ALLSTATE LIFE INSURANCE CO - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

================================================================================

FORM 10-K

THE REGISTRANT MEETS THE CONDITIONS FOR SET FORTH IN GENERAL INSTRUCTIONS
I(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT.

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 0-31248

ALLSTATE LIFE INSURANCE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

ILLINOIS 36-2554642
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)

3100 SANDERS ROAD 60062
NORTHBROOK, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 847/402-5000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE SECURITIES EXCHANGE ACT
OF 1934: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE SECURITIES EXCHANGE ACT
OF 1934: COMMON STOCK, PAR VALUE $227.00 PER SHARE

THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR
SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND
(2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES /X/ NO / /

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. /X/

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE SECURITIES EXCHANGE ACT OF 1934). YES / / NO /X/

NONE OF THE COMMON EQUITY OF THE REGISTRANT IS HELD BY NON-AFFILIATES.
THEREFORE, THE AGGREGATE MARKET VALUE OF THE COMMON EQUITY HELD BY
NON-AFFILIATES OF THE REGISTRANT IS ZERO.

AS OF MARCH 15, 2005, THE REGISTRANT HAD 23,800 COMMON SHARES, $227 PAR VALUE,
OUTSTANDING, ALL OF WHICH ARE HELD BY ALLSTATE INSURANCE COMPANY.

ALLSTATE LIFE INSURANCE COMPANY
INDEX TO ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 2004

* Omitted pursuant to General Instruction I(2) of Form 10-K

PART I

ITEM 1. BUSINESS

Allstate Life Insurance Company was organized in 1957 as a stock life
insurance company under the laws of the State of Illinois. Allstate Life
Insurance Company, together with its subsidiaries, produces personal life
insurance, retirement and investment products for individual and institutional
customers. It conducts substantially all of its operations directly or through
wholly owned U.S. subsidiaries. In this document, we refer to Allstate Life
Insurance Company as "Allstate Life" or "ALIC" and to Allstate Life and its
wholly owned subsidiaries as the "Allstate Life Group" or the "Company."

Allstate Life is a wholly owned subsidiary of Allstate Insurance Company, a
stock property-liability insurance company organized under the laws of the State
of Illinois. All of the outstanding stock of Allstate Insurance Company is owned
by The Allstate Corporation, a publicly owned holding company incorporated under
the laws of the State of Delaware. In this document, we refer to Allstate
Insurance Company as "AIC" and to The Allstate Corporation and its consolidated
subsidiaries as "Allstate", the "Parent Group" or the "Corporation". 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 (R)"
slogan, Allstate provides insurance products to more than 16 million households
and has approximately 13,600 exclusive agencies and exclusive financial
specialists in the United States and Canada. Allstate is the second-largest
personal property and casualty insurer in the United States on the basis of 2003
statutory premiums earned. In addition, it is the nation's 12th largest life
insurance business on the basis of 2003 ordinary life insurance in force and
19th largest on the basis of 2003 statutory admitted assets.

The Parent Group has four business segments, one of which is Allstate
Financial. Allstate Financial, which is not a separate legal entity, is composed
of the Allstate Life Group together with other Parent Group subsidiaries that
are not part of the Allstate Life Group. In addition to being one of the Parent
Group's business segments, the name Allstate Financial has been used from time
to time to refer collectively to the Allstate Life Group, the Allstate Bank and
other Parent Group subsidiaries. This document describes the Allstate Life
Group. It does not describe the entire group of companies that form the Allstate
Financial segment of the Parent Group.

In this annual report on Form 10-K, we occasionally refer to statutory
financial information that has been prepared in accordance with the National
Association of Insurance Commissioners ("NAIC") Accounting Practices and
Procedure Manual. All domestic U.S. insurance companies are required to prepare
statutory-basis financial statements in accordance with the Manual. As a result,
industry data is available on a widespread basis that enables comparisons
between insurance companies, including competitors that are not subject to the
requirement to publish financial statements on the basis of 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.

PRODUCTS AND DISTRIBUTION

The Allstate Life Group provides life insurance, retirement and investment
products to individual and institutional customers. Our principal products are
deferred and immediate fixed annuities, variable annuities, interest-sensitive
and traditional life insurance, and accident and health insurance. Our principal
institutional product is funding agreements backing medium-term notes. The table
on page 2 lists our major distribution channels, with the associated products
and targeted customers.

As the table indicates, we sell products to individuals through multiple
intermediary distribution channels, including Allstate Exclusive Agencies,
independent agents, banks, broker-dealers, and specialized structured settlement
brokers. We have distribution relationships with over half of the 75 largest
banks, most of the national broker-dealers, a number of regional brokerage firms
and many independent broker-dealers. We sell products through independent agents
affiliated with approximately 160 master brokerage agencies. Allstate Exclusive
Agencies also sell our accident and health insurance

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products to individuals. We sell funding agreements to unaffiliated trusts used
to back medium-term notes issued to institutional and individual investors.

DISTRIBUTION CHANNELS, PRODUCTS AND TARGET CUSTOMERS

COMPETITION

We compete principally on the basis of the scope of our distribution
systems, the breadth of our product offerings, the recognition of our brands,
our financial strength and ratings, our product features and prices, and the
level of customer service that we provide. In addition, with respect to variable
annuity and variable life insurance products in particular, we compete on the
basis of the variety of fund managers and choices of funds for our separate
accounts and the management and performance of those funds within our separate
accounts. 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, 2004, there were
approximately 770 groups of life insurance companies in the United States, most
of which offered one or more similar products. Based on information contained in
statements filed with state insurance departments, as of December 31, 2003, the
Allstate Life Group ranked 12th based on ordinary life insurance in force and
19th based on 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

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institutions. Competitive pressure is growing due to several factors, including
cross marketing alliances between unaffiliated businesses, as well as
consolidation activity in the financial services industry.

The Allstate Corporation's website for financial professionals,
accessallstate.com, won DALBAR's Communications Seal in 2004. DALBAR, Inc., an
independent financial services research organization, recognized
accessallstate.com for providing a means by which financial professionals can
easily and conveniently develop and manage their business online.

GEOGRAPHIC MARKETS

We sell life insurance, retirement and investment products throughout the
United States. The Allstate Life Group is 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 sell funding agreements in the United States and in
the Cayman Islands.

The following table reflects, in percentages, the principal geographic
distribution of statutory premiums and annuity considerations for the Allstate
Life Group for the year ended December 31, 2004, based on information contained
in statements filed with state insurance departments. Approximately 99.0% of the
statutory premiums and annuity considerations generated in Delaware represent
deposits received in connection with funding agreements sold to trusts domiciled
in Delaware. No other jurisdiction accounted for more than five percent of the
statutory premiums and annuity considerations.

Delaware 26.0%
New York 9.1%
California 8.3%
Florida 5.2%

REGULATION

The Allstate Life Group 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 regulatory 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 insurance company licensing and
examination, agent licensing and compensation, trade practices, policy forms,
accounting methods, the nature and amount of investments, claims practices,
participation in guaranty funds, reserve adequacy, insurer solvency,
transactions with affiliates, the payment of dividends, and underwriting
standards. Some of these matters are discussed in more detail below. For a
discussion of statutory financial information, see Note 14 of the Consolidated
Financial Statements. For a discussion of regulatory contingencies, see Note
11 of the Consolidated Financial Statements. Notes 11 and 14 are incorporated
in this Part I, Item 1 by reference.

In recent years the state insurance regulatory framework has come under
increased federal scrutiny. Legislation that would provide for federal
chartering of insurance companies has been proposed. 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 the insurance business or what effect any such measures would have
on the Allstate Life Group.

AGENT AND BROKER COMPENSATION. A number of states are considering new
legislation or regulations regarding the compensation of agents and brokers by
insurance companies. The rules that would be imposed if these proposals were
adopted range in nature from disclosure requirements to rules that would impose
new duties on insurance agents and brokers in dealing with customers. Because
these proposals are in the early stages of development, we cannot predict their
potential impact on our business.

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LIMITATIONS ON DIVIDENDS BY INSURANCE SUBSIDIARIES. Allstate Life may
receive dividends from time to time from its subsidiaries. When received, these
dividends represent a source of cash from which Allstate Life may meet some of
its obligations. If a subsidiary is an insurance company, its ability to pay
dividends may be restricted by state laws regulating insurance companies. For
additional information regarding those restrictions, see Note 14 of the
Consolidated Financial Statements.

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.

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. As of December 31, 2004 the
investment portfolios of our insurance subsidiaries complied with such laws and
regulations in all material respects.

VARIABLE LIFE INSURANCE, VARIABLE ANNUITIES AND REGISTERED FIXED ANNUITIES.
The sale of variable life insurance, variable annuities 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 and the National
Association of Securities Dealers.

BROKER-DEALERS, INVESTMENT ADVISORS AND INVESTMENT COMPANIES. The Allstate
Life Group entities that operate as broker-dealers, registered investment
advisors and investment companies are subject to regulation and supervision by
the Securities and Exchange Commission, the National Association of Securities
Dealers and/or, in some cases, state securities administrators.

REGULATION AND LEGISLATION AFFECTING CONSOLIDATION IN THE FINANCIAL
SERVICES INDUSTRY. The Gramm-Leach-Bliley Act of 1999 permits mergers that
combine commercial banks, insurers and securities firms within one holding
company group. In addition, it allows grandfathered unitary thrift holding
companies, including our parent company, to engage in activities that are not
financial in nature. The ability of banks to affiliate with insurers may
materially adversely affect our business by substantially increasing the number,
size and financial strength of potential competitors.

PRIVACY REGULATION. Federal law and the laws of some 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 some states also regulate disclosures of customer information.
Congress, state legislatures and regulatory authorities are expected to consider
additional regulation relating to privacy and other aspects of customer
information.

EMPLOYEES AND OTHER SHARED SERVICES

The Allstate Life Group has no employees. Instead, we primarily use the
services of employees of Allstate Insurance Company, our direct parent. We also
make use of other services and facilities provided by Allstate Insurance Company
and other members of the Parent Group. These services and facilities include
space rental, utilities, building maintenance, human resources, investment
management, finance, information technology and legal services. We reimburse our
affiliates for these services and facilities under a variety of agreements.

OTHER INFORMATION

We use the names "Allstate", "Lincoln Benefit Life" and variations of these
names extensively in our business, along with related logos and slogans. Our
rights in the United States to these names, logos and slogans continue so long
as we continue to use them in commerce. Most of these service marks are the

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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 by continued use.

"Allstate" is one of the most recognized brand names in the U. S. According
to independent market research conducted in 2004, "You're in Good Hands with
Allstate" is recognized by 87% of consumers, making it the most recognized
company tagline in the U.S.

ITEM 2. PROPERTIES

Our home office is part of the Parent Group's home office complex in
Northbrook, Illinois. The complex consists of several buildings totaling
approximately 2.3 million square feet of office space on a 250-acre site. In
addition, we operate from various administrative, data processing, claims
handling and support facilities.

All of the facilities from which we operate are owned or leased by our
direct parent, Allstate Insurance Company, except for office space in Lincoln,
Nebraska that is leased by Lincoln Benefit Life Company, a wholly owned
subsidiary of ALIC, for general operations, file storage and information
technology. Expenses associated with facilities owned or leased by Allstate
Insurance Company are allocated to us on both a direct and an indirect basis,
depending on the nature and use of each particular facility. We believe that
these facilities are suitable and adequate for our current operations.

The locations from which the Parent Group 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 under the heading "Legal
proceedings" in Note 11 of the Consolidated Financial Statements.

5

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.

No established public trading market exists for Allstate Life's common
stock. All of its outstanding common stock is owned by its parent, Allstate
Insurance Company ("AIC"). All of the outstanding common stock of AIC is owned
by The Allstate Corporation.

From January 1, 2003 through March 15, 2005, Allstate Life paid the
following amounts to AIC in the aggregate on the dates specified as dividends on
its common stock:

Within the past three years, the only equity securities sold by Allstate
Life were shares of preferred stock issued to companies that are wholly-owned by
The Allstate Corporation. These securities were issued in transactions that were
exempt from registration under the Securities Act of 1933 because they did not
involve a public offering.

