ALLSTATE CORP
Item 1. Business
The Allstate Corporation was incorporated under the laws of the State of Delaware on November 5, 1992 to serve as the holding company for Allstate Insurance Company. Its business is conducted principally through Allstate Insurance Company, Allstate Life Insurance Company and their affiliates (collectively, including The Allstate Corporation, "Allstate"). Allstate is primarily engaged in the personal property and casualty insurance business and the life insurance, retirement and investment products business. It conducts its business primarily in the United States.
The Allstate Corporation is the largest publicly held personal lines insurer in the United States. Widely known through the "You're In Good Hands With Allstate®" slogan, Allstate is reinventing protection and retirement to help individuals in approximately 16 million households protect what they have today and better prepare for tomorrow. Customers can access Allstate products and services such as auto insurance and homeowners insurance through nearly 12,000 exclusive Allstate agencies and financial representatives in the United States and Canada. Allstate is the 2nd largest personal property and casualty insurer in the United States on the basis of 2010 statutory direct premiums earned. In addition, according to A.M. Best, it is the nation's 16th largest issuer of life insurance business on the basis of 2010 ordinary life insurance in force and 21st largest on the basis of 2010 statutory admitted assets.
Allstate has four business segments:
•
Allstate Protection
•
Discontinued Lines and Coverages
•
Allstate Financial
•
Corporate and Other
To achieve its goals in 2012, Allstate is focused on the following priorities:
•maintain auto profitability; •raise returns in homeowners and annuity businesses; •grow insurance premiums; and • proactively manage investments and capital. In this annual report on Form 10-K, we occasionally refer to statutory financial information. All domestic United States insurance companies are required to prepare statutory-basis financial statements. As a result, industry data is available that enables comparisons between insurance companies, including competitors that are not subject to the requirement to prepare financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP"). We frequently use industry publications containing statutory financial information to assess our competitive position.
ALLSTATE PROTECTION SEGMENT
Products and Distribution
Our Allstate Protection segment accounted for 92% of Allstate's 2011 consolidated insurance premiums and contract charges. In this segment, we principally sell private passenger auto and homeowners insurance through agencies and directly through call centers and the internet. These products are marketed under the Allstate®, Encompass® and Esurance® brand names. The Allstate Protection segment also includes a separate organization called Emerging Businesses which comprises Business Insurance (commercial products for small business owners), Consumer Household (specialty products including motorcycle, boat, renters and condominium insurance policies), Allstate Dealer Services (insurance and non-insurance products sold primarily to auto dealers), Allstate Roadside Services (retail and wholesale roadside assistance products) and Ivantage (insurance agency). We also participate in the involuntary or shared private passenger auto insurance business in order to maintain our licenses to do business in many states. In some states, Allstate exclusive agencies offer non-proprietary property insurance products.
Allstate serves four different consumer segments with distinct interaction preferences (advice and assistance versus self-directed) and brand preferences (brand-neutral versus brand-sensitive). Allstate brand auto and homeowners insurance products are sold primarily through Allstate exclusive agencies and serve customers who prefer local personal advice and service and are brand-sensitive. In most states, customers can also purchase certain Allstate brand personal insurance products, and obtain service, directly through call centers and the internet. Beginning in 2012, Allstate Brand direct sales and service will focus on serving customers who prefer personal advice and assistance and work closer with Allstate exclusive agencies. Encompass brand auto and homeowners insurance products are sold through independent agencies and serve customers who prefer personal service and support primarily from an independent agent and are brand-neutral. Esurance brand auto insurance products are sold directly to consumers online, through call centers and through select agents, including Answer Financial, and serve the self-directed, brand-sensitive
customers. Answer Financial, an independent personal lines insurance agency, serves self-directed, brand-neutral consumers who want a choice between insurance carriers and offers comparison quotes for auto and homeowners insurance from approximately twenty insurance companies through its website and over the phone.
Allstate is transitioning to a new compensation structure for its Allstate exclusive agencies over the next two years. The plan will better align compensation with customer needs and reward higher performance. The cost neutral change will include a shift to a higher proportion of variable compensation and bonus. In 2012, base commission remains unchanged and the annual bonus will be based on portfolio growth and household bundling.
Total Allstate Protection premiums written were $25.98 billion in 2011. Our broad-based network of approximately 10,000 Allstate exclusive agencies in approximately 9,700 locations in the U.S. produced approximately 86% of the Allstate Protection segment's written premiums in 2011. 10% of Allstate Protection's written premiums in 2011 were generated by approximately 4,400 independent agencies. To support customer service, we are supporting Allstate exclusive agencies by providing products, tools, education, and resources to help them acquire more business and retain more customers. Our programs provide financing to agents to acquire books of business and award additional resources to better performing agencies, leading to fewer agencies of larger size. Approximately 300 of the decrease in the number of Allstate exclusive agencies from 11,500 in 2010 is due to consolidation of a small number of locations that, for specified reasons, were allowed to operate with two agent numbers. We are among the nine largest providers of personal property and casualty insurance products through independent agencies in the United States, based on statutory written premium information provided by A.M. Best for 2010. The remainder of Allstate Protection's written premiums in 2011 were primarily generated directly through call centers and the internet.
Additionally, Allstate distribution, through brokering arrangements, offers non-proprietary products to consumers when an Allstate product is not available. As of December 31, 2011, Allstate distribution has approximately $1.0 billion of non-proprietary personal insurance premiums under management, primarily related to property business in hurricane exposed areas, and approximately $130 million of non-proprietary commercial insurance premiums under management. Answer Financial had $400 million of non-proprietary premiums written in 2011.
Competition
The markets for personal private passenger auto and homeowners insurance are highly competitive. The following charts provide the market shares of our principal competitors in the U.S. by direct written premium for the year ended December 31, 2010 (the most recent date such competitive information is available) according to A.M. Best.
Private Passenger Auto Insurance
Homeowners Insurance
Insurer
Market Share
Insurer
Market Share
State Farm
18.1 % State Farm
20.9 %
Allstate
10.4 % Allstate
9.3 %
GEICO
8.6 % Farmers
6.3 %
Progressive
7.8 % Liberty Mutual
5.2 %
Farmers
6.1 % Travelers
4.7 %
Liberty Mutual
4.6 % USAA
4.3 %
USAA
4.4 % Nationwide
4.2 %
Nationwide
4.3 %
In the personal property and casualty insurance market, we compete principally on the basis of the recognition of our brands, the scope of our distribution system, price, the breadth of our product offerings, product features, customer service, claim handling, and use of technology. In addition, our proprietary database of underwriting and pricing experience enables Allstate to use pricing sophistication to more accurately price risks and to cross sell products within our customer base.
Pricing sophistication and related underwriting and marketing programs use a number of risk evaluation factors. For auto insurance, these factors can include but are not limited to vehicle make, model and year; driver age and marital status; territory; years licensed; loss history; years insured with prior carrier; prior liability limits; prior lapse in coverage; and insurance scoring based on credit report information. For property insurance, these factors can include but are not limited to amount of insurance purchased; geographic location of the property; loss history; age, condition and construction characteristics of the property; and insurance scoring based on credit report information.
Our primary focus in using pricing sophistication methods has been on acquiring and retaining profitable business. The aim has been to enhance Allstate's competitive position with respect to "target" market segments while
maintaining or improving profitability. "Target customers" generally refers to consumers who want to purchase multiple products from one insurance provider including auto, homeowners and financial products, who have better retention and potentially present more favorable prospects for profitability over the course of their relationships with us. We provide and continue to enhance a range of discounts to attract more target customers. For example, we discount auto insurance to attract and retain target customers. In many states, we discount homeowners insurance for customers who insure their automobiles with Allstate.
Allstate Your Choice Auto® insurance allows qualified customers to choose from a variety of optional auto insurance packages at various prices. We believe that Allstate Your Choice Auto differentiates Allstate from its competitors and allows for increased growth and increased retention. Allstate Your Choice Home® allows qualified customers to choose from options such as a claim-free bonus and greater ability to tailor their own home insurance protection coverage. Allstate Blue® is our non-standard auto insurance product which offers features such as a loyalty bonus and roadside assistance coverage. We have also introduced a claim satisfaction guarantee that promises a return of premium to any Allstate Brand standard auto insurance customer dissatisfied with their claims experience, which differentiates Allstate from the competition.
Geographic Markets
The principal geographic markets for our auto, homeowners, and other personal property and casualty products are in the United States. Through various subsidiaries, we are authorized to sell various types of personal property and casualty insurance products in all 50 states, the District of Columbia and Puerto Rico. We also sell personal property and casualty insurance products in Canada through a distribution system similar to that used in the United States.
The following table reflects, in percentages, the principal geographic distribution of premiums earned for the Allstate Protection segment for the year ended December 31, 2011, based on information contained in statements filed with state insurance departments. No other jurisdiction accounted for more than 5 percent of the premiums earned for the segment.
New York
10.6 %
California
10.0 %
Texas
9.3 %
Florida
8.4 %
Pennsylvania
5.4 %
We continue to take actions to support earning an acceptable return on the risks assumed in our property business and to reduce variability in our earnings. Accordingly, we expect to continue to adjust underwriting practices with respect to our property business in markets with significant catastrophe risk exposure. Our comprehensive strategic review of our homeowners insurance business is ongoing.
Additional Information
Information regarding the last three years' revenues and income from operations attributable to the Allstate Protection segment is contained in Note 19 of the consolidated financial statements. Note 19 also includes information regarding the last three years' identifiable assets attributable to our property-liability operations, which includes our Allstate Protection segment and our Discontinued Lines and Coverages segment. Note 19 is incorporated in this Part I, Item 1 by reference.
Information regarding the amount of premium earned for Allstate Protection segment products for the last three years is set forth in Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, in the table regarding premiums earned by brand. That table is incorporated in this Part I, Item 1 by reference.
ALLSTATE FINANCIAL SEGMENT
Products and Distribution
Our Allstate Financial segment provides life insurance, retirement and investment products, and voluntary accident and health insurance products. Our principal products are interest-sensitive, traditional and variable life insurance; fixed annuities including deferred and immediate; and voluntary accident and health insurance. Our institutional products, which we most recently offered in 2008, consist of funding agreements sold to unaffiliated trusts that use them to back medium-term notes issued to institutional and individual investors. Banking products and services were offered to customers through the Allstate Bank through September 2011. The table on page 4 lists our major distribution channels for this segment, with the associated products and targeted customers.
As the table indicates, we sell Allstate Financial products to individuals through multiple intermediary distribution channels, including Allstate exclusive agencies and exclusive financial specialists, independent agents, specialized structured settlement brokers and directly through call centers and the internet. We sell products through independent agents affiliated with approximately 125 master brokerage agencies. Independent workplace enrolling agents and Allstate exclusive agencies also sell our voluntary accident and health insurance products primarily to employees of unaffiliated businesses.
Allstate Financial Distribution Channels, Products and Target Customers
Distribution Channel
Proprietary Products
Target Customers
Allstate exclusive
agencies
(Allstate Exclusive
Agents and
Allstate Exclusive
Financial Specialists)
Term life insurance
Whole life insurance
Interest-sensitive life insurance
Variable life insurance
Deferred fixed annuities (including indexed and market value adjusted "MVA")
Immediate fixed annuities
Workplace life and voluntary accident and health insurance (4)
Middle market (1),
emerging affluent (2) and
mass affluent
consumers (3) with
retirement and family
financial protection needs
Independent agents
(through master
brokerage agencies)
Term life insurance
Interest-sensitive life insurance
Variable life insurance
Deferred fixed annuities (including indexed and MVA)
Immediate fixed annuities
Emerging affluent and
mass affluent consumers
with retirement and family
financial protection needs
Independent agents
(as workplace enrolling agents)
Workplace life and voluntary accident and health insurance (4)
Middle market consumers
with family financial
protection needs
employed by small,
medium, and large size
firms
Structured settlement
annuity brokers
Structured settlement annuities
Typically used to fund or
annuitize large claims or
litigation settlements
Broker-dealers
(Funding agreements)
Funding agreements backing medium-term notes
Institutional and individual
investors
Direct
(includes call centers
and the internet) (5)
Term life insurance
Whole life insurance
Middle market (1),
emerging affluent (2) and
mass affluent
consumers (3) with family
financial protection needs
(1)Consumers with $35,000-$75,000 in household income. (2)Consumers with $75,000-$150,000 in household income. (3)Consumers with greater than $150,000 in household income. (4)Interest-sensitive and term life insurance; disability income insurance; cancer, accident, critical illness and heart/stroke insurance; hospital indemnity; limited benefit medical insurance; and dental insurance. (5)Internet sales are not available in all states.
Allstate exclusive agencies and exclusive financial specialists also sell the following non-proprietary products in addition to Allstate Financial products: mutual funds, fixed and variable annuities, disability insurance, and long-term care insurance. As of December 31, 2011, Allstate agencies have approximately $7.5 billion of non-proprietary mutual funds and fixed and variable annuity account balances under management.
In 2011, after receiving regulatory approval to voluntarily dissolve, Allstate Bank ceased operations. In the first half of 2012, we expect to cancel the bank's charter and deregister The Allstate Corporation as a savings and loan holding company.
Competition
We compete on a wide variety of factors, including the scope of our distribution systems, the type of our product offerings, the recognition of our brands, our financial strength and ratings, our differentiated product features and prices, and the level of customer service that we provide. With regard to funding agreements, we compete principally on the basis of our financial strength and ratings.
The market for life insurance, retirement and investment products continues to be highly fragmented and competitive. As of December 31, 2011, there were approximately 450 groups of life insurance companies in the United States, most of which offered one or more similar products. According to A.M. Best, as of December 31, 2010, the Allstate Financial segment is the nation's 16th largest issuer of life insurance and related business on the basis of 2010 ordinary life insurance in force and 21st largest on the basis of 2010 statutory admitted assets. In addition, because many of these products include a savings or investment component, our competition includes domestic and foreign securities firms, investment advisors, mutual funds, banks and other financial institutions. Competitive pressure continues to grow due to several factors, including cross marketing alliances between unaffiliated businesses, as well as consolidation activity in the financial services industry.
Geographic Markets
We sell life insurance, retirement and investment products, and voluntary accident and health insurance throughout the United States. Through subsidiaries, we are authorized to sell various types of these products in all 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands and Guam. We also sell funding agreements in the United States.
The following table reflects, in percentages, the principal geographic distribution of statutory premiums and annuity considerations for the Allstate Financial segment for the year ended December 31, 2011, based on information contained in statements filed with state insurance departments. No other jurisdiction accounted for more than 5 percent of the statutory premiums and annuity considerations.
California
11.3 %
Texas
8.4 %
Florida
8.1 %
Nebraska
7.8 %
Additional Information
Information regarding the last three years' revenues and income from operations attributable to the Allstate Financial segment is contained in Note 19 of the consolidated financial statements. Note 19 also includes information regarding the last three years' identifiable assets attributable to the Allstate Financial segment. Note 19 is incorporated in this Part I, Item 1 by reference.
Information regarding premiums and contract charges for Allstate Financial segment products for the last three years is set forth in Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, in the table that summarizes premiums and contract charges by product. That table is incorporated in this Part I, Item 1 by reference.
OTHER BUSINESS SEGMENTS
Our Corporate and Other segment is comprised of holding company activities and certain non-insurance operations. Note 19 of the consolidated financial statements contains information regarding the revenues, income from operations, and identifiable assets attributable to our Corporate and Other segment over the last three years.
Our Discontinued Lines and Coverages segment includes results from insurance coverage that we no longer write and results for certain commercial and other businesses in run-off. Our exposure to asbestos, environmental and other discontinued lines claims is presented in this segment. Note 19 of the consolidated financial statements contains information for the last three years regarding revenues, income from operations, and identifiable assets attributable to our property-liability operations, which includes both our Allstate Protection segment and our Discontinued Lines and Coverages segment. Note 19 is incorporated in this Part I, Item 1 by reference.
RESERVE FOR PROPERTY-LIABILITY CLAIMS AND CLAIMS EXPENSE
The following information regarding reserves applies to all of our property-liability operations, encompassing both the Allstate Protection segment and the Discontinued Lines and Coverages segment.
Reconciliation of Claims Reserves
The following tables are summary reconciliations of the beginning and ending property-liability insurance claims and claims expense reserves, displayed individually for each of the last three years. The first table presents reserves on a gross (before reinsurance) basis. The end of year gross reserve balances are reflected in the Consolidated Statements of Financial Position. The second table presents reserves on a net (after reinsurance) basis. The total net property-liability insurance claims and claims expense amounts are reflected in the Consolidated Statements of Operations.
Gross
($ in millions)
Year ended December 31,
Gross reserve for property-liability claims and claims expense, beginning of year
$ 19,468
$ 19,167
$ 19,456
Esurance acquisition on October 7, 2011
-
-
Total gross reserve adjusted
19,955
19,167
19,456
Incurred claims and claims expense
Provision attributable to the current year
20,914
19,327
19,111
Change in provision attributable to prior years
(105 )
Total claims and claims expense
21,088
19,222
19,161
Claim payments
Claims and claims expense attributable to current year
14,105
12,087
12,002
Claims and claims expense attributable to prior years
6,563
6,834
7,448
Total payments
20,668
18,921
19,450
Gross reserve for property-liability claims and claims expense, end of year as shown on the Loss Reserve Reestimates table
$
20,375
$
19,468
$
19,167
Net
Year ended December 31,
Net reserve for property-liability claims and claims expense, beginning of year
$ 17,396
$ 17,028
$ 17,182
Esurance acquisition on October 7, 2011
-
-
Total net reserve adjusted
17,821
17,028
17,182
Incurred claims and claims expense
Provision attributable to the current year
20,496
19,110
18,858
Change in provision attributable to prior years
(335 )
(159 )
(112 )
Total claims and claims expense
20,161
18,951
18,746
Claim payments
Claims and claims expense attributable to current year
13,893
12,012
11,905
Claims and claims expense attributable to prior years
6,302
6,571
6,995
Total payments
20,195
18,583
18,900
Net reserve for property-liability claims and claims expense, end of year as shown on the Loss Reserve Reestimates table (1)
$
17,787
$
17,396
$
17,028
(1)Reserves for claims and claims expense are net of reinsurance of $2.59 billion, $2.07 billion and $2.14 billion as of December 31, 2011, 2010 and 2009, respectively.
The year-end 2011 gross reserves of $20.38 billion for property-liability insurance claims and claims expense, as determined under GAAP, were $3.83 billion more than the net reserve balance of $16.55 billion recorded on the basis of statutory accounting practices for reports provided to state regulatory authorities. The principal differences are reinsurance recoverables from third parties totaling $2.59 billion that reduce reserves for statutory reporting but are recorded as assets for GAAP reporting, and a liability for the reserves of the Canadian subsidiaries for $1.00 billion. Remaining differences are due to variations in requirements between GAAP and statutory reporting.
As the tables above illustrate, Allstate's net reserve for property-liability insurance claims and claims expense at the end of 2010 decreased in 2011 by $335 million, compared to reestimates of the gross reserves of an increase of $174 million. Net reserve reestimates in 2011, 2010 and 2009 were more favorable than the gross reserve reestimates due to reinsurance cessions.
Loss Reserve Reestimates
The following Loss Reserve Reestimates table illustrates the change over time of the net reserves established for property-liability insurance claims and claims expense at the end of the last eleven calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of Allstate's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest reestimated reserve to the reserve originally established, and indicates whether the original reserve was adequate to cover the estimated costs of unsettled claims. The table also presents the gross reestimated liability as of the end of the latest reestimation period, with separate disclosure of the related reestimated reinsurance recoverable.
The Loss Reserve Reestimates table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. Unfavorable reserve reestimates are shown in this table in parentheses.
($ in millions)
Loss Reserve Reestimates
December 31,
& prior
Gross reserves for unpaid claims and claims Expense
$ 16,500
$ 16,690
$ 17,714
$ 19,338
$ 22,117
$ 18,866
$ 18,865
$ 19,456
$ 19,167
$ 19,468
20,375
Reinsurance recoverable
1,667
1,672
1,734
2,577
3,186
2,256
2,205
2,274
2,139
2,072
2,588
Reserve for unpaid claims and claims expense
14,833
15,018
15,980
16,761
18,931
16,610
16,660
17,182
17,028
17,396
17,787
Paid (cumulative) as of:
One year later
6,874
6,275
6,073
6,665
7,952
6,684
6,884
6,995
6,571
6,302
Two years later
9,931
9,241
9,098
9,587
11,293
9,957
9,852
10,069
9,491
Three years later
11,730
11,165
10,936
11,455
13,431
11,837
11,761
11,915
Four years later
12,949
12,304
12,088
12,678
14,608
12,990
12,902
Five years later
13,648
13,032
12,866
13,374
15,325
13,723
Six years later
14,135
13,583
13,326
13,866
15,839
Seven years later
14,558
13,928
13,703
14,303
Eight years later
14,829
14,243
14,082
Nine years later
15,099
14,588
Ten years later
15,406
Reserve reestimated as of:
End of year
14,833
15,018
15,980
16,761
18,931
16,610
16,660
17,182
17,028
17,396
17,787
One year later
15,518
15,419
15,750
16,293
17,960
16,438
16,830
17,070
16,869
17,061
Two years later
16,175
15,757
15,677
16,033
17,876
16,633
17,174
17,035
16,903
Three years later
16,696
15,949
15,721
16,213
18,162
17,135
17,185
17,217
Four years later
16,937
16,051
15,915
16,337
18,805
17,238
17,393
Five years later
17,041
16,234
16,027
16,895
19,014
17,447
Six years later
17,207
16,351
16,496
17,149
19,215
Seven years later
17,321
16,778
16,763
17,344
Eight years later
17,701
17,062
16,950
Nine years later
17,991
17,224
Ten years later
18,137
Initial reserve in excess of (less than) reestimated reserve:
Amount of reestimate
(3,304 )
(2,206 )
(970 )
(583 )
(284 )
(837 )
(733 )
(35 )
Percent
(22.3 )%
(14.7 )%
(6.1 )%
(3.5 )%
(1.5 )%
(5.0 )%
(4.4 )%
(0.2 )%
0.7 %
1.9 %
Gross reestimated liability-latest
21,763
20,838
20,386
21,030
23,384
20,547
20,361
20,163
19,565
19,642
Reestimated recoverable-latest
3,626
3,614
3,436
3,686
4,169
3,100
2,968
2,946
2,662
2,581
Net reestimated liability-latest
18,137
17,224
16,950
17,344
19,215
17,447
17,393
17,217
16,903
17,061
Gross cumulative reestimate (increase) decrease
$ (5,263 ) $ (4,148 ) $ (2,672 ) $ (1,692 ) $ (1,267 ) $ (1,681 ) $ (1,496 ) $ (707 ) $ (398 ) $ (174 )
($ in millions)
Amount of reestimates for each segment
December 31,
& prior
Net Discontinued Lines and Coverages reestimate
$ (1,877 ) $ (1,646 ) $ (1,072 ) $ (437 ) $ (270 ) $ (138 ) $ (91 ) $ (73 ) $ (49 ) $ (21 )
Net Allstate Protection reestimate
(1,427 )
(560 )
(146 )
(14 )
(699 )
(642 )
Amount of reestimate (net)
$ (3,304 ) $ (2,206 ) $ (970 ) $ (583 ) $ (284 ) $ (837 ) $ (733 ) $ (35 ) $
$
As shown in the above table, the subsequent cumulative increase in the net reserves established up to December 31, 2004, in general, reflect additions to reserves in the Discontinued Lines and Coverages Segment, primarily for asbestos and environmental liabilities, which offset the effects of favorable severity trends experienced by Allstate Protection, as discussed more fully below. The cumulative increases in reserves established as of December 31, 2006 and 2007 are due to the shift of reserves to older accident years attributable to a reallocation of reserves related to employee postretirement benefits to more accident years, litigation settlements, reclassification of injury and non-injury reserves to older years along with reserve strengthening as discussed below.
The following table is derived from the Loss Reserve Reestimates table and summarizes the effect of reserve reestimates, net of reinsurance, on calendar year operations for the ten-year period ended December 31, 2011. The total of each column details the amount of reserve reestimates made in the indicated calendar year and shows the accident years to which the reestimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve reestimates for the indicated accident year(s). Favorable reserve reestimates are shown in this table in parentheses. Since December 31, 2003, the changes in total have generally been favorable other than 2008 which was adversely impacted due to litigation filed in conjunction with a Louisiana deadline for filing suits related to Hurricane Katrina, as shown and discussed more fully below.
Effect of net reserve reestimates on calendar year operations
($ in millions)
Total
BY ACCIDENT YEAR
2001 & prior
$
$
$
$
$
$
$
$
$
$
$ 3,302
(256 )
(183 )
(49 )
(2 )
(6 )
(412 )
(568 )
(265 )
(58 )
(4 )
(17 )
(833 )
(395 )
(304 )
(14 )
(13 )
(616 )
(711 )
(264 )
(45 )
(768 )
(89 )
(91 )
(141 )
(106 )
(419 )
(25 )
(158 )
(92 )
(1 )
(276 )
(456 )
(46 )
(26 )
(528 )
(124 )
(148 )
(272 )
(369 )
(369 )
TOTAL
$
$
$ (230 ) $ (468 ) $ (971 ) $ (172 ) $
$ (112 ) $ (159 ) $ (335 ) $ (1,191 )
In 2011, favorable prior year reserve reestimates were primarily due to auto severity development that was less than anticipated in previous estimates and catastrophe losses. The increased reserves in accident years 2001 & prior is due to a reclassification of injury reserves to older years and reserve strengthening.
In 2010, favorable prior year reserve reestimates were primarily due to Allstate Protection catastrophe losses and auto severity development that was less than anticipated in previous estimates, partially offset by litigation settlements. The increased reserves in accident years 2000 & prior is due to the litigation settlements of $100 million, a reclassification of injury reserves to older years and reserve strengthening.
In 2009, favorable prior year reserve reestimates were primarily due to Allstate Protection catastrophe losses that were less than anticipated in previous estimates. The shift of reserves to older accident years is attributable to a reallocation of reserves related to employee postretirement benefits to more accident years, and a reclassification of injury and 2008 non-injury reserves to older years.
In 2008, unfavorable prior year reserve reestimates were primarily due to Allstate Protection catastrophe losses that were more than anticipated in previous estimates.
In 2007, favorable prior year reserve reestimates were primarily due to Allstate Protection auto severity development that was less than what was anticipated in previous estimates. Decreased reserve reestimates for Allstate
Protection more than offset increased reestimates of losses primarily related to environmental liabilities reported by the Discontinued Lines and Coverages segment.
In 2006, 2005 and 2004, favorable prior year reserve reestimates were primarily due to Allstate Protection auto injury severity and late reported loss development that was less than what was anticipated in previous reserve estimates and in 2006, also by catastrophe losses that were less than anticipated in previous estimates. Decreased reserve reestimates for Allstate Protection more than offset increased reestimates of losses primarily related to asbestos liabilities reported by the Discontinued Lines and Coverages segment.
In 2003, unfavorable prior year reserve reestimates were due to increases primarily related to asbestos and other discontinued lines, partially offset by favorable Allstate Protection auto injury severity and late reported loss development that was better than previous estimates.
In 2002, unfavorable prior year reserve reestimates were due to claim severity and late reported losses for Allstate Protection that were greater than what was anticipated in previous reserve estimates and to increased estimates of losses primarily related to asbestos and environmental liabilities in the Discontinued Lines and Coverages segment.
For additional information regarding reserves, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Property-Liability Claims and Claims Expense Reserves."
REGULATION
Allstate is subject to extensive regulation, primarily at the state level. The method, extent, and substance of such regulation varies by state but generally has its source in statutes that establish standards and requirements for conducting the business of insurance and that delegate regulatory authority to a state agency. In general, such regulation is intended for the protection of those who purchase or use insurance products. These rules have a substantial effect on our business and relate to a wide variety of matters, including insurer solvency, reserve adequacy, insurance company licensing and examination, agent and adjuster licensing, policy forms, price setting, the nature and amount of investments, claims practices, participation in shared markets and guaranty funds, transactions with affiliates, the payment of dividends, underwriting standards, statutory accounting methods, trade practices, and corporate governance. Some of these matters are discussed in more detail below. For a discussion of statutory financial information, see Note 16 of the consolidated financial statements. For a discussion of regulatory contingencies, see Note 14 of the consolidated financial statements. Notes 14 and 16 are incorporated in this Part I, Item 1 by reference.
In recent years, the state insurance regulatory framework has come under increased federal scrutiny. As part of an effort to strengthen the regulation of the financial services market, the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") was enacted in 2010. Hundreds of regulations must still be promulgated and implemented pursuant to this new law, and we cannot predict what the final regulations will require but do not expect a material impact on Allstate's operations. The new law also created the Federal Insurance Office ("FIO") within the Treasury Department. The FIO will monitor the insurance industry, provide advice to the new Financial Stability Oversight Council, represent the U.S. on international insurance matters and study the current regulatory system and submit a report to Congress in 2012. In addition, state legislators and insurance regulators continue to examine the appropriate nature and scope of state insurance regulation. We cannot predict whether any specific state or federal measures will be adopted to change the nature or scope of the regulation of insurance or what effect any such measures would have on Allstate. We are working for changes in the regulatory environment, including recognizing the need for better catastrophe preparedness, improving appropriate risk based pricing and promoting the creation of government sponsored, privately funded solutions for mega-catastrophes that will make insurance more available and affordable. We have also taken actions to reduce the catastrophe exposure in our property business and also consider their impact on our ability to market our auto lines.
Agent and Broker Compensation. In recent years, several states considered new legislation or regulations regarding the compensation of agents and brokers by insurance companies. The proposals ranged in nature from new disclosure requirements to new duties on insurance agents and brokers in dealing with customers. New disclosure requirements have been imposed in certain circumstances upon agents and brokers in New York.
Limitations on Dividends By Insurance Subsidiaries. As a holding company with no significant business operations of its own, The Allstate Corporation relies on dividends from Allstate Insurance Company as one of the principal sources of cash to pay dividends and to meet its obligations, including the payment of principal and interest on debt. Allstate Insurance Company is regulated as an insurance company in Illinois and its ability to pay dividends is restricted by Illinois law. For additional information regarding those restrictions, see Part II, Item 5 of this report. The laws of the other
jurisdictions that generally govern our other insurance subsidiaries contain similar limitations on the payment of dividends and in some jurisdictions the laws may be more restrictive.
Insurance Holding Company Regulation. The Allstate Corporation and Allstate Insurance Company are insurance holding companies subject to regulation in the jurisdictions in which their insurance subsidiaries do business. In the U.S., these subsidiaries are organized under the insurance codes of California, Florida, Illinois, Massachusetts, Nebraska, New York, Texas, and Wisconsin, and some of these subsidiaries are considered commercially domiciled in California, Florida, and Utah. Generally, the insurance codes in these states provide that the acquisition or change of "control" of a domestic or commercially domiciled insurer or of any person that controls such an insurer cannot be consummated without the prior approval of the relevant insurance regulator. In general, a presumption of "control" arises from the ownership, control, possession with the power to vote, or possession of proxies with respect to, ten percent or more of the voting securities of an insurer or of a person that controls an insurer. In addition, certain state insurance laws require pre-acquisition notification to state agencies of a change in control with respect to a non-domestic insurance company licensed to do business in that state. While such pre-acquisition notification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize certain remedies, including the issuance of a cease and desist order with respect to the non-domestic insurer if certain conditions exist, such as undue market concentration. Thus, any transaction involving the acquisition of ten percent or more of The Allstate Corporation's common stock would generally require prior approval by the state insurance departments in California, Illinois, Massachusetts, Nebraska, New York, Texas, Utah, and Wisconsin. The prior approval of the Florida insurance department would be necessary for the acquisition of five percent or more. Moreover, notification would be required in those other states that have adopted pre-acquisition notification provisions and where the insurance subsidiaries are admitted to transact business. Such approval requirements may deter, delay, or prevent certain transactions affecting the ownership of The Allstate Corporation's common stock.
Price Regulation. Nearly all states have insurance laws requiring personal property and casualty insurers to file price schedules, policy or coverage forms, and other information with the state's regulatory authority. In many cases, such price schedules, policy forms, or both must be approved prior to use. While they vary from state to state, the objectives of the pricing laws are generally the same: a price cannot be excessive, inadequate, or unfairly discriminatory.
The speed with which an insurer can change prices in response to competition or in response to increasing costs depends, in part, on whether the pricing laws are (i) prior approval, (ii) file-and-use, or (iii) use-and-file laws. In states having prior approval laws, the regulator must approve a price before the insurer may use it. In states having file-and-use laws, the insurer does not have to wait for the regulator's approval to use a price, but the price must be filed with the regulatory authority prior to being used. A use-and-file law requires an insurer to file prices within a certain period of time after the insurer begins using them. Eighteen states, including California and New York, have prior approval laws. Under all three types of pricing laws, the regulator has the authority to disapprove a price subsequent to its filing.
An insurer's ability to adjust its prices in response to competition or to changing costs is often dependent on an insurer's ability to demonstrate to the regulator that its pricing or proposed pricing meets the requirements of the pricing laws. In those states that significantly restrict an insurer's discretion in selecting the business that it wants to underwrite, an insurer can manage its risk of loss by charging a price that reflects the cost and expense of providing the insurance. In those states that significantly restrict an insurer's ability to charge a price that reflects the cost and expense of providing the insurance, the insurer can manage its risk of loss by being more selective in the type of business it underwrites. When a state significantly restricts both underwriting and pricing, it becomes more difficult for an insurer to maintain its profitability.
From time to time, the private passenger auto insurance industry comes under pressure from state regulators, legislators, and special interest groups to reduce, freeze, or set prices at levels that do not correspond with our analysis of underlying costs and expenses. Homeowners insurance can come under similar pressure, particularly in states subject to significant increases in loss costs from high levels of catastrophe losses. We expect this kind of pressure to persist. In addition, our use of insurance scoring based on credit report information for underwriting and pricing has been the subject of challenges and investigations by regulators, legislators, and special interest groups. The result could be legislation or regulation that adversely affects the profitability of the Allstate Protection segment. We cannot predict the impact on our business of possible future legislative and regulatory measures regarding pricing.
Involuntary Markets. As a condition of maintaining our licenses to write personal property and casualty insurance in various states, we are required to participate in assigned risk plans, reinsurance facilities, and joint underwriting associations that provide various types of insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Underwriting results related to these arrangements, which tend to be adverse, have been immaterial to our results of operations.
Guaranty Funds. Under state insurance guaranty fund laws, insurers doing business in a state can be assessed, up to prescribed limits, in order to cover certain obligations of insolvent insurance companies.
National Flood Insurance Program. We voluntarily participate as a Write Your Own carrier in the National Flood Insurance Program ("NFIP"). The NFIP is administered and regulated by the Federal Emergency Management Agency. We operate in a fiduciary capacity as a fiscal agent of the federal government in the issuing and administering of the Standard Flood Insurance Policy. This involves the collection of premiums belonging to the federal government and the paying of covered claims by directly drawing on funds of the United States Treasury. We receive expense allowances from the NFIP for underwriting administration, claims management, commissions and adjuster fees. The federal government is obligated to pay all claims that fall under the arrangement.
Investment Regulation. Our insurance subsidiaries are subject to regulations that require investment portfolio diversification and that limit the amount of investment in certain categories. Failure to comply with these rules leads to the treatment of non-conforming investments as non-admitted assets for purposes of measuring statutory surplus. Further, in some instances, these rules require divestiture of non-conforming investments.
Exiting Geographic Markets; Canceling and Non-Renewing Policies. Most states regulate an insurer's ability to exit a market. For example, states limit, to varying degrees, an insurer's ability to cancel and non-renew policies. Some states prohibit an insurer from withdrawing one or more types of insurance business from the state, except pursuant to a plan that is approved by the state insurance department. Regulations that limit cancellation and non-renewal and that subject withdrawal plans to prior approval requirements may restrict an insurer's ability to exit unprofitable markets.
Variable Life Insurance and Registered Fixed Annuities. The sale and administration of variable life insurance and registered fixed annuities with market value adjustment features are subject to extensive regulatory oversight at the federal and state level, including regulation and supervision by the Securities and Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA").
Broker-Dealers, Investment Advisors, and Investment Companies. The Allstate entities that operate as broker-dealers, registered investment advisors, and investment companies are subject to regulation and supervision by the SEC, FINRA and/or, in some cases, state securities administrators.
Banking. Allstate Bank ceased operations in 2011, and we expect to cancel its charter and deregister The Allstate Corporation as a savings and loan holding company in the first half of 2012. The principal supervisory authority for the diversified unitary savings and loan holding company activities of The Allstate Corporation is the Federal Reserve Board ("FRB"), and the principal supervisory authority for the Bank is the Office of the Comptroller of the Currency ("OCC"). The Allstate Corporation and the Bank, respectively, are subject to FRB and OCC regulation, examination, supervision and reporting requirements and enforcement authority. The Bank is also subject to the authority of the Federal Deposit Insurance Corporation.
Privacy Regulation. Federal law and the laws of many states require financial institutions to protect the security and confidentiality of customer information and to notify customers about their policies and practices relating to collection and disclosure of customer information and their policies relating to protecting the security and confidentiality of that information. Federal law and the laws of many states also regulate disclosures and disposal of customer information. Congress, state legislatures, and regulatory authorities are expected to consider additional regulation relating to privacy and other aspects of customer information.
Asbestos. Congress has considered legislation to address asbestos claims and litigation in the past, but unified support among various defendant and insurer groups considered essential to any possible reform has been lacking. We cannot predict the impact on our business of possible future legislative measures regarding asbestos.
Environmental. Environmental pollution and clean-up of polluted waste sites is the subject of both federal and state regulation. The Comprehensive Environmental Response Compensation and Liability Act of 1980 ("Superfund") and comparable state statutes ("mini-Superfund") govern the clean-up and restoration of waste sites by Potentially Responsible Parties ("PRPs"). Superfund and the mini-Superfunds (Environmental Clean-up Laws or "ECLs") establish a mechanism to assign liability to PRPs or to fund the clean-up of waste sites if PRPs fail to do so. The extent of liability to be allocated to a PRP is dependent on a variety of factors. By some estimates, there are thousands of potential waste sites subject to clean-up, but the exact number is unknown. The extent of clean-up necessary and the process of assigning liability remain in dispute. The insurance industry is involved in extensive litigation regarding coverage issues arising out of the clean-up of waste sites by insured PRPs and the insured parties' alleged liability to third parties responsible for the clean-up. The insurance industry, including Allstate, has disputed and is disputing many such claims. Key coverage issues include whether Superfund response, investigation, and clean-up costs are considered damages
under the policies; trigger of coverage; the applicability of several types of pollution exclusions; proper notice of claims; whether administrative liability triggers the duty to defend; appropriate allocation of liability among triggered insurers; and whether the liability in question falls within the definition of an "occurrence." Identical coverage issues exist for clean-up and waste sites not covered under Superfund. To date, courts have been inconsistent in their rulings on these issues. Allstate's exposure to liability with regard to its insureds that have been, or may be, named as PRPs is uncertain. While comprehensive Superfund reform proposals have been introduced in Congress, only modest reform measures have been enacted.
INTERNET WEBSITE
Our Internet website address is allstate.com. The Allstate Corporation's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports that we file or furnish pursuant to Section 13(a) of the Securities Exchange Act of 1934 are available through our Internet website, free of charge, as soon as reasonably practicable after they are electronically filed or furnished to the SEC. In addition, our corporate governance guidelines, our code of ethics, and the charters of our Audit Committee, Compensation and Succession Committee, Executive Committee, and Nominating and Governance Committee are available on our website and in print to any stockholder who requests copies by contacting Investor Relations, The Allstate Corporation, 2775 Sanders Road, Northbrook, Illinois 60062-6127, 1-800-416-8803.
OTHER INFORMATION ABOUT ALLSTATE
As of December 31, 2011, Allstate had approximately 37,000 full-time employees and 600 part-time employees.
Information regarding revenues generated outside of the United States is incorporated in this Part I, Item 1 by reference to Note 19 of the consolidated financial statements.
Allstate's four business segments use shared services, including human resources, investment, finance, information technology and legal services, provided by Allstate Insurance Company and other affiliates.
Although the insurance business generally is not seasonal, claims and claims expense for the Allstate Protection segment tend to be higher for periods of severe or inclement weather.
"Allstate" is one of the most recognized brand names in the United States. We use the names "Allstate," "Encompass," "Esurance" and "Lincoln Benefit Life®" extensively in our business, along with related service marks, logos, and slogans, such as "Good Hands®." Our rights in the United States to these names, service marks, logos, and slogans continue so long as we continue to use them in commerce. These service marks and many others used by Allstate are the subject of renewable U.S. and/or foreign service mark registrations. We believe that these service marks are important to our business and we intend to maintain our rights to them through continued use.
Executive Officers
The following table sets forth the names of our executive officers, their ages as of February 1, 2012, their positions, and the years of their first election as officers. "AIC" refers to Allstate Insurance Company.
Name
Age
Position/Offices
Year First
Elected
Officer
Thomas J. Wilson
Chairman of the Board, President, and Chief Executive Officer of The Allstate Corporation; Chairman of the Board, President, and Chief Executive Officer of AIC.
Donald J. Bailey
Executive Vice President of AIC (Emerging Businesses).
Don Civgin
Executive Vice President and Chief Financial Officer of The Allstate Corporation; Executive Vice President and Chief Financial Officer of AIC.
James D. DeVries
Executive Vice President and Chief Administrative Officer of AIC (Human Resources).
Judith P. Greffin
Executive Vice President and Chief Investment Officer of AIC.
Suren Gupta
Executive Vice President of AIC (Technology and Operations).
Mark R. LaNeve
Senior Executive Vice President and Chief Marketing Officer of AIC.
Michele C. Mayes
Executive Vice President and General Counsel of The Allstate Corporation; Executive Vice President and General Counsel of AIC (Chief Legal Officer).
Samuel H. Pilch
Senior Group Vice President and Controller of The Allstate Corporation; Senior Group Vice President and Controller of AIC.
Joan H. Walker
Executive Vice President of AIC (Corporate Relations).
Matthew E. Winter
Senior Executive Vice President of AIC; President and Chief Executive Officer Allstate Financial.
Each of the officers named above may be removed from office at any time, with or without cause, by the board of directors of the relevant company.
Mr. Wilson, Ms. Greffin, Mr. Pilch, and Ms. Walker have held the listed positions for at least the last five years or have served Allstate in various executive or administrative capacities for at least five years.
Prior to joining Allstate in 2010, Mr. Bailey served as Chairman and Chief Executive Officer of Willis North America since 2006.
Prior to joining Allstate in 2008, Mr. Civgin was Executive Vice President and Chief Financial Officer of OfficeMax, Incorporated and served in that position since 2005.
Prior to joining Allstate in 2008, Mr. DeVries served as Senior Vice President of Human Resources at Principal Financial Group since 2000.
Prior to joining Allstate in 2011, Mr. Gupta served as Executive Vice President of Wells Fargo since 2003.
Prior to joining Allstate in 2009, Mr. LaNeve served as Vice President of Sales, Service and Marketing of General Motors Corporation since 2004.
Prior to joining Allstate in 2007, Ms. Mayes served as Senior Vice President and General Counsel of Pitney Bowes since 2003.
Prior to joining Allstate in 2009, Mr. Winter served as Vice Chairman of American International Group ("AIG") in 2009 and President and Chief Executive Officer of AIG American General Domestic Life Companies since 2006.
Item 1A. Risk Factors
This document contains "forward-looking statements" that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These statements are made subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. We assume no obligation to update any forward-looking statements as a result of new information or future events or developments.
These forward-looking statements do not relate strictly to historical or current facts and may be identified by their use of words like "plans," "seeks," "expects," "will," "should," "anticipates," "estimates," "intends," "believes," "likely," "targets" and other words with similar meanings. These statements may address, among other things, our strategy for growth, catastrophe exposure management, product development, investment results, 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 plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements.
In addition to the normal risks of business, we are subject to significant risks and uncertainties, including those listed below, which apply to us as an insurer and a provider of other financial services. These risks constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995 and readers should carefully review such cautionary statements as they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and historical trends. These cautionary statements are not exclusive and are in addition to other factors discussed elsewhere in this document, in our filings with the SEC or in materials incorporated therein by reference.
Risks Relating to the Property-Liability business
As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events
Because of the exposure of our property and casualty business to catastrophic events, our operating results and financial condition may vary significantly from one period to the next. Catastrophes can be caused by various natural and man-made events, including earthquakes, volcanic eruptions, wildfires, tornadoes, tsunamis, hurricanes, tropical storms and certain types of terrorism or industrial accidents. We may incur catastrophe losses in our auto and property business in excess of: (1) those experienced in prior years, (2) the average expected level used in pricing, (3) our current reinsurance coverage limits, or (4) estimate of loss from external hurricane and earthquake models at various levels of profitability. Despite our catastrophe management programs, we are exposed to catastrophes that could have a material effect on operating results and financial condition. For example, our historical catastrophe experience includes losses relating to Hurricane Katrina in 2005 totaling $3.6 billion, the Northridge earthquake of 1994 totaling $2.1 billion and Hurricane Andrew in 1992 totaling $2.3 billion. We are also exposed to assessments from the California Earthquake Authority and various state-created insurance facilities, and to losses that could surpass the capitalization of these facilities. Our liquidity could be constrained by a catastrophe, or multiple catastrophes, which result in extraordinary losses or a downgrade of our debt or financial strength ratings.
In addition, we are subject to claims arising from weather events such as winter storms, rain, hail and high winds. The incidence and severity of weather conditions are largely unpredictable. There is generally an increase in the frequency and severity of auto and property claims when severe weather conditions occur.
The nature and level of catastrophes in any period cannot be predicted and could be material to our operating results and financial condition
Along with others in the industry, we use models developed by third party vendors in assessing our property insurance exposure to catastrophe losses. These models assume various conditions and probability scenarios. Such models do not necessarily accurately predict future losses or accurately measure losses currently incurred. Catastrophe models, which have been evolving since the early 1990s, use historical information about hurricanes and earthquakes and also utilize detailed information about our in-force business. While we use this information in connection with our pricing and risk management activities, there are limitations with respect to its usefulness in predicting losses in any reporting period. These limitations are evident in significant variations in estimates between models, material increases and decreases in results due to model changes and refinements of the underlying data elements and actual conditions that are not well understood and not properly incorporated into the models including seismic and weather phenomenon, demand surge, loss adjustment expense and impact of non-modeled conditions that compound losses.
Impacts of catastrophes and our catastrophe management strategy may adversely affect premium growth
Due to our catastrophe risk management efforts, the size of our homeowners business has been negatively impacted and may continue to be negatively impacted if we take further actions. Homeowners premium growth rates and retention could be more adversely impacted than we expect by adjustments to our business structure, size and underwriting practices in markets with significant catastrophe risk exposure. In addition, due to the diminished potential for cross-selling opportunities that cannot be fully replaced by our brokering arrangement to allow our agents to write property products with other carriers, new business growth in our auto lines could be lower than expected.
A regulatory environment that limits rate increases and requires us to underwrite business and participate in loss sharing arrangements may adversely affect our operating results and financial condition
From time to time, political events and positions affect the insurance market, including efforts to suppress rates to a level that may not allow us to reach targeted levels of profitability. For example, if Allstate Protection's loss ratio compares favorably to that of the industry, state regulatory authorities may impose rate rollbacks, require us to pay premium refunds to policyholders, or resist or delay our efforts to raise rates even if the property and casualty industry generally is not experiencing regulatory resistance to rate increases. Such resistance affects our ability, in all product lines, to obtain approval for rate changes that may be required to achieve targeted levels of profitability and returns on equity. Our ability to afford reinsurance required to reduce our catastrophe risk in designated areas may be dependent upon the ability to adjust rates for its cost.
In addition to regulating rates, certain states have enacted laws that require a property-liability insurer conducting business in that state to participate in assigned risk plans, reinsurance facilities and joint underwriting associations or require the insurer to offer coverage to all consumers, often restricting an insurer's ability to charge the price it might otherwise charge. In these markets, we may be compelled to underwrite significant amounts of business at lower than desired rates, possibly leading to an unacceptable return on equity, or as the facilities recognize a financial deficit, they may in turn have the ability to assess participating insurers, adversely affecting our results of operations and financial condition. Laws and regulations of many states also limit an insurer's ability to withdraw from one or more lines of insurance in the state, except pursuant to a plan that is approved by the state insurance department. Additionally, certain states require insurers to participate in guaranty funds for impaired or insolvent insurance companies. These funds periodically assess losses against all insurance companies doing business in the state. Our operating results and financial condition could be adversely affected by any of these factors.
The potential benefits of our sophisticated risk segmentation process may not be fully realized
We believe that pricing sophistication and underwriting (including Strategic Risk Management which, in some situations, considers information that is obtained from credit reports among other factors) has allowed us to be more competitive and operate more profitably. However, because many of our competitors have adopted underwriting criteria and sophisticated pricing models similar to those we use and because other competitors may follow suit, our competitive advantage could decline or be lost. Further, the use of insurance scoring from information that is obtained from credit reports as a factor in underwriting and pricing has at times been challenged by regulators, legislators, litigants and special interest groups in various states. Competitive pressures could also force us to modify our pricing sophistication models. Furthermore, we cannot be assured that these pricing sophistication models will accurately reflect the level of losses that we will ultimately incur.
Allstate Protection's operating results and financial condition may be adversely affected by the cyclical nature of the property and casualty business
The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates. A downturn in the profitability cycle of the property and casualty business could have a material effect on our operating results and financial condition.
Unexpected increases in the severity or frequency of claims may adversely affect our operating results and financial condition
Unexpected changes in the severity or frequency of claims may affect the profitability of our Allstate Protection segment. Changes in bodily injury claim severity are driven primarily by inflation in the medical sector of the economy and litigation. Changes in auto physical damage claim severity are driven primarily by inflation in auto repair costs, auto parts prices and used car prices. Changes in homeowners claim severity are driven by inflation in the construction industry, in building materials and in home furnishings, and by other economic and environmental factors, including
increased demand for services and supplies in areas affected by catastrophes. However, changes in the level of the severity of claims are not limited to the effects of inflation and demand surge in these various sectors of the economy. Increases in claim severity can arise from unexpected events that are inherently difficult to predict. Examples of such events include a decision in 2001 by the Georgia Supreme Court which held that diminished value coverage was included in auto policies under Georgia law and the emergence of mold-related homeowners losses in the state of Texas during 2002. Although we pursue various loss management initiatives in the Allstate Protection segment in order to mitigate future increases in claim severity, there can be no assurances that these initiatives will successfully identify or reduce the effect of future increases in claim severity.
Our Allstate Protection segment may experience volatility in claim frequency from time to time, and short-term trends may not continue over the longer term. In recent years gas prices have increased while miles driven have declined to the lowest level since 2008. A significant increase in claim frequency could have an adverse effect on our operating results and financial condition.
Actual claims incurred may exceed current reserves established for claims and may adversely affect our operating results and financial condition
Recorded claim reserves in the Property-Liability business are based on our best estimates of losses, both reported and incurred but not reported ("IBNR"), after considering known facts and interpretations of circumstances. Internal factors are considered including our experience with similar cases, actual claims paid, historical trends involving claim payment patterns, pending levels of unpaid claims, loss management programs, product mix and contractual terms. External factors are also considered which include, but are not limited to, law changes, court decisions, changes to regulatory requirements and economic conditions. Because reserves are estimates of the unpaid portion of losses that have occurred, including IBNR losses, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded reserves and such variance may adversely affect our operating results and financial condition.
Predicting claim expense relating to asbestos, environmental and other discontinued lines is inherently uncertain and may have a material effect on our operating results and financial condition
The process of estimating asbestos, environmental and other discontinued lines liabilities is complicated by complex legal issues concerning, among other things, the interpretation of various insurance policy provisions and whether those losses are covered, or were ever intended to be covered, and whether losses could be recoverable through retrospectively determined premium, reinsurance or other contractual agreements. Asbestos-related bankruptcies and other asbestos litigation are complex, lengthy proceedings that involve substantial uncertainty for insurers. Actuarial techniques and databases used in estimating asbestos, environmental and other discontinued lines net loss reserves may prove to be inadequate indicators of the extent of probable loss. Ultimate net losses from these discontinued lines could materially exceed established loss reserves and expected recoveries and have a material effect on our operating results and financial condition.
Risks Relating to the Allstate Financial Segment
Changes in underwriting and actual experience could materially affect profitability and financial condition
Our product pricing includes long-term assumptions regarding investment returns, mortality, morbidity, persistency and operating costs and expenses of the business. We establish target returns for each product based upon these factors and the average amount of capital that we must hold to support in-force contracts taking into account rating agencies and regulatory requirements. We monitor and manage our pricing and overall sales mix to achieve target new business returns on a portfolio basis, which could result in the discontinuation or de-emphasis of products or distribution relationships and a decline in sales. Profitability from new business emerges over a period of years depending on the nature and life of the product and is subject to variability as actual results may differ from pricing assumptions. Additionally, many of our products have fixed or guaranteed terms that limit our ability to increase revenues or reduce benefits, including credited interest, once the product has been issued.
Our profitability in this segment depends on the adequacy of investment spreads, the management of market and credit risks associated with investments, the sufficiency of premiums and contract charges to cover mortality and morbidity benefits, the persistency of policies to ensure recovery of acquisition expenses, and the management of operating costs and expenses within anticipated pricing allowances. Legislation and regulation of the insurance marketplace and products could also affect our profitability and financial condition.
Changes in reserve estimates may adversely affect our operating results
The reserve for life-contingent contract benefits is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, persistency and expenses. We periodically review the adequacy of these reserves on an aggregate basis and if future experience differs significantly from assumptions, adjustments to reserves and amortization of deferred policy acquisition costs ("DAC") may be required which could have a material effect on our operating results.
Changes in market interest rates may lead to a significant decrease in the sales and profitability of spread-based products
Our ability to manage the Allstate Financial spread-based products, such as fixed annuities and institutional products, is dependent upon maintaining profitable spreads between investment yields and interest crediting rates. When market interest rates decrease or remain at relatively low levels, proceeds from investments that have matured or have been prepaid or sold may be reinvested at lower yields, reducing investment spread. Lowering interest crediting rates on some products in such an environment can partially offset decreases in investment yield. However, these changes could be limited by market conditions, regulatory minimum rates or contractual minimum rate guarantees on many contracts and may not match the timing or magnitude of changes in investment yields. Decreases in the interest crediting rates offered on products in the Allstate Financial segment could make those products less attractive, leading to lower sales and/or changes in the level of policy loans, surrenders and withdrawals. Non-parallel shifts in interest rates, such as increases in short-term rates without accompanying increases in medium- and long-term rates, can influence customer demand for fixed annuities, which could impact the level and profitability of new customer deposits. Increases in market interest rates can also have negative effects on Allstate Financial, for example by increasing the attractiveness of other investments to our customers, which can lead to increased surrenders at a time when the segment's fixed income investment asset values are lower as a result of the increase in interest rates. This could lead to the sale of fixed income securities at a loss. For certain products, principally fixed annuity and interest-sensitive life products, the earned rate on assets could lag behind rising market yields. We may react to market conditions by increasing crediting rates, which could narrow spreads and reduce profitability. Unanticipated surrenders could result in accelerated amortization of DAC or affect the recoverability of DAC and thereby increase expenses and reduce profitability.
Changes in estimates of profitability on interest-sensitive life, fixed annuities and other investment products may adversely affect our profitability and financial condition through the amortization of DAC
DAC related to interest-sensitive life, fixed annuities and other investment contracts is amortized in proportion to actual historical gross profits and estimated future gross profits ("EGP") over the estimated lives of the contracts. The principal assumptions for determining the amount of EGP are investment returns, including capital gains and losses on assets supporting contract liabilities, interest crediting rates to contractholders, and the effects of persistency, mortality, expenses, and hedges if applicable. Updates to these assumptions (commonly referred to as "DAC unlocking") could adversely affect our profitability and financial condition.
Reducing our concentration in fixed annuities and funding agreements may adversely affect reported results
We have been reducing our concentration in fixed annuities and funding agreements. Lower new sales of these products could negatively impact investment portfolio levels, complicate settlement of expiring contracts including forced sales of assets with unrealized capital losses, and affect goodwill impairment testing and insurance reserves deficiency testing.
Changes in tax laws may decrease sales and profitability of products and adversely affect our financial condition
Under current federal and state income tax law, certain products we offer, primarily life insurance and annuities, receive favorable tax treatment. This favorable treatment may give certain of our products a competitive advantage over noninsurance products. Congress and various state legislatures from time to time consider legislation that would reduce or eliminate the favorable policyholder tax treatment currently applicable to life insurance and annuities. Congress and various state legislatures also consider proposals to reduce the taxation of certain products or investments that may compete with life insurance or annuities. Legislation that increases the taxation on insurance products or reduces the taxation on competing products could lessen the advantage or create a disadvantage for certain of our products making them less competitive. Such proposals, if adopted, could have a material effect on our profitability and financial condition or ability to sell such products and could result in the surrender of some existing contracts and policies. In addition, changes in the federal estate tax laws could negatively affect the demand for the types of life insurance used in estate planning.
Risks Relating to Investments
We are subject to market risk and declines in credit quality which may adversely affect investment income, cause additional realized losses, and cause increased unrealized losses
Although we continually reevaluate our return optimization and risk mitigation strategies, we remain subject to the risk that we will incur losses due to adverse changes in interest rates, credit spreads, equity prices or currency exchange rates. Adverse changes to these rates, spreads and prices may occur due to changes in fiscal policy and the economic climate, the liquidity of a market or market segment, insolvency or financial distress of key market makers or participants, or changes in market perceptions of credit worthiness and/or risk tolerance.
We are subject to risks associated with potential declines in credit quality related to specific issuers or specific industries and a general weakening in the economy, which are typically reflected through credit spreads. Credit spread is the additional yield on fixed income securities above the risk-free rate (typically referenced as the yield on U.S. Treasury securities) that market participants require to compensate them for assuming credit, liquidity and/or prepayment risks. Credit spreads vary (i.e. increase or decrease) in response to the market's perception of risk and liquidity in a specific issuer or specific sector and are influenced by the credit ratings, and the reliability of those ratings, published by external rating agencies. Although we use derivative financial instruments to manage these risks, the effectiveness of such instruments is subject to the same risks. A decline in the quality of our investment portfolio as a result of adverse economic conditions or otherwise could cause additional realized and unrealized losses on securities, including realized and unrealized losses relating to equity and derivative strategies.
A decline in market interest rates or credit spreads could have an adverse effect on our investment income as we invest cash in new investments that may earn less than the portfolio's average yield. In a declining interest rate environment, borrowers may prepay or redeem securities more quickly than expected as they seek to refinance at lower rates. A decline could also lead us to purchase longer-term or riskier assets in order to obtain adequate investment yields resulting in a duration gap when compared to the duration of liabilities. An increase in market interest rates or credit spreads could have an adverse effect on the value of our investment portfolio by decreasing the fair values of the fixed income securities that comprise a substantial majority of our investment portfolio. A declining equity market could also cause the investments in our pension plans to decrease or decreasing interest rates could cause the funding target and the projected benefit obligation of our pension plans or the accumulated benefit obligation of our other postretirement benefit plans to increase, either or both resulting in a decrease in the funded status of the pension plans and a reduction of shareholders' equity, increases in pension and other postretirement benefit expense and increases in required contributions to the pension plans.
Deteriorating financial performance impacting securities collateralized by residential and commercial mortgage loans, collateralized corporate loans, and commercial mortgage loans may lead to write-downs and impact our results of operations and financial condition
Changes in residential or commercial mortgage delinquencies, loss severities or recovery rates, declining residential or commercial real estate prices, corporate loan delinquencies or recovery rates, changes in credit or bond insurer strength ratings and the quality of service provided by service providers on securities in our portfolios could lead us to determine that write-downs are necessary in the future.
The impact of our investment strategies may be adversely affected by developments in the financial markets
The impact of our investment portfolio return optimization and risk mitigation strategies may be adversely affected by unexpected developments in the financial markets. For example, derivative contracts may result in coverage that is not as effective as intended thereby leading to the recognition of losses without the recognition of gains expected to mitigate the losses.
Concentration of our investment portfolios in any particular segment of the economy may have adverse effects on our operating results and financial condition
The concentration of our investment portfolios in any particular industry, collateral type, group of related industries, geographic sector or risk type could have an adverse effect on our investment portfolios and consequently on our results of operations and financial condition. Events or developments that have a negative impact on any particular industry, group of related industries or geographic region may have a greater adverse effect on the investment portfolios to the extent that the portfolios are concentrated rather than diversified.
The determination of the amount of realized capital losses recorded for impairments of our investments is subjective and could materially impact our operating results and financial condition
The determination of the amount of realized capital losses recorded for impairments vary by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. We update our evaluations regularly and reflect changes in other-than-temporary impairments in our results of operations. The assessment of whether other-than-temporary impairments have occurred is based on our case-by-case evaluation of the underlying reasons for the decline in fair value. There can be no assurance that we have accurately assessed the level of or amounts recorded for other-than-temporary impairments taken in our financial statements. Furthermore, historical trends may not be indicative of future impairments and additional impairments may need to be recorded in the future.
The determination of the fair value of our fixed income and equity securities is subjective and could materially impact our operating results and financial condition
In determining fair values we generally utilize market transaction data for the same or similar instruments. The degree of management judgment involved in determining fair values is inversely related to the availability of market observable information. The fair value of assets may differ from the actual amount received upon sale of an asset in an orderly transaction between market participants at the measurement date. Moreover, the use of different valuation assumptions may have a material effect on the assets' fair values. The difference between amortized cost or cost and fair value, net of deferred income taxes, certain life and annuity DAC, certain deferred sales inducement costs ("DSI"), and certain reserves for life-contingent contract benefits, is reflected as a component of accumulated other comprehensive income in shareholders' equity. Changing market conditions could materially affect the determination of the fair value of securities and unrealized net capital gains and losses could vary significantly. Determining fair value is subjective and could materially impact our operating results and financial condition.
Risks Relating to the Insurance Industry
Our future results are dependent in part on our ability to successfully operate in an insurance industry that is highly competitive
The insurance industry is highly competitive. Our competitors include other insurers and, because some of our products include a savings or investment component, securities firms, investment advisers, mutual funds, banks and other financial institutions. Many of our competitors have well-established national reputations and market similar products. Because of the competitive nature of the insurance industry, including competition for producers such as exclusive and independent agents, there can be no assurance that we will continue to effectively compete with our industry rivals, or that competitive pressures will not have a material effect on our business, operating results or financial condition. Furthermore, certain competitors operate using a mutual insurance company structure and therefore may have dissimilar profitability and return targets. Our ability to successfully operate may also be impaired if we are not effective in filling critical leadership positions, in developing the talent and skills of our human resources, in assimilating new executive talent into our organization, or in deploying human resource talent consistently with our business goals.
Difficult conditions in the global capital markets and the economy generally could adversely affect our business and operating results and these conditions may not improve in the near future
As with most businesses, we believe difficult conditions in the global capital markets and economy, such as significant negative macroeconomic trends, including relatively high and sustained unemployment, reduced consumer spending, lower home prices, substantial increases in delinquencies on consumer debt, including defaults on home mortgages, and the relatively low availability of credit could have an adverse effect on our business and operating results.
Stressed conditions, volatility and disruptions in global capital markets, particular markets or financial asset classes could adversely affect our investment portfolio. Disruptions in one market or asset class can also spread to other markets or asset classes. Although the disruption in the global financial markets has moderated, not all global financial markets are functioning normally, and the rate of recovery from the U.S. recession has been below historic averages. Several governments around the world have announced austerity actions to address their budget deficits that may lead to a decline in economic activity. Specifically, the global recession and disruption of the financial markets has led to concerns over capital markets access and the solvency of European Union member states.
General economic conditions could adversely affect us in the form of consumer behavior and pressure investment results. Consumer behavior changes could include decreased demand for our products. For example, as consumers
purchase fewer automobiles, our sales of auto insurance may decline. Also, as consumers become more cost conscious, they may choose lower levels of auto and homeowners insurance. In addition, holders of some of our interest-sensitive life insurance and annuity products may engage in an elevated level of discretionary withdrawals of contractholder funds. Our investment results could be adversely affected as deteriorating financial and business conditions affect the issuers of the securities in our investment portfolio.
There can be no assurance that actions of the U.S. federal government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets and stimulating the economy will achieve the intended effect
In response to the financial crises affecting the banking system, the financial markets and the broader economy in recent years, the U.S. federal government, the Federal Reserve and other governmental and regulatory bodies have taken actions such as purchasing mortgage-backed and other securities from financial institutions, investing directly in banks, thrifts and bank and savings and loan holding companies and increasing federal spending to stimulate the economy. There can be no assurance as to the long term impact such actions will have on the financial markets or on economic conditions, including potential inflationary affects. Continued volatility and any further economic deterioration could materially and adversely affect our business, financial condition and results of operations.
Losses from legal and regulatory actions may be material to our operating results, cash flows and financial condition
As is typical for a large company, we are involved in various legal actions, including class action litigation challenging a range of company practices and coverage provided by our insurance products, some of which involve claims for substantial or indeterminate amounts. We are also involved in various regulatory actions and inquiries, including market conduct exams by state insurance regulatory agencies. In the event of an unfavorable outcome in one or more of these matters, the ultimate liability may be in excess of amounts currently accrued and may be material to our operating results or cash flows for a particular quarter or annual period and to our financial condition. The aggregate estimate of the range of reasonably possible loss in excess of the amount accrued, if any, disclosed in Note 14 of the consolidated financial statements is not an indication of expected loss, if any. Actual results may vary significantly from the current estimate.
We are subject to extensive regulation and potential further restrictive regulation may increase our operating costs and limit our growth
As insurance companies, broker-dealers, investment advisers, a federal stock savings bank and/or investment companies, many of our subsidiaries are subject to extensive laws and regulations. These laws and regulations are complex and subject to change. Changes may sometimes lead to additional expenses, increased legal exposure, limit our ability to grow or to achieve targeted profitability. Moreover, laws and regulations are administered and enforced by a number of different governmental authorities, each of which exercises a degree of interpretive latitude, including state insurance regulators; state securities administrators; state attorneys general and federal agencies including the SEC, the FINRA, the U.S. Department of Justice, and until such time as Allstate Bank is dissolved and Allstate deregisters as a savings and loan holding company, the OCC, the FRB, and the Federal Deposit Insurance Corporation ("FDIC"). Consequently, we are subject to the risk that compliance with any particular regulator's or enforcement authority's interpretation of a legal issue may not result in compliance with another's interpretation of the same issue, particularly when compliance is judged in hindsight. In addition, there is risk that any particular regulator's or enforcement authority's interpretation of a legal issue may change over time to our detriment, or that changes in the overall legal environment may, even absent any particular regulator's or enforcement authority's interpretation of a legal issue changing, cause us to change our views regarding the actions we need to take from a legal risk management perspective, thus necessitating changes to our practices that may, in some cases, limit our ability to grow or to improve the profitability of our business. Furthermore, in some cases, these laws and regulations are designed to protect or benefit the interests of a specific constituency rather than a range of constituencies. For example, state insurance laws and regulations are generally intended to protect or benefit purchasers or users of insurance products, not holders of securities issued by The Allstate Corporation. In many respects, these laws and regulations limit our ability to grow or to improve the profitability of our business.
Regulatory reforms, and the more stringent application of existing regulations, may make it more expensive for us to conduct our business
The federal government has enacted comprehensive regulatory reforms for financial services entities. As part of a larger effort to strengthen the regulation of the financial services market, certain reforms are applicable to the insurance industry, including the FIO established within the Treasury Department.
We are a diversified unitary savings and loan holding company for Allstate Bank, a federal stock savings bank and a member of the FDIC. The principal supervisory authorities for the diversified unitary savings and loan holding company activities of The Allstate Corporation is the FRB, and the principal supervisory authority for the Bank is the OCC. The Allstate Corporation and the Bank, respectively, are subject to FRB and OCC regulation, examination, supervision and reporting requirements and enforcement authority. The Bank is also subject to the authority of the FDIC.
Among other things, this permits one or more of these governmental entities to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness and stability of Allstate Bank. In 2011, after receiving regulatory approval to voluntarily dissolve, Allstate Bank ceased operations. In the first half of 2012, we expect to cancel the bank's charter and deregister The Allstate Corporation as a savings and loan holding company.
In recent years, the state insurance regulatory framework has come under public scrutiny, members of Congress have discussed proposals to provide for federal chartering of insurance companies, and FIO and the Federal Stability Oversight Council ("FSOC") were established. In the future, if the FSOC were to determine that Allstate is a "systemically important" nonbank financial company, Allstate would again be subject to regulation by the Federal Reserve Board. We can make no assurances regarding the potential impact of state or federal measures that may change the nature or scope of insurance and financial regulation.
These regulatory reforms and any additional legislative change or regulatory requirements imposed upon us in connection with the federal government's regulatory reform of the financial services industry or arising from reform related to the international regulatory capital framework for banking or financial services firms, and any more stringent enforcement of existing regulations by federal authorities, may make it more expensive for us to conduct our business, or limit our ability to grow or to achieve profitability.
Reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business
Our personal lines catastrophe reinsurance program was designed, utilizing our risk management methodology, to address our exposure to catastrophes nationwide. Market conditions beyond our control impact the availability and cost of the reinsurance we purchase. No assurances can be made that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as is currently available. For example, our ability to afford reinsurance to reduce our catastrophe risk in designated areas may be dependent upon our ability to adjust premium rates for its cost, and there are no assurances that the terms and rates for our current reinsurance program will continue to be available next year. If we were unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we would have to either accept an increase in our exposure risk, reduce our insurance writings, or develop or seek other alternatives.
Reinsurance subjects us to the credit risk of our reinsurers and may not be adequate to protect us against losses arising from ceded insurance, which could have a material effect on our operating results and financial condition
The collectability of reinsurance recoverables is subject to uncertainty arising from a number of factors, including changes in market conditions, whether insured losses meet the qualifying conditions of the reinsurance contract and whether reinsurers, or their affiliates, have the financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract. Our inability to collect a material recovery from a reinsurer could have a material effect on our operating results and financial condition.
A large scale pandemic, the continued threat of terrorism or ongoing military actions may have an adverse effect on the level of claim losses we incur, the value of our investment portfolio, our competitive position, marketability of product offerings, liquidity and operating results
A large scale pandemic, the continued threat of terrorism, within the United States and abroad, or ongoing military and other actions, and heightened security measures in response to these types of threats, may cause significant volatility and losses in our investment portfolio from declines in the equity markets and from interest rate changes in the United States, Europe and elsewhere, and result in loss of life, property damage, disruptions to commerce and reduced economic activity. Some of the assets in our investment portfolio may be adversely affected by declines in the equity markets and reduced economic activity caused by a large scale pandemic or the continued threat of terrorism. Additionally, in the Allstate Protection and Allstate Financial segments, a large scale pandemic or terrorist act could have a material effect on the sales, profitability, competitiveness, marketability of product offerings, liquidity, and operating results.
A downgrade in our financial strength ratings may have an adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition
Financial strength ratings are important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company's business. On an ongoing basis, rating agencies review the financial performance and condition of insurers and could downgrade or change the outlook on an insurer's ratings due to, for example, a change in an insurer's statutory capital; a change in a rating agency's determination of the amount of risk-adjusted capital required to maintain a particular rating; an increase in the perceived risk of an insurer's investment portfolio; a reduced confidence in management or a host of other considerations that may or may not be under the insurer's control. The insurance financial strength ratings of Allstate Insurance Company and Allstate Life Insurance Company and The Allstate Corporation's senior debt ratings from A.M. Best, Standard & Poor's and Moody's are subject to continuous review, and the retention of current ratings cannot be assured. A downgrade in any of these ratings could have a material effect on our sales, our competitiveness, the marketability of our product offerings, and our liquidity, operating results and financial condition.
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or our ability to obtain credit on acceptable terms
In periods of extreme volatility and disruption in the capital and credit markets, liquidity and credit capacity may be severely restricted. In such circumstances, our ability to obtain capital to fund operating expenses, financing costs, capital expenditures or acquisitions may be limited, and the cost of any such capital may be significant. Our access to additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as lenders' perception of our long- or short-term financial prospects. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. If a combination of these factors were to occur, our internal sources of liquidity may prove to be insufficient and in such case, we may not be able to successfully obtain additional financing on favorable terms.
We may be required to recognize impairments in the value of our goodwill, which may adversely affect our operating results and financial condition
Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets acquired. Goodwill is evaluated for impairment annually, or more frequently if conditions warrant, by comparing the carrying value (attributed equity) of a reporting unit to its estimated fair value. Market declines or other events impacting the fair value of a reporting unit could result in a goodwill impairment, resulting in a charge to income. Such a charge could have an adverse effect on our results of operations or financial condition.
Changes in accounting standards issued by the Financial Accounting Standards Board ("FASB") or other standard-setting bodies may adversely affect our results of operations and financial condition
Our financial statements are subject to the application of generally accepted accounting principles, which are periodically revised, interpreted and/or expanded. Accordingly, we are required to adopt new guidance or interpretations, or could be subject to existing guidance as we enter into new transactions, which may have a material effect on our results of operations and financial condition that is either unexpected or has a greater impact than expected. For a description of changes in accounting standards that are currently pending and, if known, our estimates of their expected impact, see Note 2 of the consolidated financial statements.
The change in our unrecognized tax benefit during the next 12 months is subject to uncertainty
We have disclosed our estimate of net unrecognized tax benefits and the reasonably possible increase or decrease in its balance during the next 12 months in Note 15 of the consolidated financial statements. However, actual results may differ from our estimate for reasons such as changes in our position on specific issues, developments with respect to the governments' interpretations of income tax laws or changes in judgment resulting from new information obtained in audits or the appeals process.
The realization of deferred tax assets is subject to uncertainty
The realization of our deferred tax assets, net of valuation allowance, is based on our assumption that we will be able to fully utilize the deductions that are ultimately recognized for tax purposes. However, actual results may differ from our assumptions if adequate levels of taxable income are not attained.
The ability of our subsidiaries to pay dividends may affect our liquidity and ability to meet our obligations
The Allstate Corporation is a holding company with no significant operations. The principal asset is the stock of its subsidiaries. State insurance regulatory authorities limit the payment of dividends by insurance subsidiaries, as described in Note 16 of the consolidated financial statements. In addition, competitive pressures generally require the subsidiaries to maintain insurance financial strength ratings. These restrictions and other regulatory requirements affect the ability of the subsidiaries to make dividend payments. Limits on the ability of the subsidiaries to pay dividends could adversely affect holding company liquidity, including our ability to pay dividends to shareholders, service our debt, or complete share repurchase programs in the timeframe expected.
The occurrence of events unanticipated in our disaster recovery systems and management continuity planning or a support failure from external providers during a disaster could impair our ability to conduct business effectively
The occurrence of a disaster such as a natural catastrophe, an industrial accident, a terrorist attack or war, cyber attack, events unanticipated in our disaster recovery systems, or a support failure from external providers, could have an adverse effect on our ability to conduct business and on our results of operations and financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems. In the event that a significant number of our managers could be unavailable in the event of a disaster, our ability to effectively conduct our business could be severely compromised.
Changing climate conditions may adversely affect our financial condition, profitability or cash flows
Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency or severity of weather events and wildfires, the affordability and availability of homeowners insurance, and the results for our Allstate Protection segment.
Loss of key vendor relationships or failure of a vendor to protect personal information of our customers, claimants or employees could affect our operations
We rely on services and products provided by many vendors in the United States and abroad. These include, for example, vendors of computer hardware and software and vendors of services such as claim adjustment services and human resource benefits management services. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, or fails to protect personal information of our customers, claimants or employees, we may suffer operational impairments and financial losses.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our home office complex is located in Northbrook, Illinois. As of December 31, 2011, the Home Office complex consists of several buildings totaling 2.3 million square feet of office space on a 278-acre site.
