

(2)          Includes securities with a fair value of $15.3million with change in intent write-downs and $9.3 million with impairmentwrite downs.

----

 

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.

 

43

----

 

**APPLICATIONOF CRITICAL ACCOUNTING ESTIMATES**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America (“GAAP”) requires management to adopt accounting policies and makeestimates and assumptions that affect amounts reported in the financialstatements.

 

In applying policies, management makes subjective and complex judgmentsthat frequently require estimates about matters that are inherently uncertain.Many of these policies, estimates and related judgments are common in theinsurance and financial services industries; others are specific to ourbusinesses and operations.  It isreasonably likely that changes in these estimates could occur from period toperiod and result in a material impact on our financial statements.

 

Our critical accounting estimate for the fair value of financial assetsand financial liabilities follows.  For adescription of critical accounting estimates not discussed below, see the Applicationof Critical Accounting Estimates section of the MD&A found under Part II.Item 7. of the Allstate Life Insurance Company of New York Annual Report on Form 10-Kfor 2007.

 

**Fair Value of Financial Assets and FinancialLiabilities**SFASNo. 157 is effective for fiscal years beginning after November 15,2007. We adopted the provisions of SFAS No. 157 as of January 1, 2008for financial assets and financial liabilities that are measured at fair 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.

 

We categorize our financial assets and financial liabilities measuredat fair value based on the priority of the inputs to the valuation technique,into a three-level fair value hierarchy. The fair value hierarchy gives thehighest priority to quoted prices in active markets for identical assets orliabilities which we can access (Level 1); the second highest priority forsimilar assets or liabilities in active markets, quoted prices for identical orsimilar assets or liabilities in non-active markets, or valuation models whoseinputs are observable (Level 2); and the lowest priority to unobservable inputs(Level 3).  To distinguish among thecategories we consider the frequency of completed transactions.  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 thefair value measurement of the entire instrument.  Certain financial assets are not carried atfair value on a recurring basis, including investments such as mortgage loansand policy loans. Accordingly, such investments are only included in the fairvalue hierarchy disclosure when the investment is subject to remeasurement atfair value after initial recognition and the resulting measurement is reflectedin the condensed financial statements.

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.  Inthe absence of sufficient observable inputs, unobservable inputs reflect ourestimates of the assumptions market participants would use in valuing financialassets and financial liabilities and are developed based on the bestinformation available in the circumstances. The degree of management judgment involved in determining fair values isinversely related to the availability of market observable information.

 

44

----

 

Financialassets and financial liabilities recorded on the Condensed Statements ofFinancial Position at fair value as of September 30, 2008 are categorizedbased on the reliability 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 we can access.

 

*Level 2:*****Financial assets andfinancial liabilities whose values are based on the following:

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

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

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

 

*Level 3:****    ***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 value measurement.These inputs may reflect our estimates of the assumptions that marketparticipants would use in valuing the financial assets and financialliabilities.

 

We utilize a combination of thirdparty valuation service providers, brokers, and internal valuation models todetermine fair value.  We gain assurance on theoverall reasonableness and consistent application of valuation inputassumptions, valuation methodologies, and compliance with accounting standardsfor fair value determination through the execution of various processes andcontrols designed to ensure that our financial assets and financial liabilitiesare appropriately valued. We monitor fair values received from third partiesand those derived internally on an ongoing basis.

 

We are responsible for the determination of the value of the financialassets and financial liabilities carried at fair value and the supportingassumptions and methodologies.  Incertain situations, we employ independent third-party valuation serviceproviders to gather, analyze, and interpret market information and derive fairvalues based upon relevant assumptions and methodologies for individualinstruments.  In situations where ourvaluation service providers are unable to obtain sufficient market observableinformation upon which to estimate the fair value for a particular security,fair value is determined either by requesting brokers who are knowledgeableabout these securities to provide a single quote or by employing internalvaluation models that are widely accepted in the financial servicesindustry.  Changing market conditions areincorporated into valuation assumptions and reflected in the fair values, whichare validated by calibration and other analytical techniques to availablemarket observable data.

Valuation service providers typically obtain data about markettransactions and other key valuation model inputs from multiple sources and,through the use of proprietary algorithms, produce valuation information in theform of a single fair value for individual securities for which a fair valuehas been requested under the terms of our agreements.  For certain types of securities, fair valuesare derived 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, liquidity spread, currency rates, and othermarket-observable information, as applicable. Credit and liquidity spreads are typically implied from completedtransactions and transactions of comparable securities.  Valuation service providers also use proprietarydiscounted cash flow models that are widely accepted in the financial servicesindustry and similar to those used by other market participants to value thesame financial instruments.  Thevaluation models take into account, among other things, market observableinformation as of the measurement date, as described above, as well as thespecific attributes of the security being valued including its term, interestrate, credit rating, industry sector, and where applicable, collateral qualityand other issue or issuer specific information. Executing valuation models effectively requires seasoned professionaljudgment and experience.  In cases wheremarket transactions or other market observable data is limited, the extent towhich judgment is applied varies inversely with the availability of marketobservable information.

Forcertain of our financial assets carried at fair value, where our valuationservice providers cannot provide fair value determinations, we obtainnon-binding price quotes from brokers familiar with the security who, similarto our valuation service providers, may consider transactions or activity insimilar securities, as applicable, among other information.  The brokers providing price quotes aregenerally from the brokerage divisions of leading financial institutions withmarket making, underwriting and distribution expertise.