For additional information on dividends, including restrictions on the
payment of dividends by Allstate Life and its subsidiaries, see the Limitations
on Dividends by Insurance Subsidiaries subsection of the "Regulation" section of
Item 1. Business of this Form 10-K and the discussion under the heading
"Dividends" in Note 14 of our consolidated financial statements, which are
incorporated herein by reference.

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ITEM 6. SELECTED FINANCIAL DATA.

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
5-YEAR SUMMARY OF SELECTED FINANCIAL DATA

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

The following discussion highlights significant factors influencing the
consolidated financial position and results of operations of Allstate Life
Insurance Company (referred to in this document as "we", "our", "us", the
"Company" or "ALIC"). 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. We operate as a single
segment entity, based on the manner in which financial information is used
internally to evaluate performance and determine the allocation of resources.

The most important matters that we monitor to evaluate the financial
condition and performance of our Company include:

- For operations: premiums, deposits, gross margins including investment
and benefit margins, the amortization of deferred policy acquisition
costs, expenses, operating income, and invested assets;
- For investments: credit quality/experience, stability of long-term
returns, cash flows and asset and liability duration;
- For financial condition: our financial strength ratings and statutory
capital levels and ratios; and
- For product distribution: profitably growing distribution partner
relationships and Allstate agent sales of all products and services.

2004 HIGHLIGHTS

- - Revenues increased 0.4% in 2004 compared to 2003. Increased net investment
income, higher contract charges and improved realized capital gains and
losses, were offset by lower premiums resulting from the disposal of
substantially all of our direct response distribution business and a
decline in premiums on immediate annuities with life contingencies.
- - Income before cumulative effect of change in accounting principle,
after-tax, increased 22.3% in 2004 compared to 2003 as lower contract
benefits and operating costs and expenses were partially offset by higher
interest credited and deferred policy acquisition costs ("DAC")
amortization. Net income decreased to $181 million in 2004 from $278
million in 2003. This decrease was attributable to a $175 million after-tax
charge related to the cumulative effect of a change in accounting principle
for Statement of Position No. 03-1, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts" ("SOP 03-1"), which was adopted on January 1, 2004.
- - Total investments increased 16.2% in 2004 due to the investment of cash
provided by operating and financing activities, which included record
annual contractholder fund deposits.

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- - Contractholder fund deposits totaled $13.08 billion for 2004 compared to
$9.84 billion in 2003. The increase of $3.24 billion was primarily
attributable to deposits from fixed annuities, interest-sensitive life
policies and institutional funding agreements.
- - When comparing 2004 to 2003, the disposal of substantially all of our
direct response distribution business resulted in the following impacts to
the Consolidated Statements of Operations and Comprehensive Income:

CONSOLIDATED NET INCOME

AS OF AND FOR THE YEARS ENDED DECEMBER 31,

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APPLICATION OF CRITICAL ACCOUNTING POLICIES

We have identified four accounting policies that require us to make
assumptions and estimates that are significant to the consolidated financial
statements. It is reasonably likely that changes in these assumptions and
estimates could occur from period to period and have a material impact on our
consolidated financial statements. A brief summary of each of these critical
accounting policies follows. For a more complete discussion of the effect of
these policies on our consolidated financial statements, and the judgments and
estimates relating to these policies, see the referenced sections of the MD&A.
For a complete summary of our significant accounting policies see Note 2 of the
consolidated financial statements.

INVESTMENT VALUATION The fair value of publicly traded fixed income and equity
securities is based on independent market quotations, whereas the fair value of
non-publicly traded securities is based on either widely accepted pricing
valuation models which use internally developed ratings and independent third
party data as inputs or independent third party pricing sources. Factors used in
our internally developed models, such as liquidity risk associated with
privately-placed securities, are difficult to independently observe and to
quantify. Because of this, judgment is required in developing certain of these
estimates and, as a result, the estimated fair value of non-publicly traded
securities may differ from amounts that would be realized upon an immediate sale
of the securities.

Periodic changes in fair values of investments classified as available for
sale are reported as a component of accumulated other comprehensive income on
the Consolidated Statements of Financial Position and are 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 declines in
fair values are deemed other than temporary. The assessment of other than
temporary impairment of a security's fair value is performed on a case-by-case
basis considering a wide range of factors. There are a number of assumptions and
estimates inherent in assessing impairments and determining if they are other
than temporary, including 1) our ability and intent to retain the investment for
a period of time sufficient to allow for an anticipated recovery in value; 2)
the expected recoverability of principal and interest; 3) the duration and
extent to which the fair value has been less than cost for equity securities or
amortized cost for fixed income securities; 4) the financial condition,
near-term and long-term prospects of the issuer, including relevant industry
conditions and trends, and implications of rating agency actions and offering
prices; and 5) the specific reasons that a security is in a significant
unrealized loss position, including market conditions which could affect
liquidity. Additionally, once assumptions and estimates are made, any number of
changes in facts and circumstances could cause us to later determine that an
impairment is other than temporary, including 1) general economic conditions
that are worse than previously assumed or that have a greater adverse effect on
a particular issuer than originally estimated; 2) changes in the facts and
circumstances related to a particular issuer's ability to meet all of its
contractual obligations; and 3) changes in facts and circumstances or new
information that we obtain which causes a change in our ability or intent to
hold a security to maturity or 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 shareholder's equity since the majority of our portfolio
is held at fair value and as a result, any related unrealized loss, net of
deferred acquisition costs, deferred sales inducement costs and tax, would
already be reflected as accumulated other comprehensive income in shareholder's
equity.

For a more detailed discussion of the risks relating to changes in
investment values and levels of investment impairment, and the potential causes
of such changes, see Note 6 of the consolidated financial statements and the
Investments, Market Risk and Forward-looking Statements and Risk Factors
sections of the MD&A.

DERIVATIVE INSTRUMENT HEDGE EFFECTIVENESS In the normal course of business, we
primarily use derivative financial instruments to reduce our exposure to market
risk and in conjunction with asset/liability management. The fair value of
exchange traded derivative contracts is based on independent market quotations,
whereas the fair value of non-exchange traded derivative contracts is based on
either widely accepted pricing valuation models which use independent third
party data as inputs or independent third party pricing sources.

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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. When designating a derivative
as an accounting hedge, we formally document the hedging relationship, risk
management objective and strategy. The documentation identifies the hedging
instrument, the hedged item, the nature of the risk being hedged and the
assumptions used to assess how effective the hedging instrument is in offsetting
the exposure to changes in the hedged item's fair value attributable to the
hedged risk. In the case of a cash flow hedge, this documentation includes the
exposure to changes in the hedged transaction's variability in cash flows
attributable to the hedged risk. We do not exclude any component of the change
in fair value of the hedging instrument from the effectiveness assessment. At
each reporting date, we confirm that the hedging instrument continues to be
highly effective in offsetting the hedged risk. The determination of whether a
hedging instrument is effective both at its inception and on an on-going basis
requires a significant degree of judgment. For further discussion of these
policies and quantification of the impact of these estimates and assumptions,
see Note 7 of the consolidated financial statements and the Investments, Market
Risk and Forward-looking Statements and Risk Factors sections of the MD&A.

DAC AMORTIZATION We incur significant costs in connection with acquiring
business. In accordance with generally accepted accounting principles ("GAAP"),
costs that vary with and are primarily related to acquiring business are
deferred and recorded as an asset on the Consolidated Statements of Financial
Position. The amortization methodology for DAC 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. Assumptions relating to estimated premiums, investment income and
realized capital gains and losses, as well as to all other aspects of DAC are
determined based upon conditions as of the date of policy issuance 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, change the rate of
amortization in the period such events occur.

DAC related to interest-sensitive life, variable annuities and investment
contracts is amortized in proportion to the incidence of the present value of
estimated gross profits ("EGP") over the estimated lives of the contracts.
Generally, the amortization period ranges from 15-30 years. However, an
assumption for the rate of contract surrenders is also used, which results in
the majority of the DAC being amortized over the surrender charge period. EGP
consists of estimates of the following components: benefit margins primarily
from mortality, including guaranteed minimum death, income and accumulation
benefits; investment margin including realized capital gains and losses; and
contract administration, surrender and other contract charges, less maintenance
expenses.

For variable annuity and life contracts, the most significant assumptions
involved in determining EGP are the expected separate accounts fund performance
after fees, surrender rates, lapse rates, and investment and mortality margins.
Our long-term assumption of separate accounts fund performance net of fees is
approximately 8%. Whenever actual separate accounts fund performance, based on
the two most recent years, varies from 8%, we project performance levels over
the next five years such that the mean return over that seven-year period equals
the long-term 8% assumption. This process is referred to as "reversion to the
mean" and is commonly used by the life insurance industry. Although the use of a
reversion to the mean assumption is common within the industry, the parameters
used in the methodology are subject to judgment and vary between companies. For
example, when applying this assumption we do not allow the mean future rates of
return after fees projected over the five-year period to exceed 12.75% or fall
below 0%. Revisions to EGPs result in changes in the cumulative amounts expensed
as a component of amortization of DAC in the period in which the revision is
made. This is commonly known as "DAC unlocking".

For quantification of the impact of these estimates and assumptions, see
the Forward-looking Statements and Risk Factors sections of the MD&A and Note 2
of the consolidated financial statements.

RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS ESTIMATION 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. These assumptions, which for traditional life
insurance are applied using the net level premium method, include provisions for

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adverse deviation and generally vary by such characteristics as type of
coverage, year of issue and policy duration. Future investment yield
assumptions are determined at the time the policy is issued 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 prevailing at the time the policies are
issued. Expense assumptions include the estimated effects of inflation and
expenses to be incurred beyond the premium-paying period.

For further discussion of these policies see Note 8 of the consolidated
financial statements and the Forward-looking Statements and Risk Factors section
of the MD&A.

OPERATIONS

OVERVIEW AND STRATEGY We are a major provider of life insurance, retirement and
investment products to individual and institutional customers. Our mission is to
assist financial services professionals in meeting their clients' financial
protection, savings and retirement needs by providing top-tier products
delivered with reliable and efficient service.

We will pursue the following to grow our current business profitably:
maintain and develop focused, top-tier products; deepen distribution partner
relationships; improve our cost structure; and advance our systematic risk
management program. We also leverage the strength of the Allstate brand name
across products and distribution channels.

Our individual retail product line includes a wide variety of products
designed to meet the financial protection, savings and retirement needs of our
customers. Individual retail products include traditional life,
interest-sensitive life, accident and health insurance, variable life, long-term
care insurance, variable and fixed annuities and funding agreements backing
retail medium-term notes ("RMTNs"). Individual retail products are sold through
a variety of distribution channels including Allstate exclusive agencies,
independent agents (including master brokerage agencies), and financial service
firms such as banks, broker/dealers and specialized structured settlement
brokers. Our 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.

PREMIUMS AND CONTRACT CHARGES Premiums represent revenues generated from
traditional life, immediate annuities with life contingencies, accident and
health and other insurance products that have significant mortality or morbidity
risk. Contract charges are revenues generated from interest-sensitive life,
variable annuities, fixed annuities and institutional products for which
deposits are classified as contractholder funds or separate accounts
liabilities. Contract charges are assessed against the contractholder account
values for maintenance, administration, cost of insurance and surrender prior to
contractually specified dates. As a result, changes in contractholder funds and
separate accounts liabilities are considered in the evaluation of growth and as
indicators of future levels of revenues.

The following table summarizes premiums and contract charges by product.

12

The following table summarizes premiums and contract charges by
distribution channel.

Total premiums decreased 33.6% in 2004 compared to 2003. The decrease was
primarily due to the disposal of substantially all of our direct response
distribution business, which resulted in lower other premiums and traditional
life premiums. Additionally, 2004 reflects lower premiums on immediate annuities
with life contingencies as underwriting actions taken in 2003 reduced the
maximum premium received on individual contracts sold.

Total premiums decreased 6.3% in 2003 compared to 2002. The decrease was
primarily the result of the discontinuance of the majority of our direct
response business in 2003, and lower traditional life and immediate annuity
premium.

Contract charges increased 10.2% in 2004 compared to 2003. The increase was
primarily due to higher contract charges on interest-sensitive life and variable
annuities. The increase in the interest-sensitive life contract charges was
attributable to in-force business growth resulting from deposits and credited
interest more than offsetting contract charges, surrenders and benefits. Higher
variable annuity contract charges were the result of increased average account
values during 2004, reflecting positive investment results during 2003 and 2004.
Variable annuity contract charges, as a percent of average separate account
values, increased to 175 basis points in 2004 from 166 basis points in 2003
driven by increases in fees charged for our variable annuity benefits on the
Allstate Advisor product in addition to a higher percentage of our in-force
contracts providing these benefits.