We also operate from approximately 1,300 administrative, data processing, claims handling and other support facilities in North America. In addition to our home office facilities, 2.3 million square feet are owned and 6.3 million square feet are leased. Outside North America, we lease three properties in Northern Ireland comprising 139,400 square feet. We also have one lease in London for 3,650 square feet. Generally, only major Allstate facilities are owned. In a majority of cases, new lease terms and renewals are for five years or less.
The locations out of which the Allstate exclusive agencies operate in the U.S. are normally leased by the agencies as lessees.
Item 3. Legal Proceedings
Information required for Item 3 is incorporated by reference to the discussion under the heading "Regulation and Compliance" and under the heading "Legal and regulatory proceedings and inquiries" in Note 14 of the consolidated financial statements.
Item 4. Mine Safety Disclosures
Not applicable.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of February 1, 2012, there were 103,193 record holders of The Allstate Corporation's common stock. The principal market for the common stock is the New York Stock Exchange but it is also listed on the Chicago Stock Exchange. Set forth below are the high and low New York Stock Exchange Composite listing prices of, and cash dividends declared for, the common stock during 2011 and 2010.
High
Low
Close
Dividends
Declared
First quarter
32.61
30.43
31.78
.21
Second quarter
34.40
29.27
30.53
.21
Third quarter
31.01
22.27
23.69
.21
Fourth quarter
27.98
22.34
27.41
.21
First quarter
32.48
28.13
32.31
.20
Second quarter
35.51
28.41
28.73
.20
Third quarter
32.36
26.86
31.55
.20
Fourth quarter
33.29
29.00
31.88
.20
The payment of dividends by Allstate Insurance Company ("AIC") to The Allstate Corporation is limited by Illinois insurance law to formula amounts based on statutory net income and statutory surplus, as well as the timing and amount of dividends paid in the preceding twelve months. In the twelve-month period ending December 31, 2011, AIC paid dividends of $838 million. Based on the greater of 2011 statutory net income or 10% of statutory surplus, the maximum amount of dividends that AIC will be able to pay without prior Illinois Department of Insurance approval at a given point in time in 2012 is $1.51 billion, less dividends paid during the preceding twelve months measured at that point in time. Notification and approval of intercompany lending activities is also required by the Illinois Department of Insurance for those transactions that exceed formula amounts based on statutory admitted assets and statutory surplus.
Issuer Purchases of Equity Securities
Period
Total number
of shares
(or units)
purchased (1)
Average price
paid per share
(or unit)
Total number of
shares (or units)
purchased as part
of publicly
announced plans
or programs (2)
Maximum number
(or approximate
dollar value) of
shares (or units)
that may yet be
purchased under
the plans or
programs (3)
October 1, 2011 -
October 31, 2011
$ 23.5200
-
$ -
November 1, 2011 -
November 30, 2011
1,208,075
$ 25.1579
1,206,200
$ 970 million
December 1, 2011 -
December 31, 2011
2,815,655
$ 26.8696
2,815,655
$ 894 million
Total
4,023,754
$ 26.3557
4,021,855
(1)In accordance with the terms of its equity compensation plans, Allstate acquired the following shares in connection with stock option exercises by employees and/or directors. The stock was received in payment of the exercise price of the options and in satisfaction of withholding taxes due upon exercise or vesting.
October:
November:
1,875
December:
none
(2)Repurchases under our programs are, from time to time, executed under the terms of a pre-set trading plan meeting the requirements of Rule 10b5-1(c) of the Securities Exchange Act of 1934.
(3)On November 8, 2011, we announced the approval of a new share repurchase program for $1.00 billion. This program is expected to be completed by March 31, 2013.
Item 6. Selected Financial Data
5-YEAR SUMMARY OF SELECTED FINANCIAL DATA
($ in millions, except per share data and ratios)
Consolidated Operating Results
Insurance premiums and contract charges
$ 28,180
$ 28,125
$ 28,152
$ 28,862
$ 29,099
Net investment income
3,971
4,102
4,444
5,622
6,435
Realized capital gains and losses
(827 )
(583 )
(5,090 )
1,235
Total revenues
32,654
31,400
32,013
29,394
36,769
Net income (loss)
(1,679 )
4,636
Net income (loss) per share:
Net income (loss) per share - basic
1.51
1.72
1.58
(3.06 )
7.80
Net income (loss) per share - diluted
1.51
1.71
1.58
(3.06 )
7.76
Cash dividends declared per share
0.84
0.80
0.80
1.64
1.52
Consolidated Financial Position
Investments
$ 95,618
$ 100,483
$ 99,833
$ 95,998
$ 118,980
Total assets
125,563
130,874
132,652
134,798
156,408
Reserves for claims and claims expense, life-contingent contract benefits and contractholder funds
77,156
81,145
84,659
90,750
94,052
Long-term debt
5,908
5,908
5,910
5,659
5,640
Shareholders' equity
18,674
19,016
16,692
12,641
21,851
Shareholders' equity per diluted share
36.92
35.32
30.84
23.47
38.54
Equity
18,702
19,044
16,721
12,673
21,902
Property-Liability Operations
Premiums earned
$ 25,942
$ 25,957
$ 26,194
$ 26,967
$ 27,233
Net investment income
1,201
1,189
1,328
1,674
1,972
Net income
1,054
1,543
4,258
Operating ratios (1)
Claims and claims expense ("loss") ratio
77.7
73.0
71.6
74.4
64.9
Expense ratio
25.7
25.1
24.6
25.0
24.9
Combined ratio
103.4
98.1
96.2
99.4
89.8
Allstate Financial Operations
Premiums and contract charges
$ 2,238
$ 2,168
$ 1,958
$ 1,895
$ 1,866
Net investment income
2,716
2,853
3,064
3,811
4,297
Net income (loss)
(483 )
(1,721 )
Investments
57,373
61,582
62,216
61,449
74,256
(1)We use operating ratios to measure the profitability of our Property-Liability results. We believe that they enhance an investor's understanding of our profitability. They are calculated as follows: Claims and claims expense ("loss") ratio is the ratio of claims and claims expense to premiums earned. Loss ratios include the impact of catastrophe losses. Expense ratio is the ratio of amortization of deferred policy acquisition costs, operating costs and expenses and restructuring and related charges to premiums earned. Combined ratio is the ratio of claims and claims expense, amortization of deferred policy acquisition costs, operating costs and expenses and restructuring and related charges to premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio. The difference between 100% and the combined ratio represents underwriting income (loss) as a percentage of premiums earned, or underwriting margin.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Page
Overview
2011 Highlights
Consolidated Net Income
Application of Critical Accounting Estimates
Property-Liability 2011 Highlights
Property-Liability Operations
Allstate Protection Segment
Discontinued Lines and Coverages Segment
Property-Liability Investment Results
Property-Liability Claims and Claims Expense Reserves
Allstate Financial 2011 Highlights
Allstate Financial Segment
Investments 2011 Highlights
Investments
Market Risk
Pension Plans
Goodwill
Deferred Taxes
Capital Resources and Liquidity 2011 Highlights
Capital Resources and Liquidity
Enterprise Risk and Return Management
Regulation and Legal Proceedings
Pending Accounting Standards
OVERVIEW
The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The Allstate Corporation (referred to in this document as "we," "our," "us," the "Company" or "Allstate"). It should be read in conjunction with the 5-year summary of selected financial data, consolidated financial statements and related notes found under Part II, Item 6 and Item 8 contained herein. Further analysis of our insurance segments is provided in the Property-Liability Operations (which includes the Allstate Protection and the Discontinued Lines and Coverages segments) and in the Allstate Financial Segment sections of Management's Discussion and Analysis ("MD&A"). The segments are consistent with the way in which we use financial information to evaluate business performance and to determine the allocation of resources.
Allstate is focused on the following priorities in 2012:
•maintain auto profitability; •raise returns in homeowners and annuity businesses; •grow insurance premiums; and •proactively manage investments and capital.
The most important factors we monitor to evaluate the financial condition and performance of our company include:
•For Allstate Protection: premium written, the number of policies in force ("PIF"), retention, price changes, claim frequency (rate of claim occurrence per policy in force) and severity (average cost per claim), catastrophes, loss ratio, expenses, underwriting results, and sales of all products and services; •For Allstate Financial: benefit and investment spread, amortization of deferred policy acquisition costs ("DAC"), expenses, operating income, net income, invested assets, and premiums and contract charges; •For Investments: credit quality/experience, total return, investment income, cash flows, realized capital gains and losses, unrealized capital gains and losses, stability of long-term returns, and asset and liability duration; and •For financial condition: liquidity, parent holding company level of deployable invested assets, financial strength ratings, operating leverage, debt leverage, book value per share, and return on equity.
Summary of Results:
•Consolidated net income was $788 million in 2011, a decrease of 15.1% compared to $928 million in 2010, following an 8.7% increase in 2010 from $854 million in 2009. The decrease in 2011 compared to 2010 was primarily due to lower net income from Property-Liability, partially offset by higher net income from Allstate Financial. The increase in 2010 compared to 2009 was primarily due to higher net income from Allstate Financial, partially offset by lower net income from Property-Liability. Net income per diluted share was $1.51, $1.71 and $1.58 in 2011, 2010 and 2009, respectively. •Allstate Protection had an underwriting loss of $849 million in 2011 compared to underwriting income of $526 million in 2010 and underwriting income of $1.03 billion in 2009. The decrease in 2011 compared to 2010 was primarily due to increases in homeowners underwriting losses and decreases in other personal lines and standard auto underwriting income. The decrease in 2010 compared to 2009 was primarily due to decreases in standard auto underwriting income and increases in homeowners underwriting losses, partially offset by increases in other personal lines underwriting income. The Allstate Protection combined ratio was 103.3, 98.0 and 96.1 in 2011, 2010 and 2009, respectively. Underwriting income (loss), as measure not based on GAAP, is defined in the Property-Liability Operations section of the MD&A. •Allstate Financial net income was $586 million in 2011 compared to net income of $58 million in 2010 and a net loss of $483 million in 2009. The increase in 2011 compared to 2010 was primarily due to net realized capital gains in the current year compared to net realized capital losses in the prior year and decreased interest credited to contractholder funds, partially offset by higher amortization of DAC and lower net investment income. The favorable change of $541 million in 2010 compared to 2009 was primarily due to lower amortization of DAC, decreased interest credited to contractholder funds and higher premiums and contract charges, partially offset by lower net investment income.
2011 HIGHLIGHTS
•Consolidated net income was $788 million in 2011 compared to $928 million in 2010. Net income per diluted share was $1.51 in 2011 compared to $1.71 in 2010. •Property-Liability net income was $408 million in 2011 compared to $1.05 billion in 2010.
•The Property-Liability combined ratio was 103.4 in 2011 compared to 98.1 in 2010. •Allstate Financial net income was $586 million in 2011 compared to $58 million in 2010. •Total revenues were $32.65 billion in 2011 compared to $31.40 billion in 2010. •Property-Liability premiums earned totaled $25.94 billion in 2011 compared to $25.96 billion in 2010. •Net realized capital gains were $503 million in 2011 compared to net realized capital losses of $827 million in 2010. •Investments totaled $95.62 billion as of December 31, 2011, a decrease of 4.8% from $100.48 billion as of December 31, 2010. Net investment income was $3.97 billion in 2011, a decrease of 3.2% from $4.10 billion in 2010. •Book value per diluted share (ratio of shareholders' equity to total shares outstanding and dilutive potential shares outstanding) was $36.92 as of December 31, 2011, an increase of 4.5% from $35.32 as of December 31, 2010. •For the twelve months ended December 31, 2011, return on the average of beginning and ending period shareholders' equity was 4.2%, a decrease of 1.0 points from 5.2% for the twelve months ended December 31, 2010. •As of December 31, 2011, we had $18.67 billion in shareholders' equity. This total included $2.24 billion in deployable invested assets at the parent holding company level. •On October 7, 2011, we obtained all required regulatory approvals and closed our acquisition of certain entities making up the Esurance and Answer Financial groups of companies from White Mountains Holdings for a total price of $1.01 billion.
CONSOLIDATED NET INCOME
($ in millions)
For the years ended December 31,
Revenues
Property-liability insurance premiums
$ 25,942
$ 25,957
$ 26,194
Life and annuity premiums and contract charges
2,238
2,168
1,958
Net investment income
3,971
4,102
4,444
Realized capital gains and losses:
Total other-than-temporary impairment losses
(563 )
(937 )
(2,376 )
Portion of loss recognized in other comprehensive income
(33 )
(64 )
Net other-than-temporary impairment losses recognized in earnings
(596 )
(1,001 )
(1,919 )
Sales and other realized capital gains and losses
1,099
1,336
Total realized capital gains and losses
(827 )
(583 )
Total revenues
32,654
31,400
32,013
Costs and expenses
Property-liability insurance claims and claims expense
(20,161 )
(18,951 )
(18,746 )
Life and annuity contract benefits
(1,761 )
(1,815 )
(1,617 )
Interest credited to contractholder funds
(1,645 )
(1,807 )
(2,126 )
Amortization of deferred policy acquisition costs
(4,233 )
(4,034 )
(4,754 )
Operating costs and expenses
(3,468 )
(3,281 )
(3,007 )
Restructuring and related charges
(44 )
(30 )
(130 )
Interest expense
(367 )
(367 )
(392 )
Total costs and expenses
(31,679 )
(30,285 )
(30,772 )
(Loss) gain on disposition of operations
(15 )
Income tax expense
(172 )
(198 )
(394 )
Net income
$
$
$
Property-Liability
$
$
1,054
$
1,543
Allstate Financial
(483 )
Corporate and Other
(206 )
(184 )
(206 )
Net income
$
$
$
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the consolidated financial statements. The most critical estimates include those used in determining:
•Fair value of financial assets •Impairment of fixed income and equity securities •Deferred policy acquisition costs amortization •Reserve for property-liability insurance claims and claims expense estimation •Reserve for life-contingent contract benefits estimation
In making these determinations, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to our businesses and operations. It is reasonably likely that changes in these estimates could occur from period to period and result in a material impact on our consolidated financial statements.
A brief summary of each of these critical accounting estimates follows. For a more detailed discussion of the effect of these estimates on our consolidated financial statements, and the judgments and assumptions related to these estimates, see the referenced sections of this document. For a complete summary of our significant accounting policies, see the notes to the consolidated financial statements.
Fair value of financial assets Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We categorize our financial assets measured at fair value into a three-level hierarchy based on the observability of inputs to the valuation techniques as follows:
Level 1:
Financial asset values are based on unadjusted quoted prices for identical assets in an active market that we can access.
Level 2:
Financial asset values are based on the following:
(a)
Quoted prices for similar assets in active markets;
(b)
Quoted prices for identical or similar assets in markets that are not active; or
(c)
Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset.
Level 3:
Financial asset values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect our estimates of the assumptions that market participants would use in valuing the financial assets.
Observable inputs are inputs that reflect the assumptions market participants would use in valuing financial assets that are developed based on market data obtained from independent sources. In the absence of sufficient observable inputs, unobservable inputs reflect our estimates of the assumptions market participants would use in valuing financial assets and are developed based on the best information available in the circumstances. The degree of management judgment involved in determining fair values is inversely related to the availability of market observable information.
We are responsible for the determination of fair value of financial assets and the supporting assumptions and methodologies. We gain assurance on the overall reasonableness and consistent application of valuation input assumptions, valuation methodologies and compliance with accounting standards for fair value determination through the execution of various processes and controls designed to ensure that our financial assets are appropriately valued. We monitor fair values received from third parties and those derived internally on an ongoing basis.
We employ independent third-party valuation service providers, broker quotes and internal pricing methods to determine fair values. We obtain or calculate only one single quote or price for each financial instrument.
Valuation service providers typically obtain data about market transactions and other key valuation model inputs from multiple sources and, through the use of proprietary models, produce valuation information in the form of a single fair value for individual securities for which a fair value has been requested under the terms of our agreements. For certain equity securities, valuation service providers provide market quotations for completed transactions on the measurement date. For other security types, fair values are derived from the valuation service providers' proprietary valuation models. The inputs used by the valuation service providers include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads,
liquidity spreads, currency rates, and other information, as applicable. Credit and liquidity spreads are typically implied from completed transactions and transactions of comparable securities. Valuation service providers also use proprietary discounted cash flow models that are widely accepted in the financial services industry and similar to those used by other market participants to value the same financial instruments. The valuation models take into account, among other things, market observable information as of the measurement date, as described above, as well as the specific attributes of the security being valued including its term, interest rate, credit rating, industry sector, and where applicable, collateral quality and other issue or issuer specific information. Executing valuation models effectively requires seasoned professional judgment and experience. In cases where market transactions or other market observable data is limited, the extent to which judgment is applied varies inversely with the availability of market observable information.
For certain of our financial assets measured at fair value, where our valuation service providers cannot provide fair value determinations, we obtain a single non-binding price quote from a broker familiar with the security who, similar to our valuation service providers, may consider transactions or activity in similar securities among other information. The brokers providing price quotes are generally from the brokerage divisions of leading financial institutions with market making, underwriting and distribution expertise regarding the security subject to valuation.
The fair value of certain financial assets, including privately placed corporate fixed income securities, auction rate securities ("ARS") backed by student loans, equity-indexed notes, and certain free-standing derivatives, for which our valuation service providers or brokers do not provide fair value determinations, is determined using valuation methods and models widely accepted in the financial services industry. Internally developed valuation models, which include inputs that may not be market observable and as such involve some degree of judgment, are considered appropriate for each class of security to which they are applied.
Our internal pricing methods are primarily based on models using discounted cash flow methodologies that develop a single best estimate of fair value. Our models generally incorporate inputs that we believe are representative of inputs other market participants would use to determine fair value of the same instruments, including yield curves, quoted market prices of comparable securities, published credit spreads, and other applicable market data. Additional inputs that are used include internally-derived assumptions such as liquidity premiums and credit ratings, as well as instrument-specific characteristics that include, but are not limited to, coupon rates, expected cash flows, sector of the issuer, and call provisions. Our internally assigned credit ratings are developed at a more detailed level than externally published ratings and allow for a more precise match of these ratings to other market observable valuation inputs, such as credit and sector spreads, when performing these valuations. Due to the existence of non-market observable inputs, such as liquidity premiums, judgment is required in developing these fair values. As a result, the fair value of these financial assets may differ from the amount actually received to sell an asset in an orderly transaction between market participants at the measurement date. Moreover, the use of different valuation assumptions may have a material effect on the financial assets' fair values.
For the majority of our financial assets measured at fair value, all significant inputs are based on market observable data and significant management judgment does not affect the periodic determination of fair value. The determination of fair value using discounted cash flow models involves management judgment when significant model inputs are not based on market observable data. However, where market observable data is available, it takes precedence, and as a result, no range of reasonably likely inputs exists from which the basis of a sensitivity analysis could be constructed.
There is one primary situation where a discounted cash flow model utilizes a significant input that is not market observable, and it relates to the determination of fair value for our ARS backed by student loans. The significant input utilized is the anticipated date liquidity will return to this market (that is, when auction failures will cease). Determination of this assumption allows for matching to market observable inputs when performing these valuations.
The following table displays the sensitivity of reasonably likely changes in the anticipated date liquidity will return to the student loan ARS market as of December 31, 2011. The selection of these hypothetical scenarios represents an illustration of the estimated potential proportional effect of alternate assumptions and should not be construed as either a prediction of future events or an indication that it would be reasonably likely that all securities would be similarly affected.
($ in millions)
ARS backed by student loans at fair value
$
Percentage change in fair value resulting from:
Decrease in the anticipated date liquidity will return to this market by six months
1.4 %
Increase in the anticipated date liquidity will return to this market by six months
(1.4 )%
We believe our most significant exposure to changes in fair value is due to market risk. Our exposure to changes in market conditions is discussed fully in the Market Risk section of the MD&A.
We employ specific control processes to determine the reasonableness of the fair value of our financial assets. Our processes are designed to ensure that the values received or internally estimated are accurately recorded and that the data inputs and the valuation techniques utilized are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, we assess the reasonableness of individual security values that have stale prices or that exceed certain thresholds as compared to previous values received from those valuation service providers or derived from internal models. We perform procedures to understand and assess the methodologies, processes and controls of our valuation service providers. In addition, we may validate the reasonableness of fair value by comparing information obtained from our valuation service providers to other third party valuation sources for selected securities. We perform ongoing price validation procedures such as back-testing of actual sales, which corroborate the various inputs used in internal pricing models to market observable data. When fair value determinations are expected to be more variable, we validate them through reviews by members of management who have relevant expertise and who are independent of those charged with executing investment transactions.
We also perform an analysis to determine whether there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity, and if so, whether transactions may not be orderly. Among the indicators we consider in determining whether a significant decrease in the volume and level of market activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, level of credit spreads over historical levels, bid-ask spread, and price consensuses among market participants and sources. If evidence indicates that prices are based on transactions that are not orderly, we place little, if any, weight on the transaction price and will estimate fair value using an internal pricing model. As of December 31, 2011 and 2010, we did not alter fair values provided by our valuation service providers or brokers or substitute them with an internal pricing model for such securities.
The following table identifies fixed income and equity securities and short-term investments as of December 31, 2011 by source of fair value determination:
($ in millions)
Fair
value
Percent
to total
Fair value based on internal sources
$ 7,047
8.6 %
Fair value based on external sources (1)
74,720
91.4
Total
$ 81,767
100.0 %
(1)Includes $3.87 billion that are valued using broker quotes.
For more detailed information on our accounting policy for the fair value of financial assets and the financial assets by level in the fair value hierarchy, see Note 6 of the consolidated financial statements.
Impairment of fixed income and equity securities For investments classified as available for sale, the difference between fair value and amortized cost for fixed income securities and cost for equity securities, net of certain other items and deferred income taxes (as disclosed in Note 5), is reported as a component of accumulated other comprehensive income on the Consolidated Statements of Financial Position and is not reflected in the operating results of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when a write-down is recorded due to an other-than-temporary decline in fair value. We have a comprehensive portfolio monitoring process to identify and evaluate each fixed income and equity security whose carrying value may be other-than-temporarily impaired.
For each fixed income security in an unrealized loss position, we assess whether management with the appropriate authority has made the decision to sell or whether it is more likely than not we will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, the security's decline in fair value is considered other than temporary and is recorded in earnings.
If we have not made the decision to sell the fixed income security and it is not more likely than not we will be required to sell the fixed income security before recovery of its amortized cost basis, we evaluate whether we expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. We use our best estimate of future cash flows expected to be collected from the fixed income security, discounted at the security's original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists. The
determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, foreign exchange rates, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate recovery value if we determine that the security is dependent on the liquidation of collateral for ultimate settlement. If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an other-than-temporary impairment for the difference between the estimated recovery value and amortized cost is recorded in earnings. The portion of the unrealized loss related to factors other than credit remains classified in accumulated other comprehensive income. If we determine that the fixed income security does not have sufficient cash flow or other information to estimate a recovery value for the security, we may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.
There are a number of assumptions and estimates inherent in evaluating impairments of equity securities and determining if they are other than temporary, including: 1) our ability and intent to hold the investment for a period of time sufficient to allow for an anticipated recovery in value; 2) the length of time and extent to which the fair value has been less than cost; 3) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; and 4) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity.
Once assumptions and estimates are made, any number of changes in facts and circumstances could cause us to subsequently determine that a fixed income or equity security is other-than-temporarily impaired, including: 1) general economic conditions that are worse than previously forecasted or that have a greater adverse effect on a particular issuer or industry sector than originally estimated; 2) changes in the facts and circumstances related to a particular issue or issuer's ability to meet all of its contractual obligations; and 3) changes in facts and circumstances that result in changes to management's intent to sell or result in our assessment that it is more likely than not we will be required to sell before recovery of the amortized cost basis of a fixed income security or causes a change in our ability or intent to hold an equity security until it recovers in value. Changes in assumptions, facts and circumstances could result in additional charges to earnings in future periods to the extent that losses are realized. The charge to earnings, while potentially significant to net income, would not have a significant effect on shareholders' equity, since our securities are designated as available for sale and carried at fair value and as a result, any related unrealized loss, net of deferred income taxes and related DAC, deferred sales inducement costs ("DSI") and reserves for life-contingent contract benefits, would already be reflected as a component of accumulated other comprehensive income in shareholders' equity.
The determination of the amount of other-than-temporary impairment is an inherently subjective process based on periodic evaluation of the factors described above. Such evaluations and assessments are revised as conditions change and new information becomes available. We update our evaluations regularly and reflect changes in other-than-temporary impairments in results of operations as such evaluations are revised. The use of different methodologies and assumptions in the determination of the amount of other-than-temporary impairments may have a material effect on the amounts presented within the consolidated financial statements.
For additional detail on investment impairments, see Note 5 of the consolidated financial statements.
Deferred policy acquisition costs amortization We incur significant costs in connection with acquiring insurance policies and investment contracts. In accordance with GAAP, costs that vary with and are primarily related to acquiring insurance policies and investment contracts are deferred and recorded as an asset on the Consolidated Statements of Financial Position.
DAC related to property-liability contracts is amortized into income as premiums are earned, typically over periods of six or twelve months. The amortization methodology for DAC related to Allstate Financial policies and contracts includes significant assumptions and estimates.
DAC related to traditional life insurance is amortized over the premium paying period of the related policies in proportion to the estimated revenues on such business. Significant assumptions relating to estimated premiums, investment returns, as well as mortality, persistency and expenses to administer the business are established at the time
the policy is issued and are generally not revised during the life of the policy. The assumptions for determining the timing and amount of DAC amortization are consistent with the assumptions used to calculate the reserve for life-contingent contract benefits. Any deviations from projected business in force resulting from actual policy terminations differing from expected levels and any estimated premium deficiencies may result in a change to the rate of amortization in the period such events occur. Generally, the amortization periods for these policies approximates the estimated lives of the policies. The recovery of DAC is dependent upon the future profitability of the business. We periodically review the adequacy of reserves and recoverability of DAC for these policies on an aggregate basis using actual experience. We aggregate all traditional life insurance products and immediate annuities with life contingencies in the analysis. In the event actual experience is significantly adverse compared to the original assumptions and a premium deficiency is determined to exist, any remaining unamortized DAC balance must be expensed to the extent not recoverable and a premium deficiency reserve may be required if the remaining DAC balance is insufficient to absorb the deficiency. In 2011, 2010 and 2009, our reviews concluded that no premium deficiency adjustments were necessary, primarily due to projected profit from traditional life insurance more than offsetting the projected losses in immediate annuities with life contingencies.
DAC related to interest-sensitive life, fixed annuities and other investment contracts is amortized in proportion to the incidence of the total present value of gross profits, which includes both actual historical gross profits ("AGP") and estimated future gross profits ("EGP") expected to be earned over the estimated lives of the contracts. The amortization is net of interest on the prior period DAC balance using rates established at the inception of the contracts. Actual amortization periods generally range from 15-30 years; however, incorporating estimates of the rate of customer surrenders, partial withdrawals and deaths generally results in the majority of the DAC being amortized during the surrender charge period, which is typically 10-20 years for interest-sensitive life and 5-10 years for fixed annuities. The cumulative DAC amortization is reestimated and adjusted by a cumulative charge or credit to income when there is a difference between the incidence of actual versus expected gross profits in a reporting period or when there is a change in total EGP.
AGP and EGP primarily consist of the following components: contract charges for the cost of insurance less mortality costs and other benefits (benefit margin); investment income and realized capital gains and losses less interest credited (investment margin); and surrender and other contract charges less maintenance expenses (expense margin). The principal assumptions for determining the amount of EGP are investment returns, including capital gains and losses on assets supporting contract liabilities, interest crediting rates to contractholders, and the effects of persistency, mortality, expenses, and hedges if applicable, and these assumptions are reasonably likely to have the greatest impact on the amount of DAC amortization. Changes in these assumptions can be offsetting and we are unable to reasonably predict their future movements or offsetting impacts over time.
Each reporting period, DAC amortization is recognized in proportion to AGP for that period adjusted for interest on the prior period DAC balance. This amortization process includes an assessment of AGP compared to EGP, the actual amount of business remaining in force and realized capital gains and losses on investments supporting the product liability. The impact of realized capital gains and losses on amortization of DAC depends upon which product liability is supported by the assets that give rise to the gain or loss. If the AGP is greater than EGP in the period, but the total EGP is unchanged, the amount of DAC amortization will generally increase, resulting in a current period decrease to earnings. The opposite result generally occurs when the AGP is less than the EGP in the period, but the total EGP is unchanged. However, when DAC amortization or a component of gross profits for a quarterly period is potentially negative (which would result in an increase of the DAC balance) as a result of negative AGP, the specific facts and circumstances surrounding the potential negative amortization are considered to determine whether it is appropriate for recognition in the consolidated financial statements. Negative amortization is only recorded when the increased DAC balance is determined to be recoverable based on facts and circumstances. Negative amortization was not recorded for certain fixed annuities during 2011, 2010 and 2009 periods in which significant capital losses were realized on their related investment portfolio. For products whose supporting investments are exposed to capital losses in excess of our expectations which may cause periodic AGP to become temporarily negative, EGP and AGP utilized in DAC amortization may be modified to exclude the excess capital losses.
Annually, we review and update all assumptions underlying the projections of EGP, including investment returns, comprising investment income and realized capital gains and losses, interest crediting rates, persistency, mortality, expenses and the effect of any hedges. At each reporting period, we assess whether any revisions to assumptions used to determine DAC amortization are required. These reviews and updates may result in amortization acceleration or deceleration, which are commonly referred to as "DAC unlocking". If the update of assumptions causes total EGP to increase, the rate of DAC amortization will generally decrease, resulting in a current period increase to earnings. A decrease to earnings generally occurs when the assumption update causes the total EGP to decrease.
Over the past three years, our most significant DAC assumption updates that resulted in a change to EGP and the amortization of DAC have been revisions to expected future investment returns, primarily realized capital losses, mortality, expenses and the number of contracts in force or persistency. The following table provides the effect on DAC amortization of changes in assumptions relating to the gross profit components of investment margin, benefit margin and expense margin during the years ended December 31.
($ in millions)
Investment margin
$
$
$ (399 )
Benefit margin
(45 )
Expense margin
(21 )
(7 )
Net (acceleration) deceleration
$ (12 ) $
$ (277 )
In 2011, DAC amortization deceleration related to changes in the investment margin component of EGP primarily related to equity-indexed annuities and was due to an increase in projected investment margins. The deceleration related to benefit margin was primarily due to increased projected persistency on interest-sensitive life insurance. The acceleration related to expense margin primarily related to interest-sensitive life insurance and was due to an increase in projected expenses. In 2010, DAC amortization deceleration related to changes in the investment margin component of EGP primarily related to interest-sensitive life insurance and was due to higher than previously projected investment income and lower interest credited, partially offset by higher projected realized capital losses. The acceleration related to benefit margin was primarily due to lower projected renewal premium (which is also expected to reduce persistency) on interest-sensitive life insurance, partially offset by higher than previously projected revenues associated with variable life insurance due to appreciation in the underlying separate account valuations. The deceleration related to expense margin resulted from current and expected expense levels lower than previously projected. DAC amortization acceleration related to changes in the investment margin component of EGP in the first quarter of 2009 was primarily due to an increase in the level of expected realized capital losses in 2009 and 2010. The deceleration related to benefit margin was due to more favorable projected life insurance mortality. The acceleration related to expense margin resulted from current and expected expense levels higher than previously projected.
The following table displays the sensitivity of reasonably likely changes in assumptions included in the gross profit components of investment margin or benefit margin to amortization of the DAC balance as of December 31, 2011.
($ in millions)
Increase/(reduction) in DAC
Increase in future investment margins of 25 basis points
$
Decrease in future investment margins of 25 basis points
$ (81 )
Decrease in future life mortality by 1%
$
Increase in future life mortality by 1%
$ (22 )
Any potential changes in assumptions discussed above are measured without consideration of correlation among assumptions. Therefore, it would be inappropriate to add them together in an attempt to estimate overall variability in amortization.
For additional detail related to DAC, see the Allstate Financial Segment section of this document.
Reserve for property-liability insurance claims and claims expense estimation Reserves are established to provide for the estimated costs of paying claims and claims expenses under insurance policies we have issued. Property-Liability underwriting results are significantly influenced by estimates of property-liability insurance claims and claims expense reserves. These reserves are an estimate of amounts necessary to settle all outstanding claims, including claims that have been incurred but not reported ("IBNR"), as of the financial statement date.
Characteristics of reserves Reserves are established independently of business segment management for each business segment and line of business based on estimates of the ultimate cost to settle claims, less losses that have been paid. The significant lines of business are auto, homeowners, and other lines for Allstate Protection, and asbestos, environmental, and other discontinued lines for Discontinued Lines and Coverages. Allstate Protection's claims are typically reported promptly with relatively little reporting lag between the date of occurrence and the date the loss is reported. Auto and homeowners liability losses generally take an average of about two years to settle, while auto physical damage, homeowners property and other personal lines have an average settlement time of less than one year. Discontinued Lines and Coverages involve long-tail losses, such as those related to asbestos and environmental claims, which often involve substantial reporting lags and extended times to settle.
Reserves are the difference between the estimated ultimate cost of losses incurred and the amount of paid losses as of the reporting date. Reserves are estimated for both reported and unreported claims, and include estimates of all expenses associated with processing and settling all incurred claims. We update most of our reserve estimates quarterly and as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Changes in prior year reserve estimates (reserve reestimates), which may be material, are determined by comparing updated estimates of ultimate losses to prior estimates, and the differences are recorded as property-liability insurance claims and claims expense in the Consolidated Statements of Operations in the period such changes are determined. Estimating the ultimate cost of claims and claims expenses is an inherently uncertain and complex process involving a high degree of judgment and is subject to the evaluation of numerous variables.
The actuarial methods used to develop reserve estimates Reserve estimates are derived by using several different actuarial estimation methods that are variations on one primary actuarial technique. The actuarial technique is known as a "chain ladder" estimation process in which historical loss patterns are applied to actual paid losses and reported losses (paid losses plus individual case reserves established by claim adjusters) for an accident year or a report year to create an estimate of how losses are likely to develop over time. An accident year refers to classifying claims based on the year in which the claims occurred. A report year refers to classifying claims based on the year in which the claims are reported. Both classifications are used to prepare estimates of required reserves for payments to be made in the future. The key assumptions affecting our reserve estimates comprise data elements including claim counts, paid losses, case reserves, and development factors calculated with this data.
In the chain ladder estimation technique, a ratio (development factor) is calculated which compares current period results to results in the prior period for each accident year. A three-year or two-year average development factor, based on historical results, is usually multiplied by the current period experience to estimate the development of losses of each accident year into the next time period. The development factors for the future time periods for each accident year are compounded over the remaining future periods to calculate an estimate of ultimate losses for each accident year. The implicit assumption of this technique is that an average of historical development factors is predictive of future loss development, as the significant size of our experience data base achieves a high degree of statistical credibility in actuarial projections of this type. The effects of inflation are implicitly considered in the reserving process, the implicit assumption being that a multi-year average development factor includes an adequate provision. Occasionally, unusual aberrations in loss patterns are caused by external and internal factors such as changes in claim reporting, settlement patterns, unusually large losses, process changes, legal or regulatory changes, and other influences. In these instances, analyses of alternate development factor selections are performed to evaluate the effect of these factors and actuarial judgment is applied to make appropriate development factor assumptions needed to develop a best estimate of ultimate losses.
How reserve estimates are established and updated Reserve estimates are developed at a very detailed level, and the results of these numerous micro-level best estimates are aggregated to form a consolidated reserve estimate. For example, over one thousand actuarial estimates of the types described above are prepared each quarter to estimate losses for each line of insurance, major components of losses (such as coverages and perils), major states or groups of states and for reported losses and IBNR. The actuarial methods described above are used to analyze the settlement patterns of claims by determining the development factors for specific data elements that are necessary components of a reserve estimation process. Development factors are calculated quarterly and periodically throughout the year for data elements such as claim counts reported and settled, paid losses, and paid losses combined with case reserves. The calculation of development factors from changes in these data elements also impacts claim severity trends, which is a common industry reference used to explain changes in reserve estimates. The historical development patterns for these data elements are used as the assumptions to calculate reserve estimates.
Often, several different estimates are prepared for each detailed component, incorporating alternative analyses of changing claim settlement patterns and other influences on losses, from which we select our best estimate for each component, occasionally incorporating additional analyses and actuarial judgment, as described above. These micro-level estimates are not based on a single set of assumptions. Actuarial judgments that may be applied to these components of certain micro-level estimates generally do not have a material impact on the consolidated level of reserves. Moreover, this detailed micro-level process does not permit or result in a compilation of a company-wide roll up to generate a range of needed loss reserves that would be meaningful. Based on our review of these estimates, our best estimate of required reserves for each state/line/coverage component is recorded for each accident year, and the required reserves for each component are summed to create the reserve balance carried on our Consolidated Statements of Financial Position.
Reserves are reestimated quarterly and periodically throughout the year, by combining historical results with current actual results to calculate new development factors. This process incorporates the historic and latest actual trends, and other underlying changes in the data elements used to calculate reserve estimates. New development factors are likely to differ from previous development factors used in prior reserve estimates because actual results (claims reported or settled, losses paid, or changes to case reserves) occur differently than the implied assumptions contained in the previous development factor calculations. If claims reported, paid losses, or case reserve changes are greater or less than the levels estimated by previous development factors, reserve reestimates increase or decrease. When actual development of these data elements is different than the historical development pattern used in a prior period reserve estimate, a new reserve is determined. The difference between indicated reserves based on new reserve estimates and recorded reserves (the previous estimate) is the amount of reserve reestimate and is recognized as an increase or decrease in property-liability insurance claims and claims expense in the Consolidated Statements of Operations. Total Property-liability reserve reestimates, after-tax, as a percent of net income in 2011, 2010 and 2009 were 27.7%, 11.1%, and 8.5%, respectively. For Property-Liability, the 3-year average of reserve reestimates as a percentage of total reserves was a favorable 1.2%, for Allstate Protection, the 3-year average of reserve estimates was a favorable 1.5% and for Discontinued Lines and Coverages, the 3-year average of reserve reestimates was an unfavorable 1.3%, each of these results being consistent within a reasonable actuarial tolerance for our respective businesses. A more detailed discussion of reserve reestimates is presented in the Property-Liability Claims and Claims Expense Reserves section of this document.
The following table shows net claims and claims expense reserves by segment and line of business as of December 31:
($ in millions)
Allstate Protection
Auto
$ 11,404
$ 11,034
$ 10,606
Homeowners
2,439
2,442
2,399
Other lines
2,237
2,141
2,145
Total Allstate Protection
16,080
15,617
15,150
Discontinued Lines and Coverages
Asbestos
1,078
1,100
1,180
Environmental
Other discontinued lines
Total Discontinued Lines and Coverages
1,707
1,779
1,878
Total Property-Liability
$ 17,787
$ 17,396
$ 17,028
Allstate Protection reserve estimates
Factors affecting reserve estimates Reserve estimates are developed based on the processes and historical development trends as previously described. These estimates are considered in conjunction with known facts and interpretations of circumstances and factors including our experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. When we experience changes of the type previously mentioned, we may need to apply actuarial judgment in the determination and selection of development factors considered more reflective of the new trends, such as combining shorter or longer periods of historical results with current actual results to produce development factors based on two-year, three-year, or longer development periods to reestimate our reserves. For example, if a legal change is expected to have a significant impact on the development of claim severity for a coverage which is part of a particular line of insurance in a specific state, actuarial judgment is applied to determine appropriate development factors that will most accurately reflect the expected impact on that specific estimate. Another example would be when a change in economic conditions is expected to affect the cost of repairs to damaged autos or property for a particular line, coverage, or state, actuarial judgment is applied to determine appropriate development factors to use in the reserve estimate that will most accurately reflect the expected impacts on severity development.
As claims are reported, for certain liability claims of sufficient size and complexity, the field adjusting staff establishes case reserve estimates of ultimate cost, based on their assessment of facts and circumstances related to each individual claim. For other claims which occur in large volumes and settle in a relatively short time frame, it is not practical or efficient to set case reserves for each claim, and a statistical case reserve is set for these claims based on
estimation techniques previously described. In the normal course of business, we may also supplement our claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims.
Historically, the case reserves set by the field adjusting staff have not proven to be an entirely accurate estimate of the ultimate cost of claims. To provide for this, a development reserve is estimated using previously described processes, and allocated to pending claims as a supplement to case reserves. Typically, the case and supplemental development reserves comprise about 90% of total reserves.
Another major component of reserves is IBNR. Typically, IBNR comprises about 10% of total reserves.
Generally, the initial reserves for a new accident year are established based on severity assumptions for different business segments, lines and coverages based on historical relationships to relevant inflation indicators, and reserves for prior accident years are statistically determined using processes previously described. Changes in auto current year claim severity are generally influenced by inflation in the medical and auto repair sectors of the economy. We mitigate these effects through various loss management programs. Injury claims are affected largely by medical cost inflation while physical damage claims are affected largely by auto repair cost inflation and used car prices. For auto physical damage coverages, we monitor our rate of increase in average cost per claim against a weighted average of the Maintenance and Repair price index and the Parts and Equipment price index. We believe our claim settlement initiatives, such as improvements to the claim review and settlement process, the use of special investigative units to detect fraud and handle suspect claims, litigation management and defense strategies, as well as various other loss management initiatives underway, contribute to the mitigation of injury and physical damage severity trends.
Changes in homeowners current year claim severity are generally influenced by inflation in the cost of building materials, the cost of construction and property repair services, the cost of replacing home furnishings and other contents, the types of claims that qualify for coverage, deductibles and other economic and environmental factors. We employ various loss management programs to mitigate the effect of these factors.
As loss experience for the current year develops for each type of loss, it is monitored relative to initial assumptions until it is judged to have sufficient statistical credibility. From that point in time and forward, reserves are reestimated using statistical actuarial processes to reflect the impact actual loss trends have on development factors incorporated into the actuarial estimation processes. Statistical credibility is usually achieved by the end of the first calendar year; however, when trends for the current accident year exceed initial assumptions sooner, they are usually determined to be credible, and reserves are increased accordingly.
The very detailed processes for developing reserve estimates, and the lack of a need and existence of a common set of assumptions or development factors, limits aggregate reserve level testing for variability of data elements. However, by applying standard actuarial methods to consolidated historic accident year loss data for major loss types, comprising auto injury losses, auto physical damage losses and homeowner losses, we develop variability analyses consistent with the way we develop reserves by measuring the potential variability of development factors, as described in the section titled "Potential Reserve Estimate Variability" below.
Causes of reserve estimate uncertainty Since reserves are estimates of unpaid portions of claims and claims expenses that have occurred, including IBNR losses, the establishment of appropriate reserves, including reserves for catastrophes, requires regular reevaluation and refinement of estimates to determine our ultimate loss estimate.
At each reporting date, the highest degree of uncertainty in estimates of losses arises from claims remaining to be settled for the current accident year and the most recent preceding accident year. The greatest degree of uncertainty exists in the current accident year because the current accident year contains the greatest proportion of losses that have not been reported or settled but must be estimated as of the current reporting date. Most of these losses relate to damaged property such as automobiles and homes, and medical care for injuries from accidents. During the first year after the end of an accident year, a large portion of the total losses for that accident year are settled. When accident year losses paid through the end of the first year following the initial accident year are incorporated into updated actuarial estimates, the trends inherent in the settlement of claims emerge more clearly. Consequently, this is the point in time at which we tend to make our largest reestimates of losses for an accident year. After the second year, the losses that we pay for an accident year typically relate to claims that are more difficult to settle, such as those involving serious injuries or litigation. Private passenger auto insurance provides a good illustration of the uncertainty of future loss estimates: our typical annual percentage payout of reserves for an accident year is approximately 45% in the first year after the end of the accident year, 20% in the second year, 15% in the third year, 10% in the fourth year, and the remaining 10% thereafter.
Reserves for catastrophe losses Property-Liability claims and claims expense reserves also include reserves for catastrophe losses. Catastrophe losses are an inherent risk of the property-liability insurance industry that have contributed, and will continue to contribute, to potentially material year-to-year fluctuations in our results of operations and financial position. We define a "catastrophe" as an event that produces pre-tax losses before reinsurance in excess of $1 million and involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are caused by various natural events including high winds, winter storms, tornadoes, hailstorms, wildfires, tropical storms, hurricanes, earthquakes and volcanoes. We are also exposed to man-made catastrophic events, such as certain types of terrorism or industrial accidents. The nature and level of catastrophes in any period cannot be predicted.
The estimation of claims and claims expense reserves for catastrophes also comprises estimates of losses from reported claims and IBNR, primarily for damage to property. In general, our estimates for catastrophe reserves are based on claim adjuster inspections and the application of historical loss development factors as described previously. However, depending on the nature of the catastrophe, as noted above, the estimation process can be further complicated. For example, for hurricanes, complications could include the inability of insureds to promptly report losses, limitations placed on claims adjusting staff affecting their ability to inspect losses, determining whether losses are covered by our homeowners policy (generally for damage caused by wind or wind driven rain) or specifically excluded coverage caused by flood, estimating additional living expenses, and assessing the impact of demand surge, exposure to mold damage, and the effects of numerous other considerations, including the timing of a catastrophe in relation to other events, such as at or near the end of a financial reporting period, which can affect the availability of information needed to estimate reserves for that reporting period. In these situations, we may need to adapt our practices to accommodate these circumstances in order to determine a best estimate of our losses from a catastrophe. As an example, in 2005 to complete an estimate for certain areas affected by Hurricane Katrina and not yet inspected by our claims adjusting staff, or where we believed our historical loss development factors were not predictive, we relied on analysis of actual claim notices received compared to total PIF, as well as visual, governmental and third party information, including aerial photos, area observations, and data on wind speed and flood depth to the extent available.
Potential reserve estimate variability The aggregation of numerous micro-level estimates for each business segment, line of insurance, major components of losses (such as coverages and perils), and major states or groups of states for reported losses and IBNR forms the reserve liability recorded in the Consolidated Statements of Financial Position. Because of this detailed approach to developing our reserve estimates, there is not a single set of assumptions that determine our reserve estimates at the consolidated level. Given the numerous micro-level estimates for reported losses and IBNR, management does not believe the processes that we follow will produce a statistically credible or reliable actuarial reserve range that would be meaningful. Reserve estimates, by their very nature, are very complex to determine and subject to significant judgment, and do not represent an exact determination for each outstanding claim. Accordingly, as actual claims, and/or paid losses, and/or case reserve results emerge, our estimate of the ultimate cost to settle will be different than previously estimated.
To develop a statistical indication of potential reserve variability within reasonably likely possible outcomes, an actuarial technique (stochastic modeling) is applied to the countrywide consolidated data elements for paid losses and paid losses combined with case reserves separately for injury losses, auto physical damage losses, and homeowners losses excluding catastrophe losses. Based on the combined historical variability of the development factors calculated for these data elements, an estimate of the standard error or standard deviation around these reserve estimates is calculated within each accident year for the last twenty years for each type of loss. The variability of these reserve estimates within one standard deviation of the mean (a measure of frequency of dispersion often viewed to be an acceptable level of accuracy) is believed by management to represent a reasonable and statistically probable measure of potential variability. Based on our products and coverages, historical experience, the statistical credibility of our extensive data and stochastic modeling of actuarial chain ladder methodologies used to develop reserve estimates, we estimate that the potential variability of our Allstate Protection reserves, excluding reserves for catastrophe losses, within a reasonable probability of other possible outcomes, may be approximately plus or minus 4%, or plus or minus $450 million in net income. A lower level of variability exists for auto injury losses, which comprise approximately 75% of reserves, due to their relatively stable development patterns over a longer duration of time required to settle claims. Other types of losses, such as auto physical damage, homeowners losses and other losses, which comprise about 25% of reserves, tend to have greater variability but are settled in a much shorter period of time. Although this evaluation reflects most reasonably likely outcomes, it is possible the final outcome may fall below or above these amounts. Historical variability of reserve estimates is reported in the Property-Liability Claims and Claims Expense Reserves section of this document.
Adequacy of reserve estimates We believe our net claims and claims expense reserves are appropriately established based on available methodology, facts, technology, laws and regulations. We calculate and record a single best reserve estimate, in conformance with generally accepted actuarial standards, for each line of insurance, its components (coverages and perils) and state, for reported losses and for IBNR losses, and as a result we believe that no other estimate is better than our recorded amount. Due to the uncertainties involved, the ultimate cost of losses may vary materially from recorded amounts, which are based on our best estimates.
Discontinued Lines and Coverages reserve estimates
Characteristics of Discontinued Lines exposure We continue to receive asbestos and environmental claims. Asbestos claims relate primarily to bodily injuries asserted by people who were exposed to asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up costs.
Our exposure to asbestos, environmental and other discontinued lines claims arises principally from assumed reinsurance coverage written during the 1960s through the mid-1980s, including reinsurance on primary insurance written on large U.S. companies, and from direct excess insurance written from 1972 through 1985, including substantial excess general liability coverages on large U.S. companies. Additional exposure stems from direct primary commercial insurance written during the 1960s through the mid-1980s. Other discontinued lines exposures primarily relate to general liability and product liability mass tort claims, such as those for medical devices and other products.
In 1986, the general liability policy form used by us and others in the property-liability industry was amended to introduce an "absolute pollution exclusion," which excluded coverage for environmental damage claims, and to add an asbestos exclusion. Most general liability policies issued prior to 1987 contain annual aggregate limits for product liability coverage. General liability policies issued in 1987 and thereafter contain annual aggregate limits for product liability coverage and annual aggregate limits for all coverages. Our experience to date is that these policy form changes have limited the extent of our exposure to environmental and asbestos claim risks.
Our exposure to liability for asbestos, environmental and other discontinued lines losses manifests differently depending on whether it arises from assumed reinsurance coverage, direct excess insurance or direct primary commercial insurance. The direct insurance coverage we provided that covered asbestos, environmental and other discontinued lines was substantially "excess" in nature.
Direct excess insurance and reinsurance involve coverage written by us for specific layers of protection above retentions and other insurance plans. The nature of excess coverage and reinsurance provided to other insurers limits our exposure to loss to specific layers of protection in excess of policyholder retention on primary insurance plans. Our exposure is further limited by the significant reinsurance that we had purchased on our direct excess business.
Our assumed reinsurance business involved writing generally small participations in other insurers' reinsurance programs. The reinsured losses in which we participate may be a proportion of all eligible losses or eligible losses in excess of defined retentions. The majority of our assumed reinsurance exposure, approximately 85%, is for excess of loss coverage, while the remaining 15% is for pro-rata coverage.
Our direct primary commercial insurance business did not include coverage to large asbestos manufacturers. This business comprises a cross section of policyholders engaged in many diverse business sectors located throughout the country.
How reserve estimates are established and updated We conduct an annual review in the third quarter to evaluate and establish asbestos, environmental and other discontinued lines reserves. Changes to reserves are recorded in the reporting period in which they are determined. Using established industry and actuarial best practices and assuming no change in the regulatory or economic environment, this detailed and comprehensive methodology determines asbestos reserves based on assessments of the characteristics of exposure (i.e. claim activity, potential liability, jurisdiction, products versus non-products exposure) presented by individual policyholders, and determines environmental reserves based on assessments of the characteristics of exposure (i.e. environmental damages, respective shares of liability of potentially responsible parties, appropriateness and cost of remediation) to pollution and related clean-up costs. The number and cost of these claims is affected by intense advertising by trial lawyers seeking asbestos plaintiffs, and entities with asbestos exposure seeking bankruptcy protection as a result of asbestos liabilities, initially causing a delay in the reporting of claims, often followed by an acceleration and an increase in claims and claims expenses as settlements occur.
After evaluating our insureds' probable liabilities for asbestos and/or environmental claims, we evaluate our insureds' coverage programs for such claims. We consider our insureds' total available insurance coverage, including the
coverage we issued. We also consider relevant judicial interpretations of policy language and applicable coverage defenses or determinations, if any.
Evaluation of both the insureds' estimated liabilities and our exposure to the insureds depends heavily on an analysis of the relevant legal issues and litigation environment. This analysis is conducted by our specialized claims adjusting staff and legal counsel. Based on these evaluations, case reserves are established by claims adjusting staff and actuarial analysis is employed to develop an IBNR reserve, which includes estimated potential reserve development and claims that have occurred but have not been reported. As of December 31, 2011 and 2010, IBNR was 59.0% and 60.1%, respectively, of combined asbestos and environmental reserves.
For both asbestos and environmental reserves, we also evaluate our historical direct net loss and expense paid and incurred experience to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid and incurred activity.
Other Discontinued Lines and Coverages The following table shows reserves for other discontinued lines which provide for remaining loss and loss expense liabilities related to business no longer written by us, other than asbestos and environmental, as of December 31.
($ in millions)
Other mass torts
$
$
$
Workers' compensation
Commercial and other
Other discontinued lines
$
$
$
Other mass torts describes direct excess and reinsurance general liability coverage provided for cumulative injury losses other than asbestos and environmental. Workers' compensation and commercial and other include run-off from discontinued direct primary, direct excess and reinsurance commercial insurance operations of various coverage exposures other than asbestos and environmental. Reserves are based on considerations similar to those previously described, as they relate to the characteristics of specific individual coverage exposures.
Potential reserve estimate variability Establishing Discontinued Lines and Coverages net loss reserves for asbestos, environmental and other discontinued lines claims is subject to uncertainties that are much greater than those presented by other types of claims. Among the complications are lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure and unresolved legal issues regarding policy coverage; unresolved legal issues regarding the determination, availability and timing of exhaustion of policy limits; plaintiffs' evolving and expanding theories of liability; availability and collectability of recoveries from reinsurance; retrospectively determined premiums and other contractual agreements; estimates of the extent and timing of any contractual liability; the impact of bankruptcy protection sought by various asbestos producers and other asbestos defendants; and other uncertainties. There are also complex legal issues concerning the interpretation of various insurance policy provisions and whether those losses are covered, or were ever intended to be covered, and could be recoverable through retrospectively determined premium, reinsurance or other contractual agreements. Courts have reached different and sometimes inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are covered; whether there is an insurer obligation to defend; how policy limits are determined; how policy exclusions and conditions are applied and interpreted; and whether clean-up costs represent insured property damage. Our reserves for asbestos and environmental exposures could be affected by tort reform, class action litigation, and other potential legislation and judicial decisions. Environmental exposures could also be affected by a change in the existing federal Superfund law and similar state statutes. There can be no assurance that any reform legislation will be enacted or that any such legislation will provide for a fair, effective and cost-efficient system for settlement of asbestos or environmental claims. We believe these issues are not likely to be resolved in the near future, and the ultimate costs may vary materially from the amounts currently recorded resulting in material changes in loss reserves. Historical variability of reserve estimates is demonstrated in the Property-Liability Claims and Claims Expense Reserves section of this document.
Adequacy of reserve estimates Management believes its net loss reserves for environmental, asbestos and other discontinued lines exposures are appropriately established based on available facts, technology, laws, regulations, and assessments of other pertinent factors and characteristics of exposure (i.e. claim activity, potential liability, jurisdiction, products versus non-products exposure) presented by individual policyholders, assuming no change in the legal, legislative or economic environment. Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserves that may be required.
Further discussion of reserve estimates For further discussion of these estimates and quantification of the impact of reserve estimates, reserve reestimates and assumptions, see Notes 8 and 14 to the consolidated financial statements and the Property-Liability Claims and Claims Expense Reserves section of this document.
Reserve for life-contingent contract benefits estimation Due to the long term nature of traditional life insurance, life-contingent immediate annuities and voluntary accident and health products, benefits are payable over many years; accordingly, the reserves are calculated as the present value of future expected benefits to be paid, reduced by the present value of future expected net premiums. Long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses are used when establishing the reserve for life-contingent contract benefits payable under these insurance policies. These assumptions, which for traditional life insurance are applied using the net level premium method, include provisions for adverse deviation and generally vary by characteristics such as type of coverage, year of issue and policy duration. Future investment yield assumptions are determined based upon prevailing investment yields as well as estimated reinvestment yields. Mortality, morbidity and policy termination assumptions are based on our experience and industry experience. Expense assumptions include the estimated effects of inflation and expenses to be incurred beyond the premium-paying period. These assumptions are established at the time the policy is issued, are consistent with assumptions for determining DAC amortization for these policies, and are generally not changed during the policy coverage period. However, if actual experience emerges in a manner that is significantly adverse relative to the original assumptions, adjustments to DAC or reserves may be required resulting in a charge to earnings which could have a material effect on our operating results and financial condition. We periodically review the adequacy of reserves and recoverability of DAC for these policies on an aggregate basis using actual experience. In the event actual experience is significantly adverse compared to the original assumptions and a premium deficiency is determined to exist, any remaining unamortized DAC balance must be expensed to the extent not recoverable and the establishment of a premium deficiency reserve may be required. In 2011, 2010 and 2009, our reviews concluded that no premium deficiency adjustments were necessary, primarily due to profit from traditional life insurance more than offsetting the projected losses in immediate annuities with life contingencies. We will continue to monitor the experience of our traditional life insurance and immediate annuities. We anticipate that mortality, investment and reinvestment yields, and policy terminations are the factors that would be most likely to require premium deficiency adjustments to these reserves or related DAC.
For further detail on the reserve for life-contingent contract benefits, see Note 9 of the consolidated financial statements.
PROPERTY-LIABILITY 2011 HIGHLIGHTS
•Premiums written, an operating measure that is defined and reconciled to premiums earned in the Property-Liability Operations section of the MD&A, increased 0.3% to $25.98 billion in 2011 from $25.91 billion in 2010.
-Allstate brand standard auto premiums written decreased 0.9% to $15.70 billion in 2011 from $15.84 billion in 2010. -Allstate brand homeowners premiums written increased 2.4% to $5.89 billion in 2011 from $5.75 billion in 2010. -Encompass brand premiums written decreased 3.6% to $1.06 billion in 2011 from $1.10 billion 2010. -Esurance brand premiums written were $181 million in 2011 for the period from the October 7, 2011 acquisition date to December 31, 2011. •Premium operating measures and statistics contributing to overall Allstate brand standard auto premiums written decrease were the following:
-1.5% decrease in PIF as of December 31, 2011 compared to December 31, 2010 -0.2% increase in the six month policy term average gross premium before reinsurance to $444 in 2011 from $443 in 2010 -0.3 point increase in the six month renewal ratio to 89.0% in 2011 compared to 88.7% in 2010 -5.8% decrease in new issued applications in 2011 compared to 2010 •Premium operating measures and statistics contributing to overall Allstate brand homeowners premiums written increase were the following:
-4.8% decrease in PIF as of December 31, 2011 compared to December 31, 2010 -5.9% increase in the twelve month policy term average gross premium before reinsurance to $999 in 2011 from $943 in 2010 -0.1 point decrease in the twelve month renewal ratio to 88.3% in 2011 compared to 88.4% in 2010 -14.9% decrease in new issued applications in 2011 compared to 2010 -$39 million decrease in catastrophe reinsurance costs to $495 million in 2011 from $534 million in
•Factors comprising the Allstate brand standard auto loss ratio decrease of 0.1 points to 70.6 in 2011 from 70.7 in 2010 were the following:
-1.6 point increase in the effect of catastrophe losses to 2.6 points in 2011 compared to 1.0 points in 2010 -2.0% decrease in standard auto claim frequency for property damage in 2011 compared to 2010 -1.6% decrease in standard auto claim frequency for bodily injury in 2011 compared to 2010 -2.2% increase in auto paid claim severities for property damage in 2011 compared to 2010 -1.5% increase in auto paid claim severities for bodily injury in 2011 compared to 2010
•Factors comprising the Allstate brand homeowners loss ratio, which includes catastrophes, increase of 15.9 points to 98.0 in 2011 from 82.1 in 2010 were the following:
-18.7 point increase in the effect of catastrophe losses to 50.0 points in 2011 compared to 31.3 points in 2010 -2.9% increase in homeowner claim frequency, excluding catastrophes, in 2011 compared to 2010 -2.1% increase in paid claim severity, excluding catastrophes, in 2011 compared to 2010 •Factors comprising the $1.61 billion increase in catastrophe losses to $3.82 billion in 2011 compared to $2.21 billion in 2010 were the following:
-91 events with losses of $3.95 billion in 2011 compared to 90 events with losses of $2.37 billion in 2010 -$130 million favorable prior year reserve reestimates in 2011 compared to $163 million favorable reserve reestimates in 2010 •Factors comprising the $335 million of favorable prior year reserve reestimates in 2011 compared to $159 million favorable in 2010 included:
-prior year reserve reestimates related to auto, homeowners and other personal lines in 2011 contributed $381 million favorable, $69 million favorable and $94 million unfavorable, respectively, compared to prior year reserve reestimates in 2010 of $179 million favorable, $23 million favorable and $15 million unfavorable, respectively -prior year reserve reestimates in 2011 and 2010 are largely attributable to severity development that was better than expected and catastrophes. Prior year reserve reestimates in 2010 also included a litigation settlement. •Property-Liability underwriting loss was $874 million in 2011 compared to underwriting income of $495 million in 2010. Underwriting income (loss), a measure not based on GAAP, is defined below. •Net realized capital gains were $85 million in 2011 compared to net realized capital losses of $321 million in 2010. •Property-Liability investments were $36.00 billion as of December 31, 2011, an increase of 2.7% from $35.05 billion as of December 31, 2010. Net investment income was $1.20 billion in 2011, an increase of 1.0% from $1.19 billion in 2010.
PROPERTY-LIABILITY OPERATIONS
Overview Our Property-Liability operations consist of two reporting segments: Allstate Protection and Discontinued Lines and Coverages. Allstate Protection comprises three brands: Allstate, Encompass and Esurance. Allstate Protection is principally engaged in the sale of personal property and casualty insurance, primarily private passenger auto and homeowners insurance, to individuals in the United States and Canada. Discontinued Lines and Coverages includes results from insurance coverage that we no longer write and results for certain commercial and other businesses in run-off. These segments are consistent with the groupings of financial information that management uses to evaluate performance and to determine the allocation of resources.
Underwriting income (loss), a measure that is not based on GAAP and is reconciled to net income (loss) below, is calculated as premiums earned, less claims and claims expense ("losses"), amortization of DAC, operating costs and expenses and restructuring and related charges, as determined using GAAP. We use this measure in our evaluation of results of operations to analyze the profitability of the Property-Liability insurance operations separately from investment results. It is also an integral component of incentive compensation. It is useful for investors to evaluate the components of income separately and in the aggregate when reviewing performance. Net income (loss) is the GAAP measure most directly comparable to underwriting income (loss). Underwriting income (loss) should not be considered as a substitute for net income and does not reflect the overall profitability of the business.
The table below includes GAAP operating ratios we use to measure our profitability. We believe that they enhance an investor's understanding of our profitability. They are calculated as follows:
•Claims and claims expense ("loss") ratio - the ratio of claims and claims expense to premiums earned. Loss ratios include the impact of catastrophe losses. •Expense ratio - the ratio of amortization of DAC, operating costs and expenses, and restructuring and related charges to premiums earned.
•Combined ratio - the ratio of claims and claims expense, amortization of DAC, operating costs and expenses, and restructuring and related charges to premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio. The difference between 100% and the combined ratio represents underwriting income (loss) as a percentage of premiums earned, or underwriting margin. We have also calculated the following impacts of specific items on the GAAP operating ratios because of the volatility of these items between fiscal periods.
•Effect of catastrophe losses on combined ratio - the percentage of catastrophe losses included in claims and claims expense to premiums earned. This ratio includes prior year reserve reestimates of catastrophe losses. •Effect of prior year reserve reestimates on combined ratio - the percentage of prior year reserve reestimates included in claims and claims expense to premiums earned. This ratio includes prior year reserve reestimates of catastrophe losses. •Effect of business combination expenses and the amortization of purchased intangible assets on combined and expense ratio - the percentage of business combination expenses and the amortization of purchased intangible assets to premiums earned. •Effect of restructuring and related charges on combined ratio - the percentage of restructuring and related charges to premiums earned. •Effect of Discontinued Lines and Coverages on combined ratio - the ratio of claims and claims expense and operating costs and expenses in the Discontinued Lines and Coverages segment to Property-Liability premiums earned. The sum of the effect of Discontinued Lines and Coverages on the combined ratio and the Allstate Protection combined ratio is equal to the Property-Liability combined ratio.
Summarized financial data, a reconciliation of underwriting (loss) income to net income, and GAAP operating ratios for our Property-Liability operations are presented in the following table.
($ in millions, except ratios)
Premiums written
$ 25,980
$ 25,907
$ 25,971
Revenues
Premiums earned
$ 25,942
$ 25,957
$ 26,194
Net investment income
1,201
1,189
1,328
Realized capital gains and losses
(321 )
(168 )
Total revenues
27,228
26,825
27,354
Costs and expenses
Claims and claims expense
(20,161 )
(18,951 )
(18,746 )
Amortization of DAC
(3,640 )
(3,678 )
(3,789 )
Operating costs and expenses
(2,972 )
(2,800 )
(2,559 )
Restructuring and related charges
(43 )
(33 )
(105 )
Total costs and expenses
(26,816 )
(25,462 )
(25,199 )
Gain on disposition of operations
-
-
Income tax expense
(4 )
(314 )
(612 )
Net income
$
$ 1,054
$ 1,543
Underwriting (loss) income
$
(874
)
$
$
Net investment income
1,201
1,189
1,328
Income tax benefit (expense) on operations
(426 )
(558 )
Realized capital gains and losses, after-tax
(207 )
(222 )
Gain on disposition of operations, after-tax
-
-
Net income
$
$ 1,054
$ 1,543
Catastrophe losses (1)
$
3,815
$
2,207
$
2,069
GAAP operating ratios
Claims and claims expense ratio
77.7
73.0
71.6
Expense ratio
25.7
25.1
24.6
Combined ratio
103.4
98.1
96.2
Effect of catastrophe losses on combined ratio (1)
14.7
8.5
7.9
Effect of prior year reserve reestimates on combined ratio (1)
(1.3 )
(0.6 )
(0.4 )
Effect of business combination expenses and the amortization of purchased intangible assets on combined ratio
0.2
-
-
Effect of restructuring and related charges on combined ratio
0.2
0.1
0.4
Effect of Discontinued Lines and Coverages on combined ratio
0.1
0.1
0.1
(1)Prior year reserve reestimates included in catastrophe losses totaled $130 million favorable in 2011, $163 million favorable in 2010 and $169 million favorable in 2009.
ALLSTATE PROTECTION SEGMENT
Overview and strategy The Allstate Protection segment primarily sells private passenger auto and homeowners insurance to individuals through Allstate exclusive agencies and directly through call centers and the internet under the Allstate brand. We sell auto and homeowners insurance through independent agencies under both the Allstate brand and the Encompass brand. We also sell auto insurance direct to consumers online, through a call center and through select agents, including Answer Financial, under the Esurance brand.
Our strategy is to position our products and distribution systems to meet the changing needs of the customer in managing the risks they face. This includes customers who want advice and assistance and those who are self-directed. In addition, there are customers who are brand-sensitive and those who are brand-neutral. Our strategy is to serve all
four of these sectors with unique products and in unique and innovative ways while leveraging our claims, pricing and operational capabilities. When we do not offer a product our customers need, we may offer non-proprietary products that meet their needs.
Our operating priorities for the Protection segment include achieving profitable market share growth for our auto business as well as earning acceptable returns on our homeowners business. Key goals include:
•Improving customer loyalty and retention;
•Deepening customer product relationships;
•Improving auto competitive position through price optimization;
•Improving the profitability of our homeowners business;
•Investing in the effectiveness and reach of our multiple distribution channels including self-directed consumers through our newly acquired Esurance brand; and
•Maintaining a strong capital foundation through risk management and effective resource allocation. Our customer-focused strategy for the Allstate brand aligns targeted marketing, product innovation, distribution effectiveness, and pricing toward acquiring and retaining an increased share of our target customers, which generally refers to consumers who want to purchase multiple products from one insurance provider including auto, homeowners and financial products, who have better retention and potentially present more favorable prospects for profitability over the course of their relationships with us.
The Allstate brand utilizes marketing delivered to target customers to promote our strategic priorities, with messaging that continues to communicate affordability and ease of doing business with Allstate, as well as the importance of having proper coverage by highlighting our comprehensive product and coverage options.
At Allstate we differentiate ourselves from competitors by offering a comprehensive range of innovative product options and features as well as product customization, including Allstate Your Choice Auto® with options such as accident forgiveness, safe driving deductible rewards and a safe driving bonus. We will continue to focus on developing and introducing products and services that benefit today's consumers and further differentiate Allstate and enhance the customer experience. We will deepen customer relationships through value-added customer interactions and expanding our presence in households with multiple products by providing financial protection for customer needs. In addition, we introduced a claim satisfaction guarantee that promises a return of premium to any Allstate Brand standard auto insurance customer dissatisfied with their claims experience, which differentiates Allstate from the competition.
Within our multiple distribution channels we are undergoing a focused effort to enhance our capabilities by implementing uniform processes and standards to elevate the level and consistency of our customer experience. We continue to enhance technology to integrate our distribution channels, improve customer service, facilitate the introduction of new products and services and reduce infrastructure costs related to supporting agencies and handling claims. These actions and others are designed to optimize the effectiveness of our distribution and service channels by increasing the productivity of the Allstate brand's exclusive agencies. Beginning in 2012, Allstate Brand direct sales and service will focus on serving customers who prefer personal advice and assistance and work closer with Allstate exclusive agencies.
Our pricing and underwriting strategies and decisions, made in conjunction within a program called Strategic Risk Management, are designed to enhance both our competitive position and our profit potential. Pricing sophistication, which underlies our Strategic Risk Management program, uses a number of risk evaluation factors including insurance scoring, to the extent permissible by regulations, based on information that is obtained from credit reports. Our updated auto risk evaluation pricing model was implemented for 25 states in 2011 and these implementations will continue in other states throughout 2012. Our pricing strategy involves marketplace pricing and underwriting decisions that are based on these risk evaluation models and an evaluation of competitors. We will utilize pricing sophistication to increase our price competiveness to a greater share of target customers. We call this price optimization and it includes using underwriting information, pricing and discounts to achieve a higher close rate.
We will also continue to provide a range of discounts to attract more target customers. For the Allstate brand auto and homeowners business, we continue to improve our mix of customers towards those customers that have better retention and thus potentially present more favorable prospects for profitability over the course of their relationships with us. For homeowners, we will address rate adequacy and improve underwriting and claim effectiveness. Our comprehensive strategic review of our homeowners insurance business is ongoing.
The Allstate Protection segment also includes a separate organization called Emerging Businesses which comprises Business Insurance (commercial products for small business owners), Consumer Household (specialty products including motorcycle, boat, renters and condominium insurance policies), Allstate Dealer Services (insurance and non-insurance products sold primarily to auto dealers), Allstate Roadside Services (retail and wholesale roadside assistance products) and Ivantage (insurance agency). Premiums written by Emerging Businesses were $2.49 billion in 2011 compared to $2.43 billion in 2010. We expect we will continue to accelerate profitable growth in Emerging Businesses during 2012.
Our strategy for the Encompass brand includes enhancing our premier package policy (providing customers with the ability to simplify their insurance needs by consolidating their coverage into one policy, with one bill, one premium and one renewal date) to appeal to customers with broad personal lines coverage needs and that value an independent agent. Additionally, Encompass is focused on increasing distribution effectiveness and improving agency technology interfaces to become the package carrier of choice for aligned agencies to generate stable, consistent earnings growth.
Our strategy for Esurance brand focuses on self-directed and web-savvy customers. To best serve these customers, Esurance develops its technology and website to continuously improve its hassle-free purchase and claims experience. In 2012, Esurance plans to broaden its product offering and increase its preferred driver mix, while raising its advertising investment and marketing effectiveness to support growth.
We continue to manage our property catastrophe exposure with the goal of providing shareholders an acceptable return on the risks assumed in our property business and to reduce the variability of our earnings. Our property business includes personal homeowners, commercial property and other property lines. As of December 31, 2011, we continue to be within our goal to have no more than a 1% likelihood of exceeding annual aggregate catastrophe losses by $2 billion, net of reinsurance, from hurricanes and earthquakes, based on modeled assumptions and applications currently available. The use of different assumptions and updates to industry models could materially change the projected loss.
Property catastrophe exposure management includes purchasing reinsurance to provide coverage for known exposure to hurricanes, earthquakes, wildfires, fires following earthquakes and other catastrophes. We are also working for changes in the regulatory environment, including recognizing the need for better catastrophe preparedness, improving appropriate risk based pricing and promoting the creation of government sponsored, privately funded solutions for mega-catastrophes that will make insurance more available and affordable. While the actions that we take will be primarily focused on reducing the catastrophe exposure in our property business, we also consider their impact on our ability to market our auto lines.
Pricing of property products is typically intended to establish returns that we deem acceptable over a long-term period. Losses, including losses from catastrophic events and weather-related losses (such as wind, hail, lightning and freeze losses not meeting our criteria to be declared a catastrophe), are accrued on an occurrence basis within the policy period. Therefore, in any reporting period, loss experience from catastrophic events and weather-related losses may contribute to negative or positive underwriting performance relative to the expectations we incorporated into the products' pricing. We pursue rate increases where indicated using a newly re-designed methodology that appropriately addresses the changing costs of losses from catastrophes such as severe weather and the net cost of reinsurance.
Allstate Protection outlook
•Allstate Protection will continue to focus on its strategy of offering differentiated products and services to our target customers while maintaining pricing discipline.
•We expect that volatility in the level of catastrophes we experience will contribute to variation in our underwriting results; however, this volatility will be mitigated due to our catastrophe management actions, including the purchase of reinsurance.
•We will continue to study the efficiencies of our operations and cost structure for additional areas where costs may be reduced. Premiums written, an operating measure, is the amount of premiums charged for policies issued during a fiscal period. Premiums earned is a GAAP measure. Premiums are considered earned and are included in the financial results on a pro-rata basis over the policy period. The portion of premiums written applicable to the unexpired terms of the policies is recorded as unearned premiums on our Consolidated Statements of Financial Position. Since policy periods are typically 6 or 12 months, rate changes will generally be recognized in premiums earned over a period of 6 to 24 months.
The following table shows the unearned premium balance as of December 31 and the timeframe in which we expect to recognize these premiums as earned.
($ in millions)
% earned after
90 days
180 days
270 days
360 days
Allstate brand:
Standard auto
$ 4,120
$ 4,103
72.2 %
97.3 %
99.3 %
100.0 %
Non-standard auto
67.5 %
93.9 %
98.6 %
100.0 %
Homeowners
3,314
3,259
43.5 %
75.6 %
94.2 %
100.0 %
Other personal lines (1)
1,293
1,276
40.9 %
69.2 %
86.5 %
92.9 %
Total Allstate brand
8,943
8,877
57.0 %
85.2 %
95.6 %
99.0 %
Encompass brand:
Standard auto
43.6 %
75.3 %
94.1 %
100.0 %
Non-standard auto
-
- %
- %
- %
- %
Homeowners
43.6 %
75.5 %
94.1 %
100.0 %
Other personal lines (1)
43.8 %
75.6 %
94.2 %
100.0 %
Total Encompass brand
43.6 %
75.4 %
94.1 %
100.0 %
Esurance brand (2)
Standard auto
-
74.5 %
99.1 %
99.8 %
100.0 %
Allstate Protection unearned premiums
$ 9,711
$ 9,458
56.6 %
84.9 %
95.6 %
99.1 %
(1)Other personal lines include commercial, condominium, renters, involuntary auto and other personal lines. (2)Esurance brand business was acquired on October 7, 2011.