 

45

----

 

 Thefair value of financial assets and financial liabilities, includingprivately-placed securities, certain free-standing derivatives and certainderivatives 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 internal pricing methods are primarily based on models usingdiscounted cash flow methodologies that determine a single best estimate offair value for individual financial instruments.  In addition, our models use internallyassigned credit ratings as inputs (which are generally consistent with anyexternal ratings and those we use to report our holdings by credit rating) andstochastically determined cash flows for certain derivatives embedded incertain contractholder liabilities, both of which are difficult toindependently observe and verify. Instrument specific inputs used in our internal fair valuedeterminations include: coupon rate, weighted average life, sector of theissuer, call provisions, and the contractual elements of derivatives embeddedin certain contractholder liabilities. Market related inputs used in these fair values, which we believe arerepresentative of inputs other market participants would use to determine fairvalue of the same instruments include: interest rate yield curves, quotedmarket prices of comparable securities, credit spreads, estimated liquiditypremiums, and other applicable market data including lapse and anticipatedmarket return estimates for derivatives embedded in certain contractholderliabilities.  Credit spreads aredetermined using those published by a commonly used industry specialist forcomparable public securities.  Aliquidity premium is also added to reflect spreads commonly required for thetypes of securities being valued and are calibrated based on actual trades orother market data.  As a result of thesignificance of non-market observable inputs, including internally assignedcredit ratings and stochastic cash flow estimates as described above, judgmentis required in developing these fair values. The fair value of these financialassets and financial liabilities may differ from the amount actually receivedto sell an asset or the amount paid to transfer a liability in an orderlytransaction between market participants at the measurement date.  Moreover, the use of different valuationassumptions may have a material effect on the financial assets’ and financialliabilities’ fair values.

Fairvalue of our investments comprise an aggregation of numerous, single bestestimates for each security in the Condensed Statements of FinancialPosition.  Because of this detailed approach,there is no single set of assumptions that determine our fair valueestimates.  Moreover, management does notcompile a range of estimates for items reported at fair value because we do notbelieve that a range would provide meaningful information.  Level 1 and Level 2 measurements representvaluations where all significant inputs are market observable. Level 3measurements have one or more significant inputs that are not market observableand as a result these fair value determinations have greater potentialvariability as it relates to their significant inputs.  The Level 3 principal components areprivately placed securities valued using internal models, broker quotedsecurities, ABS RMBS, Alt-A, ARS backed by student loans, and other CDO. In general,the greater the reliance on significant inputs that are not market observable,the greater potential variability of the fair value determinations. Due to thereduced availability of actual market prices or relevant observable inputs as aresult of the decrease in liquidity that has been experienced in the market,all ABS RMBS and Alt-A are categorized as Level 3.  For broker quoted securities’ fair valuedeterminations, we believe the brokers providing the quotes may consider marketobservable transactions or activity in similar securities, as applicable, andother information as calibration points. Privately placed securities’ fair value determinations, which were basedon internal ratings that are not market observable, are calibrated to marketobservable information in the form of external NAIC ratings and credit spreads.

Webelieve our most significant exposure to changes in fair value is due to marketrisk.  Our exposure to changes in marketconditions is discussed fully in the Market Risk section of the MD&Aincluded in our 2007 Form 10-K.

We employ specific control processes to determine the reasonableness ofthe fair values of 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 investment transactions. We do notalter fair values provided by our valuation providers or brokers.

 

46

----

 

Thefollowing table identifies investments as of September 30, 2008 by sourceof value determination:

 
| ** **                                                                | ** ** | **Investments**     | ** ** |
|---------------------------------------------------------------------------|------------|---------------------|------------|
| **($ in thousands)**                                            | ** ** | **F****air  value** | ** ** | **Percent  to total** | ** ** |
| Fair value based on internal sources                                      |       | $                   | 1,354,413  |   | 19.5 | % |
| Fair value based on external sources (1)                                  |       | 4,846,523           |       | 69.7 |   |
| Total fixed income securities and certain  short-term securities          |       | 6,200,936           |       | 89.2 |   |
| Fair value of derivatives                                                 |       | 2,162               |       | — |   |
| Mortgage loans, policy loans, and  short-term investments, valued at cost |       | 751,047             |       | 10.8 |   |
| Total                                                                     |       | $                   | 6,954,145  |   | 100.0 | % |

 

----

(1)          Includes $118.6 million that are valued usingbroker quotes.

----

 

Formore detailed information on our accounting policy for the fair value offinancial assets and financial liabilities and information on the financialassets and financial liabilities included in the levels promulgated by SFAS No. 157,see Note 4 to the Condensed Financial Statements.

 

47

----

 

The following table provides additional detailsregarding Level 1, 2 and 3 financial assets and financial liabilities by theirclassification in the Condensed Statement of Financial Position at September 30,2008.