Contract charges increased 2.2% in 2003 compared to 2002. The slight
increase was the result of higher interest-sensitive life contract charges
resulting from in-force business growth, partially offset by lower variable
annuity contract charges on lower average variable annuity account balances
during the period. Variable annuity contract charges, as a percent of average
separate account values, increased to 166 basis points in 2003 from 163 basis
points in 2002 as a result of increases in benefit rider fee rates and
utilization by contractholders.

13

CONTRACTHOLDER FUNDS represent interest-bearing liabilities arising from the
sale of individual and institutional products, such as interest-sensitive life,
fixed annuities, and funding agreements. 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.

(1) The increase in contractholder funds due to the adoption of SOP 03-1
reflects the reclassification of certain products previously included as a
component of separate accounts to contractholder funds, the reclassification
of deferred sales inducements ("DSI") from contractholder funds to other
assets and the establishment of reserves for certain liabilities that are
primarily related to income and death benefit guarantees provided under
fixed annuity, variable annuity and interest-sensitive life contracts.
(2) In 2004, other adjustments includes an increase to contractholder funds of
$379 million and $93 million as a result of reinsurance assumed transactions
with American Heritage Life Insurance Company and Columbia Universal Life
Insurance Company, respectively (see Note 5 to the Consolidated Financial
Statements).

Contractholder deposits increased 32.9% in 2004 compared to 2003 due
primarily to greater issuances of fixed annuities, interest-sensitive life
policies and retail and institutional funding agreements. These deposits led to
an increase in average contractholder funds, excluding the impact of adopting
SOP 03-1, of 17.5% in 2004 compared to 2003. Fixed annuity deposits increased
39.1% in 2004 compared to 2003 due to strong consumer demand, competitive
pricing and effective distribution efforts in our bank channel. Institutional
product deposits increased 43.8% in 2004 compared to 2003, largely due to
favorable market conditions for our funding agreements and the broadening of our
customer base through the development and launch of our new Securities and
Exchange Commission ("SEC") registered program in the second quarter of 2004 and
our new registered RMTN program in the fourth quarter. The registered programs

14

generated $1.74 billion of new funding agreement deposits during the year
including $85 million in RMTN deposits.

Benefits, surrenders and partial withdrawals increased 27.5% in 2004
compared to 2003 reflecting a withdrawal rate of 9.8% for 2004 based on the
beginning of period contractholder funds balance excluding institutional product
reserves. This compares to a withdrawal rate of 9.0% and 10.2% for 2003 and 2002
respectively. Surrenders and withdrawals may vary with changes in interest rates
and equity market conditions and the aging of our in-force contracts.

Contractholder deposits increased 10.4% in 2003 compared to 2002, and
average contractholder funds increased 17.7% in 2003 compared to 2002, due to
significant increases in institutional product and fixed annuity deposits in
2003. Fixed annuity deposits increased 6.0% over 2002 due to competitive pricing
and our decision to maintain a market presence despite a challenging interest
rate environment. Institutional products deposits increased 44.8% largely due to
our assessment of market opportunities.

SEPARATE ACCOUNTS LIABILITIES represent contractholders' claims to the related
separate accounts assets. Separate accounts liabilities primarily arise from the
sale of variable annuity contracts and variable life insurance policies. The
following table shows the changes in separate accounts liabilities.

(1) The decrease in separate accounts due to the adoption of SOP 03-1 reflects
the reclassification of certain products previously included as a component
of separate accounts to contractholder funds.

Separate accounts liabilities, excluding the impact of adopting SOP 03-1,
increased $1.16 billion during 2004. The increase was primarily attributable to
positive investment results. Net deposits and transfers from fixed accounts were
mostly offset by surrenders and benefits. Variable annuity contractholders often
allocate a significant portion of their initial variable annuity contract
deposit into a fixed rate investment option. The level of this activity is
reflected above in the deposits allocated to fixed accounts, while all other
transfer activity between the fixed and separate accounts investment options is
reflected in net transfers from fixed accounts. The liability for the fixed
portion of variable annuity contracts is reflected in contractholder funds.

Separate accounts liabilities increased $2.30 billion during 2003 compared
to 2002 reflecting a significant improvement in investment results and net
deposits, partially offset by surrenders and benefits. The increase in the
variable annuity net deposits in 2003 resulted from the increasing
attractiveness of the separate accounts equity investment funds following
improved equity market performance and the introduction of the multi-manager
Allstate(R) Advisor variable annuity product.

NET INVESTMENT INCOME increased 5.8% in 2004 compared to 2003 and 3.5% in 2003
compared to 2002. The increase in both periods was the result of the effect of
higher portfolio balances, partially offset by lower portfolio yields. Higher
portfolio balances resulted from the investment of cash flows from operating and
financing activities related primarily to deposits from fixed annuities and
interest-sensitive life policies and institutional funding agreements.
Investment balances as of December 31, 2004, increased 16.2% from

15

December 31, 2003 and increased 13.9% as of December 31, 2003 compared to
December 31, 2002. The lower portfolio yields were primarily due to purchases,
including reinvestments, of fixed income securities with yields lower than the
current portfolio average.

NET INCOME analysis is presented in the following table.

(1) Periodic settlements and accruals on non-hedge derivative
instruments are reflected as a component of realized capital gains
and losses on the Consolidated Statements of Operations and
Comprehensive Income.
(2) Beginning in 2004, amortization of DSI is excluded from interest
credited to contractholder funds for purposes of calculating gross
margin. Amortization of DSI totaled $45 million in 2004. Prior
periods have not been restated.

GROSS MARGIN, a non-GAAP measure, represents premiums and contract charges and
net investment income, less contract benefits and interest credited to
contractholder funds. We use gross margin as a component of our evaluation of
the profitability of the life insurance and financial product portfolio.
Additionally, for many of our products, including fixed annuities, variable life
and annuities, and interest-sensitive life insurance, the amortization of DAC
and DSI is determined based on actual and expected gross margin. Gross margin is
comprised of four components that are utilized to further analyze the business:
investment margin, benefit margin, maintenance charges and surrender charges. We
believe gross margin and its components are useful to investors because they
allow for the evaluation of income components separately and in the aggregate
when reviewing performance. Gross margin, investment margin and benefit margin
should not be considered as a substitute for net income and do not reflect the
overall profitability of the business. Net income is the GAAP measure that is
most directly comparable to these margins. Gross margin is reconciled to GAAP
net income in the table above.

16

The components of gross margin are reconciled to the corresponding
financial statement line items in the following table.

(1) Periodic settlements and accruals on non-hedge derivative instruments are
reflected as a component of realized capital gains and losses on the
Consolidated Statements of Operations and Comprehensive Income.
(2) Beginning in 2004, amortization of DSI is excluded from interest credited to
contractholder funds for purposes of calculating gross margin. Amortization
of DSI totaled $45 million for the year ended December 31, 2004. Prior
periods have not been restated.

17

Gross margin increased 5.9% in 2004 compared to 2003. The increase was
attributable to increased investment margin and higher maintenance charges,
partially offset by lower benefit margin. Gross margin declined 3.0% in 2003
compared to 2002 as an increased investment margin was more than offset by lower
benefit margin.

INVESTMENT MARGIN is a component of gross margin, both of which are non-GAAP
measures. Investment margin represents the excess of net investment income over
interest credited to contractholder funds and the implied interest on
life-contingent immediate annuities included in the reserve for life-contingent
contract benefits. We use investment margin to evaluate our profitability
related to the difference between investment returns on assets supporting
certain products and amounts credited to customers ("spread") during a fiscal
period.

Investment margin by product group is shown in the following table.

Investment margin increased 9.3% in 2004 compared to 2003 and increased
3.3% in 2003 compared to 2002. Both increases were primarily due to higher
contractholder funds and actions to reduce crediting rates, partially offset by
lower portfolio yields. The difference between the weighted average crediting
rate and the average guaranteed rate on interest-sensitive life and deferred
annuities, excluding market value adjusted annuities and equity-indexed
annuities, was 52 basis points as of December 31, 2004 compared with 70 basis
points as of December 31, 2003 and 140 basis points as of December 31, 2002. The
crediting rates on approximately 62% of these contracts were at the minimum
guaranteed rate at December 31, 2004.

The following table summarizes the annualized weighted average investment
yield, interest crediting rates and investment spreads during 2004, 2003 and
2002.

18

The following table summarizes the liabilities as of December 31 for these
contracts and policies.

BENEFIT MARGIN is a component of gross margin, both of which are non-GAAP
measures. Benefit margin represents life and life-contingent immediate annuity
premiums and cost of insurance contract charges less contract benefits. Benefit
margin excludes the implied interest on life-contingent immediate annuities,
which is included in the calculation of investment margin, and mortality charges
on variable annuities, which are included as a component of maintenance charges.
We use the benefit margin to evaluate our underwriting performance, as it
reflects the profitability of our products with respect to mortality or
morbidity risk during a fiscal period.

Benefit margin by product group is shown in the following table.

Benefit margin decreased 9.0% in 2004 compared to 2003. This decline was
primarily the result of the disposal of substantially all of our direct response
distribution business and unfavorable mortality experience on life-contingent
immediate annuities, partially offset by an improved benefit margin on life
insurance products and lower contract benefits related to guaranteed minimum
death benefits ("GMDBs") on variable annuities.

As required by SOP 03-1, as of January 1, 2004, a reserve was established
for benefits provided for under variable annuities and secondary guarantees on
interest-sensitive life insurance and certain fixed annuity contracts. For
variable annuities, the reserve includes GMDBs and guaranteed minimum income
benefits ("GMIBs"). In previous periods, GMDBs were expensed as paid and no
costs were recognizable for GMIBs or other guarantees. Under the SOP, we
anticipate that the benefit margin will be less volatile, as contract benefit
expense pertaining to product guarantees will be proportionate to the related
revenue rather than cash payments made during the period. Included in the
benefit margin for 2004 are additions to these secondary product guarantee
reserves of $46 million for variable annuities, net of reinsurance and hedging
gains and losses and $3 million for fixed annuities and interest-sensitive life
policies. Included in the benefit margin for 2003 are GMDB payments of $83
million, net of reinsurance, hedging gains and losses and other contractual
arrangements. For further explanation of the impacts of the adoption of this
accounting guidance, see Note 2 to the Consolidated Financial Statements.

Benefit margin was $346 million in 2003, reflecting a $75 million or 17.8%
decline compared to 2002. An increase in GMDBs on variable annuity contracts in
2003 compared to 2002 represents $30 million of the $75 million decline. The
remainder was due to a larger number of life claims in the first quarter of
2003, poor mortality results on certain closed blocks of business and the effect
of the discontinuance of direct response non-life credit insurance, partially
offset by higher mortality margin from growth of interest-sensitive life. In
2003, GMDB payments were $83 million, net of reinsurance, hedging results and
other contractual

19

arrangements ("net GMDB payments"), compared to $53 million in 2002. While 2003
net GMDB payments were higher than in 2002, improved equity market performance
during 2003 resulted in sequential quarterly reductions in gross GMDB payments.
Direct response non-life credit insurance generated a benefit margin of $2
million and $7 million in 2003 and 2002, respectively.

AMORTIZATION OF DAC AND DSI increased 1.8% during 2004 compared to 2003.
The higher amortization is reflective of increased gross margins on fixed and
variable annuities. In 2003, amortization of DAC and DSI included an
acceleration of DAC amortization (commonly referred to as "DAC unlocking")
totaling $89 million and $37 million of DAC amortization on the direct response
distribution business sold in 2004.

The adoption of SOP 03-1 required a new modeling approach for estimating
expected future gross profits that are used when determining the amortization of
DAC. Because of this new modeling approach, effective January 1, 2004, the
variable annuity DAC and DSI assets were reduced by $124 million. This reduction
was recognized as a component of cumulative effect of a change in accounting
principle.