A reconciliation of premiums written to premiums earned is shown in the following table.
($ in millions)
Premiums written:
Allstate Protection
$ 25,981
$ 25,906
$ 25,972
Discontinued Lines and Coverages
(1 )
(1 )
Property-Liability premiums written
25,980
25,907
25,971
(Increase) decrease in unearned premiums
(33 )
Other
(5 )
Property-Liability premiums earned
$ 25,942
$ 25,957
$ 26,194
Premiums earned:
Allstate Protection
$ 25,942
$ 25,955
$ 26,195
Discontinued Lines and Coverages
-
(1 )
Property-Liability
$ 25,942
$ 25,957
$ 26,194
Premiums written by brand are shown in the following table.
Allstate brand
Encompass brand
Esurance brand
Allstate Protection
($ in millions)
Standard auto
$ 15,703
$ 15,842
$ 15,763
$
$
$
$
$ 16,488
$ 16,486
$ 16,563
Non-standard auto
-
Homeowners
5,893
5,753
5,635
-
6,255
6,110
6,043
Other personal lines
2,372
2,331
2,317
-
2,462
2,421
2,417
Total
$ 24,743
$ 24,809
$ 24,642
$ 1,057
$ 1,097
$ 1,330
$
$ 25,981
$ 25,906
$ 25,972
Premiums earned by brand are shown in the following table.
Allstate brand
Encompass brand
Esurance brand
Allstate Protection
($ in millions)
Standard auto
$ 15,679
$ 15,814
$ 15,735
$
$
$
$
$ 16,500
$ 16,530
$ 16,642
Non-standard auto
-
Homeowners
5,835
5,693
5,633
-
6,200
6,078
6,077
Other personal lines
2,352
2,348
2,402
-
2,443
2,442
2,510
Total
$ 24,663
$ 24,751
$ 24,709
$ 1,078
$ 1,204
$ 1,486
$
$ 25,942
$ 25,955
$ 26,195
Premium operating measures and statistics that are used to analyze the business are calculated and described below. Measures and statistics presented for Allstate brand exclude Allstate Canada, loan protection and specialty auto.
•PIF: Policy counts are based on items rather than customers. A multi-car customer would generate multiple item (policy) counts, even if all cars were insured under one policy. •Average premium-gross written: Gross premiums written divided by issued item count. Gross premiums written include the impacts from discounts and surcharges, and exclude the impacts from mid-term premium adjustments, ceded reinsurance premiums, and premium refund accruals. Allstate brand average gross premiums represent the appropriate policy term for each line, which is 6 months for standard and non-standard auto and 12 months for homeowners. Encompass brand average gross premiums represent the appropriate policy term for each line, which is 12 months for standard auto and homeowners and 6 months for non-standard auto. Esurance brand average gross premiums represent the appropriate policy term, which is 6 months for standard auto. •Renewal ratio: Renewal policies issued during the period, based on contract effective dates, divided by the total policies issued 6 months prior for standard and non-standard auto (12 months prior for Encompass brand standard auto) or 12 months prior for homeowners. •New issued applications: Item counts of automobiles or homeowners insurance applications for insurance policies that were issued during the period. Does not include automobiles that are added by existing customers. •Net items added to existing policies: Net increases in insured cars by policy endorsement activity. Standard auto premiums written total of $16.49 billion in 2011 was comparable to 2010, following a 0.5% decrease in 2010 from $16.56 billion in 2009.
Allstate brand
Encompass brand
Esurance brand
Standard Auto
PIF (thousands)
17,213
17,484
17,744
Average premium-gross written (1)
$
$
$
$
$
$
$ N/A (8)
Renewal ratio (%) (1)
89.0
88.7
88.9
69.5
69.2
69.6
76.3
Approved rate changes (2):
# of states
(6)
(6)
N/A
Countrywide (%) (3)
4.7
1.4
4.6
3.5
1.4
7.3
N/A
State specific (%) (4)(5)
8.1 (7)
2.2
7.2
6.1
2.7
9.3
N/A
(1)Policy term is six months for Allstate and Esurance brands and twelve months for Encompass brand. (2)Rate changes that are indicated based on loss trend analysis to achieve a targeted return will continue to be pursued. Rate changes do not include rating plan enhancements, including the introduction of discounts and surcharges, that result in no change in the overall rate level in the state. These rate changes do not reflect initial rates filed for insurance subsidiaries initially writing business in a state. (3)Represents the impact in the states where rate changes were approved during 2011, 2010 and 2009, respectively, as a percentage of total countrywide prior year-end premiums written. (4)Represents the impact in the states where rate changes were approved during 2011, 2010 and 2009, respectively, as a percentage of its respective total prior year-end premiums written in those states. (5)Based on historical premiums written in those states, rate changes approved for standard auto totaled $731 million, $218 million and $784 million in 2011, 2010 and 2009, respectively. (6)Includes Washington D.C. (7)2011 includes the impact of Florida rate increases averaging 18.5%, and New York rate increases averaging 11.2% taken across multiple companies. (8)N/A reflects not available.
Allstate brand standard auto premiums written totaled $15.70 billion in 2011, a decrease of 0.9% from $15.84 billion in 2010, following a 0.5% increase in 2010 from $15.76 billion in 2009. Contributing to the Allstate brand standard auto premiums written decrease in 2011 compared to 2010 were the following:
-decrease in PIF of 1.5% as of December 31, 2011 compared to December 31, 2010, due to fewer new issued applications and fewer policies available to renew. Excluding Florida and New York, PIF as of December 31, 2011 were comparable to December 31, 2010. -5.8% decrease in new issued applications on a countrywide basis to 1,908 thousand in 2011 from 2,025 thousand in 2010. Excluding Florida and New York (impacted by actions to improve profitability), new issued applications on a countrywide basis decreased 0.1% to 1,697 thousand in 2011 from 1,699 thousand in 2010. New issued applications increased in 17 states in 2011 compared to 2010. -increase in average gross premium in 2011 compared to 2010. -0.3 point increase in the renewal ratio in 2011 compared to 2010. In 2011, 39 states are showing favorable comparisons to prior year.
Allstate brand standard auto premiums written increased in 2010 compared to 2009. Contributing to the Allstate brand standard auto premiums written increase in 2010 compared to 2009 were the following:
-decrease in PIF as of December 31, 2010 compared to December 31, 2009, due to fewer policies available to renew and a 0.7% decrease in net items added to existing policies to 1,498 thousand from 1,509 thousand, reflecting industry economic trends for declines in the number of cars per household -0.2% decrease in new issued applications on a countrywide basis to 2,025 thousand in 2010 from 2,029 thousand in 2009 impacted by decreases in Florida and California, due in part to rate actions that were approved in 2009 in these markets and other actions to improve profitability. Excluding Florida and California, new issued applications on a countrywide basis increased 12.9% to 1,606 thousand in 2010 from 1,423 thousand in 2009. New issued application increased in 40 states in 2010 compared to 2009, most of which offer an auto discount (the Preferred Package Discount) for our target customer. -increased average gross premium in 2010 compared to 2009, primarily due to rate changes, partially offset by customers electing to lower coverage levels of their policy -0.2 point decrease in the renewal ratio in 2010 compared to 2009, reflects profit management actions in California, New York and Georgia as well as the effects of the direct channel which has a lower renewal ratio. Excluding these items the renewal ratio had a 0.3 point increase.
The level of Encompass premiums written continues to be impacted by comprehensive actions designed to reposition Encompass as the package policy carrier of choice for above middle market customers through independent agencies in order to drive stable, consistent earnings growth over time. Some of the actions contributing to the Encompass brand standard auto premiums written decrease in 2011 compared to 2010 were the following:
-Aligned pricing and underwriting with strategic direction -Terminated relationships with certain independent agencies -Non-renewal of underperforming business -Discontinued writing the Special Value product (middle market auto product focused on segment auto) and Deerbrook (non-standard auto) in certain states -Non-renewal of property in Florida
Non-standard auto premiums written totaled $776 million in 2011, a decrease of 12.7% from $889 million in 2010, following a 6.3% decrease in 2009 from $949 million in 2009.
Allstate brand
Non-Standard Auto
PIF (thousands)
Average premium-gross written (6 months)
$
$
$
Renewal ratio (%) (6 months)
70.4
71.4
72.5
Approved rate changes:
# of states
(2)
(2)
Countrywide (%)
6.0
4.6
2.6
State specific (%) (1)
12.8
9.6
6.5
(1)Based on historical premiums written in those states, rate changes approved for non-standard auto totaled $49 million, $41 million and $25 million in 2011, 2010 and 2009, respectively. (2)Includes Washington D.C.
Allstate brand non-standard auto premiums written totaled $775 million in 2011, a decrease of 12.2% from $883 million in 2010, following a 4.7% decrease in 2010 from $927 million in 2009. Contributing to the Allstate brand non-standard auto premiums written decrease in 2011 compared to 2010 were the following:
-decrease in PIF as of December 31, 2011 compared to December 31, 2010, due to a decline in the number of policies available to renew, a lower retention rate and fewer new issued applications -17.2% decrease in new issued applications to 256 thousand in 2011 from 309 thousand in 2010, driven in large part by management actions in Florida through October 2011 -decrease in average gross premium in 2011 compared to 2010 -1.0 point decrease in the renewal ratio in 2011 compared to 2010
Allstate brand non-standard auto premiums written decreased in 2010 compared to 2009. Contributing to the Allstate brand non-standard auto premiums written decrease in 2010 compared to 2009 were the following:
-decrease in PIF as of December 31, 2010 compared to December 31, 2009, due to a decline in the number of policies available to renew and fewer new issued applications -14.9% decrease in new issued applications to 309 thousand in 2010 from 363 thousand in 2009 -increase in average gross premium in 2010 compared to 2009 -1.1 point decrease in the renewal ratio in 2010 compared to 2009
Homeowners premiums written totaled $6.26 billion in 2011, an increase of 2.4% from $6.11 billion in 2010, following a 1.1% increase in 2010 from $6.04 billion in 2009. Excluding the cost of catastrophe reinsurance, premiums written increased 1.6% in 2011 compared to 2010. For a more detailed discussion on reinsurance, see the Property-Liability Claims and Claims Expense Reserves section of the MD&A and Note 10 of the consolidated financial statements.
Allstate brand
Encompass brand
Homeowners
PIF (thousands)
6,369
6,690
6,973
Average premium-gross written (12 months)
$
$
$
$ 1,297
$ 1,298
$ 1,265
Renewal ratio (%) (12 months)
88.3
88.4
88.1
79.8
78.1
78.9
Approved rate changes (1):
# of states (3)
Countrywide (%)
8.6
7.0
8.4
3.1
0.7
4.4
State specific (%) (2)
11.0
10.0
10.7
4.1
1.4
5.9
(1)Includes rate changes approved based on our net cost of reinsurance. (2)Based on historical premiums written in those states, rate changes approved for homeowners totaled $533 million, $424 million and $534 million in 2011, 2010 and 2009, respectively. (3)Includes Washington D.C.
Allstate brand homeowners premiums written totaled $5.89 billion in 2011, an increase of 2.4% from $5.75 billion in 2010, following a 2.1% increase in 2010 from $5.64 billion in 2009. Contributing to the Allstate brand homeowners premiums written increase in 2011 compared to 2010 were the following:
-4.8% decrease in PIF as of December 31, 2011 compared to December 31, 2010, due to fewer policies available to renew and fewer new issued applications -14.9% decrease in new issued applications to 456 thousand in 2011 from 536 thousand in 2010. During the second quarter of 2011, our Castle Key Indemnity Company subsidiary completed a 2008 regulatory consent decree to sell 50,000 new homeowners policies in Florida by November 2011. -increase in average gross premium in 2011 compared to 2010, primarily due to rate changes -0.1 point decrease in the renewal ratio in 2011 compared to 2010 -decrease in the cost of our catastrophe reinsurance program in 2011 compared to 2010
Actions taken to manage our catastrophe exposure in areas with known exposure to hurricanes, earthquakes, wildfires, fires following earthquakes and other catastrophes have had an impact on our new business writings and retention for homeowners insurance. Homeowners PIF has declined 1.2 million or 16% in the four years ended December 31, 2011. This impact will continue in 2012, although to a lesser degree. For a more detailed discussion on exposure management actions, see the Catastrophe Management section of the MD&A.
We have different plans around the country to improve the growth and profitability of our homeowners business. In states where we offer homeowners and other property coverages that do not have severe weather issues and that have acceptable returns, we are seeking to grow. In another group of states where we offer homeowners and other property coverages, we plan to implement pricing and/or underwriting actions that will improve performance to achieve our profitability targets. For two other groups of states, including those with severe weather issues and other risks such as hurricane exposure, we may take more substantial actions including raising prices, offering policies with more limited coverage, or brokering to other carriers. We are currently piloting our Allstate House and HomeSM product which provides greater options of coverage for roof damage including depreciated value versus replacement value and uses a number of factors to determine price, some of which relate to auto insurance risks. We expect to roll it out countrywide for new business gradually over the next three years.
Allstate brand homeowners premiums written increased in 2010 compared to 2009. Contributing to the Allstate brand homeowners premiums written increase in 2010 compared to 2009 were the following:
-4.1% decrease in PIF as of December 31, 2010 compared to December 31, 2009, following a 3.9% decrease as of December 31, 2009 compared to December 31, 2008, due to fewer policies available to renew and fewer new issued applications -3.6% decrease in new issued applications to 536 thousand in 2010 from 556 thousand in 2009. Excluding Florida, new issued applications on a countrywide basis decreased 12.4% to 487 thousand in 2010 from 556 thousand in 2009. -increase in average gross premium in 2010 compared to 2009, primarily due to rate changes -0.3 point increase in the renewal ratio in 2010 compared to 2009 -decrease in the net cost of our catastrophe reinsurance program in 2010 compared to 2009
Underwriting results are shown in the following table.
($ in millions)
Premiums written
$ 25,981
$ 25,906
$ 25,972
Premiums earned
$ 25,942
$ 25,955
$ 26,195
Claims and claims expense
(20,140 )
(18,923 )
(18,722 )
Amortization of DAC
(3,640 )
(3,678 )
(3,789 )
Other costs and expenses
(2,968 )
(2,795 )
(2,552 )
Restructuring and related charges
(43 )
(33 )
(105 )
Underwriting (loss) income
$ (849 ) $
$ 1,027
Catastrophe losses
$ 3,815
$ 2,207
$ 2,069
Underwriting income (loss) by line of business
Standard auto
$
$
$
Non-standard auto
Homeowners
(1,330 )
(335 )
(125 )
Other personal lines
(188 )
Underwriting (loss) income
$ (849 ) $
$ 1,027
Underwriting income (loss) by brand
Allstate brand
$ (666 ) $
$ 1,022
Encompass brand
(146 )
(43 )
Esurance brand
(37 )
-
-
Underwriting (loss) income
$ (849 ) $
$ 1,027
Allstate Protection experienced an underwriting loss of $849 million in 2011 compared to underwriting income of $526 million in 2010, primarily due to an increase in homeowners underwriting loss, an underwriting loss for other personal lines compared to an underwriting gain in the prior year, and a decrease in standard auto underwriting income. Homeowners underwriting loss increased $995 million to $1.33 billion in 2011 from $335 million in 2010, primarily due to increases in catastrophe losses and higher expenses partially offset by average earned premiums increasing faster than loss costs. Other personal lines underwriting income decreased $283 million to an underwriting loss of $188 million in 2011 from underwriting income of $95 million in 2010, primarily due to increases in catastrophe losses, unfavorable reserve reestimates and higher expenses. Standard auto underwriting income decreased $124 million to
$568 million in 2011 from $692 million in 2010, primarily due to increases in catastrophe losses and higher expenses, partially offset by favorable reserve reestimates. For further discussion and quantification of the impact of reserve estimates and assumptions, see the Application of Critical Accounting Estimates and Property-Liability Claims and Claims Expense Reserves sections of the MD&A.
Allstate Protection experienced underwriting income of $526 million in 2010 compared to $1.03 billion in 2009, primarily due to decreases in standard auto underwriting income and increases in homeowners underwriting losses, partially offset by increases in other personal lines underwriting income. Standard auto underwriting income decreased 29.9% to an underwriting income of $692 million in 2010 from an underwriting income of $987 million in 2009 primarily due to increases in auto claim frequency and expenses and a $25 million litigation settlement, partially offset by favorable reserve reestimates and decreases in catastrophe losses. Homeowners underwriting loss increased $210 million to an underwriting loss of $335 million in 2010 from an underwriting loss of $125 million in 2009 primarily due to a $75 million unfavorable prior year reserve reestimate related to a litigation settlement and increases in expenses and catastrophe losses, including prior year reestimates for catastrophes, partially offset by average earned premiums increasing faster than loss costs. Other personal lines underwriting income increased 6.7% to an underwriting income of $95 million in 2010 from an underwriting income of $89 million in 2009 primarily due to lower unfavorable reserve reestimates.
Catastrophe losses were $3.82 billion in 2011 as detailed in the table below. This compares to catastrophe losses of $2.21 billion in 2010.
We define a "catastrophe" as an event that produces pre-tax losses before reinsurance in excess of $1 million and involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are caused by various natural events including high winds, winter storms, tornadoes, hailstorms, wildfires, tropical storms, hurricanes, earthquakes and volcanoes. We are also exposed to man-made catastrophic events, such as certain types of terrorism or industrial accidents. The nature and level of catastrophes in any period cannot be reliably predicted.
Catastrophe losses related to events that occurred by the size of the event are shown in the following table.
($ in millions)
Number
of events
Claims
and claims
expense
Combined
ratio
impact
Average
catastrophe
loss per event
Size of catastrophe
Greater than $250 million
4.4 % $ 1,595
41.8 %
6.1
$
$101 million to $250 million
4.4
14.8
2.2
$50 million to $100 million
13.2
23.0
3.4
Less than $50 million
78.0
23.8
3.5
Total
100.0 %
3,945
103.4
15.2
Prior year reserve reestimates
(130 )
(3.4 )
(0.5 )
Total catastrophe losses
$ 3,815
100.0 %
14.7
Catastrophe losses incurred by the type of event are shown in the following table.
($ in millions)
Number
of events
Number
of events
Number
of events
Hurricanes/Tropical storms
$
$
$
Tornadoes
1,234
Wind/Hail
1,775
1,908
1,561
Wildfires
Other events
Prior year reserve reestimates
(130 )
(163 )
(169 )
Total catastrophe losses
$ 3,815
$ 2,207
$ 2,069
Catastrophes excluding hurricanes named or numbered by the National Weather Service, fires following earthquakes and earthquakes totaled $3.30 billion, $2.27 billion and $2.16 billion in 2011, 2010 and 2009, respectively, and are the result of severe weather experienced during these periods.
Combined ratio Loss ratios are a measure of profitability. Loss ratios by product, and expense and combined ratios by brand, are shown in the following table. These ratios are defined in the Property-Liability Operations section of the MD&A.
Ratio (1)
Effect of catastrophe
losses on combined ratio
Effect of prior year
reserve reestimates on
combined ratio
Effect of
business
combination
expenses
and the
amortization
of purchased
intangible
assets on
combined
ratio
Allstate brand loss ratio:
Standard auto
70.6
70.7
69.3
2.6
1.0
1.2
(2.3 )
(0.9 )
(0.3 )
Non-standard auto
62.8
67.2
67.1
1.1
0.3
0.7
(4.9 )
(3.6 )
(1.6 )
Homeowners
98.0
82.1
79.6
50.0
31.3
29.0
(1.2 )
(0.3 )
(2.6 )
Other personal lines
76.0
66.4
67.3
13.6
7.2
7.0
4.0
0.7
3.5
Total Allstate brand loss ratio
77.3
72.8
71.4
14.8
8.5
8.1
(1.5
)
(0.7
)
(0.5
)
Allstate brand expense ratio
25.4
24.9
24.5
-
-
-
-
-
-
-
Allstate brand combined ratio
102.7
97.7
95.9
Encompass brand loss ratio:
Standard auto
81.8
75.4
75.4
1.8
0.8
0.3
2.4
-
0.7
Non-standard auto
150.0
100.0
74.1
-
-
-
(50.0 )
-
(11.1 )
Homeowners
88.5
74.3
66.0
39.7
23.1
14.6
0.3
(1.3 )
(4.3 )
Other personal lines
83.5
73.4
75.9
9.9
4.3
1.9
-
(1.1 )
5.6
Total Encompass brand loss ratio
84.3
75.1
72.6
15.3
8.2
4.7
1.4
(0.5
)
(0.7
)
Encompass brand expense ratio
29.2
28.5
27.1
-
-
-
-
-
-
-
Encompass brand combined ratio
113.5
103.6
99.7
Esurance brand loss ratio:
Standard auto
78.1
-
-
-
-
-
-
-
-
Total Esurance brand loss ratio
78.1
-
-
-
-
-
-
-
-
Esurance brand expense ratio
40.3
-
-
-
-
-
-
-
-
20.9
Esurance brand combined ratio
118.4
-
-
Allstate Protection loss ratio
77.6
72.9
71.5
14.7
8.5
7.9
(1.4
)
(0.7
)
(0.5
)
Allstate Protection expense ratio
25.7
25.1
24.6
-
-
-
-
-
-
0.2
Allstate Protection combined ratio
103.3
98.0
96.1
(1)Ratios are calculated using the premiums earned for the respective line of business.
Standard auto loss ratio for the Allstate brand decreased 0.1 points in 2011 compared to 2010 primarily due to favorable reserve reestimates, partially offset by higher catastrophe losses. Excluding the impact of catastrophe losses, the Allstate brand standard auto loss ratio improved 1.7 points in 2011 compared 2010. Florida and New York continued to have loss ratios higher than the countrywide average in 2011 though results in these two key states have improved relative to 2010, reducing the pressure on countrywide results. However, Florida and New York have improved underwriting results in the fourth quarter of 2011. We continue to pursue profitability management actions in Florida and New York, including rate increases, underwriting restrictions, increased claims staffing and review, and continued advocacy for legislative reform. In 2011, claim frequencies in the bodily injury and physical damage coverages have decreased compared to 2010. Bodily injury and physical damage coverages severity results in 2011 increased in line with historical Consumer Price Index ("CPI") trends. Standard auto loss ratio for the Allstate brand increased 1.4 points in 2010 compared to 2009 due to higher claim frequency and a $25 million litigation settlement, partially offset by
favorable reserve reestimates and lower catastrophe losses. The increase is primarily driven by increases in Florida and New York. In 2010, claim frequencies in the bodily injury and physical damage coverages have increased compared to 2009, but remain within historical norms. Bodily injury and physical damage coverages severity results in 2010 increased in line with historical CPI trends.
Homeowners loss ratio for the Allstate brand increased 15.9 points to 98.0 in 2011 from 82.1 in 2010 due to higher catastrophe losses. Excluding the impact of catastrophe losses, the Allstate brand homeowners loss ratio improved 2.8 points in 2011 compared to 2010 due to average earned premiums increasing faster than loss costs. Homeowners loss ratio for the Allstate brand increased 2.5 points to 82.1 in 2010 from 79.6 in 2009 due to a $75 million unfavorable prior year reserve reestimate related to a litigation settlement and higher catastrophe losses including prior year reserve reestimates for catastrophes, partially offset by average earned premiums increasing faster than loss costs.
Expense ratio for Allstate Protection increased 0.6 points in 2011 compared to 2010. Restructuring costs increased 0.1 points in 2011 compared to 2010, driven by technology and operations efficiency efforts and agent pension plan settlement charges. Excluding restructuring, the expense ratio for Allstate Protection increased 0.5 points in 2011 compared to 2010, driven by additional marketing, including $78 million spent on the Grow to Win initiative, and other growth initiative costs, and reduced guaranty fund accrual levels in 2010. We expect advertising costs to increase in 2012 as we focus on growing Esurance. The expense ratio for Allstate Protection increased 0.5 points in 2010 compared to 2009. Restructuring costs decreased 0.3 points in 2010 compared to 2009, driven by prior year costs associated with claim office consolidations, reorganization of Business Insurance and technology prioritization and efficiency efforts. Excluding restructuring, the expense ratio for Allstate Protection increased 0.8 points in 2010 compared to 2009, driven by additional marketing expenses and increases in net costs of employee benefits, partially offset by reduced guaranty fund accrual levels and improved operational efficiencies.
The impact of specific costs and expenses on the expense ratio are included in the following table.
Allstate brand
Encompass brand
Esurance
brand
Allstate Protection
Amortization of DAC
13.9
14.0
14.2
18.0
18.3
18.5
2.0
13.9
14.2
14.5
Other costs and expenses
11.3
10.8
9.9
11.2
9.7
8.3
17.4
11.4
10.8
9.7
Business combination expenses and amortization of purchased intangible assets
-
-
-
-
-
-
20.9
0.2
-
-
Restructuring and related charges
0.2
0.1
0.4
-
0.5
0.3
-
0.2
0.1
0.4
Total expense ratio
25.4
24.9
24.5
29.2
28.5
27.1
40.3
25.7
25.1
24.6
The expense ratio for the standard auto and homeowners businesses generally approximates the total Allstate Protection expense ratio. The expense ratio for the non-standard auto business generally is lower than the total Allstate Protection expense ratio due to lower agent commission rates and higher average premiums for non-standard auto as compared to standard auto. The Encompass brand DAC amortization is higher on average than Allstate brand DAC amortization due to higher commission rates. The Esurance brand expense ratio is higher than Allstate and Encompass brands due to business combination expenses and amortization of purchased intangible assets. Purchased intangible assets will be amortized on an accelerated basis with over 80% of the amortization taking place by 2016. Since Esurance uses a direct distribution model, its primary acquisition-related costs are advertising as opposed to commissions for the Allstate and Encompass brands. Advertising expense had a 10.9 point impact on the Esurance brand expense ratio in 2011. Advertising costs are not capitalized as DAC while commission costs are capitalized as DAC. As a result the Esurance expense and combined ratios will be higher during periods of growth since the expenses will be recognized prior to the premium earned.
DAC We establish a DAC asset for costs that vary with and are primarily related to acquiring business, principally agents' remuneration, premium taxes and inspection costs. For the Allstate Protection business, DAC is amortized to
income over the period in which premiums are earned. The balance of DAC for each product type as of December 31 is included in the following table.
Allstate brand
Encompass brand
Esurance
brand
Allstate Protection
($ in millions)
Standard auto
$
$
$
$
$ (1) $
$
Non-standard auto
-
-
-
Homeowners
-
Other personal lines
-
Total DAC
$ 1,287
$ 1,279
$
$
$
$ 1,412
$ 1,377
(1)Includes $21 million of present value of future profits, which will be fully amortized by March 31, 2012.
On January 1, 2012, we will adopt new DAC accounting guidance on a retrospective basis (see Note 2 of the consolidated financial statements for further details). It is currently estimated that the restated Allstate Protection DAC balance will decline by $63 million when compared to the reported December 31, 2011 balance. We estimate that the new DAC accounting guidance will have an insignificant effect on net income in 2012.
Catastrophe management
Historical catastrophe experience Since the beginning of 1992, the average annual impact of catastrophes on our Property-Liability loss ratio was 8.0 points. However, this average does not reflect the impact of some of the more significant actions we have taken to limit our catastrophe exposure. Consequently, it is useful to consider the impact of catastrophes after excluding losses that are now partially or substantially covered by the California Earthquake Authority ("CEA"), the Florida Hurricane Catastrophe Fund ("FHCF") or placed with a third party, such as hurricane coverage in Hawaii. The average annual impact of all catastrophes, excluding losses from Hurricanes Andrew and Iniki and losses from California earthquakes, on our Property-Liability loss ratio was 7.0 points since the beginning of 1992.
Comparatively, the average annual impact of catastrophes on the homeowners loss ratio for the years 1992 through 2011 is shown in the following table.
Average annual impact of
catastrophes on the
homeowners loss ratio
Average annual impact of catastrophes on the
homeowners loss ratio excluding losses from
hurricanes Andrew and Iniki, and losses from
California earthquakes
Florida
95.6
46.5
Other hurricane exposure states
30.5
30.3
Total hurricane exposure states
35.5
31.6
All other
25.0
20.6
Total
30.6
26.5
Over time, we have limited our aggregate insurance exposure to catastrophe losses in certain regions of the country that are subject to high levels of natural catastrophes. Limitations include our participation in various state facilities, such as the CEA, which provides insurance for California earthquake losses; the FHCF, which provides reimbursements to participating insurers for certain qualifying Florida hurricane losses; and other state facilities, such as wind pools. However, the impact of these actions may be diminished by the growth in insured values, and the effect of state insurance laws and regulations. In addition, in various states we are required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations that provide insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Because of our participation in these and other state facilities such as wind pools, we may be exposed to losses that surpass the capitalization of these facilities and to assessments from these facilities.
We continue to take actions to maintain an appropriate level of exposure to catastrophic events while continuing to meet the needs of our customers, including the following:
•Selectively not offering continuing coverage of mono-line homeowners policies in coastal areas of certain states. •Increased capacity in our brokerage platform for customers not offered a renewal.
•Expanded our excess and surplus carrier (North Light Specialty) to eight new states in 2011, bringing the total number of active states to 25. •In Texas we are ceding wind exposure related to insured property located in wind pool eligible areas along the coast including the Galveston Islands. •We have ceased writing new homeowners business in California. We will continue to renew current policyholders and have a renewal ratio of approximately 91% in California. •We have ceased writing new business in Florida beyond a modest stance for existing customers who replace their currently-insured home with an acceptable property. Withdrawal from the property lines was completed for the Encompass companies operating in Florida. Hurricanes
We consider the greatest areas of potential catastrophe losses due to hurricanes generally to be major metropolitan centers in counties along the eastern and gulf coasts of the United States. Usually, the average premium on a property policy near these coasts is greater than in other areas. However, average premiums are often not considered commensurate with the inherent risk of loss. In addition and as explained in Note 14 of the consolidated financial statements, in various states Allstate is subject to assessments from assigned risk plans, reinsurance facilities and joint underwriting associations providing insurance for wind related property losses.
We have addressed our risk of hurricane loss by, among other actions, purchasing reinsurance for specific states and on a countrywide basis for our personal lines property insurance in areas most exposed to hurricanes; limiting personal homeowners new business writings in coastal areas in southern and eastern states; implementing tropical cyclone deductibles where appropriate; and not offering continuing coverage on certain policies in coastal counties in certain states. We continue to seek appropriate returns for the risks we write. This may require further actions, similar to those already taken, in geographies where we are not getting appropriate returns. However, we may maintain or opportunistically increase our presence in areas where we achieve adequate returns and do not materially increase our hurricane risk.
Earthquakes
Actions taken to reduce our exposure from earthquake coverage are substantially complete. These actions included purchasing reinsurance on a countrywide basis and in the state of Kentucky; no longer offering new optional earthquake coverage in most states; removing optional earthquake coverage upon renewal in most states; and entering into arrangements in many states to make earthquake coverage available through other insurers for new and renewal business.
We expect to retain approximately 30,000 PIF with earthquake coverage due to regulatory and other reasons. We also will continue to have exposure to earthquake risk on certain policies that do not specifically exclude coverage for earthquake losses, including our auto policies, and to fires following earthquakes. Allstate policyholders in the state of California are offered coverage through the CEA, a privately-financed, publicly-managed state agency created to provide insurance coverage for earthquake damage. Allstate is subject to assessments from the CEA under certain circumstances as explained in Note 14 of the consolidated financial statements.
Fires Following Earthquakes
Actions taken related to our risk of loss from fires following earthquakes include changing homeowners underwriting requirements in California, purchasing reinsurance for Kentucky personal lines property risks, and purchasing nationwide occurrence reinsurance, excluding Florida and New Jersey.
Wildfires
Actions we are taking to reduce our risk of loss from wildfires include changing homeowners underwriting requirements in certain states and purchasing nationwide occurrence reinsurance. Catastrophe losses related to the Southern California wildfires occurred during 2009 and totaled $76 million.
Reinsurance
A description of our current catastrophe reinsurance program appears in Note 10 of the consolidated financial statements and a description of program changes as of June 1, 2012 appears in the Property-Liability Claims and Claims Expense Reserves section of the MD&A.
DISCONTINUED LINES AND COVERAGES SEGMENT
Overview The Discontinued Lines and Coverages segment includes results from insurance coverage that we no longer write and results for certain commercial and other businesses in run-off. Our exposure to asbestos, environmental and other discontinued lines claims is reported in this segment. We have assigned management of this segment to a designated group of professionals with expertise in claims handling, policy coverage interpretation, exposure identification and reinsurance collection. As part of its responsibilities, this group is also regularly engaged in policy buybacks, settlements and reinsurance assumed and ceded commutations.
Summarized underwriting results for the years ended December 31 are presented in the following table.
($ in millions)
Premiums written
$ (1 ) $
$ (1 )
Premiums earned
$
-
$
$
(1
)
Claims and claims expense
(21 )
(28 )
(24 )
Operating costs and expenses
(4 )
(5 )
(7 )
Underwriting loss
$ (25 ) $ (31 ) $ (32 )
Underwriting losses of $25 million in 2011 related to a $26 million unfavorable reestimate of asbestos reserves and a $5 million unfavorable reestimate of other reserves, primarily as a result of our annual review using established industry and actuarial best practices, partially offset by a $26 million decrease of our allowance for future uncollectible reinsurance and environmental reserves essentially unchanged. The cost of administering claims settlements totaled $11 million in 2011 and $13 million for each of 2010 and 2009.
Underwriting losses of $31 million in 2010 related to an $18 million unfavorable reestimate of environmental reserves and a $5 million unfavorable reestimate of asbestos reserves, partially offset by a $4 million favorable reestimate of other reserves, primarily as a result of our annual review using established industry and actuarial best practices.
Underwriting losses of $32 million in 2009 were primarily related to a $13 million unfavorable reestimate of environmental reserves and a $28 million unfavorable reestimate of other reserves, partially offset by an $8 million favorable reestimate of asbestos reserves, primarily as a result of our annual review using established industry and actuarial best practices.
See the Property-Liability Claims and Claims Expense Reserves section of the MD&A for a more detailed discussion.
Discontinued Lines and Coverages outlook
•We may continue to experience asbestos and/or environmental losses in the future. These losses could be due to the potential adverse impact of new information relating to new and additional claims or the impact of resolving unsettled claims based on unanticipated events such as litigation or legislative, judicial and regulatory actions. Environmental losses may also increase as the result of additional funding for environmental site cleanup. Because of our annual review, we believe that our reserves are appropriately established based on available information, technology, laws and regulations.
•We continue to be encouraged that the pace of industry asbestos claim activity has slowed, perhaps reflecting various state legislative and judicial actions with respect to medical criteria and increased legal scrutiny of the legitimacy of claims.
PROPERTY-LIABILITY INVESTMENT RESULTS
Net investment income increased 1.0% or $12 million to $1.20 billion in 2011 from $1.19 billion in 2010, after decreasing 10.5% in 2010 compared to 2009. The 2011 increase was primarily due to higher yields, partially offset by lower average investment balances. The 2010 decrease was primarily due to lower yields and duration shortening actions taken to protect the portfolio from rising interest rates, partially offset by higher average investment balances.
The following table presents the average pre-tax investment yields for the years ended December 31. Pre-tax yield is calculated as investment income (including dividend income in the case of equity securities) divided by the average of
the investment balances at the beginning and end of period and interim quarters. Amortized cost is used to calculate the average investment balance for fixed income securities and mortgage loans. Cost is used for equity securities.
Fixed income securities: tax-exempt
4.8 %
4.9 %
5.1 %
Fixed income securities: tax-exempt equivalent
7.0
7.1
7.4
Fixed income securities: taxable
3.8
3.5
4.1
Equity securities
2.8
2.3
2.1
Mortgage loans
4.0
5.7
4.7
Cost method limited partnership interests
5.6
3.1
1.5
Total portfolio
3.9
3.8
4.2
Net realized capital gains and losses are presented in the following table.
($ in millions)
Impairment write-downs
$ (250 ) $ (295 ) $ (534 )
Change in intent write-downs
(49 )
(62 )
(89 )
Net other-than-temporary impairment losses recognized in earnings
(299 )
(357 )
(623 )
Sales
Valuation of derivative instruments
(54 )
(331 )
Settlements of derivative instruments
(127 )
(143 )
(203 )
EMA limited partnership income
(5 )
Realized capital gains and losses, pre-tax
(321 )
(168 )
Income tax (expense) benefit
(31 )
(54 )
Realized capital gains and losses, after-tax
$
$ (207 ) $ (222 )
For a further discussion of net realized capital gains and losses, see the Investments section of the MD&A.
PROPERTY-LIABILITY CLAIMS AND CLAIMS EXPENSE RESERVES
Property-Liability underwriting results are significantly influenced by estimates of property-liability claims and claims expense reserves. For a description of our reserve process, see Note 8 of the consolidated financial statements and for a further description of our reserving policies and the potential variability in our reserve estimates, see the Application of Critical Accounting Estimates section of the MD&A. These reserves are an estimate of amounts necessary to settle all outstanding claims, including IBNR claims, as of the reporting date.
The facts and circumstances leading to our reestimates of reserves relate to revisions to the development factors used to predict how losses are likely to develop from the end of a reporting period until all claims have been paid. Reestimates occur because actual losses are likely different than those predicted by the estimated development factors used in prior reserve estimates. As of December 31, 2011, the impact of a reserve reestimation corresponding to a one percent increase or decrease in net reserves would be a decrease or increase of approximately $116 million in net income.
The table below shows total net reserves as of December 31 by line of business.
($ in millions)
Allstate brand
$ 14,792
$ 14,696
$ 14,123
Encompass brand
1,027
Esurance brand
-
-
Total Allstate Protection
16,080
15,617
15,150
Discontinued Lines and Coverages
1,707
1,779
1,878
Total Property-Liability
$ 17,787
$ 17,396
$ 17,028
The tables below show reserves, net of reinsurance, representing the estimated cost of outstanding claims as they were recorded at the beginning of years 2011, 2010 and 2009, and the effect of reestimates in each year.
($ in millions)
January 1 reserves
Allstate brand
$ 14,696
$ 14,123
$ 14,118
Encompass brand
1,027
1,133
Esurance brand
-
-
-
Total Allstate Protection
15,617
15,150
15,251
Discontinued Lines and Coverages
1,779
1,878
1,931
Total Property-Liability
$ 17,396
$ 17,028
$ 17,182
($ in millions, except ratios)
Reserve
reestimate (1)
Effect on
combined
ratio
Reserve
reestimate (1)
Effect on
combined
ratio
Reserve
reestimate (1)
Effect on
combined
ratio
Allstate brand
$ (371 )
(1.4 ) $ (181 )
(0.7 ) $ (126 )
(0.5 )
Encompass brand
-
(6 )
-
(10 )
-
Esurance brand
-
-
-
-
-
-
Total Allstate Protection
(356 )
(1.4 )
(187 )
(0.7 )
(136 )
(0.5 )
Discontinued Lines and Coverages
0.1
0.1
0.1
Total Property-Liability
$ (335 )
(1.3 ) $ (159 )
(0.6 ) $ (112 )
(0.4 )
Reserve reestimates, after-tax
$ (218 )
$ (103 )
$ (73 )
Net income
$
$
$
Reserve reestimates as a % of net income
27.7 %
11.1 %
8.5 %
(1)Favorable reserve reestimates are shown in parentheses.
Allstate Protection
The tables below show Allstate Protection net reserves representing the estimated cost of outstanding claims as they were recorded at the beginning of years 2011, 2010 and 2009, and the effect of reestimates in each year.
January 1 reserves
($ in millions)
Auto
$ 11,034
$ 10,606
$ 10,220
Homeowners
2,442
2,399
2,824
Other personal lines
2,141
2,145
2,207
Total Allstate Protection
$ 15,617
$ 15,150
$ 15,251
($ in millions, except ratios)
Reserve
reestimate
Effect on
combined
ratio
Reserve
reestimate
Effect on
combined
ratio
Reserve
reestimate
Effect on
combined
ratio
Auto
$ (381 )
(1.5 ) $ (179 )
(0.7 ) $ (57 )
(0.2 )
Homeowners
(69 )
(0.3 )
(23 )
(0.1 )
(168 )
(0.6 )
Other personal lines
0.4
0.1
0.3
Total Allstate Protection
$ (356 )
(1.4 ) $ (187 )
(0.7 ) $ (136 )
(0.5 )
Underwriting (loss) income
$ (849 )
$
$ 1,027
Reserve reestimates as a % of underwriting (loss) income
41.9 %
35.6 %
13.2 %
Auto reserve reestimates in 2011, 2010 and 2009 were primarily due to claim severity development that was better than expected. 2010 was also impacted by a litigation settlement.
Favorable homeowners reserve reestimates in 2011 were primarily due to favorable catastrophe reserve reestimates. Favorable homeowners reserve reestimates in 2010 were primarily due to favorable catastrophe reserve reestimates, partially offset by a litigation settlement. Favorable homeowners reserve reestimates in 2009 were primarily due to favorable reserve reestimates from Hurricanes Ike and Gustav and a catastrophe related subrogation recovery.
Other personal lines reserve reestimates in 2011, 2010 and 2009 were primarily the result of loss development higher than anticipated in previous estimates.
Pending, new and closed claims for Allstate Protection are summarized in the following table for the years ended December 31.
Number of claims
2011 (1)
Auto
Pending, beginning of year
490,459
540,424
566,394
New
5,656,687
5,571,199
5,482,941
Total closed
(5,710,174 )
(5,621,164 )
(5,508,911 )
Pending, end of year
436,972
490,459
540,424
Homeowners
Pending, beginning of year
51,031
59,685
74,772
New
1,214,792
991,962
997,954
Total closed
(1,221,689 )
(1,000,616 )
(1,013,041 )
Pending, end of year
44,134
51,031
59,685
Other personal lines
Pending, beginning of year
33,388
36,537
41,001
New
333,209
282,137
278,978
Total closed
(334,726 )
(285,286 )
(283,442 )
Pending, end of year
31,871
33,388
36,537
Total Allstate Protection
Pending, beginning of year
574,878
636,646
682,167
New
7,204,688
6,845,298
6,759,873
Total closed
(7,266,589 )
(6,907,066 )
(6,805,394 )
Pending, end of year
512,977
574,878
636,646
(1)Excludes Esurance brand number of claims since not available.
We believe the net loss reserves for Allstate Protection exposures are appropriately established based on available facts, technology, laws and regulations.
The following tables reflect the accident years to which the reestimates shown above are applicable by line of business. Favorable reserve reestimates are shown in parentheses.
2011 Prior year reserve reestimates
($ in millions)
2001 &
prior
Total
Allstate brand
$
$
$
$
$
$
$ -
$ (28 ) $ (150 ) $ (378 ) $ (371 )
Encompass brand
-
(1 )
-
(1 )
Total Allstate Protection
(1 )
(26 )
(148 )
(369 )
(356 )
Discontinued Lines and Coverages
-
-
-
-
-
-
-
-
-
Total Property- Liability
$
$
$
$
$
$
$ (1 ) $ (26 ) $ (148 ) $ (369 ) $ (335 )
2010 Prior year reserve reestimates
($ in millions)
2000 &
prior
Total
Allstate brand
$
$ (1 ) $ (7 ) $ (18 ) $ (15 ) $ (51 ) $ (106 ) $ (86 ) $ (45 ) $ (114 ) $ (181 )
Encompass brand
-
-
(6 )
(1 )
(10 )
(6 )
Total Allstate Protection
(1 )
(6 )
(17 )
(13 )
(45 )
(106 )
(92 )
(46 )
(124 )
(187 )
Discontinued Lines and Coverages
-
-
-
-
-
-
-
-
-
Total Property-Liability
$
$ (1 ) $ (6 ) $ (17 ) $ (13 ) $ (45 ) $ (106 ) $ (92 ) $ (46 ) $ (124 ) $ (159 )
2009 Prior year reserve reestimates
($ in millions)
1999 &
prior
Total
Allstate brand
$
$
$
$
$
$
$
$ (149 ) $ (151 ) $ (417 ) $ (126 )
Encompass brand
-
(7 )
(39 )
(10 )
Total Allstate Protection
(141 )
(158 )
(456 )
(136 )
Discontinued Lines and Coverages
-
-
-
-
-
-
-
-
-
Total Property- Liability
$
$
$
$
$
$
$
$ (141 ) $ (158 ) $ (456 ) $ (112 )
Allstate brand prior year reserve reestimates were $371 million favorable in 2011, $181 million favorable in 2010 and $126 million favorable in 2009. In 2011, this was primarily due to severity development that was better than expected and favorable catastrophe reserve reestimates. The increased reserves in accident years 2001 & prior is due to a reclassification of injury reserves to older years and reserve strengthening. In 2010, this was primarily due to favorable catastrophe reserve reestimates and severity development that was better than expected, partially offset by litigation settlements. The increased reserves in accident years 2000 & prior is due to the litigation settlements of $100 million, a reclassification of injury reserves to older years and reserve strengthening. In 2009, this was primarily due to favorable reserve reestimates from Hurricanes Ike and Gustav and a catastrophe related subrogation recovery. The shift of reserves to older accident years is attributable to a reallocation of reserves related to employee postretirement benefits to more accident years, and a reclassification of injury and 2008 non-injury reserves to older years.
These trends are primarily responsible for revisions to loss development factors, as previously described, used to predict how losses are likely to develop from the end of a reporting period until all claims have been paid. Because these trends cause actual losses to differ from those predicted by the estimated development factors used in prior reserve estimates, reserves are revised as actuarial studies validate new trends based on the indications of updated development factor calculations.
The impact of these reestimates on the Allstate brand underwriting (loss) income is shown in the table below.
($ in millions)
Reserve reestimates
$ (371 ) $ (181 ) $ (126 )
Allstate brand underwriting (loss) income
(666 )
1,022
Reserve reestimates as a % of underwriting (loss) income
55.7 %
31.8 %
12.3 %
Encompass brand Reserve reestimates in 2011 were related to higher than anticipated claim settlement costs. 2010 and 2009 Encompass brand reserve reestimates were related to lower than anticipated claim settlement costs.
The impact of these reestimates on the Encompass brand underwriting (loss) income is shown in the table below.
($ in millions)
Reserve reestimates
$
$ (6 ) $ (10 )
Encompass brand underwriting (loss) income
(146 )
(43 )
Reserve reestimates as a % of underwriting (loss) income
(10.3 )%
14.0 %
200.0 %
Discontinued Lines and Coverages We conduct an annual review in the third quarter of each year to evaluate and establish asbestos, environmental and other discontinued lines reserves. Reserves are recorded in the reporting period in which they are determined. Using established industry and actuarial best practices and assuming no change in the regulatory or economic environment, this detailed and comprehensive methodology determines reserves based on assessments of the characteristics of exposure (e.g. claim activity, potential liability, jurisdiction, products versus non-products exposure) presented by policyholders.
Reserve reestimates for the Discontinued Lines and Coverages, as shown in the table below, were increased primarily for asbestos in 2011, environmental in 2010 and other discontinued lines in 2009.
($ in millions)
January 1
reserves
Reserve
reestimate
January 1
reserves
Reserve
reestimate
January 1
reserves
Reserve
reestimate
Asbestos claims
$ 1,100
$
$ 1,180
$
$ 1,228
$ (8 )
Environmental claims
-
Other discontinued lines
(5 )
Total Discontinued Lines and Coverages
$ 1,779
$
$ 1,878
$
$ 1,931
$
Underwriting loss
$ (25 )
$ (31 )
$ (32 )
Reserve reestimates as a % of underwriting loss
(84.0 )%
(90.3 )%
(75.0 )%
Reserve additions for asbestos in 2011 totaling $26 million were primarily for products related coverage due to increases for the assumed reinsurance portion of discontinued lines where we are reliant on our ceding companies to report claims. Reserve additions for asbestos in 2010 totaling $5 million were primarily for products related coverage. Asbestos reserves reestimates in 2009 were $8 million favorable.
Normal environmental claim activity resulted in essentially no change in estimated reserves for 2011. The reserve additions for environmental in 2010 and 2009 were primarily related to site-specific remediations where the clean-up cost estimates and responsibility for the clean-up were more fully determined. IBNR now represents 64% of total net environmental reserves, 2 points higher than as of December 31, 2010.
The table below summarizes reserves and claim activity for asbestos and environmental claims before (Gross) and after (Net) the effects of reinsurance for the past three years.
($ in millions, except ratios)
Gross
Net
Gross
Net
Gross
Net
Asbestos claims
Beginning reserves
$ 1,655
$ 1,100
$ 1,780
$ 1,180
$ 1,933
$ 1,228
Incurred claims and claims expense
(7 )
(3 )
(8 )
Claims and claims expense paid
(86 )
(48 )
(118 )
(85 )
(150 )
(40 )
Ending reserves
$ 1,607
$ 1,078
$ 1,655
$ 1,100
$ 1,780
$ 1,180
Annual survival ratio
18.7
22.5
14.0
12.9
11.9
11.5
3-year survival ratio
13.6
13.6
12.6
12.2
12.4
12.9
Environmental claims
Beginning reserves
$
$
$
$
$
$
Incurred claims and claims expense
(2 )
-
Claims and claims expense paid
(21 )
(16 )
(18 )
(15 )
(19 )
(10 )
Ending reserves
$
$
$
$
$
$
Annual survival ratio
10.7
11.6
13.8
13.4
12.7
12.1
3-year survival ratio
11.8
11.6
8.0
8.7
7.1
7.5
Combined environmental and asbestos claims
Annual survival ratio
17.1
19.7
14.0
13.0
12.0
11.6
3-year survival ratio
13.4
13.3
11.7
11.6
11.4
11.7
Percentage of IBNR in ending reserves
59.0 %
60.1 %
62.3 %
The survival ratio is calculated by taking our ending reserves divided by payments made during the year. This is a commonly used but extremely simplistic and imprecise approach to measuring the adequacy of asbestos and environmental reserve levels. Many factors, such as mix of business, level of coverage provided and settlement procedures have significant impacts on the amount of environmental and asbestos claims and claims expense reserves, claim payments and the resultant ratio. As payments result in corresponding reserve reductions, survival ratios can be expected to vary over time. The 2009 net survival ratios in the table above have been adjusted to remove the claims and claims expense paid of $63 million for asbestos and $7 million for environmental attributable to commutation activity related to three reinsurers.
In 2011, the asbestos net 3-year survival ratio increased due to lower average annual payments. In 2010, the asbestos net 3-year survival ratio decreased due to lower reserve levels as the result of loss settlements. The environmental net 3-year survival ratio increased in both 2011 and 2010 due to lower average annual payments.
Our net asbestos reserves by type of exposure and total reserve additions are shown in the following table.
($ in millions)
December 31, 2011
December 31, 2010
December 31, 2009
Active
policy-
holders
Net
reserves
% of
reserves
Active
policy-
holders
Net
reserves
% of
reserves
Active
policy-
holders
Net
reserves
% of
reserves
Direct policyholders:
-Primary
$
%
$
%
$
%
-Excess
Total
Assumed reinsurance
IBNR
Total net reserves
$ 1,078
%
$ 1,100
%
$ 1,180
%
Total reserve additions
$
$
$ (8 )
During the last three years, 57 direct primary and excess policyholders reported new claims, and claims of 75 policyholders were closed, decreasing the number of active policyholders by 18 during the period. The 18 decrease comprised (4) from 2011, 1 from 2010 and (15) from 2009. The decrease of 4 from 2011 included 16 new policyholders reporting new claims and the closing of 20 policyholders' claims.
IBNR net reserves decreased by $30 million. As of December 31, 2011 IBNR represented 58% of total net asbestos reserves, compared to 60% as of December 31, 2010. IBNR provides for reserve development of known claims and future reporting of additional unknown claims from current and new policyholders and ceding companies.
Pending, new, total closed and closed without payment claims for asbestos and environmental exposures for the years ended December 31, are summarized in the following table.
Number of claims
Asbestos
Pending, beginning of year
8,421
8,252
8,780
New
Total closed
(856 )
(619 )
(1,342 )
Pending, end of year
8,072
8,421
8,252
Closed without payment
Environmental
Pending, beginning of year
4,297
4,114
4,603
New
Total closed
(472 )
(315 )
(878 )
Pending, end of year
4,176
4,297
4,114
Closed without payment
Property-Liability reinsurance ceded For Allstate Protection, we utilize reinsurance to reduce exposure to catastrophe risk and manage capital, and to support the required statutory surplus and the insurance financial strength ratings of certain subsidiaries such as Castle Key Insurance Company and Allstate New Jersey Insurance Company. We purchase significant reinsurance to manage our aggregate countrywide exposure to an acceptable level. The price and terms of reinsurance and the credit quality of the reinsurer are considered in the purchase process, along with whether the price can be appropriately reflected in the costs that are considered in setting future rates charged to policyholders. We also participate in various reinsurance mechanisms, including industry pools and facilities, which are backed by the financial resources of the property-liability insurance company market participants, and have historically purchased reinsurance to mitigate long-tail liability lines, including environmental, asbestos and other discontinued lines exposures. We retain primary liability as a direct insurer for all risks ceded to reinsurers.
The impacts of reinsurance on our reserve for claims and claims expense as of December 31 are summarized in the following table, net of allowances we have established for uncollectible amounts.
Reserve for
property-liability
insurance claims
and claims expense
Reinsurance
recoverables, net
($ in millions)
Industry pools and facilities
$ 2,491
$ 1,990
$ 1,865
$ 1,419
Asbestos and environmental
1,832
1,903
Other including allowance for future uncollectible reinsurance recoverables
16,052
15,575
Total Property-Liability
$ 20,375
$ 19,468
$ 2,674
$ 2,152
Reinsurance recoverables include an estimate of the amount of property-liability insurance claims and claims expense reserves that may be ceded under the terms of the reinsurance agreements, including incurred but not reported unpaid losses. We calculate our ceded reinsurance estimate based on the terms of each applicable reinsurance agreement, including an estimate of how IBNR losses will ultimately be ceded under the agreement. We also consider other limitations and coverage exclusions under our reinsurance agreements. Accordingly, our estimate of reinsurance recoverables is subject to similar risks and uncertainties as our estimate of reserve for property-liability claims and claims expense. We believe the recoverables are appropriately established; however, as our underlying reserves continue to develop, the amount ultimately recoverable may vary from amounts currently recorded. We regularly evaluate the reinsurers and the respective amounts recoverable, and a provision for uncollectible reinsurance is recorded if needed. The establishment of reinsurance recoverables and the related allowance for uncollectible reinsurance is also an inherently uncertain process involving estimates. Changes in estimates could result in additional changes to the Consolidated Statements of Operations.
The allowance for uncollectible reinsurance relates to Discontinued Lines and Coverages reinsurance recoverables and was $103 million and $142 million as of December 31, 2011 and 2010, respectively. This amount represents 13.4% and 17.6% of the related reinsurance recoverable balances as of December 31, 2011 and 2010, respectively. The allowance is based upon our ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, and other relevant factors. In addition, in the ordinary course of business, we may become involved in coverage disputes with certain of our reinsurers which may ultimately result in lawsuits and arbitrations brought by or against such reinsurers to determine the parties' rights and obligations under the various reinsurance agreements. We employ dedicated specialists to manage reinsurance collections and disputes. We also consider recent developments in commutation activity between reinsurers and cedants, and recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers in seeking to maximize our reinsurance recoveries.
Adverse developments in the insurance industry have led to a decline in the financial strength of some of our reinsurance carriers, causing amounts recoverable from them and future claims ceded to them to be considered a higher risk. There has also been consolidation activity in the industry, which causes reinsurance risk across the industry to be concentrated among fewer companies. In addition, over the last several years the industry has increasingly segregated asbestos, environmental, and other discontinued lines exposures into separate legal entities with dedicated capital. Regulatory bodies in certain cases have supported these actions. We are unable to determine the impact, if any, that these developments will have on the collectability of reinsurance recoverables in the future.
The largest reinsurance recoverable balances are shown in the following table as of December 31, net of the allowance we have established for uncollectible amounts.
Standard
& Poor's
financial
strength
rating (1)
Reinsurance
recoverable on paid
and unpaid claims, net
($ in millions)
Industry pools and facilities
Michigan Catastrophic Claim Association ("MCCA")
N/A
$ 1,709
$ 1,243
North Carolina Reinsurance Facility
N/A
New Jersey Unsatisfied Claim and Judgment Fund
N/A
National Flood Insurance Program
N/A
Other
Total
1,865
1,419
Asbestos, Environmental and Other
Lloyd's of London ("Lloyd's")
A+
Westport Insurance Corporation (formerly Employers Reinsurance Corporation)
AA-
New England Reinsurance Corporation
N/A
R&Q Reinsurance Company
N/A
OneBeacon Insurance Company
A-
Clearwater Insurance Company
BB+
Other, including allowance for future uncollectible reinsurance recoverables
Total
Total Property-Liability
$ 2,674
$ 2,152
(1)N/A reflects no rating available.
The effects of reinsurance ceded on our property-liability premiums earned and claims and claims expense for the years ended December 31 are summarized in the following table.
($ in millions)
Ceded property-liability premiums earned
$ 1,098
$ 1,092
$ 1,056
Ceded property-liability claims and claims expense
Industry pool and facilities
FHCF
$
$
$
National Flood Insurance Program
MCCA
Other
Subtotal industry pools and facilities
Asbestos, Environmental and Other
Ceded property-liability claims and claims expense
$
$
$
For the year ended December 31, 2011, ceded property-liability premiums earned increased $6 million when compared to prior year, primarily due to higher premium rates and an increase in policies written for the National Flood Insurance Program. For the year ended December 31, 2010, ceded property-liability premiums earned increased $36 million when compared to prior year, primarily due to the adoption of accounting guidance related to the consolidation of variable interest entities, which resulted in the consolidation of two insurance company affiliates, Allstate Texas Lloyds and Allstate County Mutual Insurance Company.
Ceded property-liability claims and claims expense increased in 2011 primarily due to reserve increases in the MCCA program and an increase in claim activity on the National Flood Insurance Program due to multiple flooding events throughout the year. Ceded property-liability claims and claims expense decreased in 2010 primarily due to amounts ceded to National Flood Insurance Program.
For a detailed description of the MCCA, FHCF and Lloyd's, see Note 10 of the consolidated financial statements. As of December 31, 2011, other than the recoverable balances listed in the table above, no other amount due or estimated to be due from any single Property-Liability reinsurer was in excess of $19 million.
We enter into certain intercompany insurance and reinsurance transactions for the Property-Liability operations in order to maintain underwriting control and manage insurance risk among various legal entities. These reinsurance agreements have been approved by the appropriate regulatory authorities. All significant intercompany transactions have been eliminated in consolidation.
Catastrophe reinsurance
Our catastrophe reinsurance program is designed, utilizing our risk management methodology, to address our exposure to catastrophes nationwide. Our program provides reinsurance protection for catastrophes including storms named or numbered by the National Weather Service, fires following earthquakes, earthquakes and wildfires including California wildfires. These reinsurance agreements are part of our catastrophe management strategy, which is intended to provide our shareholders an acceptable return on the risks assumed in our property business, and to reduce variability of earnings, while providing protection to our customers.
We anticipate completing the placement of our 2012 catastrophe reinsurance program in February 2012. We expect the program will be substantially similar to our 2011 catastrophe reinsurance program. The information below provides further detail regarding our 2012 catastrophe reinsurance program.
Our 2012 reinsurance program will continue to support our goal to have no more than a 1% likelihood of exceeding annual aggregate catastrophe losses by $2 billion, net of reinsurance, from hurricanes and earthquakes, based on modeled assumptions and applications currently available. Since the 2006 inception of Allstate's catastrophe reinsurance program, our exposure to wind loss has been materially reduced and we have nearly eliminated our exposure to earthquake loss. Similar to our 2011 program, we have designed our 2012 program to respond to these exposure changes by including coverage for multiple perils, in addition to hurricanes and earthquakes, in all agreements except for the Kentucky agreement, which provides coverage for earthquakes and fires following earthquakes.
The 2012 program, as described below, is expected to provide $3.25 billion of reinsurance coverage above the retention. Similar to the expiring program, the 2012 program will include a Per Occurrence Excess Catastrophe Reinsurance agreement reinsuring our personal lines property and auto excess catastrophe losses resulting from multiple perils in every state other than New Jersey and Florida. For June 1, 2012 to May 31, 2013, it is anticipated the program will consist of two agreements: a Per Occurrence Excess Catastrophe Reinsurance agreement providing coverage in six layers with the reinstatement of limits available for the First through Fifth Layers, and a Top and Drop Excess Catastrophe Reinsurance agreement which includes Coverage A and Coverage B.
The Per Occurrence Excess Catastrophe Reinsurance agreement provides an initial $3.25 billion per occurrence limit in excess of a $500 million retention and after the Company has incurred $250 million in losses "otherwise recoverable." The $250 million in losses otherwise recoverable applies once each contract year to the First Layer only and losses from multiple qualifying occurrences can apply to this $250 million threshold in excess of $500 million per occurrence. For June 1, 2012 to May 31, 2013, the program will consist of two existing contracts which expire May 31, 2013 and May 31, 2014 and three new contracts which expire May 31, 2013, May 31, 2014, and May 31, 2015.
The Top and Drop Excess Catastrophe Reinsurance agreement provides $250 million of reinsurance limits which may be used for Coverage A, Coverage B, or a combination of both. For June 1, 2012 to May 31, 2013, Coverage A reinsures the "Top" of the program and provides 12.66% of $500 million excess of a $3.25 billion retention. For June 1, 2012 to May 31, 2013, Coverage B allows the program limit to "Drop" and provides reinsurance for 25% of $250 million in limits excess of a $750 million retention and after the Company has incurred $500 million in losses "otherwise recoverable" under the agreement. Losses from multiple qualifying occurrences, in excess of $750 million per occurrence, can apply to this $500 million threshold.
The New Jersey and Florida components of the reinsurance program are designed separately from the other components of the program to address the distinct needs of our separately capitalized legal entities in those states. The New Jersey agreement reinsures personal lines property losses resulting from multiple perils and consists of three contracts which expire on May 31, 2013, May 31, 2014 and May 31, 2015. The Florida component will be placed in May of
2012. Allstate Protection's separate reinsurance programs in Pennsylvania and Kentucky will continue to address exposures unique to those states. A description of the catastrophe reinsurance treaties that will reinsure Allstate Protection as of June 1, 2012 follows:
Nationwide excluding Florida and New Jersey
•The Per Occurrence Excess Catastrophe Reinsurance agreement reinsures personal lines property and auto excess catastrophe losses caused by multiple perils under Seven Layers of coverage as follows:
First Layer
$250 million limit in excess of a $500 million retention and after an initial $250 million in losses "otherwise recoverable" has been satisfied, 1 reinstatement
Second Layer
$250 million limit in excess of a $750 million retention, 1 reinstatement
Third Layer
$500 million limit in excess of a $1 billion retention, 1 reinstatement
Fourth Layer
$750 million limit in excess of a $1.5 billion retention, 1 reinstatement
Fifth Layer
$1 billion limit in excess of a $2.25 billion retention, 1 reinstatement
Sixth Layer
$500 million limit in excess of a $3.25 billion retention
Coverage for the First through the Fifth Layers comprises three contracts, each contract providing one third of 95% of the total limit and expiring as of May 31, 2013, May 31, 2014 and May 31, 2015. Coverage for the Sixth Layer will comprise five contracts and will be 82.34% placed. For June 1, 2012 to May 31, 2013, two existing contracts, expiring May 31, 2013 and May 31, 2014, provide 31.67% of the placed limit; and three newly placed contracts, expiring May 31, 2013, May 31, 2014, and May 31, 2015, in total provide 50.67% of the placed limit. The newly placed contracts, effective June 1, 2012, will not have a prepaid reinstatement limit thus requiring premium for the reinstatement of limits. The Sixth Layer does not have a reinstatement of limits. Reinsurance premium is subject to redetermination for exposure changes at each anniversary.
•The Top and Drop Excess Catastrophe Reinsurance agreement reinsures personal lines property and auto excess catastrophe losses caused by multiple perils under a three year term contract expiring May 31, 2014. The reinsurance limit may be used for Coverage A, Coverage B or a combination of both and is not subject to reinstatement. For June 1, 2012 to May 31, 2013, Coverage A of the Top and Drop provides 12.66% of $500 million in limits in excess of a $3.25 billion retention, which completes the 95% placement of the Sixth Layer of the Per Occurrence Excess Catastrophe Reinsurance agreement. Coverage B provides 25% of $250 million in limits in excess of a $750 million retention. In addition to this retention, the Company must incur $500 million in losses, "otherwise recoverable", under Coverage B during the contract year before Coverage B attaches. Losses from multiple qualifying occurrences can apply to this $500 million threshold. For June 1, 2013 to May 31, 2014, the contract provides 6% of Coverage A's and 12.66% of Coverage B's placement. Reinsurance premium is subject to redetermination for exposure changes.
New Jersey
•The Excess Catastrophe Reinsurance contract reinsures personal lines property excess catastrophe losses in New Jersey caused by multiple perils. One existing and a newly placed contract each provides 32% of $400 million of limits excess of a $150 million retention and include one reinstatement per contract year. In addition, a separate existing New Jersey contract will remain in place until May 31, 2013 and provides a First Layer of 32% of $300 million of limits in excess of a $184 million retention and a Second Layer of 42% of $200 million in limits excess of a $484 million retention. Each Layer includes one reinstatement per contract year. The reinsurance premium and retention are subject to redetermination for exposure changes at each anniversary.
Pennsylvania
•The Excess Catastrophe Reinsurance Contract reinsures personal lines property losses in Pennsylvania caused by multiple perils. This agreement will be effective June 1, 2012 for three years and provide 95% of $100 million of limits in excess of a $100 million retention with two limits being available for the remaining term of the contract. The reinsurance premium and retention are not subject to redetermination for exposure changes.
Kentucky
•The Earthquake Excess Catastrophe Reinsurance Contract reinsures personal lines property losses in Kentucky caused by earthquakes or fires following earthquakes. The agreement is effective June 1, 2012 for three years and provides 95% of $25 million of limits in excess of a $5 million retention. The agreement provides three limits over its three year term subject to two limits being available in any one contract year. The reinsurance premium and retention are not subject to redetermination for exposure changes.
See Note 10 for further details of the existing 2011 program.
We estimate that the total annualized cost of all catastrophe reinsurance programs for the year beginning June 1, 2012 will be approximately $577 million compared to $564 million annualized cost for the year beginning June 1, 2011. The total cost of our catastrophe reinsurance programs in 2011 was $558 million compared to $593 million in 2010. These annual costs reflect premium re-measurements recognized in the year. We continue to attempt to capture our reinsurance cost in premium rates as allowed by state regulatory authorities.
ALLSTATE FINANCIAL 2011 HIGHLIGHTS
•Net income was $586 million in 2011 compared to $58 million in 2010. •Premiums and contract charges on underwritten products, including traditional life, interest-sensitive life and accident and health insurance, totaled $2.10 billion in 2011, an increase of 3.3% from $2.03 billion in 2010. •Net realized capital gains totaled $388 million in 2011 compared to net realized capital losses of $517 million in 2010. •Investments totaled $57.37 billion as of December 31, 2011, reflecting a decrease in carrying value of $4.21 billion from $61.58 billion as of December 31, 2010. Net investment income decreased 4.8% to $2.72 billion in 2011 from $2.85 billion in 2010. •Contractholder funds totaled $42.33 billion as of December 31, 2011, reflecting a decrease of $5.86 billion from $48.19 billion as of December 31, 2010.
ALLSTATE FINANCIAL SEGMENT
Overview and strategy The Allstate Financial segment is a major provider of life insurance, retirement and investment products, and voluntary accident and health insurance. We serve our customers through Allstate exclusive agencies, workplace distribution and non-proprietary distribution channels. Allstate Financial's strategic vision is to reinvent protection and retirement for the consumer and its purpose is to create financial value and to add strategic value to the organization.
To fulfill its purpose, Allstate Financial's primary objectives are to deepen relationships with Allstate customers by adding financial services to their suite of products with Allstate, dramatically expand Allstate Benefits (our workplace distribution business) and improve profitability by decreasing earnings volatility and increasing our returns. Allstate Financial brings value to The Allstate Corporation in three principal ways: through profitable growth of Allstate Financial, improving the economics of the Protection business through increased customer loyalty and renewal rates by cross selling Allstate Financial products to existing customers, and by bringing new customers to Allstate. We continue to shift our mix of products in force by decreasing spread based products, principally fixed annuities and institutional products, and through growth of underwritten products having mortality or morbidity risk, principally life insurance and accident and health products. In addition to focusing on higher return markets, products, and distribution channels, Allstate Financial continues to emphasize capital efficiency and enterprise risk and return management strategies and actions.
Allstate Financial's strategy provides a platform to profitably grow its business. Based upon Allstate's strong financial position and brand, we have a unique opportunity to cross-sell to our customers. We will leverage trusted customer relationships through our Allstate exclusive agencies or direct marketing to serve those who are looking for assistance in meeting their protection and retirement needs by providing them with the information, products and services that they need. Life insurance applications issued through Allstate agencies increased 33% in 2011 compared to 2010. Our employer relationships through Allstate Benefits also afford opportunities to offer additional Allstate products.
Our products include interest-sensitive, traditional and variable life insurance; fixed annuities such as deferred and immediate annuities; voluntary accident and health insurance; and funding agreements backing medium-term notes, which we most recently offered in 2008. Our products are sold through multiple distribution channels including Allstate exclusive agencies and exclusive financial specialists, independent agents (including master brokerage agencies and workplace enrolling agents), specialized structured settlement brokers and directly through call centers and the internet.
Our institutional product line consists of funding agreements sold to unaffiliated trusts that use them to back medium-term notes issued to institutional and individual investors. Banking products and services were previously offered to customers through the Allstate Bank. In 2011, after receiving regulatory approval to voluntarily dissolve, Allstate Bank ceased operations. In the first half of 2012, we expect to cancel the bank's charter and deregister The Allstate Corporation as a savings and loan holding company.
Allstate Financial outlook
•We plan to continue to increase premiums and contract charges on underwritten insurance products and develop products our customers need for retirement income. •Our growth initiatives will be primarily focused on increasing the number of customers served through our proprietary and Allstate Benefits (workplace distribution) channels. •We will continue to focus on improving returns and reducing our concentration in spread based products resulting in net reductions in contractholder funds obligations. •We expect increases in Allstate Financial's attributed GAAP equity as there may be limitations on the amount of dividends Allstate Financial companies can pay without prior approval by their insurance departments. •We expect lower investment spread due to reduced contractholder funds, the continuing low interest rate environment and changes in asset allocations. The amount by which the low interest rate environment will reduce our investment spread is contingent on our ability to maintain the portfolio yield and lower interest crediting rates on spread based products, which could be limited by market conditions, regulatory minimum rates or contractual minimum rate guarantees, and may not match the timing or magnitude of changes in asset yields. We also anticipate changing our asset allocation for long-term immediate annuities by reducing fixed income securities and increasing investments in limited partnerships, equities and other alternative investments. This shift could result in lower and more volatile investment income; however, we anticipate that this strategy will lead to higher total returns and attributed equity. Summary analysis Summarized financial data for the years ended December 31 is presented in the following table.
($ in millions)
Revenues
Life and annuity premiums and contract charges
$ 2,238
$ 2,168
$ 1,958
Net investment income
2,716
2,853
3,064
Realized capital gains and losses
(517 )
(431 )
Total revenues
5,342
4,504
4,591
Costs and expenses
Life and annuity contract benefits
(1,761 )
(1,815 )
(1,617 )
Interest credited to contractholder funds
(1,645 )
(1,807 )
(2,126 )
Amortization of DAC
(593 )
(356 )
(965 )
Operating costs and expenses
(455 )
(469 )
(430 )
Restructuring and related charges
(1 )
(25 )
Total costs and expenses
(4,455 )
(4,444 )
(5,163 )
(Loss) gain on disposition of operations
(15
)
Income tax (expense) benefit
(286 )
(8 )
Net income (loss)
$
$
$ (483 )
Investments as of December 31
$
57,373
$
61,582
$
62,216
Net income
Life insurance
$
Accident and health insurance
Annuities and institutional and bank products
Net income
$
Net income in 2011 was $586 million compared to $58 million in 2010. The $528 million increase was primarily due to net realized capital gains in the current year compared to net realized capital losses in the prior year, decreased
interest credited to contractholder funds, higher life and annuity premiums and contract charges and lower life and annuity contract benefits, partially offset by higher amortization of DAC and lower net investment income.
Net income in 2010 was $58 million compared to a net loss of $483 million in 2009. The favorable change of $541 million was primarily due to lower amortization of DAC, decreased interest credited to contractholder funds and higher premiums and contract charges, partially offset by lower net investment income, higher life and annuity contract benefits and increased net realized capital losses.
Analysis of revenues Total revenues increased 18.6% or $838 million in 2011 compared to 2010 due to net realized capital gains in the current year compared to net realized capital losses in the prior year and higher premiums and contract charges, partially offset by lower net investment income. Total revenues decreased 1.9% or $87 million in 2010 compared to 2009 due to lower net investment income and higher net realized capital losses, partially offset by higher premiums and contract charges.
Life and annuity premiums and contract charges Premiums represent revenues generated from traditional life insurance, immediate annuities with life contingencies, and accident and health insurance products that have significant mortality or morbidity risk. Contract charges are revenues generated from interest-sensitive and variable life insurance and fixed annuities for which deposits are classified as contractholder funds or separate account liabilities. Contract charges are assessed against the contractholder account values for maintenance, administration, cost of insurance and surrender prior to contractually specified dates.
The following table summarizes life and annuity premiums and contract charges by product for the years ended December 31.
($ in millions)
Underwritten products
Traditional life insurance premiums
$
$
$
Accident and health insurance premiums
Interest-sensitive life insurance contract charges
1,015
Subtotal
2,099
2,032
1,811
Annuities
Immediate annuities with life contingencies premiums
Other fixed annuity contract charges
Subtotal
Life and annuity premiums and contract charges (1)
$
2,238
$
2,168
$
1,958
(1)Contract charges related to the cost of insurance totaled $659 million, $637 million and $616 million in 2011, 2010 and 2009, respectively.
Total premiums and contract charges increased 3.2% in 2011 compared to 2010 primarily due to higher contract charges on interest-sensitive life insurance products primarily resulting from the aging of our policyholders, growth in Allstate Benefits's accident and health insurance business in force and increased traditional life insurance premiums. Increased traditional life insurance premiums were primarily due to lower reinsurance premiums resulting from higher retention, partially offset by lower renewal premiums.
Total premiums and contract charges increased 10.7% in 2010 compared to 2009 primarily due to higher sales of accident and health insurance through Allstate Benefits, with a significant portion of the increase resulting from sales to employees of one large company, and higher contract charges on interest-sensitive life insurance products resulting from a shift in the mix of policies in force to contracts with higher cost of insurance rates and policy administration fees. In addition, increased traditional life insurance premiums in 2010 were primarily due to lower reinsurance premiums resulting from higher retention, partially offset by lower renewal premiums and decreased sales.
Contractholder funds represent interest-bearing liabilities arising from the sale of individual and institutional products, such as interest-sensitive life insurance, fixed annuities, funding agreements and bank deposits. The balance of contractholder funds is equal to the cumulative deposits received and interest credited to the contractholder less
cumulative contract maturities, benefits, surrenders, withdrawals and contract charges for mortality or administrative expenses. The following table shows the changes in contractholder funds for the years ended December 31.