 
| ** **                                                 | ** ** | **Quoted prices  in active  markets for  identical  assets** | ** **  | **Significant  other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** | **Other  valuations  and** | ** **    | **Balance as of  September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------------|-------------|--------------------------------------------|------------|---------------------------------------|------------|----------------------------|---------------|-------------------------------------------------|------------|
| **($ in thousands)**                             | ** ** | **(Level 1)**                                                          | ** **  | **(Level 2)**                         | ** ** | **(Level 3)**                    | ** ** | **netting**                | ** **    | **2008**                                        | ** ** |
| **Financial assets**                                       |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Fixed income securities:                                   |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Corporate                                                  |       | $                                                                           | —      |                                       | $          | 1,634,980                             |       | $                          | 33,284        |                                            |       |   | $ | 1,668,264 |   |
| Corporate privately placed securities                      |       | —                                                                      |        | 301,189                                    |       | 1,099,121                             |       |                       |          | 1,400,310                                       |       |
| Municipal                                                  |       | —                                                                      |        | 346,478                                    |       | —                                |       |                       |          | 346,478                                         |       |
| Municipal-ARS                                              |       | —                                                                      |        | —                                     |       | 108,787                               |       |                       |          | 108,787                                         |       |
| U.S. government and agencies                               |       | 165,200                                                                     |        | 662,137                                    |       | —                                |       |                       |          | 827,337                                         |       |
| ABS RMBS                                                   |       | —                                                                      |        | —                                     |       | 52,877                                |       |                       |          | 52,877                                          |       |
| Alt-A                                                      |       | —                                                                      |        | —                                     |       | 24,106                                |       |                       |          | 24,106                                          |       |
| Other CDO                                                  |       | —                                                                      |        | —                                     |       | 22,659                                |       |                       |          | 22,659                                          |       |
| CRE CDO                                                    |       | —                                                                      |        | —                                     |       | 5,329                                 |       |                       |          | 5,329                                           |       |
| CMBS                                                       |       | —                                                                      |        | 630,622                                    |       | —                                |       |                       |          | 630,622                                         |       |
| Preferred stock                                            |       | —                                                                      |        | 8,505                                      |       | —                                |       |                       |          | 8,505                                           |       |
| MBS                                                        |       | —                                                                      |        | 355,410                                    |       | 10,303                                |       |                       |          | 365,713                                         |       |
| Foreign government                                         |       | —                                                                      |        | 341,653                                    |       | —                                |       |                       |          | 341,653                                         |       |
| Total fixed income securities                              |       | 165,200                                                                     |        | 4,280,974                                  |       | 1,356,466                             |       |                       |          | 5,802,640                                       |       |
|                                                       |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Short-term investments:                                    |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Commercial paper and other                                 |       | —                                                                      |        | 396,221                                    |       | —                                |       |                       |          | 396,221                                         |       |
| Money market funds                                         |       | 2,075                                                                       |        | —                                     |       | —                                |       |                       |          | 2,075                                           |       |
| Total short-term investments                               |       | 2,075                                                                       |        | 396,221                                    |       | —                                |       |                       |          | 398,296                                         |       |
|                                                       |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Other investments:                                         |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Free-standing derivatives                                  |       | —                                                                      |        | 226                                        |       | 1,936                                 |       |                       |          | 2,162                                           |       |
| Total other investments                                    |       | —                                                                      |        | 226                                        |       | 1,936                                 |       |                       |          | 2,162                                           |       |
| **Total recurring basis assets**                           | ** ** | **167,275**                                                                 | ** **  | **4,677,421**                              | ** ** | **1,358,402**                         | ** ** | ** **                 | ** **    | **6,203,098**                                   | ** ** |
| ** **                                                 | ** ** | ** **                                                                  | ** **  | ** **                                 | ** ** | ** **                            | ** ** | ** **                 | ** **    | ** **                                      | ** ** |
| Non-recurring basis                                        |       | —                                                                      |        | —                                     |       | 5,520                                 |       |                       |          | 5,520                                           |       |
| Valued at cost, amortized cost or using the  equity method |       | —                                                                      |        | —                                     |       | —                                |       | $                          | 745,527       |                                            | 745,527    |   |
| **Total investments**                                      | ** ** | **167,275**                                                                 | ** **  | **4,677,421**                              | ** ** | **1,363,922**                         | ** ** | **745,527**                | ** **    | **6,954,145**                                   | ** ** |
| Separate account assets                                    |       | 697,363                                                                     |        | —                                     |       | —                                |       | —                     |          | 697,363                                         |       |
| Other assets                                               |       | (1,356                                                                      | )           | —                                     |       | (472                                  | )          | —                     |          | (1,828                                          | )          |
|                                                       |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| **Total financial assets**                                 | ** ** | **$**                                                                       | **863,282** | ** **                                 | **$**      | **4,677,421**                         | ** ** | **$**                      | **1,363,450** | ** **                                      | **$**      | **745,527** | ** ** | **$** | **7,649,680** | ** ** |
| % of total financial assets                                |       | 11.3                                                                        | %           | 61.1                                       | %          | 17.8                                  | %          | 9.8                        | %             | 100.0                                           | %          |
|                                                       |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| **Financial liabilities**                                  |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Contractholder funds:                                      |       |                                                                        |        |                                       |       |                                  |       |                       |          |                                            |       |
| Derivatives embedded in annuity contracts                  |       | $                                                                           | —      |                                       | $          | —                                |       | $                          | (5,238        | )                                               |       |   | $ | (5,238 | ) |
| Other liabilities:                                         |       | —                                                                      |        | —                                     |       |                                  |       |                       |          |                                            |       |
| Free–standing derivatives                             |       |                                                                        |        |                                       |       | (3,883                                | )          |                       |          | (3,883                                          | )          |
| **Total financial liabilities**                            | ** ** | **$**                                                                       | **—**  | ** **                                 | **$**      | **—**                            | ** ** | **$**                      | **(9,121**    | **)**                                           | ** ** | ** ** | **$** | **(9,121** | **)** |
| % of Total financial liabilities                           |       | —                                                                      | %           | —                                     | %          | 100.0                                 | %          |                       |          | 100.0                                           | %          |

 

48

----

 

