Allstate (ALL)

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 uses models that consider 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. We will continue to manage risks associated with rising interest rates, equity market declines, commercial real estate and municipal bonds.

       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 and to achieve an appropriate return on capital. Within the ranges set by the strategic asset allocation model, tactical investment decisions are made in consideration of prevailing market conditions.

       The Corporate and Other portfolio's investment strategy balances the pursuit of competitive returns with the unique liquidity needs of the portfolio in relation to the overall corporate capital structure. The portfolio is primarily invested in high quality, liquid fixed income and short-term securities with additional investments in less liquid holdings in order to enhance overall returns.

Investments

       Fixed income securities include bonds, asset-backed securities ("ABS"), residential mortgage-backed securities ("RMBS"), commercial mortgage-backed securities ("CMBS") 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 is reflected as a component of investment collections within the Consolidated Statements of Cash Flows.

       Equity securities primarily include common and non-redeemable preferred stocks and real estate investment trust equity investments. Common and non-redeemable preferred stocks and real estate investment trust equity investments are classified 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. Valuation allowances for impaired loans reduce the carrying value to the fair value of the collateral or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate.

       Investments in limited partnership interests, including interests in limited liability companies, private equity/debt funds, real estate funds and hedge 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; otherwise, investments in limited partnership interests are accounted for in accordance with the equity method of accounting.

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       Short-term investments, including money market funds, commercial paper and other short-term investments, are carried at fair value. Other investments consist primarily of policy loans and bank loans. Policy loans are carried at the respective unpaid principal balances. Bank loans are comprised primarily of senior secured corporate loans which are carried at amortized cost.

       Investment income consists primarily of interest and dividends, income from certain 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 asset-backed securities, residential mortgage-backed securities and commercial mortgage-backed securities is determined considering estimated principal repayments 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 all other asset-backed securities, residential mortgage-backed securities and commercial mortgage-backed securities, 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. Income from investments in limited partnership interests accounted for on the cost basis is recognized upon receipt of amounts distributed by the partnerships as investment income. Subsequent to October 1, 2008, income from investments in limited partnership interests accounted for utilizing the equity method of accounting ("EMA LP") is reported in realized capital gains and losses.

       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, periodic changes in the fair value and settlements of certain derivatives including hedge ineffectiveness, and income from certain limited partnership interests. Realized capital gains and losses on investment sales include calls and prepayments and are determined on a specific identification basis. Income from investments in limited partnership interests accounted for utilizing the equity method of accounting is recognized based on the financial results of the entity and the Company's proportionate investment interest, and is recognized on a delay due to the availability of the related financial statements. The recognition of income on hedge funds is generally on a one month delay and the income recognition on private equity/debt funds and real estate funds are generally on a three month delay.

       The Company recognizes other-than-temporary impairment losses on fixed income securities when the decline in fair value is deemed other than temporary including when 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 deemed to be related to other factors and recognized in other comprehensive income ("OCI"). Fixed income securities subject to other-than-temporary impairment write-downs continue to earn investment income when future expected payments are reasonably estimable, and any discount or premium is recognized using the effective yield method over the expected life of the security; otherwise income recognition is discontinued. The Company recognizes other-than-temporary impairment losses on equity securities when the decline in fair value is deemed other than temporary including when the Company does not have a positive intent and ability to hold an impaired security until recovery.

INVESTMENTS

        Overview and Strategy    An important component of our financial results is the return on our investment portfolios. 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.

        The global economy is under significant stress and financial markets continue to experience extreme levels of volatility. Our strategy in 2009 will focus primarily upon mitigating the risks from a potential increase in risk-free interest rates, reducing exposure to certain investment sectors, and maintaining sufficient liquidity and capital. In order to achieve this, we expect to use a combination of reinvestment of the portfolio's significant cash flows, derivatives and other portfolio actions.

        The Property-Liability portfolio's investment strategy emphasizes safety 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. We employ a strategic asset allocation approach, which uses models that consider 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. The recommended asset allocation is informed by our economic and market outlook, as well as other inputs and constraints, including duration, liquidity and capital considerations.