($ in millions)
Contractholder funds, beginning balance
$ 48,195
$ 52,582
$ 58,413
Deposits
Fixed annuities
1,964
Interest-sensitive life insurance
1,288
1,512
1,438
Bank and other deposits
1,178
Total deposits
2,318
3,438
4,580
Interest credited
1,629
1,794
2,025
Maturities, benefits, withdrawals and other adjustments
Maturities and retirements of institutional products
(867 )
(1,833 )
(4,773 )
Benefits
(1,461 )
(1,552 )
(1,588 )
Surrenders and partial withdrawals
(6,398 )
(5,203 )
(5,172 )
Contract charges
(1,028 )
(983 )
(918 )
Net transfers from separate accounts
Fair value hedge adjustments for institutional products
(34 )
(196 )
Other adjustments (1)
(34 )
(21 )
Total maturities, benefits, withdrawals and other adjustments
(9,810 )
(9,619 )
(12,436 )
Contractholder funds, ending balance
$ 42,332
$ 48,195
$ 52,582
(1)The table above illustrates the changes in contractholder funds, which are presented gross of reinsurance recoverables on the Consolidated Statements of Financial Position. The table above is intended to supplement our discussion and analysis of revenues, which are presented net of reinsurance on the Consolidated Statements of Operations. As a result, the net change in contractholder funds associated with products reinsured to third parties is reflected as a component of the other adjustments line.
Contractholder funds decreased 12.2%, 8.3% and 10.0% in 2011, 2010 and 2009, respectively, reflecting our continuing actions to reduce our concentration in spread-based products and the return of funds to Allstate Bank account holders in December 2011 in connection with ceasing operations. Average contractholder funds decreased 10.2% in 2011 compared to 2010 and 9.2% in 2010 compared to 2009.
Contractholder deposits decreased 32.6% in 2011 compared to 2010 primarily due to lower deposits on Allstate Bank products and fixed annuities. In September 2011, Allstate Bank stopped opening new customer accounts.
Contractholder deposits decreased 24.9% in 2010 compared to 2009 primarily due to lower deposits on fixed annuities. Deposits on fixed annuities decreased 52.5% in 2010 compared to 2009 due to our strategic decision to discontinue distributing fixed annuities through banks and broker-dealers and our goal to reduce our concentration in spread-based products and improve returns on new business.
Maturities and retirements of institutional products decreased $966 million to $867 million in 2011 from $1.83 billion in 2010, reflecting the continuing decline in these obligations over the past four years.
Maturities and retirements of institutional products decreased 61.6% to $1.83 billion in 2010 from $4.77 billion in 2009. During 2009, we retired all of our remaining outstanding extendible institutional market obligations totaling $1.45 billion. In addition, 2009 included the redemption of $1.39 billion of institutional product liabilities in conjunction with cash tender offers.
Surrenders and partial withdrawals on deferred fixed annuities, interest-sensitive life insurance products and Allstate Bank products (including maturities of certificates of deposit) increased 23.0% to $6.40 billion in 2011 from $5.20 billion in 2010, and increased 0.6% in 2010 from $5.17 billion in 2009. In 2011, the increase was primarily due to higher surrenders and partial withdrawals on fixed annuities and the return of $1.09 billion of funds to Allstate Bank account holders, partially offset by lower surrenders and partial withdrawals on interest-sensitive life insurance products. The increase for fixed annuities resulted from an increased number of contracts reaching the 30-45 day period (typically at their 5 or 6 year anniversary) during which there is no surrender charge as well as crediting rate actions taken by management. In 2010, the increase was primarily due to higher surrenders and partial withdrawals on fixed annuities, partially offset by lower surrenders and partial withdrawals on Allstate Bank products.
The surrender and partial withdrawal rate on deferred fixed annuities, interest-sensitive life insurance products and Allstate Bank products, based on the beginning of year contractholder funds, was 15.9% in 2011 compared to 12.2% in 2010 and 11.8% in 2009. Excluding Allstate Bank products, the surrender and partial withdrawal rate on deferred fixed annuities and interest-sensitive life insurance products, based on the beginning of year contractholder funds, was 12.6% in 2011 compared to 10.1% in 2010 and 9.6% in 2009.
Net investment income decreased 4.8% or $137 million to $2.72 billion in 2011 from $2.85 billion in 2010 primarily due to lower average investment balances which were partially offset by higher yields. The higher yields are primarily attributable to yield optimization actions including the termination of interest rate swaps during the first quarter of 2011. Net investment income decreased 6.9% or $211 million to $2.85 billion in 2010 from $3.06 billion in 2009 primarily due to lower yields, reduced average investment balances and risk reduction actions.
Net realized capital gains and losses are presented in the following table for the years ended December 31.
($ in millions)
Impairment write-downs
$ (246 ) $ (501 ) $ (1,021 )
Change in intent write-downs
(51 )
(142 )
(268 )
Net other-than-temporary impairment losses recognized in earnings
(297 )
(643 )
(1,289 )
Sales
Valuation of derivative instruments
(237 )
(94 )
Settlements of derivative instruments
(31 )
EMA limited partnership income
(136 )
Realized capital gains and losses, pre-tax
(517 )
(431 )
Income tax (expense) benefit
(138 )
Realized capital gains and losses, after-tax
$
$ (337 ) $ (417 )
For further discussion of realized capital gains and losses, see the Investments section of the MD&A.
Analysis of costs and expenses Total costs and expenses increased 0.2% or $11 million in 2011 compared to 2010 primarily due to higher amortization of DAC, partially offset by lower interest credited to contractholder funds and life and annuity contract benefits. Total costs and expenses decreased 13.9% or $719 million in 2010 compared to 2009 primarily due to lower amortization of DAC and interest credited to contractholder funds, partially offset by higher life and annuity contract benefits.
Life and annuity contract benefits decreased 3.0% or $54 million in 2011 compared to 2010 primarily due to reserve reestimations recorded in second quarter 2010 that did not recur in 2011 and a $38 million reduction in accident and health insurance reserves at Allstate Benefits as of December 31, 2011 related to a contract modification, partially offset by unfavorable mortality experience on life insurance.
The reserve reestimations in the second quarter of 2010 utilized more refined policy level information and assumptions. The increase in reserves for certain secondary guarantees on universal life insurance policies resulted in a charge to contract benefits of $68 million and a related reduction in amortization of DAC of $50 million. The decrease in reserves for immediate annuities resulted in a credit to contract benefits of $26 million. The net impact was an increase to income of $8 million, pre-tax.
Life and annuity contract benefits increased 12.2% or $198 million in 2010 compared to 2009 primarily due to higher contract benefits on accident and health insurance and interest-sensitive life insurance products, partially offset by lower contract benefits on immediate annuities with life contingencies. Higher contract benefits on accident and health insurance were proportionate to growth in premiums. The increase in contract benefits on interest-sensitive life insurance was primarily due to the reestimation of reserves for certain secondary guarantees on universal life insurance policies and higher mortality experience resulting from an increase in average claim size and higher incidence of claims. Lower contract benefits on immediate annuities with life contingencies were due to the reestimation of reserves for benefits payable to certain annuitants to reflect current contractholder information.
We analyze our mortality and morbidity results using the difference between premiums and contract charges earned for the cost of insurance and life and annuity contract benefits excluding the portion related to the implied interest on immediate annuities with life contingencies ("benefit spread"). This implied interest totaled $541 million in 2011, $549 million in 2010 and $558 million in 2009.
The benefit spread by product group is disclosed in the following table for the years ended December 31.
($ in millions)
Life insurance
$
$
$
Accident and health insurance
Annuities
(55 )
(25 )
(33 )
Total benefit spread
$
$
$
Benefit spread increased 23.6% or $120 million in 2011 compared to 2010 primarily due to reestimations of reserves that increased contract benefits for interest-sensitive life insurance and decreased contract benefits for immediate annuities with life contingencies in 2010, a reduction in accident and health insurance reserves at Allstate Benefits as of December 31, 2011 related to a contract modification, and favorable morbidity experience on certain accident and health products and growth at Allstate Benefits.
Benefit spread decreased 3.2% or $17 million in 2010 compared to 2009. The decrease was primarily due to higher mortality experience on interest-sensitive life insurance and reestimations of reserves that increased contract benefits for interest-sensitive life insurance and decreased contract benefits for immediate annuities, partially offset by growth in accident and health insurance sold through Allstate Benefits.
Interest credited to contractholder funds decreased 9.0% or $162 million in 2011 compared to 2010 primarily due to lower average contractholder funds and lower interest crediting rates on deferred fixed annuities, interest-sensitive life insurance and immediate fixed annuities. Additionally, valuation changes on derivatives embedded in equity-indexed annuity contracts that are not hedged increased interest credited to contractholder funds by $18 million in 2011. Amortization of deferred sales inducement costs was $23 million in 2011 compared to $27 million in 2010.
Interest credited to contractholder funds decreased 15.0% or $319 million in 2010 compared to 2009 primarily due to lower average contractholder funds and management actions to reduce interest crediting rates on deferred fixed annuities and interest-sensitive life insurance. In addition, the decline in 2010 also reflects lower amortization of DSI. Amortization of DSI declined to $27 million in 2010 compared to $129 million in 2009, primarily due to a $46 million decrease in amortization relating to realized capital gains and losses and a $38 million reduction in amortization acceleration for changes in assumptions.
In order to analyze the impact of net investment income and interest credited to contractholders on net income, we monitor the difference between net investment income and the sum of interest credited to contractholder funds and the implied interest on immediate annuities with life contingencies, which is included as a component of life and annuity contract benefits on the Consolidated Statements of Operations ("investment spread").
The investment spread by product group is shown in the following table for the years ended December 31.
($ in millions)
Annuities and institutional products
$
$
$
Life insurance
Allstate Bank products
Accident and health insurance
Net investment income on investments supporting capital
Total investment spread
$
$
$
Investment spread increased 6.6% or $33 million in 2011 compared to 2010 as actions to improve investment portfolio yields and lower crediting rates more than offset the effect of the continuing decline in our spread-based business in force.
Investment spread increased 30.8% or $117 million in 2010 compared to 2009 as lower net investment income was more than offset by decreased interest credited to contractholder funds, which includes lower amortization of DSI. Excluding amortization of DSI, investment spread increased 2.9% or $15 million in 2010 compared to 2009.
To further analyze investment spreads, the following table summarizes the weighted average investment yield on assets supporting product liabilities and capital, interest crediting rates and investment spreads.
Weighted average
investment yield
Weighted average
interest crediting rate
Weighted average
investment spreads
Interest-sensitive life insurance
5.4 %
5.5 %
5.5 %
4.2 %
4.4 %
4.6 %
1.2 %
1.1 %
0.9 %
Deferred fixed annuities and institutional products
4.6
4.4
4.5
3.3
3.2
3.4
1.3
1.2
1.1
Immediate fixed annuities with and without life contingencies
6.3
6.4
6.3
6.2
6.4
6.5
0.1
-
(0.2 )
Investments supporting capital, traditional life and other products
3.9
3.7
3.7
n/a
n/a
n/a
n/a
n/a
n/a
The following table summarizes our product liabilities as of December 31 and indicates the account value of those contracts and policies in which an investment spread is generated.
($ in millions)
Immediate fixed annuities with life contingencies
$ 8,831
$ 8,696
$ 8,454
Other life contingent contracts and other
5,618
4,786
4,456
Reserve for life-contingent contract benefits
$ 14,449
$ 13,482
$ 12,910
Interest-sensitive life insurance
$ 10,826
$ 10,675
$ 10,276
Deferred fixed annuities
25,228
29,367
32,194
Immediate fixed annuities without life contingencies
3,821
3,799
3,869
Institutional products
1,891
2,650
4,370
Allstate Bank products
-
1,091
1,085
Market value adjustments related to fair value hedges and other
Contractholder funds
$ 42,332
$ 48,195
$ 52,582
The following table summarizes the weighted average guaranteed crediting rates and weighted average current crediting rates as of December 31, 2011 for certain fixed annuities and interest-sensitive life contracts where management has the ability to change the crediting rate, subject to a contractual minimum. Other products, including equity-indexed, variable and immediate annuities, equity-indexed and variable life, and institutional products totaling $11.01 billion of contractholder funds, have been excluded from the analysis because management does not have the ability to change the crediting rate or the minimum crediting rate is not considered meaningful in this context.
($ in millions)
Weighted
average
guaranteed
crediting rates
Weighted
average
current
crediting rates
Contractholder
funds
Annuities with annual crediting rate resets
3.12 %
3.14 % $ 11,537
Annuities with multi-year rate guarantees: (1)
Resetable in next 12 months
2.16
4.16
2,432
Resetable after 12 months
1.61
3.74
6,597
Interest-sensitive life insurance
3.95
4.30
10,756
(1)These contracts include interest rate guarantee periods which are typically 5 or 6 years.
Amortization of DAC increased 66.6% or $237 million in 2011 compared to 2010 and decreased 63.1% or $609 million in 2010 compared to 2009. The components of amortization of DAC are summarized in the following table for the years ended December 31.
($ in millions)
Amortization of DAC before amortization relating to realized capital gains and losses, valuation changes on embedded derivatives that are not hedged and changes in assumptions
$
$
$
Amortization relating to realized capital gains and losses (1) and valuation changes on embedded derivatives that are not hedged
Amortization acceleration (deceleration) for changes in assumptions ("DAC unlocking")
(12 )
Total amortization of DAC
$
$
$
(1)The impact of realized capital gains and losses on amortization of DAC is dependent upon the relationship between the assets that give rise to the gain or loss and the product liability supported by the assets. Fluctuations result from changes in the impact of realized capital gains and losses on actual and expected gross profits.
The increase of $237 million in 2011 was primarily due to increased amortization relating to realized capital gains, lower amortization in the second quarter of 2010 resulting from decreased benefit spread on interest-sensitive life insurance due to the reestimation of reserves, and an unfavorable change in amortization acceleration/deceleration for changes in assumptions. In 2011, DAC amortization relating to realized capital gains and losses primarily resulted from realized capital gains on sales of fixed income securities.
The decrease of $609 million in 2010 was primarily due to a favorable change in amortization acceleration/deceleration for changes in assumptions, lower amortization relating to realized capital gains and losses, a decreased amortization rate on fixed annuities and lower amortization from decreased benefit spread on interest-sensitive life insurance due to the reestimation of reserves. In 2010, DAC amortization relating to realized capital gains and losses primarily resulted from realized capital gains on derivatives and sales of fixed income securities.
During the first quarter of 2011, we completed our annual comprehensive review of the profitability of our products to determine DAC balances for our interest-sensitive life, fixed annuities and other investment contracts which covers assumptions for investment returns, including capital gains and losses, interest crediting rates to policyholders, the effect of any hedges, persistency, mortality and expenses in all product lines. The review resulted in an acceleration of DAC amortization (charge to income) of $12 million in the first quarter of 2011. Amortization acceleration of $17 million related to interest-sensitive life insurance and was primarily due to an increase in projected expenses. Amortization deceleration of $5 million related to equity-indexed annuities and was primarily due to an increase in projected investment margins.
In 2010, our annual comprehensive review resulted in a deceleration of DAC amortization (credit to income) of $12 million. Amortization deceleration of $45 million related to variable life insurance and was primarily due to appreciation in the underlying separate account valuations. Amortization acceleration of $32 million related to interest-sensitive life insurance and was primarily due to an increase in projected realized capital losses and lower projected renewal premium (which is also expected to reduce persistency), partially offset by lower expenses.
In 2009, our annual comprehensive review resulted in the acceleration of DAC amortization of $277 million. $289 million related to fixed annuities, of which $210 million was attributable to market value adjusted annuities, and $18 million related to variable life insurance. Partially offsetting these amounts was amortization deceleration for interest-sensitive life insurance of $30 million. The principal assumption impacting fixed annuity amortization acceleration was an increase in the level of expected realized capital losses in 2009 and 2010. For interest-sensitive life insurance, the amortization deceleration was due to a favorable change in our mortality assumptions, partially offset by increased expected capital losses.
The changes in DAC are detailed in the following table.
($ in millions)
Traditional life and
accident and
health
Interest-sensitive
life insurance
Fixed annuities
Other
Total
Beginning balance
$
$
$ 2,265
$ 2,246
$
$ 1,159
$
$
$ 3,392
$ 4,060
Acquisition costs deferred
-
-
Amortization of DAC before amortization relating to realized capital gains and losses, valuation changes on embedded derivatives that are not hedged and changes in assumptions (1)
(119 )
(113 )
(212 )
(140 )
(65 )
(71 )
(1 )
(2 )
(397 )
(326 )
(Amortization) accretion relating to realized capital gains and losses and valuation changes on embedded derivatives that are not hedged (1)
-
-
(24 )
(160 )
(57 )
-
-
(184 )
(42 )
Amortization (acceleration) deceleration for changes in assumptions ("DAC unlocking") (1)
-
-
(17 )
(1 )
-
-
(12 )
Effect of unrealized capital gains and losses (2)
-
-
(204 )
(144 )
(651 )
-
-
(201 )
(795 )
Ending balance
$
$
$ 2,034
$ 2,265
$
$
$
$
$ 3,031
$ 3,392
(1)Included as a component of amortization of DAC on the Consolidated Statements of Operations. (2)Represents the change in the DAC adjustment for unrealized capital gains and losses. The DAC adjustment balance was $(126) million and $75 million as of December 31, 2011 and 2010, respectively, and represents the amount by which the amortization of DAC would increase or decrease if the unrealized gains and losses in the respective product portfolios were realized.
On January 1, 2012, we will adopt new DAC accounting guidance on a retrospective basis (see Note 2 of the consolidated financial statements for further details). It is currently estimated that the restated Allstate Financial DAC balance will decline by $508 million when compared to the reported December 31, 2011 balance. We estimate that the new DAC accounting guidance will reduce net income by approximately $40 million, after-tax, in 2012.
Operating costs and expenses decreased 3.0% or $14 million in 2011 compared to 2010 and increased 9.1% or $39 million in 2010 compared to 2009. The following table summarizes operating costs and expenses for the years ended December 31.
($ in millions)
Non-deferrable acquisition costs
$
$
$
Other operating costs and expenses
Total operating costs and expenses
$
$
$
Restructuring and related charges
$
$ (3 ) $
Non-deferrable acquisition costs in 2011 were comparable to 2010. Other operating costs and expenses decreased 4.7% or $14 million in 2011 compared to 2010 primarily due to lower employee and professional service costs, reduced insurance department assessments for 2011 and lower net Allstate agencies distribution channel expenses reflecting increased fees from sales of third party financial products, partially offset by a charge related to the liquidation plan for Executive Life Insurance Company of New York.
Non-deferrable acquisition costs increased 7.7% or $12 million in 2010 compared to 2009 primarily due to higher non-deferrable commissions related to accident and health insurance business sold through Allstate Benefits. Other operating costs and expenses increased 9.9% or $27 million in 2010 compared to 2009 primarily due to higher product development, marketing and technology costs, increased litigation expenses, lower reinsurance expense allowances resulting from higher retention and increases in the net cost of employee benefits. In 2010, these increased costs were partially offset by our expense reduction actions, which resulted in lower employee, professional services and sales support expenses.
During 2009, restructuring and related charges of $25 million were recorded in connection with our plan to improve efficiency and narrow our focus of product offerings. In accordance with this plan, among other actions, we eliminated approximately 1,000 workforce positions relative to December 31, 2008 levels through a combination of attrition, position elimination and outsourcing. This reduction reflected approximately 30% of Allstate Financial's work force at the time the plan was initiated.
Loss on disposition of $15 million in 2011 includes $22 million related to the dissolution of Allstate Bank. In 2011, after receiving regulatory approval to voluntarily dissolve, Allstate Bank ceased operations. In the first half of 2012, we expect to cancel the bank's charter and deregister The Allstate Corporation as a savings and loan holding company.
Income tax expense was $286 million in 2011 compared to income tax expense of $8 million in 2010 and an income tax benefit of $82 million in 2009. The change in 2011 was due to the proportionate change in income on which income tax expense was determined. The income tax benefit for 2009 included expense of $142 million attributable to an increase in the valuation allowance relating to the deferred tax asset on capital losses recorded in the first quarter of 2009. This valuation allowance was released in connection with the adoption of new OTTI accounting guidance on April 1, 2009; however, the release was recorded as an increase to retained income and therefore did not reverse the amount recorded in income tax benefit.
Reinsurance ceded We enter into reinsurance agreements with unaffiliated reinsurers to limit our risk of mortality and morbidity losses. In addition, Allstate Financial has used reinsurance to effect the acquisition or disposition of certain blocks of business. We retain primary liability as a direct insurer for all risks ceded to reinsurers. As of December 31, 2011 and 2010, 42% and 45%, respectively, of our face amount of life insurance in force was reinsured. Additionally, we ceded substantially all of the risk associated with our variable annuity business and we cede 100% of the morbidity risk on substantially all of our long-term care contracts.
Our reinsurance recoverables, summarized by reinsurer as of December 31, are shown in the following table.
($ in millions)
Standard & Poor's financial strength rating (4)
Reinsurance
recoverable on paid
and unpaid benefits
Prudential Insurance Company of America
AA-
$ 1,681
$ 1,633
Employers Reassurance Corporation
A+
Transamerica Life Group
AA-
RGA Reinsurance Company
AA-
Swiss Re Life and Health America, Inc. (1)
AA-
Scottish Re Group (2)
N/A
Paul Revere Life Insurance Company
A-
Munich American Reassurance
AA-
Mutual of Omaha Insurance
A+
Security Life of Denver
A-
Manulife Insurance Company
AA-
Lincoln National Life Insurance
AA-
Triton Insurance Company
N/A
American Health & Life Insurance Co.
N/A
Other (3)
Total
$ 4,577
$ 4,400
(1)The Company has extensive reinsurance contracts directly with Swiss Re and its affiliates and indirectly through Swiss Re's acquisition of other companies with whom we had reinsurance or retrocession contracts. (2)The reinsurance recoverable on paid and unpaid benefits related to the Scottish Re Group as of December 31, 2011 comprised $73 million related to Scottish Re Life Corporation and $61 million related to Scottish Re (U.S.), Inc. The reinsurance recoverable on paid and unpaid benefits related to the Scottish Re Group as of December 31, 2010 comprised $73 million related to Scottish Re Life Corporation and $63 million related to Scottish Re (U.S.), Inc. (3)As of December 31, 2011 and 2010, the other category includes $103 million and $106 million, respectively, of recoverables due from reinsurers with an investment grade credit rating from Standard & Poor's ("S&P"). (4)N/A reflects no rating available.
Certain of our reinsurers experienced rating downgrades in 2011 by S&P, including Surety Life of Denver and Mutual of Omaha. We continuously monitor the creditworthiness of reinsurers in order to determine our risk of recoverability on an individual and aggregate basis, and a provision for uncollectible reinsurance is recorded if needed. No amounts have been deemed unrecoverable in the three-years ended December 31, 2011.
We enter into certain intercompany reinsurance transactions for the Allstate Financial operations in order to maintain underwriting control and manage insurance risk among various legal entities. These reinsurance agreements
have been approved by the appropriate regulatory authorities. All significant intercompany transactions have been eliminated in consolidation.
INVESTMENTS 2011 HIGHLIGHTS
•Investments totaled $95.62 billion as of December 31, 2011, a decrease of 4.8% from $100.48 billion as of December 31, 2010. •Unrealized net capital gains totaled $2.88 billion as of December 31, 2011, increasing from $1.39 billion as of December 31, 2010. •As of December 31, 2011, $334 million or 40% of our $825 million below investment grade gross unrealized losses related to Subprime residential mortgage-backed securities compared to $438 million as of December 31, 2010. The fair value of these securities totaled $586 million as of December 31, 2011 compared to $796 million as of December 31, 2010. •Net investment income was $3.97 billion in 2011, a decrease of 3.2% from $4.10 billion in 2010. •Net realized capital gains were $503 million in 2011 compared to net realized capital losses of $827 million in 2010.
INVESTMENTS
Overview and strategy The return on our investment portfolios is an important component of our financial results. Investment portfolios are segmented between the Property-Liability, Allstate Financial and Corporate and Other operations. While taking into consideration the investment portfolio in aggregate, we manage the underlying portfolios based upon the nature of each respective business and its corresponding liability structure.
We employ a strategic asset allocation approach which considers the nature of the liabilities and risk tolerances, as well as the risk and return parameters of the various asset classes in which we invest. This asset allocation is informed by our global economic and market outlook, as well as other inputs and constraints, including diversification effects, duration, liquidity and capital considerations. Within the ranges set by the strategic asset allocation, tactical investment decisions are made in consideration of prevailing market conditions. We manage risks associated with interest rates, credit spreads, equity markets, real estate and currency exchange rates. Our continuing focus is to manage risks and to position our portfolio to take advantage of market opportunities while attempting to mitigate adverse effects.
The Property-Liability portfolio's investment strategy emphasizes protection of principal and consistent income generation, within a total return framework. This approach, which has produced competitive returns over the long term, is designed to ensure financial strength and stability for paying claims, while maximizing economic value and surplus growth.
The Allstate Financial portfolio's investment strategy focuses on the total return of assets needed to support the underlying liabilities, asset-liability management and achieving an appropriate return on capital.
The Corporate and Other portfolio's investment strategy balances the unique liquidity needs of the portfolio in relation to the overall corporate capital structure with the pursuit of returns.
Investments outlook
We anticipate the financial markets will continue to have periods of high volatility. Invested assets and income are expected to decline in line with reductions in contractholder funds for the Allstate Financial segment. We plan to focus on the following priorities:
•Optimizing return and risk in an uncertain economic climate and volatile investment markets. •Expanding ownership of real estate and other cash-generating assets, including real assets, through direct and fund investments. •Managing the alignment of assets with respect to Allstate Financial's changing liability profile.
Portfolio composition The composition of the investment portfolios as of December 31, 2011 is presented in the table below. Also see Notes 2 and 5 of the consolidated financial statements for investment accounting policies and additional information.
Property-
Liability (5)
Allstate
Financial (5)
Corporate and
Other (5)
Total
($ in millions)
Percent
to total
Percent
to total
Percent
to total
Percent
to total
Fixed income securities (1)
$ 27,801
77.2 % $ 46,290
80.7 % $ 2,022
90.0 % $ 76,113
79.6 %
Equity securities (2)
4,165
11.6
0.4
-
-
4,363
4.5
Mortgage loans
1.3
6,665
11.6
-
-
7,139
7.5
Limited partnership interests (3)
3,055
8.5
1,612
2.8
1.3
4,697
4.9
Short-term (4)
1.3
1.1
8.7
1,291
1.4
Other
0.1
1,963
3.4
-
-
2,015
2.1
Total
$ 35,998
100.0 % $ 57,373
100.0 % $ 2,247
100.0 % $ 95,618
100.0 %
(1)Fixed income securities are carried at fair value. Amortized cost basis for these securities was $27.12 billion, $44.30 billion and $1.96 billion for Property-Liability, Allstate Financial and Corporate and Other, respectively. (2)Equity securities are carried at fair value. Cost basis for these securities was $4.04 billion and $159 million for Property-Liability and Allstate Financial, respectively. (3)We have commitments to invest in additional limited partnership interests totaling $1.22 billion and $797 million for Property-Liability and Allstate Financial, respectively. (4)Short-term investments are carried at fair value. Amortized cost basis for these investments was $451 million, $645 million and $195 million for Property-Liability, Allstate Financial and Corporate and Other, respectively. (5)Balances reflect the elimination of related party investments between segments.
Total investments decreased to $95.62 billion as of December 31, 2011, from $100.48 billion as of December 31, 2010, primarily due to net reductions in contractholder funds, partially offset by higher valuations of fixed income securities. Valuations of fixed income securities are typically driven by a combination of changes in relevant risk-free interest rates and credit spreads over the period. Risk-free interest rates are typically referenced as the yield on U.S. Treasury securities, whereas credit spread is the additional yield on fixed income securities above the risk-free rate that market participants require to compensate them for assuming credit, liquidity and/or prepayment risks. U.S. Treasury securities continue to trade in active markets, and the yield curve on U.S. Treasury securities remains an appropriate basis for determining risk-free rates. The increase in valuation of fixed income securities during 2011 was due to declining risk-free interest rates, partially offset by widening credit spreads.
The Property-Liability investment portfolio increased to $36.00 billion as of December 31, 2011, from $35.05 billion as of December 31, 2010, primarily due to the acquisition of Esurance, higher valuations of fixed income securities, positive operating cash flows and increased collateral from securities lending activities, partially offset by dividends paid by Allstate Insurance Company ("AIC") to its parent, The Allstate Corporation (the "Corporation").
The Allstate Financial investment portfolio decreased to $57.37 billion as of December 31, 2011, from $61.58 billion as of December 31, 2010, primarily due to net reductions in contractholder funds of $5.86 billion, partially offset by higher valuations of fixed income securities.
The Corporate and Other investment portfolio decreased to $2.25 billion as of December 31, 2011, from $3.85 billion as of December 31, 2010, primarily due to the acquisition of Esurance and Answer Financial, share repurchases, dividends paid to shareholders and interest paid on debt, partially offset by dividends of $838 million paid by AIC to the Corporation.
Fixed income securities by type are listed in the table below.
($ in millions)
Fair value as of
December 31, 2011
Percent to
total
investments
Fair value as of
December 31,
Percent to
total
investments
U.S. government and agencies
$ 6,315
6.6 % $ 8,596
8.6 %
Municipal
14,241
14.9
15,934
15.9
Corporate
43,581
45.6
37,655
37.5
Foreign government
2,081
2.2
3,158
3.1
Residential mortgage-backed securities ("RMBS")
4,121
4.3
7,993
7.9
Commercial mortgage-backed securities ("CMBS")
1,784
1.9
1,994
2.0
Asset-backed securities ("ABS")
3,966
4.1
4,244
4.2
Redeemable preferred stock
-
-
Total fixed income securities
$ 76,113
79.6 % $ 79,612
79.2 %
As of December 31, 2011, 92.1% of the consolidated fixed income securities portfolio was rated investment grade, which is defined as a security having a rating of Aaa, Aa, A or Baa from Moody's, a rating of AAA, AA, A or BBB from S&P, Fitch, Dominion, or Realpoint, a rating of aaa, aa, a or bbb from A.M. Best, or a comparable internal rating if an externally provided rating is not available. All of our fixed income securities are rated by third party credit rating agencies, the National Association of Insurance Commissioners ("NAIC"), and/or internally rated. Our initial investment decisions and ongoing monitoring procedures for fixed income securities are based on a thorough due diligence process which includes, but is not limited to, an assessment of the credit quality, sector, structure, and liquidity risks of each issue.
The following table summarizes the fair value and unrealized net capital gains and losses for fixed income securities by credit rating as of December 31, 2011.
($ in millions)
Aaa
Aa
A
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
U.S. government and agencies
$ 6,315
$
$ -
$ -
$ -
$ -
Municipal
Tax exempt
4,557
2,134
Taxable
2,690
1,093
ARS
(37 )
(13 )
(14 )
Corporate
Public
1,000
2,816
11,716
Privately placed
1,029
1,524
4,173
Foreign government
RMBS
U.S. government sponsored entities ("U.S. Agency")
1,897
-
-
-
-
Prime residential mortgage-backed securities ("Prime")
-
Alt-A residential mortgage-backed securities ("Alt-A")
-
-
(1 )
-
Subprime residential mortgage-backed securities ("Subprime")
-
-
(18 )
(7 )
CMBS
(5
)
(31
)
ABS
Collateralized debt obligations ("CDO")
(2 )
(34 )
(74 )
Consumer and other asset-backed securities ("Consumer and other ABS")
1,418
Redeemable preferred stock
-
-
-
-
-
Total fixed income securities
$ 15,343
$
$ 13,574
$
$ 20,818
$ 1,159
Baa
Ba or lower
Total
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
U.S. government and agencies
$ -
$ -
$ -
$ -
$ 6,315
$
Municipal
Tax exempt
(59 )
9,005
Taxable
(26 )
(22 )
4,494
ARS
-
-
(16 )
(80 )
Corporate
Public
11,468
2,405
29,405
1,763
Privately placed
6,385
1,065
(13 )
14,176
Foreign government
-
-
2,081
RMBS
U.S. Agency
-
-
-
-
1,897
Prime
-
(32 )
(28 )
Alt-A
-
(79 )
(80 )
Subprime
(30 )
(328 )
(383 )
CMBS
(83
)
(92
)
1,784
(178
)
ABS
CDO
(64 )
(79 )
1,624
(253 )
Consumer and other ABS
(2 )
2,342
Redeemable preferred stock
-
-
Total fixed income securities
$ 20,373
$
$ 6,005
$ (703 ) $ 76,113
$ 2,734
Municipal bonds, including tax exempt, taxable and ARS securities, totaled $14.24 billion as of December 31, 2011 with an unrealized net capital gain of $607 million. The municipal bond portfolio includes general obligations of state and local issuers, revenue bonds and pre-refunded bonds, which are bonds for which an irrevocable trust has been established to fund the remaining payments of principal and interest.
The following table summarizes by state the fair value, amortized cost and credit rating of our municipal bonds, excluding $1.39 billion of pre-refunded bonds, as of December 31, 2011.
State
general
obligation
Local general
obligation
Amortized
cost
Average
credit
rating
($ in millions)
Revenue (1)
Fair value
State
California
$
$
$
$ 1,334
$ 1,316
A
Texas
Aa
Florida
A
New York
Aa
Ohio
A
Illinois
-
A
Missouri
A
Delaware
-
-
Aa
Pennsylvania
Aa
Michigan
Aa
All others
1,127
1,422
3,898
6,447
6,164
A
Total
$ 1,559
$ 3,414
$ 7,883
$ 12,856
$ 12,354
A
(1)The nature of the activities supporting revenue bonds is highly diversified and includes transportation, health care, industrial development, housing, higher education, utilities, recreation/convention centers and other activities.
Our practice for acquiring and monitoring municipal bonds is predominantly based on the underlying credit quality of the primary obligor. We currently rely on the primary obligor to pay all contractual cash flows and are not relying on bond insurers for payments. As a result of downgrades in the insurers' credit ratings, the ratings of the insured municipal bonds generally reflect the underlying ratings of the primary obligor. As of December 31, 2011, 99.3% of our insured municipal bond portfolio is rated investment grade.
ARS totaled $742 million with an unrealized net capital loss of $80 million as of December 31, 2011. Our holdings primarily have a credit rating of Aaa. As of December 31, 2011, $710 million of our ARS backed by student loans was 80% to 100% insured by the U.S. Department of Education. All of our ARS holdings are experiencing failed auctions and we receive the failed auction rate or, for those which contain maximum reset rate formulas, we receive the contractual maximum rate. We anticipate that failed auctions may persist and most of our holdings will continue to pay the failed auction rate or, for those that contain maximum rate reset formulas, the maximum rate. Auctions continue to be conducted as scheduled for each of the securities.
Corporate bonds, including publicly traded and privately placed, totaled $43.58 billion as of December 31, 2011 with an unrealized net capital gain of $2.36 billion. Privately placed securities primarily consist of corporate issued senior debt securities that are directly negotiated with the borrower or are in unregistered form.
Our portfolio of privately placed securities is broadly diversified by issuer, industry sector and country. The portfolio is made up of 525 issuers. Privately placed corporate obligations contain structural security features such as financial covenants and call protections that provide investors greater protection against credit deterioration, reinvestment risk or fluctuations in interest rates than those typically found in publicly registered debt securities. Additionally, investments in these securities are made after extensive due diligence of the issuer, typically including direct discussions with senior management and on-site visits to company facilities. Ongoing monitoring includes direct periodic dialog with senior management of the issuer and continuous monitoring of operating performance and financial position. Every issue not rated by an independent rating agency is internally rated with a formal rating affirmation at least once a year.
Foreign government securities totaled $2.08 billion as of December 31, 2011, with 100% rated investment grade and an unrealized net capital gain of $215 million. Of these securities, 18.8% are backed by the U.S. government, 35.1% are in Canadian governmental securities held in our Canadian subsidiary and the remaining 46.1% are highly diversified in other foreign governments.
RMBS, CMBS and ABS are structured securities that are primarily collateralized by residential and commercial real estate loans and other consumer or corporate borrowings. The cash flows from the underlying collateral paid to the securitization trust are generally applied in a pre-determined order and are designed so that each security issued by the trust, typically referred to as a "class", qualifies for a specific original rating. For example, the "senior" portion or "top" of the capital structure, or rating class, which would originally qualify for a rating of Aaa typically has priority in receiving principal repayments on the underlying collateral and retains this priority until the class is paid in full. In a sequential structure, underlying collateral principal repayments are directed to the most senior rated Aaa class in the structure until paid in full, after which principal repayments are directed to the next most senior Aaa class in the structure until it is paid in full. Senior Aaa classes generally share any losses from the underlying collateral on a pro-rata basis after losses are absorbed by classes with lower original ratings. The payment priority and class subordination included in these securities serves as credit enhancement for holders of the senior or top portions of the structures. These securities continue to retain the payment priority features that existed at the origination of the securitization trust. Other forms of credit enhancement may include structural features embedded in the securitization trust, such as overcollateralization, excess spread and bond insurance. The underlying collateral can have fixed interest rates, variable interest rates (such as adjustable rate mortgages) or may contain features of both fixed and variable rate mortgages.
RMBS, including U.S. Agency, Prime, Alt-A and Subprime, totaled $4.12 billion, with 63.7% rated investment grade, as of December 31, 2011. The RMBS portfolio is subject to interest rate risk, but unlike other fixed income securities, is additionally subject to significant prepayment risk from the underlying residential mortgage loans. The credit risk associated with U.S. Agency portfolio is mitigated because they were issued by or have underlying collateral guaranteed by U.S. government agencies. The unrealized net capital loss of $411 million as of December 31, 2011 was the result of wider credit spreads than at initial purchase on the non-U.S. Agency portion of our RMBS portfolio, largely due to higher risk premiums caused by macroeconomic conditions and credit market deterioration, including the impact of lower residential real estate valuations, which show signs of stabilization or recovery in certain geographic areas but remain under stress in other geographic areas. The following table shows our RMBS portfolio as of December 31, 2011 based upon vintage year of the issuance of the securities.
($ in millions)
U.S. Agency
Prime
Alt-A
Subprime
Total RMBS
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
Fair
value
Unrealized
gain/(loss)
$
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$
$ -
-
-
-
-
-
-
-
-
-
-
-
-
-
(4 )
(24 )
(96 )
(120 )
(4 )
(29 )
(106 )
(134 )
(18 )
(18 )
(108 )
(132 )
Pre-2005
(4 )
(10 )
(73 )
1,169
(50 )
Total
$ 1,897
$
$
$ (28 ) $
$ (80 ) $
$ (383 ) $ 4,121
$ (411 )
Prime are collateralized by residential mortgage loans issued to prime borrowers. As of December 31, 2011, $684 million of the Prime had fixed rate underlying collateral and $228 million had variable rate underlying collateral.
Alt-A includes securities collateralized by residential mortgage loans issued to borrowers who do not qualify for prime financing terms due to high loan-to-value ratios or limited supporting documentation, but have stronger credit profiles than subprime borrowers. As of December 31, 2011, $386 million of the Alt-A had fixed rate underlying collateral and $113 million had variable rate underlying collateral.
Subprime includes securities collateralized by residential mortgage loans issued to borrowers that cannot qualify for Prime or Alt-A financing terms due in part to weak or limited credit history. It also includes securities that are collateralized by certain second lien mortgages regardless of the borrower's credit history. The Subprime portfolio consisted of $605 million and $208 million of first lien and second lien securities, respectively. As of December 31, 2011, $444 million of the Subprime had fixed rate underlying collateral and $369 million had variable rate underlying collateral.
CMBS totaled $1.78 billion, with 90.5% rated investment grade, as of December 31, 2011. The CMBS portfolio is subject to credit risk, but unlike certain other structured securities, is generally not subject to prepayment risk due to protections within the underlying commercial mortgage loans. Of the CMBS investments, 93.0% are traditional conduit transactions collateralized by commercial mortgage loans, broadly diversified across property types and geographical
area. The remainder consists of non-traditional CMBS such as small balance transactions, large loan pools and single borrower transactions.
The following table shows our CMBS portfolio as of December 31, 2011 based upon vintage year of the underlying collateral.
($ in millions)
Fair
value
Unrealized
gain/(loss)
$
$ -
(22 )
(120 )
(43 )
Pre-2005
Total CMBS
$ 1,784
$ (178 )
The unrealized net capital loss of $178 million as of December 31, 2011 on our CMBS portfolio was the result of wider credit spreads than at initial purchase, largely due to the macroeconomic conditions and credit market deterioration, including the impact of lower commercial real estate valuations, which show signs of stabilization or recovery in certain geographic areas but remain under stress in other geographic areas. CMBS credit spreads are wider than at initial purchase in our 2005-2007 vintage year CMBS.
ABS, including CDO and Consumer and other ABS, totaled $3.97 billion, with 93.7% rated investment grade, as of December 31, 2011. Credit risk is managed by monitoring the performance of the underlying collateral. Many of the securities in the ABS portfolio have credit enhancement with features such as overcollateralization, subordinated structures, reserve funds, guarantees and/or insurance. The unrealized net capital loss of $214 million as of December 31, 2011 on our ABS portfolio was the result of wider credit spreads than at initial purchase.
CDO totaled $1.62 billion, with 85.6% rated investment grade, as of December 31, 2011. CDO consist primarily of obligations collateralized by high yield and investment grade corporate credits including $1.34 billion of cash flow collateralized loan obligations ("CLO") with unrealized losses of $136 million. Cash flow CLO are structures collateralized primarily by below investment grade senior secured corporate loans. The underlying collateral is actively managed by external managers that monitor the collateral's performance and is well diversified across industries and among issuers. The remaining $283 million of securities consisted of synthetic CDO, trust preferred CDO, project finance CDO, market value CDO, collateralized bond obligations and other CLO with unrealized losses of $117 million.
Consumer and other ABS totaled $2.34 billion, with 99.3% rated investment grade, as of December 31, 2011. Consumer and other ABS consists of $684 million of consumer auto and $1.66 billion of credit card and other ABS with unrealized gains of $1 million and $38 million, respectively.
Equity securities Equity securities primarily include common stocks, exchange traded and mutual funds, non-redeemable preferred stocks and real estate investment trust equity investments. The equity securities portfolio was $4.36 billion as of December 31, 2011 compared to $4.81 billion as of December 31, 2010. Net unrealized gains totaled $160 million as of December 31, 2011 compared to $583 million as of December 31, 2010.
Mortgage loans Our mortgage loan portfolio, which is primarily held in the Allstate Financial portfolio, totaled $7.14 billion as of December 31, 2011, compared to $6.68 billion as of December 31, 2010, and primarily comprises loans secured by first mortgages on developed commercial real estate. Key considerations used to manage our exposure include property type and geographic diversification.
We recognized $37 million of realized capital losses related to net increases in the valuation allowance on impaired mortgage loans in 2011, primarily due to the risk associated with refinancing near-term maturities, and decreases in occupancy which resulted in deteriorating debt service coverage and declines in property valuations. While property valuations show signs of stabilization or recovery in many larger, primary markets, valuations in many smaller cities remain under stress. We recognized $65 million of realized capital losses related to net increases in the valuation allowance on impaired loans in 2010.
For further detail on our mortgage loan portfolio, see Note 5 of the consolidated financial statements.
Limited partnership interests consist of investments in private equity/debt funds, real estate funds, hedge funds and tax credit funds. The limited partnership interests portfolio is well diversified across a number of characteristics
including fund managers, vintage years, strategies, geography (including international), and company/property types. The following table presents information about our limited partnership interests as of December 31, 2011.
($ in millions)
Private
equity/debt
funds
Real estate
funds
Hedge
funds
Tax
credit
funds
Total
Cost method of accounting ("Cost")
$ 1,095
$
$
$
$ 1,569
Equity method of accounting ("EMA")
1,047
3,128
Total
$ 1,896
$ 1,099
$ 1,142
$
$ 4,697
Number of managers
Number of individual funds
Largest exposure to single fund
$
$
$
$
Our aggregate limited partnership exposure represented 4.9% and 3.8% of total invested assets as of December 31, 2011 and 2010, respectively.
The following table shows the results from our limited partnership interests by fund type and accounting classification for the years ended December 31.
($ in millions)
Cost
EMA
Total
income
Impairment
write-downs (1)
Cost
EMA
Total income
Impairment
write-downs (1)
Private equity/debt funds
$
$
$
$ (3 ) $
$
$
$ (9 )
Real estate funds
(3 )
(34 )
(32 )
(35 )
Hedge funds
-
-
-
(2 )
Tax credit funds
(1 )
(11 )
(12 )
-
(2 )
-
(2 )
-
Total
$
$
$
$ (6 ) $
$
$
$ (46 )
(1)Impairment write-downs related to Cost limited partnerships were $4 million and $45 million in 2011 and 2010, respectively. Impairment write-downs related to EMA limited partnerships were $2 million and $1 million in 2011 and 2010, respectively.
Limited partnership interests, excluding impairment write-downs, produced income of $247 million in 2011 compared to income of $129 million in 2010. Income on EMA limited partnerships is recognized on a delay due to the availability of the related financial statements. The recognition of income on hedge funds is primarily on a one-month delay and the income recognition on private equity/debt funds, real estate funds and tax credit funds are generally on a three-month delay. Income on Cost limited partnerships is recognized only upon receipt of amounts distributed by the partnerships.
Short-term investments Our short-term investment portfolio was $1.29 billion and $3.28 billion as of December 31, 2011 and 2010, respectively.
Other investments Our other investments as of December 31, 2011 primarily comprise $1.15 billion of policy loans, $339 million of bank loans and $168 million of certain derivatives. Policy loans are carried at unpaid principal balances. Bank loans are primarily senior secured corporate loans and are carried at amortized cost. For further detail on our use of derivatives, see Note 7 of the consolidated financial statements.
Unrealized net capital gains totaled $2.88 billion as of December 31, 2011 compared to unrealized net capital gains of $1.39 billion as of December 31, 2010. The improvement since December 31, 2010 for fixed income securities was due to declining risk-free interest rates, partially offset by widening credit spreads. The decline since December 31, 2010 for
equity securities was primarily due to lower equity valuations. The following table presents unrealized net capital gains and losses as of December 31.
($ in millions)
U.S. government and agencies
$
$
Municipal
(267 )
Corporate
2,364
1,395
Foreign government
RMBS
(411 )
(516 )
CMBS
(178 )
(219 )
ABS
(214 )
(181 )
Redeemable preferred stock
Fixed income securities (1)
2,734
Equity securities
EMA limited partnership interests
-
Derivatives
(17 )
(22 )
Unrealized net capital gains and losses, pre-tax
$ 2,879
$ 1,387
(1)Unrealized net capital gains and losses for fixed income securities as of December 31, 2011 and 2010 comprise $(267) million and $(293) million, respectively, related to unrealized net capital losses on fixed income securities with other-than-temporary impairment and $3.00 billion and $1.12 billion, respectively, related to other unrealized net capital gains and losses.
The unrealized net capital gains for the fixed income portfolio totaled $2.73 billion and comprised $4.40 billion of gross unrealized gains and $1.67 billion of gross unrealized losses as of December 31, 2011. This is compared to unrealized net capital gains for the fixed income portfolio totaling $826 million, comprised of $3.26 billion of gross unrealized gains and $2.43 billion of gross unrealized losses as of December 31, 2010.
Gross unrealized gains and losses as of December 31, 2011 on fixed income securities by type and sector are provided in the table below.
Gross unrealized
Amortized
cost as a
percent of
par value (2)
Fair value
as a
percent of
par value (2)
($ in millions)
Par
value (1)
Amortized
cost
Fair
value
Gains
Losses
Corporate:
Banking
$ 3,649
$ 3,621
$
$ (185 ) $ 3,532
99.2 %
96.8 %
Financial services
3,695
3,643
(54 )
3,758
98.6
101.7
Capital goods
4,878
4,915
(32 )
5,255
100.8
107.7
Utilities
7,204
7,201
(32 )
7,880
100.0
109.4
Consumer goods (cyclical and non-cyclical)
8,250
8,361
(21 )
8,861
101.3
107.4
Transportation
1,851
1,858
(15 )
2,007
100.4
108.4
Communications
2,638
2,647
(14 )
2,784
100.3
105.5
Basic industry
2,287
2,302
(8 )
2,434
100.7
106.4
Energy
3,363
3,408
(4 )
3,646
101.3
108.4
Technology
1,841
1,874
(3 )
1,980
101.8
107.6
Other
1,491
1,387
(11 )
1,444
93.0
96.8
Total corporate fixed income portfolio
41,147
41,217
2,743
(379 )
43,581
100.2
105.9
U.S. government and agencies
6,310
5,966
-
6,315
94.5
100.1
Municipal
15,543
13,634
(256 )
14,241
87.7
91.6
Foreign government
1,951
1,866
(1 )
2,081
95.6
106.7
RMBS
5,292
4,532
(521 )
4,121
85.6
77.9
CMBS
2,017
1,962
(226 )
1,784
97.3
88.4
ABS
4,458
4,180
(287 )
3,966
93.8
89.0
Redeemable preferred stock
-
100.0
109.1
Total fixed income securities
$ 76,740
$ 73,379
$ 4,404
$ (1,670 ) $ 76,113
95.6
99.2
(1)Included in par value are zero-coupon securities that are generally purchased at a deep discount to the par value that is received at maturity. These primarily included corporate, U.S. government and agencies, municipal and foreign government zero-coupon securities with par value of $514 million, $948 million, $3.48 billion and $382 million, respectively. (2)Excluding the impact of zero-coupon securities, the percentage of amortized cost to par value would be 100.5% for corporates, 101.4% for U.S. government and agencies, 101.2% for municipals and 103.3% for foreign governments. Similarly, excluding the impact of zero-coupon securities, the percentage of fair value to par value would be 106.2% for corporates, 104.7% for U.S. government and agencies, 106.1% for municipals and 111.3% for foreign governments.
The banking, financial services, and capital goods sectors had the highest concentration of gross unrealized losses in our corporate fixed income securities portfolio as of December 31, 2011. In general, credit spreads remain wider than at initial purchase for most of the securities with gross unrealized losses in these categories.
The unrealized net capital gain for the equity portfolio totaled $160 million and comprised $369 million of gross unrealized gains and $209 million of gross unrealized losses as of December 31, 2011. This is compared to an unrealized net capital gain for the equity portfolio totaling $583 million, comprised of $646 million of gross unrealized gains and $63 million of gross unrealized losses as of December 31, 2010.
Gross unrealized gains and losses as of December 31, 2011 on equity securities by sector are provided in the table below.
Gross unrealized
Amortized
cost
Fair
value
($ in millions)
Gains
Losses
Financial services
$
$
$ (39 ) $
Emerging market equity funds
-
(35 )
Index-based funds
(24 )
Consumer goods (cyclical and non-cyclical)
(21 )
Emerging market fixed income funds
-
(18 )
Technology
(12 )
Basic industry
(12 )
Banking
(11 )
Energy
(10 )
Capital goods
(9 )
Real estate
(7 )
Communications
(7 )
Utilities
(2 )
Transportation
(2 )
Total equity securities
$ 4,203
$
$ (209 ) $ 4,363
Within the equity portfolio, the losses were primarily concentrated in financial services, emerging market equity funds and index-based funds. The unrealized losses were company and sector specific. As of December 31, 2011, we have the intent and ability to hold our equity securities with unrealized losses until recovery.
As of December 31, 2011, the total fair value of our investments in the European Union ("EU") is $4.03 billion, with net unrealized capital gains of $79 million, comprised of $224 million of gross unrealized gains and $145 million of gross unrealized losses. The following table summarizes our total direct exposure related to Greece, Ireland, Italy, Portugal and Spain (collectively "GIIPS") and the EU.
($ in millions)
Banking
Sovereign
Other corporate
Total
Fair
value
Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
Fair
value
Gross
unrealized
losses
GIIPS
Fixed income securities
$
$ (11 ) $
$ -
$
$ (37 ) $
$ (48 )
Equity securities
-
-
-
-
-
-
Total
(11 )
-
(37 )
(48 )
EU non-GIIPS
Fixed income securities
(49 )
(1 )
2,785
(34 )
3,228
(84 )
Equity securities
(2 )
-
-
(11 )
(13 )
Total
(51 )
(1 )
3,055
(45 )
3,505
(97 )
Total EU
$
$ (62 ) $
$ (1 ) $ 3,557
$ (82 ) $ 4,032
$ (145 )
We have a comprehensive portfolio monitoring process to identify and evaluate each fixed income and equity security that may be other-than-temporarily impaired. The process includes a quarterly review of all securities to identify instances where the fair value of a security compared to its amortized cost (for fixed income securities) or cost (for equity securities) is below established thresholds. The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and payment defaults. The securities identified, in addition to other securities for which we may have a concern, are evaluated based on facts and circumstances for inclusion on our watch-list. All investments in an unrealized loss position as of December 31, 2011 were included in our portfolio monitoring process for determining whether declines in value were other than temporary.
The extent and duration of a decline in fair value for fixed income securities have become less indicative of actual credit deterioration with respect to an issue or issuer. While we continue to use declines in fair value and the length of time a security is in an unrealized loss position as indicators of potential credit deterioration, our determination of
whether a security's decline in fair value is other than temporary has placed greater emphasis on our analysis of the underlying credit and collateral and related estimates of future cash flows.
The following table summarizes the fair value and gross unrealized losses of fixed income securities by type and investment grade classification as of December 31, 2011.
Investment grade
Below
investment grade
Total
($ in millions)
Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
U.S. government and agencies
$
$ -
$ -
$ -
$
$ -
Municipal
1,536
(155 )
(101 )
2,021
(256 )
Corporate
3,625
(305 )
1,087
(74 )
4,712
(379 )
Foreign government
(1 )
-
-
(1 )
RMBS
(63 )
1,112
(458 )
1,555
(521 )
CMBS
(130 )
(96 )
(226 )
ABS
1,795
(191 )
(96 )
1,980
(287 )
Total
$ 8,253
$ (845 ) $ 3,029
$ (825 ) $ 11,282
$ (1,670 )
We have experienced declines in the fair values of fixed income securities primarily due to wider credit spreads resulting from higher risk premiums since the time of initial purchase, largely due to macroeconomic conditions and credit market deterioration, including the impact of lower real estate valuations, which show signs of stabilization or recovery in certain geographic areas but remain under stress in other geographic areas. Consistent with their ratings, our portfolio monitoring process indicates that investment grade securities have a low risk of default. Securities rated below investment grade, comprising securities with a rating of Ba, B and Caa or lower, have a higher risk of default. As of December 31, 2011, 40% of our below investment grade gross unrealized losses related to Subprime RMBS.
Fair values for our structured securities are obtained from third-party valuation service providers and are subject to review as disclosed in our Application of Critical Accounting Estimates. In accordance with GAAP, when fair value is less than the amortized cost of a security and we have not made the decision to sell the security and it is not more likely than not we will be required to sell the security before recovery of its amortized cost basis, we evaluate if we expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. We calculate the estimated recovery value by discounting our best estimate of future cash flows at the security's original or current effective rate, as appropriate, and compare this to the amortized cost of the security. If we do not expect to receive cash flows sufficient to recover the entire amortized cost basis of the security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors ("non-credit-related") recognized in other comprehensive income.
The non-credit-related unrealized losses for our structured securities, including our below investment grade Subprime, are heavily influenced by risk factors other than those related to our best estimate of future cash flows. The difference between these securities' original or current effective rates and the yields implied by their fair value indicates that a higher risk premium is included in the valuation of these securities than existed at initial issue or purchase. This risk premium represents the return that a market participant requires as compensation to assume the risk associated with the uncertainties regarding the future performance of the underlying collateral. The risk premium is comprised of: default risk, which reflects the probability of default and the uncertainty related to collection of contractual principal and interest; liquidity risk, which reflects the risk associated with exiting the investment in an illiquid market, both in terms of timeliness and cost; and volatility risk, which reflects the potential valuation volatility during an investor's holding period. Other factors reflected in the risk premium include the costs associated with underwriting, monitoring and holding these types of complex securities. Certain aspects of the default risk are included in the development of our best estimate of future cash flows, as appropriate. Other aspects of the risk premium are considered to be temporary in nature and are expected to reverse over the remaining lives of the securities as future cash flows are received.
Other-than-temporary impairment assessment for below investment grade Subprime RMBS
As of December 31, 2011, the fair value of our below investment grade Subprime securities with gross unrealized losses totaled $586 million, a decrease of 26.4% compared to $796 million as of December 31, 2010, primarily due to sales. As of December 31, 2011, gross unrealized losses for our below investment grade Subprime portfolio totaled $334 million, an improvement of 23.7% compared to $438 million as of December 31, 2010, due to impairment write-downs, sales and principal collections, partially offset by the downgrade of certain securities to below investment grade
and lower valuations. For our below investment grade Subprime with gross unrealized gains totaling $5 million, we have recognized cumulative write-downs in earnings totaling $123 million as of December 31, 2011.
The credit loss evaluation for Subprime securities with gross unrealized losses is performed in two phases. The first phase estimates the future cash flows of the entire securitization trust from which our security was issued. A critical part of this estimate involves forecasting default rates and loss severities of the residential mortgage loans that collateralize the securitization trust. The factors that affect the default rates and loss severities include, but are not limited to, historical collateral performance, collateral type, transaction vintage year, geographic concentrations, borrower credit quality, origination practices of the transaction sponsor, and practices of the mortgage loan servicers. Current loan-to-value ratios of underlying collateral are not consistently available and accordingly they are not a primary factor in our impairment evaluation. While our projections are developed internally and customized to our specific holdings, they are informed by and benchmarked against credit opinions obtained from third parties, such as industry analysts, nationally recognized credit rating agencies and an RMBS loss modeling advisory service. The default rate and loss severity forecasts result in an estimate of trust-level projected additional collateral loss.
We then analyze the actual cumulative collateral losses incurred to date by the securitization trust, our projected additional collateral losses expected to be incurred and the position of the class of securities we own in the securitization trust relative to the trust's other classes to determine whether any of the collateral losses will be applied to our class. If our class has remaining credit enhancement sufficient to withstand the projected additional collateral losses, no collateral losses will be realized by our class and we expect to collect all contractual principal and interest of the security we own. Remaining credit enhancement is measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security we own and (ii) the expected impact of other structural features embedded in the securitization trust beneficial to our class, such as overcollateralization and excess spread.
For securities where there is insufficient remaining credit enhancement for the class of securities we own, a recovery value is calculated based on our best estimate of future cash flows specific to that security. This estimate is based on the contractual principal payments and current interest payments of the securities we own, adjusted for actual cumulative collateral losses incurred to date and the projected additional collateral losses expected to be incurred. This estimate also takes into consideration additional secondary sources of credit support, such as reliable bond insurance. For securities without secondary sources of credit support or for which the secondary sources do not fully offset the actual and projected additional collateral losses applied to them, a credit loss is recorded in earnings to the extent amortized cost exceeds recovery value.
75.3%, 20.9% and 3.8% of the fair value of our below investment grade Subprime securities with gross unrealized losses were issued with Aaa, Aa and A original ratings and capital structure classifications, respectively. As described previously, Subprime securities with higher original ratings typically have priority in receiving the principal repayments on the underlying collateral compared to those with lower original ratings. While the projected cash flow assumptions for our below investment grade Subprime securities with gross unrealized losses have deteriorated since the securities were originated, as reflected by their current credit ratings, these securities continue to retain the payment priority features that existed at the origination of the securitization trust.
The following tables show trust-level, class-level and security-specific detailed information for our below investment grade Subprime securities with gross unrealized losses that are not reliably insured, by credit rating.
($ in millions)
December 31, 2011
With other-than-temporary
impairments recorded
in earnings
Without other-than-temporary
impairments recorded
in earnings
B
Caa or
lower
Total
Ba
B
Caa or
lower
Total
Total
Trust-level
Actual cumulative collateral losses incurred to date (1)
14.6 %
19.1 %
18.8 %
3.8 %
6.6 %
13.2 %
8.8 %
n/a
Projected additional collateral losses to be incurred (2)
40.0 %
42.9 %
42.8 %
32.6 %
31.6 %
40.2 %
35.7 %
n/a
Class-level
Average remaining credit enhancement (3)
28.7 %
19.7 %
20.2 %
46.8 %
43.9 %
46.9 %
46.0 %
n/a
Security-specific
Number of positions
Par value
$
$
$
$
$
$
$
$ 1,063
Amortized cost
$
$
$
$
$
$
$
$
Fair value
$
$
$
$
$
$
$
$
Gross unrealized losses
Total
$ (8 ) $ (168 ) $ (176 ) $ (24 ) $ (33 ) $ (65 ) $ (122 ) $ (298 )
12-24 months
$ -
$ -
$ -
$ -
$ -
$ -
$ -
$ -
Over 24 months (4)
$ (8 ) $ (167 ) $ (175 ) $ (24 ) $ (33 ) $ (65 ) $ (122 ) $ (297 )
Cumulative write-downs recognized
$ (7 ) $ (249 ) $ (256 ) $ -
$ -
$ -
$ -
$ (256 )
Principal payments received during the period
$
December 31, 2010
With other-than-temporary
impairments recorded
in earnings
Without other-than-temporary
impairments recorded
in earnings
B
Caa or
lower
Total
Ba
B
Caa or
lower
Total
Total
Trust-level
Actual cumulative collateral losses incurred to date
12.0 %
16.1 %
16.0 %
13.2 %
12.5 %
12.6 %
12.7 %
n/a
Projected additional collateral losses to be incurred
38.2 %
43.2 %
43.0 %
46.5 %
42.7 %
40.8 %
42.1 %
n/a
Class-level
Average remaining credit enhancement
26.0 %
22.6 %
22.8 %
72.7 %
63.6 %
50.5 %
56.7 %
n/a
Security-specific
Number of positions
Par value
$
$
$
$
$
$
$
$ 1,401
Amortized cost
$
$
$
$
$
$
$
$ 1,090
Fair value
$
$
$
$
$
$
$
$
Gross unrealized losses
Total
$ (12 ) $ (225 ) $ (237 ) $ (11 ) $ (15 ) $ (107 ) $ (133 ) $ (370 )
12-24 months
$ -
$ (9 ) $ (9 ) $ -
$ -
$ -
$ -
$ (9 )
Over 24 months (4)
$ (12 ) $ (216 ) $ (228 ) $ (11 ) $ (15 ) $ (107 ) $ (133 ) $ (361 )
Cumulative write-downs recognized
$ (9 ) $ (293 ) $ (302 ) $ -
$ -
$ -
$ -
$ (302 )
Principal payments received during the period
$
(1)Weighted average actual cumulative collateral losses incurred to date as of period end are based on the actual principal losses incurred as a percentage of the remaining principal amount of the loans in the trust. The weighting calculation is based on the par value of each security. Actual losses on the securities we hold are less than the losses on the underlying collateral as presented in this table. Actual cumulative realized principal losses on the below investment grade Subprime securities we own, as reported by the trust servicers, were $16 million as of December 31, 2011. (2)Weighted average projected additional collateral losses to be incurred as of period end are based on our projections of future losses to be incurred by the trust, taking into consideration the actual cumulative collateral losses incurred to date, as a percentage of the remaining principal amount of the loans in the trust. Our projections are developed internally and customized to our specific holdings and are informed by and benchmarked
against credit opinions obtained from third parties, such as industry analysts, nationally recognized credit rating agencies and an RMBS loss modeling advisory service. Projected additional collateral losses to be incurred are compared to average remaining credit enhancement for each security. For securities where the projected additional collateral losses exceed remaining credit enhancement, a recovery value is calculated to determine whether impairment losses should be recorded in earnings. The weighting calculation is based on the par value of each security.
(3)Weighted average remaining credit enhancement as of period end is based on structural subordination and the expected impact of other structural features existing in the securitization trust beneficial to our class and reflects our projection of future principal losses that can occur as a percentage of the remaining principal amount of the loans in the trust before the class of the security we own will incur its first dollar of principal loss. The weighting calculation is based on the par value of each security. (4)As of December 31, 2011, $122 million of unrealized losses on securities with other-than-temporary impairments recognized in earnings and $104 million of unrealized losses on securities without other-than-temporary impairments recognized in earnings have been greater than or equal to 20% of those securities' amortized cost for a period of more than 24 consecutive months. As of December 31, 2010, $188 million of unrealized losses on securities with other-than-temporary impairments recognized in earnings and $108 million of unrealized losses on securities without other-than-temporary impairments recognized in earnings have been greater than or equal to 20% of those securities' amortized cost for a period of more than 24 consecutive months. The above tables include information only about below investment grade Subprime securities with gross unrealized losses that are not reliably insured as of each period presented. As such, the par value and composition of securities included can vary significantly from period to period due to changes in variables such as credit ratings, principal payments, sales, purchases and realized principal losses.
As of December 31, 2011, our Subprime securities that are reliably insured include nine below investment grade Subprime securities with a total fair value of $87 million and aggregate gross unrealized losses of $36 million, all of which are rated B. These securities are insured by one bond insurer rated B that we estimate has sufficient claims paying capacity to service its obligations on these securities. The securitization trusts from which our securities were issued are currently receiving contractual payments from the bond insurer and considering the combination of expected future payments from the bond insurer and cash flows available from the underlying collateral, we expect the trust to have adequate cash flows to make all contractual payments due to the class of securities we own. As a result, our security-specific estimates of future cash flows indicate that these securities' estimated recovery values equal or exceed their amortized cost. Accordingly, no other-than-temporary impairments have been recognized on these securities. As of December 31, 2010, our Subprime securities that are reliably insured included ten below investment grade Subprime securities with a total fair value of $76 million and aggregate gross unrealized losses of $68 million.
As of December 31, 2011, our below investment grade Subprime securities with gross unrealized losses that are not reliably insured and without other-than-temporary impairments recorded in earnings had incurred actual cumulative collateral losses of 8.8%. Our impairment evaluation forecasts more severe assumptions than the trusts are actually experiencing, including a projected weighted average underlying default rate of 51.9% and a projected weighted average loss severity of 69.5%, which resulted in projected additional collateral losses of 35.7%. As the average remaining credit enhancement for these securities of 46.0% exceeds the projected additional collateral losses of 35.7%, these securities have not been impaired.
As of December 31, 2011, our below investment grade Subprime securities with gross unrealized losses that are not reliably insured and with other-than-temporary impairments recorded in earnings had incurred actual cumulative collateral losses of 18.8%. Our impairment evaluation forecasts more severe assumptions than the trusts are actually experiencing, including a projected weighted average underlying default rate of 56.8% and a projected weighted average loss severity of 76.5%, which resulted in projected additional collateral losses of 42.8%. As the average remaining credit enhancement for these securities of 20.2% is insufficient to withstand the projected additional collateral losses, we have recognized cumulative write-downs in earnings on the securities as reflected in the table above using our calculated recovery value at the time of impairment. The current average recovery value of these securities as a percentage of par was 67.1% and exceeded these securities' current average amortized cost as a percentage of par of 65.4%, which demonstrates our conclusion that the nature of the remaining unrealized loss on these securities is temporary and will reverse over time. The comparison indicates that recovery value exceeds amortized cost based on a comprehensive evaluation of financial, economic and capital markets assumptions developed for this reporting period.
We believe the unrealized losses on our Subprime securities, including those over 24 months, result from the current risk premium on these securities, which should continue to reverse over the securities' remaining lives, as demonstrated by improved valuations since 2009, primarily in 2010. We expect to receive our estimated share of contractual principal and interest collections used to determine the securities' recovery value. As of December 31, 2011, we do not have the intent to sell and it is not more likely than not we will be required to sell these securities before the recovery of their amortized cost basis. We believe that our valuation and impairment processes are comprehensive, employ the most current views about collateral and securitization trust financial positions, and demonstrate our recorded impairments and that the remaining unrealized losses on these positions are temporary.
Net investment income The following table presents net investment income for the years ended December 31.
($ in millions)
Fixed income securities
$ 3,484
$ 3,737
$ 3,998
Equity securities
Mortgage loans
Limited partnership interests
Short-term investments
Other
(10 )
Investment income, before expense
4,154
4,279
4,610
Investment expense
(183 )
(177 )
(166 )
Net investment income
$ 3,971
$ 4,102
$ 4,444
Net investment income decreased 3.2% or $131 million in 2011 compared to 2010, after decreasing 7.7% or $342 million in 2010 compared to 2009. The 2011 decline was primarily due to lower average investment balances due to decreased Allstate Financial contractholder funds, partially offset by higher yields. The higher yields are primarily attributable to yield optimization actions including the termination of interest rate swaps during the first quarter of 2011, higher distributions from cost method limited partnerships and dividend income from equity securities. The 2010 decrease was primarily due to lower interest rates, risk reduction actions related to municipal bonds and commercial real estate, duration shortening actions taken to protect the portfolio from rising interest rates and lower average investment balances.
Realized capital gains and losses The following table presents the components of realized capital gains and losses and the related tax effect for the years ended December 31.
($ in millions)
Impairment write-downs
$ (496 ) $ (797 ) $ (1,562 )
Change in intent write-downs
(100 )
(204 )
(357 )
Net other-than-temporary impairment losses recognized in earnings
(596 )
(1,001 )
(1,919 )
Sales
1,336
1,272
Valuation of derivative instruments
(291 )
(427 )
Settlements of derivative instruments
(105 )
(174 )
(162 )
EMA limited partnership income
(141 )
Realized capital gains and losses, pre-tax
(827 )
(583 )
Income tax (expense) benefit
(179 )
(45 )
Realized capital gains and losses, after-tax
$
$ (537 ) $ (628 )
Impairment write-downs for the years ended December 31 are presented in the following table.
($ in millions)
Fixed income securities
$ (302 ) $ (626 ) $ (886 )
Equity securities
(131 )
(57 )
(237 )
Mortgage loans
(37 )
(65 )
(97 )
Limited partnership interests
(6 )
(46 )
(308 )
Other investments
(20 )
(3 )
(34 )
Impairment write-downs
$ (496 ) $ (797 ) $ (1,562 )
Impairment write-downs in 2011 were primarily driven by RMBS, which experienced deterioration in expected cash flows; investments with commercial real estate exposure, including CMBS, mortgage loans and municipal bonds, which were impacted by lower real estate valuations or experienced deterioration in expected cash flows; and corporate fixed income securities impacted by issuer specific circumstances. Impairment write-downs on below investment grade RMBS and CMBS in 2011 were $169 million and $55 million, respectively. Equity securities were also written down due to the length of time and extent to which fair value was below cost, considering our assessment of the financial condition and near-term and long-term prospects of the issuer, including relevant industry conditions and trends.
Impairment write-downs in 2010 were primarily driven by RMBS, which experienced deterioration in expected cash flows; investments with commercial real estate exposure, including CMBS, mortgage loans, limited partnership interests and certain housing related municipal bonds, which were impacted by lower real estate valuations or experienced deterioration in expected cash flows; and privately placed corporate bonds and municipal bonds impacted by issuer specific circumstances. Impairment write-downs on below investment grade RMBS, CMBS and ABS in 2010 were $332 million, $118 million and $29 million, respectively.
Change in intent write-downs for the years ended December 31 are presented in the following table.
($ in millions)
Fixed income securities
$ (92 ) $ (198 ) $ (318 )
Equity securities
(8 )
-
(27 )
Mortgage loans
-
(6 )
(6 )
Other investments
-
-
(6 )
Change in intent write-downs
$ (100 ) $ (204 ) $ (357 )
The change in intent write-downs in 2011 were primarily a result of ongoing comprehensive reviews of our portfolios resulting in write-downs of individually identified investments, primarily lower yielding, floating rate RMBS and municipal bonds, and equity securities. The change in intent write-downs in 2010 were primarily a result of ongoing comprehensive reviews of our portfolios resulting in write-downs of individually identified investments, primarily municipal bonds and RMBS.
Sales generated $1.34 billion of net realized gains in 2011 primarily due to $1.11 billion of net gains on sales of corporate, foreign government, U.S. government, ABS, U.S. Agency and municipal fixed income securities and $202 million of net gains on sales of equity securities. During the second half of 2011, interest rates were at historical lows and we capitalized on valuation gains on fixed income securities through $8.49 billion in sales generating $750 million of realized capital gains. Net realized gains from sales of $686 million in 2010 were primarily due to $595 million of net gains on sales of corporate, U.S. government, foreign government and municipal fixed income securities and $210 million of net gains on sales of equity securities, partially offset by $139 million of net losses on sales of CMBS and ABS.
Valuation and settlements of derivative instruments net realized capital losses totaling $396 million in 2011 included $291 million of losses on the valuation of derivative instruments and $105 million of losses on the settlement of derivative instruments. The net realized capital losses on derivative instruments in 2011 primarily included losses on interest rate risk management due to decreases in interest rates. In 2010, net realized capital losses on the valuation and settlement of derivative instruments totaled $601 million. As a component of our approach to managing interest rate risk, realized gains and losses on certain derivative instruments are most appropriately considered in conjunction with the unrealized gains and losses on the fixed income portfolio. This approach mitigates the impacts of general interest rate changes to our overall financial condition.
MARKET RISK
Market risk is the risk that we will incur losses due to adverse changes in interest rates, credit spreads, equity prices or currency exchange rates. Adverse changes to these rates and prices may occur due to changes in fiscal policy, the economic climate, the liquidity of a market or market segment, insolvency or financial distress of key market makers or participants or changes in market perceptions of credit worthiness and/or risk tolerance. Our primary market risk exposures are to changes in interest rates, credit spreads and equity prices.
The active management of market risk is integral to our results of operations. We may use the following approaches to manage exposure to market risk within defined tolerance ranges: 1) rebalancing existing asset or liability portfolios, 2) changing the character of investments purchased in the future and 3) using derivative instruments to modify the market risk characteristics of existing assets and liabilities or assets expected to be purchased. For a more detailed discussion of our use of derivative financial instruments, see Note 7 of the consolidated financial statements.
Overview In formulating and implementing guidelines for investing funds, we seek to earn returns that enhance our ability to offer competitive rates and prices to customers while contributing to attractive and stable profits and long-term capital growth. Accordingly, our investment decisions and objectives are a function of the underlying risks and product profiles of each business.
Investment policies define the overall framework for managing market and other investment risks, including accountability and controls over risk management activities. Subsidiaries that conduct investment activities follow
policies that have been approved by their respective boards of directors. These investment policies specify the investment limits and strategies that are appropriate given the liquidity, surplus, product profile and regulatory requirements of the subsidiary. Executive oversight of investment activities is conducted primarily through subsidiaries' boards of directors and investment committees. For Allstate Financial, its asset-liability management ("ALM") policies further define the overall framework for managing market and investment risks. ALM focuses on strategies to enhance yields, mitigate market risks and optimize capital to improve profitability and returns for Allstate Financial. Allstate Financial ALM activities follow asset-liability policies that have been approved by their respective boards of directors. These ALM policies specify limits, ranges and/or targets for investments that best meet Allstate Financial's business objectives in light of its product liabilities.
We manage our exposure to market risk through the use of asset allocation, duration, simulation, and as appropriate, through the use of stress tests. We have asset allocation limits that place restrictions on the total funds that may be invested within an asset class. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by investment policies. For Allstate Financial, this day-to-day management is integrated with and informed by the activities of the ALM organization. This integration is intended to result in a prudent, methodical and effective adjudication of market risk and return, conditioned by the unique demands and dynamics of Allstate Financial's product liabilities and supported by the continuous application of advanced risk technology and analytics.
Although we apply a similar overall philosophy to market risk, the underlying business frameworks and the accounting and regulatory environments differ considerably between the Property-Liability and Allstate Financial businesses affecting investment decisions and risk parameters.
Interest rate risk is the risk that we will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of our interest bearing assets and liabilities. This risk arises from many of our primary activities, as we invest substantial funds in interest-sensitive assets and issue interest-sensitive liabilities. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key risk-free reference yields.