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

 
| ** **                                | ** ** | ** **                                           | ** **    | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                  | ** **  | ** **                                                          | ** ** | **Total  gains (losses)  included in  Net income for** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|---------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------|-------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in thousands)**            | ** ** | **Balance as of  June 30, 2008** | ** **    | **Net income ****(1)**                                                             | ** ** | **OCI on  Statement of  Financial  Position** | ** ** | **Purchases,  sales,issuances  and settlements,  net** | ** **  | **Net  transfers in  and/or (out)  of Level 3** | ** ** | **Balance as of  September 30,  2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                      |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Fixed income securities:                  |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Corporate                                 |       | $                                                    | 35,095        |                                                                                         | $          | 324                                                     |       | $                                                           | (1,985      | )                                                                   | $          | (16,133                                                                    | )          | $ | 15,983 |   | $ | 33,284 |   | $ | 4 |   |
| Corporate privately placed securities     |       | 1,198,528                                            |          | 410                                                                                          |       | (58,761                                                 | )          | (41,056                                                     | )           | —                                                              |       | 1,099,121                                                                  |       | (1,435 | ) |
| Municipal                                 |       | —                                               |          | —                                                                                       |       | (5,000                                                  | )          | 5,000                                                       |        | —                                                              |       | —                                                                     |       | — |   |
| Municipal-ARS                             |       | 119,225                                              |          | —                                                                                       |       | 4,612                                                   |       | (15,050                                                     | )           | —                                                              |       | 108,787                                                                    |       | — |   |
| ABS RMBS                                  |       | 59,454                                               |          | (2,911                                                                                       | )          | 1,130                                                   |       | (4,796                                                      | )           | —                                                              |       | 52,877                                                                     |       | (2,859 | ) |
| Alt–A                                |       | 25,474                                               |          | 5                                                                                            |       | (1,373                                                  | )          | —                                                      |        | —                                                              |       | 24,106                                                                     |       | 5 |   |
| Other CDO                                 |       | 25,020                                               |          | —                                                                                       |       | (2,361                                                  | )          | —                                                      |        | —                                                              |       | 22,659                                                                     |       | — |   |
| Other ABS                                 |       | —                                               |          | 2,032                                                                                        |       | (2,032                                                  | )          | —                                                      |        | —                                                              |       | —                                                                     |       | 2,032 |   |
| CRE CDO                                   |       | 26,428                                               |          | (1,997                                                                                       | )          | (9                                                      | )          | (19,093                                                     | )           | —                                                              |       | 5,329                                                                      |       | (1,561 | ) |
| CMBS                                      |       | 2,083                                                |          | 1,741                                                                                        |       | (12                                                     | )          | (3,812                                                      | )           | —                                                              |       | —                                                                     |       | 1 |   |
| MBS                                       |       | 11,508                                               |          | (11                                                                                          | )          | (822                                                    | )          | (372                                                        | )           | —                                                              |       | 10,303                                                                     |       | (11 | ) |
| Total fixed income securities             |       | 1,502,815                                            |          | (407                                                                                         | )          | (66,613                                                 | )          | (95,312                                                     | )           | 15,983                                                              |       | 1,356,466                                                                  |       | (3,824 | ) |
|                                      |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Other investments:                        |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Free-standing derivatives, net            |       | (2,749                                               | )             | (1,609                                                                                       | )          | —                                                  |       | 2,411                                                       |        | —                                                              |       | (1,947                                                                     | )(2)       | (460 | ) |
| Total other investments                   |       | (2,749                                               | )             | (1,609                                                                                       | )          | —                                                  |       | 2,411                                                       |        | —                                                              |       | (1,947                                                                     | )          | (460 | ) |
| **Total investments**                     | ** ** | **1,500,066**                                        | ** **    | **(2,016**                                                                                   | **)**      | **(66,613**                                             | **)**      | **(92,901**                                                 | **)**       | **15,983**                                                          | ** ** | **1,354,519**                                                              | **(3)**    | **(4,284** | **)** |
| ** **                                | ** ** | ** **                                           | ** **    | ** **                                                                                   | ** ** | ** **                                              | ** ** | ** **                                                  | ** **  | ** **                                                          | ** ** | ** **                                                                 | ** ** | ** ** | ** ** |
| Other assets                              |       | (2,067                                               | )             | 1,595                                                                                        |       | —                                                  |       | —                                                      |        | —                                                              |       | (472                                                                       | )          | 1,595 |   |
| **Total Level 3 financial assets**        | ** ** | **$**                                                | **1,497,999** | ** **                                                                                   | **$**      | **(421**                                                | **)**      | **$**                                                       | **(66,613** | **)**                                                               | **$**      | **(92,901**                                                                | **)**      | **$** | **15,983** | ** ** | **$** | **1,354,047** | ** ** | **$** | **(2,689** | **)** |
|                                      |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| **Financial liabilities**                 |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Contractholder funds:                     |       |                                                 |          |                                                                                         |       |                                                    |       |                                                        |        |                                                                |       |                                                                       |       |   |   |
| Derivatives embedded in annuity contracts |       | $                                                    | (1,896        | )                                                                                            | $          | (3,379                                                  | )          | $                                                           | —      |                                                                | $          | 37                                                                         |       | $ | — |   | $ | (5,238 | ) | $ | (3,379 | ) |
| **Total Level 3 financial liabilities**   | ** ** | **$**                                                | **(1,896**    | **)**                                                                                        | **$**      | **(3,379**                                              | **)**      | **$**                                                       | **—**  | ** **                                                          | **$**      | **37**                                                                     | ** ** | **$** | **—** | ** ** | **$** | **(5,238** | **)** | **$** | **(3,379** | **)** |

 

----

(1)          Theamounts above total $(3.8) million and are reported in the Condensed Statementsof Operations as follows: $(2.6) million in realized capital gains and losses, $2.2 million in net investmentincome, and $(3.4) million in contract benefits.

(2)          Comprises$1.9 million of financial assets and $(3.9) million of financial liabilities.

(3)          Comprises$1.36 billion of investments and $(3.9) million of free-standing derivativesincluded in financial liabilities.