Amortization of DAC increased 4.1% during 2003 compared to 2002. The
increase was primarily due to in-force business growth, partially offset by
decreased amortization from lower gross margins on variable annuities and
certain fixed annuities. Net DAC unlocking totaled $89 million and $94 million
in 2003 and 2002.

We performed our annual comprehensive evaluation of DAC assumptions in the
first quarter of 2003 and concluded that, due to sustained poor performance of
the equity markets coupled with an expectation of moderate future performance
due to continuing weakness in the U.S. economy and uncertainty in the
geopolitical environment, it was no longer reasonably possible that variable
annuity fund returns would revert to the expected long-term mean within the time
horizon used in our reversion to the mean model.

The changes in the DAC asset are summarized in the following tables.

(IN MILLIONS)

20

(IN MILLIONS)

(1) Included as a component of Amortization of DAC on the Consolidated
Statements of Operations and Comprehensive Income.
(2) The impact of adoption of SOP 03-1 includes a write-down in variable
annuity DAC of $108 million, the reclassification of DSI from DAC to other
assets resulting in a decrease to DAC of $44 million, and an increase to
DAC of $8 million for an adjustment to the effect of unrealized capital
gains and losses.
(3) The amortization of DAC for interest-sensitive life, variable annuities and
investment contracts is proportionate to the recognition of actual gross
profits, which include realized capital gains and losses. The increase in
amortization in 2004 compared to 2003 was due in part to the effect of
realized capital gains and losses that were in excess of those utilized in
the determination of EGP. Amortization related to realized capital gains
and losses was $120 million and $46 million in 2004 and 2003, respectively.
Future amortization will be affected by the recognition of actual realized
capital gains and losses to the extent that they differ from those utilized
in the determination of EGP.
(4) The DAC balance was increased $40 million during 2004 as a result of
certain reinsurance transactions. In 2004, ALIC entered into a reinsurance
agreement with American Heritage Life Insurance Company, an affiliate of
the Company, whereby certain interest-sensitive life and fixed annuity
business was assumed by ALIC. In addition, in 2004, an existing reinsurance
agreement between ALIC and Columbia Universal Life Insurance Company, a
former affiliate of the Company, was changed from modified coinsurance to
coinsurance resulting in an increase in traditional life and
interest-sensitive life DAC.

OPERATING COSTS AND EXPENSES decreased 6.3% in 2004 compared to 2003 and
increased 3.8% in 2003 compared to 2002. The following table summarizes
operating costs and expenses.

The decline in total operating costs and expenses in 2004 compared to 2003
was primarily attributable to the disposal of substantially all of our direct
response distribution business. Excluding the impact of the disposition,
non-deferrable acquisition costs increased due to higher non-deferrable renewal
commissions; and taxes, licenses and fees. For other operating costs and
expenses, the decline due to the disposition was partially offset by higher
technology and employee related expenses.

The increase in total operating costs and expenses in 2003 compared to 2002
was primarily due to higher non-deferrable commissions. Other operating costs
and expenses in 2003 compared to 2002 decreased as higher employee benefit and
technology related costs were more than offset by lower litigation expense.

REINSURANCE CEDED We enter into reinsurance agreements with unaffiliated
carriers to limit our risk of mortality losses. As of December 31, 2004 and
2003, 50% and 46%, respectively, of our face amount of life insurance in force
is reinsured. In 2004, for certain term life insurance policies, we ceded
25-100% of the mortality risk depending on the length of the term and policy
premium guarantees. Comparatively, in 2003, mortality risk ceded on certain term
life insurance policies was in the range of 60-100%, depending on the length of
the term and policy premium guarantees. Additionally, we cede 100% of the
morbidity

21

risk on our long-term care contracts. Since 1998, we have ceded the mortality
risk on new life contracts that exceed $2 million per individual, whereas prior
to 1998, we ceded mortality risk in excess of specific amounts up to $1 million
per life for individual coverage. Also, on certain in-force variable annuity
contracts we cede 100% of the mortality and certain other risks related to
product features. We retain primary liability as a direct insurer for all risks
ceded to reinsurers.

The impacts of reinsurance on our reserve for life-contingent contract
benefits at December 31, are summarized in the following table.

(1) As of December 31, 2004, life insurance and other include $52
million and $72 million, respectively, related to the disposal of
substantially all of our direct response distribution business.

Estimating amounts of reinsurance recoverables is impacted by the
uncertainties involved in the establishment of reserves.

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 to be considered a higher risk. There has also been
consolidation activity between reinsurers in the industry, which has resulted in
reinsurance risk across the industry to be concentrated among fewer companies.
As a result, we have increased our percentage of underwriting retention of new
term life insurance policies by approximately 20-30% on average depending on
product mix.

Our reinsurance recoverables, summarized by the reinsurers' Standard &
Poor's financial strength ratings as of December 31, are shown in the following
table. In certain cases, these ratings refer to the financial strength of the
affiliated group or parent company of the reinsurer.

(1) As of December 31, 2004, the A- and other categories include $51
million and $118 million, respectively, related to the disposal of
substantially all of our direct response distribution business. The
amount included as a component of the other category reflects two of
three unrelated third party purchasers of the business for which
Standard and Poor's does not rate. These two insurers are rated A+
(Superior) and A (Excellent) by A.M. Best. Furthermore, the other
category, at December 31, 2004, includes $184 million related to the
reinsurance recoverables of acquired entities, of which $176 million
is collateralized by a reinsurance trust.

22

Our reinsurance recoverables, summarized by reinsurer as of December 31,
are shown in the following table.

(1) As of December 31, 2004, the other category includes $52 million
of recoverables due from reinsurers with an investment grade
credit rating from S&P.

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, 2004.

ALIC's insurance subsidiaries are domiciled in Illinois, New York, Arizona
and Nebraska. Except for those domiciled in New York, ALIC has 100%
intercompany reinsurance agreements in place with most of its domestic
insurance subsidiaries. With the exception of Allstate Life Insurance Company of
New York, which retains substantially all of its business up to its per life
limit, only invested assets supporting capital and relating to Separate Accounts
remain in these subsidiaries. All significant intercompany transactions have
been eliminated in consolidation.

OUTLOOK

- - Our ability to grow our investment margin depends upon maintaining
sufficient spreads between investment yields and interest crediting rates,
and growing the amount of business in force. As interest rates rise, we
expect a gradual increase in investment yields. The amount by which these
higher yields will increase our investment margin depends upon the amount
and pace at which we reset interest-crediting rates, which could be
influenced by market conditions and the actions of our policyholders. A
significant and sudden increase in interest rates could cause policyholders
to exercise surrender provisions in their policies that might cause
investment margins to decline. As a result, growth in our investment margin
from net new business activity could be partially offset by compression in
our in-force investment margins.
- - If equity markets perform at historical norms, we expect to see positive
growth in our variable annuity gross margins from increased revenue.
However, improvements or deteriorations in our variable annuity gross
margins from changes in equity market performance or policyholder retention
creates a proportional increase or decrease in amortization of variable
annuity DAC, which will offset a significant portion of the changes in
gross margins.

23

- - Market conditions beyond our control determine the availability and cost of
the reinsurance we purchase. To eliminate some of these market concerns, we
are expecting to retain more of our term life insurance mortality risk in
2005. This change will not have a discernable effect on our net income in
the short-term, but will provide the foundation to drive increased
long-term growth in our life insurance business. Our mortality margins will
also be more volatile in the future as we retain and manage more of our
mortality risk, which will require increased statutory capital.

INVESTMENTS

An important component of our financial results is the return on our
investment portfolio. The investment portfolio is managed based upon the nature
of the business and its corresponding liability structure.

OVERVIEW AND STRATEGY The investment strategy focuses on the need for
risk-adjusted spread on the underlying liabilities while maximizing return on
capital. We believe investment spread is maximized by selecting assets that
perform favorably on a long-term basis and by disposing of certain assets to
minimize the effect of downgrades and defaults. We believe this strategy
maintains the investment margin necessary to sustain income over time. The
portfolio management approach employs a combination of recognized market,
analytical and proprietary modeling, including a strategic asset allocation
model, as the primary basis for the allocation of interest sensitive, illiquid
and credit assets as well as for determining overall below investment grade
exposure and diversification requirements. Within the targets set by the
strategic asset allocation model, tactical investment decisions are made in
consideration of prevailing market conditions. Portfolio reviews, which include
identifying securities that are other than temporarily impaired, are conducted
regularly. For more information, see the Portfolio Monitoring section of the
MD&A.

PORTFOLIO COMPOSITION The composition of the investment portfolio at December
31, 2004 is presented in the table below. Also see Notes 2 and 6 to the
consolidated financial statements for investment accounting policies and
additional information.

(1) Fixed income securities are carried at fair value. Amortized
cost basis for these securities was $55.96 billion.

Investments increased to $69.69 billion at December 31, 2004, from $59.99
billion at December 31, 2003. The increase in investments was primarily due to
positive cash flows from operating and financing activities and increased funds
associated with securities lending.

Investment balances related to collateral increased to $2.93 billion at
December 31, 2004, from $1.92 billion at December 31, 2003.

We use different methodologies to estimate the fair value of publicly and
non-publicly traded marketable investment securities and exchange traded and
non-exchange traded derivative contracts. For a discussion of these methods, see
the Application of Critical Accounting Policies section of the MD&A.

24

The following table shows total investments categorized by the method used
to determine fair value at December 31, 2004.

FIXED INCOME SECURITIES See Note 6 of the consolidated financial statements for
a table showing the amortized cost, unrealized gains, unrealized losses and fair
value for each type of fixed income security for the years ended December 31,
2004 and 2003.

Municipal bonds, including tax-exempt and taxable securities, totaled $3.32
billion and 100.0% were rated investment grade at December 31, 2004.
Approximately 48.8% of the municipal bond portfolio was insured by six bond
insurers and accordingly have a rating of Aaa or Aa. The municipal bond
portfolio at December 31, 2004 consisted of approximately 223 issues from
approximately 176 issuers. The largest exposure to a single issuer was less than
5.4% of the municipal bond portfolio. Corporate entities were the ultimate
obligors of approximately 26.2% of the municipal bond portfolio.

Corporate bonds totaled $34.21 billion and 90.1% were rated investment
grade at December 31, 2004. As of December 31, 2004, the portfolio contained
$15.82 billion of privately placed corporate obligations, 46.2% of the total
corporate obligations in the portfolio, compared with $14.33 billion at December
31, 2003. Privately placed securities that were rated investment grade totaled
87.9% at December 31, 2004. Approximately $13.84 billion or 87.5% of the
privately placed corporate obligations consisted of fixed rate privately placed
securities. The benefits of fixed rate privately placed securities when compared
to publicly issued securities are generally higher yields, improved cash flow
predictability through pro-rata sinking funds, and a combination of covenant and
call protection features designed to better protect the holder against losses
resulting from credit deterioration, reinvestment risk or fluctuations in
interest rates. A disadvantage of fixed rate privately placed securities when
compared to publicly issued securities is relatively reduced liquidity. Foreign
government securities totaled $1.84 billion and 90.7% were rated investment
grade at December 31, 2004.

Mortgage-backed securities ("MBS") totaled $5.97 billion at December 31,
2004, all of which were investment grade. In our MBS portfolio, the credit risk
associated with MBS is mitigated due to the fact that the portfolio consists
primarily of securities that were issued by, or have underlying collateral that
is guaranteed by, U.S. government agencies or U.S. government sponsored
entities. The MBS portfolio is subject to interest rate risk since price
volatility and the ultimate realized yield are affected by the rate of
prepayment of the underlying mortgages. The current consistently low interest
rate environment has resulted in prepayments, which have eroded the prepayment
protection in this portfolio over recent years.

Commercial mortgage-backed securities ("CMBS") totaled $6.20 billion at
December 31, 2004. CMBS positions primarily represent pools of commercial
mortgages, broadly diversified across property types and geographical area. The
CMBS portfolio is subject to credit risk, but unlike other structured products,
is generally not subject to prepayment risk. Due to protections within the
underlying commercial mortgages, borrowers are restricted from prepaying their
mortgages due to changes in interest rates. Credit defaults can result in credit
directed prepayments. Approximately 82.3% of the CMBS portfolio had a Moody's
rating of Aaa or a Standard & Poor's rating of AAA, the highest rating category,
at December 31, 2004.