We manage the interest rate risk in our assets relative to the interest rate risk in our liabilities. One of the measures used to quantify this exposure is duration. Duration measures the price sensitivity of the assets and liabilities to changes in interest rates. For example, if interest rates increase 100 basis points, the fair value of an asset with a duration of 5 is expected to decrease in value by 5%. To calculate the duration gap between assets and liabilities, we project asset and liability cash flows and calculate their net present value using a risk-free market interest rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing these cash flows at alternative interest rates and determining the percentage change in aggregate fair value. The cash flows used in this calculation include the expected maturity and repricing characteristics of our derivative financial instruments, all other financial instruments, and certain other items including unearned premiums, property-liability insurance claims and claims expense reserves, annuity liabilities and other interest-sensitive liabilities. The projections include assumptions (based upon historical market experience and our experience) that reflect the effect of changing interest rates on the prepayment, lapse, leverage and/or option features of instruments, where applicable. The preceding assumptions relate primarily to mortgage-backed securities, municipal housing bonds, callable municipal and corporate obligations, and fixed rate single and flexible premium deferred annuities. Additionally, the calculations include assumptions regarding the renewal of property-liability policies.
As of December 31, 2011, the difference between our asset and liability duration was a (0.62) gap, compared to a (0.65) gap as of December 31, 2010. A negative duration gap indicates that the fair value of our liabilities is more sensitive to interest rate movements than the fair value of our assets. The Property-Liability segment generally maintains a positive duration gap between its assets and liabilities due to the relatively short duration of auto and homeowners claims, which are its primary liabilities. The Allstate Financial segment may have a positive or negative duration gap, as the duration of its assets and liabilities vary with its product mix and investing activity. As of December 31, 2011, Property-Liability had a positive duration gap while Allstate Financial had a negative duration gap.
In the management of investments supporting the Property-Liability business, we adhere to an objective of emphasizing safety of principal and consistency of income within a total return framework. This approach is designed to ensure our financial strength and stability for paying claims, while maximizing economic value and surplus growth.
For the Allstate Financial business, we seek to invest premiums, contract charges and deposits to generate future cash flows that will fund future claims, benefits and expenses, and that will earn stable spreads across a wide variety of interest rate and economic scenarios. To achieve this objective and limit interest rate risk for Allstate Financial, we adhere to a philosophy of managing the duration of assets and related liabilities within predetermined tolerance levels.
This philosophy is executed using duration targets for fixed income investments in addition to interest rate swaps, futures, forwards, caps, floors and swaptions to reduce the interest rate risk resulting from mismatches between existing assets and liabilities, and financial futures and other derivative instruments to hedge the interest rate risk of anticipated purchases and sales of investments and product sales to customers.
Based upon the information and assumptions used in the duration calculation, and interest rates in effect as of December 31, 2011, we estimate that a 100 basis point immediate, parallel increase in interest rates ("rate shock") would decrease the net fair value of the assets and liabilities by $127 million, compared to a decrease of $36 million as of December 31, 2010, reflecting year to year changes in duration. Reflected in the duration calculation are the effects of a program that uses swaps, eurodollar futures, options on Treasury futures and interest rate swaptions to manage interest rate risk. In calculating the impact of a 100 basis point increase on the value of the derivatives, we have assumed interest rate volatility remains constant. Based on the swaps, eurodollar futures, options on Treasury futures and interest rate swaptions in place as of December 31, 2011, we would recognize realized capital losses totaling $14 million in the event of a 100 basis point immediate, parallel interest rate increase and $15 million in realized capital gains in the event of a 100 basis point immediate, parallel interest rate decrease on these derivatives. The selection of a 100 basis point immediate, parallel change in interest rates should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event. There are $10.49 billion of assets supporting life insurance products such as traditional and interest-sensitive life that are not financial instruments. These assets and the associated liabilities have not been included in the above estimate. The $10.49 billion of assets excluded from the calculation has increased from $9.60 billion as of December 31, 2010, due to an increase in interest-sensitive life contractholder funds and improved fixed income valuations as a result of declining risk-free interest rates and tightening of credit spreads in certain sectors. Based on assumptions described above, in the event of a 100 basis point immediate increase in interest rates, the assets supporting life insurance products would decrease in value by $660 million, compared to a decrease of $549 million as of December 31, 2010.
To the extent that conditions differ from the assumptions we used in these calculations, duration and rate shock measures could be significantly impacted. Additionally, our calculations assume that the current relationship between short-term and long-term interest rates (the term structure of interest rates) will remain constant over time. As a result, these calculations may not fully capture the effect of non-parallel changes in the term structure of interest rates and/or large changes in interest rates.
We pledge and receive collateral on certain types of derivative contracts. For over-the-counter ("OTC") derivative transactions, master netting agreements are used. These agreements allow us to net payments due for transactions covered by the agreements and, when applicable, we are required to post collateral. As of December 31, 2011, we held $64 million of cash and securities pledged by counterparties as collateral for OTC instruments, and we pledged $82 million of cash and securities as collateral to counterparties. We performed a sensitivity analysis on OTC derivative collateral by assuming a hypothetical 100 basis point decline in interest rates. The analysis indicated that we would have to post an estimated $2 million in additional collateral. The selection of these hypothetical scenarios should not be construed as our prediction of future events, but only as an illustration of the estimated potential effect of such events. We also actively manage our counterparty credit risk exposure by monitoring the level of collateral posted by our counterparties with respect to our receivable positions.
Credit spread risk is the risk that we will incur a loss due to adverse changes in credit spreads ("spreads"). This risk arises from many of our primary activities, as we invest substantial funds in spread-sensitive fixed income assets.
We manage the spread risk in our assets. One of the measures used to quantify this exposure is spread duration. Spread duration measures the price sensitivity of the assets to changes in spreads. For example, if spreads increase 100 basis points, the fair value of an asset exhibiting a spread duration of 5 is expected to decrease in value by 5%.
Spread duration is calculated similarly to interest rate duration. As of December 31, 2011, the spread duration of Property-Liability assets was 4.77, compared to 4.45 as of December 31, 2010, and the spread duration of Allstate Financial assets was 5.58, compared to 4.97 as of December 31, 2010. Based upon the information and assumptions we use in this spread duration calculation, and spreads in effect as of December 31, 2011, we estimate that a 100 basis point immediate, parallel increase in spreads across all asset classes, industry sectors and credit ratings ("spread shock") would decrease the net fair value of the assets by $4.10 billion, compared to $3.61 billion as of December 31, 2010. Reflected in the duration calculation are the effects of our risk mitigation actions that use CDS to manage spread risk. The selection of a 100 basis point immediate parallel change in spreads should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event.
Equity price risk is the risk that we will incur losses due to adverse changes in the general levels of the equity markets. As of December 31, 2011, we held $4.26 billion in common stocks and exchange traded and mutual funds and $4.82 billion in other securities with equity risk (including primarily limited partnership interests, non-redeemable preferred securities and equity-linked notes), compared to $4.67 billion and $4.88 billion, respectively, as of December 31, 2010. 95.7% and 63.3% of these totals, respectively, represented assets of the Property-Liability operations as of December 31, 2011, compared to 95.5% and 63.1%, respectively, as of December 31, 2010.
As of December 31, 2011, our portfolio of common stocks and other securities with equity risk had a cash market portfolio beta of 0.72, compared to a beta of 0.74 as of December 31, 2010. Beta represents a widely used methodology to describe, quantitatively, an investment's market risk characteristics relative to an index such as the S&P 500. Based on the beta analysis, we estimate that if the S&P 500 increases or decreases by 10%, the fair value of our equity investments will increase or decrease by 7.2%, respectively. Based upon the information and assumptions we used to calculate beta as of December 31, 2011, we estimate that an immediate decrease in the S&P 500 of 10% would decrease the net fair value of our equity investments identified above by $652 million, compared to $695 million as of December 31, 2010, and an immediate increase in the S&P 500 of 10% would increase the net fair value by $654 million compared to $708 million as of December 31, 2010. In calculating the impact of a 10% S&P index perturbation on the value of the puts, we have assumed index volatility remains constant. The selection of a 10% immediate decrease or increase in the S&P 500 should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event.
The beta of our common stocks and other securities with equity risk was determined by calculating the change in the fair value of the portfolio resulting from stressing the equity market up and down 10%. The illustrations noted above may not reflect our actual experience if the future composition of the portfolio (hence its beta) and correlation relationships differ from the historical relationships.
As of December 31, 2011 and 2010, we had separate accounts assets related to variable annuity and variable life contracts with account values totaling $6.98 billion and $8.68 billion, respectively. Equity risk exists for contract charges based on separate account balances and guarantees for death and/or income benefits provided by our variable products. In 2006, we disposed of substantially all of the variable annuity business through reinsurance agreements with The Prudential Insurance Company of America, a subsidiary of Prudential Financial Inc. and therefore mitigated this aspect of our risk. Equity risk for our variable life business relates to contract charges and policyholder benefits. Total variable life contract charges for 2011 and 2010 were $76 million and $80 million, respectively. Separate account liabilities related to variable life contracts were $716 million and $775 million in December 31, 2011 and 2010, respectively.
As of December 31, 2011 and 2010 we had $3.86 billion and $4.70 billion, respectively, in equity-indexed annuity liabilities that provide customers with interest crediting rates based on the performance of the S&P 500. We hedge the majority of the risk associated with these liabilities using equity-indexed options and futures, interest rate swaps, and eurodollar futures, maintaining risk within specified value-at-risk limits.
Foreign currency exchange rate risk is the risk that we will incur economic losses due to adverse changes in foreign currency exchange rates. This risk primarily arises from our foreign equity investments, including real estate funds and private equity funds, and our Canadian and Northern Ireland operations. We also have certain fixed income securities that are denominated in foreign currencies; however, derivatives are used to hedge the foreign currency risk of approximately 38% of the fixed income securities.
As of December 31, 2011, we had $1.24 billion in foreign currency denominated equity investments, $786 million net investment in our foreign subsidiaries, and $363 million in unhedged non-dollar pay fixed income securities. These amounts were $1.70 billion, $773 million, and $91 million, respectively, as of December 31, 2010. 90.0% of the foreign currency exposure is in the Property-Liability business.
Based upon the information and assumptions used as of December 31, 2011, we estimate that a 10% immediate unfavorable change in each of the foreign currency exchange rates to which we are exposed would decrease the value of our foreign currency denominated instruments by $225 million, compared with an estimated $257 million decrease as of December 31, 2010. The selection of a 10% immediate decrease in all currency exchange rates should not be construed as our prediction of future market events, but only as an illustration of the potential effect of such an event. Our currency exposure is diversified across 33 currencies as of December 31, 2011, compared to 32 currencies as of December 31, 2010. Our largest individual foreign currency exposures as of December 31, 2011 were to the Canadian dollar (39.6%) and the Japanese Yen (10.4%). The largest individual foreign currency exposures as of December 31,
were to the Canadian dollar (37.0%) and the British Pound (13.3%). Our primary regional exposure is to Canada, with 39.6% as of December 31, 2011, compared to Canada, with 37.0% as of December 31, 2010.
The modeling technique we use to report our currency exposure does not take into account correlation among foreign currency exchange rates. Even though we believe it is very unlikely that all of the foreign currency exchange rates that we are exposed to would simultaneously decrease by 10%, we nonetheless stress test our portfolio under this and other hypothetical extreme adverse market scenarios. Our actual experience may differ from these results because of assumptions we have used or because significant liquidity and market events could occur that we did not foresee.
PENSION PLANS
We have defined benefit pension plans, which cover most full-time and certain part-time employees and employee-agents. See Note 17 of the consolidated financial statements for a complete discussion of these plans and their effect on the consolidated financial statements. The pension and other postretirement plans may be amended or terminated at any time. Any revisions could result in significant changes to our obligations and our obligation to fund the plans.
We report unrecognized pension and other postretirement benefit cost in the Consolidated Statements of Financial Position as a component of accumulated other comprehensive income in shareholders' equity. It represents differences between the fair value of plan assets and the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for other postretirement plans that have not yet been recognized as a component of net periodic cost. The measurement of the unrecognized pension and other postretirement benefit cost can vary based upon the fluctuations in the fair value of the plan assets and the actuarial assumptions used for the plans as discussed below. The unrecognized pension and other postretirement benefit cost as of December 31, 2011 was $1.43 billion, an increase of $239 million from $1.19 billion as of December 31, 2010. The increase was the result of a lower discount rate used to value the pension and postretirement benefit obligations along with asset returns that were less than expected.
The market-related value component of expected returns recognizes plan losses and gains on equity securities over a five-year period, which we believe is consistent with the long-term nature of pension obligations. As a result, the effect of changes in fair value of equity securities on our net periodic pension cost may be experienced in periods subsequent to those in which the fluctuations actually occur.
Net periodic pension cost in 2012 is estimated to be $270 million based on current assumptions, including settlement charges. This represents a decrease compared to $304 million in 2011 due to an increase in the market-related value of assets and a decrease in anticipated settlement charges. Net periodic pension cost decreased in 2011 compared to $345 million in 2010 primarily due to an increase in the market-related value of assets. Net periodic pension cost increased in 2010 due to the effect of equity losses during the 2008 fiscal year and the decrease in discount rates experienced at the end of 2009. In 2011 and 2010, net pension cost included non-cash settlement charges primarily resulting from lump sum distributions made to agents. Settlement charges also occurred during 2011, 2010 and 2009 related to the Supplemental Retirement Income Plan as a result of lump sum payments made from the plan. Settlement charges are likely to continue for some period in the future as we settle our remaining agent pension obligations by making lump sum distributions to agents.
Amounts recorded for pension cost and accumulated other comprehensive income are significantly affected by fluctuations in the returns on plan assets and the amortization of unrecognized actuarial gains and losses. Plan assets sustained net losses in prior periods primarily due to declines in equity and credit markets. These asset losses, combined with all other unrecognized actuarial gains and losses, resulted in amortization of net actuarial loss (and additional net periodic pension cost) of $153 million in 2011 and $160 million in 2010. We anticipate that the unrealized loss for our pension plans will exceed 10% of the greater of the projected benefit obligations or the market-related value of assets in 2012 and into the foreseeable future, resulting in additional amortization and net periodic pension cost.
Amounts recorded for net periodic pension cost and accumulated other comprehensive income are also significantly affected by changes in the assumptions used to determine the weighted average discount rate and the expected long-term rate of return on plan assets. The weighted average discount rate is based on rates at which expected pension benefits attributable to past employee service could effectively be settled on a present value basis at the measurement date. We develop the assumed weighted average discount rate by utilizing the weighted average yield of a theoretical dedicated portfolio derived from non-callable bonds and bonds with a make-whole provision available in the Barclays corporate bond universe having ratings of at least "AA" by S&P or at least "Aa" by Moody's on the measurement date with cash flows that match expected plan benefit requirements. Significant changes in discount rates, such as those caused by changes in the credit spreads, yield curve, the mix of bonds available in the market, the duration of selected bonds and expected benefit payments, may result in volatility in pension cost and accumulated other comprehensive income.
Holding other assumptions constant, a hypothetical decrease of 100 basis points in the weighted average discount rate would result in an increase of $52 million in net periodic pension cost and a $427 million increase in the unrecognized pension and other postretirement benefit cost liability of our pension plans recorded as accumulated other comprehensive income as of December 31, 2011, compared to an increase of $43 million in net periodic pension cost and a $392 million increase in the unrecognized pension and other postretirement benefit cost liability as of December 31, 2010. A hypothetical increase of 100 basis points in the weighted average discount rate would decrease net periodic pension cost by $46 million and would decrease the unrecognized pension and other postretirement benefit cost liability of our pension plans recorded as accumulated other comprehensive income by $360 million as of December 31, 2011, compared to a decrease in net periodic pension cost of $38 million and a $331 million decrease in the unrecognized pension and other postretirement benefit cost liability of our pension plans recorded as accumulated other comprehensive income as of December 31, 2010. This non-symmetrical range results from the non-linear relationship between discount rates and pension obligations, and changes in the amortization of unrealized net actuarial gains and losses.
The expected long-term rate of return on plan assets reflects the average rate of earnings expected on plan assets. While this rate reflects long-term assumptions and is consistent with long-term historical returns, sustained changes in the market or changes in the mix of plan assets may lead to revisions in the assumed long-term rate of return on plan assets that may result in variability of pension cost. Differences between the actual return on plan assets and the expected long-term rate of return on plan assets are a component of unrecognized gains or losses, which may be amortized as a component of net actuarial gains and losses and recorded in accumulated other comprehensive income. As a result, the effect of changes in fair value on our pension cost may be experienced in results of operations in periods subsequent to those in which the fluctuations actually occur.
Holding other assumptions constant, a hypothetical decrease of 100 basis points in the expected long-term rate of return on plan assets would result in an increase of $47 million in pension cost as of December 31, 2011, compared to $44 million as of December 31, 2010. A hypothetical increase of 100 basis points in the expected long-term rate of return on plan assets would result in a decrease in net periodic pension cost of $47 million as of December 31, 2011, compared to $44 million as of December 31, 2010.
We target funding levels that do not restrict the payment of plan benefits in our domestic plans and were within our targeted range as of December 31, 2011. In 2011, we contributed $264 million to our pension plans. We expect to contribute $417 million for the 2012 fiscal year to maintain the plans' funded status. This estimate could change significantly following either a dramatic improvement or decline in investment markets.
Other post employment benefits
In 2010, the Patient Protection and Affordable Care Act was signed into law. One aspect of this legislation is the introduction of an excise tax, effective in 2018, on "high cost" plans. The liabilities as of December 31, 2011 for the postretirement medical plans include an estimate of this additional liability, which amounts to $3 million.
GOODWILL
Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets acquired. The goodwill balances were $824 million and $418 million as of December 31, 2011 and $456 million and $418 million as of December 31, 2010 for the Allstate Protection segment and the Allstate Financial segment, respectively. The increase in 2011 relates to the acquisition of Esurance and Answer Financial. Our reporting units are equivalent to our reporting segments, Allstate Protection and Allstate Financial. Goodwill is allocated to reporting units based on which unit is expected to benefit from the synergies of the business combination.
Goodwill is not amortized but is tested for impairment at least annually. We perform our annual goodwill impairment testing during the fourth quarter of each year based upon data as of the close of the third quarter. We also review goodwill for impairment whenever events or changes in circumstances, such as deteriorating or adverse market conditions, indicate that it is more likely than not that the carrying amount of goodwill may exceed its implied fair value.
Impairment testing requires the use of estimates and judgments. For purposes of goodwill impairment testing, if the carrying value of a reporting unit exceeds its estimated fair value, the second step of the goodwill test is required. In such instances, the implied fair value of the goodwill is determined in the same manner as the amount of goodwill that would be determined in a business acquisition. The excess of the carrying value of goodwill over the implied fair value of goodwill would be recognized as an impairment and recorded as a charge against net income.
To estimate the fair value of our reporting units for our annual impairment test as of September 30, 2011, we utilized a combination of widely accepted valuation techniques including a stock price and market capitalization analysis,
discounted cash flow calculations and peer company price to earnings multiples analysis. The analyses were weighted based on management's judgment of their relevance given current facts and circumstances.
The stock price and market capitalization analysis takes into consideration the quoted market price of our outstanding common stock and includes a control premium, derived from historical insurance industry acquisition activity, in determining the estimated fair value of the consolidated entity before allocating that fair value to individual reporting units. The discounted cash flow analysis utilizes long term assumptions for revenue growth, capital growth, earnings projections including those used in our strategic plan, and an appropriate discount rate. The peer company price to earnings multiples analysis takes into consideration the price earnings multiples of peer companies for each reporting unit and estimated income from our strategic plan. We apply significant judgment when determining the fair value of our reporting units and when assessing the relationship of market capitalization to the estimated fair value of our reporting units. The valuation analyses described above are subject to critical judgments and assumptions and may be potentially sensitive to variability. Estimates of fair value are inherently uncertain and represent management's reasonable expectation regarding future developments. These estimates and the judgments and assumptions utilized may differ from future actual results. Declines in the estimated fair value of our reporting units could result in goodwill impairments in future periods which may be material to our results of operations but not our financial position.
Goodwill impairment evaluations indicated no impairment as of December 31, 2011 and no reporting unit was at risk of having its carrying value including goodwill exceed its fair value.
DEFERRED TAXES
As of December 31, 2011, we had a net deferred tax asset of $520 million. Included in the deferred tax asset was $99 million, net of valuation allowance, for net operating loss carryforwards obtained in the acquisition of Esurance and Answer Financial. The total deferred tax valuation allowance was $67 million as of December 31, 2011 compared to $6 million as of December 31, 2010. The valuation allowance increased primarily due to the acquisition of Answer Financial. The valuation allowance relates to the portion of Answer Financial's net operating loss carryforwards that, due to limitations contained in the Internal Revenue Code, are expected to expire prior to their utilization.
We evaluate whether a valuation allowance for our deferred tax assets is required each reporting period. A valuation allowance is established if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred income tax asset will not be realized. In determining whether a valuation allowance is needed, all available evidence is considered. This includes the potential for capital and ordinary loss carryback, future reversals of existing taxable temporary differences, tax planning strategies that we may employ to avoid a tax benefit from expiring unused and future taxable income exclusive of reversing temporary differences.
With respect to our evaluation of the need for a valuation allowance related to the deferred tax asset on capital losses that have been realized but have not yet been recognized for tax purposes, we utilize prudent and feasible tax planning strategies that optimize the ability to carry back capital losses as well as the ability to offset future capital losses with unrealized capital gains that could be recognized for tax purposes. We have remaining capital loss carryback capacity of $266 million, $37 million and $329 million from 2009, 2010 and 2011, respectively.
With respect to our evaluation of the need for a valuation allowance related to the deferred tax asset on unrealized capital losses on fixed income and equity securities, our tax planning strategies first consider the availability of unrealized capital gains to offset future capital losses and then we rely on our assertion that we have the intent and ability to hold certain securities with unrealized losses to recovery. As a result, the unrealized losses on these securities would not be expected to materialize and no valuation allowance on the associated deferred tax asset is needed.
CAPITAL RESOURCES AND LIQUIDITY 2011 HIGHLIGHTS
•Shareholders' equity as of December 31, 2011 was $18.67 billion, a decrease of 1.8% from $19.02 billion as of December 31, 2010. •On January 3, 2011, April 1, 2011, July 1, 2011 and October 3, 2011, we paid a quarterly shareholder dividend of $0.20, $0.21, $0.21 and $0.21, respectively. On November 8, 2011, we declared a quarterly shareholder dividend of $0.21 payable on January 3, 2012. On February 21, 2012, we declared a quarterly shareholder dividend of $0.22 payable on April 2, 2012. •In September 2011, we completed our $1.00 billion share repurchase program that commenced in November 2010. •In November 2011, we commenced a $1.00 billion share repurchase program that is expected to be completed by March 31, 2013. As of December 31, 2011, this program had $894 million remaining.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources consist of shareholders' equity and debt, representing funds deployed or available to be deployed to support business operations or for general corporate purposes. The following table summarizes our capital resources as of December 31.
($ in millions)
Common stock, retained income and other shareholders' equity items
$ 18,681
$ 19,200
$ 18,798
Accumulated other comprehensive loss
(7 )
(184 )
(2,106 )
Total shareholders' equity
18,674
19,016
16,692
Debt
5,908
5,908
5,910
Total capital resources
$ 24,582
$ 24,924
$ 22,602
Ratio of debt to shareholders' equity
31.6%
31.1%
35.4%
Ratio of debt to capital resources
24.0%
23.7%
26.1%
Shareholders' equity decreased in 2011, primarily due to share repurchases and dividends paid to shareholders, partially offset by net income and increased unrealized net capital gains on investments. Shareholders' equity increased in 2010, primarily due to unrealized net capital gains on investments and net income, partially offset by dividends paid to shareholders and share repurchases.
Debt The debt balance did not change during 2011 and decreased $2 million in 2010. On January 11, 2012, we issued $500 million of 5.20% Senior Notes due 2042, utilizing the registration statement filed with the Securities and Exchange Commission on May 8, 2009. The proceeds of this issuance will be used for general corporate purposes, including the repayment of $350 million of 6.125% Senior Notes maturing on February 15, 2012. The next debt maturity is on June 15, 2013 when $250 million of 7.50% Debentures are due. For further information on outstanding debt, see Note 12 of the consolidated financial statements. As of December 31, 2011 and 2010, there were no outstanding commercial paper borrowings.
Share repurchases In September 2011, we completed our $1.00 billion share repurchase program that we commenced in November 2010. In November 2011, we commenced a $1.00 billion share repurchase program that is expected to be completed by March 31, 2013. As of December 31, 2011, this program had $894 million remaining.
Since 1995, we have acquired 496 million shares of our common stock at a cost of $20.20 billion, primarily as part of various stock repurchase programs. We have reissued 99 million shares since 1995, primarily associated with our equity incentive plans, the 1999 acquisition of American Heritage Life Investment Corporation and the 2001 redemption of certain mandatorily redeemable preferred securities. Since 1995, total shares outstanding has decreased by 395 million shares or 44.1%, primarily due to our repurchase programs.
On November 8, 2011, we announced that we may issue debt or preferred stock to fund the existing $1.00 billion share repurchase program.
Financial ratings and strength The following table summarizes our debt, commercial paper and insurance financial strength ratings as of December 31, 2011.
Moody's
Standard
& Poor's
A.M. Best
The Allstate Corporation (senior long-term debt)
A3
A-
a-
The Allstate Corporation (commercial paper)
P-2
A-2
AMB-1
Allstate Insurance Company (insurance financial strength)
Aa3
AA-
A+
Allstate Life Insurance Company (insurance financial strength)
A1
A+
A+
Our ratings are influenced by many factors including our operating and financial performance, asset quality, liquidity, asset/liability management, overall portfolio mix, financial leverage (i.e., debt), exposure to risks such as catastrophes and the current level of operating leverage.
On November 8, 2011, Moody's affirmed The Allstate Corporation's debt and commercial paper ratings of A3 and P-2, respectively, AIC's financial strength rating of Aa3 and Allstate Life Insurance Company's ("ALIC's") financial strength rating of A1. The outlook for all Moody's ratings was revised to negative from stable. On November 2, 2011, S&P affirmed The Allstate Corporation's debt and commercial paper ratings of A- and A-2, respectively, AIC's financial
strength rating of AA- and ALIC's financial strength rating of A+. The outlook for all S&P ratings was revised to negative from stable. On January 26, 2012, A.M. Best affirmed The Allstate Corporation's debt and commercial paper ratings of a- and AMB-1, respectively, and our insurance entities financial strength ratings of A+ for AIC and ALIC. The outlook for AIC is stable and ALIC was revised to stable from negative. A.M. Best also gives our legal entities that are fully reinsured the financial strength rating of the assuming company.
We have distinct and separately capitalized groups of subsidiaries licensed to sell property and casualty insurance in New Jersey and Florida that maintain separate group ratings. The ratings of these groups are influenced by the risks that relate specifically to each group. Many mortgage companies require property owners to have insurance from an insurance carrier with a secure financial strength rating from an accredited rating agency. Allstate New Jersey Insurance Company, which writes auto and homeowners insurance, is rated A- by A.M. Best. The outlook for this rating is stable. Allstate New Jersey Insurance Company also has a Financial Stability Rating® of A" from Demotech, which was affirmed on November 16, 2011. Castle Key Insurance Company, which underwrites personal lines property insurance in Florida, is rated B- by A.M. Best. The outlook for the rating is negative. Castle Key Insurance Company also has a Financial Stability Rating® of A' from Demotech, which was affirmed on November 16, 2011.
ALIC, AIC and The Allstate Corporation are party to the Amended and Restated Intercompany Liquidity Agreement ("Liquidity Agreement") which allows for short-term advances of funds to be made between parties for liquidity and other general corporate purposes. The Liquidity Agreement does not establish a commitment to advance funds on the part of any party. ALIC and AIC each serve as a lender and borrower and the Corporation serves only as a lender. AIC also has a capital support agreement with ALIC. Under the capital support agreement, AIC is committed to provide capital to ALIC to maintain an adequate capital level. The maximum amount of potential funding under each of these agreements is $1.00 billion.
In addition to the Liquidity Agreement, the Corporation also has an intercompany loan agreement with certain of its subsidiaries, which include, but are not limited to, AIC and ALIC. The amount of intercompany loans available to the Corporation's subsidiaries is at the discretion of the Corporation. The maximum amount of loans the Corporation will have outstanding to all its eligible subsidiaries at any given point in time is limited to $1.00 billion. The Corporation may use commercial paper borrowings, bank lines of credit and securities lending to fund intercompany borrowings.
Allstate's domestic property-liability and life insurance subsidiaries prepare their statutory-basis financial statements in conformity with accounting practices prescribed or permitted by the insurance department of the applicable state of domicile. Statutory surplus is a measure that is often used as a basis for determining dividend paying capacity, operating leverage and premium growth capacity, and it is also reviewed by rating agencies in determining their ratings. As of December 31, 2011, AIC's statutory surplus is approximately $15.13 billion compared to $15.38 billion as of December 31, 2010. These amounts include ALIC's statutory surplus of approximately $3.46 billion as of December 31, 2011, compared to $3.34 billion as of December 31, 2010.
The ratio of net premiums written to statutory surplus is a common measure of operating leverage used in the property-casualty insurance industry and serves as an indicator of a company's premium growth capacity. Ratios in excess of 3 to 1 are typically considered outside the usual range by insurance regulators and rating agencies, and for homeowners and related coverages that have significant net exposure to natural catastrophes a ratio of 1 to 1 is considered appropriate. AIC's premium to surplus ratio was 1.6x as of December 31, 2011 and 2010.
State laws specify regulatory actions if an insurer's risk-based capital ("RBC"), a measure of an insurer's solvency, falls below certain levels. The NAIC has a standard formula for annually assessing RBC. The formula for calculating RBC for property-liability companies takes into account asset and credit risks but places more emphasis on underwriting factors for reserving and pricing. The formula for calculating RBC for life insurance companies takes into account factors relating to insurance, business, asset and interest rate risks. As of December 31, 2011, the RBC for each of our domestic insurance companies was within the range that we target.
The NAIC has also developed a set of financial relationships or tests known as the Insurance Regulatory Information System to assist state regulators in monitoring the financial condition of insurance companies and identifying companies that require special attention or actions by insurance regulatory authorities. The NAIC analyzes financial data provided by insurance companies using prescribed ratios, each with defined "usual ranges". Generally, regulators will begin to monitor an insurance company if its ratios fall outside the usual ranges for four or more of the ratios. If an insurance company has insufficient capital, regulators may act to reduce the amount of insurance it can issue. The ratios of our domestic insurance companies are within these ranges.
Liquidity sources and uses Our potential sources of funds principally include activities shown in the following table.
Property-
Liability
Allstate
Financial
Corporate
and Other
Receipt of insurance premiums
X
X
Contractholder fund deposits
X
Reinsurance recoveries
X
X
Receipts of principal, interest and dividends on investments
X
X
X
Sales of investments
X
X
X
Funds from securities lending, commercial paper and line of credit agreements
X
X
X
Intercompany loans
X
X
X
Capital contributions from parent
X
X
Dividends from subsidiaries
X
X
Tax refunds/settlements
X
X
X
Funds from periodic issuance of additional securities
X
Funds from the settlement of our benefit plans
X
Our potential uses of funds principally include activities shown in the following table.
Property-
Liability
Allstate
Financial
Corporate
and Other
Payment of claims and related expenses
X
Payment of contract benefits, maturities, surrenders and withdrawals
X
Reinsurance cessions and payments
X
X
Operating costs and expenses
X
X
X
Purchase of investments
X
X
X
Repayment of securities lending, commercial paper and line of credit agreements
X
X
X
Payment or repayment of intercompany loans
X
X
X
Capital contributions to subsidiaries
X
X
Dividends to shareholders/parent company
X
X
X
Tax payments/settlements
X
X
Share repurchases
X
Debt service expenses and repayment
X
X
X
Settlement payments of employee and agent benefit plans
X
X
X
We actively manage our financial position and liquidity levels in light of changing market, economic, and business conditions. Liquidity is managed at both the entity and enterprise level across the Company, and is assessed on both base and stressed level liquidity needs. We believe we have sufficient liquidity to meet these needs. Additionally, we have existing intercompany agreements in place that facilitate liquidity management across the Company to enhance flexibility.
Parent company capital capacity At the parent holding company level, we have deployable invested assets totaling $2.24 billion as of December 31, 2011. These assets include investments that are generally saleable within one quarter totaling $1.72 billion. The substantial earnings capacity of the operating subsidiaries is the primary source of capital generation for the Corporation. In 2012, AIC will have the capacity to pay dividends currently estimated at $1.51 billion without prior regulatory approval. In addition, we have access to $1.00 billion of funds from either commercial paper issuance or an unsecured revolving credit facility. This provides funds for the parent company's relatively low fixed charges and other corporate purposes.
In 2011, dividends totaling $838 million were paid by AIC to its parent, the Corporation. In 2010, dividends totaling $1.30 billion were paid by AIC to the Corporation. There were no dividends paid by AIC to the Corporation in 2009. There were no capital contributions paid by the Corporation to AIC in 2011, 2010 or 2009.
In 2011, 2010 and 2009, return of capital by American Heritage Life Investment Corporation to the Corporation totaled $27 million, $24 million and $13 million, respectively.
In 2011, return of capital by Kennett Capital Holdings, LLC to the Corporation totaled $5 million.
There were no capital contributions by AIC to ALIC in 2011 or 2010. In 2009, capital contributions of $697 million were paid by AIC to ALIC.
The Corporation has access to additional borrowing to support liquidity as follows:
•A commercial paper facility with a borrowing limit of $1.00 billion to cover short-term cash needs. As of December 31, 2011, there were no balances outstanding and therefore the remaining borrowing capacity was $1.00 billion; however, the outstanding balance can fluctuate daily. •Our primary credit facility is available for short-term liquidity requirements and backs our commercial paper facility. Our $1.00 billion unsecured revolving credit facility has an initial term of five years expiring in May 2012. The facility is fully subscribed among 11 lenders with the largest commitment being $185 million. We have the option to extend the expiration by one year upon approval of existing or replacement lenders providing more than two-thirds of the commitments to lend. The commitments of the lenders are several and no lender is responsible for any other lender's commitment if such lender fails to make a loan under the facility. This facility contains an increase provision that would allow up to an additional $500 million of borrowing provided the increased portion could be fully syndicated at a later date among existing or new lenders. This facility has a financial covenant requiring that we not exceed a 37.5% debt to capital resources ratio as defined in the agreement. This ratio as of December 31, 2011 was 20.0%. Although the right to borrow under the facility is not subject to a minimum rating requirement, the costs of maintaining the facility and borrowing under it are based on the ratings of our senior, unsecured, nonguaranteed long-term debt. There were no borrowings under the credit facility during 2011. The total amount outstanding at any point in time under the combination of the commercial paper program and the credit facility cannot exceed the amount that can be borrowed under the credit facility. •A universal shelf registration statement was filed with the Securities and Exchange Commission on May 8, 2009. We can use this shelf registration to issue an unspecified amount of debt securities, common stock (including 399 million shares of treasury stock as of December 31, 2011), preferred stock, depositary shares, warrants, stock purchase contracts, stock purchase units and securities of trust subsidiaries. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements. Liquidity exposure Contractholder funds as of December 31, 2011 were $42.33 billion. The following table summarizes contractholder funds by their contractual withdrawal provisions as of December 31, 2011.
($ in millions)
Percent to
total
Not subject to discretionary withdrawal
$ 6,072
14.3 %
Subject to discretionary withdrawal with adjustments:
Specified surrender charges (1)
16,079
38.0
Market value adjustments (2)
6,435
15.2
Subject to discretionary withdrawal without adjustments (3)
13,746
32.5
Total contractholder funds (4)
$ 42,332
100.0 %
(1)Includes $8.76 billion of liabilities with a contractual surrender charge of less than 5% of the account balance. (2)$5.28 billion of the contracts with market value adjusted surrenders have a 30-45 day period at the end of their initial and subsequent interest rate guarantee periods (which are typically 5 or 6 years) during which there is no surrender charge or market value adjustment. (3)70% of these contracts have a minimum interest crediting rate guarantee of 3% or higher. (4)Includes $1.16 billion of contractholder funds on variable annuities reinsured to The Prudential Insurance Company of America, a subsidiary of Prudential Financial Inc., in 2006.
While we are able to quantify remaining scheduled maturities for our institutional products, anticipating retail product surrenders is less precise. Retail life and annuity products may be surrendered by customers for a variety of reasons. Reasons unique to individual customers include a current or unexpected need for cash or a change in life insurance coverage needs. Other key factors that may impact the likelihood of customer surrender include the level of the contract surrender charge, the length of time the contract has been in force, distribution channel, market interest rates, equity market conditions and potential tax implications. In addition, the propensity for retail life insurance policies to lapse is lower than it is for fixed annuities because of the need for the insured to be re-underwritten upon policy replacement. Surrenders and partial withdrawals for our retail annuities increased 21.9% in 2011 compared to 2010. The annualized surrender and partial withdrawal rate on deferred annuities and interest-sensitive life insurance products, based on the beginning of year contractholder funds, was 12.6% and 10.1% in 2011 and 2010, respectively. Allstate
Financial strives to promptly pay customers who request cash surrenders; however, statutory regulations generally provide up to six months in most states to fulfill surrender requests.
Our institutional products are primarily funding agreements sold to unaffiliated trusts used to back medium-term notes. As of December 31, 2011, total institutional products outstanding were $1.88 billion, with scheduled maturities of $40 million, $1.75 billion and $85 million in 2012, 2013 and 2016, respectively.
Our asset-liability management practices limit the differences between the cash flows generated by our investment portfolio and the expected cash flow requirements of our life insurance, annuity and institutional product obligations.
Certain remote events and circumstances could constrain our liquidity. Those events and circumstances include, for example, a catastrophe resulting in extraordinary losses, a downgrade in our long-term debt rating of A3, A- and a- (from Moody's, S&P and A.M. Best, respectively) to non-investment grade status of below Baa3/BBB-/bb, a downgrade in AIC's financial strength rating from Aa3, AA- and A+ (from Moody's, S&P and A.M. Best, respectively) to below Baa2/BBB/A-, or a downgrade in ALIC's financial strength ratings from A1, A+ and A+ (from Moody's, S&P and A.M. Best, respectively) to below A3/A-/A-. The rating agencies also consider the interdependence of our individually rated entities; therefore, a rating change in one entity could potentially affect the ratings of other related entities.
The following table summarizes consolidated cash flow activities by segment.
($ in millions)
Property-Liability (1)
Allstate Financial (1)
Corporate and Other (1)
Consolidated
Net cash provided by (used in):
Operating activities
$
$ 1,373
$ 2,183
$ 1,295
$ 2,407
$ 2,196
$ (155 ) $ (91 ) $ (78 ) $ 1,929
$ 3,689
$ 4,301
Investing activities
(44 )
(1,919 )
5,284
3,096
4,755
(720 )
6,161
2,332
3,440
Financing activities
(4 )
(8 )
(6 )
(6,504 )
(5,510 )
(7,246 )
(1,368 )
(553 )
(292 )
(7,876 )
(6,071 )
(7,544 )
Net increase (decrease) in consolidated cash
$
$ (50 ) $
(1)Business unit cash flows reflect the elimination of intersegment dividends, contributions and borrowings.
Property-Liability Lower cash provided by operating activities in 2011 compared to 2010 was primarily due to higher claim payments, partially offset by lower income tax payments. Lower cash provided by operating activities for Property-Liability in 2010 compared to 2009 was primarily due to income tax payments in 2010 compared to income tax refunds in 2009 and lower claim payments.
Cash provided by investing activities in 2011 compared to cash used in investing activities in 2010 was primarily due to higher net sales of fixed income and equity securities, partially offset by higher net purchases of fixed income and equity securities. Lower cash used in investing activities in 2010 compared to 2009 was primarily due to decreased net purchases of fixed income and equity securities and higher net sales of fixed income and equity securities, partially offset by net change in short-term investments.
Allstate Financial Lower cash provided by operating cash flows in 2011 was primarily due to income tax payments in 2011 compared to income tax refunds in 2010. Operating cash flows for Allstate Financial in 2010 were higher than 2009 as higher premiums and tax refunds received were partially offset by lower investment income and higher life and annuity contract benefits paid.
Higher cash provided by investing activities in 2011 compared to 2010 were impacted by lower net purchases of fixed income securities and higher net sales of fixed income securities used to fund reductions in contractholder fund liabilities. Cash flows provided by investing activities in 2010 were impacted by reductions of investments to fund reductions in contractholder fund liabilities.
Higher cash used in financing activities in 2011 compared to 2010 was primarily due to higher surrenders and partial withdrawals on fixed annuities and Allstate Bank products and lower deposits on Allstate Bank products and fixed annuities, partially offset by decreased maturities and retirements of institutional products. In 2011, Allstate Bank ceased operations and all funds were returned to customers by December 31, 2011. Lower cash flows used in financing activities in 2010 compared to 2009 were primarily due to decreased maturities and retirements of institutional products, partially offset by lower deposits on fixed annuities. For quantification of the changes in contractholder funds, see the Allstate Financial Segment section of the MD&A.
Corporate and Other Fluctuations in the Corporate and Other operating cash flows were primarily due to the timing of intercompany settlements. Investing activities primarily relate to investments in the parent company portfolio,
including the acquisition of Esurance and Answer Financial. Financing cash flows of the Corporate and Other segment reflect actions such as fluctuations in short-term debt, repayment of debt, proceeds from the issuance of debt, dividends to shareholders of The Allstate Corporation and share repurchases; therefore, financing cash flows are affected when we increase or decrease the level of these activities.
Contractual obligations and commitments Our contractual obligations as of December 31, 2011 and the payments due by period are shown in the following table.
($ in millions)
Total
Less than
1 year
1-3 years
4-5 years
Over
5 years
Liabilities for collateral (1)
$
$
$ -
$ -
$ -
Contractholder funds (2)
55,368
6,771
12,808
7,651
28,138
Reserve for life-contingent contract benefits (2)
35,097
1,140
2,154
2,067
29,736
Long-term debt (3)
12,086
1,887
8,959
Capital lease obligations (3)
Operating leases (3)
Unconditional purchase obligations (3)
-
Defined benefit pension plans and other postretirement benefit plans (3)(4)
3,207
2,168
Reserve for property-liability insurance claims and claims expense (5)
20,375
9,041
6,148
2,218
2,968
Other liabilities and accrued expenses (6)(7)
3,769
3,530
Net unrecognized tax benefits (8)
-
-
-
Total contractual cash obligations
$ 131,336
$ 22,443
$ 23,873
$ 12,946
$ 72,074
(1)Liabilities for collateral are typically fully secured with cash or short-term investments. We manage our short-term liquidity position to ensure the availability of a sufficient amount of liquid assets to extinguish short-term liabilities as they come due in the normal course of business, including utilizing potential sources of liquidity as disclosed previously. (2)Contractholder funds represent interest-bearing liabilities arising from the sale of products such as interest-sensitive life, fixed annuities, including immediate annuities without life contingencies and institutional products. The reserve for life-contingent contract benefits relates primarily to traditional life insurance, immediate annuities with life contingencies and voluntary accident and health insurance. These amounts reflect the present value of estimated cash payments to be made to contractholders and policyholders. Certain of these contracts, such as immediate annuities without life contingencies and institutional products, involve payment obligations where the amount and timing of the payment is essentially fixed and determinable. These amounts relate to (i) policies or contracts where we are currently making payments and will continue to do so and (ii) contracts where the timing of a portion or all of the payments has been determined by the contract. Other contracts, such as interest-sensitive life, fixed deferred annuities, traditional life insurance, immediate annuities with life contingencies and voluntary accident and health insurance, involve payment obligations where a portion or all of the amount and timing of future payments is uncertain. For these contracts, we are not currently making payments and will not make payments until (i) the occurrence of an insurable event such as death or illness or (ii) the occurrence of a payment triggering event such as the surrender or partial withdrawal on a policy or deposit contract, which is outside of our control. We have estimated the timing of payments related to these contracts based on historical experience and our expectation of future payment patterns. Uncertainties relating to these liabilities include mortality, morbidity, expenses, customer lapse and withdrawal activity, estimated additional deposits for interest-sensitive life contracts, and renewal premium for life policies, which may significantly impact both the timing and amount of future payments. Such cash outflows reflect adjustments for the estimated timing of mortality, retirement, and other appropriate factors, but are undiscounted with respect to interest. As a result, the sum of the cash outflows shown for all years in the table exceeds the corresponding liabilities of $42.33 billion for contractholder funds and $14.45 billion for reserve for life-contingent contract benefits as included in the Consolidated Statements of Financial Position as of December 31, 2011. The liability amount in the Consolidated Statements of Financial Position reflects the discounting for interest as well as adjustments for the timing of other factors as described above. (3)Our payment obligations relating to long-term debt, capital lease obligations, operating leases, unconditional purchase obligations and pension and other post employment benefits ("OPEB") contributions are managed within the structure of our intermediate to long-term liquidity management program. Amount differs from the balance presented on the Consolidated Statements of Financial Position as of December 31, 2011 because the long-term debt amount above includes interest. (4)The pension plans' obligations in the next 12 months represent our planned contributions, and the remaining years' contributions are projected based on the average remaining service period using the current underfunded status of the plans. The OPEB plans' obligations are estimated based on the expected benefits to be paid. These liabilities are discounted with respect to interest, and as a result the sum of the cash outflows shown for all years in the table exceeds the corresponding liability amount of $1.89 billion included in other liabilities and accrued expenses on the Consolidated Statements of Financial Position. (5)Reserve for property-liability insurance claims and claims expense is an estimate of amounts necessary to settle all outstanding claims, including claims that have been IBNR as of the balance sheet date. We have estimated the timing of these payments based on our historical experience and our expectation of future payment patterns. However, the timing of these payments may vary significantly from the amounts shown above, especially for IBNR claims. The ultimate cost of losses may vary materially from recorded amounts which are our best estimates. The reserve for property-liability insurance claims and claims expense includes loss reserves related to asbestos and environmental claims as of December 31, 2011, of $1.61 billion and $225 million, respectively.
(6)Other liabilities primarily include accrued expenses and certain benefit obligations and claim payments and other checks outstanding. Certain of these long-term liabilities are discounted with respect to interest, as a result the sum of the cash outflows shown for all years in the table exceeds the corresponding liability amount of $3.76 billion. (7)Balance sheet liabilities not included in the table above include unearned and advance premiums of $10.81 billion and deferred tax liabilities of $2.14 billion netted in the net deferred tax asset of $520 million. These items were excluded as they do not meet the definition of a contractual liability as we are not contractually obligated to pay these amounts to third parties. Rather, they represent an accounting mechanism that allows us to present our financial statements on an accrual basis. In addition, other liabilities of $273 million were not included in the table above because they did not represent a contractual obligation or the amount and timing of their eventual payment was sufficiently uncertain. (8)Net unrecognized tax benefits represent our potential future obligation to the taxing authority for a tax position that was not recognized in the consolidated financial statements. We believe it is reasonably possible that the liability balance will be reduced by $25 million within the next twelve months upon the resolution of an outstanding issue resulting from the 2005-2006 Internal Revenue Service examination. The resolution of this obligation may be for an amount different than what we have accrued.
Our contractual commitments as of December 31, 2011 and the periods in which the commitments expire are shown in the following table.
($ in millions)
Total
Less than
1 year
1-3 years
4-5 years
Over
5 years
Other commitments - conditional
$
$
$
$
$
Other commitments - unconditional
2,015
1,082
Total commitments
$ 2,208
$
$
$ 1,085
$
Contractual commitments represent investment commitments such as private placements, limited partnership interests and other loans.
We have agreements in place for services we conduct, generally at cost, between subsidiaries relating to insurance, reinsurance, loans and capitalization. All material intercompany transactions have appropriately been eliminated in consolidation. Intercompany transactions among insurance subsidiaries and affiliates have been approved by the appropriate departments of insurance as required.
For a more detailed discussion of our off-balance sheet arrangements, see Note 7 of the consolidated financial statements.
ENTERPRISE RISK AND RETURN MANAGEMENT
Allstate manages enterprise risk under an integrated Enterprise Risk and Return Management ("ERRM") framework with governance and analytics. This framework provides an enterprise view of risks and opportunities and is used by senior leaders and business managers to drive strategic and business decisions. Allstate's risk management strategies adapt to changes in business and market environments and seek to optimize returns. Allstate continually validates and improves its ERRM practices by benchmarking and securing external perspectives for our processes.
ERRM governance includes an executive management committee structure, Board oversight and chief risk officers ("CROs"). The Enterprise Risk & Return Council ("ERRC") is Allstate's senior risk management committee. It directs ERRM by establishing risk-return targets, determining economic capital levels and directing integrated strategies and actions from an enterprise perspective. It consists of Allstate's chief executive officer, enterprise and business unit chief risk officers and chief financial officers, general counsel and treasurer. Allstate's Board of Directors and Audit Committee provide ERRM oversight by reviewing enterprise principles, guidelines and limits for Allstate's significant risks and by monitoring strategies and actions management has taken to control these risks.
CROs are appointed for the enterprise and for Allstate Protection, Allstate Financial and Allstate Investments. Collectively, the CROs create an integrated approach to risk and return management to ensure risk management practices and strategies are aligned with Allstate's overall enterprise objectives.
Our ERRM governance is supported with an analytic framework to manage risk exposure and optimize returns on risk-adjusted capital. Allstate views economic capital primarily on a statutory accounting basis. Management and the ERRC use enterprise stochastic modeling, risk expertise and judgment to determine an appropriate level of enterprise economic capital to hold considering a broad range of risk objectives. These include limiting risks of financial stress, insolvency, likelihood of capital stress and volatility, maintaining stakeholder value and financial strength ratings and satisfying regulatory risk-based capital requirements. Enterprise economic capital approximates a combination of statutory surplus and deployable invested assets at the parent holding company level.
Using our governance and analytic framework, Allstate designs business and enterprise strategies that seek to optimize returns on risk-adjusted capital. Examples include shifting Allstate Financial away from spread-based products toward underwritten products, implementing a suite of margin improvement and exposure reduction actions in homeowners insurance and shifting our fixed income securities portfolio from short and long maturities towards intermediate maturities to optimize returns, reductions in certain asset classes such as municipal securities or European sovereign debt and manage risk under a steep and potentially changing interest rate curve.
REGULATION AND LEGAL PROCEEDINGS
We are subject to extensive regulation and we are involved in various legal and regulatory actions, all of which have an effect on specific aspects of our business. For a detailed discussion of the legal and regulatory actions in which we are involved, see Note 14 of the consolidated financial statements.
PENDING ACCOUNTING STANDARDS
There are several pending accounting standards that we have not implemented either because the standard has not been finalized or the implementation date has not yet occurred. For a discussion of these pending standards, see Note 2 of the consolidated financial statements.
The effect of implementing certain accounting standards on our financial results and financial condition is often based in part on market conditions at the time of implementation of the standard and other factors we are unable to determine prior to implementation. For this reason, we are sometimes unable to estimate the effect of certain pending accounting standards until the relevant authoritative body finalizes these standards or until we implement them.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information required for Item 7A is incorporated by reference to the material under the caption "Market Risk" in Part II, Item 7 of this report.
Item 8. Financial Statements and Supplementary Data
Page
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Financial Position
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements (Notes)
Report of Independent Registered Public Accounting Firm
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in millions, except per share data)
Year Ended December 31,
Revenues
Property-liability insurance premiums (net of reinsurance ceded of $1,098, $1,092 and $1,056)
$ 25,942
$ 25,957
$ 26,194
Life and annuity premiums and contract charges (net of reinsurance ceded of $750, $804 and $838)
2,238
2,168
1,958
Net investment income
3,971
4,102
4,444
Realized capital gains and losses:
Total other-than-temporary impairment losses
(563 )
(937 )
(2,376 )
Portion of loss recognized in other comprehensive income
(33 )
(64 )
Net other-than-temporary impairment loss recognized in earnings
(596 )
(1,001 )
(1,919 )
Sales and other realized capital gains and losses
1,099
1,336
Total realized capital gains and losses
(827 )
(583 )
32,654
31,400
32,013
Costs and expenses
Property-liability insurance claims and claims expense (net of reinsurance ceded of $927, $271 and $415)
20,161
18,951
18,746
Life and annuity contract benefits (net of reinsurance ceded of $653, $702 and $642)
1,761
1,815
1,617
Interest credited to contractholder funds (net of reinsurance ceded of $27, $32 and $32)
1,645
1,807
2,126
Amortization of deferred policy acquisition costs
4,233
4,034
4,754
Operating costs and expenses
3,468
3,281
3,007
Restructuring and related charges
Interest expense
31,679
30,285
30,772
(Loss) gain on disposition of operations
(15 )
Income from operations before income tax expense
1,126
1,248
Income tax expense
Net income
$
$
$
Earnings per share:
Net income per share - Basic
$ 1.51
$ 1.72
$ 1.58
Weighted average shares - Basic
520.7
540.3
539.6
Net income per share - Diluted
$ 1.51
$ 1.71
$ 1.58
Weighted average shares - Diluted
523.1
542.5
540.9
Cash dividends declared per share
$ 0.84
$ 0.80
$ 0.80
See notes to consolidated financial statements.
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in millions)
Year Ended December 31,
Net income
$
$
$
Other comprehensive income, after-tax
Changes in:
Unrealized net capital gains and losses
1,785
3,446
Unrealized foreign currency translation adjustments
(12
)
Unrecognized pension and other postretirement benefit cost
(239
)
(214
)
Other comprehensive income, after-tax
1,902
3,273
Comprehensive income
$
$
2,830
$
4,127
See notes to consolidated financial statements.
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
($ in millions, except par value data)
December 31,
Assets
Investments
Fixed income securities, at fair value (amortized cost $73,379 and $78,786)
$ 76,113
$ 79,612
Equity securities, at fair value (cost $4,203 and $4,228)
4,363
4,811
Mortgage loans
7,139
6,679
Limited partnership interests
4,697
3,816
Short-term, at fair value (amortized cost $1,291 and $3,279)
1,291
3,279
Other
2,015
2,286
Total investments
95,618
100,483
Cash
Premium installment receivables, net
4,920
4,839
Deferred policy acquisition costs
4,443
4,769
Reinsurance recoverables, net
7,251
6,552
Accrued investment income
Deferred income taxes
Property and equipment, net
Goodwill
1,242
Other assets
2,069
1,605
Separate Accounts
6,984
8,676
Total assets
$ 125,563
$ 130,874
Liabilities
Reserve for property-liability insurance claims and claims expense
$ 20,375
$ 19,468
Reserve for life-contingent contract benefits
14,449
13,482
Contractholder funds
42,332
48,195
Unearned premiums
10,057
9,800
Claim payments outstanding
Other liabilities and accrued expenses
5,929
5,564
Long-term debt
5,908
5,908
Separate Accounts
6,984
8,676
Total liabilities
106,861
111,830
Commitments and Contingent Liabilities (Note 7, 8 and 14)
Equity
Preferred stock, $1 par value, 25 million shares authorized, none issued
-
-
Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 501 million and 533 million shares outstanding
Additional capital paid-in
3,189
3,176
Retained income
32,321
31,969
Deferred ESOP expense
(43 )
(44 )
Treasury stock, at cost (399 million and 367 million shares)
(16,795 )
(15,910 )
Accumulated other comprehensive income:
Unrealized net capital gains and losses:
Unrealized net capital losses on fixed income securities with OTTI
(174 )
(190 )
Other unrealized net capital gains and losses
2,041
1,089
Unrealized adjustment to DAC, DSI and insurance reserves
(504 )
Total unrealized net capital gains and losses
1,363
Unrealized foreign currency translation adjustments
Unrecognized pension and other postretirement benefit cost
(1,427 )
(1,188 )
Total accumulated other comprehensive loss
(7 )
(184 )
Total shareholders' equity
18,674
19,016
Noncontrolling interest
Total equity
18,702
19,044
Total liabilities and equity
$ 125,563
$ 130,874
See notes to consolidated financial statements.
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
($ in millions, except per share data)
Year Ended December 31,
Common stock
$
$
$
Additional capital paid-in
Balance, beginning of year
3,176
3,172
3,130
Equity incentive plans activity
Balance, end of year
3,189
3,176
3,172
Retained income
Balance, beginning of year
31,969
31,492
30,207
Net income
Dividends ($0.84, $0.80 and $0.80 per share)
(436 )
(433 )
(432 )
Cumulative effect of change in accounting principle
-
(18 )
Balance, end of year
32,321
31,969
31,492
Deferred ESOP expense
Balance, beginning of year
(44 )
(47 )
(49 )
Payments
Balance, end of year
(43 )
(44 )
(47 )
Treasury stock
Balance, beginning of year
(15,910 )
(15,828 )
(15,855 )
Shares acquired
(950 )
(166 )
(3 )
Shares reissued under equity incentive plans, net
Balance, end of year
(16,795 )
(15,910 )
(15,828 )
Accumulated other comprehensive income
Balance, beginning of year
(184 )
(2,106 )
(4,801 )
Cumulative effect of change in accounting principle
-
(578 )
Change in unrealized net capital gains and losses
1,785
3,446
Change in unrealized foreign currency translation adjustments
(12 )
Change in unrecognized pension and other postretirement benefit cost
(239 )
(214 )
Balance, end of year
(7 )
(184 )
(2,106 )
Total shareholders' equity
18,674
19,016
16,692
Noncontrolling interest
Balance, beginning of year
Cumulative effect of change in accounting principle
-
-
Change in noncontrolling interest ownership
(4 )
(14 )
(3 )
Noncontrolling gain
-
Balance, end of year
Total equity
$ 18,702
$ 19,044
$ 16,721
See notes to consolidated financial statements.
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
Year Ended December 31,
Cash flows from operating activities
Net income
$
$
$
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and other non-cash items
(91 )
Realized capital gains and losses
(503 )
Loss (gain) on disposition of operations
(11 )
(7 )
Interest credited to contractholder funds
1,645
1,807
2,126
Changes in:
Policy benefits and other insurance reserves
(77 )
(577 )
Unearned premiums
(40 )
(247 )
Deferred policy acquisition costs
(94 )
Premium installment receivables, net
Reinsurance recoverables, net
(716 )
(265 )
(85 )
Income taxes
1,660
Other operating assets and liabilities
(5 )
(455 )
Net cash provided by operating activities
1,929
3,689
4,301
Cash flows from investing activities
Proceeds from sales
Fixed income securities
29,436
22,881
21,359
Equity securities
2,012
4,349
6,894
Limited partnership interests
1,000
Mortgage loans
Other investments
Investment collections
Fixed income securities
4,951
5,147
5,556
Mortgage loans
1,076
1,764
Other investments
Investment purchases
Fixed income securities
(27,896 )
(25,745 )
(29,573 )
Equity securities
(1,824 )
(3,564 )
(8,496 )
Limited partnership interests
(1,696 )
(1,342 )
(784 )
Mortgage loans
(1,241 )
(120 )
(26 )
Other investments
(204 )
(181 )
(64 )
Change in short-term investments, net
2,182
(382 )
5,981
Change in other investments, net
(415 )
(519 )
(340 )
(Acquisition) disposition of operations, net of cash acquired
(916 )
Purchases of property and equipment, net
(246 )
(162 )
(189 )
Net cash provided by investing activities
6,161
2,332
3,440
Cash flows from financing activities
Proceeds from issuance of long-term debt
-
1,003
Repayment of long-term debt
(7 )
(2 )
(752 )
Contractholder fund deposits
2,176
2,980
4,150
Contractholder fund withdrawals
(8,680 )
(8,470 )
(11,406 )
Dividends paid
(435 )
(430 )
(542 )
Treasury stock purchases
(953 )
(152 )
(4 )
Shares reissued under equity incentive plans, net
Excess tax benefits on share-based payment arrangements
(5 )
(7 )
(5 )
Other
(18 )
Net cash used in financing activities
(7,876 )
(6,071 )
(7,544 )
Net increase (decrease) in cash
(50 )
Cash at beginning of year
Cash at end of year
$
$
$
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
Basis of presentation
The accompanying consolidated financial statements include the accounts of The Allstate Corporation and its wholly owned subsidiaries, primarily Allstate Insurance Company ("AIC"), a property-liability insurance company with various property-liability and life and investment subsidiaries, including Allstate Life Insurance Company ("ALIC") (collectively referred to as the "Company" or "Allstate"). These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). All significant intercompany accounts and transactions have been eliminated.
To conform to the current year presentation, certain amounts in the prior years' consolidated financial statements and notes have been reclassified.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Nature of operations
Allstate is engaged, principally in the United States, in the property-liability insurance, life insurance, retirement and investment product business. Allstate's primary business is the sale of private passenger auto and homeowners insurance. The Company also sells several other personal property and casualty insurance products, select commercial property and casualty coverages, life insurance, annuities, voluntary accident and health insurance and funding agreements. Allstate primarily distributes its products through exclusive agencies, financial specialists, independent agencies, call centers and the internet.
The Allstate Protection segment principally sells private passenger auto and homeowners insurance, with earned premiums accounting for 79% of Allstate's 2011 consolidated revenues. Allstate was the country's second largest insurer for both private passenger auto and homeowners insurance as of December 31, 2010. Allstate Protection, through several companies, is authorized to sell certain property-liability products in all 50 states, the District of Columbia and Puerto Rico. The Company is also authorized to sell certain insurance products in Canada. For 2011, the top geographic locations for premiums earned by the Allstate Protection segment were New York, California, Texas, Florida and Pennsylvania. No other jurisdiction accounted for more than 5% of premiums earned for Allstate Protection.
Allstate has exposure to catastrophes, an inherent risk of the property-liability insurance business, which have contributed, and will continue to contribute, to material year-to-year fluctuations in the Company's results of operations and financial position (see Note 8). The nature and level of catastrophic loss caused by natural events (high winds, winter storms, tornadoes, hailstorms, wildfires, tropical storms, hurricanes, earthquakes and volcanoes) and man-made events (terrorism and industrial accidents) experienced in any period cannot be predicted and could be material to results of operations and financial position. The Company considers the greatest areas of potential catastrophe losses due to hurricanes to generally be major metropolitan centers in counties along the eastern and gulf coasts of the United States. The Company considers the greatest areas of potential catastrophe losses due to earthquakes and fires following earthquakes to be major metropolitan areas near fault lines in the states of California, Oregon, Washington, South Carolina, Missouri, Kentucky and Tennessee. The Company also has exposure to asbestos, environmental and other discontinued lines claims (see Note 14).
The Allstate Financial segment sells life insurance, retirement and investment products and voluntary accident and health insurance. The principal individual products are interest-sensitive, traditional and variable life insurance; fixed annuities including deferred and immediate; and voluntary accident and health insurance. The institutional product line, which the Company most recently offered in 2008, consists primarily of funding agreements sold to unaffiliated trusts that use them to back medium-term notes issued to institutional and individual investors. Banking products and services were previously offered to customers through the Allstate Bank. In 2011, after receiving regulatory approval to voluntarily dissolve, Allstate Bank ceased operations. In the first half of 2012 the Company expects to cancel the bank's charter and deregister The Allstate Corporation as a savings and loan holding company.
Allstate Financial, through several companies, is authorized to sell life insurance and retirement products in all 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands and Guam. For 2011, the top geographic locations for statutory premiums and annuity considerations for the Allstate Financial segment were California, Texas, Florida and Nebraska. No other jurisdiction accounted for more than 5% of statutory premiums and annuity considerations for
Allstate Financial. Allstate Financial distributes its products to individuals through multiple distribution channels, including Allstate exclusive agencies and exclusive financial specialists, independent agents (including master brokerage agencies and workplace enrolling agents), specialized structured settlement brokers and directly through call centers and the internet.
Allstate has exposure to market risk as a result of its investment portfolio. Market risk is the risk that the Company will incur realized and unrealized net capital losses due to adverse changes in interest rates, credit spreads, equity prices or currency exchange rates. The Company's primary market risk exposures are to changes in interest rates, credit spreads and equity prices. Interest rate risk is the risk that the Company will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of its interest bearing assets and liabilities. This risk arises from many of the Company's primary activities, as it invests substantial funds in interest-sensitive assets and issues interest-sensitive liabilities. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key risk-free reference yields. Credit spread risk is the risk that the Company will incur a loss due to adverse changes in credit spreads. This risk arises from many of the Company's primary activities, as the Company invests substantial funds in spread-sensitive fixed income assets. Equity price risk is the risk that the Company will incur losses due to adverse changes in the general levels of the equity markets.
The Company monitors economic and regulatory developments that have the potential to impact its business. Federal and state laws and regulations affect the taxation of insurance companies and life insurance and annuity products. Congress and various state legislatures from time to time consider legislation that would reduce or eliminate the favorable policyholder tax treatment currently applicable to life insurance and annuities. Congress and various state legislatures also consider proposals to reduce the taxation of certain products or investments that may compete with life insurance or annuities. Legislation that increases the taxation on insurance products or reduces the taxation on competing products could lessen the advantage or create a disadvantage for certain of the Company's products making them less competitive. Such proposals, if adopted, could have an adverse effect on the Company's financial position or Allstate Financial's ability to sell such products and could result in the surrender of some existing contracts and policies. In addition, changes in the federal estate tax laws could negatively affect the demand for the types of life insurance used in estate planning.
2. Summary of Significant Accounting Policies
Investments
Fixed income securities include bonds, residential mortgage-backed securities ("RMBS"), commercial mortgage-backed securities ("CMBS"), asset-backed securities ("ABS") and redeemable preferred stocks. Fixed income securities, which may be sold prior to their contractual maturity, are designated as available for sale and are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes, certain life and annuity deferred policy acquisition costs ("DAC"), certain deferred sales inducement costs ("DSI") and certain reserves for life-contingent contract benefits, is reflected as a component of accumulated other comprehensive income. Cash received from calls, principal payments and make-whole payments is reflected as a component of proceeds from sales and cash received from maturities and pay-downs, including prepayments, is reflected as a component of investment collections within the Consolidated Statements of Cash Flows.
Equity securities primarily include common stocks, exchange traded and mutual funds, non-redeemable preferred stocks and real estate investment trust equity investments. Equity securities are designated as available for sale and are carried at fair value. The difference between cost and fair value, net of deferred income taxes, is reflected as a component of accumulated other comprehensive income.
Mortgage loans are carried at outstanding principal balances, net of unamortized premium or discount and valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected.
Investments in limited partnership interests, including interests in private equity/debt funds, real estate funds, hedge funds and tax credit funds, where the Company's interest is so minor that it exercises virtually no influence over operating and financial policies are accounted for in accordance with the cost method of accounting; all other investments in limited partnership interests are accounted for in accordance with the equity method of accounting ("EMA").
Short-term investments, including money market funds, commercial paper and other short-term investments, are carried at fair value. Other investments primarily consist of policy loans, bank loans and derivatives. Policy loans are carried at unpaid principal balances and were $1.15 billion and $1.14 billion as of December 31, 2011 and 2010,
respectively. Bank loans are primarily senior secured corporate loans and are carried at amortized cost. Derivatives are carried at fair value.
Investment income primarily consists of interest, dividends, income from cost method limited partnership interests and income from certain derivative transactions. Interest is recognized on an accrual basis using the effective yield method and dividends are recorded at the ex-dividend date. Interest income for certain RMBS, CMBS and ABS is determined considering estimated pay-downs, including prepayments, obtained from third party data sources and internal estimates. Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. For beneficial interests in securitized financial assets not of high credit quality, the effective yield is recalculated on a prospective basis. For other RMBS, CMBS and ABS, the effective yield is recalculated on a retrospective basis. For other-than-temporarily impaired fixed income securities, the effective yield method utilizes the difference between the amortized cost basis at impairment and the cash flows expected to be collected. Accrual of income is suspended for other-than-temporarily impaired fixed income securities when the timing and amount of cash flows expected to be received is not reasonably estimable. Accrual of income is suspended for mortgage loans and bank loans that are in default or when full and timely collection of principal and interest payments is not probable. Cash receipts on investments on nonaccrual status are generally recorded as a reduction of carrying value. Income from cost method limited partnership interests is recognized upon receipt of amounts distributed by the partnerships.
Realized capital gains and losses include gains and losses on investment sales, write-downs in value due to other-than-temporary declines in fair value, adjustments to valuation allowances on mortgage loans, periodic changes in fair value and settlements of certain derivatives including hedge ineffectiveness, and income from EMA limited partnership interests. Realized capital gains and losses on investment sales, including calls and principal payments, are determined on a specific identification basis. Income from EMA limited partnership interests is recognized based on the Company's share of the earnings of the partnerships, and is recognized on a delay due to the availability of the related financial statements. Income recognition on hedge funds is generally on a one month delay and income recognition on private equity/debt funds, real estate funds and tax credit funds is generally on a three month delay.
The Company recognizes other-than-temporary impairment losses on fixed income securities in earnings when a security's fair value is less than its amortized cost and the Company has made the decision to sell or it is more likely than not the Company will be required to sell the fixed income security before recovery of its amortized cost basis. Additionally, if the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors recognized in other comprehensive income ("OCI"). The Company recognizes other-than-temporary impairment losses on equity securities in earnings when the decline in fair value is considered other than temporary including when the Company does not have the intent and ability to hold the equity security for a period of time sufficient to recover its cost basis.
Derivative and embedded derivative financial instruments
Derivative financial instruments include interest rate swaps, credit default swaps, futures (interest rate and equity), options (including swaptions), interest rate caps and floors, warrants and rights, foreign currency swaps, foreign currency forwards, certain investment risk transfer reinsurance agreements, and certain bond forward purchase commitments. Derivatives required to be separated from the host instrument and accounted for as derivative financial instruments ("subject to bifurcation") are embedded in certain fixed income securities, equity-indexed life and annuity contracts, reinsured variable annuity contracts and certain funding agreements.
All derivatives are accounted for on a fair value basis and reported as other investments, other assets, other liabilities and accrued expenses or contractholder funds. Embedded derivative instruments subject to bifurcation are also accounted for on a fair value basis and are reported together with the host contract. The change in fair value of derivatives embedded in certain fixed income securities and subject to bifurcation is reported in realized capital gains and losses. The change in fair value of derivatives embedded in life and annuity product contracts and subject to bifurcation is reported in life and annuity contract benefits or interest credited to contractholder funds. Cash flows from embedded derivatives subject to bifurcation and derivatives receiving hedge accounting are reported consistently with the host contracts and hedged risks, respectively, within the Consolidated Statements of Cash Flows. Cash flows from other derivatives are reported in cash flows from investing activities within the Consolidated Statements of Cash Flows.
When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges. The hedged item may be either all or a specific portion of a recognized asset, liability or an unrecognized firm commitment attributable to a particular risk for
fair value hedges. At the inception of the hedge, the Company formally documents the hedging relationship and risk management objective and strategy. The documentation identifies the hedging instrument, the hedged item, the nature of the risk being hedged and the methodology used to assess the effectiveness of the hedging instrument in offsetting the exposure to changes in the hedged item's fair value attributable to the hedged risk. For a cash flow hedge, this documentation includes the exposure to changes in the variability in cash flows attributable to the hedged risk. The Company does not exclude any component of the change in fair value of the hedging instrument from the effectiveness assessment. At each reporting date, the Company confirms that the hedging instrument continues to be highly effective in offsetting the hedged risk. Ineffectiveness in fair value hedges and cash flow hedges, if any, is reported in realized capital gains and losses.
Fair value hedges The change in fair value of hedging instruments used in fair value hedges of investment assets or a portion thereof is reported in net investment income, together with the change in fair value of the hedged items. The change in fair value of hedging instruments used in fair value hedges of contractholder funds liabilities or a portion thereof is reported in interest credited to contractholder funds, together with the change in fair value of the hedged items. Accrued periodic settlements on swaps are reported together with the changes in fair value of the swaps in net investment income or interest credited to contractholder funds. The amortized cost for fixed income securities, the carrying value for mortgage loans or the carrying value of the hedged liability is adjusted for the change in fair value of the hedged risk.
Cash flow hedges For hedging instruments used in cash flow hedges, the changes in fair value of the derivatives representing the effective portion of the hedge are reported in accumulated other comprehensive income. Amounts are reclassified to net investment income, realized capital gains and losses or interest expense as the hedged or forecasted transaction affects income. Accrued periodic settlements on derivatives used in cash flow hedges are reported in net investment income. The amount reported in accumulated other comprehensive income for a hedged transaction is limited to the lesser of the cumulative gain or loss on the derivative less the amount reclassified to income, or the cumulative gain or loss on the derivative needed to offset the cumulative change in the expected future cash flows on the hedged transaction from inception of the hedge less the derivative gain or loss previously reclassified from accumulated other comprehensive income to income. If the Company expects at any time that the loss reported in accumulated other comprehensive income would lead to a net loss on the combination of the hedging instrument and the hedged transaction which may not be recoverable, a loss is recognized immediately in realized capital gains and losses. If an impairment loss is recognized on an asset or an additional obligation is incurred on a liability involved in a hedge transaction, any offsetting gain in accumulated other comprehensive income is reclassified and reported together with the impairment loss or recognition of the obligation.
Termination of hedge accounting If, subsequent to entering into a hedge transaction, the derivative becomes ineffective (including if the hedged item is sold or otherwise extinguished, the occurrence of a hedged forecasted transaction is no longer probable or the hedged asset becomes other-than-temporarily impaired), the Company may terminate the derivative position. The Company may also terminate derivative instruments or redesignate them as non-hedge as a result of other events or circumstances. If the derivative instrument is not terminated when a fair value hedge is no longer effective, the future gains and losses recognized on the derivative are reported in realized capital gains and losses. When a fair value hedge is no longer effective, is redesignated as non-hedge or when the derivative has been terminated, the fair value gain or loss on the hedged asset, liability or portion thereof which has already been recognized in income while the hedge was in place and used to adjust the amortized cost for fixed income securities, the carrying value for mortgage loans or the carrying value of the hedged liability, is amortized over the remaining life of the hedged asset, liability or portion thereof, and reflected in net investment income or interest credited to contractholder funds beginning in the period that hedge accounting is no longer applied. If the hedged item in a fair value hedge is an asset that has become other-than-temporarily impaired, the adjustment made to the amortized cost for fixed income securities or the carrying value for mortgage loans is subject to the accounting policies applied to other-than-temporarily impaired assets.
When a derivative instrument used in a cash flow hedge of an existing asset or liability is no longer effective or is terminated, the gain or loss recognized on the derivative is reclassified from accumulated other comprehensive income to income as the hedged risk impacts income. If the derivative instrument is not terminated when a cash flow hedge is no longer effective, the future gains and losses recognized on the derivative are reported in realized capital gains and losses. When a derivative instrument used in a cash flow hedge of a forecasted transaction is terminated because it is probable the forecasted transaction will not occur, the gain or loss recognized on the derivative is immediately reclassified from accumulated other comprehensive income to realized capital gains and losses in the period that hedge accounting is no longer applied.
Non-hedge derivative financial instruments For derivatives for which hedge accounting is not applied, the income statement effects, including fair value gains and losses and accrued periodic settlements, are reported either in realized capital gains and losses or in a single line item together with the results of the associated asset or liability for which risks are being managed.
Securities loaned
The Company's business activities include securities lending transactions, which are used primarily to generate net investment income. The proceeds received in conjunction with securities lending transactions are reinvested in short-term investments and fixed income securities. These transactions are short-term in nature, usually 30 days or less.
The Company receives cash collateral for securities loaned in an amount generally equal to 102% and 105% of the fair value of domestic and foreign securities, respectively, and records the related obligations to return the collateral in other liabilities and accrued expenses. The carrying value of these obligations approximates fair value because of their relatively short-term nature. The Company monitors the market value of securities loaned on a daily basis and obtains additional collateral as necessary under the terms of the agreements to mitigate counterparty credit risk. The Company maintains the right and ability to redeem the securities loaned on short notice.