        The Allstate Financial portfolio's investment strategy focuses on the total return of assets needed to support the underlying liabilities to achieve return on capital and profitable growth. The portfolio management process begins with a strategic asset allocation model which considers the nature and risk tolerances of the liabilities and risk tolerances, as well as the risk and return parameters, of the various asset classes in which we invest. This approach is informed by our economic and market outlook, as well as other inputs and constraints including duration, liquidity and capital preservation. Within the ranges set by the strategic asset allocation model, tactical investment decisions are made in consideration of prevailing market conditions.

        The Corporate and Other portfolio's investment strategy balances the pursuit of competitive returns with the unique liquidity needs of the portfolio relative to the overall corporate capital structure. The portfolio is primarily invested in high quality, liquid fixed income and short-term securities with additional investments in less liquid holdings in order to enhance overall returns.

        As a result of decisions in managing each of the portfolios, we may sell securities during a period in which fair value has declined below amortized cost for fixed income securities or cost for equity securities. For more information, see the Net Realized Capital Gains and Losses section of the MD&A.

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        During 2008, we developed risk mitigation and return optimization programs as our outlook on the economy changed significantly as conditions deteriorated throughout the year. The risk mitigation and return optimization programs augment earlier actions to reduce investments in real estate and other market sectors as well as to mitigate exposures to risk-free interest rate spikes. At the end of the second quarter of 2008, we had an outlook for continued weakness in the global financial markets and economy including continued volatility in the financial markets, reduced liquidity in certain asset classes and unfavorable economic trends. During the third quarter of 2008, we significantly modified our outlook to a more severe and prolonged downturn. We continue to expect extreme levels of volatility in the financial markets, suppressed liquidity in certain asset classes and further unfavorable global economic conditions. In addition, the potential for market supply and demand imbalances has remained above normal due to the deteriorating credit strength of financial institutions and eroding investor confidence.

        Among our risk mitigation and return optimization activities, we have taken the following actions:

•

Developed and maintained a tactical positioning in liquid assets and assets that we can sell without generating significant additional realized capital losses.



•

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.



•

Decreased exposure to financial-related market sectors to $7.69 billion as of December 31, 2008 from $14.45 billion as of December 31, 2007, primarily as a result of targeted sales and declines in fair value. Also reduced our short-term investing in financial institutions.



•

Decreased exposure to residential and commercial real estate market sectors to $22.00 billion as of December 31, 2008 from $31.54 billion as of December 31, 2007 as a result of targeted sales, principal payments and declines in fair value.



•

Reduced overall counterparty exposure replacing over-the-counter ("OTC") derivatives transactions used as stock market hedges with exchange-traded instruments where available.



•

In the second half of 2008, we sold $1.67 billion of government securities and recognized realized capital gains of $241 million.



•

Generated losses as part of tax planning strategy primarily within our equity portfolios that are effectively carried on a lower of cost or fair value basis to realize capital loss carryback benefits.

        Investments for which we had changed our intent to hold to recovery as of June 30, 2008 totaled $6.39 billion and included $3.31 billion as part of the risk mitigation and return optimization programs, $2.39 billion of securities as part of our enterprise-wide asset allocation program and $688 million related to individual securities. A risk mitigation and return optimization program, approved as of the end of the second quarter of 2008, was designed to reduce our exposure to residential and commercial real estate and the financial-related market sector by approximately $4 billion of amortized cost, prior to change in intent write-downs. A comprehensive review identified specific investments that could be significantly impacted by continued deterioration in the economy that may be sold. This included a portion of our residential and commercial real estate securities including securities collateralized by residential and commercial mortgage loans, mortgage loans and securities issued by financial institutions.

        During the third and fourth quarters of 2008, we sold $2.94 billion of these securities. On October 1, 2008, it was determined that, due to the financial markets experiencing additional severe deterioration and disruptions, we would be unable to sell certain of the investments identified as part of the programs at a value equal to or greater than our view of their intrinsic values. Approximately $2.59 billion of these investments were re-designated as intent to hold to recovery. Investments for which we had changed our intent to hold to recovery totaled $996 million as of December 31, 2008. For a more detailed discussion on securities written down due to a change in intent, see the Net Realized Capital Gains and Losses section of the MD&A.