Asset-backed securities ("ABS") totaled $4.35 billion at December 31, 2004.
Our ABS portfolio is subject to credit and interest rate risk. Credit risk is
managed by monitoring the performance of the collateral. In addition, many of
the securities in the ABS portfolio are credit enhanced with features such as
over-collateralization, subordinated debt, reserve funds, guarantees and/or
insurance. Approximately 53.6% of the ABS portfolio had a Moody's rating of Aaa
or a Standard & Poor's ("S&P") rating of AAA,

25

the highest rating category. A portion of the ABS portfolio is also subject to
interest rate risk since, for example, price volatility and ultimate realized
yield are affected by the rate of prepayment of the underlying assets. The ABS
portfolio includes collateralized debt obligations and other bonds that are
secured by a variety of asset types, predominately credit card receivables, home
equity loans, and auto loans.

At December 31, 2004, 93.7% of the consolidated fixed income securities
portfolio was rated investment grade, which is defined as a security having a
rating from The National Association of Insurance Commissioners ("NAIC") of 1 or
2; a rating of Aaa, Aa, A or Baa Moody's; a rating of AAA, AA, A or BBB from
S&P, Fitch or Dominion; or a comparable internal rating if an externally
provided rating is not available.

The following table summarizes the credit quality of the fixed income
securities portfolio at December 31, 2004.

(IN MILLIONS)

EQUITY SECURITIES Equity securities include limited partnership, non-redeemable
preferred and common stock investments. The equity securities portfolio was $214
million at December 31, 2004 compared to $164 million at December 31, 2003.
Investments in limited partnership interests had a carrying value and cost of
$172 million and $81 million at December 31, 2004 and 2003, respectively.
Non-redeemable preferred and common stocks had a carrying value of $42 million
and $83 million, and cost of $33 million and $79 million at December 31, 2004
and 2003, respectively. Gross unrealized gains on common stocks and
non-redeemable preferred stocks totaled $9 million at December 31, 2004 compared
to $4 million at December 31, 2003. There were no unrealized losses on common
stocks or non-redeemable preferred stocks at December 31, 2004 and 2003.

26

UNREALIZED GAINS AND LOSSES See Note 6 of the consolidated financial statements
for further disclosures regarding unrealized losses on fixed income and equity
securities and factors considered in determining whether they are not other than
temporarily impaired. The unrealized net capital gains on fixed income and
equity securities at December 31, 2004 totaled $3.34 billion, an increase of
$155 million since December 31, 2003. Gross unrealized gains and losses on fixed
income securities are provided in the table below.

The banking, consumer goods and transportation sectors had the highest
concentration of gross unrealized losses in our corporate fixed income
securities portfolio at December 31, 2004. The gross unrealized losses in these
sectors were primarily interest rate related or company specific. Approximately
$8 million of the total gross unrealized losses in the corporate fixed income
portfolio and $11 million of the total gross unrealized losses in the
asset-backed securities portfolio were associated with the airline industry for
which values were generally depressed due to company specific issues and
economic issues primarily related to fuel and labor costs. We expect eventual
recovery of these securities. Every security was included in our portfolio
monitoring process.

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The following table shows the composition by credit quality of the fixed
income securities with gross unrealized losses at December 31, 2004.

(IN MILLIONS)

The table above includes 29 securities that have not yet received an NAIC
rating, for which we have assigned a comparable internal rating, with a fair
value totaling $620 million and an unrealized loss of $6 million. Due to lags
between the funding of an investment, processing of final legal documents,
filing with the Securities Valuation Office of the NAIC ("SVO"), and rating by
the SVO, we will always have a small number of securities that have a pending
rating.

At December 31, 2004, $131 million, or 80.4%, of the gross unrealized
losses were related to investment grade fixed income securities. Unrealized
losses on investment grade securities principally relate to changes in interest
rates or changes in sector-related credit spreads since the securities were
acquired.

As of December 31, 2004, $32 million of the gross unrealized losses were
related to below investment grade fixed income securities. Of this amount, $11
million was in a significant unrealized loss position (greater than or equal to
20% of amortized cost) for six or more consecutive months prior to December 31,
2004. Included among the securities rated below investment grade are both public
and privately placed high-yield bonds and securities that were investment grade
when originally acquired. We mitigate the credit risk of investing in below
investment grade fixed income securities by limiting the percentage of our fixed
income portfolio invested in such securities, and through diversification of the
portfolio, and active credit monitoring and portfolio management.

The scheduled maturity dates for fixed income securities in an unrealized
loss position at December 31, 2004 is shown below. Actual maturities may differ
from those scheduled as a result of prepayments by the issuers.

(1) Because of the potential for prepayment, mortgage- and asset-backed
securities are not categorized based on their contractual maturities.

PORTFOLIO MONITORING We have a comprehensive portfolio monitoring process to
identify and evaluate fixed income and equity securities whose carrying value
may be other than temporarily impaired. The process includes a quarterly review
of all securities using a screening process to identify those securities whose
fair value compared to amortized cost for fixed income securities or cost for
equity securities is below established thresholds for certain time periods, or
which are identified through other monitoring criteria such as ratings
downgrades or 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

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on our watch-list. The watch-list is reviewed in detail to determine whether any
other than temporary impairment exists.

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

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

The largest individual unrealized loss was $3 million for category (i), $1
million for category (ii), $3 million for category (iii) and $3 million for
category (iv) as of December 31, 2004.

Categories (i) and (ii) have generally been adversely affected by overall
economic conditions including interest rate changes and the market's evaluation
of certain sectors. The degree to which and/or length of time that the
securities have been in an unrealized loss position does not suggest that these
securities pose a high risk of being other than temporarily impaired. Categories
(iii) and (iv) have primarily been adversely affected by industry and issue
specific conditions. All of the securities in these categories are monitored for
impairment. We expect that the fair values of these securities will recover over
time.

Whenever our initial analysis indicates that a fixed income security's
unrealized loss of 20% or more for at least 36 months or any equity security's
unrealized loss of 20% or more for at least 12 months is temporary, additional
evaluations and management approvals are required to substantiate that a
write-down is not appropriate. As of December 31, 2004, no securities met these
criteria.

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The following table contains the individual securities with the largest
unrealized losses as of December 31, 2004. No other fixed income or equity
security had an unrealized loss greater than $2 million, or 1.0% of the total
unrealized loss on fixed income and equity securities.

We also monitor the quality of our fixed income portfolio by categorizing
certain investments as "problem", "restructured" or "potential problem." Problem
fixed income securities are securities in default with respect to principal or
interest and/or securities issued by companies that have gone into bankruptcy
subsequent to our acquisition of the security. Restructured fixed income
securities have rates and terms that are not consistent with market rates or
terms prevailing at the time of the restructuring. Potential problem fixed
income securities are current with respect to contractual principal and/or
interest, but because of other facts and circumstances, we have concerns
regarding the borrower's ability to pay future principal and interest, which
causes us to believe these securities may be classified as problem or
restructured in the future.

The following table summarizes problem, restructured and potential problem
fixed income securities at December 31.

We have experienced a decrease in the amortized cost of fixed income
securities categorized as potential problem and problem as of December 31, 2004
compared to December 31, 2003. The decrease was primarily related to prepayments
by issuers, sales in these categories due to specific developments causing a
change in our outlook and intent to hold those securities, and an improvement in
the outlook for these securities.

We also evaluated each of these securities through our portfolio monitoring
process at December 31, 2004 and recorded write-downs when appropriate. We
further concluded that any remaining unrealized losses on these securities were
temporary in nature. While these balances may increase in the future,
particularly if economic conditions are unfavorable, management expects that the
total amount of securities in these categories will remain low relative to the
total fixed income securities portfolio.

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NET 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.

Investment write-downs during 2004 represented approximately 0.1% of the
average total investment portfolio value during the year. Included in losses
from written down investments were $28 million related to airline industry
holdings. For the year ended December 31, 2004, the $129 million in net gains
from sales was comprised of gross gains of $300 million and gross losses of $171
million. Gross losses from sales of fixed income and equity securities combined
with investment write-downs on fixed income and equity securities of $80
million, represented total gross realized losses of $251 million. Of the $171
million in gross losses from sales of fixed income and equity securities, $160
million resulted from sales of fixed income securities and $11 million resulted
from sales of equity securities.

Dispositions in the above table include sales and other transactions such
as calls and prepayments. We may sell securities during the period in which fair
value has declined below amortized cost for fixed income securities or cost for
equity securities. In certain situations new factors such as negative
developments, subsequent credit deterioration, relative value opportunities,
market liquidity concerns and portfolio reallocations can subsequently change
our previous intent to continue holding a security. In a changing interest rate
environment we may manage securities differently, for example, by changing the
targeted duration of our portfolios, leading to cash market transactions,
changes in the profile of our investment purchases or moving securities between
portfolios supporting differing products or to another affiliate.

The ten largest losses from sales of individual securities for the year
ended December 31, 2004 totaled $25 million with the largest being $4 million
and the smallest being $2 million. None of the $25 million related to securities
that were in an unrealized loss position greater than or equal to 20% of
amortized cost for fixed income securities.

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Our largest aggregate losses on sales and writedowns are shown in the
following table by issuer and its affiliates. No other issuer together with its
affiliates had an aggregated loss on sales and writedowns greater than 2.0% of
the total gross loss on sales and writedowns on fixed income and equity
securities. We have also included in this table the related circumstances giving
rise to the losses and a discussion of how those circumstances may have affected
other material investments held.

(1) Holdings could include fixed income securities at amortized cost or equity
securities at cost.

The circumstances of the above losses are considered to be company specific
and are not expected to have an effect on other holdings in our portfolios.

MORTGAGE LOANS Our mortgage loan portfolio was $7.32 billion at December 31,
2004 and $6.35 billion at December 31, 2003, and comprised primarily of loans
secured by first mortgages on developed commercial real estate. Geographical and
property type diversification are key considerations used to manage our mortgage
loan risk.

We closely monitor our commercial mortgage loan portfolio on a loan-by-loan
basis. Loans with an estimated collateral value less than the loan balance, as
well as loans with other characteristics indicative of higher than normal credit
risk, are reviewed by financial and investment management at least quarterly for
purposes of establishing valuation allowances and placing loans on non-accrual
status. The underlying collateral values are based upon discounted property cash
flow projections or a commonly used valuation method that utilizes a one-year
projection of expected annual income divided by an expected rate of return. We
had net realized capital losses related to write-downs on mortgage loans of $1
million and $4 million for the years ended December 31, 2004 and 2003. There
were no realized capital losses related to prepayments and write-downs on
mortgage loans for the year ended December 31, 2002.

SHORT-TERM INVESTMENTS Our short-term investment portfolio was $1.44 billion and
$765 million at December 31, 2004 and 2003, respectively. We invest available
cash balances primarily in taxable short-term securities having a final maturity
date or redemption date of one year or less.

We also participate in securities lending, primarily as an investment yield
enhancement, with third parties such as brokerage firms. We obtain collateral in
an amount equal to 102% of the fair value of the securities and monitor the
market value of the securities loaned on a daily basis with additional
collateral obtained as necessary. The cash we receive is invested in short-term
and fixed income investments, and an

32

offsetting liability is recorded in other liabilities. At December 31, 2004, the
amount of securities lending collateral reinvested in short-term investments had
a carrying value of $739 million. This compares to $271 million at December 31,
2003.

MARKET RISK

Market risk is the risk that we will incur losses due to adverse changes in
equity, interest, commodity, or currency exchange rates and prices. Our primary
market risk exposures are to changes in interest rates and equity prices,
although we also have a smaller exposure to changes in foreign currency exchange
rates.

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
to the consolidated financial statements.

OVERVIEW We generate substantial investable funds from our business. 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 our product profiles.

Investment policies define the overall framework for managing market and
other investment risks, including accountability and control over these risk
management activities. These investment policies have been approved by our
board of directors and they specify the investment limits and strategies that
are appropriate given our liquidity, surplus, product profile and regulatory
requirements. Oversight activities are conducted primarily through our board
of directors and investment committee. The asset-liability management ("ALM")
policy guidelines further define the overall asset-liability framework for
managing market and investment risks. ALM activities follow asset-liability
policies that have been approved by our board of directors. The ALM policies
specify limits, ranges and targets for investments that best meet our
business objectives in light of our product liabilities.