Recognition of premium revenues and contract charges, and related benefits and interest credited
Property-liability premiums are deferred and earned on a pro-rata basis over the terms of the policies, typically periods of six or twelve months. The portion of premiums written applicable to the unexpired terms of the policies is recorded as unearned premiums. Premium installment receivables, net, represent premiums written and not yet collected, net of an allowance for uncollectible premiums. The Company regularly evaluates premium installment receivables and adjusts its valuation allowance as appropriate. The valuation allowance for uncollectible premium installment receivables was $70 million and $75 million as of December 31, 2011 and 2010, respectively.
Traditional life insurance products consist principally of products with fixed and guaranteed premiums and benefits, primarily term and whole life insurance products. Voluntary accident and health insurance products are expected to remain in force for an extended period. Premiums from these products are recognized as revenue when due from policyholders. Benefits are reflected in life and annuity contract benefits and recognized in relation to premiums, so that profits are recognized over the life of the policy.
Immediate annuities with life contingencies, including certain structured settlement annuities, provide insurance protection over a period that extends beyond the period during which premiums are collected. Premiums from these products are recognized as revenue when received at the inception of the contract. Benefits and expenses are recognized in relation to premiums. Profits from these policies come from investment income, which is recognized over the life of the contract.
Interest-sensitive life contracts, such as universal life and single premium life, are insurance contracts whose terms are not fixed and guaranteed. The terms that may be changed include premiums paid by the contractholder, interest credited to the contractholder account balance and contract charges assessed against the contractholder account balance. Premiums from these contracts are reported as contractholder fund deposits. Contract charges consist of fees assessed against the contractholder account balance for the cost of insurance (mortality risk), contract administration and surrender of the contract prior to contractually specified dates. These contract charges are recognized as revenue when assessed against the contractholder account balance. Life and annuity contract benefits include life-contingent benefit payments in excess of the contractholder account balance.
Contracts that do not subject the Company to significant risk arising from mortality or morbidity are referred to as investment contracts. Fixed annuities, including market value adjusted annuities, equity-indexed annuities and immediate annuities without life contingencies, and funding agreements (primarily backing medium-term notes) are considered investment contracts. Consideration received for such contracts is reported as contractholder fund deposits. Contract charges for investment contracts consist of fees assessed against the contractholder account balance for maintenance, administration and surrender of the contract prior to contractually specified dates, and are recognized when assessed against the contractholder account balance.
Interest credited to contractholder funds represents interest accrued or paid on interest-sensitive life contracts and investment contracts. Crediting rates for certain fixed annuities and interest-sensitive life contracts are adjusted periodically by the Company to reflect current market conditions subject to contractually guaranteed minimum rates. Crediting rates for indexed annuities and indexed funding agreements are generally based on a specified interest rate index, such as LIBOR, or an equity index, such as the Standard & Poor's ("S&P") 500 Index. Interest credited also
includes amortization of DSI expenses. DSI is amortized into interest credited using the same method used to amortize DAC.
Contract charges for variable life and variable annuity products consist of fees assessed against the contractholder account balances for contract maintenance, administration, mortality, expense and surrender of the contract prior to contractually specified dates. Contract benefits incurred for variable annuity products include guaranteed minimum death, income, withdrawal and accumulation benefits. Substantially all of the Company's variable annuity business is ceded through reinsurance agreements and the contract charges and contract benefits related thereto are reported net of reinsurance ceded.
Deferred policy acquisition and sales inducement costs
Costs that vary with and are primarily related to acquiring property-liability insurance, life insurance and investment contracts are deferred and recorded as DAC. These costs are principally agents' and brokers' remuneration, premium taxes, inspection costs, and certain underwriting expenses. DSI costs, which are deferred and recorded as other assets, relate to sales inducements offered on sales to new customers, principally on annuity and interest-sensitive life contracts. These sales inducements are primarily in the form of additional credits to the customer's account balance or enhancements to interest credited for a specified period which are in excess of the rates currently being credited to similar contracts without sales inducements. All other acquisition costs are expensed as incurred and included in operating costs and expenses. DAC associated with property-liability insurance is amortized into income as premiums are earned, typically over periods of six or twelve months, and is included in amortization of deferred policy acquisition costs. Future investment income is considered in determining the recoverability of DAC. Amortization of DAC associated with life insurance and investment contracts is included in amortization of deferred policy acquisition costs and is described in more detail below. DSI is amortized into income using the same methodology and assumptions as DAC and is included in interest credited to contractholder funds. DAC and DSI are periodically reviewed for recoverability and adjusted if necessary.
For traditional life insurance, DAC is amortized over the premium paying period of the related policies in proportion to the estimated revenues on such business. Assumptions used in the amortization of DAC and reserve calculations are established at the time the policy is issued and are generally not revised during the life of the policy. Any deviations from projected business in force resulting from actual policy terminations differing from expected levels and any estimated premium deficiencies may result in a change to the rate of amortization in the period such events occur. Generally, the amortization periods for these policies approximates the estimated lives of the policies.
For interest-sensitive life, fixed annuities and other investment contracts, DAC and DSI are amortized in proportion to the incidence of the total present value of gross profits, which includes both actual historical gross profits ("AGP") and estimated future gross profits ("EGP") expected to be earned over the estimated lives of the contracts. The amortization is net of interest on the prior period DAC balance using rates established at the inception of the contracts. Actual amortization periods generally range from 15-30 years; however, incorporating estimates of the rate of customer surrenders, partial withdrawals and deaths generally results in the majority of the DAC being amortized during the surrender charge period, which is typically 10-20 years for interest-sensitive life and 5-10 years for fixed annuities. The cumulative DAC and DSI amortization is reestimated and adjusted by a cumulative charge or credit to income when there is a difference between the incidence of actual versus expected gross profits in a reporting period or when there is a change in total EGP. When DAC or DSI amortization or a component of gross profits for a quarterly period is potentially negative (which would result in an increase of the DAC or DSI balance) as a result of negative AGP, the specific facts and circumstances surrounding the potential negative amortization are considered to determine whether it is appropriate for recognition in the consolidated financial statements. Negative amortization is only recorded when the increased DAC or DSI balance is determined to be recoverable based on facts and circumstances. Recapitalization of DAC and DSI is limited to the originally deferred costs plus interest.
AGP and EGP primarily consist of the following components: contract charges for the cost of insurance less mortality costs and other benefits; investment income and realized capital gains and losses less interest credited; and surrender and other contract charges less maintenance expenses. The principal assumptions for determining the amount of EGP are investment returns, including capital gains and losses on assets supporting contract liabilities, interest crediting rates to contractholders, and the effects of persistency, mortality, expenses, and hedges if applicable. For products whose supporting investments are exposed to capital losses in excess of the Company's expectations which may cause periodic AGP to become temporarily negative, EGP and AGP utilized in DAC and DSI amortization may be modified to exclude the excess capital losses.
The Company performs quarterly reviews of DAC and DSI recoverability for interest-sensitive life, fixed annuities and other investment contracts in the aggregate using current assumptions. If a change in the amount of EGP is significant, it could result in the unamortized DAC or DSI not being recoverable, resulting in a charge which is included as a component of amortization of deferred policy acquisition costs or interest credited to contractholder funds, respectively.
The DAC and DSI balances presented include adjustments to reflect the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized capital gains or losses in the respective product investment portfolios were actually realized. The adjustments are recorded net of tax in accumulated other comprehensive income. DAC, DSI and deferred income taxes determined on unrealized capital gains and losses and reported in accumulated other comprehensive income recognize the impact on shareholders' equity consistently with the amounts that would be recognized in the income statement on realized capital gains and losses.
Customers of the Company may exchange one insurance policy or investment contract for another offered by the Company, or make modifications to an existing investment, life or property-liability contract issued by the Company. These transactions are identified as internal replacements for accounting purposes. Internal replacement transactions determined to result in replacement contracts that are substantially unchanged from the replaced contracts are accounted for as continuations of the replaced contracts. Unamortized DAC and DSI related to the replaced contracts continue to be deferred and amortized in connection with the replacement contracts. For interest-sensitive life and investment contracts, the EGP of the replacement contracts are treated as a revision to the EGP of the replaced contracts in the determination of amortization of DAC and DSI. For traditional life and property-liability insurance policies, any changes to unamortized DAC that result from replacement contracts are treated as prospective revisions. Any costs associated with the issuance of replacement contracts are characterized as maintenance costs and expensed as incurred. Internal replacement transactions determined to result in a substantial change to the replaced contracts are accounted for as an extinguishment of the replaced contracts, and any unamortized DAC and DSI related to the replaced contracts are eliminated with a corresponding charge to amortization of deferred policy acquisition costs or interest credited to contractholder funds, respectively.
The costs assigned to the right to receive future cash flows from certain business purchased from other insurers are also classified as DAC in the Consolidated Statements of Financial Position. The costs capitalized represent the present value of future profits expected to be earned over the lives of the contracts acquired. These costs are amortized as profits emerge over the lives of the acquired business and are periodically evaluated for recoverability. The present value of future profits was $136 million and $133 million as of December 31, 2011 and 2010, respectively. Amortization expense of the present value of future profits was $39 million, $23 million and $28 million in 2011, 2010 and 2009, respectively.
Reinsurance
In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The Company has also used reinsurance to effect the acquisition or disposition of certain blocks of business. The amounts reported as reinsurance recoverables include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities and contractholder funds that have not yet been paid. Reinsurance recoverables on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverables. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. For catastrophe coverage, the cost of reinsurance premiums is recognized ratably over the contract period to the extent coverage remains available. Reinsurance does not extinguish the Company's primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers, including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance as appropriate.
Goodwill
Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets acquired. The goodwill balances were $824 million and $418 million as of December 31, 2011 and $456 million and $418 million as of December 31, 2010 for the Allstate Protection segment and the Allstate Financial segment, respectively. The increase in 2011 relates to the acquisition of Esurance and Answer Financial. The Company's reporting units are equivalent to its reporting segments, Allstate Protection and Allstate Financial. Goodwill is allocated to reporting units based on which unit is expected to benefit from the synergies of the business combination. Goodwill is not amortized but is tested for impairment at least annually. The Company performs its annual goodwill impairment
testing during the fourth quarter of each year based upon data as of the close of the third quarter. The Company also reviews goodwill for impairment whenever events or changes in circumstances, such as deteriorating or adverse market conditions, indicate that it is more likely than not that the carrying amount of goodwill may exceed its implied fair value.
To estimate the fair value of its reporting units, the Company may utilize a combination of widely accepted valuation techniques including a stock price and market capitalization analysis, discounted cash flow calculations and peer company price to earnings multiples analysis. The stock price and market capitalization analysis takes into consideration the quoted market price of the Company's outstanding common stock and includes a control premium, derived from historical insurance industry acquisition activity, in determining the estimated fair value of the consolidated entity before allocating that fair value to individual reporting units. The discounted cash flow analysis utilizes long term assumptions for revenue growth, capital growth, earnings projections including those used in the Company's strategic plan, and an appropriate discount rate. The peer company price to earnings multiples analysis takes into consideration the price earnings multiples of peer companies for each reporting unit and estimated income from the Company's strategic plan.
Goodwill impairment evaluations indicated no impairment as of December 31, 2011 or 2010.
Property and equipment
Property and equipment is carried at cost less accumulated depreciation. Included in property and equipment are capitalized costs related to computer software licenses and software developed for internal use. These costs generally consist of certain external payroll and payroll related costs. Certain facilities and equipment held under capital leases are also classified as property and equipment with the related lease obligations recorded as liabilities. Property and equipment depreciation is calculated using the straight-line method over the estimated useful lives of the assets, generally 3 to 10 years for equipment and 40 years for real property. Depreciation expense is reported in operating costs and expenses. Accumulated depreciation on property and equipment was $2.29 billion and $2.41 billion as of December 31, 2011 and 2010, respectively. Depreciation expense on property and equipment was $222 million, $239 million and $256 million in 2011, 2010 and 2009, respectively. The Company reviews its property and equipment for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Income taxes
The income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are DAC, unrealized capital gains and losses on certain investments, differences in tax bases of invested assets, insurance reserves and unearned premiums. A deferred tax asset valuation allowance is established when there is uncertainty that such assets will be realized.
Reserves for property-liability insurance claims and claims expense and life-contingent contract benefits
The reserve for property-liability insurance claims and claims expense is the estimate of amounts necessary to settle all reported and unreported claims for the ultimate cost of insured property-liability losses, based upon the facts of each case and the Company's experience with similar cases. Estimated amounts of salvage and subrogation are deducted from the reserve for claims and claims expense. The establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. Reserve estimates are regularly reviewed and updated, using the most current information available. Any resulting reestimates are reflected in current results of operations.
The reserve for life-contingent contract benefits payable under insurance policies, including traditional life insurance, life-contingent immediate annuities and voluntary accident and health products, is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses. These assumptions, which for traditional life insurance are applied using the net level premium method, include provisions for adverse deviation and generally vary by characteristics such as type of coverage, year of issue and policy duration. To the extent that unrealized gains on fixed income securities would result in a premium deficiency if those gains were realized, the related increase in reserves for certain immediate annuities with life contingencies is recorded net of tax as a reduction of unrealized net capital gains included in accumulated other comprehensive income.
Contractholder funds
Contractholder funds represent interest-bearing liabilities arising from the sale of products such as interest-sensitive life insurance, fixed annuities, bank deposits and funding agreements. Contractholder funds primarily comprise deposits received and interest credited to the benefit of the contractholder less surrenders and withdrawals, mortality
charges and administrative expenses. Contractholder funds also include reserves for secondary guarantees on interest-sensitive life insurance and certain fixed annuity contracts and reserves for certain guarantees on reinsured variable annuity contracts.
Separate accounts
Separate accounts assets are carried at fair value. The assets of the separate accounts are legally segregated and available only to settle separate account contract obligations. Separate accounts liabilities represent the contractholders' claims to the related assets and are carried at an amount equal to the separate accounts assets. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and therefore are not included in the Company's Consolidated Statements of Operations. Deposits to and surrenders and withdrawals from the separate accounts are reflected in separate accounts liabilities and are not included in consolidated cash flows.
Absent any contract provision wherein the Company provides a guarantee, variable annuity and variable life insurance contractholders bear the investment risk that the separate accounts' funds may not meet their stated investment objectives. Substantially all of the Company's variable annuity business was reinsured beginning in 2006.
Deferred Employee Stock Ownership Plan ("ESOP") expense
Deferred ESOP expense represents the remaining unrecognized cost of shares acquired by the Allstate ESOP to pre-fund a portion of the Company's contribution to the Allstate 401(k) Savings Plan.
Equity incentive plans
The Company currently has equity incentive plans that permit the Company to grant nonqualified stock options, incentive stock options and restricted stock units ("equity awards") to certain employees and directors of the Company. The Company recognizes the fair value of equity awards computed at the award date over the period in which the requisite service is rendered. The Company uses a binomial lattice model to determine the fair value of employee stock options.
Off-balance-sheet financial instruments
Commitments to invest, commitments to purchase private placement securities, commitments to extend loans, financial guarantees and credit guarantees have off-balance-sheet risk because their contractual amounts are not recorded in the Company's Consolidated Statements of Financial Position (see Note 7 and Note 14).
Consolidation of variable interest entities ("VIEs")
The Company consolidates VIEs when it is the primary beneficiary. A primary beneficiary is the entity with both the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE (see Note 12).
Foreign currency translation
The local currency of the Company's foreign subsidiaries is deemed to be the functional currency of the country in which these subsidiaries operate. The financial statements of the Company's foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect at the end of a reporting period for assets and liabilities and at average exchange rates during the period for results of operations. The unrealized gains and losses from the translation of the net assets are recorded as unrealized foreign currency translation adjustments and included in accumulated other comprehensive income. Changes in unrealized foreign currency translation adjustments are included in other comprehensive income. Gains and losses from foreign currency transactions are reported in operating costs and expenses and have not been material.
Earnings per share
Basic earnings per share is computed using the weighted average number of common shares outstanding, including unvested participating restricted stock units. Diluted earnings per share is computed using the weighted average number of common and dilutive potential common shares outstanding. For the Company, dilutive potential common shares consist of outstanding stock options and unvested non-participating restricted stock units.
The computation of basic and diluted earnings per share for the years ended December 31 is presented in the following table.
($ in millions, except per share data)
Numerator:
Net income
$
$
$
Denominator:
Weighted average common shares outstanding
520.7
540.3
539.6
Effect of dilutive potential common shares:
Stock options
1.8
2.0
1.3
Restricted stock units (non-participating)
0.6
0.2
-
Weighted average common and dilutive potential common shares outstanding
523.1
542.5
540.9
Earnings per share - Basic
$
1.51
$
1.72
$
1.58
Earnings per share - Diluted
$ 1.51
$ 1.71
$ 1.58
The effect of dilutive potential common shares does not include the effect of options with an anti-dilutive effect on earnings per share because their exercise prices exceed the average market price of Allstate common shares during the period or for which the unrecognized compensation cost would have an anti-dilutive effect. Options to purchase 27.2 million, 26.7 million and 25.9 million Allstate common shares, with exercise prices ranging from $22.71 to $62.84, $27.36 to $64.53 and $23.13 to $65.38, were outstanding in 2011, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share in those years.
Adopted accounting standards
Consolidation Analysis Considering Investments Held through Separate Accounts
In April 2010, the Financial Accounting Standards Board ("FASB") issued guidance clarifying that an insurer is not required to combine interests in investments held in a qualifying separate account with its interests in the same investments held in the general account when performing a consolidation evaluation. The adoption of this guidance as of January 1, 2011 had no impact on the Company's results of operations or financial position.
Disclosure of Supplementary Pro Forma Information for Business Combinations
In December 2010, the FASB issued disclosure guidance for entities that enter into material business combinations. The guidance specifies that if an entity presents comparative financial statements, it should disclose pro forma revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The guidance expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination. The Company will apply the guidance to any material business combinations entered into on or after January 1, 2011.
Criteria for Classification as a Troubled Debt Restructuring ("TDR")
In April 2011, the FASB issued clarifying guidance related to determining whether a loan modification or restructuring should be classified as a TDR. The additional guidance provided pertains to the two criteria used to determine whether a TDR exists, whether the creditor has granted a concession and whether the debtor is experiencing financial difficulties. The guidance related to the identification of a TDR is to be applied retrospectively to the beginning of the annual period of adoption. The measurement of impairment on a TDR identified under this guidance is effective prospectively. Additional disclosures about TDRs of financing receivables are also required. The adoption of this guidance as of July 1, 2011 did not have a material effect on the Company's results of operations or financial position.
Pending accounting standards
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued guidance modifying the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance contracts. The guidance specifies that the costs must be directly related to the successful acquisition of insurance contracts. The guidance also specifies that advertising costs should be included as deferred acquisition costs only when the direct-response advertising accounting
criteria are met. The new guidance is effective for reporting periods beginning after December 15, 2011. The Company will adopt the new guidance retrospectively. Upon adoption on January 1, 2012, the DAC balance will be reduced by an estimated $571 million with a corresponding decrease to shareholders' equity of an estimated $375 million, net of taxes. In future periods, operating costs and expenses will increase since a lower amount of acquisition costs will be capitalized, which will be partially offset by a decrease in amortization of DAC due to the retrospective reduction of the DAC balance.
Criteria for Determining Effective Control for Repurchase Agreements
In April 2011, the FASB issued guidance modifying the assessment criteria of effective control for repurchase agreements. The new guidance removes the criteria requiring an entity to have the ability to repurchase or redeem financial assets on substantially the agreed terms and the collateral maintenance guidance related to that criteria. The guidance is to be applied prospectively to transactions or modifications of existing transactions that occur during reporting periods beginning on or after December 15, 2011. Early adoption is not permitted. The impact of adoption is not expected to be material to the Company's results of operations or financial position.
Amendments to Fair Value Measurement and Disclosure Requirements
In May 2011, the FASB issued guidance that clarifies the application of existing fair value measurement and disclosure requirements and amends certain fair value measurement principles, requirements and disclosures. Changes were made to improve consistency in global application. The guidance is to be applied prospectively for reporting periods beginning after December 15, 2011. Early adoption is not permitted. The impact of adoption is not expected to be material to the Company's results of operations or financial position.
Presentation of Comprehensive Income
In June and December 2011, the FASB issued guidance amending the presentation of comprehensive income and its components. Under the new guidance, a reporting entity has the option to present comprehensive income in a single continuous statement or in two separate but consecutive statements. The guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively. The new guidance affects presentation only and will have no impact on the Company's results of operations or financial position.
Intangibles - Goodwill and Other
In September 2011, the FASB issued guidance providing the option to first assess qualitative factors, such as macroeconomic conditions and industry and market considerations, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If impairment is indicated by the qualitative assessment, then it is necessary to perform the two-step goodwill impairment test. If the option is not elected, the guidance requiring the two-step goodwill impairment test is unchanged. The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The impact of adoption is not expected to be material to the Company's results of operations or financial position.
Disclosures about Offsetting Assets and Liabilities for Financial Instruments and Derivative Instruments
In December 2011, the FASB issued guidance requiring expanded disclosures, including both gross and net information, for financial instruments and derivative instruments that are either offset in the reporting entity's financial statements or those that are subject to an enforceable master netting arrangement or similar agreement. The guidance is effective for reporting periods beginning on or after January 1, 2013 and is to be applied retrospectively. The new guidance affects disclosures only and will have no impact on the Company's results of operations or financial position.
3. Acquisition
On October 7, 2011, The Allstate Corporation acquired all of the shares of White Mountains, Inc. and Answer Financial Inc. ("Answer Financial") from White Mountains Holdings (Luxembourg) S.à r.l. for $1.01 billion in cash. White Mountains, Inc. primarily comprises the Esurance insurance business ("Esurance"). Esurance sells private passenger auto insurance direct to consumers online, through a call center and through select agents, including Answer Financial. Answer Financial is an independent personal lines insurance agency that offers comparison quotes for auto and homeowners insurance from more than a dozen insurance companies through its website and over the phone. Esurance expands the Company's ability to serve the self-directed, brand-sensitive market segment. Answer Financial strengthens the Company's offering to self-directed consumers who want a choice between insurance carriers.
In connection with the acquisition, the Company recorded present value of future profits of $42 million, goodwill of $368 million, other intangible assets of $426 million, reserve for property-liability claims and claims expense of $487 million, and unearned premiums of $229 million.
4. Supplemental Cash Flow Information
Non-cash investment exchanges, including modifications of certain mortgage loans (primarily refinances at maturity with no concessions granted to the borrower), fixed income securities, limited partnerships and other investments, as well as mergers completed with equity securities, totaled $601 million, $664 million and $485 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Liabilities for collateral received in conjunction with the Company's securities lending program were $419 million, $461 million and $449 million as of December 31, 2011, 2010 and 2009, respectively, and are reported in other liabilities and accrued expenses. Obligations to return cash collateral for over-the-counter ("OTC") derivatives were $43 million, $23 million and $209 million as of December 31, 2011, 2010 and 2009, respectively, and are reported in other liabilities and accrued expenses or other investments. The accompanying cash flows are included in cash flows from operating activities in the Consolidated Statements of Cash Flows along with the activities resulting from management of the proceeds, which for the years ended December 31 are as follows:
($ in millions)
Net change in proceeds managed
Net change in short-term investments
$
$
$ (316 )
Operating cash flow provided (used)
(316 )
Net change in cash
(2 )
Net change in proceeds managed
$
$
$
(318
)
Net change in liabilities
Liabilities for collateral, beginning of year
$ (484 ) $ (658 ) $ (340 )
Liabilities for collateral, end of year
(462 )
(484 )
(658 )
Operating cash flow (used) provided
$ (22 ) $ (174 ) $
5. Investments
Fair values
The amortized cost, gross unrealized gains and losses and fair value for fixed income securities are as follows:
Gross unrealized
($ in millions)
Amortized
cost
Fair
value
Gains
Losses
December 31, 2011
U.S. government and agencies
$ 5,966
$
$ -
$ 6,315
Municipal
13,634
(256 )
14,241
Corporate
41,217
2,743
(379 )
43,581
Foreign government
1,866
(1 )
2,081
RMBS
4,532
(521 )
4,121
CMBS
1,962
(226 )
1,784
ABS
4,180
(287 )
3,966
Redeemable preferred stock
-
Total fixed income securities
$ 73,379
$ 4,404
$ (1,670 ) $ 76,113
Gross unrealized
($ in millions)
Amortized
cost
Fair
value
Gains
Losses
December 31, 2010
U.S. government and agencies
$ 8,320
$
$ (51 ) $ 8,596
Municipal
16,201
(646 )
15,934
Corporate
36,260
1,816
(421 )
37,655
Foreign government
2,821
(10 )
3,158
RMBS
8,509
(732 )
7,993
CMBS
2,213
(277 )
1,994
ABS
4,425
(294 )
4,244
Redeemable preferred stock
-
Total fixed income securities
$ 78,786
$ 3,257
$ (2,431 ) $ 79,612
Scheduled maturities
The scheduled maturities for fixed income securities are as follows as of December 31, 2011:
($ in millions)
Amortized
cost
Fair
value
Due in one year or less
$ 3,243
$ 3,279
Due after one year through five years
21,377
22,153
Due after five years through ten years
21,718
23,247
Due after ten years
18,329
19,347
64,667
68,026
RMBS and ABS
8,712
8,087
Total
$ 73,379
$ 76,113
Actual maturities may differ from those scheduled as a result of prepayments by the issuers. Because of the potential for prepayment on RMBS and ABS, they are not categorized by contractual maturity. CMBS are categorized by contractual maturity because they generally are not subject to prepayment risk.
Net investment income
Net investment income for the years ended December 31 is as follows:
($ in millions)
Fixed income securities
$ 3,484
$ 3,737
$ 3,998
Equity securities
Mortgage loans
Limited partnership interests
Short-term investments
Other
(10 )
Investment income, before expense
4,154
4,279
4,610
Investment expense
(183 )
(177 )
(166 )
Net investment income
$ 3,971
$ 4,102
$ 4,444
Realized capital gains and losses
Realized capital gains and losses by asset type for the years ended December 31 are as follows:
($ in millions)
Fixed income securities
$
$ (366 ) $ (302 )
Equity securities
Mortgage loans
(27 )
(71 )
(144 )
Limited partnership interests
(446 )
Derivatives
(397 )
(600 )
Other
(7 )
-
(78 )
Realized capital gains and losses
$
$ (827 ) $ (583 )
Realized capital gains and losses by transaction type for the years ended December 31 are as follows:
($ in millions)
Impairment write-downs
$ (496 ) $ (797 ) $ (1,562 )
Change in intent write-downs
(100 )
(204 )
(357 )
Net other-than-temporary impairment losses recognized in earnings
(596 )
(1,001 )
(1,919 )
Sales
1,336
1,272
Valuation of derivative instruments
(291 )
(427 )
Settlements of derivative instruments
(105 )
(174 )
(162 )
EMA limited partnership income
(141 )
Realized capital gains and losses
$
$ (827 ) $ (583 )
Gross gains of $1.27 billion, $819 million and $1.21 billion and gross losses of $240 million, $435 million and $373 million were realized on sales of fixed income securities during 2011, 2010 and 2009, respectively.
Other-than-temporary impairment losses by asset type for the years ended December 31 are as follows:
($ in millions)
Gross
Included in OCI
Net
Gross
Included in OCI
Net
Gross
Included in OCI
Net
Fixed income securities:
Municipal
$ (59 ) $ (3 ) $ (62 ) $ (203 ) $
$ (179 ) $ (140 ) $
$ (130 )
Corporate
(30 )
(24 )
(68 )
(66 )
(213 )
(13 )
(226 )
Foreign government
(1 )
-
(1 )
-
-
-
(17 )
-
(17 )
RMBS
(196 )
(39 )
(235 )
(381 )
(47 )
(428 )
(672 )
(288 )
CMBS
(66 )
(65 )
(94 )
(27 )
(121 )
(411 )
(309 )
ABS
(9 )
(7 )
(14 )
(16 )
(30 )
(208 )
(26 )
(234 )
Total fixed income securities
(361 )
(33 )
(394 )
(760 )
(64 )
(824 )
(1,661 )
(1,204 )
Equity securities
(139 )
-
(139 )
(57 )
-
(57 )
(264 )
-
(264 )
Mortgage loans
(37 )
-
(37 )
(71 )
-
(71 )
(103 )
-
(103 )
Limited partnership interests
(6 )
-
(6 )
(46 )
-
(46 )
(308 )
-
(308 )
Other
(20 )
-
(20 )
(3 )
-
(3 )
(40 )
-
(40 )
Other-than-temporary impairment losses
$ (563 ) $ (33 ) $ (596 ) $ (937 ) $ (64 ) $ (1,001 ) $ (2,376 ) $
$ (1,919 )
The total amount of other-than-temporary impairment losses included in accumulated other comprehensive income at the time of impairment for fixed income securities, which were not included in earnings, are presented in the following table. The amount excludes $172 million and $322 million as of December 31, 2011 and 2010, respectively, of
net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.
($ in millions)
December 31,
December 31,
Municipal
$ (11 ) $ (27 )
Corporate
(35 )
(31 )
RMBS
(353 )
(467 )
CMBS
(19 )
(49 )
ABS
(21 )
(41 )
Total
$ (439 ) $ (615 )
Rollforwards of the cumulative credit losses recognized in earnings for fixed income securities held as of December 31 are as follows:
($ in millions)
Beginning balance
$ (1,046 ) $ (1,187 ) $ -
Beginning balance of cumulative credit loss for securities held as of April 1, 2009
-
-
(1,357 )
Cumulative effect of change in accounting principle
-
-
Additional credit loss for securities previously other-than-temporarily impaired
(152 )
(314 )
(136 )
Additional credit loss for securities not previously other-than-temporarily impaired
(150 )
(312 )
(518 )
Reduction in credit loss for securities disposed or collected
Reduction in credit loss for securities the Company has made the decision to sell or more likely than not will be required to sell
-
Change in credit loss due to accretion of increase in cash flows
-
Ending balance
$ (944 ) $ (1,046 ) $ (1,187 )
The Company uses its best estimate of future cash flows expected to be collected from the fixed income security, discounted at the security's original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, foreign exchange rates, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate recovery value if the Company determines that the security is dependent on the liquidation of collateral for ultimate settlement. If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an other-than-temporary impairment for the difference between the estimated recovery value and amortized cost is recorded in earnings. The portion of the unrealized loss related to factors other than credit remains classified in accumulated other comprehensive income. If the Company determines that the fixed income security does not have sufficient cash flow or other information to estimate a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.
Unrealized net capital gains and losses
Unrealized net capital gains and losses included in accumulated other comprehensive income are as follows:
Gross unrealized
Fair
value
Unrealized net
gains (losses)
($ in millions)
Gains
Losses
December 31, 2011
Fixed income securities
$ 76,113
$ 4,404
$ (1,670 ) $ 2,734
Equity securities
4,363
(209 )
Short-term investments
1,291
-
-
-
Derivative instruments (1)
(12 )
(20 )
(17 )
EMA limited partnership interests (2)
Unrealized net capital gains and losses, pre-tax
2,879
Amounts recognized for:
Insurance reserves (3)
(637 )
DAC and DSI (4)
(139 )
Amounts recognized
(776 )
Deferred income taxes
(740 )
Unrealized net capital gains and losses, after-tax
$ 1,363
(1)Included in the fair value of derivative instruments are $(5) million classified as assets and $7 million classified as liabilities. (2)Unrealized net capital gains and losses for limited partnership interests represent the Company's share of EMA limited partnerships' other comprehensive income. Fair value and gross gains and losses are not applicable. (3)The insurance reserves adjustment represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency. Although the Company evaluates premium deficiencies on the combined performance of life insurance and immediate annuities with life contingencies, the adjustment primarily relates to structured settlement annuities with life contingencies, in addition to annuity buy-outs and certain payout annuities with life contingencies. (4)The DAC and DSI adjustment balance represents the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized gains or losses in the respective product portfolios were realized.
Gross unrealized
Fair
value
Unrealized net
gains (losses)
December 31, 2010
Gains
Losses
Fixed income securities
$ 79,612
$ 3,257
$ (2,431 ) $
Equity securities
4,811
(63 )
Short-term investments
3,279
-
-
-
Derivative instruments (1)
(17 )
(24 )
(22 )
Unrealized net capital gains and losses, pre-tax
1,387
Amounts recognized for:
Insurance reserves
(41 )
DAC and DSI
Amounts recognized
Deferred income taxes
(508 )
Unrealized net capital gains and losses, after-tax
$
(1)Included in the fair value of derivative instruments are $2 million classified as assets and $19 million classified as liabilities.
Change in unrealized net capital gains and losses
The change in unrealized net capital gains and losses for the years ended December 31 is as follows:
($ in millions)
Fixed income securities
$ 1,908
$ 3,303
$ 6,019
Equity securities
(423 )
Short-term investments
-
-
(3 )
Derivative instruments
(34 )
EMA limited partnership interests
-
-
Total
1,492
3,708
6,493
Amounts recognized for:
Insurance reserves
(596 )
(41 )
DAC and DSI
(236 )
(893 )
(2,510 )
Amounts recognized
(832 )
(934 )
(2,132 )
Deferred income taxes
(232 )
(969 )
(1,493 )
Increase in unrealized net capital gains and losses
$
$ 1,805
$ 2,868
Portfolio monitoring
The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income and equity security whose carrying value may be other-than-temporarily impaired.
For each fixed income security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made the decision to sell or whether it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, the security's decline in fair value is considered other than temporary and is recorded in earnings.
If the Company has not made the decision to sell the fixed income security and it is not more likely than not the Company will be required to sell the fixed income security before recovery of its amortized cost basis, the Company evaluates whether it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security. The Company calculates the estimated recovery value by discounting the best estimate of future cash flows at the security's original or current effective rate, as appropriate, and compares this to the amortized cost of the security. If the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors recognized in other comprehensive income.
For equity securities, the Company considers various factors, including whether it has the intent and ability to hold the equity security for a period of time sufficient to recover its cost basis. Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended, the equity security's decline in fair value is considered other than temporary and is recorded in earnings. For equity securities managed by a third party, the Company has contractually retained its decision making authority as it pertains to selling equity securities that are in an unrealized loss position.
The Company's portfolio monitoring process includes a quarterly review of all securities to identify instances where the fair value of a security compared to its amortized cost (for fixed income securities) or cost (for equity securities) is below established thresholds. The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and payment defaults. The securities identified, in addition to other securities for which the Company may have a concern, are evaluated for potential other-than-temporary impairment using all reasonably available information relevant to the collectability or recovery of the security. Inherent in the Company's evaluation of other-than-temporary impairment for these fixed income and equity securities are assumptions and estimates about the financial condition and future earnings potential of the issue or issuer. Some of the factors that may be considered in evaluating whether a decline in fair value is other than temporary are: 1) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; 2) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity; and 3) the length of time and extent to which the fair value has been less than amortized cost or cost.
The following table summarizes the gross unrealized losses and fair value of fixed income and equity securities by the length of time that individual securities have been in a continuous unrealized loss position.
($ in millions)
Less than 12 months
12 months or more
Number
of issues
Fair
value
Unrealized
losses
Number
of issues
Fair
value
Unrealized
losses
Total
unrealized
losses
December 31, 2011
Fixed income securities
U.S. government and agencies
$
$ -
-
$ -
$ -
$ -
Municipal
(11 )
1,886
(245 )
(256 )
Corporate
3,439
(113 )
1,273
(266 )
(379 )
Foreign government
(1 )
-
(1 )
RMBS
(11 )
1,182
(510 )
(521 )
CMBS
(49 )
(177 )
(226 )
ABS
(17 )
1,020
(270 )
(287 )
Redeemable preferred stock
-
-
-
-
-
-
Total fixed income securities
5,431
(202 )
5,851
(1,468 )
(1,670 )
Equity securities
1,397
2,120
(203 )
(6 )
(209 )
Total fixed income and equity securities
2,206
$ 7,551
$ (405 )
$ 5,881
$ (1,474 ) $ (1,879 )
Investment grade fixed income securities
$ 4,480
$ (145 )
$ 3,773
$ (700 ) $ (845 )
Below investment grade fixed income securities
(57 )
2,078
(768 )
(825 )
Total fixed income securities
$ 5,431
$ (202 )
$ 5,851
$ (1,468 ) $ (1,670 )
December 31, 2010
Fixed income securities
U.S. government and agencies
$ 2,081
$ (51 )
-
$ -
$ -
$ (51 )
Municipal
4,130
(175 )
2,715
(471 )
(646 )
Corporate
5,994
(186 )
1,992
(235 )
(421 )
Foreign government
(9 )
(1 )
(10 )
RMBS
(12 )
1,939
(720 )
(732 )
CMBS
(3 )
(274 )
(277 )
ABS
(8 )
1,313
(286 )
(294 )
Total fixed income securities
1,712
13,985
(444 )
1,231
8,804
(1,987 )
(2,431 )
Equity securities
(48 )
(15 )
(63 )
Total fixed income and equity securities
2,485
$ 14,595
$ (492 )
1,275
$ 8,895
$ (2,002 ) $ (2,494 )
Investment grade fixed income securities
1,607
$ 13,280
$ (408 )
$ 6,217
$ (943 ) $ (1,351 )
Below investment grade fixed income securities
(36 )
2,587
(1,044 )
(1,080 )
Total fixed income securities
1,712
$ 13,985
$ (444 )
1,231
$ 8,804
$ (1,987 ) $ (2,431 )
As of December 31, 2011, $634 million of unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost or cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired. Of the $634 million, $363 million are related to unrealized losses on investment grade fixed income securities. Investment grade is defined as a security having a rating of Aaa, Aa, A or Baa from Moody's, a rating of AAA, AA, A or BBB from S&P, Fitch, Dominion or Realpoint, a rating of aaa, aa, a or bbb from A.M. Best, or a comparable internal rating if an externally provided rating is not available. Unrealized losses on investment grade securities are principally related to widening credit spreads or rising interest rates since the time of initial purchase.
As of December 31, 2011, the remaining $1.25 billion of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost. Investment grade fixed income securities comprising $482 million of these unrealized losses were evaluated based on factors such as expected cash flows and the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations. Of the $1.25 billion, $693 million are related to below investment grade fixed income securities and $70 million are related to equity securities. Of these amounts, $486 million of the below investment grade fixed income securities had been in an unrealized loss position greater than or equal to 20% of amortized cost for a period of twelve or more consecutive months as of December 31, 2011. Unrealized losses on below investment grade securities are principally related to RMBS, CMBS and ABS and were the result of wider credit spreads resulting from higher risk premiums since the time of initial purchase, largely due to macroeconomic conditions and credit market deterioration, including the impact of lower real estate valuations.
RMBS, CMBS and ABS in an unrealized loss position were evaluated based on actual and projected collateral losses relative to the securities' positions in the respective securitization trusts, security specific expectations of cash flows, and credit ratings. This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread, and (iii) for RMBS and ABS in an unrealized loss position, credit enhancements from reliable bond insurers, where applicable. Municipal bonds in an unrealized loss position were evaluated based on the quality of the underlying securities. Unrealized losses on equity securities are primarily related to temporary equity market fluctuations of securities that are expected to recover.
As of December 31, 2011, the Company has not made the decision to sell and it is not more likely than not the Company will be required to sell fixed income securities with unrealized losses before recovery of the amortized cost basis. As of December 31, 2011, the Company had the intent and ability to hold equity securities with unrealized losses for a period of time sufficient for them to recover.
Limited partnerships
As of December 31, 2011 and December 31, 2010, the carrying value of equity method limited partnership interests totaled $3.13 billion and $2.47 billion, respectively. The Company recognizes an impairment loss for equity method investments when evidence demonstrates that the loss is other than temporary. Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment. In 2011, 2010 and 2009, the Company had write-downs related to equity method limited partnership interests of $2 million, $1 million and $11 million, respectively.
As of December 31, 2011 and December 31, 2010, the carrying value for cost method limited partnership interests was $1.57 billion and $1.35 billion, respectively. To determine if an other-than-temporary impairment has occurred, the Company evaluates whether an impairment indicator has occurred in the period that may have a significant adverse effect on the carrying value of the investment. Impairment indicators may include: significantly reduced valuations of the investments held by the limited partnerships; actual recent cash flows received being significantly less than expected cash flows; reduced valuations based on financing completed at a lower value; completed sale of a material underlying investment at a price significantly lower than expected; or any other adverse events since the last financial statements received that might affect the fair value of the investee's capital. Additionally, the Company's portfolio monitoring process includes a quarterly review of all cost method limited partnerships to identify instances where the net asset value is below established thresholds for certain periods of time, as well as investments that are performing below expectations, for further impairment consideration. If a cost method limited partnership is other-than-temporarily impaired, the carrying value is written down to fair value, generally estimated to be equivalent to the reported net asset value of the underlying funds. In 2011, 2010 and 2009, the Company had write-downs related to cost method investments of $4 million, $45 million and $297 million, respectively.
Mortgage loans
The Company's mortgage loans are commercial mortgage loans collateralized by a variety of commercial real estate property types located throughout the United States and totaled, net of valuation allowance, $7.14 billion and $6.68 billion as of December 31, 2011 and 2010, respectively. Substantially all of the commercial mortgage loans are non-recourse to the borrower. The following table shows the principal geographic distribution of commercial real estate represented in the Company's mortgage loan portfolio. No other state represented more than 5% of the portfolio as of December 31.
(% of mortgage loan portfolio carrying value)
California
22.6 %
23.2 %
Illinois
9.1
9.4
New Jersey
6.5
6.5
Texas
6.2
5.3
New York
5.8
6.6
Pennsylvania
5.3
5.6
The types of properties collateralizing the mortgage loans as of December 31 are as follows:
(% of mortgage loan portfolio carrying value)
Office buildings
27.9 %
32.1 %
Retail
24.8
27.3
Apartment complex
19.6
12.8
Warehouse
19.4
21.9
Other
8.3
5.9
Total
100.0 %
100.0 %
The contractual maturities of the mortgage loan portfolio as of December 31, 2011, excluding $43 million of mortgage loans in the process of foreclosure, are as follows:
($ in millions)
Number of
loans
Carrying
value
Percent
$
8.2 %
6.6
13.2
13.3
Thereafter
4,166
58.7
Total
$ 7,096
100.0 %
Mortgage loans are evaluated for impairment on a specific loan basis through a quarterly credit monitoring process and review of key credit quality indicators. Mortgage loans are considered impaired when it is probable that the Company will not collect the contractual principal and interest. Valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral less costs to sell or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate. Impaired mortgage loans may not have a valuation allowance when the fair value of the collateral less costs to sell is higher than the carrying value. Mortgage loan valuation allowances are charged off when there is no reasonable expectation of recovery. The impairment evaluation is non-statistical in respect to the aggregate portfolio but considers facts and circumstances attributable to each loan. It is not considered probable that additional impairment losses, beyond those identified on a specific loan basis, have been incurred as of December 31, 2011.
Accrual of income is suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable. Cash receipts on mortgage loans on nonaccrual status are generally recorded as a reduction of carrying value.
Debt service coverage ratio is considered a key credit quality indicator when mortgage loans are evaluated for impairment. Debt service coverage ratio represents the amount of estimated cash flows from the property available to the borrower to meet principal and interest payment obligations. Debt service coverage ratio estimates are updated annually or more frequently if conditions are warranted based on the Company's credit monitoring process.
The following table reflects the carrying value of non-impaired fixed rate and variable rate mortgage loans summarized by debt service coverage ratio distribution as of December 31:
($ in millions)
Debt service coverage ratio distribution
Fixed rate
mortgage loans
Variable rate
mortgage loans
Total
Fixed rate
mortgage loans
Variable rate
mortgage loans
Total
Below 1.0
$
$ -
$
$
$ -
$
1.0 - 1.25
1,527
1,571
1,583
1,599
1.26 - 1.50
1,573
1,597
1,520
1,525
Above 1.50
3,214
3,382
2,540
3,086
Total non-impaired mortgage loans
$ 6,659
$
$ 6,895
$ 5,923
$
$ 6,490
Mortgage loans with a debt service coverage ratio below 1.0 that are not considered impaired primarily relate to instances where the borrower has the financial capacity to fund the revenue shortfalls from the properties for the foreseeable term, the decrease in cash flows from the properties is considered temporary, or there are other risk mitigating circumstances such as additional collateral, escrow balances or borrower guarantees.
The net carrying value of impaired mortgage loans as of December 31 is as follows:
($ in millions)
Impaired mortgage loans with a valuation allowance
$
$
Impaired mortgage loans without a valuation allowance
-
Total impaired mortgage loans
$
$
Valuation allowance on impaired mortgage loans
$
$
The average balance of impaired loans was $210 million, $278 million and $327 million during 2011, 2010 and 2009, respectively.
The rollforward of the valuation allowance on impaired mortgage loans for the years ended December 31 is as follows:
($ in millions)
Beginning balance
$
$
$
Net increase in valuation allowance
Charge offs
(58 )
(76 )
(6 )
Ending balance
$
$
$
The carrying value of past due mortgage loans as of December 31 is as follows:
($ in millions)
Less than 90 days past due
$ -
$
90 days or greater past due
Total past due
Current loans
7,096
6,589
Total mortgage loans
$ 7,139
$ 6,679
Municipal bonds
The Company maintains a diversified portfolio of municipal bonds. The following table shows the principal geographic distribution of municipal bond issuers represented in the Company's portfolio as of December 31. No other state represents more than 5% of the portfolio.
(% of municipal bond portfolio carrying value)
California
10.4 %
12.3 %
Texas
7.7
10.1
Florida
5.9
5.8
New York
5.3
4.3
Concentration of credit risk
As of December 31, 2011, the Company is not exposed to any credit concentration risk of a single issuer and its affiliates greater than 10% of the Company's shareholders' equity.
Securities loaned
The Company's business activities include securities lending programs with third parties, mostly large banks. As of December 31, 2011 and 2010, fixed income and equity securities with a carrying value of $406 million and $448 million, respectively, were on loan under these agreements. In return, the Company receives cash that it invests and includes in short-term investments and fixed income securities, with an offsetting liability recorded in other liabilities and accrued expenses to account for the Company's obligation to return the collateral. Interest income on collateral, net of fees, was $2 million in 2011, 2010 and 2009.
Other investment information
Included in fixed income securities are below investment grade assets totaling $6.01 billion and $6.66 billion as of December 31, 2011 and 2010, respectively.
As of December 31, 2011, fixed income securities and short-term investments with a carrying value of $293 million were on deposit with regulatory authorities as required by law.
As of December 31, 2011, the carrying value of fixed income securities and other investments that were non-income producing was $36 million.
6. Fair Value of Assets and Liabilities
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Assets and liabilities recorded on the Consolidated Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
Level 1:
Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.
Level 2:
Assets and liabilities whose values are based on the following:
(a)
Quoted prices for similar assets or liabilities in active markets;
(b)
Quoted prices for identical or similar assets or liabilities in markets that are not active; or
(c)
Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.
Level 3:
Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect the Company's estimates of the assumptions that market participants would use in valuing the assets and liabilities.
The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment. The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy. The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.
The Company has two types of situations where investments are classified as Level 3 in the fair value hierarchy. The first is where quotes continue to be received from independent third-party valuation service providers and all significant inputs are market observable; however, there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate. The indicators considered in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, the level of credit spreads over historical levels, applicable bid-ask spreads, and price consensus among market participants and other pricing sources.
The second situation where the Company classifies securities in Level 3 is where specific inputs significant to the fair value estimation models are not market observable. This occurs in two primary instances. The first relates to the Company's use of broker quotes to value certain securities where the inputs have not been corroborated to be market observable. The second relates to auction rate securities ("ARS") backed by student loans for which a key input, the anticipated date liquidity will return to this market, is not market observable.
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans, limited partnership interests, bank loans and policy loans. Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting remeasurement is reflected in the consolidated financial statements. In addition, derivatives embedded in fixed
income securities are not disclosed in the hierarchy as free-standing derivatives since they are presented with the host contracts in fixed income securities.
In determining fair value, the Company principally uses the market approach which generally utilizes market transaction data for the same or similar instruments. To a lesser extent, the Company uses the income approach which involves determining fair values from discounted cash flow methodologies. For the majority of Level 2 and Level 3 valuations, a combination of the market and income approaches is used.
Summary of significant valuation techniques for assets and liabilities measured at fair value on a recurring basis
Level 1 measurements
•Fixed income securities: Comprise U.S. Treasuries. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.
•Equity securities: Comprise actively traded, exchange-listed U.S. and international equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.
•Short-term: Comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access.
•Separate account assets: Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access. Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers.
Level 2 measurements
•Fixed income securities:
U.S. government and agencies: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
Municipal: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
Corporate, including privately placed: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads. Also included are privately placed securities valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data. The primary inputs to the discounted cash flow model include an interest rate yield curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.
Foreign government: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
RMBS and ABS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads. Certain ABS are valued based on non-binding broker quotes whose inputs have been corroborated to be market observable.
CMBS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, collateral performance and credit spreads.
Redeemable preferred stock: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, underlying stock prices and credit spreads.
•Equity securities: The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that are not active.
•Short-term: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads. For certain short-term investments, amortized cost is used as the best estimate of fair value.
•Other investments: Free-standing exchange listed derivatives that are not actively traded are valued based on quoted prices for identical instruments in markets that are not active.
OTC derivatives, including interest rate swaps, foreign currency swaps, foreign exchange forward contracts, certain options and certain credit default swaps, are valued using models that rely on inputs such as interest rate yield curves, currency rates, and counterparty credit spreads that are observable for substantially the full term of the contract. The valuation techniques underlying the models are widely accepted in the financial services industry and do not involve significant judgment.
Level 3 measurements
•Fixed income securities:
Municipal: ARS primarily backed by student loans that have become illiquid due to failures in the auction market are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, including estimates of future coupon rates if auction failures continue, the anticipated date liquidity will return to the market and illiquidity premium. Also included are municipal bonds that are not rated by third party credit rating agencies but are rated by the National Association of Insurance Commissioners ("NAIC"). The primary inputs to the valuation of these municipal bonds include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields and credit spreads.
Corporate, including privately placed: Primarily valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable. Also included are equity-indexed notes which are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, such as volatility. Other inputs include an interest rate yield curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.
RMBS, CMBS and ABS: Valued based on non-binding broker quotes received from brokers who are familiar with the investments and where the inputs have not been corroborated to be market observable.
•Other investments: Certain OTC derivatives, such as interest rate caps and floors, certain credit default swaps and certain options (including swaptions), are valued using models that are widely accepted in the financial services industry. These are categorized as Level 3 as a result of the significance of non-market observable inputs such as volatility. Other primary inputs include interest rate yield curves and credit spreads.
•Contractholder funds: Derivatives embedded in certain life and annuity contracts are valued internally using models widely accepted in the financial services industry that determine a single best estimate of fair value for the embedded derivatives within a block of contractholder liabilities. The models primarily use stochastically determined cash flows based on the contractual elements of embedded derivatives, projected option cost and applicable market data, such as interest rate yield curves and equity index volatility assumptions. These are categorized as Level 3 as a result of the significance of non-market observable inputs.
Assets and liabilities measured at fair value on a non-recurring basis
Mortgage loans written-down to fair value in connection with recognizing impairments are valued based on the fair value of the underlying collateral less costs to sell. Limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments are valued using net asset values.
The following table summarizes the Company's assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2011:
($ in millions)
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Counterparty
and cash
collateral
netting
Balance
as of
December 31,
Assets
Fixed income securities:
U.S. government and agencies
$ 4,707
$ 1,608
$ -
$ 6,315
Municipal
-
12,909
1,332
14,241
Corporate
-
42,176
1,405
43,581
Foreign government
-
2,081
-
2,081
RMBS
-
4,070
4,121
CMBS
-
1,724
1,784
ABS
-
3,669
3,966
Redeemable preferred stock
-
Total fixed income securities
4,707
68,260
3,146
76,113
Equity securities
3,433
4,363
Short-term investments
1,103
-
1,291
Other investments:
Free-standing derivatives
-
$ (114 )
Separate account assets
6,984
-
-
6,984
Other assets
-
Total recurring basis assets
15,313
70,531
3,191
(114 )
88,921
Non-recurring basis (1)
-
-
Total assets at fair value
$ 15,313
$ 70,531
$ 3,226
$ (114 ) $ 88,956
% of total assets at fair value
17.2 %
79.3 %
3.6 %
(0.1 )%
100.0 %
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ -
$ -
$ (723 )
$ (723 )
Other liabilities:
Free-standing derivatives
(1 )
(112 )
(96 ) $
(132 )
Total liabilities at fair value
$ (1 ) $ (112 ) $ (819 ) $
$ (855 )
% of total liabilities at fair value
0.1 %
13.1 %
95.8 %
(9.0 )%
100.0 %
(1)Includes $19 million of mortgage loans and $16 million of other investments written-down to fair value in connection with recognizing other-than-temporary impairments.
The following table summarizes the Company's assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2010:
($ in millions)
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Counterparty
and cash
collateral
netting
Balance
as of
December 31,
Assets
Fixed income securities:
U.S. government and agencies
$ 4,976
$ 3,620
$ -
$ 8,596
Municipal
-
13,918
2,016
15,934
Corporate
-
35,747
1,908
37,655
Foreign government
-
3,158
-
3,158
RMBS
-
6,199
1,794
7,993
CMBS
-
1,071
1,994
ABS
-
1,827
2,417
4,244
Redeemable preferred stock
-
Total fixed income securities
4,976
65,577
9,059
79,612
Equity securities
4,316
4,811
Short-term investments
3,105
-
3,279
Other investments:
Free-standing derivatives
-
$ (286 )
Separate account assets
8,676
-
-
8,676
Other assets
-
-
Total recurring basis assets
18,142
69,765
9,197
(286 )
96,818
Non-recurring basis (1)
-
-
Total assets at fair value
$ 18,142
$ 69,765
$ 9,317
$ (286 ) $ 96,938
% of total assets at fair value
18.7 %
72.0 %
9.6 %
(0.3 )%
100.0 %
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ -
$ -
$ (653 )
$ (653 )
Other liabilities:
Free-standing derivatives
(2 )
(529 )
(95 ) $
(363 )
Total liabilities at fair value
$ (2 ) $ (529 ) $ (748 ) $
$ (1,016 )
% of total liabilities at fair value
0.2 %
52.1 %
73.6 %
(25.9 )%
100.0 %
(1)Includes $111 million of mortgage loans and $9 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments.
The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2011.
Total realized and
unrealized gains (losses)
included in:
($ in millions)
Balance as of
December 31,
Net
income (1)
OCI on
Statement of
Financial
Position
Transfers
into
Level 3
Transfers
out of
Level 3
Assets
Fixed income securities:
Municipal
$ 2,016
$ (44 ) $
$
$ (82 )
Corporate
1,908
(44 )
(523 )
RMBS
1,794
(86 )
-
(1,256 )
CMBS
(43 )
(966 )
ABS
2,417
(65 )
-
(2,137 )
Redeemable preferred stock
-
-
-
-
Total fixed income securities
9,059
(88 )
(4,964 )
Equity securities
(10 )
-
-
(10 )
Other investments:
Free-standing derivatives, net
(21 )
(91 )
-
-
-
Other assets
-
-
-
-
Total recurring Level 3 assets
$ 9,102
$ (189 ) $
$
$ (4,974 )
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ (653 ) $ (134 ) $ -
$ -
$ -
Total recurring Level 3 liabilities
$ (653 ) $ (134 ) $ -
$ -
$ -
Purchases
Sales
Issuances
Settlements
Balance as of
December 31,
Assets
Fixed income securities:
Municipal
$
$ (689 ) $ -
$ (7 ) $ 1,332
Corporate
(537 )
-
(87 )
1,405
RMBS
(378 )
-
(134 )
CMBS
(66 )
-
(4 )
ABS
(169 )
-
(276 )
Redeemable preferred stock
-
-
-
-
Total fixed income securities
(1,839 )
-
(508 )
3,146
Equity securities
(1 )
-
-
Other investments:
Free-standing derivatives, net
-
-
(53 )
(95 ) (2)
Other assets
-
-
-
-
Total recurring Level 3 assets
$
$ (1,840 ) $ -
$ (561 ) $ 3,095
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ -
$ -
$ (100 ) $
$ (723 )
Total recurring Level 3 liabilities
$ -
$ -
$ (100 ) $
$ (723 )
(1)The effect to net income totals $(323) million and is reported in the Consolidated Statements of Operations as follows: $(221) million in realized capital gains and losses, $36 million in net investment income, $(106) million in interest credited to contractholder funds and $(32) million in life and annuity contract benefits. (2)Comprises $1 million of assets and $96 million of liabilities.
The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2010.
Total realized and
unrealized gains (losses)
included in:
($ in millions)
OCI on
Statement of
Financial
Position
Balance as of
December 31,
Net
income (1)
Purchases, sales,
issuances and
settlements, net
Transfers
into
Level 3
Transfers
out of
Level 3
Balance as of
December 31,
Assets
Fixed income securities:
Municipal
$ 2,706
$ (40 ) $
$ (588 ) $
$ (146 ) $ 2,016
Corporate
2,241
(167 )
(730 )
1,908
Foreign government
-
-
(20 )
-
-
-
RMBS
1,671
(421 )
(135 )
-
(57 )
1,794
CMBS
1,404
(233 )
(526 )
(421 )
ABS
2,001
-
(467 )
2,417
Redeemable preferred stock
-
-
(1 )
-
-
Total fixed income securities
10,045
(634 )
1,764
(884 )
(1,821 )
9,059
Equity securities
(12 )
-
(7 )
Other investments:
Free-standing derivatives, net
(202 )
-
-
-
(21 ) (2)
Other assets
(1 )
-
-
-
-
Total recurring Level 3 assets
$ 10,171
$ (829 ) $ 1,769
$ (770 ) $
$ (1,828 ) $ 9,102
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ (110 ) $ (31 ) $ -
$
$ (515 ) $ -
$ (653 )
Total recurring Level 3 liabilities
$ (110 ) $ (31 ) $ -
$
$ (515 ) $ -
$ (653 )
(1)The effect to net income totals $(860) million and is reported in the Consolidated Statements of Operations as follows: $(901) million in realized capital gains and losses, $73 million in net investment income, $(1) million in interest credited to contractholder funds and $(31) million in life and annuity contract benefits. (2)Comprises $74 million of assets and $95 million of liabilities.
Transfers between level categorizations may occur due to changes in the availability of market observable inputs, which generally are caused by changes in market conditions such as liquidity, trading volume or bid-ask spreads. Transfers between level categorizations may also occur due to changes in the valuation source. For example, in situations where a fair value quote is not provided by the Company's independent third-party valuation service provider and as a result the price is stale or has been replaced with a broker quote whose inputs have not been corroborated to be market observable, the security is transferred into Level 3. Transfers in and out of level categorizations are reported as having occurred at the beginning of the quarter in which the transfer occurred. Therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the Level 3 rollforward table.
There were no transfers between Level 1 and Level 2 during 2011 or 2010.
During 2011, certain RMBS, CMBS and ABS were transferred into Level 2 from Level 3 as a result of increased liquidity in the market and a sustained increase in market activity for these assets. Additionally, certain ABS that are valued based on non-binding broker quotes were transferred into Level 2 from Level 3 since the inputs were corroborated to be market observable. During 2010, certain CMBS and ABS were transferred into Level 2 from Level 3 as a result of increased liquidity in the market and a sustained increase in market activity for these assets. When transferring these securities into Level 2, the Company did not change the source of fair value estimates or modify the estimates received from independent third-party valuation service providers or the internal valuation approach. Accordingly, for securities included within this group, there was no change in fair value in conjunction with the transfer resulting in a realized or unrealized gain or loss.
Transfers into Level 3 during 2011 and 2010 included situations where a fair value quote was not provided by the Company's independent third-party valuation service provider and as a result the price was stale or had been replaced with a broker quote where inputs have not been corroborated to be market observable resulting in the security being classified as Level 3. Transfers out of Level 3 during 2011 and 2010 included situations where a broker quote was used in
the prior period and a fair value quote became available from the Company's independent third-party valuation service provider in the current period. A quote utilizing the new pricing source was not available as of the prior period, and any gains or losses related to the change in valuation source for individual securities were not significant.
The following table provides the total gains and (losses) included in net income for Level 3 assets and liabilities still held as of December 31.
($ in millions)
Assets
Fixed income securities:
Municipal
$ (28 ) $ (33 )
Corporate
RMBS
-
(292 )
CMBS
(11 )
(28 )
ABS
(33 )
Total fixed income securities
(52 )
(253 )
Equity securities
(10 )
(3 )
Other investments:
Free-standing derivatives, net
(41 )
(61 )
Other assets
-
(1 )
Total recurring Level 3 assets
$ (103 ) $ (318 )
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ (134 ) $ (31 )
Total recurring Level 3 liabilities
$ (134 ) $ (31 )
The amounts in the table above represent gains and losses included in net income during 2011 and 2010 for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $(237) million in 2011 and are reported as follows: $(147) million in realized capital gains and losses, $44 million in net investment income, $(102) million in interest credited to contractholder funds and $(32) million in life and annuity contract benefits. These gains and losses total $(349) million in 2010 and are reported as follows: $(402) million in realized capital gains and losses, $86 million in net investment income, $(2) million in interest credited to contractholder funds and $(31) million in life and annuity contract benefits.
The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2009.
Total
gains (losses)
included in
net income
for financial
instruments still
held as of
December 31,
2009 (3)
Total realized and
unrealized gains (losses)
included in:
Purchases,
sales,
issuances
and
settlements,
net
($ in millions)
Balance as of
December 31,
Net
income (1)
OCI on
Statement of
Financial
Position
Net
transfers in
and/or (out)
of Level 3
Balance as of
December 31,
Assets
Fixed income securities:
Municipal
$ 2,463
$ (34 ) $
$ (202 ) $
$ 2,706
$ (34 )
Corporate
10,195
(20 )
1,216
(1,411 )
(7,739 )
2,241
Foreign government
-
-
-
(60 )
-
RMBS
2,988
(179 )
(470 )
(951 )
1,671
(128 )
CMBS
(399 )
(42 )
1,404
(318 )
ABS
1,714
(202 )
(450 )
2,001
(122 )
Redeemable preferred stock
-
-
-
-
(1 )
Total fixed income securities
17,819
(834 )
3,412
(2,024 )
(8,328 )
10,045
(550 )
Equity securities
(4 )
(3 )
(5 )
Other investments:
Free-standing derivatives, net
(101 )
-
-
(2)
Other assets
-
-
-
Total recurring Level 3 assets
$ 17,793
$ (775 ) $ 3,413
$ (1,929 ) $ (8,331 ) $ 10,171
$ (374 )
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts
$ (265 ) $
$ -
$
$ -
$ (110 ) $
Total recurring Level 3 liabilities
$ (265 ) $
$ -
$
$ -
$ (110 ) $
(1)The effect to net income totals $(627) million and is reported in the Consolidated Statements of Operations as follows: $(889) million in realized capital gains and losses, $111 million in net investment income, $3 million in interest credited to contractholder funds and $148 million in life and annuity contract benefits. (2)Comprises $146 million of assets and $91 million of liabilities. (3)The amounts represent gains and losses included in net income for the period of time that the asset or liability was determined to be in Level 3. These gains and losses total $(226) million and are reported in the Consolidated Statements of Operations as follows: $(486) million in realized capital gains and losses, $106 million in net investment income, $6 million in interest credited to contractholder funds and $148 million in life and annuity contract benefits.
Presented below are the carrying values and fair value estimates of financial instruments not carried at fair value.
Financial assets
($ in millions)
December 31, 2011
December 31, 2010
Carrying
value
Fair
value
Carrying
value
Fair
value
Mortgage loans
$ 7,139
$ 7,350
$ 6,679
$ 6,439
Limited partnership interests - cost basis
1,569
1,838
1,348
1,481
Bank loans
The fair value of mortgage loans is based on discounted contractual cash flows or, if the loans are impaired due to credit reasons, the fair value of collateral less costs to sell. Risk adjusted discount rates are selected using current rates at which similar loans would be made to borrowers with similar characteristics, using similar types of properties as collateral. The fair value of limited partnership interests accounted for on the cost basis is determined using reported net asset values of the underlying funds. The fair value of bank loans, which are reported in other investments, is based on broker quotes from brokers familiar with the loans and current market conditions.
Financial liabilities
($ in millions)
December 31, 2011
December 31, 2010
Carrying
value
Fair
value
Carrying
value
Fair
value
Contractholder funds on investment contracts
$ 30,192
$ 30,499
$ 36,163
$ 35,194
Long-term debt
5,908
6,312
5,908
6,325
Liability for collateral
The fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts utilizing prevailing market rates for similar contracts adjusted for the Company's own credit risk. Deferred annuities included in contractholder funds are valued using discounted cash flow models which incorporate market value margins, which are based on the cost of holding economic capital, and the Company's own credit risk. Immediate annuities without life contingencies and fixed rate funding agreements are valued at the present value of future benefits using market implied interest rates which include the Company's own credit risk.
The fair value of long-term debt is based on market observable data (such as the fair value of the debt when traded as an asset) or, in certain cases, is determined using discounted cash flow calculations based on current interest rates for instruments with comparable terms and considers the Company's own credit risk. The liability for collateral is valued at carrying value due to its short-term nature.
7. Derivative Financial Instruments and Off-balance-sheet Financial Instruments
The Company uses derivatives to manage risks with certain assets and liabilities arising from the potential adverse impacts from changes in risk-free interest rates, negative equity market valuations, increases in credit spreads and foreign currency fluctuations, and for asset replication. The Company does not use derivatives for speculative purposes.
Property-Liability uses interest rate swaps, swaptions, futures and options to manage the interest rate risks of existing investments and to reduce exposure to rising or falling interest rates. Portfolio duration management is a risk management strategy that is principally employed by Property-Liability wherein financial futures and interest rate swaps are utilized to change the duration of the portfolio in order to offset the economic effect that interest rates would otherwise have on the fair value of its fixed income securities. Equity index futures and options are used by Property-Liability to offset valuation losses in the equity portfolio during periods of declining equity market values. Credit default swaps are typically used to mitigate the credit risk within the Property-Liability fixed income portfolio. Property-Liability uses futures to hedge the market risk related to deferred compensation liability contracts and forward contracts to hedge foreign currency risk associated with holding foreign currency denominated investments and foreign operations.
Asset-liability management is a risk management strategy that is principally employed by Allstate Financial to balance the respective interest-rate sensitivities of its assets and liabilities. Depending upon the attributes of the assets acquired and liabilities issued, derivative instruments such as interest rate swaps, caps, floors, swaptions and futures are utilized to change the interest rate characteristics of existing assets and liabilities to ensure the relationship is maintained within specified ranges and to reduce exposure to rising or falling interest rates. Allstate Financial uses financial futures and interest rate swaps to hedge anticipated asset purchases and liability issuances and futures and options for hedging the equity exposure contained in its equity indexed life and annuity product contracts that offer equity returns to contractholders. In addition, Allstate Financial uses interest rate swaps to hedge interest rate risk inherent in funding agreements. Allstate Financial uses foreign currency swaps and forward contracts primarily to reduce the foreign currency risk associated with issuing foreign currency denominated funding agreements and holding foreign currency denominated investments. Credit default swaps are also typically used to mitigate the credit risk within the Allstate Financial fixed income portfolio.
Asset replication refers to the "synthetic" creation of assets through the use of derivatives and primarily investment grade host bonds to replicate securities that are either unavailable in the cash markets or more economical to acquire in synthetic form. The Company replicates fixed income securities using a combination of a credit default swap and one or more highly rated fixed income securities to synthetically replicate the economic characteristics of one or more cash market securities. The Company also creates "synthetic" exposure to equity markets through the use of exchange traded equity index future contracts and an investment grade host bond.
The Company also has derivatives embedded in non-derivative host contracts that are required to be separated from the host contracts and accounted for at fair value. The Company's primary embedded derivatives are equity options in life and annuity product contracts, which provide equity returns to contractholders; equity-indexed notes
containing equity call options, which provide a coupon payout that is determined using one or more equity-based indices; credit default swaps in synthetic collateralized debt obligations, which provide enhanced coupon rates as a result of selling credit protection; and conversion options in fixed income securities, which provide the Company with the right to convert the instrument into a predetermined number of shares of common stock.
When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair value, cash flow, foreign currency fair value or foreign currency cash flow hedges. Allstate Financial designates certain of its interest rate and foreign currency swap contracts and certain investment risk transfer reinsurance agreements as fair value hedges when the hedging instrument is highly effective in offsetting the risk of changes in the fair value of the hedged item. Allstate Financial designates certain of its foreign currency swap contracts as cash flow hedges when the hedging instrument is highly effective in offsetting the exposure of variations in cash flows for the hedged risk that could affect net income. Amounts are reclassified to net investment income or realized capital gains and losses as the hedged item affects net income.
The notional amounts specified in the contracts are used to calculate the exchange of contractual payments under the agreements and are generally not representative of the potential for gain or loss on these agreements. However, the notional amounts specified in credit default swaps where the Company has sold credit protection represent the maximum amount of potential loss, assuming no recoveries.
Fair value, which is equal to the carrying value, is the estimated amount that the Company would receive or pay to terminate the derivative contracts at the reporting date. The carrying value amounts for OTC derivatives are further adjusted for the effects, if any, of legally enforceable master netting agreements and are presented on a net basis, by counterparty agreement, in the Consolidated Statements of Financial Position. For certain exchange traded derivatives, the exchange requires margin deposits as well as daily cash settlements of margin accounts. As of December 31, 2011, the Company pledged $11 million of securities in the form of margin deposits.
For those derivatives which qualify for fair value hedge accounting, net income includes the changes in the fair value of both the derivative instrument and the hedged risk, and therefore reflects any hedging ineffectiveness. For cash flow hedges, gains and losses are amortized from accumulated other comprehensive income and are reported in net income in the same period the forecasted transactions being hedged impact net income. For embedded derivatives in fixed income securities, net income includes the change in fair value of the embedded derivative and accretion income related to the host instrument.
Non-hedge accounting is generally used for "portfolio" level hedging strategies where the terms of the individual hedged items do not meet the strict homogeneity requirements to permit the application of hedge accounting. For non-hedge derivatives, net income includes changes in fair value and accrued periodic settlements, when applicable. With the exception of non-hedge derivatives used for asset replication and non-hedge embedded derivatives, all of the Company's derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative financial instruments on at least a quarterly basis.
The following table provides a summary of the volume and fair value positions of derivative instruments as well as their reporting location in the Consolidated Statement of Financial Position as of December 31, 2011.
($ in millions, except number of contracts)
Asset derivatives
Volume (1)
Balance sheet location
Notional
amount
Number
of
contracts
Fair
value,
net
Gross
asset
Gross
liability
Derivatives designated as accounting hedging instruments
Interest rate swap agreements
Other investments
$
n/a
$ (8 ) $ -
$ (8 )
Foreign currency swap agreements
Other investments
n/a
(5 )
(8 )
Total
n/a
(13 )
(16 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Interest rate swap agreements
Other investments
8,028
n/a
(15 )
Interest rate swaption agreements
Other investments
1,750
n/a
-
-
-
Interest rate cap and floor agreements
Other investments
1,591
n/a
(12 )
-
(12 )
Financial futures contracts and options
Other assets
n/a
-
-
-
Equity and index contracts
Options, futures and warrants (2)
Other investments
15,180
-
Options, futures and warrants
Other assets
n/a
2,132
-
Foreign currency contracts
Foreign currency swap agreements
Other investments
n/a
-
Foreign currency forwards and options
Other investments
n/a
(2 )
Embedded derivative financial instruments
Conversion options
Fixed income securities
n/a
-
-
-
Equity-indexed call options
Fixed income securities
n/a
-
Credit default swaps
Fixed income securities
n/a
(115 )
-
(115 )
Other embedded derivative financial instruments
Other investments
1,000
n/a
-
-
-
Credit default contracts
Credit default swaps - buying protection
Other investments
n/a
(3 )
Credit default swaps - selling protection
Other investments
n/a
(4 )
(5 )
Other contracts
Other contracts
Other investments
n/a
-
-
-
Other contracts
Other assets
n/a
-
Total
13,540
17,352
(152 )
Total asset derivatives
$ 13,811
17,352
$
$
$ (168 )
(1)Volume for OTC derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable) (2)In addition to the number of contracts presented in the table, the Company held 10,798 stock rights and 4,392,937 stock warrants. Stock rights and warrants can be converted to cash upon sale of those instruments or exercised for shares of common stock.
Liability derivatives
Volume (1)
Balance sheet location
Notional
amount
Number
of
contracts
Fair
value,
net
Gross
asset
Gross
liability
Derivatives designated as accounting hedging instruments
Interest rate swap agreements
Other liabilities & accrued expenses
$
n/a
$ (5 ) $ -
$ (5 )
Foreign currency swap agreements
Other liabilities & accrued expenses
n/a
(7 )
-
(7 )
Total
n/a
(12 )
-
(12 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Interest rate swap agreements
Other liabilities & accrued expenses
n/a
-
Interest rate swaption agreements
Other liabilities & accrued expenses
1,250
n/a
-
-
-
Interest rate cap and floor agreements
Other liabilities & accrued expenses
n/a
(9 )
-
(9 )
Equity and index contracts
Options and futures
Other liabilities & accrued expenses
n/a
15,677
(50 )
-
(50 )
Foreign currency contracts
Foreign currency forwards and options
Other liabilities & accrued expenses
n/a
(1 )
-
(1 )
Embedded derivative financial instruments
Guaranteed accumulation benefits
Contractholder funds
n/a
(105 )
-
(105 )
Guaranteed withdrawal benefits
Contractholder funds
n/a
(57 )
-
(57 )
Equity-indexed and forward starting options in life and annuity product contracts
Contractholder funds
3,996
n/a
(553 )
-
(553 )
Other embedded derivative financial instruments
Contractholder funds
n/a
(8 )
-
(8 )
Credit default contracts
Credit default swaps - buying protection
Other liabilities & accrued expenses
n/a
(5 )
Credit default swaps - selling protection
Other liabilities & accrued expenses
n/a
(77 )
(79 )
Total
8,968
15,677
(845 )
(867 )
Total liability derivatives
9,046
15,677
(857 ) $
$ (879 )
Total derivatives
$ 22,857
33,029
$ (752 )
(1)Volume for OTC derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable)
The following table provides a summary of the volume and fair value positions of derivative instruments as well as their reporting location in the Consolidated Statement of Financial Position as of December 31, 2010.
($ in millions, except number of contracts)
Asset derivatives
Volume (1)
Balance sheet location
Notional
amount
Number
of
contracts
Fair
value,
net
Gross
asset
Gross
liability
Derivatives designated as accounting hedging instruments
Interest rate swap agreements
Other investments
$
n/a
$ (18 ) $ -
$ (18 )
Foreign currency swap agreements
Other investments
n/a
(1 )
Total
n/a
(16 )
(19 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Interest rate swap agreements
Other investments
1,469
n/a
(16 )
Interest rate swaption agreements
Other investments
4,161
n/a
-
Interest rate cap and floor agreements
Other investments
n/a
(2 )
(3 )
Financial futures contracts and options
Other investments
n/a
8,000
-
Financial futures contracts and options
Other assets
n/a
1,420
-
-
-
Equity and index contracts
Options, futures and warrants (2)
Other investments
38,451
-
Options, futures and warrants
Other assets
n/a
-
-
-
Foreign currency contracts
Foreign currency swap agreements
Other investments
n/a
-
Foreign currency forwards and options
Other investments
n/a
(1 )
Embedded derivative financial instruments
Conversion options
Fixed income securities
n/a
(2 )
Equity-indexed call options
Fixed income securities
n/a
-
Credit default swaps
Fixed income securities
n/a
(88 )
-
(88 )
Other embedded derivative financial instruments
Other investments
1,000
n/a
-
-
-
Credit default contracts
Credit default swaps - buying protection
Other investments
n/a
(5 )
(7 )
Credit default swaps - selling protection
Other investments
n/a
(8 )
(10 )
Other contracts
Other contracts
Other investments
n/a
-
-
-
Other contracts
Other assets
n/a
-
Total
9,035
48,163
(127 )
Total asset derivatives
$ 9,255
48,163
$
$
$ (146 )
(1)Volume for OTC derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable) (2)In addition to the number of contracts presented in the table, the Company held 2,768 stock rights and 1,379,932 stock warrants. Stock warrants can be converted to cash upon sale of those instruments or exercised for shares of common stock.
