Allstate (ALL)

Investment Risk Mitigation and Return Optimization

As we concluded the third quarter of 2008, we modified our outlook to a more severe and prolonged downturn in the global financial markets and economy, which represents a significant change from our assessment of the economy in the second quarter.  We expect continued volatility in the financial markets, significantly reduced liquidity in certain asset classes and unfavorable economic trends.  In addition, the potential for systemic investment supply and demand imbalances has remained above normal due to the deteriorating credit strength of financial institutions and eroding investor confidence.

During the third quarter, reflecting decisions made and reported at the end of the second quarter, we pursued risk mitigation and return optimization programs to protect portfolio value. As part of these programs, hedges were implemented during the third quarter to mitigate portfolio interest rate risk, credit spread risk, and equity market valuation declines. These performed as intended.  Our equity market portfolio hedge, for example, helped mitigate the impact of a 9% market decline on a large portion of our publicly traded equities portfolio. As of June 30, 2008, we held $8.2 billion of investments for which we had changed our intent to hold to recovery. These investments included $1.8 billion of equity securities effectively carried on a lower of cost or fair value basis due to the nature of the investment management style employed.  Excluding these equity securities, investments for which we changed our intent to hold to recovery as of June 30, 2008 totaled $6.4 billion and included $3.3 billion that we believed to be vulnerable to significant additional credit and pricing pressures, $2.4 billion of securities to be sold in connection with our EAA program and $688 million related to individual securities.  During the third quarter of 2008, we sold $2.7 billion of these securities and total investments for which we changed our intent to hold to recovery totaled $3.9 billion as of September 30, 2008, excluding equity securities carried on a lower of cost or fair value basis.

As a part of our risk mitigation and return optimization activities, we have taken the following actions:

·                  Developed a tactical positioning in liquid assets and assets that we can sell without significant loss. See Liquidity and Capital Management section of this document for more detail.

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

·                  Our exposure to financial-related market sectors decreased to $10.3 billion as of September 30, 2008 from $14.3 billion as of December 31, 2007, primarily as a result of targeted sales and declines in fair value.

·                  Our exposure to residential and commercial real estate market sectors decreased to $24.8 billion as of September 30, 2008 from $31.5 billion as of December 31, 2007 as a result of targeted sales and declines in fair value.

·                  Reduced short-term investing in financial institutions.

·                  Reduced overall counterparty exposure, replacing OTC derivatives transactions used as stock market hedges with exchange traded instruments where available and, in one case, terminating a counterparty relationship.

·                  During the third quarter, we sold $592 million of government securities and recognized realized capital gains of $132 million.  In addition, through October 20, 2008, we sold government securities with a carrying value of $506 million on which we realized capital gains of $87 million.

We continue to monitor the progress of these programs as market and economic conditions develop and will adapt our decisions as appropriate.  Our continuing focus is to manage our risks and to position our portfolio to take advantage of market opportunities while attempting to mitigate further adverse effects consistent with our intent designation.

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