(4)          Theamounts above represent gains and losses included in net income for the periodof time that the financial asset or financial liability was determined to be inLevel 3.  These gains and losses total $(6.1)million and are reported in the Condensed Statements of Operations as follows:$(4.9) million in realized capital gainsand losses, $2.2 million in net investment income, and $(3.4) million incontract benefits.

----

 

49

----

 

The following table provides a summary of changes infair value during the nine-month period ended September 30, 2008 of Level3 financial assets and financial liabilities held at fair value on a recurringbasis at September 30, 2008.

 
| ** **                                         | ** ** | ** **                                         | ** **    | **Total realized and unrealized  gains (losses) included in:** | ** ** | ** **                                              | ** ** | ** **                                                        | ** **   | ** **                                                          | ** ** | **Total  gains (losses)  included in  Net income for** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|---------------|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------------|--------------|---------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **($ in thousands)**                     | ** ** | **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  September 30,  2008**                      | ** ** | **instruments  still held at  September 30,  2008 ****(4)** | ** ** |
| **Financial assets**                               |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Fixed income securities:                           |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Corporate                                          |       | $                                                  | 38,270        |                                                                                         | $          | 7,116                                                   |       | $                                                                 | (12,134      | )                                                                   | $          | (16,247                                                                    | )          | $ | 16,279 |   | $ | 33,284 |   | $ | (2 | ) |
| Corporate privately placed securities              |       | 1,211,628                                          |          | 3,633                                                                                        |       | (88,529                                                 | )          | (33,061                                                           | )            | 5,450                                                               |       | 1,099,121                                                                  |       | 91 |   |
| Municipal                                          |       | —                                             |          | —                                                                                       |       | (5,000                                                  | )          | 1,600                                                             |         | 3,400                                                               |       | —                                                                     |       | — |   |
| Municipal-ARS                                      |       | 33,200                                             |          | —                                                                                       |       | 1,137                                                   |       | (20,050                                                           | )            | 94,500                                                              |       | 108,787                                                                    |       | — |   |
| ABS RMBS                                           |       | 76,110                                             |          | (7,691                                                                                       | )          | (2,808                                                  | )          | (12,734                                                           | )            | —                                                              |       | 52,877                                                                     |       | (5,467 | ) |
| Alt–A                                         |       | 28,836                                             |          | 15                                                                                           |       | (4,745                                                  | )          | —                                                            |         | —                                                              |       | 24,106                                                                     |       | 15 |   |
| Other CDO                                          |       | 30,768                                             |          | 269                                                                                          |       | (5,243                                                  | )          | (3,135                                                            | )            | —                                                              |       | 22,659                                                                     |       | — |   |
| Other ABS                                          |       | —                                             |          | 2,032                                                                                        |       | (2,032                                                  | )          | —                                                            |         | —                                                              |       | —                                                                     |       | — |   |
| ABS CDO                                            |       | —                                             |          | —                                                                                       |       | —                                                  |       | —                                                            |         | —                                                              |       | —                                                                     |       | — |   |
| CRE CDO                                            |       | 33,067                                             |          | (14,021                                                                                      | )          | 5,390                                                   |       | (19,107                                                           | )            | —                                                              |       | 5,329                                                                      |       | (9,525 | ) |
| CMBS                                               |       | 3,727                                              |          | (2,071                                                                                       | )          | 2,156                                                   |       | (3,812                                                            | )            | —                                                              |       | —                                                                     |       | — |   |
| MBS                                                |       | 14,292                                             |          | (82                                                                                          | )          | (996                                                    | )          | (2,911                                                            | )            | —                                                              |       | 10,303                                                                     |       | (82 | ) |
| Total fixed income securities                      |       | 1,469,898                                          |          | (10,800                                                                                      | )          | (112,804                                                | )          | (109,457                                                          | )            | 119,629                                                             |       | 1,356,466                                                                  |       | (14,970 | ) |
|                                               |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Other investments:                                 |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Free-standing derivatives, net                     |       | (980                                               | )             | (3,945                                                                                       | )          | —                                                  |       | 2,978                                                             |         | —                                                              |       | (1,947                                                                     | )(2)       | 1,142 |   |
| Total other investments                            |       | (980                                               | )             | (3,945                                                                                       | )          | —                                                  |       | 2,978                                                             |         | —                                                              |       | (1,947                                                                     | )          | 1,142 |   |
| **Total investments**                              | ** ** | **1,468,918**                                      | ** **    | **(14,745**                                                                                  | **)**      | **(112,804**                                            | **)**      | **(106,479**                                                      | **)**        | **119,629**                                                         | ** ** | **1,354,519**                                                              | **(3)**    | **(13,828** | **)** |
|                                               |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Other assets                                       |       | (1,733                                             | )             | 1,261                                                                                        |       | —                                                  |       | —                                                            |         | —                                                              |       | (472                                                                       | )          | 1,261 |   |
| **Total recurring Level 3 financial assets**       | ** ** | **$**                                              | **1,467,185** | ** **                                                                                   | **$**      | **(13,484**                                             | **)**      | **$**                                                             | **(112,804** | **)**                                                               | **$**      | **(106,479**                                                               | **)**      | **$** | **119,629** | ** ** | **$** | **1,354,047** | ** ** | **$** | **(12,567** | **)** |
|                                               |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| **Financial liabilities**                          |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Contractholder funds:                              |       |                                               |          |                                                                                         |       |                                                    |       |                                                              |         |                                                                |       |                                                                       |       |   |   |
| Derivatives embedded in annuity contracts          |       | $                                                  | 174           |                                                                                         | $          | (5,482                                                  | )          | $                                                                 | —       |                                                                | $          | 70                                                                         |       | $ | — |   | $ | (5,238 | ) | $ | (5,482 | ) |
| **Total recurring Level 3 financial  liabilities** | ** ** | **$**                                              | **174**       | ** **                                                                                   | **$**      | **(5,482**                                              | **)**      | **$**                                                             | **—**   | ** **                                                          | **$**      | **70**                                                                     | ** ** | **$** | **—** | ** ** | **$** | **(5,238** | **)** | **$** | **(5,482** | **)** |

 

----

(1)          Theamounts above total $(19.0) million and are reported in the CondensedStatements of Operations as follows: $(18.7) million in realized capital gains and losses, $5.2 million in net investmentincome, and $(5.5) million in contract benefits.