Liability derivatives
Volume (1)
Balance sheet location
Notional
amount
Number
of
contracts
Fair
value,
net
Gross
asset
Gross
liability
Derivatives designated as accounting hedging instruments
Interest rate swap agreements
Other liabilities & accrued expenses
$ 3,345
n/a
$ (181 ) $
$ (201 )
Interest rate swap agreements
Contractholder funds
-
n/a
-
Foreign currency swap agreements
Other liabilities & accrued expenses
n/a
(20 )
-
(20 )
Foreign currency and interest rate swap agreements
Other liabilities & accrued expenses
n/a
-
Foreign currency and interest rate swap agreements
Contractholder funds
-
n/a
-
Total
3,918
n/a
(137 )
(221 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Interest rate swap agreements
Other liabilities & accrued expenses
4,543
n/a
(68 )
Interest rate swaption agreements
Other liabilities & accrued expenses
4,400
n/a
-
Interest rate cap and floor agreements
Other liabilities & accrued expenses
3,216
n/a
(22 )
(23 )
Financial futures contracts and options
Other liabilities & accrued expenses
n/a
15,150
(1 )
-
(1 )
Equity and index contracts
Options and futures
Other liabilities & accrued expenses
21,585
(168 )
(170 )
Foreign currency contracts
Foreign currency forwards and options
Other liabilities & accrued expenses
n/a
(1 )
Embedded derivative financial instruments
Guaranteed accumulation benefits
Contractholder funds
1,067
n/a
(88 )
-
(88 )
Guaranteed withdrawal benefits
Contractholder funds
n/a
(47 )
-
(47 )
Equity-indexed and forward starting options in life and annuity product contracts
Contractholder funds
4,694
n/a
(515 )
-
(515 )
Other embedded derivative financial instruments
Contractholder funds
n/a
(3 )
-
(3 )
Credit default contracts
Credit default swaps - buying protection
Other liabilities & accrued expenses
1,127
n/a
(13 )
(19 )
Credit default swaps - selling protection
Other liabilities & accrued expenses
n/a
(66 )
(67 )
Total
20,733
36,735
(875 )
(1,002 )
Total liability derivatives
24,651
36,735
(1,012 ) $
$ (1,223 )
Total derivatives
$ 33,906
84,898
$ (358 )
(1)Volume for OTC derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable)
The following table provides a summary of the impacts of the Company's foreign currency contracts in cash flow hedging relationships for the years ended December 31. There is no expected amortization of net losses from accumulated other comprehensive income related to cash flow hedges during the next twelve months.
($ in millions)
Effective portion
Gain (loss) recognized in OCI on derivatives during the period
$
$
$ (35 )
Loss recognized in OCI on derivatives during the term of the hedging relationship
(17 )
(22 )
(23 )
Gain reclassified from AOCI into income (net investment income)
-
-
(Loss) gain reclassified from AOCI into income (realized capital gains and losses)
(1 )
(3 )
Ineffective portion and amount excluded from effectiveness testing
Gain recognized in income on derivatives (realized capital gains and losses)
-
-
-
The following tables present gains and losses from valuation, settlements and hedge ineffectiveness reported on derivatives used in fair value hedging relationships and derivatives not designated as accounting hedging instruments in the Consolidated Statements of Operations for the years ended December 31.
($ in millions)
Net
investment
income
Realized
capital
gains and
losses
Life and
annuity
contract
benefits
Interest
credited to
contractholder
funds
Operating
costs and
expenses
Total gain
(loss)
recognized
in net
income on
derivatives
Derivatives in fair value accounting hedging relationships
Interest rate contracts
$ (2 ) $ (8 ) $ -
$ (5 ) $ -
$ (15 )
Foreign currency and interest rate contracts
-
-
-
(32 )
-
(32 )
Subtotal
(2 )
(8 )
-
(37 )
-
(47 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
-
(304 )
-
-
-
(304 )
Equity and index contracts
-
(43 )
-
(2 )
(3 )
(48 )
Embedded derivative financial instruments
-
(37 )
(32 )
(38 )
-
(107 )
Foreign currency contracts
-
(12 )
-
-
(10 )
Credit default contracts
-
-
-
-
Other contracts
-
-
-
-
Subtotal
-
(388 )
(32 )
(33 )
(1 )
(454 )
Total
$ (2 ) $ (396 ) $ (32 ) $ (70 ) $ (1 ) $ (501 )
Net
investment
income
Realized
capital
gains and
losses
Life and
annuity
contract
benefits
Interest
credited to
contractholder
funds
Operating
costs and
expenses
Total gain
(loss)
recognized
in net
income on
derivatives
Derivatives in fair value accounting hedging relationships
Interest rate contracts
$ (139 ) $
$ -
$
$ -
$ (119 )
Foreign currency and interest rate contracts
-
(2 )
-
(18 )
-
(20 )
Subtotal
(139 )
-
(7 )
-
(139 )
Derivatives not designated as accounting hedging instruments
Interest rate contracts
-
(496 )
-
-
-
(496 )
Equity and index contracts
-
(91 )
-
Embedded derivative financial instruments
-
(3 )
(28 )
-
Foreign currency contracts
-
(10 )
-
-
(3 )
(13 )
Credit default contracts
-
(8 )
-
-
-
(8 )
Other contracts
-
-
-
-
Subtotal
-
(608 )
(28 )
(471 )
Total
$ (139 ) $ (601 ) $ (28 ) $
$
$ (610 )
Net
investment
income
Realized
capital
gains and
losses
Life and
annuity
contract
benefits
Interest
credited to
contractholder
funds
Operating
costs and
expenses
Total gain
(loss)
recognized
in net
income on
derivatives
Derivatives in fair value accounting hedging relationships
Interest rate contracts
$
$
$ -
$ (13 ) $ -
$
Foreign currency and interest rate contracts
-
(9 )
-
-
Subtotal
-
-
Derivatives not designated as accounting hedging instruments
Interest rate contracts
-
-
-
-
Equity and index contracts
-
(160 )
-
(21 )
Embedded derivative financial instruments
-
(184 )
-
Foreign currency contracts
-
-
-
(10 )
(3 )
Credit default contracts
-
(18 )
-
-
-
(18 )
Other contracts
(1 )
-
-
-
Subtotal
(1 )
(66 )
Total
$
$
$
$ (2 ) $
$
The hedge ineffectiveness reported in realized capital gains and losses amounted to losses of $8 million in 2011, gains of $7 million in 2010, and losses of $1 million in 2009.
The following tables provide a summary of the changes in fair value of the Company's fair value hedging relationships in the Consolidated Statements of Operations for the years ended December 31.
($ in millions)
Gain (loss) on derivatives
Gain (loss) on hedged risk
Location of gain or (loss) recognized
in net income on derivatives
Interest
rate
contracts
Foreign
currency &
interest rate
contracts
Contractholder
funds
Investments
Interest credited to contractholder funds
$ (7 ) $ (34 ) $
$ -
Net investment income
-
-
(26 )
Realized capital gains and losses
(8 )
-
-
-
Total
$
$ (34 ) $
$ (26 )
Gain (loss) on derivatives
Gain (loss) on hedged risk
Location of gain or (loss) recognized
in net income on derivatives
Interest
rate
contracts
Foreign
currency &
interest rate
contracts
Contractholder
funds
Investments
Interest credited to contractholder funds
$ -
$ (48 ) $
$ -
Net investment income
(33 )
-
-
Realized capital gains and losses
(2 )
-
-
Total
$ (24 ) $ (50 ) $
$
Gain (loss) on derivatives
Gain (loss) on hedged risk
Location of gain or (loss) recognized
in net income on derivatives
Interest
rate
contracts
Foreign
currency &
interest rate
contracts
Contractholder
funds
Investments
Interest credited to contractholder funds
$ (26 ) $
$ (13 ) $ -
Net investment income
-
-
(164 )
Realized capital gains and losses
(9 )
-
-
Total
$
$
$ (13 ) $ (164 )
The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements ("MNAs") and obtaining collateral where appropriate. The Company uses MNAs for OTC derivative transactions that permit either party to net payments due for transactions and collateral is either pledged or obtained when certain predetermined exposure limits are exceeded. As of December 31, 2011, counterparties pledged $64 million in cash and securities to the Company, and the Company pledged $82 million in cash and securities to counterparties which includes $76 million of collateral posted under MNAs for contracts containing credit-risk-contingent provisions that are in a liability position and $6 million of collateral posted under MNAs for contracts without credit-risk-contingent liabilities. The Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance. Other derivatives, including futures and certain option contracts, are traded on organized exchanges which require margin deposits and guarantee the execution of trades, thereby mitigating any potential credit risk.
Counterparty credit exposure represents the Company's potential loss if all of the counterparties concurrently fail to perform under the contractual terms of the contracts and all collateral, if any, becomes worthless. This exposure is
measured by the fair value of OTC derivative contracts with a positive fair value at the reporting date reduced by the effect, if any, of legally enforceable master netting agreements.
The following table summarizes the counterparty credit exposure as of December 31 by counterparty credit rating as it relates to the Company's OTC derivatives.
($ in millions)
Rating (1)
Number
of
counter-
parties
Notional
amount (2)
Credit
exposure (2)
Exposure,
net of
collateral (2)
Number
of
counter-
parties
Notional
amount (2)
Credit
exposure (2)
Exposure,
net of
collateral (2)
AA-
$
$
$
$ 2,322
$
$
A+
3,026
3,189
A
5,307
3,479
A-
3,815
-
BBB+
-
-
-
-
Total
$ 12,230
$
$
$ 9,079
$
$
(1)Rating is the lower of S&P or Moody's ratings. (2)Only OTC derivatives with a net positive fair value are included for each counterparty.
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. To limit this risk, the Company's senior management has established risk control limits. In addition, changes in fair value of the derivative financial instruments that the Company uses for risk management purposes are generally offset by the change in the fair value or cash flows of the hedged risk component of the related assets, liabilities or forecasted transactions.
Certain of the Company's derivative instruments contain credit-risk-contingent termination events, cross-default provisions and credit support annex agreements. Credit-risk-contingent termination events allow the counterparties to terminate the derivative on certain dates if AIC's, ALIC's or Allstate Life Insurance Company of New York's ("ALNY") financial strength credit ratings by Moody's or S&P fall below a certain level or in the event AIC, ALIC or ALNY are no longer rated by both Moody's and S&P. Credit-risk-contingent cross-default provisions allow the counterparties to terminate the derivative instruments if the Company defaults by pre-determined threshold amounts on certain debt instruments. Credit-risk-contingent credit support annex agreements specify the amount of collateral the Company must post to counterparties based on AIC's, ALIC's or ALNY's financial strength credit ratings by Moody's or S&P, or in the event AIC, ALIC or ALNY are no longer rated by both Moody's and S&P.
The following summarizes the fair value of derivative instruments with termination, cross-default or collateral credit-risk-contingent features that are in a liability position as of December 31, as well as the fair value of assets and collateral that are netted against the liability in accordance with provisions within legally enforceable MNAs.
($ in millions)
Gross liability fair value of contracts containing credit-risk-contingent features
$
$
Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs
(69 )
(255 )
Collateral posted under MNAs for contracts containing credit-risk-contingent features
(76 )
(171 )
Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently
$
$
Credit derivatives - selling protection
Free-standing credit default swaps ("CDS") are utilized for selling credit protection against a specified credit event. A credit default swap is a derivative instrument, representing an agreement between two parties to exchange the credit risk of a specified entity (or a group of entities), or an index based on the credit risk of a group of entities (all commonly referred to as the "reference entity" or a portfolio of "reference entities"), in return for a periodic premium. In selling protection, CDS are used to replicate fixed income securities and to complement the cash market when credit exposure to certain issuers is not available or when the derivative alternative is less expensive than the cash market alternative. CDS typically have a five-year term.
The following table shows the CDS notional amounts by credit rating and fair value of protection sold as of December 31, 2011:
($ in millions)
Notional amount
AA
A
BBB
BB and
lower
Total
Fair
value
Single name
Investment grade corporate debt
$
$
$
$
$
$ (7 )
High yield debt
-
-
-
-
Municipal
-
-
-
(12 )
Subtotal
(19 )
Baskets
Tranche
Investment grade corporate debt
-
-
-
(29 )
First-to-default
Municipal
-
-
-
(33 )
Subtotal
-
-
(62 )
Total
$
$
$
$
$
$ (81 )
The following table shows the CDS notional amounts by credit rating and fair value of protection sold as of December 31, 2010:
($ in millions)
Notional amount
AA
A
BBB
BB and
lower
Total
Fair
value
Single name
Investment grade corporate debt
$
$
$
$
$
$ (4 )
High yield debt
-
-
-
-
Municipal
-
-
-
(14 )
Subtotal
(18 )
Baskets
Tranche
Investment grade corporate debt
-
-
-
(19 )
First-to-default
Municipal
-
-
-
(37 )
Subtotal
-
-
(56 )
Total
$
$
$
$
$
$ (74 )
In selling protection with CDS, the Company sells credit protection on an identified single name, a basket of names in a first-to-default ("FTD") structure or a specific tranche of a basket, or credit derivative index ("CDX") that is generally investment grade, and in return receives periodic premiums through expiration or termination of the agreement. With single name CDS, this premium or credit spread generally corresponds to the difference between the yield on the reference entity's public fixed maturity cash instruments and swap rates at the time the agreement is executed. With a FTD basket or a tranche of a basket, because of the additional credit risk inherent in a basket of named reference entities, the premium generally corresponds to a high proportion of the sum of the credit spreads of the names in the basket and the correlation between the names. CDX index is utilized to take a position on multiple (generally 125) reference entities. Credit events are typically defined as bankruptcy, failure to pay, or restructuring, depending on the nature of the reference entities. If a credit event occurs, the Company settles with the counterparty, either through physical settlement or cash settlement. In a physical settlement, a reference asset is delivered by the buyer of protection to the Company, in exchange for cash payment at par, whereas in a cash settlement, the Company pays the difference between par and the prescribed value of the reference asset. When a credit event occurs in a single name or FTD basket (for FTD, the first credit event occurring for any one name in the basket), the contract terminates at the time of settlement. When a credit event occurs in a tranche of a basket, there is no immediate impact to the Company until cumulative losses in the basket exceed the contractual subordination. To date, realized losses have not exceeded the subordination. For CDX index, the reference entity's name incurring the credit event is removed from the index while the contract continues until expiration. The maximum payout on a CDS is the contract notional amount. A physical settlement may afford the Company with recovery rights as the new owner of the asset.
The Company monitors risk associated with credit derivatives through individual name credit limits at both a credit derivative and a combined cash instrument/credit derivative level. The ratings of individual names for which protection has been sold are also monitored.
In addition to the CDS described above, the Company's synthetic collateralized debt obligations contain embedded credit default swaps which sell protection on a basket of reference entities. The synthetic collateralized debt obligations are fully funded; therefore, the Company is not obligated to contribute additional funds when credit events occur related to the reference entities named in the embedded credit default swaps. The Company's maximum amount at risk equals the amount of its aggregate initial investment in the synthetic collateralized debt obligations.
Off-balance-sheet financial instruments
The contractual amounts of off-balance-sheet financial instruments as of December 31 are as follows:
($ in millions)
Commitments to invest in limited partnership interests
$ 2,015
$ 1,471
Commitments to extend mortgage loans
-
Private placement commitments
Other loan commitments
In the preceding table, the contractual amounts represent the amount at risk if the contract is fully drawn upon, the counterparty defaults and the value of any underlying security becomes worthless. Unless noted otherwise, the Company does not require collateral or other security to support off-balance-sheet financial instruments with credit risk.
Commitments to invest generally represent commitments to acquire financial interests or instruments. The Company enters into these agreements to allow for additional participation in certain limited partnership investments. Because the equity investments in the limited partnerships are not actively traded, it is not practical to estimate the fair value of these commitments.
Commitments to extend mortgage loans are agreements to lend to a borrower provided there is no violation of any condition established in the contract. The Company enters into these agreements to commit to future loan fundings at a predetermined interest rate. Commitments generally have fixed expiration dates or other termination clauses. The fair value of commitments to extend mortgage loans, which are secured by the underlying properties, is $1 million as of December 31, 2011, and is valued based on estimates of fees charged by other institutions to make similar commitments to similar borrowers.
Private placement commitments represent conditional commitments to purchase private placement debt and equity securities at a specified future date. The Company regularly enters into these agreements in the normal course of business. The fair value of these commitments generally cannot be estimated on the date the commitment is made as the terms and conditions of the underlying private placement securities are not yet final.
Other loan commitments are agreements to lend to a borrower provided there is no violation of any condition established in the contract. The Company enters into these agreements to commit to future loan fundings at predetermined interest rates. Commitments generally have fixed or varying expiration dates or other termination clauses. The fair value of these commitments is insignificant.
8. Reserve for Property-Liability Insurance Claims and Claims Expense
As described in Note 2, the Company establishes reserves for claims and claims expense ("loss") on reported and unreported claims of insured losses. The Company's reserving process takes into account known facts and interpretations of circumstances and factors including the Company's experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. In the normal course of business, the Company may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.
Because reserves are estimates of unpaid portions of losses that have occurred, including incurred but not reported ("IBNR") losses, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded amounts, which are based on management's best estimates. The highest degree of uncertainty is associated with reserves for losses
incurred in the current reporting period as it contains the greatest proportion of losses that have not been reported or settled. The Company regularly updates its reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reported in property-liability insurance claims and claims expense in the Consolidated Statements of Operations in the period such changes are determined.
Activity in the reserve for property-liability insurance claims and claims expense is summarized as follows:
($ in millions)
Balance as of January 1
$ 19,468
$ 19,167
$ 19,456
Less reinsurance recoverables
2,072
2,139
2,274
Net balance as of January 1
17,396
17,028
17,182
Esurance acquisition as of October 7, 2011
-
-
Incurred claims and claims expense related to:
Current year
20,496
19,110
18,858
Prior years
(335 )
(159 )
(112 )
Total incurred
20,161
18,951
18,746
Claims and claims expense paid related to:
Current year
13,893
12,012
11,905
Prior years
6,302
6,571
6,995
Total paid
20,195
18,583
18,900
Net balance as of December 31
17,787
17,396
17,028
Plus reinsurance recoverables
2,588
2,072
2,139
Balance as of December 31
$ 20,375
$ 19,468
$ 19,167
Incurred claims and claims expense represents the sum of paid losses and reserve changes in the calendar year. This expense includes losses from catastrophes of $3.82 billion, $2.21 billion and $2.07 billion in 2011, 2010 and 2009, respectively, net of reinsurance and other recoveries (see Note 10). Catastrophes are an inherent risk of the property-liability insurance business that have contributed to, and will continue to contribute to, material year-to-year fluctuations in the Company's results of operations and financial position.
The Company calculates and records a single best reserve estimate for losses from catastrophes, in conformance with generally accepted actuarial standards. As a result, management believes that no other estimate is better than the recorded amount. Due to the uncertainties involved, including the factors described above, the ultimate cost of losses may vary materially from recorded amounts, which are based on management's best estimates. Accordingly, management believes that it is not practical to develop a meaningful range for any such changes in losses incurred.
During 2011, incurred claims and claims expense related to prior years was primarily composed of net decreases in auto reserves of $381 million primarily due to claim severity development that was better than expected, net decreases in homeowners reserves of $69 million due to favorable catastrophe reserve reestimates, and net increases in other reserves of $94 million. Incurred claims and claims expense includes favorable catastrophe loss reestimates of $130 million, net of reinsurance and other recoveries.
During 2010, incurred claims and claims expense related to prior years was primarily composed of net decreases in auto reserves of $179 million primarily due to claim severity development that was better than expected partially offset by a litigation settlement, net decreases in homeowners reserves of $23 million due to favorable catastrophe reserve reestimates partially offset by a litigation settlement, and net increases in other reserves of $15 million. Incurred claims and claims expense includes favorable catastrophe loss reestimates of $163 million, net of reinsurance and other recoveries.
During 2009, incurred claims and claims expense related to prior years was primarily composed of net decreases in homeowners and auto reserves of $168 million and $57 million, respectively, partially offset by increases in other reserves of $89 million. Incurred claims and claims expense includes favorable catastrophe loss reestimates of $169 million, net of reinsurance and other recoveries, primarily attributable to favorable reserve reestimates from Hurricanes Ike and Gustav and a catastrophe related subrogation recovery.
Management believes that the reserve for property-liability insurance claims and claims expense, net of reinsurance recoverables, is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and
unreported claims arising from losses which had occurred by the date of the Consolidated Statements of Financial Position based on available facts, technology, laws and regulations.
For further discussion of asbestos and environmental reserves, see Note 14.
9. Reserve for Life-Contingent Contract Benefits and Contractholder Funds
As of December 31, the reserve for life-contingent contract benefits consists of the following:
($ in millions)
Immediate fixed annuities:
Structured settlement annuities
$ 7,110
$ 6,522
Other immediate fixed annuities
2,358
2,215
Traditional life insurance
3,004
2,938
Accident and health insurance
1,859
1,720
Other
Total reserve for life-contingent contract benefits
$ 14,449
$ 13,482
The following table highlights the key assumptions generally used in calculating the reserve for life-contingent contract benefits:
Product
Mortality
Interest rate
Estimation method
Structured settlement annuities
U.S. population with projected calendar year improvements; mortality rates adjusted for each impaired life based on reduction in life expectancy
Interest rate assumptions range from 0% to 9.3%
Present value of contractually specified future benefits
Other immediate fixed annuities
1983 group annuity mortality table with internal modifications; 1983 individual annuity mortality table; Annuity 2000 mortality table; Annuity 2000 mortality table with internal modifications; 1983 individual annuity mortality table with internal modifications
Interest rate assumptions range from 0.9% to 11.5%
Present value of expected future benefits based on historical experience
Traditional life insurance
Actual company experience
plus loading
Interest rate assumptions range from 4.0% to 11.3%
Net level premium reserve method using the Company's withdrawal experience rates; includes reserves for unpaid claims
Accident and health insurance
Actual company experience
plus loading
Interest rate assumptions range from 3.0% to 5.3%
Unearned premium; additional contract reserves for mortality risk and unpaid claims
Other:
Variable annuity
guaranteed minimum
death benefits (1)
100% of Annuity 2000 mortality table
Interest rate assumptions range from 4.0% to 5.1%
Projected benefit ratio applied to cumulative assessments
(1)In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with The Prudential Insurance Company of America, a subsidiary of Prudential Financial, Inc. (collectively "Prudential").
To the extent that unrealized gains on fixed income securities would result in a premium deficiency had those gains actually been realized, a premium deficiency reserve is recorded for certain immediate annuities with life contingencies.
A liability of $637 million and $41 million is included in the reserve for life-contingent contract benefits with respect to this deficiency as of December 31, 2011 and 2010, respectively. The offset to this liability is recorded as a reduction of the unrealized net capital gains included in accumulated other comprehensive income.
As of December 31, contractholder funds consist of the following:
($ in millions)
Interest-sensitive life insurance
$ 10,826
$ 10,675
Investment contracts:
Fixed annuities
29,049
33,166
Funding agreements backing medium-term notes
1,929
2,749
Other investment contracts
Allstate Bank deposits
-
1,091
Total contractholder funds
$ 42,332
$ 48,195
The following table highlights the key contract provisions relating to contractholder funds:
Product
Interest rate
Withdrawal/surrender charges
Interest-sensitive life insurance
Interest rates credited range from 0% to 11.0% for equity-indexed life (whose returns are indexed to the S&P 500) and 1.5% to 6.0% for all other products
Either a percentage of account balance or dollar amount grading off generally over 20 years
Fixed annuities
Interest rates credited range from 0% to 9.9% for immediate annuities; (8.0)% to 11.0% for equity-indexed annuities (whose returns are indexed to the S&P 500); and 0.2% to 6.6% for all other products
Either a declining or a level percentage charge generally over ten years or less. Additionally, approximately 25.3% of fixed annuities are subject to market value adjustment for discretionary withdrawals
Funding agreements backing medium-term notes
Interest rates credited range from 0.9% to 5.8% (excluding currency-swapped medium-term notes)
Not applicable
Other investment contracts:
Guaranteed minimum income, accumulation and withdrawal benefits on variable and fixed annuities (1) and secondary guarantees on interest-sensitive life insurance and fixed annuities
Interest rates used in establishing reserves range from 1.8% to 10.3%
Withdrawal and surrender charges are based on the terms of the related interest-sensitive life insurance or fixed annuity contract
(1)In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with Prudential.
Contractholder funds include funding agreements held by VIEs issuing medium-term notes. The VIEs are Allstate Life Funding, LLC, Allstate Financial Global Funding, LLC, Allstate Life Global Funding and Allstate Life Global Funding II, and their primary assets are funding agreements used exclusively to back medium-term note programs.
Contractholder funds activity for the years ended December 31 is as follows:
($ in millions)
Balance, beginning of year
$ 48,195
$ 52,582
Deposits
2,318
3,438
Interest credited
1,629
1,794
Benefits
(1,461 )
(1,552 )
Surrenders and partial withdrawals
(6,398 )
(5,203 )
Maturities and retirements of institutional products
(867 )
(1,833 )
Contract charges
(1,028 )
(983 )
Net transfers from separate accounts
Fair value hedge adjustments for institutional products
(34 )
(196 )
Other adjustments
(34 )
Balance, end of year
$ 42,332
$ 48,195
The Company offered various guarantees to variable annuity contractholders. Liabilities for variable contract guarantees related to death benefits are included in the reserve for life-contingent contract benefits and the liabilities related to the income, withdrawal and accumulation benefits are included in contractholder funds. All liabilities for variable contract guarantees are reported on a gross basis on the balance sheet with a corresponding reinsurance recoverable asset for those contracts subject to reinsurance. In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with Prudential.
Absent any contract provision wherein the Company guarantees either a minimum return or account value upon death, a specified contract anniversary date, partial withdrawal or annuitization, variable annuity and variable life insurance contractholders bear the investment risk that the separate accounts' funds may not meet their stated investment objectives. The account balances of variable annuities contracts' separate accounts with guarantees included $5.54 billion and $6.94 billion of equity, fixed income and balanced mutual funds and $837 million and $1.09 billion of money market mutual funds as of December 31, 2011 and 2010, respectively.
The table below presents information regarding the Company's variable annuity contracts with guarantees. The Company's variable annuity contracts may offer more than one type of guarantee in each contract; therefore, the sum of amounts listed exceeds the total account balances of variable annuity contracts' separate accounts with guarantees.
($ in millions)
December 31,
In the event of death
Separate account value
$ 6,372
$ 8,029
Net amount at risk (1)
$ 1,502
$ 1,402
Average attained age of contractholders
66 years
66 years
At annuitization (includes income benefit guarantees)
Separate account value
$ 1,489
$ 1,945
Net amount at risk (2)
$
$
Weighted average waiting period until annuitization options available
1 year
2 years
For cumulative periodic withdrawals
Separate account value
$
$
Net amount at risk (3)
$
$
Accumulation at specified dates
Separate account value
$
$ 1,100
Net amount at risk (4)
$
$
Weighted average waiting period until guarantee date
6 years
7 years
(1)Defined as the estimated current guaranteed minimum death benefit in excess of the current account balance as of the balance sheet date. (2)Defined as the estimated present value of the guaranteed minimum annuity payments in excess of the current account balance. (3)Defined as the estimated current guaranteed minimum withdrawal balance (initial deposit) in excess of the current account balance as of the balance sheet date. (4)Defined as the estimated present value of the guaranteed minimum accumulation balance in excess of the current account balance.
The liability for death and income benefit guarantees is equal to a benefit ratio multiplied by the cumulative contract charges earned, plus accrued interest less contract excess guarantee benefit payments. The benefit ratio is calculated as the estimated present value of all expected contract excess guarantee benefits divided by the present value of all expected contract charges. The establishment of reserves for these guarantees requires the projection of future fund values, mortality, persistency and customer benefit utilization rates. These assumptions are periodically reviewed and updated. For guarantees related to death benefits, benefits represent the projected excess guaranteed minimum death benefit payments. For guarantees related to income benefits, benefits represent the present value of the minimum guaranteed annuitization benefits in excess of the projected account balance at the time of annuitization.
Projected benefits and contract charges used in determining the liability for certain guarantees are developed using models and stochastic scenarios that are also used in the development of estimated expected gross profits. Underlying assumptions for the liability related to income benefits include assumed future annuitization elections based on factors such as the extent of benefit to the potential annuitant, eligibility conditions and the annuitant's attained age. The liability for guarantees is re-evaluated periodically, and adjustments are made to the liability balance through a charge or credit to life and annuity contract benefits.
Guarantees related to the majority of withdrawal and accumulation benefits are considered to be derivative financial instruments; therefore, the liability for these benefits is established based on its fair value.
The following table summarizes the liabilities for guarantees:
($ in millions)
Liability for
guarantees
related to
death benefits
and interest-
sensitive life
products
Liability for
guarantees
related to
income
benefits
Liability for
guarantees
related to
accumulation
and withdrawal
benefits
Total
Balance, December 31, 2010 (1)
$
$
$
$
Less reinsurance recoverables
Net balance as of December 31, 2010
Incurred guaranteed benefits
(1 )
Paid guarantee benefits
-
-
-
-
Net change
(1 )
Net balance as of December 31, 2011
Plus reinsurance recoverables
Balance, December 31, 2011 (2)
$
$
$
$
Balance, December 31, 2009 (3)
$
$
$
$
Less reinsurance recoverables
Net balance as of December 31, 2009
Incurred guaranteed benefits
(2 )
-
Paid guarantee benefits
-
-
-
-
Net change
(2 )
-
Net balance as of December 31, 2010
Plus reinsurance recoverables
Balance, December 31, 2010 (1)
$
$
$
$
(1)Included in the total liability balance as of December 31, 2010 are reserves for variable annuity death benefits of $85 million, variable annuity income benefits of $211 million, variable annuity accumulation benefits of $88 million, variable annuity withdrawal benefits of $47 million and other guarantees of $168 million. (2)Included in the total liability balance as of December 31, 2011 are reserves for variable annuity death benefits of $116 million, variable annuity income benefits of $175 million, variable annuity accumulation benefits of $105 million, variable annuity withdrawal benefits of $57 million and other guarantees of $191 million. (3)Included in the total liability balance as of December 31, 2009 are reserves for variable annuity death benefits of $92 million, variable annuity income benefits of $269 million, variable annuity accumulation benefits of $66 million, variable annuity withdrawal benefits of $41 million and other guarantees of $82 million.
10. Reinsurance
The effects of reinsurance on property-liability insurance premiums written and earned and life and annuity premiums and contract charges for the years ended December 31 are as follows:
($ in millions)
Property-liability insurance premiums written
Direct
$ 27,066
$ 26,984
$ 26,980
Assumed
Ceded
(1,108 )
(1,106 )
(1,050 )
Property-liability insurance premiums written, net of reinsurance
$ 25,980
$ 25,907
$ 25,971
Property-liability insurance premiums earned
Direct
$ 27,016
$ 27,015
$ 27,200
Assumed
Ceded
(1,098 )
(1,092 )
(1,056 )
Property-liability insurance premiums earned, net of reinsurance
$ 25,942
$ 25,957
$ 26,194
Life and annuity premiums and contract charges
Direct
$ 2,953
$ 2,935
$ 2,757
Assumed
Ceded
(750 )
(804 )
(838 )
Life and annuity premiums and contract charges, net of reinsurance
$ 2,238
$ 2,168
$ 1,958
Property-Liability
The Company purchases reinsurance after evaluating the financial condition of the reinsurer, as well as the terms and price of coverage. Developments in the insurance and reinsurance industries have fostered a movement to segregate asbestos, environmental and other discontinued lines exposures into separate legal entities with dedicated capital. Regulatory bodies in certain cases have supported these actions. The Company is unable to determine the impact, if any, that these developments will have on the collectability of reinsurance recoverables in the future.
Property-Liability reinsurance recoverable
Total amounts recoverable from reinsurers as of December 31, 2011 and 2010 were $2.67 billion and $2.15 billion, respectively, including $86 million and $81 million, respectively, related to property-liability losses paid by the Company and billed to reinsurers, and $2.59 billion and $2.07 billion, respectively, estimated by the Company with respect to ceded unpaid losses (including IBNR), which are not billable until the losses are paid.
With the exception of the recoverable balances from the Michigan Catastrophic Claim Association ("MCCA"), Lloyd's of London and other industry pools and facilities, the largest reinsurance recoverable balance the Company had outstanding was $98 million and $56 million from Westport Insurance Corporation (formerly Employers' Reinsurance Company) as of December 31, 2011 and 2010, respectively. No other amount due or estimated to be due from any single property-liability reinsurer was in excess of $36 million and $37 million as of December 31, 2011 and 2010, respectively.
The allowance for uncollectible reinsurance was $103 million and $142 million as of December 31, 2011 and 2010, respectively, and is related to the Company's Discontinued Lines and Coverages segment.
Industry pools and facilities
Reinsurance recoverable on paid and unpaid claims including IBNR as of December 31, 2011 and 2010 includes $1.71 billion and $1.24 billion, respectively, from the MCCA. The MCCA is a mandatory reinsurance mechanism for personal injury protection losses over a retention level that increases each MCCA fiscal year. The retention levels are $500 thousand per claim and $480 thousand per claim for the fiscal years ending June 30, 2012 and 2011, respectively. The MCCA is funded by assessments from member companies who, in turn, can recover assessments from policyholders.
Ceded premiums earned under the Florida Hurricane Catastrophe Fund ("FHCF") agreement were $27 million, $15 million and $13 million in 2011, 2010 and 2009, respectively. Ceded losses incurred include $8 million, $10 million and $47 million in 2011, 2010 and 2009, respectively. The Company has access to reimbursement provided by the FHCF for 90% of qualifying personal property losses that exceed its current retention of $100 million for the two largest
hurricanes and $33 million for other hurricanes, up to a maximum total of $349 million effective from June 1, 2011 to May 31, 2012. Reinsurance recoverables from the FHCF were zero as of December 31, 2011 due to a commutation finalized in July 2011. Reinsurance recoverables include $41 million recoverable from the FHCF for qualifying property losses as of December 31, 2010.
Allstate sells and administers policies as a participant in the National Flood Insurance Program ("NFIP"). The total amounts recoverable as of December 31, 2011 and 2010 were $33 million and $10 million, respectively. Ceded premiums earned include $312 million, $306 million and $298 million in 2011, 2010 and 2009, respectively. Ceded losses incurred include $196 million, $50 million and $111 million in 2011, 2010 and 2009, respectively. Under the arrangement, the Federal Government is obligated to pay all claims.
Catastrophe reinsurance
The Company has the following catastrophe reinsurance treaties in effect as of December 31, 2011:
•Nationwide Per Occurrence Excess Catastrophe Reinsurance agreement comprising three contracts, all incepting as of June 1, 2011 and with one, two and three year terms. This agreement reinsures Allstate Protection personal lines auto and property business countrywide, in all states except Florida and New Jersey, for excess catastrophe losses caused by multiple perils. The contracts are placed in six layers, with the first five layers subject to reinstatement, and cover $3.25 billion in per occurrence losses in excess of a $500 million retention and after $250 million in losses "otherwise recoverable." Losses from multiple qualifying occurrences can apply to this $250 million threshold which applies once to each contract year and only to the agreement's first layer.
•Top and Drop Excess Catastrophe Reinsurance agreement comprising an annual contract and a three year term contract, both incepting as of June 1, 2011, and providing $250 million of reinsurance limits which may be used for Coverage A, Coverage B, or a combination of both. Coverage A reinsures 47.5% of $500 million in limits excess of a $3.25 billion retention. Coverage B provides 95% of $250 million in limits excess of a $750 million retention and after $500 million in losses "otherwise recoverable" under the agreement. Losses from multiple qualifying occurrences can apply to this $500 million threshold.
Losses recoverable under the Company's New Jersey, Kentucky and Pennsylvania reinsurance agreements, described below, are disregarded when determining coverage under the Nationwide Per Occurrence Excess Catastrophe Reinsurance agreement and the Top and Drop Excess Catastrophe Reinsurance agreement.
•New Jersey Excess Catastrophe Reinsurance agreement, comprising three contracts each with a three year duration and effective respectively June 1, 2009, June 1, 2010, and June 1, 2011, provides coverage for Allstate Protection personal lines property excess catastrophe losses for multiple perils in New Jersey. Effective June 1, 2011 to May 31, 2012, one contract provides 32% of a $400 million limit excess of a $150 million retention with one prepaid reinstatement. The other two contracts are placed in two layers: the first layer provides 63% of $300 million of limits in excess of a $200 million retention, and the second layer provides 68% of $200 million of limits in excess of a $500 million retention.
•Kentucky Excess Catastrophe Reinsurance agreement provides coverage for Allstate Protection personal lines property excess catastrophe losses in the state for earthquakes and fires following earthquakes effective June 1, 2011 to May 31, 2014. The agreement provides three limits of $25 million excess of a $5 million retention subject to two limits being available in any one contract year and is 95% placed.
•Pennsylvania Excess Catastrophe Reinsurance agreement provides coverage for Allstate Protection personal lines property excess catastrophe losses in the state for multi-perils effective June 1, 2009 through May 31, 2012. The agreement provides three limits of $100 million excess of a $100 million retention subject to two limits being available in any one contract year and is 95% placed.
•Five separate agreements for Castle Key Insurance Company and its subsidiaries ("Castle Key") provide coverage for personal lines property excess catastrophe losses in Florida and coordinate coverage with the Company's participation in the FHCF, effective June 1, 2011 to May 31, 2012. The agreements, including agreements that provide coverage through the FHCF, provide an estimated provisional limit of $916.7 million in excess of a provisional retention of $30 million and after $10 million in losses "otherwise recoverable".
The Company ceded premiums earned of $531 million, $582 million and $616 million under catastrophe reinsurance agreements in 2011, 2010 and 2009, respectively.
Asbestos, environmental and other
Reinsurance recoverables include $193 million and $183 million from Lloyd's of London as of December 31, 2011 and 2010, respectively. Lloyd's of London, through the creation of Equitas Limited, implemented a restructuring plan in 1996 to solidify its capital base and to segregate claims for years prior to 1993.
Allstate Financial
The Company's Allstate Financial segment reinsures certain of its risks to other insurers primarily under yearly renewable term, coinsurance, modified coinsurance and coinsurance with funds withheld agreements. These agreements result in a passing of the agreed-upon percentage of risk to the reinsurer in exchange for negotiated reinsurance premium payments. Modified coinsurance and coinsurance with funds withheld are similar to coinsurance, except that the cash and investments that support the liability for contract benefits are not transferred to the assuming company and settlements are made on a net basis between the companies. Allstate Financial cedes 100% of the morbidity risk on substantially all of its long-term care contracts.
For certain term life insurance policies issued prior to October 2009, Allstate Financial ceded up to 90% of the mortality risk depending on the year of policy issuance under coinsurance agreements to a pool of fourteen unaffiliated reinsurers. Effective October 2009, mortality risk on term business is ceded under yearly renewable term agreements under which Allstate Financial cedes mortality in excess of its retention, which is consistent with how Allstate Financial generally reinsures its permanent life insurance business. The following table summarizes those retention limits by period of policy issuance.
Period
Retention limits
April 2011 through current
Single life: $5 million per life, $3 million age 70 and over, and $10 million for contracts that meet specific criteria
Joint life: $8 million per life, and $10 million for contracts that meet specific criteria
July 2007 through March 2011
$5 million per life, $3 million age 70 and over, and $10 million for contracts that meet specific criteria
September 1998 through June 2007
$2 million per life, in 2006 the limit was increased to $5 million for instances when specific criteria were met
August 1998 and prior
Up to $1 million per life
In addition, Allstate Financial has used reinsurance to effect the acquisition or disposition of certain blocks of business. Allstate Financial had reinsurance recoverables of $1.68 billion and $1.63 billion as of December 31, 2011 and 2010, respectively, due from Prudential related to the disposal of substantially all of its variable annuity business that was effected through reinsurance agreements. In 2011, life and annuity premiums and contract charges of $152 million, contract benefits of $121 million, interest credited to contractholder funds of $20 million, and operating costs and expenses of $27 million were ceded to Prudential. In 2010, life and annuity premiums and contract charges of $171 million, contract benefits of $152 million, interest credited to contractholder funds of $29 million, and operating costs and expenses of $31 million were ceded to Prudential. In 2009, life and annuity premiums and contract charges of $170 million, contract benefits of $44 million, interest credited to contractholder funds of $27 million, and operating costs and expenses of $28 million were ceded to Prudential. In addition, as of December 31, 2011 and 2010 Allstate Financial had reinsurance recoverables of $165 million and $170 million, respectively, due from subsidiaries of Citigroup (Triton Insurance and American Health and Life Insurance) and Scottish Re (U.S.) Inc. in connection with the disposition of substantially all of the direct response distribution business in 2003.
As of December 31, 2011, the gross life insurance in force was $528.78 billion of which $222.38 billion was ceded to the unaffiliated reinsurers.
Allstate Financial's reinsurance recoverables on paid and unpaid benefits as of December 31 are summarized in the following table.
($ in millions)
Annuities
$ 1,827
$ 1,785
Life insurance
1,600
1,569
Long-term care insurance
1,063
Other
Total Allstate Financial
$ 4,577
$ 4,400
As of December 31, 2011 and 2010, approximately 94% of Allstate Financial's reinsurance recoverables are due from companies rated A- or better by S&P.
11. Deferred Policy Acquisition and Sales Inducement Costs
Deferred policy acquisition costs for the years ended December 31 are as follows:
($ in millions)
Allstate
Financial
Property-
Liability
Total
Balance, beginning of year
$ 3,392
$ 1,377
$ 4,769
Esurance acquisition present value of future profits
-
Acquisition costs deferred
3,633
4,066
Amortization charged to income
(593 )
(3,640 )
(4,233 )
Effect of unrealized gains and losses
(201 )
-
(201 )
Balance, end of year
$ 3,031
$ 1,412
$ 4,443
Allstate
Financial
Property-
Liability
Total
Balance, beginning of year
$ 4,060
$ 1,410
$ 5,470
Acquisition costs deferred
3,645
4,128
Amortization charged to income
(356 )
(3,678 )
(4,034 )
Effect of unrealized gains and losses
(795 )
-
(795 )
Balance, end of year
$ 3,392
$ 1,377
$ 4,769
Allstate
Financial
Property-
Liability
Total
Balance, beginning of year
$ 7,089
$ 1,453
$ 8,542
Impact of adoption of new other-than-temporary impairment accounting guidance before unrealized impact (1)
(176 )
-
(176 )
Impact of adoption of new other-than-temporary impairment accounting guidance effect of unrealized capital gains and losses (2)
-
Acquisition costs deferred
3,746
4,241
Amortization charged to income
(965 )
(3,789 )
(4,754 )
Effect of unrealized gains and losses
(2,559 )
-
(2,559 )
Balance, end of year
$ 4,060
$ 1,410
$ 5,470
(1)The adoption of new other-than-temporary impairment accounting guidance on April 1, 2009 resulted in an adjustment to DAC to reverse previously recorded DAC accretion related to realized capital losses that were reclassified to other comprehensive income upon adoption. (2)The adoption of new other-than-temporary impairment accounting guidance resulted in an adjustment to DAC due to the change in unrealized capital gains and losses that occurred upon adoption on April 1, 2009 when previously recorded realized capital losses were reclassified to other comprehensive income. The adjustment was recorded as an increase of the DAC balance and unrealized capital gains and losses.
DSI activity for Allstate Financial, which primarily relates to fixed annuities and interest-sensitive life contracts, for the years ended December 31 was as follows:
($ in millions)
Balance, beginning of year
$
$
$
Impact of adoption of new other-than-temporary impairment accounting guidance before unrealized impact (1)
-
-
(35 )
Impact of adoption of new other-than-temporary impairment accounting guidance effect of unrealized capital gains and losses (2)
-
-
Sales inducements deferred
Amortization charged to income
(23 )
(27 )
(129 )
Effect of unrealized gains and losses
(29 )
(96 )
(157 )
Balance, end of year
$
$
$
(1)The adoption of new other-than-temporary impairment accounting guidance on April 1, 2009 resulted in an adjustment to DSI to reverse previously recorded DSI accretion related to realized capital losses that were reclassified to other comprehensive income upon adoption. (2)The adoption of new other-than-temporary impairment accounting guidance resulted in an adjustment to DSI due to the change in unrealized capital gains and losses that occurred upon adoption on April 1, 2009 when previously recorded realized capital losses were reclassified to other comprehensive income. The adjustment was recorded as an increase of the DSI balance and unrealized capital gains and losses.
12. Capital Structure
Debt outstanding
Total debt outstanding as of December 31 consisted of the following:
($ in millions)
6.125% Senior Notes, due 2012 (1)
$
$
7.50% Debentures, due 2013
5.00% Senior Notes, due 2014 (1)
6.20% Senior Notes, due 2014 (1)
6.75% Senior Debentures, due 2018
7.45% Senior Notes, due 2019 (1)
6.125% Senior Notes, due 2032 (1)
5.35% Senior Notes due 2033 (1)
5.55% Senior Notes due 2035 (1)
5.95% Senior Notes, due 2036 (1)
6.90% Senior Debentures, due 2038
6.125% Junior Subordinated Debentures, due 2067
6.50% Junior Subordinated Debentures, due 2067
Synthetic lease VIE obligations, floating rates, due 2014
Federal Home Loan Bank ("FHLB") advances, due 2018
Total long-term debt
5,908
5,908
Short-term debt (2)
-
-
Total debt
$ 5,908
$ 5,908
(1)Senior Notes are subject to redemption at the Company's option in whole or in part at any time at the greater of either 100% of the principal amount plus accrued and unpaid interest to the redemption date or the discounted sum of the present values of the remaining scheduled payments of principal and interest and accrued and unpaid interest to the redemption date. (2)The Company classifies any borrowings which have a maturity of twelve months or less at inception as short-term debt.
Total debt outstanding by maturity as of December 31, 2011 is as follows:
($ in millions)
Due within one year or less
$
Due after one year through 5 years
1,244
Due after 5 years through 10 years
Due after 10 years through 20 years
-
Due after 20 years
3,350
Total debt
$ 5,908
On January 11, 2012, the Company issued $500 million of 5.20% Senior Notes due 2042. The proceeds of this issuance will be used for general corporate purposes, including the repayment of $350 million of 6.125% Senior Notes maturing on February 15, 2012.
The Company has outstanding $500 million of Series A 6.50% and $500 million of Series B 6.125% Fixed-to-Floating Rate Junior Subordinated Debentures (together the "Debentures"). The scheduled maturity dates for the Debentures are May 15, 2057 and May 15, 2037 for Series A and Series B, respectively, with a final maturity date of May 15, 2067. The Debentures may be redeemed (i) in whole or in part, at any time on or after May 15, 2037 or May 15, 2017 for Series A and Series B, respectively, at their principal amount plus accrued and unpaid interest to the date of redemption, or (ii) in certain circumstances, in whole or in part, prior to May 15, 2037 and May 15, 2017 for Series A and Series B, respectively, at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, a make-whole price.
Interest on the Debentures is payable semi-annually at the stated fixed annual rate to May 15, 2037 and May 15, 2017 for Series A and Series B, respectively, and then payable quarterly at an annual rate equal to the three-month LIBOR plus 2.12% and 1.935% for Series A and Series B, respectively. The Company may elect at one or more times to defer payment of interest on the Debentures for one or more consecutive interest periods that do not exceed 10 years. Interest compounds during such deferral periods at the rate in effect for each period. The interest deferral feature obligates the Company in certain circumstances to issue common stock or certain other types of securities if it cannot otherwise raise sufficient funds to make the required interest payments. The Company has reserved 75 million shares of its authorized and unissued common stock to satisfy this obligation.
In connection with the issuance of the Debentures, the Company entered into replacement capital covenants. These covenants are not intended for the benefit of the holders of the Debentures and may not be enforced by them. Rather, they are for the benefit of holders of one or more other designated series of the Company's indebtedness, initially the 6.90% Senior Debentures due 2038. Pursuant to these covenants, the Company has agreed that it will not repay, redeem, or purchase the Debentures on or before May 15, 2067 and May 15, 2047 for Series A and Series B, respectively, unless, subject to certain limitations, the Company has received proceeds in specified amounts from the issuance of specified securities. These covenants terminate in 2067 and 2047 for Series A and Series B, respectively, or earlier upon the occurrence of certain events, including an acceleration of the Debentures of the particular series due to the occurrence of an event of default. An event of default, as defined by the supplemental indentures, includes default in the payment of interest or principal and bankruptcy proceedings.
The Company is the primary beneficiary of a consolidated VIE used to acquire up to 19 automotive collision repair stores ("synthetic lease"). In 2011, the Company renewed the synthetic lease for a three-year term at a floating rate due 2014. The Company's Consolidated Statements of Financial Position include $32 million and $33 million of property and equipment, net and $44 million and $42 million of long-term debt as of December 31, 2011 and 2010, respectively.
The Allstate Bank received a $10 million long-term advance from the FHLB in April 2008, and another $10 million advance in September 2008. The FHLB advances are secured with cash pledged to the FHLB. During 2011, 2010 and 2009, $2 million, $2 million and $1 million was repaid on the advances, respectively. The Allstate Corporation will be assuming these obligations when the Bank is dissolved.
To manage short-term liquidity, the Company maintains a commercial paper program and a credit facility as a potential source of funds. These include a $1.00 billion unsecured revolving credit facility and a commercial paper program with a borrowing limit of $1.00 billion. The credit facility has an initial term of five years expiring in May 2012. The Company has the option to extend the expiration by one year upon approval of existing or replacement lenders providing more than two-thirds of the commitments to lend. This facility also contains an increase provision that would allow up to an additional $500 million of borrowing provided the increased portion could be fully syndicated at a later date among existing or new lenders. This facility has a financial covenant requiring the Company not to exceed a 37.5%
debt to capital resources ratio as defined in the agreement. Although the right to borrow under the facility is not subject to a minimum rating requirement, the costs of maintaining the facility and borrowing under it are based on the ratings of the Company's senior, unsecured, nonguaranteed long-term debt. The total amount outstanding at any point in time under the combination of the commercial paper program and the credit facility cannot exceed the amount that can be borrowed under the credit facility. No amounts were outstanding under the credit facility as of December 31, 2011 and 2010. The Company had no commercial paper outstanding as of December 31, 2011 and 2010.
The Company paid $363 million, $363 million and $383 million of interest on debt in 2011, 2010 and 2009, respectively.
During 2009, the Company filed a universal shelf registration statement with the Securities and Exchange Commission ("SEC") that expires in 2012. The registration statement covers an unspecified amount of securities and can be used to issue debt securities, common stock, preferred stock, depositary shares, warrants, stock purchase contracts, stock purchase units and securities of trust subsidiaries.
Capital stock
The Company had 900 million shares of issued common stock of which 501 million shares were outstanding and 399 million shares were held in treasury as of December 31, 2011. In 2011, the Company reacquired 33 million shares at an average cost of $28.65 and reissued 1 million shares under equity incentive plans.
13. Company Restructuring
The Company undertakes various programs to reduce expenses. These programs generally involve a reduction in staffing levels, and in certain cases, office closures. Restructuring and related charges include employee termination and relocation benefits, and post-exit rent expenses in connection with these programs, and non-cash charges resulting from pension benefit payments made to agents in connection with the 1999 reorganization of Allstate's multiple agency programs to a single exclusive agency program. In 2011, restructuring programs primarily relate to Allstate Protection's field claim office consolidations, reorganization of technology shared services and reorganization within Allstate Financial's sales and support organization. The expenses related to these activities are included in the Consolidated Statements of Operations as restructuring and related charges, and totaled $44 million, $30 million and $130 million in 2011, 2010 and 2009, respectively.
The following table presents changes in the restructuring liability in 2011.
($ in millions)
Employee
costs
Exit
costs
Total
liability
Balance as of December 31, 2010
$
$
$
Expense incurred
Adjustments to liability
(10 )
-
(10 )
Payments applied against liability
(19 )
(5 )
(24 )
Balance as of December 31, 2011
$
$
$
The payments applied against the liability for employee costs primarily reflect severance costs, and the payments for exit costs generally consist of post-exit rent expenses and contract termination penalties. As of December 31, 2011, the cumulative amount incurred to date for active programs totaled $110 million for employee costs and $47 million for exit costs.
14. Commitments, Guarantees and Contingent Liabilities
Leases
The Company leases certain office facilities and computer equipment. Total rent expense for all leases was $256 million, $256 million and $267 million in 2011, 2010 and 2009, respectively.
Minimum rental commitments under noncancelable capital and operating leases with an initial or remaining term of more than one year as of December 31, 2011 are as follows:
($ in millions)
Capital
leases
Operating
leases
$
$
Thereafter
Total
$
$
Present value of minimum capital lease payments
$
Shared markets and state facility assessments
The Company is required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations in various states that provide insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Underwriting results related to these arrangements, which tend to be adverse, have been immaterial to the Company's results of operations. Because of the Company's participation, it may be exposed to losses that surpass the capitalization of these facilities and/or assessments from these facilities.
Castle Key is subject to assessments from Citizens Property Insurance Corporation in the state of Florida ("FL Citizens"), which was initially created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. FL Citizens, at the discretion and direction of its Board of Governors ("FL Citizens Board"), can levy a regular assessment on assessable insurers and assessable insureds for a deficit in any calendar year up to a maximum of the greater of 6% of the deficit or 6% of Florida property premiums industry-wide for the prior year. Prior to July 2008, the assessment rate was 10%. The base of assessable insurers includes all property and casualty premiums in the state, except workers' compensation, medical malpractice, accident and health insurance and policies written under the NFIP. An insurer may recoup a regular assessment through a surcharge to policyholders. In order to recoup this assessment, an insurer must file for a policy surcharge with the Florida Office of Insurance Regulation ("FL OIR") at least fifteen days prior to imposing the surcharge on policies. If a deficit remains after the regular assessment, FL Citizens can also levy emergency assessments in the current and subsequent years. Companies are required to collect the emergency assessments directly from residential property policyholders and remit to FL Citizens as collected.
FL Citizens reported losses from Hurricane Wilma in 2005, which followed a deficit for the 2004 plan year. The FL Citizens Board certified the 2005 FL Citizens deficit at $1.73 billion of which $920 million was to be funded through a regular assessment. The Company paid its portion of the deficit assessment totaling $14 million during 2006 and has recouped $11 million as of December 31, 2011. The Company expects to continue recoupment in 2012. The remainder of the deficit was funded by bonds issued in 2006.
The Company is also subject to assessments from Louisiana Citizens Property Insurance Corporation ("LA Citizens"). LA Citizens can levy a regular assessment on participating companies for a deficit in any calendar year up to a maximum of the greater of 10% of the calendar year deficit or 10% of Louisiana direct property premiums industry-wide for the prior calendar year.
Florida Hurricane Catastrophe Fund
Castle Key participates in the mandatory coverage provided by the FHCF and therefore has access to reimbursements on certain qualifying Florida hurricane losses from the FHCF (see Note 10), has exposure to assessments and pays annual premiums to the FHCF for this reimbursement protection. The FHCF has the authority to issue bonds to pay its obligations to insurers participating in the mandatory coverage in excess of its capital balances. Payment of these bonds is funded by emergency assessments on all property and casualty premiums in the state, except workers' compensation, medical malpractice, accident and health insurance and policies written under the NFIP. The FHCF emergency assessments are limited to 6% of premiums per year beginning the first year in which reimbursements require bonding, and up to a total of 10% of premiums per year for assessments in the second and subsequent years, if required to fund additional bonding. The FHCF issued $625 million in bonds in 2008, and the FL OIR ordered an emergency assessment of 1% of premiums collected for all policies renewed after January 1, 2007. The FHCF issued
$676 million in bonds in 2010 and the FL OIR ordered an emergency assessment of 1.3% of premiums collected for all policies written or renewed after January 1, 2011. As required, companies will collect the FHCF emergency assessments directly from policyholders and remit them to the FHCF as they are collected.
Facilities such as FL Citizens, LA Citizens and the FHCF are generally designed so that the ultimate cost is borne by policyholders; however, the exposure to assessments from these facilities and the availability of recoupments or premium rate increases may not offset each other in the Company's financial statements. Moreover, even if they do offset each other, they may not offset each other in financial statements for the same fiscal period due to the ultimate timing of the assessments and recoupments or premium rate increases, as well as the possibility of policies not being renewed in subsequent years.
California Earthquake Authority
Exposure to certain potential losses from earthquakes in California is limited by the Company's participation in the California Earthquake Authority ("CEA"), which provides insurance for California earthquake losses. The CEA is a privately-financed, publicly-managed state agency created to provide insurance coverage for earthquake damage. Insurers selling homeowners insurance in California are required to offer earthquake insurance to their customers either through their company or by participation in the CEA. The Company's homeowners policies continue to include coverages for losses caused by explosions, theft, glass breakage and fires following an earthquake, which are not underwritten by the CEA.
As of September 30, 2011, the CEA's capital balance was approximately $3.96 billion. Should losses arising from an earthquake cause a deficit in the CEA, additional funding would be obtained from the proceeds of revenue bonds the CEA may issue, an existing $3.05 billion reinsurance layer, and finally, if needed, assessments on participating insurance companies. The authority of the CEA to assess participating insurers extends through December 1, 2018. Participating insurers are required to pay an assessment, currently estimated not to exceed $1.56 billion, if the capital of the CEA falls below $350 million. Participating insurers are required to pay a second additional assessment, currently estimated not to exceed $804 million, if aggregate CEA earthquake losses exceed $9.69 billion and the capital of the CEA falls below $350 million. Within the limits previously described, the assessment could be intended to restore the CEA's capital to a level of $350 million. There is no provision that allows insurers to recover assessments through a premium surcharge or other mechanism. The CEA's projected aggregate claim paying capacity is $9.69 billion as of October 31, 2011 and if an event were to result in claims greater than its capacity, affected policyholders would be paid a prorated portion of their covered losses.
All future assessments on participating CEA insurers are based on their CEA insurance market share as of December 31 of the preceding year. As of April 1, 2011, the Company's share of the CEA was 16.2%. The Company does not expect its CEA market share to materially change. At this level, the Company's maximum possible CEA assessment would be $382 million during 2012. Accordingly, assessments from the CEA for a particular quarter or annual period may be material to the results of operations and cash flows, but not the financial position of the Company. Management believes the Company's exposure to earthquake losses in California has been significantly reduced as a result of its participation in the CEA.
Texas Windstorm Insurance Association
The Company participates in the mandatory coverage provided by the Texas Windstorm Insurance Association ("TWIA"), for losses relating to hurricane activity. Amounts assessed to each company are allocated based upon its proportion of business written. In September 2008, TWIA assessed the Company $66 million for losses relating to Hurricane Ike. The assessment was based on 2007 direct voluntary writings in the State of Texas. The Company expects to recoup $35 million of the assessment via premium tax offsets over a five year period. $7 million of the total recoupable amount was realized via premium tax offsets in each of 2011, 2010 and 2009. The remaining $31 million of the assessment was eligible for cession under the Company's reinsurance program. The TWIA board has not indicated the likelihood of any possible future assessments to insurers at this time. However, assessments from the TWIA for a particular quarter or annual period may be material to the results of operations and cash flows, but not the financial position of the Company. Management believes the Company's exposure to losses in Texas has been significantly reduced as a result of its participation in the TWIA.
Guaranty funds
Under state insurance guaranty fund laws, insurers doing business in a state can be assessed, up to prescribed limits, for certain obligations of insolvent insurance companies to policyholders and claimants. Amounts assessed to each company are typically related to its proportion of business written in each state. The Company's policy is to accrue
assessments when the entity for which the insolvency relates has met its state of domicile's statutory definition of insolvency, the amount of the loss is reasonably estimable and the related premium upon which the assessment is based is written. In most states, the definition is met with a declaration of financial insolvency by a court of competent jurisdiction. In certain states there must also be a final order of liquidation. As of December 31, 2011 and 2010, the liability balance included in other liabilities and accrued expenses was $53 million and $46 million, respectively. The related premium tax offsets included in other assets were $35 million and $25 million as of December 31, 2011 and 2010, respectively.
PMI runoff support agreement
The Company has certain limited rights and obligations under a capital support agreement ("Runoff Support Agreement") with PMI Mortgage Insurance Company ("PMI"), the primary operating subsidiary of PMI Group, related to the Company's disposition of PMI in prior years. Under the Runoff Support Agreement, the Company would be required to pay claims on PMI policies written prior to October 28, 1994 if PMI fails certain financial covenants and fails to pay such claims. The agreement only covers these policies and not any policies issued on or after that date. In the event any amounts are so paid, the Company would receive a commensurate amount of preferred stock or subordinated debt of PMI Group or PMI. The Runoff Support Agreement also restricts PMI's ability to write new business and pay dividends under certain circumstances. On October 20, 2011, the Director of the Arizona Department of Insurance took control of the PMI insurance companies; effective October 24, 2011, the Director instituted a partial claim payment plan: claim payments will be made at 50%, with the remaining amount deferred as a policyholder claim. The effect of these developments to the Company are uncertain. Management does not believe they will have a material effect on results of operations, cash flows or financial position of the Company.
Guarantees
The Company owns certain fixed income securities that obligate the Company to exchange credit risk or to forfeit principal due, depending on the nature or occurrence of specified credit events for the reference entities. In the event all such specified credit events were to occur, the Company's maximum amount at risk on these fixed income securities, as measured by the amount of the aggregate initial investment, was $28 million as of December 31, 2011. The obligations associated with these fixed income securities expire at various dates on or before March 11, 2018.
Related to the disposal through reinsurance of substantially all of Allstate Financial's variable annuity business to Prudential in 2006, the Company and its consolidated subsidiaries, ALIC and ALNY, have agreed to indemnify Prudential for certain pre-closing contingent liabilities (including extra-contractual liabilities of ALIC and ALNY and liabilities specifically excluded from the transaction) that ALIC and ALNY have agreed to retain. In addition, the Company, ALIC and ALNY will each indemnify Prudential for certain post-closing liabilities that may arise from the acts of ALIC, ALNY and their agents, including in connection with ALIC's and ALNY's provision of transition services. The reinsurance agreements contain no limitations or indemnifications with regard to insurance risk transfer, and transferred all of the future risks and responsibilities for performance on the underlying variable annuity contracts to Prudential, including those related to benefit guarantees. Management does not believe this agreement will have a material effect on results of operations, cash flows or financial position of the Company.
The Company provides residual value guarantees on Company leased automobiles. If all outstanding leases were terminated effective December 31, 2011, the Company's maximum obligation pursuant to these guarantees, assuming the automobiles have no residual value, would be $6 million as of December 31, 2011. The remaining term of each residual value guarantee is equal to the term of the underlying lease that ranges from less than one year to three years. Historically, the Company has not made any material payments pursuant to these guarantees.
In the normal course of business, the Company provides standard indemnifications to contractual counterparties in connection with numerous transactions, including acquisitions and divestitures. The types of indemnifications typically provided include indemnifications for breaches of representations and warranties, taxes and certain other liabilities, such as third party lawsuits. The indemnification clauses are often standard contractual terms and are entered into in the normal course of business based on an assessment that the risk of loss would be remote. The terms of the indemnifications vary in duration and nature. In many cases, the maximum obligation is not explicitly stated and the contingencies triggering the obligation to indemnify have not occurred and are not expected to occur. Consequently, the maximum amount of the obligation under such indemnifications is not determinable. Historically, the Company has not made any material payments pursuant to these obligations.
The aggregate liability balance related to all guarantees was not material as of December 31, 2011.
Regulation and Compliance
The Company is subject to changing social, economic and regulatory conditions. From time to time, regulatory authorities or legislative bodies seek to influence and restrict premium rates, require premium refunds to policyholders, require reinstatement of terminated policies, restrict the ability of insurers to cancel or non-renew policies, require insurers to continue to write new policies or limit their ability to write new policies, limit insurers' ability to change coverage terms or to impose underwriting standards, impose additional regulations regarding agent and broker compensation, regulate the nature of and amount of investments, and otherwise expand overall regulation of insurance products and the insurance industry. The Company has established procedures and policies to facilitate compliance with laws and regulations, to foster prudent business operations, and to support financial reporting. The Company routinely reviews its practices to validate compliance with laws and regulations and with internal procedures and policies. As a result of these reviews, from time to time the Company may decide to modify some of its procedures and policies. Such modifications, and the reviews that led to them, may be accompanied by payments being made and costs being incurred. The ultimate changes and eventual effects of these actions on the Company's business, if any, are uncertain.
Legal and regulatory proceedings and inquiries
The Company and certain subsidiaries are involved in a number of lawsuits, regulatory inquiries, and other legal proceedings arising out of various aspects of its business.
Background
These matters raise difficult and complicated factual and legal issues and are subject to many uncertainties and complexities, including the underlying facts of each matter; novel legal issues; variations between jurisdictions in which matters are being litigated, heard, or investigated; differences in applicable laws and judicial interpretations; the length of time before many of these matters might be resolved by settlement, through litigation, or otherwise; the fact that some of the lawsuits are putative class actions in which a class has not been certified and in which the purported class may not be clearly defined; the fact that some of the lawsuits involve multi-state class actions in which the applicable law(s) for the claims at issue is in dispute and therefore unclear; and the current challenging legal environment faced by large corporations and insurance companies.
The outcome of these matters may be affected by decisions, verdicts, and settlements, and the timing of such decisions, verdicts, and settlements, in other individual and class action lawsuits that involve the Company, other insurers, or other entities and by other legal, governmental, and regulatory actions that involve the Company, other insurers, or other entities. The outcome may also be affected by future state or federal legislation, the timing or substance of which cannot be predicted.
In the lawsuits, plaintiffs seek a variety of remedies which may include equitable relief in the form of injunctive and other remedies and monetary relief in the form of contractual and extra-contractual damages. In some cases, the monetary damages sought may include punitive or treble damages. Often specific information about the relief sought, such as the amount of damages, is not available because plaintiffs have not requested specific relief in their pleadings. When specific monetary demands are made, they are often set just below a state court jurisdictional limit in order to seek the maximum amount available in state court, regardless of the specifics of the case, while still avoiding the risk of removal to federal court. In Allstate's experience, monetary demands in pleadings bear little relation to the ultimate loss, if any, to the Company.
In connection with regulatory examinations and proceedings, government authorities may seek various forms of relief, including penalties, restitution, and changes in business practices. The Company may not be advised of the nature and extent of relief sought until the final stages of the examination or proceeding.
Accrual and disclosure policy
The Company reviews its lawsuits, regulatory inquiries, and other legal proceedings on an ongoing basis and follows appropriate accounting guidance when making accrual and disclosure decisions. The Company establishes accruals for such matters at management's best estimate when the Company assesses that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company does not establish accruals for such matters when the Company does not believe both that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company's assessment of whether a loss is reasonably possible or probable is based on its assessment of the ultimate outcome of the matter following all appeals. The Company does not include potential recoveries in its estimates of reasonably possible or probable losses. Legal fees are expensed as incurred.
The Company continues to monitor its lawsuits, regulatory inquiries, and other legal proceedings for further developments that would make the loss contingency both probable and estimable, and accordingly accruable, or that could affect the amount of accruals that have been previously established. There may continue to be exposure to loss in excess of any amount accrued. Disclosure of the nature and amount of an accrual is made when there have been sufficient legal and factual developments such that the Company's ability to resolve the matter would not be impaired by the disclosure of the amount of accrual.
When the Company assesses it is reasonably possible or probable that a loss has been incurred, it discloses the matter. When it is possible to estimate the reasonably possible loss or range of loss above the amount accrued, if any, for the matters disclosed, that estimate is aggregated and disclosed. Disclosure is not required when an estimate of the reasonably possible loss or range of loss cannot be made.
For certain of the matters described below in the "Claims related proceedings" and "Other proceedings" subsections, the Company is able to estimate the reasonably possible loss or range of loss above the amount accrued, if any. In determining whether it is possible to estimate the reasonably possible loss or range of loss, the Company reviews and evaluates the disclosed matters, in conjunction with counsel, in light of potentially relevant factual and legal developments.
These developments may include information learned through the discovery process, rulings on dispositive motions, settlement discussions, information obtained from other sources, experience from managing these and other matters, and other rulings by courts, arbitrators or others. When the Company possesses sufficient appropriate information to develop an estimate of the reasonably possible loss or range of loss above the amount accrued, if any, that estimate is aggregated and disclosed below. There may be other disclosed matters for which a loss is probable or reasonably possible but such an estimate is not possible. Disclosure of the estimate of the reasonably possible loss or range of loss above the amount accrued, if any, for any individual matter would only be considered when there have been sufficient legal and factual developments such that the Company's ability to resolve the matter would not be impaired by the disclosure of the individual estimate.
As of December 31, 2011, the Company estimates that the aggregate range of reasonably possible loss in excess of the amount accrued, if any, for the disclosed matters where such an estimate is possible is zero to $855 million, pre-tax. This disclosure is not an indication of expected loss, if any. Under accounting guidance, an event is "reasonably possible" if "the chance of the future event or events occurring is more than remote but less than likely" and an event is "remote" if "the chance of the future event or events occurring is slight." This estimate is based upon currently available information and is subject to significant judgment and a variety of assumptions, and known and unknown uncertainties. The matters underlying the estimate will change from time to time, and actual results may vary significantly from the current estimate. The estimate does not include matters or losses for which an estimate is not possible. Therefore, this estimate represents an estimate of possible loss only for certain matters meeting these criteria. It does not represent the Company's maximum possible loss exposure. Information is provided below regarding the nature of all of the disclosed matters and, where specified, the amount, if any, of plaintiff claims associated with these loss contingencies.
Due to the complexity and scope of the matters disclosed in the "Claims related proceedings" and "Other proceedings" subsections below and the many uncertainties that exist, the ultimate outcome of these matters cannot be predicted. In the event of an unfavorable outcome in one or more of these matters, the ultimate liability may be in excess of amounts currently accrued, if any, and may be material to the Company's operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters described below, as they are resolved over time, is not likely to have a material effect on the financial position of the Company.
Claims related proceedings
Allstate is vigorously defending a putative class action lawsuit filed in the aftermath of Hurricane Katrina and currently pending in the United States District Court for the Eastern District of Louisiana ("District Court"). This matter was filed by the Louisiana Attorney General against Allstate and every other homeowner insurer doing business in the State of Louisiana, on behalf of the State of Louisiana, as assignee, and on behalf of a class of Road Home fund recipients. In this matter the State alleged that the insurers failed to pay all damages owed under their policies. The claims currently pending in this matter are for breach of contract and for declaratory relief on the alleged underpayment of claims by the insurers. All other claims, including extra-contractual claims, have been dismissed. The Company had moved to dismiss the complaint on the grounds that the State had no standing to bring the lawsuit as an assignee of insureds because of anti-assignment language in the underlying insurance policies. Now, however, due to a ruling by the
Louisiana Supreme Court, the Company will not pursue a motion to dismiss, but will preserve the anti-assignment issue in a defense.
The State has not yet identified the specific details by property supporting its allegations of breach of contract or the alleged deficiencies in adjusting those claims. There are many potential individual claims at issue in this matter, each of which will require individual analysis and a number of which may be subject to individual defenses, including release, accord and satisfaction, prescription, waiver, and estoppel. There has been no discovery in connection with this matter. The Company has now filed a motion seeking to force the State to provide more specificity as to its claims in this matter. The Company believes that its adjusting practices in connection with Katrina homeowners claims were sound and in accordance with industry standards and state law. There remain significant questions of Louisiana law that have yet to be decided. In the Company's judgment, given the issues discussed above, a loss is not probable.
Allstate has been vigorously defending a lawsuit in regards to certain claims employees involving worker classification issues. This lawsuit is a certified class action challenging a state wage and hour law. In this case, plaintiffs sought actual damages in an amount to be proven at trial, liquidated damages in an amount equal to an unspecified percentage of the aggregate underpayment of wages to be proven at trial, as well as attorneys' fees and costs. Plaintiffs have not made a settlement demand nor have they alleged the amount of damages with any specificity. The case was bifurcated between liability and damages and is currently focused only on liability issues. No discovery has taken place regarding plaintiffs' alleged damages. In December 2009, the liability phase of the case was tried, and, on July 6, 2010, the court issued its decision finding in favor of Allstate on all claims. The plaintiffs have appealed the decision in favor of Allstate to the first level appellate court. After concluding the current appeal, the parties may seek a subsequent appeal to the Illinois Supreme Court. Only liability issues are being addressed on appeal and no damages may be awarded at this stage of the proceedings. In the event the trial court's order were to be overturned, however, the parties would need to conduct damages discovery, and a trial on damages would have to take place, before any damages could be awarded. In the Company's judgment a loss is not probable.
Allstate is vigorously defending a class action lawsuit in Montana state court challenging aspects of its claim handling practices in Montana. The plaintiff alleges that the Company adjusts claims made by individuals who do not have attorneys in a manner that unfairly resulted in lower payments compared to claimants who were represented by attorneys. In January 2012, the court certified a class of Montana claimants who were not represented by attorneys with respect to the resolution of auto accident claims. The court certified the class to cover an indefinite period that commences in the mid-1990's. The certified claims include claims for declaratory judgment, injunctive relief and punitive damages in an unspecified amount. Injunctive relief may include a claim process by which unrepresented claimants could request that their claims be readjusted. No compensatory damages are sought on behalf of the class. To date no discovery has occurred related to the potential value of the class members' claims. The Company has asserted various defenses with respect to the plaintiff's claims which have not been finally resolved. The proposed injunctive relief claim process would be subject to defenses and offsets ordinarily associated with the adjustment of claims. Any differences in amounts paid to class members compared to what class members might be paid under a different process would be speculative and subject to individual variation and determination dependent upon the individual circumstances presented by each class claimant. In the Company's judgment a loss is not probable.
Other proceedings
The Company is defending certain matters relating to the Company's agency program reorganization announced in 1999. Although these cases have been pending for many years, they currently are in the early stages of litigation because of appellate court proceedings and threshold procedural issues.
•These matters include a lawsuit filed in 2001 by the U.S. Equal Employment Opportunity Commission ("EEOC") alleging retaliation under federal civil rights laws ("EEOC I") and a class action filed in 2001 by former employee agents alleging retaliation and age discrimination under the Age Discrimination in Employment Act ("ADEA"), breach of contract and ERISA violations ("Romero I"). In 2004, in the consolidated EEOC I and Romero I litigation, the trial court issued a memorandum and order that, among other things, certified classes of agents, including a mandatory class of agents who had signed a release, for purposes of effecting the court's declaratory judgment that the release was voidable at the option of the release signer. The court also ordered that an agent who voided the release must return to Allstate "any and all benefits received by the [agent] in exchange for signing the release." The court also stated that, "on the undisputed facts of record, there is no basis for claims of age discrimination." The EEOC and plaintiffs asked the court to clarify and/or reconsider its memorandum and order and in January 2007, the judge denied their request. In June 2007, the court reversed its prior ruling that the release was voidable and granted the Company's motions for summary judgment, ruling that the asserted claims were barred by the release signed by most plaintiffs.