        As part of the risk mitigation and return optimization programs, hedges were implemented to mitigate portfolio interest rate risk, credit spread risk, and equity market valuation declines. The equity hedge was designed to protect the equity portfolio from significant equity market valuation declines below targeted levels. The strategy employed equity indexed options which generated realized gains in the third and fourth quarters of 2008. At December 31, 2008, we had $2.32 billion of notional protection with an average strike price that was 11% below equity market levels. The interest rate component was put in place to protect a certain portion of fixed income securities if interest rates increase above a targeted maximum level. Interest rate spike protection for our

83

fixed income portfolio in the amount of $18.50 billion of notional principal protection was in place at December 31, 2008. Of this total, $14.50 billion was executed in early 2008 and $4.00 billion executed in December 2008. The $14.50 billion of protection was initially struck at 150 basis points out of the money, but, due to declining interest rates, at December 31, 2008 is struck over 300 basis points out of the money. The $4.00 billion of protection executed in December was initially struck at approximately 100 basis points out of the money. Other aspects of the hedging program have been designed to mitigate municipal bond interest rate risk and credit spread risk. The effectiveness of these hedges may be reduced due to the basis risk associated with these strategies.

        We continue to monitor the progress of these actions as market and economic conditions develop and will adapt our strategies 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.

INVESTMENTS

        Overview and Strategy    An important component of our financial results is the return on our investment portfolios. 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.

        The
global economy is under significant stress and financial markets continue to experience extreme levels of volatility. Our strategy in 2009 will focus primarily upon mitigating the
risks from a potential increase in risk-free interest rates, reducing exposure to certain investment sectors, and maintaining sufficient liquidity and capital. In order to achieve this, we
expect to use a combination of reinvestment of the portfolio's significant cash flows, derivatives and other portfolio actions.

        The
Property-Liability portfolio's investment strategy emphasizes safety 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. We employ a strategic asset
allocation approach, which uses models that consider 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. The
recommended asset allocation is informed by our economic and market outlook, as well as other inputs and constraints, including duration, liquidity and capital considerations.

        The
Allstate Financial portfolio's investment strategy focuses on the total return of assets needed to support the underlying liabilities to achieve return on capital and profitable
growth. The portfolio management process begins with a strategic asset allocation model which considers the nature and risk tolerances of the liabilities and risk tolerances, as well as the risk and
return parameters, of the various asset classes in which we invest. This approach is informed by our economic and market outlook, as well as other inputs and constraints including duration, liquidity
and capital preservation. Within the ranges set by the strategic asset allocation model, tactical investment decisions are made in consideration of prevailing market conditions.

        The
Corporate and Other portfolio's investment strategy balances the pursuit of competitive returns with the unique liquidity needs of the portfolio relative to the overall corporate
capital structure. The portfolio is primarily invested in high quality, liquid fixed income and short-term securities with additional investments in less liquid holdings in order to
enhance overall returns.

        As
a result of decisions in managing each of the portfolios, we may sell securities during a period in which fair value has declined below amortized cost for fixed income securities or
cost for equity securities. For more information, see the Net Realized Capital Gains and Losses section of the MD&A.

82

        During
2008, we developed risk mitigation and return optimization programs as our outlook on the economy changed significantly as conditions deteriorated throughout the year. The risk
mitigation and return optimization programs augment earlier actions to reduce investments in real estate and other market sectors as well as to mitigate exposures to risk-free interest
rate spikes. At the end of the second quarter of 2008, we had an outlook for continued weakness in the global financial markets and economy including continued volatility in the financial markets,
reduced liquidity in certain asset classes and unfavorable economic trends. During the third quarter of 2008, we significantly modified our outlook to a more severe and prolonged downturn. We continue
to expect extreme levels of volatility in the financial markets, suppressed liquidity in certain asset classes and further unfavorable global economic conditions. In addition, the potential for market
supply and demand imbalances has remained above normal due to the deteriorating credit strength of financial institutions and eroding investor confidence.

        Among
our risk mitigation and return optimization activities, we have taken the following actions:

•

Developed and maintained a tactical positioning in liquid assets and assets that we can sell without generating
significant additional realized capital losses.




•

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.




•

Decreased exposure to financial-related market sectors to $7.69 billion as of December 31, 2008 from
$14.45 billion as of December 31, 2007, primarily as a result of targeted sales and declines in fair value. Also reduced our short-term investing in financial institutions.




•

Decreased exposure to residential and commercial real estate market sectors to $22.00 billion as of
December 31, 2008 from $31.54 billion as of December 31, 2007 as a result of targeted sales, principal payments and declines in fair value.