(2)          Comprises$1.9 million of financial assets and $(3.9) million of financial liabilities.

(3)          Comprises$1.36 billion of investments and $(3.9) million of free—standing derivativesincluded in financial liabilities.

(4)          Theamounts above represent gains and losses included in net income for the periodof time that the financial assets or financial liability was determined to bein Level 3. These gains and losses total $(18.0) million and are reported inthe Condensed Statements of Operations as follows: $(17.7) million in realized capital gains and losses, $5.2 millionin net investment income, and $(5.5) million in contract benefits.

----

 

Transfersinto and out of Level 3 during the nine months ended September 30, 2008are attributable to a change in the availability of market observableinformation for individual securities within the respective categories.  Due to a continued deterioration in liquidityfor the segment of the ARS market backed by student loans, certain marketobservable data utilized for valuation purposes became unavailable during thesecond quarter of 2008.  As of September 30,2008, $108.8 million or 100.0% of our total ARS holdings continued to be valuedusing a discounted cash flow model.  Certain inputs to the valuation modelthat are significant to the overall valuation and not market observableincluded: estimates of future coupon rates if auction failures continue,maturity assumptions, and illiquidity premium. As a result of the reliance on certain non-market observable inputs, theportion of the ARS portfolio backed by student loans have been transferred toLevel 3 for the quarters ended June 30, 2008 and September 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.

 

50

----

 

Thefollowing table presents fair value as a percent of amortized cost for Level 3investments at September 30, 2008.

 
| **($ in thousands)**          | ** ** | **Fair value** | ** ** | **Fair value as a  % of  Amortized cost** | ** ** |
|-----------------------------------------|------------|---------------------|------------|--------------------------------------------------------------------|------------|
|                                    |       |                |       |                                                               |       |
| Fixed income securities:                |       |                |       |                                                               |       |
| Corporate                               |       | $                   | 33,284     |                                                               | 90.1       | % |
| Corporate - privately placed securities |       | 1,099,121           |       | 95.9                                                               |       |
| Municipal - ARS                         |       | 108,787             |       | 96.6                                                               |       |
| ABS RMBS                                |       | 52,877              |       | 81.6                                                               |       |
| Alt-A                                   |       | 24,106              |       | 81.4                                                               |       |
| Other CDO                               |       | 22,659              |       | 78.3                                                               |       |
| CRE CDO                                 |       | 5,329               |       | 100.3                                                              |       |
| MBS                                     |       | 10,303              |       | 90.6                                                               |       |
| Total fixed income securities           |       | 1,356,466           |       | 94.5                                                               |       |
| Other investments:                      |       |                |       |                                                               |       |
| Free-standing derivatives               |       | 1,936               |       | N/A                                                                |       |
| Sub-total recurring Level 3 investments |       | 1,358,402           |       | 94.5                                                               |       |
| Non-recurring basis                     |       | 5,520               |       | 100.0                                                              |       |
| **Total Level 3 investments**           |       | $                   | 1,363,922  |                                                               | 94.5       |   |

 

Non-recurringinvestments include certain mortgage loans and other investments remeasured atfair value during the third quarter of 2008 due to our change in intentwrite-downs and credit impairments.

 

51

----

 

### **CAPITAL RESOURCES AND LIQUIDITY**

 

**Capital Resources**consist of shareholder’sequity, representing funds deployed or available to be deployed to supportbusiness operations.  The following tablesummarizes our capital resources.

 
| **($ in thousands)**                                | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                          |       |                         |       |                        |       |
| Common stock, additional capital paid-in  and retained income |       | $                            | 633,135    |                        | $          | 615,684 |   |
| Accumulated other comprehensive (loss)  income                |       | (39,705                      | )          | 65,188                      |       |
| Total shareholder’s equity                               |       | $                            | 593,430    |                        | $          | 680,872 |   |

 

*Shareholder’s equity* decreased in thefirst nine months of 2008, due primarily to unrealized net capital losses onfixed income securities partially offset by net income.

 

**FinancialRatings and Strength** Our ratings are influenced by many factorsincluding our operating and financial performance, asset quality, liquidity,asset/liability management, overall portfolio mix, financial leverage (i.e.,debt), exposure to risks, the current level of operating leverage, ALIC’s andAllstate Insurance Company’s (“AIC”) ratings and other factors.  In October 2008, A.M. Best affirmedALIC’s and our A+ financial strength rating. The outlook for this rating is stable. S&P affirmed ALIC’s and our rating of AA but revised its outlookfrom stable to negative.  Moody’sdowngraded ALIC’s and our insurance financial strength rating to Aa3 from Aa2with a negative outlook.

 

**LiquiditySources and Uses** As reflected in our Condensed Statements of CashFlows, higher operating cash flows in the first nine months of 2008, comparedto the first nine months of 2007, were primarily related to higher netinvestment income and the settlement of an inter-company obligation inthe prior year, partially offset by a decrease in premiums and higher incometax payments.

Cash flowsused in investing activities increased in the first nine months of 2008,compared to the first nine months of 2007, primarily due to the investment ofhigher contractholder fund deposits.