We manage our exposure to market risk through the use of asset allocation,
duration and value-at-risk limits, through the use of 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. We have duration limits on our investment portfolio and, as appropriate,
on individual components of the portfolio. These duration limits place
restrictions on the amount of interest rate risk that may be taken. Our
value-at-risk limits, used on a subset of the portfolio, restrict the potential
loss in fair value that could arise from adverse movements in the fixed income,
equity, and currency markets based on historical volatilities and correlations
among market risk factors. 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 the
investment policies. This day-to-day management is integrated within the
day-to-day activities of the ALM function. One result of this work is the
development and implementation of an asset allocation strategy for optimizing
our investment income.

INTEREST RATE RISK is the risk that we will incur an economic loss due to
adverse changes in interest rates. This risk arises from many of our primary
activities, as we invest substantial funds in interest-sensitive assets and
issue interest-sensitive liabilities.

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 approximately 5%. At December 31, 2004, the
difference between our asset and liability duration, excluding life insurance
assets and liabilities, was approximately 0.72, compared to a 0.78 gap at
December 31, 2003. If life insurance assets and liabilities were included, the
duration gap would be significantly reduced. A positive duration gap indicates
that the fair value of our assets is more sensitive to interest rate movements
than the fair value of our liabilities.

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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 margins across a wide variety of interest rate and economic
scenarios. In order to achieve this objective and limit exposure to interest
rate risk, we adhere to a philosophy of managing the duration of assets and
related liabilities. This philosophy may include using interest rate swaps,
futures, forwards, caps and floors 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.

We pledge and receive collateral on certain types of derivative contracts.
For futures and option contracts traded on exchanges, we have pledged securities
as margin deposits totaling $15 million as of December 31, 2004. For
over-the-counter derivative transactions involving interest rate swaps, foreign
currency swaps, interest rate caps, interest rate floor agreements and credit
default swaps, 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, 2004,
counterparties have posted collateral to us totaling $490 million.

To calculate 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 (as described in Note 7 of the consolidated
financial statements), and certain other items including interest-sensitive
liabilities and annuity 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. Such assumptions relate primarily to
mortgage-backed securities, collateralized mortgage obligations, callable
municipal and corporate obligations, and fixed rate single and flexible premium
deferred annuities.

Based upon the information and assumptions we use in this duration
calculation, and interest rates in effect at December 31, 2004, 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 approximately
$750 million, compared to $641 million at December 31, 2003. Additionally, there
are $6.40 billion of assets supporting life insurance products such as
traditional and interest-sensitive life that are not financial instruments and
as a result have not been included in the above estimate. This amount has
increased from the $5.42 billion reported at December 31, 2003 due to increases
in policies in force. Based on assumptions described above, in the event of a
100 basis point immediate increase in interest rates, these assets would
decrease in value by $383 million, compared to a decrease of $240 million at
December 31, 2003. 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.

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.

EQUITY PRICE RISK is the risk that we will incur losses due to adverse changes
in the general levels of the equity markets. At December 31, 2004, we held
approximately $10 million in common stocks and $619 million in other securities
with equity risk (including primarily convertible securities, limited
partnership funds and non-redeemable preferred securities), compared to
approximately $43 million in common stocks and $533 million in other equity
investments at December 31, 2003.

At December 31, 2004, our portfolio of equity instruments had a beta of
approximately 0.48, compared to a beta of approximately 0.52 at December 31,
2003. Beta represents a widely used methodology to describe, quantitively, an
investment's market risk characteristics relative to the Standard & Poor's 500
Composite Price Index ("S&P 500"). Based on the beta analysis, we estimate that
if the S&P 500 decreases by 10%, the fair value of our equity investments will
decrease by approximately 4.8%. Likewise, we estimate that if the S&P 500
increases by 10%, the fair value of our equity investments will increase by
approximately 4.8%. Based upon the information and assumptions we used to
calculate beta at December

34

31, 2004, 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
approximately $30 million, comparable to $30 million at December 31, 2003. The
selection of a 10% immediate decrease 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 equity investments was determined by comparing the monthly
total returns of the equity investments to monthly total returns of the S&P 500
over a three-year historical period. Since beta is historically based,
projecting future price volatility using this method involves an inherent
assumption that historical volatility and correlation relationships between
stocks will not change in the future. Therefore, the illustrations noted above
may not reflect our actual experience if future volatility and correlation
relationships differ from the historical relationships.

At December 31, 2004 and 2003, we had separate accounts assets related to
variable annuity and variable life contracts with account values totaling $14.38
billion and $13.43 billion, respectively. We earn contract charges as a
percentage of these account values. In the event of an immediate decline of 10%
in the account values due to equity market declines, we would have earned
approximately $24 million and $21 million less in fee income at December 31,
2004 and December 31, 2003, respectively.

Variable annuity contracts have a GMDB and customers may choose to purchase
an enhanced GMDB, guaranteed minimum income benefits ("GMIB") prior to 2004, a
TrueReturn-SM- guaranteed minimum accumulation benefit ("GMAB") beginning in
2004, and beginning in 2005, a SureIncome-SM- guaranteed minimum withdrawal
benefit ("GMWB"). These guarantees subject us to additional equity market risk
because the beneficiary or contractholder may receive a benefit that is greater
than their corresponding account value. GMDBs are payable upon death. GMIBs may
be exercised on or after the tenth-year anniversary (not prior to 2008) of the
contract if the contractholder elects to receive a defined stream of payments
("annuitize"). GMABs are credited to the contractholder account on a contract
anniversary date that is pre-determined by the contractholder, between the
eighth and twentieth year after contract issue (not prior to 2012). GMABs
guarantee an account value of up to 2.5 times (or 250%) of the amount deposited
in the contract, depending on the amount of time the contract is in force and
adherence to certain fund allocation requirements. GMWBs will be payable if the
contractholder elects to take partial withdrawals. GMWBs guarantee that the
contractholder can take annual partial withdrawals up to 8% of the amount
deposited in the contract until their withdrawals total the initial deposit.

In January 2004, we established reserves for GMDBs and GMIBs in conjunction
with the adoption of SOP 03-1. Because of this change in accounting, guarantee
payments will be recognized over future periods rather than expensed as paid.
For more details see Notes 2 and 8 of the consolidated financial statements.

At December 31, 2004 and 2003, the guaranteed value of these death benefits
in excess of account values was estimated to be $1.80 billion and $2.46 billion,
respectively, net of reinsurance. The decrease in this estimate between periods
is attributable to improved equity markets during 2004 and customer surrenders
of contracts with in-the-money GMDBs. In both periods, approximately two-thirds
of this exposure is related to the return of deposits guarantee, while the
remaining one-third is attributable to a death benefit guarantee greater than
the original deposits. In addition to reinsurance for a portion of these
benefits, we entered into various derivative instruments beginning in 2003 to
offset the risk of future death claims on substantially all new business issued
on or after January 1, 2003. A similar program for GMABs was established in 2004
and a similar program for GMWBs will be established in 2005.

In the event of an immediate decline in account values of 10% due to equity
market declines, payments for guaranteed death benefits at December 31, 2004
would increase by an estimated $15 million in 2005. These payments would be
charged against the related reserve rather than directly to earnings as paid.
Contributions to the reserve for GMDBs would be reduced by approximately $1
million in 2005 in the event of an immediate 10% decline in account values. For
discussion of the accounting treatment, see Note 2 of the consolidated financial
statements. The selection of a 10% immediate decrease should not be construed as
our prediction of future market events, but only as an example to illustrate the
potential effect on earnings and cash flow of equity market declines as a result
of this guarantee. Also, our actual payment experience in the future may not be
consistent with the assumptions used in the model.

GMIB contracts that we sold provide the contractholder with the right to
annuitize based on the highest account value at any anniversary date or on a
guaranteed earnings rate based on the initial account value over the specified
period. The guaranteed income benefit feature was first offered in our variable
annuity products beginning in 1998, with guaranteed benefits available for
election by contractholders ten years after issue. Accordingly, the earliest
date at which benefits would become payable is 2008. In the event of

35

an immediate decline of 10% in contractholders' account values as of December
31, 2004 due to equity market declines, contributions to the reserve would be
reduced by a nominal amount in 2005. For discussion of the accounting treatment,
see Note 2 of the consolidated financial statements. The selection of a 10%
immediate decrease should not be construed as our prediction of future market
events, but only as an example to illustrate the potential effect on earnings
and cash flow of equity market declines as a result of this guarantee.

In the event of an immediate decline of 10% in GMAB contractholders'
account values as of December 31, 2004, due to equity market declines, there
would be no net impact on our earnings because these benefits are hedged,
however the reserve for GMABs would be increased by approximately $5 million.

In addition to our GMDB, GMIB and GMAB equity risk, at December 31, 2004
and 2003 we had approximately $2.02 billion and $1.55 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 equity
risk associated with these liabilities through the purchase and sale of
equity-indexed options and futures, swap futures, and eurodollar futures,
maintaining risk within specified value-at-risk limits.

We are also exposed to equity risk in DAC. Fluctuations in the value of the
variable annuity and life contract account values due to the equity market
affect DAC amortization, because the expected fee income and guaranteed benefits
payable are components of the EGP for variable annuity and life contracts. For a
more detailed discussion of DAC, see Note 2 to the consolidated financial
statements and the Application of Critical Accounting Policies section of the
MD&A.

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 private equity and real estate investments.
We also have funding agreement programs and a small amount of fixed income
securities that are denominated in foreign currencies, but we use derivatives
to hedge the foreign currency risk of these funding agreements and
securities. At December 31, 2004 and 2003, we had approximately $1.22 billion
and $1.36 billion, respectively, in funding agreements denominated in foreign
currencies.

At December 31, 2004, we had approximately $4 million in foreign
currency denominated equity securities, compared to $0.7 million at December 31,
2003.

Based upon the information and assumptions we used at December 31, 2004,
we estimate that a 10% immediate unfavorable change in each of the foreign
currency exchange rates that we are exposed to would decrease the value of
our foreign currency denominated instruments by approximately $0.4 million,
compared with an estimated $0.1 million decrease at December 31, 2003. 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 11 countries, compared to 10 countries at December 31,
2003. Our largest individual currency exchange exposures at December 31, 2004
were to the Euro (56%) and the British pound (16%). The largest individual
currency exchange exposures at December 31, 2003 were to the Euro (66%) and
the British pound (32%). Our primary regional exposure is to Western Europe,
approximately 80% at December 31, 2004, compared to 97% at December 31, 2003.

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.

36

CAPITAL RESOURCES AND LIQUIDITY

CAPITAL RESOURCES consist of shareholder's equity and debt. The following
table summarizes the Company's capital resources at December 31.

(IN MILLIONS)

SHAREHOLDER'S EQUITY decreased in 2004 when compared to 2003, primarily due
to dividends paid to AIC, and the reclassification of a portion of redeemable
preferred stock to long-term debt, partially offset by net income. In addition,
in 2004, a capital contribution was recorded in conjunction with certain
reinsurance transactions (see Note 5 to the consolidated financial statements).

Shareholder's equity increased in 2003 compared to 2002 as net income was
partially offset by dividends paid to AIC. The balance of redeemable preferred
stock declined during 2003 due to the reduction of investment by a strategic
alliance partner.

DEBT as of December 31, 2004, includes $57 million of mandatorily
redeemable preferred stock that was reclassified to long-term debt from
shareholder's equity during the second quarter of 2004 in accordance with the
provisions of Statement of Financial Accounting Standard No. 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity". This stock was formerly reflected as a component of redeemable
preferred stock on the Consolidated Statements of Financial Position. The
reclassification occurred as a result of changes to contractual arrangements
between us and the holder of the stock that resulted in the stock becoming
mandatorily redeemable. As of December 31, 2003, the balance of the stock
subject to reclassification amounted to $77 million. During 2004, $20 million of
this stock was redeemed.

In addition, debt as of December 31, 2004, also reflects $47 million
related to the debt of an investment security consolidated under the provisions
of Financial Accounting Standards Board Interpretation No. 46 ("FIN 46"). The
increase in debt in 2003 compared to 2002 was primarily due to the adoption of
FIN 46, which required us to consolidate the debt of a previously unconsolidated
investment security. For more information about FIN 46 see Note 2 of the
consolidated financial statements. We have no legal ownership of the assets and
no obligation to repay the debt, and the holders of this debt have no recourse
to the equity of the Company, as the sole source of payment of the liabilities
is the assets.