•

Reduced overall counterparty exposure replacing over-the-counter ("OTC") derivatives transactions
used as stock market hedges with exchange-traded instruments where available.




•

In the second half of 2008, we sold $1.67 billion of government securities and recognized realized capital gains of
$241 million.




•

Generated losses as part of tax planning strategy primarily within our equity portfolios that are effectively carried on a
lower of cost or fair value basis to realize capital loss carryback benefits.

        Investments
for which we had changed our intent to hold to recovery as of June 30, 2008 totaled $6.39 billion and included $3.31 billion as part of the risk
mitigation and return optimization programs, $2.39 billion of securities as part of our enterprise-wide asset allocation program and $688 million related to individual
securities. A risk mitigation and return optimization program, approved as of the end of the second quarter of 2008, was designed to reduce our exposure to residential and commercial real estate and
the financial-related market sector by approximately $4 billion of amortized cost, prior to change in intent write-downs. A comprehensive review identified specific investments that could be
significantly impacted by continued deterioration in the economy that may be sold. This included a portion of our residential and commercial real estate securities including securities collateralized
by residential and commercial mortgage loans, mortgage loans and securities issued by financial institutions.

        During
the third and fourth quarters of 2008, we sold $2.94 billion of these securities. On October 1, 2008, it was determined that, due to the financial markets
experiencing additional severe deterioration and disruptions, we would be unable to sell certain of the investments identified as part of the programs at a value equal to or greater than our view of
their intrinsic values. Approximately $2.59 billion of these investments were re-designated as intent to hold to recovery. Investments for which we had changed our intent to hold to
recovery totaled $996 million as of December 31, 2008. For a more detailed discussion on securities written down due to a change in intent, see the Net Realized Capital Gains and Losses
section of the MD&A.

        As
part of the risk mitigation and return optimization programs, hedges were implemented to mitigate portfolio interest rate risk, credit spread risk, and equity market valuation
declines. The equity hedge was designed to protect the equity portfolio from significant equity market valuation declines below targeted levels. The strategy employed equity indexed options which
generated realized gains in the third and fourth quarters of 2008. At December 31, 2008, we had $2.32 billion of notional protection with an average strike price that was 11% below
equity market levels. The interest rate component was put in place to protect a certain portion of fixed income securities if interest rates increase above a targeted maximum level. Interest rate
spike protection for our

83

fixed
income portfolio in the amount of $18.50 billion of notional principal protection was in place at December 31, 2008. Of this total, $14.50 billion was executed in early 2008
and $4.00 billion executed in December 2008. The
$14.50 billion of protection was initially struck at 150 basis points out of the money, but, due to declining interest rates, at December 31, 2008 is struck over 300 basis points out of
the money. The $4.00 billion of protection executed in December was initially struck at approximately 100 basis points out of the money. Other aspects of the hedging program have been designed
to mitigate municipal bond interest rate risk and credit spread risk. The effectiveness of these hedges may be reduced due to the basis risk associated with these strategies.

        We
continue to monitor the progress of these actions as market and economic conditions develop and will adapt our strategies 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.

Investments

        Fixed income securities include bonds, asset-backed securities, mortgage-backed securities, commercial mortgage-backed securities and redeemable preferred stocks. Fixed income securities 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 is reflected as a component of investment collections within the Consolidated Statements of Cash Flows. Reported in fixed income securities are hybrid securities which have characteristics of fixed income securities and equity securities. Many of these securities have attributes most similar to those of fixed income securities such as a stated interest rate, a mandatory redemption date or an interest rate step-up feature which is intended to incent the issuer to redeem the security at a specified call date. Hybrid securities are carried at fair value and amounted to $1.40 billion and $2.81 billion at December 31, 2008 and 2007, respectively.

        Equity securities primarily include common and non-redeemable preferred stocks and real estate investment trust equity investments. Common and non-redeemable preferred stocks and real estate investment trust equity investments are classified 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. Valuation allowances for impaired loans reduce the carrying value to the fair value of the collateral or the present value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate.

        Investments in limited partnership interests, including certain interests in limited liability companies, private equity/debt funds, real estate funds and hedge 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; otherwise, investments in limited partnership interests are accounted for in accordance with the equity method of accounting.