Cash flowsprovided by financing activities increased in the first nine months of 2008 comparedto the first nine months of 2007, primarily due to increased contractholderfund deposits.  For quantification of thechanges in contractholder funds, see the Operations section of the MD&A.

We have aninter-company loan agreement with The Allstate Corporation.  The amount of inter-company loans availableto us is at the discretion of The Allstate Corporation.  The maximum amount of loans The AllstateCorporation will have outstanding to all its eligible subsidiaries at any givenpoint in time is limited to $1.00 billion. We had no amounts outstanding under the inter-company loan agreement at September 30,2008 or December 31, 2007.  TheAllstate Corporation uses commercial paper borrowings and bank lines of creditto fund intercompany borrowings.

As of September 30,2008, we recorded a net deferred tax asset of $15.8 million, whichincluded $40.3 million relating to unrealized and realized net capital lossesthat have not yet been recognized for tax purposes.  Although realization is not assured, managementbelieves it is more likely than not that the deferred tax asset will berealized based on our assumption that the deductions ultimately recognized fortax purposes will be utilized.

 

52

----

 

### **Item 4.**           Controls andProcedures

 

*Evaluationof Disclosure Controls and Procedures. *Wemaintain disclosure controls and procedures as defined in Rule 13a-15(e) and15(d)-15(e) under the Securities Exchange Act of 1934.  Under the supervision and with the participationof our management, including our principal executive officer and principalfinancial officer, we conducted an evaluation of the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisreport.  Based upon this evaluation, theprincipal executive officer and the principal financial officer concluded thatour disclosure controls and procedures are effective in providing reasonableassurance that material information required to be disclosed in our reportsfiled with or submitted to the Securities and Exchange Commission under theSecurities Exchange Act is made known to management, including the principalexecutive officer and the principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

### ***Changes in Internal Control over Financial Reporting. ***During the fiscal quarter ended September 30,2008, there have been no changes in our internal control over financialreporting that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

53

----

 

### **PART II. OTHER INFORMATION**

 

### **Item 1.**           LegalProceedings

 

Information required for Part II, Item1, is incorporated by reference to the discussion under the heading “Regulation”and under the heading “Legal and regulatory proceedings and inquiries” in Note5 of the Company’s Condensed Financial Statements in Part I, Item 1, ofthis Form 10-Q.

 

**Item 1A. Risk Factors**

 

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

 

These forward-looking statements do not relatestrictly to historical or current facts and may be identified by their use of wordslike “plans,” “seeks,” “expects,” “will,” “should,” “anticipates,” “estimates,”“intends,” “believes,” “likely,” “targets” and other words with similarmeanings. These statements may address, among other things, our strategy forgrowth, product development, regulatory approvals, market position, expenses,financial results, litigation and reserves. We believe that these statements are based on reasonable estimates,assumptions and plans. However, if the estimates, assumptions or plansunderlying the forward-looking statements prove inaccurate or if other risks oruncertainties arise, actual results could differ materially from thosecommunicated in these forward-looking statements.  Risk factors which 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 of New York Annual Report on Form 10-Kfor 2007.

 

**The impactof our investment strategies may be adversely affected by developments in theinvestment markets**

 

Theimpact of our investment portfolio risk mitigation and return optimizationprograms may be adversely affected by unexpected developments in the investmentmarkets.

 

**Our capital position and ourliquidity levels may be adversely affected by developments in the investmentmarkets**

 

Ourcapital position and our liquidity levels may be adversely affected byunexpected developments in the investment markets, such as disruptions,uncertainty or volatility in the capital and credit markets, and result inrealized and unrealized capital losses that may significantly reduce ourfinancial position and may limit our access to capital required to operate ourbusiness.

 

**Reducing our concentration infixed annuities may adversely affect reported results**

 

Due to the current capital market conditions, we are evaluatingstrategies to reduce our concentration in fixed annuities. Lower new sales ofthese products, as well as our ongoing risk mitigation and return optimizationprograms, may lead to lower levels of income which could negatively impact DACamortization and insurance reserve deficiency testing.

 

**Therealization of deferred tax assets is subject to uncertainty**

 

The realization of our deferred tax assets is basedon our assumption that we will be able to fully utilize the deductions that areultimately recognized for tax purposes. However, actual results may differ from our assumptions if adequatelevels of taxable income are not attained.

 

**Item5.  Other Information**

 

On September 25, 2008, Deloitte & ToucheLLP (“Deloitte”) advised The Allstate Corporation (the “Corporation”) AuditCommittee (the “Allstate Audit Committee”) that it had become aware that aformer Deloitte advisory partner (the “Former Advisory Partner”) traded in theCorporation’s securities on two occasions in 2006.  Allstate Life Insurance Company of New York(“ALNY”) is a consolidated subsidiary of the Corporation, and Deloitte is ourregistered public accounting firm, and performs our audits, in addition tothose of the Corporation.  Deloitteconcluded that these securities transactions violated the SEC’s independencerules.  Deloitte had conducted aninternal review and concluded that the Former Advisory Partner’s actions didnot impair Deloitte’s impartiality or objectivity or that of the engagementteam that has conducted both the Corporation’s and our audits.  Deloitte’s audit engagement team consisted ofa lead client service partner, who had responsibility for all substantiveissues with respect to the planning, scope and conduct of the audit, an additionalaudit partner, a concurring review partner, a senior manager, additionalprofessional staff, as well as the Former Advisory Partner, who functionedprimarily in a client relationship and assessment role and had no substantiveor technical role in the audit.  The FormerAdvisory Partner attended many, but not all, of the Allstate Audit Committeemeetings.  He has not attended anymeetings of the Board of Directors or of the Audit Committee of ALNY.  His primary role at the Corporation level wasto function in a client service role, including conducting Deloitte’s annualclient service assessments, and he did not review any substantive audit matterswith the Allstate Audit Committee at any of these meetings.  Deloitte provided a draft letter on September25 to the Allstate Audit Committee concluding the actions of its FormerAdvisory Partner did not impair Deloitte’s past or continuing independence. 