FINANCIAL RATINGS AND STRENGTH The following table summarizes our financial
strength ratings at December 31, 2004.

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), and the current level of
operating leverage. In 2004, A.M. Best revised the outlook to stable from
positive for the insurance financial strength ratings of the Company and certain
rated ALIC subsidiaries and affiliates.

37

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 life insurance companies takes into account factors relating
to insurance, business, asset and interest rate risks. At December 31, 2004, our
RBC and the RBC for each of our insurance companies was above levels that would
require regulatory actions.

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 insurance companies are within these ranges.

LIQUIDITY SOURCES AND USES Our potential sources of funds principally include
the following activities.

- Receipt of insurance premiums
- Contractholder fund deposits
- Reinsurance recoveries
- Receipts of principal, interest and dividends on investments
- Sales of investments
- Funds from investment repurchase agreements, securities lending,
dollar roll and lines of credit agreements
- Intercompany loans
- Capital contributions from parent
- Dividends from subsidiaries

Our potential uses of funds principally include the following activities.

- Payment of contract benefits, maturities, surrenders and withdrawals
- Reinsurance cessions and payments
- Operating costs and expenses
- Purchase of investments
- Repayment of investment repurchase agreements, securities lending,
dollar roll and lines of credit agreements
- Payment or repayment of intercompany loans
- Capital contributions to subsidiaries
- Tax payments/settlements
- Dividends to parent

As reflected in our Consolidated Statements of Cash Flows, lower cash flows
from operating activities in 2004, compared to 2003, were primarily due to lower
premium collections and higher deferrable expenses paid, partially offset by
lower policy and contract benefits paid and higher interest received on fixed
income securities and mortgage loans. The lower premium collections were
primarily the result of the disposal of substantially all of our direct response
distribution business and lower sales of life-contingent immediate annuities.
Higher operating cash flows in 2003 primarily relate to increases in investment
income, partially offset by an increase in benefits and acquisition related
expenses from new business growth.

Cash flows used in investing activities increased in 2004 compared to 2003
as the investment of higher financing cash flows was partially offset by lower
operating cash flow. Cash flows used in investing activities declined in 2003
compared to 2002 as the investment of higher operating cash flows were offset by
lower financing cash flow.

38

Increased cash flows from financing activities in 2004, compared to 2003,
were primarily attributable to higher deposits of fixed annuities and
institutional products, partially offset by fixed annuity withdrawals and
institutional product maturities. Lower cash flow from financing activities
during 2003 reflect an increase in maturities of institutional products and
benefits and withdrawals from contractholders' accounts, partially offset by
increased deposits received from contractholders.

A portion of our product portfolio, primarily fixed annuity and
interest-sensitive life insurance products, is subject to surrender and
withdrawal at the discretion of contractholders. The following table summarizes
our liabilities for these products by their contractual withdrawal provisions at
December 31, 2004. Approximately 15.4% of these liabilities is subject to
discretionary withdrawal without adjustment.

(1) Includes $8.73 billion of liabilities with a contractual surrender charge
of less than 5% of the account balance.

(2) Approximately $8.14 billion of the contracts with market value adjusted
surrenders have a 30-45 day period during which there is no surrender
charge or market value adjustment, including approximately $1.45 billion of
market-value adjusted annuities with a period commencing during 2005.

To ensure we have the appropriate level of liquidity, we perform actuarial
tests on the impact to cash flows of policy surrenders and other actions under
various scenarios. Depending upon the years in which certain policy types were
sold with specific surrender provisions, our cash flow could vary due to higher
surrender of policies exiting their surrender charge periods.

As of December 31, 2004, the Company had $2.20 billion of putable funding
agreements of varying lengths of putable periods ranging from seven to three
hundred sixty five days. At December 31, 2004, the weighted average put period
was 345 days.

We have entered into an intercompany loan agreement with the Corporation.
The amount of intercompany loans available to us 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. We had no amounts outstanding under the intercompany loan agreement at
December 31, 2004 or 2003. The Corporation uses commercial paper borrowings and
bank lines of credit to fund intercompany borrowings.

The Corporation has established external sources of short-term liquidity
that include a commercial paper program, lines-of-credit, dollar rolls and
repurchase agreements. In the aggregate, at December 31, 2004, these sources
could provide over $3.16 billion of additional liquidity. For additional
liquidity, we can also issue new insurance contracts, incur additional debt and
sell assets from our investment portfolio. The liquidity of our investment
portfolio varies by type of investment. For example, $15.82 billion of privately
placed corporate obligations that represent 22.7% of the investment portfolio,
and $7.32 billion of mortgage loans that represent 10.5% of the investment
portfolio, generally are considered to be less liquid than many of our other
types of investments, such as our U.S. government and agencies, municipal and
public corporate fixed income security portfolios.

We have access to additional borrowing through the Corporation to support
liquidity as follows:

- - A commercial paper program with a borrowing limit of $1.00 billion to cover
short-term cash needs. As of December 31, 2004, the remaining borrowing
capacity was $957 million; however, the outstanding balance fluctuates
daily.

- - One primary credit facility and one additional credit facility totaling
$1.05 billion to cover short-term liquidity requirements. The primary
facility is a $1 billion five-year revolving line of credit expiring in
2009. It contains an increase provision that would make up to an additional
$500 million available for borrowing provided the increased portion could
be fully syndicated at a later date among existing or new lenders. The
other facility is a $50 million one-year revolving line of credit renewed
in July 2004 for an

39

additional year. Although the right to borrow under the five-year facility
is not subject to a minimum rating requirement, the costs of maintaining
the five-year facility and borrowing under it are based on the ratings of
our senior, unsecured, nonguaranteed long-term debt. There were no
borrowings under either of these lines of credit during 2004. The total
amount outstanding at any point in time under the combination of the
commercial paper program and the two credit facilities cannot exceed the
amount that can be borrowed under the credit facilities.

- - The right of the Corporation to issue up to an additional $2.15 billion of
debt securities, equity securities, warrants for debt and equity
securities, trust preferred securities, stock purchase contracts and stock
purchase units utilizing the shelf registration statement filed with the
SEC in August 2003.

The Corporation's only financial covenant exists with respect to its
primary credit facility and $18 million of its capital lease obligations. The
covenant requires that the Corporation not exceed a 37.5% debt to capital
resources ratio as defined in the agreements. This ratio at December 31, 2004
was 19.9%.

We closely monitor and manage our liquidity through long- and short-term
planning that is integrated between our underwriting and investment operations.
We manage the duration of assets and related liabilities through ALM, using a
dynamic process that addresses liquidity utilizing the investment portfolio, and
components of the portfolio as appropriate, which is routinely subjected to
stress testing. We also have access to funds from the Corporation's commercial
paper program.

Certain remote events and circumstances could constrain our or the
Corporation's liquidity. Those events and circumstances include, for example, a
catastrophe resulting in extraordinary losses, a downgrade in the Corporation's
long-term debt rating of A1 and A+ (from Moody's and Standard & Poor's,
respectively) to non-investment grade status of below Baa3/BBB-, a downgrade in
AIC's financial strength rating from Aa2, AA and A+ (from Moody's, Standard &
Poor's and A.M. Best, respectively) to below Baa/BBB/A-, or a downgrade in our
financial strength ratings from Aa2, AA and A+ (from Moody's, Standard & Poor's
and A.M. Best, respectively) to below Aa3/AA-/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.

40

CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations as of
December 31, 2004 and the payments due by period are shown in the following
table.

(1) Securities lending, dollar rolls and repurchase transactions are typically
fully collateralized with marketable securities. 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.
(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. These amounts reflect estimated cash payments to be made to
policyholders and contractholders. 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 payments has been determined by the
contract. Other contracts, such as interest-sensitive life and fixed
deferred annuities, involve payment obligations where the amount and timing
of future payments is uncertain. For these contracts, the Company is
not currently making payments and will not make payments until (i) the
occurrence of an insurable event, such as death, or (ii) the occurrence of
a payment triggering event, such as the surrender of or partial withdrawal
on a policy or deposit contract, which is outside of the control of the
Company. 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, customer lapse and withdrawal activity, and estimated additional
deposits for interest-sensitive life contracts, 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
of $72.17 billion exceeds the corresponding liability amounts of $53.94
billion included in the Consolidated Statements of Financial Position as of
December 31, 2004 for contractholder funds. 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) The reserve for life-contingent contract benefits relates primarily to
traditional life and immediate annuities with life contingencies and
reflects the present value of estimated cash payments to be made to
policyholders and contractholders. Immediate annuities with life
contingencies include (i) contracts where we are currently making payments
and will continue to do so until the occurrence of a specific event such as
death and (ii) contracts where the timing of a portion of the payments has
been determined by the contract. Other contracts, such as traditional life
and accident and health insurance, involve payment obligations where the
amount and timing of future payments is uncertain. For these contracts,
the Company is 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 a surrender
of a policy or contract, which is outside of the control of the Company.
We have estimated the timing of cash outflows 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, 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 of $26.87
billion exceeds the corresponding liability amounts of $11.20 billion
included in the Consolidated Statements of Financial Position as of
December 31, 2004 for reserve for life-contingent contract benefits. 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.
(4) Other liabilities primarily include claim payments and other checks
outstanding and accrued expenses.
(5) Balance sheet liabilities not included in the table above include unearned
and advanced premiums and deferred income taxes of $678 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 of accounting.
In addition, other liabilities of $872 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.

41

The following is a distribution in U.S. Dollars of funding agreements
(non-putable) by currency at December 31. All foreign currency denominated
funding agreements have been swapped to U.S. Dollars.

(IN MILLIONS)

Our contractual commitments as of December 31, 2004 and the payments due by
period are shown in the following table.

(1) Represents investment commitments such as private placements and
mortgage 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.

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 11 of the consolidated financial statements.

PENDING ACCOUNTING STANDARDS

As of December 31, 2004, 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.

42

FORWARD-LOOKING STATEMENTS AND 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, product development,
regulatory approvals, market position, expenses, financial results, litigation
and reserves. We believe that these statements are based on reasonable
estimates, assumptions and plans. However, if the estimates, assumptions or
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. Factors which could cause
actual results to differ materially from those suggested by such forward-looking
statements include but are not limited to those discussed or identified in this
document (including the risks described below) and in our public filings with
the SEC.

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.

CHANGES IN UNDERWRITING AND ACTUAL EXPERIENCE COULD MATERIALLY AFFECT
PROFITABILITY

Our product pricing includes long-term assumptions regarding investment
returns, mortality, morbidity, persistency and operating costs and expenses of
the business. Management establishes target returns for each product based upon
these factors and the average amount of regulatory and rating agency capital
that the company must hold to support in-force contracts. We monitor and manage
our pricing and overall sales mix to achieve target returns on a portfolio
basis. 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.

Our profitability depends on the adequacy of investment margins, the
management of market and credit risks associated with investments, our ability
to maintain premiums and contract charges at a level adequate to cover mortality
and morbidity benefits, the adequacy of contract charges on variable contracts
to cover the costs of various product features, 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.

CHANGES IN RESERVE ESTIMATES MAY REDUCE PROFITABILITY

Reserve for life-contingent contract benefits is computed on the basis of
long-term actuarial assumptions of future investment yields, mortality,
morbidity, policy terminations 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 may be required which
could have a material adverse effect on our operating results and financial
condition.

CHANGES IN MARKET INTEREST RATES MAY LEAD TO A SIGNIFICANT DECREASE IN THE SALES
AND PROFITABILITY OF SPREAD-BASED PRODUCTS

Our ability to manage our investment margin for spread-based products is
dependent upon maintaining profitable spreads between investment yields and
interest crediting rates. As interest rates decrease or remain at low levels,
proceeds from investments that have matured, prepaid or been sold may be
reinvested at lower yields, reducing investment margin. Lowering interest
crediting rates can offset decreases in investment margin on some products.
However, these changes could be limited by market conditions, regulatory or
contractual minimum rate guarantees on many contracts and may not match the
timing or magnitude of changes in asset yields. Decreases in the rates offered
on products in the financial segment could make those products less attractive,
leading to lower sales and/or changes in the level of surrenders and withdrawals
for these products. Increases in market interest rates can also have negative
effects, for example by increasing the attractiveness of other investments,
which can lead to higher surrenders at a time when our investment asset values
are lower as a result of the increase in interest rates. For certain products,
principally fixed annuity and interest-sensitive life products, the earned rate
on assets could lag behind

43

market yields. We may react to market conditions by increasing crediting rates,
which could narrow spreads. Unanticipated surrenders could result in DAC
unlocking or affect the recoverability of DAC and thereby increase expenses and
reduce profitability.