Plaintiffs filed a notice of appeal with the U.S. Court of Appeals for the Third Circuit ("Third Circuit"). In July 2009, the Third Circuit vacated the trial court's entry of summary judgment in the Company's favor and remanded the cases to the trial court for additional discovery, including additional discovery related to the validity of the release and waiver. In its opinion, the Third Circuit held that if the release and waiver is held to be valid, then all of the claims in Romero I and EEOC I are barred. Thus, if the waiver and release is upheld, then only the claims in Romero I asserted by the small group of employee agents who did not sign the release and waiver would remain for adjudication. In January 2010, following the remand, the cases were assigned to a new judge for further proceedings in the trial court. Plaintiffs filed their Second Amended Complaint on July 28, 2010. Plaintiffs seek broad but unspecified "make whole relief," including back pay, compensatory and punitive damages, liquidated damages, lost investment capital, attorneys' fees and costs, and equitable relief, including reinstatement to employee agent status with all attendant benefits for up to approximately 6,500 former employee agents. Despite the length of time that these matters have been pending, to date only limited discovery has occurred related to the damages claimed by individual plaintiffs, and no damages discovery has occurred related to the claims of the putative class. Nor have plaintiffs provided any calculations of the putative class's alleged back pay or the alleged liquidated, compensatory or punitive damages, instead asserting that such calculations will be provided at a later stage during expert discovery. Damage claims are subject to reduction by amounts and benefits received by plaintiffs and putative class members subsequent to their employment termination. Little to no discovery has occurred with respect to amounts earned or received by plaintiffs and putative class members in mitigation of their alleged losses. Alleged damage amounts and lost benefits of the approximately 6,500 putative class members also are subject to individual variation and determination dependent upon retirement dates, participation in employee benefit programs, and years of service. Discovery limited to the validity of the waiver and release is in process. At present, no class is certified. Summary judgment proceedings on the validity of the waiver and release are expected to occur in the first half of 2012.
•A putative nationwide class action has also been filed by former employee agents alleging various violations of ERISA, including a worker classification issue ("Romero II"). These plaintiffs are challenging certain amendments to the Agents Pension Plan and are seeking to have exclusive agent independent contractors treated as employees for benefit purposes. Romero II was dismissed with prejudice by the trial court, was the subject of further proceedings on appeal, and was reversed and remanded to the trial court in 2005. In June 2007, the court granted the Company's motion to dismiss the case. Plaintiffs filed a notice of appeal with the Third Circuit. In July 2009, the Third Circuit vacated the district court's dismissal of the case and remanded the case to the trial court for additional discovery, and directed that the case be reassigned to another trial court judge. In its opinion, the Third Circuit held that if the release and waiver is held to be valid, then one of plaintiffs' three claims asserted in Romero II is barred. The Third Circuit directed the district court to consider on remand whether the other two claims asserted in Romero II are barred by the release and waiver. In January 2010, following the remand, the case was assigned to a new judge (the same judge for the Romero I and EEOC I cases) for further proceedings in the trial court. On April 23, 2010, plaintiffs filed their First Amended Complaint. Plaintiffs seek broad but unspecified "make whole" or other equitable relief, including losses of income and benefits as a result of their decision to retire from the Company between November 1, 1999 and December 31, 2000. They also seek repeal of the challenged amendments to the Agents Pension Plan with all attendant benefits revised and recalculated for thousands of former employee agents, and attorney's fees and costs. Despite the length of time that this matter has been pending, to date only limited discovery has occurred related to the damages claimed by individual plaintiffs, and no damages discovery has occurred related to the claims of the putative class. Nor have plaintiffs provided any calculations of the putative class's alleged losses, instead asserting that such calculations will be provided at a later stage during expert discovery. Damage claims are subject to reduction by amounts and benefits received by plaintiffs and putative class members subsequent to their employment termination. Little to no discovery has occurred with respect to amounts earned or received by plaintiffs and putative class members in mitigation of their alleged losses. Alleged damage amounts and lost benefits of the putative class members also are subject to individual variation and determination dependent upon retirement dates, participation in employee benefit programs, and years of service. As in Romero I and EEOC I, discovery at this time is limited to issues relating to the validity of the waiver and release. Class certification has not been decided. Summary judgment proceedings on the validity of the waiver and release are expected to occur in the first half of 2012.
In these agency program reorganization matters, the threshold issue of the validity and scope of the waiver and release is yet to be decided and, if decided in favor of the Company, would preclude any damages being awarded in Romero I and EEOC I and may also preclude damages from being awarded in Romero II. In the Company's judgment a
loss is not probable. Allstate has been vigorously defending these lawsuits and other matters related to its agency program reorganization.
Asbestos and environmental
Allstate's reserves for asbestos claims were $1.08 billion and $1.10 billion, net of reinsurance recoverables of $529 million and $555 million, as of December 31, 2011 and December 31, 2010, respectively. Reserves for environmental claims were $185 million and $201 million, net of reinsurance recoverables of $40 million and $47 million, as of December 31, 2011 and December 31, 2010, respectively. Approximately 59% and 60% of the total net asbestos and environmental reserves as of December 31, 2011 and 2010, respectively, were for incurred but not reported estimated losses.
Management believes its net loss reserves for asbestos, environmental and other discontinued lines exposures are appropriately established based on available facts, technology, laws and regulations. However, establishing net loss reserves for asbestos, environmental and other discontinued lines claims is subject to uncertainties that are much greater than those presented by other types of claims. The ultimate cost of losses may vary materially from recorded amounts, which are based on management's best estimate. Among the complications are lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure and unresolved legal issues regarding policy coverage; unresolved legal issues regarding the determination, availability and timing of exhaustion of policy limits; plaintiffs' evolving and expanding theories of liability; availability and collectability of recoveries from reinsurance; retrospectively determined premiums and other contractual agreements; estimates of the extent and timing of any contractual liability; the impact of bankruptcy protection sought by various asbestos producers and other asbestos defendants; and other uncertainties. There are also complex legal issues concerning the interpretation of various insurance policy provisions and whether those losses are covered, or were ever intended to be covered, and could be recoverable through retrospectively determined premium, reinsurance or other contractual agreements. Courts have reached different and sometimes inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are covered; whether there is an insurer obligation to defend; how policy limits are determined; how policy exclusions and conditions are applied and interpreted; and whether clean-up costs represent insured property damage. Management believes these issues are not likely to be resolved in the near future, and the ultimate costs may vary materially from the amounts currently recorded resulting in material changes in loss reserves. In addition, while the Company believes that improved actuarial techniques and databases have assisted in its ability to estimate asbestos, environmental, and other discontinued lines net loss reserves, these refinements may subsequently prove to be inadequate indicators of the extent of probable losses. Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserves that may be required.
15. Income Taxes
The Company and its domestic subsidiaries file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective entities.
The Internal Revenue Service ("IRS") is currently examining the Company's 2009 and 2010 federal income tax returns. The IRS has completed its examinations of the Company's federal income tax returns for 2005-2006 and 2007-2008 and the cases are under consideration at the IRS Appeals Office. The Company's tax years prior to 2005 have been examined by the IRS and the statute of limitations has expired on those years. Any adjustments that may result from IRS examinations of tax returns are not expected to have a material effect on the results of operations, cash flows or financial position of the Company.
The reconciliation of the change in the amount of unrecognized tax benefits for the years ended December 31 is as follows:
($ in millions)
Balance - beginning of year
$
$
$
Increase for tax positions taken in a prior year
-
-
Decrease for tax positions taken in a prior year
-
-
-
Increase for tax positions taken in the current year
-
Decrease for tax positions taken in the current year
-
-
-
(Decrease) increase for settlements
-
-
-
Reductions due to lapse of statute of limitations
-
-
-
Balance - end of year
$
$
$
The Company believes it is reasonably possible that the liability balance will be reduced by $25 million within the next twelve months upon the resolution of an outstanding issue resulting from the 2005-2006 IRS examination. Because of the impact of deferred tax accounting, recognition of previously unrecognized tax benefits is not expected to impact the Company's effective tax rate.
The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. The Company did not record interest income or expense relating to unrecognized tax benefits in income tax expense in 2011 or 2010. The Company recorded $0.1 million of interest income relating to unrecognized tax benefits in income tax expense in 2009. As of December 31, 2011 and 2010, there was no interest accrued with respect to unrecognized tax benefits. No amounts have been accrued for penalties.
The components of the deferred income tax assets and liabilities as of December 31 are as follows:
($ in millions)
Deferred assets
Unearned premium reserves
$
$
Difference in tax bases of invested assets
Discount on loss reserves
Pension
Alternative minimum tax credit carryforward
Accrued compensation
Net operating loss carryforwards
-
Other postretirement benefits
Life and annuity reserves
Other assets
Total deferred assets
2,726
2,500
Valuation allowance
(67 )
(6 )
Net deferred assets
2,659
2,494
Deferred liabilities
DAC
(1,102 )
(1,139 )
Unrealized net capital gains
(737 )
(504 )
Other intangible assets
(142 )
(6 )
Other liabilities
(158 )
(61 )
Total deferred liabilities
(2,139 )
(1,710 )
Net deferred asset
$
$
Although realization is not assured, management believes it is more likely than not that the deferred tax assets, net of valuation allowance, will be realized based on the Company's assessment that the deductions ultimately recognized for tax purposes will be fully utilized. The valuation allowance for deferred tax assets increased by $61 million in 2011 primarily as a result of the acquisition of Answer Financial. The valuation allowance relates to the portion of Answer
Financial's net operating loss carryforwards that, due to limitations contained in the Internal Revenue Code, are expected to expire prior to their utilization.
As of December 31, 2011, the Company has net operating loss carryforwards of $580 million which will expire at the end of 2015 through 2031. The Company has tax credit carryforwards of $9 million which will be available to offset future tax liabilities and expire at the end of 2029 through 2031. In addition, the Company has an alternative minimum tax credit carryforward of $255 million which will be available to offset future tax liabilities indefinitely.
The components of income tax expense for the years ended December 31 are as follows:
($ in millions)
Current
$
$
$ (18 )
Deferred
Total income tax expense
$
$
$
Income tax expense for the year ended December 31, 2009 includes expense of $254 million attributable to an increase in the valuation allowance relating to the deferred tax asset on capital losses recorded in the first quarter of 2009. This valuation allowance was released in connection with the adoption of new other-than-temporary impairment accounting guidance on April 1, 2009; however, the release was recorded as an increase to retained income and therefore did not reverse the amount recorded in income tax expense. The release of the valuation allowance is related to the reversal of previously recorded other-than-temporary impairment write-downs that would not have been recorded under the new other-than-temporary impairment accounting guidance.
The Company paid income taxes of $32 million in 2011 and received refunds of $8 million and $1.25 billion in 2010 and 2009, respectively. The Company had a current income tax receivable of $157 million and $129 million as of December 31, 2011 and 2010, respectively.
A reconciliation of the statutory federal income tax rate to the effective income tax rate on income from operations for the years ended December 31 is as follows:
Statutory federal income tax rate
35.0 %
35.0 %
35.0 %
Tax-exempt income
(13.6 )
(15.6 )
(20.2 )
Tax credits
(2.1 )
(0.5 )
-
Dividends received deduction
(1.8 )
(1.4 )
(1.3 )
Adjustment to prior year tax liabilities
(0.8 )
(0.2 )
(2.7 )
Other
1.2
0.3
0.9
Valuation allowance
-
-
19.9
Effective income tax rate
17.9 %
17.6 %
31.6 %
16. Statutory Financial Information
Allstate's domestic property-liability and life insurance subsidiaries prepare their statutory-basis financial statements in conformity with accounting practices prescribed or permitted by the insurance department of the applicable state of domicile. Prescribed statutory accounting practices include a variety of publications of the NAIC, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed.
All states require domiciled insurance companies to prepare statutory-basis financial statements in conformity with the NAIC Accounting Practices and Procedures Manual, subject to any deviations prescribed or permitted by the applicable insurance commissioner and/or director. Statutory accounting practices differ from GAAP primarily since they require charging policy acquisition and certain sales inducement costs to expense as incurred, establishing life insurance reserves based on different actuarial assumptions, and valuing certain investments and establishing deferred taxes on a different basis.
Statutory net income and capital and surplus of Allstate's domestic insurance subsidiaries, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities are as follows:
Net income
Capital and surplus
($ in millions)
Amounts by major business type:
Property-Liability (1)
$
$ 1,064
$ 1,318
$ 11,992
$ 12,185
Allstate Financial
(42 )
(430 )
(911 )
3,600
3,454
Amount per statutory accounting practices
$
$
$
$ 15,592
$ 15,639
(1)The Property-Liability statutory capital and surplus balances exclude wholly-owned subsidiaries included in the Allstate Financial segment.
There were no permitted practices utilized as of December 31, 2011 or 2010.
Dividends
The ability of the Company to pay dividends is dependent on business conditions, income, cash requirements of the Company, receipt of dividends from AIC and other relevant factors. The payment of shareholder dividends by AIC without the prior approval of the state insurance regulator is limited to formula amounts based on net income and capital and surplus, determined in conformity with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. AIC paid dividends of $838 million in 2011, which was less than the maximum amount allowed under Illinois insurance law without the prior approval of the Illinois Department of Insurance ("IL DOI") based on 2010 formula amounts. The maximum amount of dividends AIC will be able to pay without prior IL DOI approval at a given point in time during 2012 is $1.51 billion, less dividends paid during the preceding twelve months measured at that point in time.
Notification and approval of intercompany lending activities is also required by the IL DOI for transactions that exceed a level that is based on a formula using statutory admitted assets and statutory surplus.
17. Benefit Plans
Pension and other postretirement plans
Defined benefit pension plans cover most full-time employees, certain part-time employees and employee-agents. Benefits under the pension plans are based upon the employee's length of service and eligible annual compensation. A cash balance formula was added to the Allstate Retirement Plan effective January 1, 2003. All eligible employees hired before August 1, 2002 were provided with a one-time opportunity to choose between the cash balance formula and the final average pay formula. The cash balance formula applies to all eligible employees hired after August 1, 2002.
The Company also provides certain health care subsidies for eligible employees hired before January 1, 2003 when they retire and their eligible dependents and certain life insurance benefits for eligible employees hired before January 1, 2003 when they retire ("postretirement benefits"). Qualified employees may become eligible for these benefits if they retire in accordance with the Company's established retirement policy and are continuously insured under the Company's group plans or other approved plans in accordance with the plan's participation requirements. The Company shares the cost of retiree medical benefits with non Medicare-eligible retirees based on years of service, with the Company's share being subject to a 5% limit on annual medical cost inflation after retirement. During 2009, the Company decided to change its approach for delivering benefits to Medicare-eligible retirees. The Company no longer offers medical benefits for Medicare-eligible retirees but instead provides a fixed Company contribution (based on years of service and other factors), which is not subject to adjustments for inflation.
The Company has reserved the right to modify or terminate its benefit plans at any time and for any reason.
Obligations and funded status
The Company calculates benefit obligations based upon generally accepted actuarial methodologies using the projected benefit obligation ("PBO") for pension plans and the accumulated postretirement benefit obligation ("APBO") for other postretirement plans. The determination of pension costs and other postretirement obligations as of December 31, 2011 and 2010 are determined using a December 31 measurement date. The benefit obligations represent the actuarial present value of all benefits attributed to employee service rendered as of the measurement date. The PBO is measured using the pension benefit formula and assumptions as to future compensation levels. A plan's funded status is calculated as the difference between the benefit obligation and the fair value of plan assets. The Company's funding
policy for the pension plans is to make annual contributions at a level that is in accordance with regulations under the Internal Revenue Code ("IRC") and generally accepted actuarial principles. The Company's postretirement benefit plans are not funded.
The components of the plans' funded status that are reflected in the Consolidated Statements of Financial Position as of December 31 are as follows:
Pension
benefits
Postretirement
benefits
($ in millions)
Fair value of plan assets
$ 4,675
$ 4,669
$ -
$ -
Less: Benefit obligation
5,831
5,545
Funded status
$ (1,156 ) $ (876 ) $ (716 ) $ (628 )
Items not yet recognized as a component of net periodic cost:
Net actuarial loss (gain)
$ 2,546
$ 2,311
$ (211 ) $ (322 )
Prior service credit
(3 )
(5 )
(152 )
(175 )
Unrecognized pension and other postretirement benefit cost, pre-tax
2,543
2,306
(363
)
(497
)
Deferred income tax
(890 )
(807 )
Unrecognized pension and other postretirement benefit cost
$ 1,653
$ 1,499
$ (226 ) $ (311 )
The increase of $235 million in the pension net actuarial loss during 2011 is related to a decrease in the discount rate combined with lower than expected returns. The majority of the $2.55 billion net actuarial pension benefit losses not yet recognized as a component of net periodic pension cost in 2011 reflects decreases in the discount rate and the effect of unfavorable equity market conditions on the value of the pension plan assets in prior years. The decrease of $111 million in the OPEB net actuarial gain during 2011 is primarily related to a decrease in the discount rate, higher than expected claim costs of future retirees and amortization of net actuarial gains. The decrease of $23 million in the OPEB prior service credit is related to amortization of prior service cost.
The change in 2011 in items not yet recognized as a component of net periodic cost, which is recorded in unrecognized pension and other postretirement benefit cost, is shown in the table below.
($ in millions)
Pension
benefits
Postretirement
benefits
Items not yet recognized as a component of net periodic cost - December 31, 2010
$ 2,306
$ (497 )
Net actuarial loss arising during the period
Net actuarial (loss) gain amortized to net periodic benefit cost
(200 )
Prior service cost arising during the period
-
-
Prior service credit amortized to net periodic benefit cost
Translation adjustment and other
(2 )
(1 )
Items not yet recognized as a component of net periodic cost - December 31, 2011
$ 2,543
$ (363 )
The net actuarial loss (gain) is recognized as a component of net periodic cost amortized over the average remaining service period of active employees expected to receive benefits. Estimates of the net actuarial loss (gain) and prior service credit expected to be recognized as a component of net periodic benefit cost during 2012 are shown in the table below.
($ in millions)
Pension
benefits
Postretirement
benefits
Net actuarial loss (gain)
$
$ (21 )
Prior service credit
(2 )
(23 )
The accumulated benefit obligation ("ABO") for all defined benefit pension plans was $5.16 billion and $4.82 billion as of December 31, 2011 and 2010, respectively. The ABO is the actuarial present value of all benefits attributed by the pension benefit formula to employee service rendered at the measurement date. However, it differs from the PBO due to the exclusion of an assumption as to future compensation levels.
The PBO, ABO and fair value of plan assets for the Company's pension plans with an ABO in excess of plan assets were $5.51 billion, $4.85 billion and $4.33 billion, respectively, as of December 31, 2011 and $4.48 billion, $3.79 billion and $3.54 billion, respectively, as of December 31, 2010. Included in the accrued benefit cost of the pension benefits are certain unfunded non-qualified plans with accrued benefit costs of $142 million and $132 million for 2011 and 2010, respectively.
The changes in benefit obligations for all plans for the years ended December 31 are as follows:
Pension
benefits
Postretirement
benefits
($ in millions)
Benefit obligation, beginning of year
$ 5,545
$ 5,233
$
$
Service cost
Interest cost
Participant contributions
Actuarial loss (gain)
(58 )
Benefits paid (1)
(511 )
(407 )
(61 )
(57 )
Translation adjustment and other
(14 )
(1 )
Benefit obligation, end of year
$ 5,831
$ 5,545
$
$
(1)Benefits paid include lump sum distributions, a portion of which may trigger settlement accounting treatment.
Components of net periodic cost
The components of net periodic cost for all plans for the years ended December 31 are as follows:
Pension benefits
Postretirement benefits
($ in millions)
Service cost
$
$
$
$
$
$
Interest cost
Expected return on plan assets
(367 )
(331 )
(398 )
-
-
-
Amortization of:
Prior service credit
(2 )
(2 )
(3 )
(23 )
(22 )
(6 )
Net actuarial loss (gain)
(30 )
(22 )
(29 )
Settlement loss
-
-
Net periodic cost (credit)
$
$
$
$ (4 ) $
$
Assumptions
Weighted average assumptions used to determine net pension cost and net postretirement benefit cost for the years ended December 31 are:
Pension benefits
Postretirement benefits
($ in millions)
Discount rate
6.00 %
6.25 %
7.50 %
6.00 %
6.25 %
6.50 %
Rate of increase in compensation levels
4.0 - 4.5
4.0 - 4.5
4.0 - 4.5
n/a
n/a
n/a
Expected long-term rate of return on plan assets
8.5
8.5
8.5
n/a
n/a
n/a
Weighted average assumptions used to determine benefit obligations as of December 31 are listed in the following table.
Pension benefits
Postretirement benefits
Discount rate
5.25 %
6.00 %
5.25 %
6.00 %
Rate of increase in compensation levels
4.0 - 4.5
4.0 - 4.5
n/a
n/a
The weighted average health care cost trend rate used in measuring the accumulated postretirement benefit cost is 7.30% for 2012, gradually declining to 4.5% in 2024 and remaining at that level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement health care plans. A one percentage-point increase in assumed health care cost trend rates would increase the total of the service and interest cost components of net periodic benefit cost of other postretirement benefits and the APBO by $3 million and $27 million, respectively. A one percentage-point decrease in assumed health care cost trend rates would decrease the total of the service and interest cost components of net periodic benefit cost of other postretirement benefits and the APBO by $2 million and $21 million, respectively.
Pension plan assets
The change in pension plan assets for the years ended December 31 is as follows:
($ in millions)
Fair value of plan assets, beginning of year
$ 4,669
$ 4,127
Actual return on plan assets
Employer contribution
Benefits paid
(511 )
(407 )
Translation adjustment and other
(14 )
Fair value of plan assets, end of year
$ 4,675
$ 4,669
In general, the Company's pension plan assets are managed in accordance with investment policies approved by pension investment committees. The purpose of the policies is to ensure the plans' long-term ability to meet benefit obligations by prudently investing plan assets and Company contributions, while taking into consideration regulatory and legal requirements and current market conditions. The investment policies are reviewed periodically and specify target plan asset allocation by asset category. In addition, the policies specify various asset allocation and other risk limits. The pension plans' asset exposure within each asset category is tracked against widely accepted established benchmarks for each asset class with limits on variation from the benchmark established in the investment policy. Pension plan assets are regularly monitored for compliance with these limits and other risk limits specified in the investment policies.
The pension plans' target asset allocation and the actual percentage of plan assets, by asset category as of December 31 are as follows:
Target asset
allocation
Actual percentage
of plan assets
Asset category
U.S. equity securities
25 - 33 %
%
%
International equity securities
17 - 23
Fixed income securities
35 - 48
Real estate funds
3 - 7
Private equity funds
3 - 7
Hedge funds
6 - 9
Short-term investments and other
1 - 3
Total (1)
%
%
(1)Securities lending collateral reinvestment is excluded from target and actual percentage of plan assets.
The target asset allocation for an asset category may be achieved either through direct investment holdings, through replication using derivative instruments (e.g., futures or swaps) or net of hedges using derivative instruments to
reduce exposure to an asset category. The notional amount of derivatives used for replication net of the notional amount of hedges is limited to 115% of total plan assets. Calculating the actual allocation consistent with the target allocation results in actual allocations falling within the target allocation.
Outside the target asset allocation, the pension plans participate in a securities lending program to enhance returns. U.S. government fixed income securities and U.S. equity securities are lent out and cash collateral is invested 33% in fixed income securities and 67% in short-term investments.
The following table presents the fair values of pension plan assets as of December 31, 2011.
($ in millions)
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Balance
as of
December 31,
Assets
Equity securities:
U.S.
$
$
$
$
International
-
1,102
Fixed income securities:
U.S. government and agencies
-
Foreign government
-
-
Municipal
-
-
Corporate
-
RMBS
-
-
Short-term investments
-
Limited partnership interests:
Real estate funds (1)
-
-
Private equity funds (2)
-
-
Hedge funds (3)
-
-
Cash and cash equivalents
-
-
Free-standing derivatives:
Assets
-
Liabilities
(2 )
(4 )
-
(6 )
Total plan assets at fair value
$
$ 3,429
$
5,178
% of total plan assets at fair value
15.7 %
66.2 %
18.1 %
100.0 %
Securities lending obligation (4)
(554
)
Other net plan assets (5)
Total reported plan assets
$ 4,675
(1)Real estate funds held by the pension plans are primarily invested in U.S. commercial real estate. (2)Private equity funds held by the pension plans are primarily comprised of North American buyout funds. (3)Hedge funds held by the pension plans primarily comprise fund of funds investments in diversified pools of capital across funds with underlying strategies such as convertible arbitrage, equity market neutral, fixed income arbitrage, global macro, commodity trading advisors, long short equity, short biased equity, and event driven. (4) The securities lending obligation represents the plan's obligation to return securities lending collateral received under a securities lending program. The terms of the program allow both the plan and the counterparty the right and ability to redeem/return the securities loaned on short notice. Due to its relatively short-term nature, the outstanding balance of the obligation approximates fair value. (5)Other net plan assets represent interest and dividends receivable and net receivables related to settlements of investment transactions, such as purchases and sales.
The following table presents the fair values of pension plan assets as of December 31, 2010.
($ in millions)
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Balance
as of
December 31,
Assets
Equity securities:
U.S.
$
$
$
$ 1,144
International
-
Fixed income securities:
U.S. government and agencies
-
Foreign government
-
-
Municipal
-
-
Corporate
-
RMBS
-
Short-term investments
-
Limited partnership interests:
Real estate funds
-
-
Private equity funds
-
-
Hedge funds
-
-
Cash and cash equivalents
-
-
Free-standing derivatives:
Assets
-
-
Liabilities
(2 )
-
-
(2 )
Total plan assets at fair value
$ 2,452
$ 1,963
$
5,407
% of total plan assets at fair value
45.4 %
36.3 %
18.3 %
100.0 %
Securities lending obligation
(772
)
Other net plan assets
Total reported plan assets
$ 4,669
The fair values of pension plan assets are estimated using the same methodologies and inputs as those used to determine the fair values for the respective asset category of the Company. These methodologies and inputs are disclosed in Note 6.
The following table presents the rollforward of Level 3 plan assets for the year ended December 31, 2011.
($ in millions)
Actual return on plan assets:
Balance as of
December 31,
Relating to
assets sold
during the
period
Relating to
assets still
held at the
reporting
date
Purchases,
sales,
issuances and
settlements,
net
Net
transfers in
and/or (out)
of Level 3
Balance as of
December 31,
Assets
U. S. equity securities
$
$ -
$ (2 ) $
$ -
$
Fixed income securities:
Municipal
-
(60 )
-
Corporate
-
(2 )
-
RMBS
(8 )
(30 )
(18 )
-
Limited partnership interests:
Real estate funds
(1 )
(3 )
-
Private equity funds
(3 )
-
Hedge funds
(48 )
(44 )
-
Total Level 3 plan assets
$
$
$
$ (82 ) $ (18 ) $
The following table presents the rollforward of Level 3 plan assets for the year ended December 31, 2010.
($ in millions)
Actual return on plan assets:
Balance as of
December 31,
Relating to
assets sold
during the
period
Relating to
assets still
held at the
reporting
date
Purchases,
sales,
issuances and
settlements,
net
Net
transfers in
and/or (out)
of Level 3
Balance as of
December 31,
Assets
U. S. equity securities
$
$ -
$
$ -
$ -
$
Fixed income securities:
Municipal
-
(2 )
(114 )
(6 )
Corporate
-
-
-
-
RMBS
(10 )
(26 )
-
ABS
(1 )
-
(31 )
-
-
Limited partnership interests:
Real estate funds
(4 )
-
Private equity funds
-
(2 )
-
Hedge funds
(58 )
(10 )
-
Total Level 3 plan assets
$ 1,103
$ (73 ) $
$ (150 ) $ (6 ) $
The following table presents the rollforward of Level 3 plan assets for the year ended December 31, 2009.
($ in millions)
Actual return on plan assets:
Balance as of
January 1,
Relating to
assets sold
during the
period
Relating to
assets still
held at the
reporting
date
Purchases,
sales,
issuances and
settlements,
net
Net
transfers in
and/or (out)
of Level 3
Balance as of
December 31,
Assets
U. S. equity securities
$
$ -
$ (3 ) $
$ -
$
Fixed income securities:
Municipal
-
(48 )
(38 )
Corporate
-
(19 )
RMBS
-
(40 )
-
ABS
-
-
-
-
Limited partnership interests:
Real estate funds
-
(47 )
-
Private equity funds
-
-
Hedge funds
(20 )
-
Total Level 3 plan assets
$ 1,138
$
$
$ (5 ) $ (57 ) $ 1,103
The expected long-term rate of return on plan assets reflects the average rate of earnings expected on plan assets. The Company's assumption for the expected long-term rate of return on plan assets is reviewed annually giving consideration to appropriate financial data including, but not limited to, the plan asset allocation, forward-looking expected returns for the period over which benefits will be paid, historical returns on plan assets and other relevant market data. Given the long-term forward looking nature of this assumption, the actual returns in any one year do not immediately result in a change. In giving consideration to the targeted plan asset allocation, the Company evaluated returns using the same sources it has used historically which include: historical average asset class returns from an independent nationally recognized vendor of this type of data blended together using the asset allocation policy weights for the Company's pension plans; asset class return forecasts from a large global independent asset management firm that specializes in providing multi-asset class investment fund products which were blended together using the asset allocation policy weights; and expected portfolio returns from a proprietary simulation methodology of a widely recognized external investment consulting firm that performs asset allocation and actuarial services for corporate pension plan sponsors. This same methodology has been applied on a consistent basis each year. All of these were consistent with the Company's long-term rate of return on plan assets assumption of 8.5% as of December 31, 2011 and 2010. As of the 2011 measurement date, the arithmetic average of the annual actual return on plan assets for the most recent 10 and 5 years was 6.6% and 4.6%, respectively.
Pension plan assets did not include any of the Company's common stock as of December 31, 2011 or 2010.
Cash flows
There was no required cash contribution necessary to satisfy the minimum funding requirement under the IRC for the tax qualified pension plans as of December 31, 2011. The Company currently plans to contribute $417 million to its pension plans in 2012.
The Company contributed $41 million and $35 million to the postretirement benefit plans in 2011 and 2010, respectively. Contributions by participants were $20 million and $22 million in 2011 and 2010, respectively.
Estimated future benefit payments
Estimated future benefit payments expected to be paid in the next 10 years, based on the assumptions used to measure the Company's benefit obligation as of December 31, 2011, are presented in the table below. Effective January 1, 2010, the Company no longer participates in the Retiree Drug Subsidy program due to the change in the Company's retiree medical plan for Medicare-eligible retirees.
($ in millions)
Postretirement benefits
Pension
benefits
Gross
benefit
payments
$
$
2017-2021
2,467
Total benefit payments
$ 4,204
$
Allstate 401(k) Savings Plan
Employees of the Company, with the exception of those employed by the Company's international, Sterling Collision Centers ("Sterling"), Esurance and Answer Financial subsidiaries, are eligible to become members of the Allstate 401(k) Savings Plan ("Allstate Plan"). The Company's contributions are based on the Company's matching obligation and certain performance measures. The Company is responsible for funding its anticipated contribution to the Allstate Plan, and may, at the discretion of management, use the ESOP to pre-fund certain portions. In connection with the Allstate Plan, the Company has a note from the ESOP with a principal balance of $22 million as of December 31, 2011. The ESOP note has a fixed interest rate of 7.9% and matures in 2019. The Company records dividends on the ESOP shares in retained income and all the shares held by the ESOP are included in basic and diluted weighted average common shares outstanding.
The Company's contribution to the Allstate Plan was $48 million, $36 million, and $78 million in 2011, 2010 and 2009, respectively. These amounts were reduced by the ESOP benefit computed for the years ended December 31 as follows:
($ in millions)
Interest expense recognized by ESOP
$
$
$
Less: dividends accrued on ESOP shares
(2 )
(2 )
(2 )
Cost of shares allocated
Compensation expense
Reduction of defined contribution due to ESOP
ESOP benefit
$ (7 ) $ (9 ) $ (20 )
The Company made no contributions to the ESOP in 2011, 2010 and 2009. As of December 31, 2011, total committed to be released, allocated and unallocated ESOP shares were 0.2 million, 34 million and 5 million, respectively.
Allstate has defined contribution plans for eligible employees of its Canadian, Sterling, Esurance and Answer Financial subsidiaries. Expense for these plans was $7 million, $5 million and $6 million in 2011, 2010 and 2009, respectively.
18. Equity Incentive Plans
The Company currently has two equity incentive plans that permit it to grant nonqualified stock options, incentive stock options and restricted stock units to certain employees and directors of the Company. The total compensation expense related to equity awards was $64 million, $68 million and $74 million and the total income tax benefits were $21 million, $23 million and $25 million for 2011, 2010 and 2009, respectively. Total cash received from the exercise of options was $19 million, $28 million and $3 million for 2011, 2010 and 2009, respectively. Total tax benefit realized on options exercised and stock unrestricted was $10 million, $11 million and $3 million for 2011, 2010 and 2009, respectively.
The Company records compensation expense related to awards under these plans over the vesting period of each grant. The Company records compensation expense for employees eligible for continued vesting upon retirement over the vesting period to the date that the employee is eligible for retirement. As of December 31, 2011, total unrecognized compensation cost related to all nonvested awards was $105 million, of which $56 million related to nonqualified stock options which are expected to be recognized over the weighted average vesting period of 2.36 years and $49 million related to restricted stock units which are expected to be recognized over the weighted average vesting period of 2.46 years.
Options are granted under the plans with exercise prices equal to the closing share price of the Company's common stock on the applicable grant date. Options granted to employees generally vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date. Options granted prior to 2010 vest ratably over a four year period. Options may be exercised once vested and will expire ten years after the date of grant. For a normal retirement (age 60 with one year of service), all options granted more than 12 months before retirement, and a pro-rata portion of options granted within 12 months of retirement, continue to vest as scheduled. For an early retirement (age 55 with ten years of service), a pro-rata portion of all options continue to vest as scheduled. When the options become vested, they may be exercised on or before the earlier of the option expiration date or the fifth anniversary of the employee's retirement. If termination of employment is a result of death or disability, then all options vest and may be exercised on or before the earlier of the option expiration date or the second anniversary of the date of termination of employment. Vested options may be exercised within three months following any other type of termination of employment except termination after a change in control. Restricted stock units generally vest and unrestrict 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date, except for directors which vest immediately and unrestrict after leaving the board. Restricted stock units granted to employees prior to 2010 vest and unrestrict in full on the fourth anniversary of the grant date. Employee awards are subject to forfeiture upon termination. For a normal retirement, all restricted stock units granted more than 12 months before retirement, and a pro-rata portion of restricted stock units granted within 12 months of retirement, continue to unrestrict as provided for in the original grant. For an early retirement, a pro-rata portion of all restricted stock units continue to vest as scheduled. Upon a termination of employment as a result of death or disability, all restricted stock units vest. Unvested restricted stock units are forfeited following any other type of termination of employment except termination after a change in control.
A total of 77.8 million shares of common stock were authorized to be used for awards under the plans, subject to adjustment in accordance with the plans' terms. As of December 31, 2011, 19.2 million shares were reserved and remained available for future issuance under these plans. The Company uses its treasury shares for these issuances.
The fair value of each option grant is estimated on the date of grant using a binomial lattice model. The Company uses historical data to estimate option exercise and employee termination within the valuation model. In addition, separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the binominal lattice model and represents the period of time that options granted are expected to be outstanding. The expected volatility of the price of the underlying shares is implied based on traded options and historical volatility of the Company's common stock. The expected dividends for 2011 were based on the current dividend yield of the Company's stock as of the date of the grant. The expected dividends for 2010 were based on the current dividend yield of the Company's stock as of the date of the grant. The expected dividends for 2009 were based on a graded average of the current and historical long-term dividend yield of the Company's stock as of the date of the grant. The risk-free rate for periods within the contractual life of the
option is based on the U.S. Treasury yield curve in effect at the time of grant. The assumptions used are shown in the following table.
Weighted average expected term
7.9 years
7.8 years
8.1 years
Expected volatility
22.1 - 53.9%
23.7 - 52.3%
26.3 - 79.2%
Weighted average volatility
35.1%
35.1%
38.3%
Expected dividends
2.5 - 3.7%
2.4 - 2.8%
2.6%
Weighted average expected dividends
2.7%
2.6%
2.6%
Risk-free rate
0.0 - 3.5%
0.1 - 3.9%
0.0 - 3.7%
A summary of option activity for the year ended December 31, 2011 is shown in the following table.
Number
(in 000s)
Weighted
average
exercise
price
Aggregate
intrinsic value
(in 000s)
Weighted
average
remaining
contractual
term (years)
Outstanding as of January 1, 2011
35,296
$ 39.39
Granted
4,177
31.57
Exercised
(1,080 )
17.87
Forfeited
(1,230 )
28.69
Expired
(3,216 )
44.69
Outstanding as of December 31, 2011:
33,947
39.00
$ 71,171
5.1
Outstanding, net of expected forfeitures
33,645
39.08
70,686
5.0
Outstanding, exercisable ("vested")
21,417
45.26
28,243
3.5
The weighted average grant date fair value of options granted was $9.49, $9.89 and $5.74 during 2011, 2010 and 2009, respectively. The intrinsic value, which is the difference between the fair value and the exercise price, of options exercised was $15 million, $16 million and $428 thousand during 2011, 2010 and 2009, respectively.
The changes in restricted stock units are shown in the following table for the year ended December 31, 2011.
Number
(in 000s)
Weighted
average
grant date
fair value
Nonvested as of January 1, 2011
3,757
$ 31.50
Granted
1,366
31.38
Vested
(417 )
61.66
Forfeited
(380 )
29.08
Nonvested as of December 31, 2011
4,326
28.76
The fair value of restricted stock units is based on the market value of the Company's stock as of the date of the grant. The market value in part reflects the payment of future dividends expected. The weighted average grant date fair value of restricted stock units granted was $31.38, $31.32 and $17.47 during 2011, 2010 and 2009, respectively. The total fair value of restricted stock units vested was $13 million, $16 million and $11 million during 2011, 2010 and 2009, respectively.
The tax benefit realized in 2011, 2010 and 2009 related to tax deductions from stock option exercises and included in shareholders' equity was $3 million, $4 million and zero, respectively. The tax (expense) benefit realized in 2011, 2010 and 2009 related to all stock-based compensation and recorded directly to shareholders' equity was $(0.4) million, $0.5 million and $(6) million, respectively.
19. Reporting Segments
Allstate management is organized around products and services, and this structure is considered in the identification of its four reportable segments. These segments and their respective operations are as follows:
Allstate Protection principally sells private passenger auto and homeowners insurance in the United States and Canada. Revenues from external customers generated outside the United States were $892 million, $741 million and $619 million in 2011, 2010 and 2009, respectively. The Company evaluates the results of this segment based upon underwriting results.
Discontinued Lines and Coverages consists of business no longer written by Allstate, including results from asbestos, environmental and other discontinued lines claims, and certain commercial and other businesses in run-off. This segment also includes the historical results of the commercial and reinsurance businesses sold in 1996. The Company evaluates the results of this segment based upon underwriting results.
Allstate Financial sells life insurance, retirement and investment products and voluntary accident and health insurance. The principal individual products are interest-sensitive, traditional and variable life insurance; fixed annuities including deferred and immediate; and voluntary accident and health insurance. The institutional product line consists primarily of funding agreements sold to unaffiliated trusts that use them to back medium-term notes issued to institutional and individual investors. Banking products and services were previously offered to customers through the Allstate Bank. Allstate Financial had no revenues from external customers generated outside the United States in 2011, 2010 or 2009. The Company evaluates the results of this segment based upon operating income.
Corporate and Other comprises holding company activities and certain non-insurance operations.
Allstate Protection and Discontinued Lines and Coverages comprise Property-Liability. The Company does not allocate Property-Liability investment income, realized capital gains and losses, or assets to the Allstate Protection and Discontinued Lines and Coverages segments. Management reviews assets at the Property-Liability, Allstate Financial, and Corporate and Other levels for decision-making purposes.
The accounting policies of the reportable segments are the same as those described in Note 2. The effects of certain inter-segment transactions are excluded from segment performance evaluation and therefore are eliminated in the segment results.
Measuring segment profit or loss
The measure of segment profit or loss used by Allstate's management in evaluating performance is underwriting income (loss) for the Allstate Protection and Discontinued Lines and Coverages segments and operating income for the Allstate Financial and Corporate and Other segments. A reconciliation of these measures to net income (loss) is provided below.
Underwriting income (loss) is calculated as premiums earned, less claims and claims expenses ("losses"), amortization of DAC, operating costs and expenses, and restructuring and related charges as determined using GAAP.
Operating income (loss) is net income (loss) excluding:
•realized capital gains and losses, after-tax, except for periodic settlements and accruals on non-hedge derivative instruments, which are reported with realized capital gains and losses but included in operating income (loss),
•valuation changes on embedded derivatives that are not hedged, after-tax,
•amortization of DAC and DSI, to the extent they resulted from the recognition of certain realized capital gains and losses or valuation changes on embedded derivatives that are not hedged, after-tax,
•business combination expenses and the amortization of purchased intangible assets, after-tax,
•gain (loss) on disposition of operations, after-tax, and
•adjustments for other significant non-recurring, infrequent or unusual items, when (a) the nature of the charge or gain is such that it is reasonably unlikely to recur within two years, or (b) there has been no similar charge or gain within the prior two years.
Summarized revenue data for each of the Company's reportable segments for the years ended December 31 are as follows:
($ in millions)
Revenues
Property-Liability
Property-liability insurance premiums
Standard auto
$ 16,500
$ 16,530
$ 16,642
Non-standard auto
Total auto
17,299
17,435
17,608
Homeowners
6,200
6,078
6,077
Other personal lines
2,443
2,442
2,510
Allstate Protection
25,942
25,955
26,195
Discontinued Lines and Coverages
-
(1 )
Total property-liability insurance premiums
25,942
25,957
26,194
Net investment income
1,201
1,189
1,328
Realized capital gains and losses
(321 )
(168 )
Total Property-Liability
27,228
26,825
27,354
Allstate Financial
Life and annuity premiums and contract charges
Traditional life insurance
Immediate annuities with life contingencies
Accident and health insurance
Total life and annuity premiums
1,190
1,138
Interest-sensitive life insurance
1,015
Fixed annuities
Total contract charges
1,048
1,030
Total life and annuity premiums and contract charges
2,238
2,168
1,958
Net investment income
2,716
2,853
3,064
Realized capital gains and losses
(517 )
(431 )
Total Allstate Financial
5,342
4,504
4,591
Corporate and Other
Service fees
Net investment income
Realized capital gains and losses
Total Corporate and Other before reclassification of service fees
Reclassification of service fees (1)
(7 )
(11 )
(9 )
Total Corporate and Other
Consolidated revenues
$ 32,654
$ 31,400
$ 32,013
(1)For presentation in the Consolidated Statements of Operations, service fees of the Corporate and Other segment are reclassified to operating costs and expenses.
Summarized financial performance data for each of the Company's reportable segments for the years ended December 31 are as follows:
($ in millions)
Net income
Property-Liability
Underwriting (loss) income
Allstate Protection
$ (849 ) $
$ 1,027
Discontinued Lines and Coverages
(25 )
(31 )
(32 )
Total underwriting (loss) income
(874 )
Net investment income
1,201
1,189
1,328
Income tax benefit (expense) on operations
(426 )
(558 )
Realized capital gains and losses, after-tax
(207 )
(222 )
Gain on disposition of operations, after-tax
-
-
Property-Liability net income
1,054
1,543
Allstate Financial
Life and annuity premiums and contract charges
2,238
2,168
1,958
Net investment income
2,716
2,853
3,064
Periodic settlements and accruals on non-hedge derivative instruments
Contract benefits and interest credited to contractholder funds
(3,378 )
(3,613 )
(3,655 )
Operating costs and expenses and amortization of deferred policy acquisition costs
(865 )
(755 )
(867 )
Restructuring and related charges
(1 )
(25 )
Income tax expense on operations
(251 )
(231 )
(149 )
Operating income
Realized capital gains and losses, after-tax
(337 )
(417 )
Valuation changes on embedded derivatives that are not hedged, after-tax
(12 )
-
-
DAC and DSI amortization related to realized capital gains and losses and valuation changes on embedded derivatives that are not hedged, after-tax
(127 )
(34 )
(177 )
DAC and DSI unlocking related to realized capital gains and losses, after-tax
(18 )
(224 )
Reclassification of periodic settlements and accruals on non-hedge derivative instruments, after-tax
(45 )
(33 )
(9 )
(Loss) gain on disposition of operations, after-tax
(10 )
Allstate Financial net income (loss)
(483 )
Corporate and Other
Service fees (1)
Net investment income
Operating costs and expenses (1)
(403 )
(390 )
(419 )
Income tax benefit on operations
Operating loss
(216 )
(191 )
(217 )
Realized capital gains and losses, after-tax
Business combination expenses, after-tax
(10 )
-
-
Corporate and Other net loss
(206 )
(184 )
(206 )
Consolidated net income
$
$
$
(1)For presentation in the Consolidated Statements of Operations, service fees of the Corporate and Other segment are reclassified to operating costs and expenses.
Additional significant financial performance data for each of the Company's reportable segments for the years ended December 31 are as follows:
($ in millions)
Amortization of DAC
Property-Liability
$ 3,640
$ 3,678
$ 3,789
Allstate Financial
Consolidated
$ 4,233
$ 4,034
$ 4,754
Income tax expense
Property-Liability
$
$
$
Allstate Financial
(82 )
Corporate and Other
(118 )
(124 )
(136 )
Consolidated
$
$
$
Interest expense is primarily incurred in the Corporate and Other segment. Capital expenditures for long-lived assets are generally made in the Property-Liability segment. A portion of these long-lived assets are used by entities included in the Allstate Financial and Corporate and Other segments and, accordingly, are charged expenses in proportion to their use.
Summarized data for total assets and investments for each of the Company's reportable segments as of December 31 are as follows:
($ in millions)
Assets
Property-Liability
$ 49,833
$ 47,573
$ 47,179
Allstate Financial
72,854
79,069
81,968
Corporate and Other
2,876
4,232
3,505
Consolidated
$ 125,563
$ 130,874
$ 132,652
Investments
Property-Liability
$ 35,998
$ 35,048
$ 34,526
Allstate Financial
57,373
61,582
62,216
Corporate and Other
2,247
3,853
3,091
Consolidated
$ 95,618
$ 100,483
$ 99,833
The balances above reflect the elimination of related party investments between segments.
20. Other Comprehensive Income
The components of other comprehensive income on a pre-tax and after-tax basis for the years ended December 31 are as follows:
($ in millions)
Pre-
tax
Tax
After-
tax
Pre-
tax
Tax
After-
tax
Pre-
tax
Tax
After-
tax
Unrealized net holding gains arising during the period, net of related offsets
$ 1,455
$ (510 ) $
$ 2,523
$ (882 ) $ 1,641
$ 5,015
$ (1,754 ) $ 3,261
Less: reclassification adjustment of realized capital gains and losses
(278 )
(221 )
(144 )
(284 )
(185 )
Unrealized net capital gains and losses
(232 )
2,744
(959 )
1,785
5,299
(1,853 )
3,446
Unrealized foreign currency translation adjustments
(18 )
(12 )
(12 )
(22 )
Unrecognized pension and other postretirement benefit cost
(371 )
(239 )
(48 )
(292 )
(214 )
Other comprehensive income
$
$ (94 ) $
$ 2,921
$ (1,019 ) $ 1,902
$ 5,070
$ (1,797 ) $ 3,273
21. Quarterly Results (unaudited)
($ in millions, except per share data)
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Revenues
$ 8,095
$ 7,749
$ 8,081
$ 7,656
$ 8,242
$ 7,908
$ 8,236
$ 8,087
Net income (loss)
(620 )
Net income (loss) earnings per share - Basic
0.98
0.22
(1.19 )
0.27
0.32
0.68
1.44
0.55
Net income (loss) earnings per share - Diluted
0.97
0.22
(1.19 )
0.27
0.32
0.68
1.43
0.55
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
The Allstate Corporation
Northbrook, IL 60062
We have audited the accompanying Consolidated Statements of Financial Position of The Allstate Corporation and subsidiaries (the "Company") as of December 31, 2011 and 2010, and the related Consolidated Statements of Operations, Comprehensive Income, Shareholders' Equity, and Cash Flows for each of the three years in the period ended December 31, 2011. We also have audited the Company's internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A. Controls and Procedures. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Allstate Corporation and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In 2009, the Company changed its recognition and presentation for other-than-temporary impairments of debt securities.
/s/ Deloitte & Touche LLP
Chicago, Illinois
February 22, 2012
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon this evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures are effective in providing reasonable assurance that material information required to be disclosed in our reports filed with or submitted to the Securities and Exchange Commission under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities Exchange Act and made known to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Management's Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2011 based on the criteria related to internal control over financial reporting described in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2011.
Deloitte & Touche LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Form 10-K, has issued their attestation report on the Company's internal control over financial reporting, which is included herein.
Changes in Internal Control over Financial Reporting. During the fiscal quarter ended December 31, 2011, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Information regarding directors of The Allstate Corporation standing for election at the 2012 annual stockholders meeting is incorporated in this Item 10 by reference to the descriptions in the Proxy Statement under the captions "Management Proposals - Proposal 1. Election of Directors."
Information regarding our audit committee and audit committee financial experts is incorporated in this Item 10 by reference to the chart under the captions "Corporate Governance Practices and Code of Ethics - Board Meetings and Committees" in the Proxy Statement.
Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated in this Item 10 by reference to "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.
Information regarding executive officers of The Allstate Corporation is incorporated in this Item 10 by reference to Part I, Item 1 of this report under the caption "Executive Officers."
We have adopted a code of ethics that applies to all of our employees, including our principal executive officer, principal financial officer, and controller. The text of our code of ethics is posted on our Internet website, allstate.com.
Item 11. Executive Compensation
Information required for Item 11 is incorporated by reference to the sections of the Proxy Statement with the following captions:
•Corporate Governance Practices and Code of Ethics - Compensation Committee Interlocks and Insider Participation
•Director Compensation
•Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management is incorporated in this Item 12 by reference to the sections of the Proxy Statement with the following captions:
•Security Ownership of Directors and Executive Officers
•Security Ownership of Certain Beneficial Owners
Equity Compensation Plan Information
The following table includes information as of December 31, 2011 with respect to The Allstate Corporation's equity compensation plans:
Plan Category
Number of Securities to
be Issued upon Exercise
of Outstanding Options,
Warrants and Rights
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
Number of Securities
Remaining Available for
Future Issuance under
Equity Compensation
Plans (Excluding
Securities Reflected in
Column (a))
(a)
(b)
(c)
Equity Compensation Plans Approved by Security Holders (1)
38,272,921 (2) $ 34.59
19,231,792 (3)
Total
38,272,921
(2)
$
34.59
19,231,792
(3)
(1)Consists of the 2009 Equity Incentive Plan, which amended and restated the 2001 Equity Incentive Plan; the Equity Incentive Plan for Non-Employee Directors; and the 2006 Equity Compensation Plan for Non-Employee Directors. (2)Outstanding restricted stock units ("RSUs") convert to common stock without the payment of consideration. As of December 31, 2011, 4,325,572 RSUs were outstanding. The weighted-average exercise price of outstanding options, warrants, and rights excluding RSUs was $39.00. (3)Includes 18,970,528 shares that may be issued in the form of stock options, unrestricted stock, restricted stock, restricted stock units, stock appreciation rights, performance units, performance stock, and stock in lieu of cash under the 2009 Equity Incentive Plan; and 261,264 shares that may be issued in the form of stock options, unrestricted stock, restricted stock, restricted stock units, and stock in lieu of cash compensation under the 2006 Equity Compensation Plan for Non-Employee Directors.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information required for Item 13 is incorporated by reference to the material in the Proxy Statement under the captions "Corporate Governance Practices and Code of Ethics - Related Person Transactions" and "Corporate Governance Practices and Code of Ethics - Nominee Independence Determinations."
Item 14. Principal Accounting Fees and Services
Information required for Item 14 is incorporated by reference to the material in the Proxy Statement under the captions "Management Proposals - Proposal 5. Ratification of Appointment of Independent Registered Public Accountant."
Part IV
Item 15. (a) (1) Exhibits and Financial Statement Schedules.
The following consolidated financial statements, notes thereto and related information of The Allstate Corporation (the "Company") are included in Item 8.
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Financial Position
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Quarterly Results
Report of Independent Registered Public Accounting Firm
Item 15. (a) (2)
The following additional financial statement schedules and independent auditors' report are furnished herewith pursuant to the requirements of Form 10-K.
The Allstate Corporation
Page
Schedules required to be filed under the provisions of Regulation S-X Article 7:
Schedule I
Summary of Investments - Other than Investments in Related Parties
S-1
Schedule II
Condensed Financial Information of Registrant (The Allstate Corporation)
S-2
Schedule III
Supplementary Insurance Information
S-6
Schedule IV
Reinsurance
S-7
Schedule V
Valuation Allowances and Qualifying Accounts
S-8
Schedule VI
Supplementary Information Concerning Consolidated Property-Casualty Insurance Operations
S-9
Report of Independent Registered Public Accounting Firm
S-10
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or in notes thereto.
Item 15. (a) (3)
The following is a list of the exhibits filed as part of this Form 10-K. The exhibit numbers followed by an asterisk (*) indicate exhibits that are management contracts or compensatory plans or arrangements. A dagger () indicates an award form first used under The Allstate Corporation 2001 Equity Incentive Plan, which was amended and restated as The Allstate Corporation 2009 Equity Incentive Plan. The SEC File Number for the exhibits incorporated by reference is 1-11840.
3(i)
Amended and Restated Certificate of Incorporation filed with the Secretary of State of Delaware on May 18, 2011, incorporated herein by reference to Exhibit 3(i) to The Allstate Corporation current report on Form 8-K filed May 18, 2011
3(ii)
Amended and Restated By-Laws of The Allstate Corporation effective May 18, 2011, incorporated herein by reference to Exhibit 3(ii) to The Allstate Corporation current report on Form 8-K filed May 18,
4(iii)
The Allstate Corporation hereby agrees to furnish to the Commission, upon request, the instruments defining the rights of holders of each issue of long-term debt of it and its consolidated subsidiaries
10.1
Credit Agreement dated May 8, 2007, among The Allstate Corporation, Allstate Insurance Company and Allstate Life Insurance Company, as Borrowers; the Lenders party thereto, Wells Fargo Bank, National Association, as Syndication Agent; Bank of America, N.A. and Citibank, N.A., as Documentation Agents; Barclays Bank, PLC, Morgan Stanley Bank and William Street Commitment Corporation, as Co-Agents; and JPMorgan Chase Bank, N.A., as Administrative Agent; incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed May 9, 2007
10.2
Amendment No. 1 to Credit Agreement dated as of May 22, 2008, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed May 27, 2008
10.3*
The Allstate Corporation Annual Executive Incentive Plan incorporated herein by reference to Appendix B of The Allstate Corporation's Proxy Statement filed April 1, 2009
10.4*
The Allstate Corporation Deferred Compensation Plan, as amended and restated as of January 1, 2011
10.5*
The Allstate Corporation 2009 Equity Incentive Plan, as amended and restated effective February 22, 2011, incorporated herein by reference to Exhibit 10.4 to The Allstate Corporation annual report on Form 10-K for 2010
10.6*
Form of Option Award Agreement for awards granted on or after December 30, 2011 under The Allstate Corporation 2009 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.2 to The Allstate Corporation current report on Form 8-K filed on December 28, 2011
10.7*
Form of Option Award Agreement for awards granted on or after February 22, 2011 and prior to December 30, 2011 under The Allstate Corporation 2009 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.3 to The Allstate Corporation quarterly report on Form 10-Q for the quarter ended March 31, 2011
10.8*
Form of Option Award Agreement for awards granted on or after May 19, 2009 and prior to February 22, 2011 under The Allstate Corporation 2009 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.3 to The Allstate Corporation current report on Form 8-K/A filed May 20, 2009
10.9* 
Form of Option Award Agreement for awards granted on or after September 13, 2008 and prior to May 19, 2009 under The Allstate Corporation 2001 Equity Incentive Plan incorporated herein by reference to Exhibit 10.3 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.10* 
Form of Executive Officer Option Award Agreement for awards granted on or after July 18, 2006 and prior to September 13, 2008 under The Allstate Corporation 2001 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed July 20, 2006
10.11* 
Form of Executive Officer Option Award Agreement under The Allstate Corporation 2001 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.19 to The Allstate Corporation annual report on Form 10-K for 2003
10.12*
Form of Restricted Stock Unit Award Agreement for awards granted on or after December 30, 2011 under The Allstate Corporation 2009 Equity Incentive Plan incorporated herein by reference to Exhibit 10.3 to The Allstate Corporation current report on Form 8-K filed on December 28, 2011
10.13*
Form of Restricted Stock Unit Award Agreement for awards granted on or after February 22, 2011 and prior to December 30, 2011 under The Allstate Corporation 2009 Equity Incentive Plan incorporated herein by reference to Exhibit 10.4 to The Allstate Corporation quarterly report on Form 10-Q for the quarter ended March 31, 2011
10.14*
Form of Restricted Stock Unit Award Agreement for awards granted on or after February 22, 2010 and prior to February 22, 2011 under The Allstate Corporation 2009 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.17 to The Allstate Corporation annual report on Form 10-K for 2009
10.15* 
Form of amended and restated Restricted Stock Unit Award Agreement for certain retirement eligible/retired employees with regards to awards outstanding on September 13, 2008 under The Allstate Corporation 2001 Equity Incentive Plan, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.16* 
Form of Restricted Stock Unit Award Agreement for awards granted on or after September 13, 2008 and prior to February 22, 2010 under The Allstate Corporation 2001 Equity Incentive Plan incorporated herein by reference to Exhibit 10.2 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.17*
Supplemental Retirement Income Plan, as amended and restated effective November 30, 2011
10.18*
Form of Amended and Restated Tier Two Change of Control Employment Agreement effective as of December 31, 2008, incorporated herein by reference to Exhibit 10.23 to The Allstate Corporation annual report on Form 10-K for 2008
10.19*
The Allstate Corporation Change in Control Severance Plan effective December 30, 2011, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed December 28, 2011
10.20*
Offer letter dated September 9, 2007 to Michele C. Mayes incorporated herein by reference to Exhibit 10 to The Allstate Corporation quarterly report on Form 10-Q for the quarter ended March 31,
10.21*
The Allstate Corporation Deferred Compensation Plan for Non-Employee Directors, as amended and restated effective September 15, 2008, incorporated herein by reference to Exhibit 10.7 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.22*
The Allstate Corporation Equity Incentive Plan for Non-Employee Directors as amended and restated effective September 15, 2008, incorporated herein by reference to Exhibit 10.5 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.23*
The Allstate Corporation 2006 Equity Compensation Plan for Non-Employee Directors, as amended and restated effective September 15, 2008, incorporated herein by reference to Exhibit 10.6 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.24*
Form of Option Award Agreement under The Allstate Corporation 2006 Equity Compensation Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.3 to The Allstate Corporation current report on Form 8-K filed May 19, 2006
10.25*
Form of amended and restated Restricted Stock Unit Award Agreement with regards to awards outstanding on September 15, 2008 under The Allstate Corporation 2006 Equity Compensation Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.8 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.26*
Form of Restricted Stock Unit Award Agreement for awards granted on or after September 15, 2008 under The Allstate Corporation 2006 Equity Compensation Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.9 to The Allstate Corporation current report on Form 8-K filed September 19, 2008
10.27*
Form of Indemnification Agreement between the Registrant and Director incorporated herein by reference to Exhibit 10.2 to The Allstate Corporation quarterly report on Form 10-Q for the quarter ended June 30,
10.28*
Resolutions regarding Non-Employee Director Compensation, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation quarterly report on Form 10-Q for the quarter ended September 30,
10.29
Stock Purchase Agreement, dated as of May 17, 2011, between White Mountains Holdings (Luxembourg) S.à r.l. and The Allstate Corporation, incorporated herein by reference to Exhibit 10.1 to The Allstate Corporation current report on Form 8-K filed May 23, 2011. (Certain schedules and exhibits to the Stock Purchase Agreement are omitted pursuant to Item 601(b)(2) of Regulation S-K. The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any omitted schedule or exhibit.)
10.30
Guaranty Agreement, dated as of May 17, 2011, by White Mountains Insurance Group, Ltd. in favor of The Allstate Corporation, incorporated herein by reference to Exhibit 10.2 to The Allstate Corporation current report on Form 8-K filed May 23, 2011
10.31*
Voluntary Separation Agreement and Release between Joseph P. Lacher, Jr. and Allstate Insurance Company entered into on September 2, 2011, incorporated herein by reference to Exhibit 10 to The Allstate Corporation current report on Form 8-K filed September 2, 2011
Computation of Earnings to Fixed Charges Ratio
The Allstate Code of Ethics incorporated herein by reference to Exhibit 14 to The Allstate Corporation current report on Form 8-K filed May 18, 2011
Subsidiaries of The Allstate Corporation
Consent of Independent Registered Public Accounting Firm
31 (i)
Rule 13a-14(a) Certification of Principal Executive Officer
31 (i)
Rule 13a-14(a) Certification of Principal Financial Officer
Section 1350 Certifications
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
XBRL Taxonomy Extension Definition Linkbase
101.LAB
XBRL Taxonomy Extension Label Linkbase
101.PRE
XBRL Taxonomy Extension Presentation Linkbase
Item 15. (b)
The exhibits are listed in Item 15. (a)(3) above.
Item 15. (c)
The financial statement schedules are listed in Item 15. (a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE ALLSTATE CORPORATION
(Registrant)
/s/ Samuel H. Pilch
By: Samuel H. Pilch
(Senior Group Vice President and Controller)
February 21, 2012
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Thomas J. Wilson
Thomas J. Wilson
Chairman of the Board, President, Chief Executive Officer
and a Director (Principal Executive Officer)
February 21, 2012
/s/ Don Civgin
Don Civgin
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
February 21, 2012
/s/ F. Duane Ackerman
F. Duane Ackerman
Director
February 21, 2012
/s/ Robert D. Beyer
Robert D. Beyer
Director
February 21, 2012
/s/ W. James Farrell
W. James Farrell
Director
February 21, 2012
/s/ Jack M. Greenberg
Jack M. Greenberg
Director
February 21, 2012
/s/ Ronald T. LeMay
Ronald T. LeMay
Director
February 21, 2012
/s/ Andrea Redmond
Andrea Redmond
Director
February 21, 2012
/s/ H. John Riley, Jr.
H. John Riley, Jr.
Lead Director
February 21, 2012
/s/ Joshua I. Smith
Joshua I. Smith
Director
February 21, 2012
/s/ Judith A. Sprieser
Judith A. Sprieser
Director
February 21, 2012
/s/ Mary Alice Taylor
Mary Alice Taylor
Director
February 21, 2012
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2011
($ in millions)
Cost/
amortized
cost
Fair
value
Amount at
which shown
in the
Balance Sheet
Type of investment
Fixed maturities:
Bonds:
United States government, government agencies and authorities
$ 5,966
$ 6,315
$ 6,315
States, municipalities and political subdivisions
13,634
14,241
14,241
Foreign governments
1,866
2,081
2,081
Public utilities
7,175
7,855
7,855
Convertibles and bonds with warrants attached
All other corporate bonds
33,346
35,175
35,175
Asset-backed securities
4,180
3,966
3,966
Residential mortgage-backed securities
4,532
4,121
4,121
Commercial mortgage-backed securities
1,962
1,784
1,784
Redeemable preferred stocks
Total fixed maturities
73,379
$ 76,113
76,113
Equity securities:
Common stocks:
Public utilities
$
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
3,654
3,809
3,809
Nonredeemable preferred stocks
Total equity securities
4,203
$ 4,363
4,363
Mortgage loans on real estate
7,139
$ 7,350
7,139
Real estate acquired in satisfaction of debt
Policy loans
1,151
1,151
Derivative instruments
$
Limited partnership interests
4,697
4,697
Other long-term investments
Short-term investments
1,291
$ 1,291
1,291
Total investments
$ 92,729
$ 95,618
S-1
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE II -
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
Year Ended December 31,
($ in millions)
Revenues
Investment income, less investment expense
$
$
$
Realized capital gains and losses
(1 )
Other income
Expenses
Interest expense
Other operating expenses
Loss from operations before income tax benefit and equity in net income of subsidiaries
(375
)
(363
)
(375
)
Income tax benefit
(135
)
(135
)
(144
)
Loss before equity in net income of subsidiaries
(240 )
(228 )
(231 )
Equity in net income of subsidiaries
1,028
1,156
1,085
Net income
Other comprehensive income , after-tax
Changes in:
Unrealized net capital gains and losses
1,785
3,446
Unrealized foreign currency translation adjustments
(12 )
Unrecognized pension and other postretirement benefit cost
(239 )
(214 )
Other comprehensive income, after-tax
1,902
3,273
Comprehensive income
$
$ 2,830
$ 4,127
See accompanying notes to condensed financial information and notes to consolidated financial statements.
S-2
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE II (CONTINUED) -
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF FINANCIAL POSITION
($ in millions, except par value data)
December 31,
Assets
Investments in subsidiaries
$ 25,036
$ 22,806
Fixed income securities, at fair value (amortized cost $446 and $809)
Short-term investments, at fair value (amortized cost $148 and $1,428)
1,428
Cash
-
Receivable from subsidiaries
Other assets
Total assets
$ 26,503
$ 25,662
Liabilities
Long-term debt
$ 5,850
$ 5,850
Pension and other postretirement benefit obligations
1,571
Deferred compensation
Dividends payable to shareholders
Other liabilities
Total liabilities
7,829
6,646
Shareholders' equity
Preferred stock, $1 par value, 25 million shares authorized, none issued
-
-
Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 501 million and 533 million shares outstanding
Additional capital paid-in
3,189
3,176
Retained income
32,321
31,969
Deferred ESOP expense
(43 )
(44 )
Treasury stock, at cost (399 million and 367 million shares)
(16,795 )
(15,910 )
Accumulated other comprehensive income:
Unrealized net capital gains and losses
1,363
Unrealized foreign currency translation adjustments
Unrealized pension and other postretirement benefit cost
(1,427 )
(1,188 )
Total accumulated other comprehensive loss
(7 )
(184 )
Total shareholders' equity
18,674
19,016
Total liabilities and equity
$ 26,503
$ 25,662
See accompanying notes to condensed financial information and notes to consolidated financial statements.
S-3
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE II (CONTINUED) -
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
Year Ended December 31,
($ in millions)
Cash flows from operating activities
Net income
$
$
$
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in net income of subsidiaries
(1,028 )
(1,156 )
(1,085 )
Dividends received from subsidiaries
1,384
Realized capital gains and losses
(28 )
-
Other operating assets and liabilities
Net cash provided by operating activities
1,259
Cash flows from investing activities
Proceeds from sales and collections of investments
1,045
Investment purchases
(653 )
(219 )
(858 )
Capital contributions to subsidiaries
-
-
(267 )
Return of investment
-
Change in short-term investments, net
1,282
(696 )
1,159
Acquisition of subsidiary, net
(1,009 )
-
-
Net cash provided by (used in) investing activities
(698 )
Cash flows from financing activities
Repayment of long-term debt
-
-
(750 )
Proceeds from issuance of long-term debt
-
-
1,000
Dividends paid to shareholders
(435 )
(430 )
(542 )
Treasury stock purchases
(953 )
(152 )
(4 )
Shares reissued under equity incentive plans, net
Excess tax benefits on share-based payment arrangements
(5 )
(7 )
(5 )
Net cash used in financing activities
(1,374 )
(561 )
(298 )
Net increase in cash
-
-
Cash at beginning of year
-
-
-
Cash at end of year
$
$ -
$ -
See accompanying notes to condensed financial information and notes to consolidated financial statements.
S-4
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE II (CONTINUED) -
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL INFORMATION
1. General
The financial statements of the Registrant should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8. The long-term debt presented in Note 12 "Capital Structure" are direct obligations of the Registrant, with the exception of the following obligations as of December 31:
($ in millions)
Long-term:
Federal Home Loan Bank ("FHLB") advances, due 2018
$
$
Synthetic lease VIE obligations, floating rates, due 2014
A majority of the pension and other postretirement benefits plans presented in Note 17 "Benefit Plans" are direct obligations of the Registrant. Effective November 30, 2011, the Registrant became the sponsor of a majority of the pension benefit plans presented in Note 17. Prior to November 30, 2011, a subsidiary of the Registrant was the sponsor of these plans.
2. Supplemental Disclosures of Non-Cash Investing Activity and Cash Flow Information
The Registrant's assumption of the obligations associated with the pension benefit plans previously sponsored by a subsidiary of the Registrant resulted in a non-cash decrease in the Registrant's investment in subsidiaries of $713 million, after-tax in 2011.
The Registrant paid $360 million, $360 million and $380 million of interest on debt in 2011, 2010 and 2009, respectively.
S-5
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
($ in millions)
As of December 31,
For the year ended December 31,
Segment
Deferred
policy
acquisition
costs
Reserves
for claims and
claims expense,
contract
benefits and
contractholder
funds
Unearned
premiums
Premium
revenue
and
contract
charges
Net
investment
income (1)
Claims and
claims
expense, contract
benefits and
interest
credited to
contractholders
Amortization
of deferred
policy
acquisition
costs
Other
operating
costs
and
expenses
Premiums
written
(excluding
life)
Property-Liability operations
Allstate Protection
$ 1,412
$ 18,042
$ 10,023
$ 25,942
$ 20,140
$ 3,640
$ 3,011
$ 25,981
Discontinued Lines and Coverages
-
2,333
-
-
-
(1 )
Total Property-Liability
1,412
20,375
10,023
25,942
$ 1,201
20,161
3,640
3,015
25,980
Allstate Financial operations
3,031
56,781
2,238
2,716
3,406
Corporate and Other
-
-
-
-
-
-
-
Total
$ 4,443
$ 77,156
$ 10,057
$ 28,180
$ 3,971
$ 23,567
$ 4,233
$ 3,879
$ 26,627
Property-Liability operations
Allstate Protection
$ 1,377
$ 17,046
$ 9,761
$ 25,955
$ 18,923
$ 3,678
$ 2,828
$ 25,906
Discontinued Lines and Coverages
-
2,422
-
-
Total Property-Liability
1,377
19,468
9,761
25,957
$ 1,189
18,951
3,678
2,833
25,907
Allstate Financial operations
3,392
61,677
2,168
2,853
3,622
Corporate and Other
-
-
-
-
-
-
-
Total
$ 4,769
$ 81,145
$ 9,800
$ 28,125
$ 4,102
$ 22,573
$ 4,034
$ 3,678
$ 26,531
Property-Liability operations
Allstate Protection
$ 1,410
$ 16,574
$ 9,780
$ 26,195
$ 18,722
$ 3,789
$ 2,657
$ 25,972
Discontinued Lines and Coverages
-
2,593
-
(1 )
-
(1 )
Total Property-Liability
1,410
19,167
9,780
26,194
$ 1,328
18,746
3,789
2,664
25,971
Allstate Financial operations
4,060
65,492
1,958
3,064
3,743
Corporate and Other
-
-
-
-
-
-
-
Total
$ 5,470
$ 84,659
$ 9,822
$ 28,152
$ 4,444
$ 22,489
$ 4,754
$ 3,529
$ 26,436
(1)A single investment portfolio supports both Allstate Protection and Discontinued Lines and Coverages segments.
S-6
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
($ in millions)
Gross
amount
Ceded to
other
companies (1)
Assumed
from other
companies
Net
amount
Percentage
of amount
assumed
to net
Year ended December 31, 2011
Life insurance in force
$ 519,639
$ 222,379
$ 9,137
$ 306,397
3.0 %
Premiums and contract charges:
Life insurance
$ 2,177
$
$
$ 1,595
2.2 %
Accident-health insurance
-
- %
Property-liability insurance
27,016
1,098
25,942
0.1 %
Total premiums and contract charges
$ 29,969
$ 1,848
$
$ 28,180
0.2 %
Year ended December 31, 2010
Life insurance in force
$ 523,214
$ 238,745
$ 9,680
$ 294,149
3.3 %
Premiums and contract charges:
Life insurance
$ 2,170
$
$
$ 1,547
2.3 %
Accident-health insurance
0.2 %
Property-liability insurance
27,015
1,092
25,957
0.1 %
Total premiums and contract charges
$ 29,950
$ 1,896
$
$ 28,125
0.3 %
Year ended December 31, 2009
Life insurance in force
$ 525,381
$ 253,650
$ 10,230
$ 281,961
3.6 %
Premiums and contract charges:
Life insurance
$ 2,142
$
$
$ 1,498
2.5 %
Accident-health insurance
0.2 %
Property-liability insurance
27,200
1,056
26,194
0.2 %
Total premiums and contract charges
$ 29,957
$ 1,894
$
$ 28,152
0.3 %
(1)No reinsurance or coinsurance income was netted against premium ceded in 2011, 2010 or 2009.
S-7
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE V - VALUATION ALLOWANCES AND QUALIFYING ACCOUNTS
($ in millions)
Additions
Description
Balance at
beginning
of period
Charged
to costs
and expenses
Other
additions
Deductions
Balance
at end
of period
Year ended December 31, 2011
Allowance for reinsurance recoverables
$
$ -
$ -
$
$
Allowance for premium installment receivable
-
Allowance for deferred tax assets
-
Allowance for estimated losses on mortgage loans
-
Year ended December 31, 2010
Allowance for reinsurance recoverables
$
$ -
$ -
$ -
$
Allowance for premium installment receivable
-
Allowance for deferred tax assets
-
-
Allowance for estimated losses on mortgage loans
-
Year ended December 31, 2009
Allowance for reinsurance recoverables
$
$ -
$ -
$
$
Allowance for premium installment receivable
-
Allowance for deferred tax assets
-
Allowance for estimated losses on mortgage loans
-
S-8
THE ALLSTATE CORPORATION AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY INFORMATION CONCERNING
CONSOLIDATED PROPERTY-CASUALTY INSURANCE OPERATIONS
($ in millions)
As of December 31,
Deferred policy acquisition costs
$ 1,412
$ 1,377
$ 1,410
Reserves for insurance claims and claims expense
20,375
19,468
19,167
Unearned premiums
10,023
9,761
9,780
Year Ended December 31,
Earned premiums
$ 25,942
$ 25,957
$ 26,194
Net investment income
1,201
1,189
1,328
Claims and claims adjustment expense incurred
Current year
20,496
19,110
18,858
Prior years
(335 )
(159 )
(112 )
Amortization of deferred policy acquisition costs
3,640
3,678
3,789
Paid claims and claims adjustment expense
20,195
18,583
18,900
Premiums written
25,980
25,907
25,971
S-9
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Allstate Corporation
Northbrook, IL 60062
We have audited the consolidated financial statements of The Allstate Corporation and subsidiaries (the "Company") as of December 31, 2011 and 2010, and for each of the three years in the period ended December 31, 2011, and the Company's internal control over financial reporting as of December 31, 2011, and have issued our report thereon dated February 22, 2012 (which report expresses an unqualified opinion and includes an explanatory paragraph relating to a change in the Company's recognition and presentation for other-than-temporary impairments of debt securities in 2009); such consolidated financial statements and report are included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedules of the Company listed in the accompanying index at Item 15. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
Chicago, Illinois
February 22, 2012
S-10