 

        The Allstate AuditCommittee thereafter initiated its own review with the assistance of externalcounsel.  The Allstate Audit Committeeand its external counsel held meetings with Deloitte and had frequent contactswith Deloitte and its counsel.  TheAllstate Audit Committee held meetings concerning the progress of its review onSeptember 29, October 8, 17, and 30, 2008. The review included an examination of the Corporation’s relationship tothe Former Advisory Partner and his role on the engagement.  Over the course of the review, the AllstateAudit Committee’s counsel examined a substantial number of documents andcommunications from the Corporation’s files and Deloitte’s, including theFormer Advisory Partner’s annual goals and assessments, his communication withthe audit engagement team and with the Corporation’s management and AllstateAudit Committee members, his independence certifications, and email and otherdocuments relating to the audit engagement. The Allstate Audit Committee’s external counsel’s review establishedthat the Former Advisory Partner had functioned in a client service role andhad not been involved in the substantive audit or influenced any substantiveportion of any audit or review of the Corporation’s financial statements.  The Allstate Audit Committee membersconfirmed that this was their view of the role of the Former AdvisoryPartner.  The Allstate Audit Committeeand its external counsel also met with the Corporation’s financial managementteam as well as with senior management of Deloitte, including the current andformer lead client service partners.  TheAllstate Audit Committee’s review confirmed Deloitte’s findings that the FormerAdvisory Partner met with the Allstate Audit Committee as well as seniormanagement of the Corporation, for the purpose of enhancing Deloitte’s clientservice to the Corporation rather than participating in the audit orreview.  

 

The Allstate Audit Committee concurred withDeloitte’s conclusion, reconfirmed in its letter to the Allstate AuditCommittee issued October 31, 2008, that Deloitte’s impartiality or objectivityrelated to its audits of the Corporation had not been compromised andtherefore, notwithstanding the violation of the independence rules, Deloitte’sindependence was not impaired.  Inreaching this conclusion, the Allstate Audit Committee took into considerationthe following: (i) the Former Advisory Partner is no longer a partner orotherwise affiliated with Deloitte; (ii) it appears that the trades in theCorporation’s securities were isolated incidents; (iii) the Former AdvisoryPartner did not disclose his investments to Deloitte, in contravention ofDeloitte’s independence policies; (iv) the problem was corrected as promptly aspossible; (v) the Former Advisory Partner had no responsibility for, and wasnot involved in, the conduct of the audit of the Corporation; (vi) it appearsthat the Former Advisory Partner did not exercise any influence over theconduct of the audit or Deloitte’s conclusions with respect to the audit oraccounting consultations related to the audit; (vii) there is no indication ofindependence issues with respect to other members of the engagement team; and(viii) Deloitte has in place a quality control system that meets therequirements of the SEC and the Public Company Accounting Oversight Board, andprovides reasonable assurance that the accounting firm and its employees do notlack independence.  The Allstate AuditCommittee and Deloitte separately reported their conclusions to the SEC Staff.

 

On November 11, 2008, after the AllstateAudit Committee and Deloitte had reported their conclusions to the SEC Staff,the ALNY Audit Committee met.  Duringthat meeting, the ALNY Audit Committee reviewed the Allstate Audit Committee’sconclusion that Deloitte’s impartiality or objectivity related to its audits ofthe Corporation had not been compromised and that Deloitte’s independence wasnot impaired.  Following that review, theALNY Audit Committee concurred with Deloitte’s conclusion, reconfirmed in itsletter to the Allstate Audit Committee issued October 31, 2008, that Deloitte’simpartiality or objectivity related to its audits of the Corporation, includingALNY as a consolidated subsidiary, had not been compromised and therefore,notwithstanding the violation of the independence rules, Deloitte’sindependence was not impaired with regard to ALNY.

 

### **Item 6.**           Exhibits

###  

(a)          Exhibits

 

An Exhibit Index has been filed as partof this report on page E-1.

 

54

----

 

### **SIGNATURE**

###  

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

 
|                    | Allstate  Life Insurance Company of New York |
|-------------------------|----------------------------------------------|
|                    | (Registrant)                                 |
|                    |                                         |
| November 20,  2008 | By                                           | /s/ Samuel  H. Pilch |   |
|                    | Samuel H.  Pilch                             |
|                    | Controller                                   |
|                    | (chief  accounting officer and duly          |
|                    | authorized  officer of Registrant)           |

 

55

----

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                               |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                 |       | Sale Agreement between Allstate Life  Insurance Company and Allstate Life Insurance Company of New York effective  July 28, 2008 for those securities listed on attached Exhibit A. |
|                 |       |                                                                                                                                                                                          |
| 15                   |       | Acknowledgement of awareness from  Deloitte & Touche LLP dated November 20, 2008, concerning  unaudited interim financial information.                                          |
|                 |       |                                                                                                                                                                                          |
| 31.1                 |       | Rule 15d-14(a) Certification of  Principal Executive Officer                                                                                                                        |
|                 |       |                                                                                                                                                                                          |
| 31.2                 |       | Rule 15d-14(a) Certification of  Principal Financial Officer                                                                                                                        |
|                 |       |                                                                                                                                                                                          |
| 32                   |       | Section 1350 Certifications                                                                                                                                                              |

 

E-1

----