146

        Short-term investments, including money market funds, commercial paper and other short-term investments, are carried at fair value. Other investments consist primarily of policy loans and bank loans. Bank loans are comprised primarily of senior secured corporate loans which are carried at amortized cost. Policy loans are carried at the respective unpaid principal balances.

        In connection with the Company's securities lending business activities, funds received in connection with securities repurchase agreements, cash collateral received from counterparties related to derivative transactions and securities purchased under agreements to resell are invested and classified as short-term investments or fixed income securities available for sale as applicable. For the Company's securities lending business activities and securities sold under agreements to repurchase, the Company records an offsetting liability in other liabilities and accrued expenses or other investments for the Company's obligation to return the collateral or funds received.

        Investment income consists primarily of interest and dividends, income from certain 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 asset-backed securities, mortgage-backed securities and commercial mortgage-backed securities is determined considering estimated principal repayments obtained from widely accepted third party data sources and internal estimates. Interest income on beneficial interests in securitized financial assets not of high credit quality is determined using the prospective yield method, based upon projections of expected future cash flows. For all other asset-backed securities, mortgage-backed securities and commercial mortgage-backed securities, the effective yield is recalculated on the retrospective basis. Accrual of income is suspended for fixed income securities, mortgage loans and bank loans that are in default or when receipt of interest payments is in doubt. Income from investments in limited partnership interests accounted for on the cost basis is recognized upon receipt of amounts distributed by the partnerships as investment income. Subsequent to October 1, 2008, income from investments in limited partnership interests accounted for utilizing the equity method of accounting ("EMA LP") is reported in realized capital gains and losses.

        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, periodic changes in the fair value and settlements of certain derivatives including hedge ineffectiveness, and income from certain limited partnership interests. Realized capital gains and losses on investment sales include calls and prepayments and are determined on a specific identification basis. Income from investments in limited partnership interests accounted for utilizing the equity method of accounting is recognized based on the financial results of the entity and the Company's proportionate investment interest, and 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 and real estate funds are generally on a three month delay.

        The Company recognizes other-than-temporary impairment losses on fixed income securities, equity securities and short-term investments when the decline in fair value is deemed other-than-temporary including when the Company cannot assert a positive intent to hold an impaired security until recovery (see Note 5). Fixed income securities subject to change in intent write-downs continue to earn investment income (other than discussed above), and any discount or premium is recognized using the effective yield method over the expected life of the security.

Investments

        Fixed income securities include bonds, asset-backed securities, mortgage-backed securities, commercial mortgage-backed securities and
redeemable preferred stocks. Fixed income securities 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 is reflected as a component of investment collections within the Consolidated
Statements of Cash Flows. Reported in fixed income securities are hybrid securities which have characteristics of fixed income securities and equity securities.
Many of these securities have attributes most similar to those of fixed income securities such as a stated interest rate, a mandatory redemption date or an interest rate step-up feature
which is intended to incent the issuer to redeem the security at a specified call date. Hybrid securities are carried at fair value and amounted to $1.40 billion and $2.81 billion at
December 31, 2008 and 2007, respectively.

        Equity
securities primarily include common and non-redeemable preferred stocks and real estate investment trust equity investments. Common and non-redeemable
preferred stocks and real estate investment trust equity investments are classified 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. Valuation allowances for impaired loans reduce the carrying value to the fair value of the collateral or the present
value of the loan's expected future repayment cash flows discounted at the loan's original effective interest rate.

        Investments
in limited partnership interests, including certain interests in limited liability companies, private equity/debt funds, real estate funds and hedge 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; otherwise, investments in
limited partnership interests are accounted for in accordance with the equity method of accounting.

146

        Short-term
investments, including money market funds, commercial paper and other short-term investments, are carried at fair value. Other investments consist
primarily of policy loans and bank loans. Bank loans are comprised primarily of senior secured corporate loans which are carried at amortized cost. Policy loans are carried at the respective unpaid
principal balances.

        In
connection with the Company's securities lending business activities, funds received in connection with securities repurchase agreements, cash collateral received from counterparties
related to derivative transactions and securities purchased under agreements to resell are invested and classified as short-term investments or fixed income securities available for sale
as applicable. For the Company's securities lending business activities and securities sold under agreements to repurchase, the Company records an offsetting liability in other liabilities and accrued
expenses or other investments for the Company's obligation to return the collateral or funds received.

        Investment
income consists primarily of interest and dividends, income from certain 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 asset-backed securities, mortgage-backed securities and
commercial mortgage-backed securities is determined considering estimated principal repayments obtained from widely accepted third party data sources and internal estimates. Interest income on
beneficial interests in securitized financial assets not of high credit quality is determined using the prospective yield method, based upon projections of expected future cash flows. For all other
asset-backed securities, mortgage-backed securities and commercial mortgage-backed securities, the effective yield is recalculated on the retrospective basis. Accrual of income is suspended for fixed
income securities, mortgage
loans and bank loans that are in default or when receipt of interest payments is in doubt. Income from investments in limited partnership interests accounted for on the cost basis is recognized upon
receipt of amounts distributed by the partnerships as investment income. Subsequent to October 1, 2008, income from investments in limited partnership interests accounted for utilizing the
equity method of accounting ("EMA LP") is reported in realized capital gains and losses.

        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, periodic
changes in the fair value and settlements of certain derivatives including hedge ineffectiveness, and income from certain limited partnership interests. Realized capital gains and losses on investment
sales include calls and prepayments and are determined on a specific identification basis. Income from investments in limited partnership interests accounted for utilizing the equity method of
accounting is recognized based on the financial results of the entity and the Company's proportionate investment interest, and 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 and real estate funds are generally on a three month
delay.

        The
Company recognizes other-than-temporary impairment losses on fixed income securities, equity securities and short-term investments when the
decline in fair value is deemed other-than-temporary including when the Company cannot assert a positive intent to hold an impaired security until recovery (see Note 5).
Fixed income securities subject to change in intent write-downs continue to earn investment income (other than discussed above), and any discount or premium is recognized using the effective yield
method over the expected life of the security.

Investments

·                  Risk mitigation efforts will focus on shortening duration of the fixed income portfolio, reducing exposures to real estate and certain other market sectors and managing excess market volatility through our macro hedging programs

·                  Declining consolidated net investment income due to lower asset balances and yields, and the costs of maintaining high liquidity and the risk mitigation programs

·                  Significant portfolio cash flow continuing from maturities, principal and interest receipts will be available to manage liabilities and take advantage of market opportunities

5

Investments

Commenting on Allstate’s investment portfolio, which generated $1.4 billion in net investment income for the quarter, Wilson said: “Our investment philosophy emphasizes diversified exposure, high quality assets and continual attention to risk mitigation and return optimization. This approach has helped us to minimize impairments in the face of unprecedented market volatility. As market conditions change, we will continue to adapt our risk and return strategies.”

Reflecting its view that pressures on the economy and investment markets will be prolonged, Allstate augmented risk mitigation and return optimization programs in its investment portfolios.  “We’re positioning our portfolio to further reduce our risk in certain market segments and hedge against significant adverse developments,” said Allstate Chief Investment Officer Ric Simonson. The expanded programs are strategically reducing exposure to certain real estate and financial services-related asset classes and guarding against significant adverse moves in equity valuations, interest rates and credit spreads through macro-hedging.  Two-thirds of the after-tax realized losses ($557 million) Allstate incurred in the quarter are related to change in intent write-downs resulting from this strategic review of investments in certain sectors. “These strategic actions largely affect assets that are current and continue to pay interest, but we believe these steps better insulate our portfolio and provide greater flexibility to take advantage of new opportunities in the investment markets,”

Investments

·                  Net realized capital losses were $655 million on a pre-tax basis for the quarter, due to $415 million of impairment write-downs and $300 million of net losses related to the settlement and valuation of derivative instruments, partly offset by net gains totaling $60 million on dispositions. 

·                  Impairment write-downs totaled $415 million, comprised $347 million on fixed income securities, primarily related to residential mortgages and other structured securities, $52 million on equity securities, $13 million on limited partnership interests and $3 million on other investments.  Approximately 70% of the fixed income write-downs relate to impaired securities that are currently performing in line with anticipated or contractual cash flows, but which were written down primarily because of expected deterioration in the performance of the underlying collateral. The remaining 30% are primarily related to securities currently experiencing a significant departure from anticipated residual cash flows.

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Threshold, target and maximum levels of performance are established for each performance measure.  If the maximum level of performance is achieved, the award would be three times the executive officer’s target award, with target awards generally ranging from 50% to 120% of annual salary for the fiscal year.