DECLINING EQUITY MARKETS MAY REDUCE BOTH SALES OF PRODUCTS AND INCOME FROM
CONTRACT CHARGES AND MAY ADVERSELY AFFECT OPERATING RESULTS AND FINANCIAL
CONDITION

Conditions in the United States and international stock markets affect the
sale and profitability of our variable annuities. In general, sales of variable
annuities decrease when stock markets are declining over an extended period of
time. The effect of decreasing separate accounts balances resulting from
volatile equity markets, lower underlying fund performance or declining consumer
confidence could cause contract charges earned to decrease. In addition, it is
possible that the assumptions and projections we use to establish prices for
GMDB, GMIB, GMAB and GMWB products, particularly assumptions and projections
about investment performance, do not accurately reflect the level of costs that
we will ultimately incur in providing those benefits, resulting in adverse
margin trends. These factors may result in accelerated DAC amortization and
require increases in reserves, which would reduce statutory capital and surplus
and/or our net income. Poor fund performance could also result in higher partial
withdrawals of account value which, for some contracts, do not reduce the GMDB
by a proportional amount.

CHANGES IN ESTIMATES OF PROFITABILITY ON INTEREST-SENSITIVE AND VARIABLE
PRODUCTS MAY HAVE AN ADVERSE EFFECT ON RESULTS THROUGH INCREASED AMORTIZATION OF
DAC

DAC related to interest-sensitive life, variable life and annuity and
investment contracts is amortized in proportion to EGP over the estimated lives
of the contracts. Assumptions underlying EGP, including those relating to
margins from mortality, investment margin, contract administration, surrender
and other contract charges, are updated from time to time in order to reflect
actual and expected experience and its potential effect on the valuation of DAC.
Updates to these assumptions could result in DAC unlocking, which in turn could
adversely affect our operating results and financial condition.

A LOSS OF KEY PRODUCT DISTRIBUTION RELATIONSHIPS COULD MATERIALLY AFFECT SALES

Certain products are distributed under agreements with other members of the
financial services industry that are not affiliated with us. Termination of one
or more of these agreements due to, for example, a change in control of one of
these distributors, could have a detrimental effect on sales.

CHANGES IN TAX LAWS MAY DECREASE SALES AND PROFITABILITY OF PRODUCTS

Under current federal and state income tax law, certain products (primarily
life insurance and annuities) we offer receive favorable tax treatment. This
favorable treatment may give certain of our products a competitive advantage
over noninsurance products. Congress from time to time considers legislation
that would reduce or eliminate the favorable policyholder tax treatment
currently applicable to life insurance and annuities. Congress also considers
proposals to reduce the taxation of certain products or investments that may
compete with life insurance and annuities. Legislation that increases the
taxation on insurance products or reduces the taxation on competing products
could lessen the advantage of certain of our products as compared to competing
products. Such proposals, if adopted, could have a material adverse effect on
our financial position 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 have negatively affected the demand for the types of
life insurance used in estate planning.

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 many 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 insurance 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
pressure will not have a material adverse effect on our business, operating
results or financial

44

condition. The ability of banks to affiliate with insurers may have a material
adverse effect on all of our product lines by substantially increasing the
number, size and financial strength of potential competitors. Furthermore,
certain competitors operate using a mutual insurance company structure and
therefore, may have dissimilar profitability and return targets.

WE ARE SUBJECT TO MARKET RISK AND SO CHANGING INTEREST RATES AND DECLINES IN
CREDIT QUALITY MAY HAVE ADVERSE EFFECTS

Because we have large investment portfolios, we are subject to market risk,
the risk that we will incur losses due to adverse changes in equity, interest,
commodity or foreign currency exchange rates and prices. Our primary market risk
exposures are to changes in interest rates and equity prices and, to a lesser
degree, changes in foreign currency exchange rates. For additional information
on market risk, see the "Market Risk" section of MD&A.

A decline in market interest rates could have an adverse effect on our
investment income as we invest cash in new investments that may yield less than
the portfolio's average rate. In a declining interest rate environment,
borrowers may prepay or redeem securities we hold more quickly than expected as
they seek to refinance at lower rates. A decline could also cause the purchase
of longer-term 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 could have an adverse effect on the value of our
investment portfolio, for example, by decreasing the fair values of the fixed
income securities that comprise a substantial majority of our investment
portfolio. Increases in interest rates also may lead to an increase in policy
loans, surrenders and withdrawals that generally would be funded at a time when
fair values of fixed income securities are lower. A decline in the quality of
our investment portfolio as a result of adverse economic conditions or otherwise
could cause additional realized losses on securities, including realized losses
relating to derivative strategies not adequately addressing portfolio risks.

CONCENTRATION OF OUR INVESTMENT PORTFOLIOS IN ANY PARTICULAR SEGMENT OF THE
ECONOMY MAY HAVE ADVERSE EFFECTS

The concentration of our investment portfolios in any particular industry,
group of related industries or geographic sector could have an adverse effect on
our investment portfolios and consequently on our results of operations and
financial position. Events or developments that have a negative impact on any
particular industry, group of related industries or geographic sector may have a
greater adverse effect on the investment portfolios to the extent that the
portfolios are concentrated rather than diversified.

WE MAY SUFFER LOSSES FROM LITIGATION

As is typical for a large company, we are involved in a substantial amount
of litigation, including class action litigation challenging a range of company
practices. Our litigation exposure could have a material adverse effect on our
operating results and financial condition in a future period in the event of an
unexpected adverse outcome or if additional reserves are required to be
established for such litigation. For a description of our current legal
proceedings, see Note 11 of the consolidated financial statements.

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 and/or
investment companies, we and many of our subsidiaries are subject to extensive
laws and regulations. These laws and regulations are complex and subject to
change. Moreover, they are administered and enforced by a number of different
governmental authorities, including state insurance regulators, state securities
administrators, the SEC, the National Association of Securities Dealers, the
U.S. Department of Justice, and state attorneys general, each of which exercises
a degree of interpretive latitude. 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
regulator's or enforcement authority'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 and improve the profitability of our
business. Furthermore, in

45

some cases, these laws and regulations are designed to protect the interests of
a specific constituency rather than a range of constituencies. For example,
state insurance laws and regulations are generally intended to protect
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 and improve the profitability of our business.

In recent years, the state insurance regulatory framework has come under
public scrutiny and members of Congress have discussed proposals to provide for
optional federal chartering of insurance companies. We can make no assurances
regarding the potential impact of state or federal measures that may change the
nature or scope of insurance regulation.

REINSURANCE MAY BE UNAVAILABLE AT HISTORICAL LEVELS AND PRICES WHICH MAY LIMIT
OUR ABILITY TO WRITE NEW BUSINESS

Market conditions beyond our control determine 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 are currently available. If we were unable to maintain our
current level of reinsurance at prices that we consider acceptable, we would
have to either accept an increase in our net liability exposure, 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

The collectibility of reinsurance recoverables is subject to uncertainty
arising from a number of factors, including 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 adverse effect on our
operating results and financial condition.

THE CONTINUED THREAT OF TERRORISM AND ONGOING MILITARY ACTIONS MAY ADVERSELY
AFFECT THE LEVEL OF CLAIM LOSSES WE INCUR AND THE VALUE OF OUR INVESTMENT
PORTFOLIO

The continued threat of terrorism, both within the United States and
abroad, and ongoing military and other actions and heightened security measures
in response to these types of threats, may cause significant volatility and
declines in the equity markets and with interest rates in the United States,
Europe and elsewhere, and result in loss of life, property damage, additional
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 the continued threat of terrorism. We
seek to mitigate the potential impact of terrorism on our commercial mortgage
portfolio by limiting geographical concentrations in key metropolitan areas and
by requiring terrorism insurance to the extent that it is commercially
available. Additionally, in the event that a terrorist act occurs, our operating
results may be adversely affected, depending on the nature of the event.

ANY DECREASE IN OUR FINANCIAL STRENGTH RATINGS MAY HAVE AN ADVERSE EFFECT ON OUR
COMPETITIVE POSITION

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 both
AIC and ALIC are A+, AA and Aa2 (from A.M. Best, Standard & Poor's and Moody's,
respectively). Because all of these ratings are subject to continuous review,
the retention of these ratings cannot be assured. A multiple level downgrade in
any of these ratings could have a material adverse effect on our sales, our
competitiveness, and the marketability of our product offerings impacting our
liquidity, operating results and financial condition.

46

CHANGES IN ACCOUNTING STANDARDS ISSUED BY THE FASB OR OTHER STANDARD-SETTING
BODIES MAY ADVERSELY AFFECT OUR FINANCIAL STATEMENTS

Our financial statements are subject to the application of GAAP, which is
periodically revised and/or expanded. Accordingly, we are required to adopt new
or revised accounting standards from time to time issued by recognized
authoritative bodies, including the Financial Accounting Standards Board
("FASB"). It is possible that future changes we are required to adopt could
change the current accounting treatment that we apply to our consolidated
financial statements and that such changes could have a material adverse effect
on our results and financial condition. For a description of potential changes
in accounting standards that could affect us currently, see Note 2 of the
consolidated financial statements.

THE OCCURRENCE OF EVENTS UNANTICIPATED IN OUR DISASTER RECOVERY SYSTEMS AND
MANAGEMENT CONTINUITY PLANNING COULD IMPAIR OUR ABILITY TO CONDUCT BUSINESS
EFFECTIVELY

In the event of a disaster such as a natural catastrophe, an industrial
accident, a terrorist attack or war, events unanticipated in our disaster
recovery systems could have an adverse impact 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information required for Item 7A is incorporated by reference to the
material under caption "Market Risk" in Part II, Item 7 of this report.

47

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

See notes to consolidated financial statements.

48

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

See notes to consolidated financial statements.

49

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY

See notes to consolidated financial statements.

50

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to consolidated financial statements.

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. GENERAL

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
Allstate Life Insurance Company ("ALIC") and its wholly owned subsidiaries
(collectively referred to as the "Company"). ALIC is wholly owned by Allstate
Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate Corporation
(the "Corporation"). 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.

Effective January 1, 2005, Glenbrook Life and Annuity Company ("GLAC"), a
wholly owned subsidiary of ALIC, was merged into ALIC to achieve future cost
savings and operational efficiency. The merger had no impact on the Company's
results of operations or financial position.

To conform to the 2004 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

The Company sells life insurance, retirement and investment products to
individual and institutional customers through several distribution channels.
The principal individual products are deferred and immediate fixed annuities,
variable annuities, interest-sensitive and traditional life insurance, and
accident and health insurance. The principal institutional product is funding
agreements backing medium-term notes.

The Company, 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 2004, the top geographic
locations for statutory premiums and annuity considerations for the Company were
Delaware, New York, California, and Florida. No other jurisdiction accounted for
more than 5% of statutory premiums and annuity considerations for the Company.
The Company distributes its products to individuals through multiple
intermediary distribution channels, including Allstate Exclusive Agencies,
independent agents, banks, broker-dealers, and specialized structured settlement
brokers. The Company has distribution relationships with over half of the 75
largest banks, most of the national broker-dealers, a number of regional
brokerage firms and many independent broker-dealers. The Company sells products
through independent agents affiliated with master brokerage agencies. Allstate
Exclusive Agencies also sell the Company's accident and health insurance
products to employees of small and medium size firms. The Company sells funding
agreements to unaffiliated trusts used to back medium-term notes issued to
institutional and individual investors. Although the Company currently benefits
from agreements with financial services entities that market and distribute its
products, change in control of these non-affiliated entities could negatively
impact the Company's sales.

The Company monitors economic and regulatory developments that have the
potential to impact its business. The ability of banks to affiliate with
insurers may have a material adverse effect on all of the Company's product
lines by substantially increasing the number, size and financial strength of
potential competitors. Furthermore, federal and state laws and regulations
affect the taxation of insurance companies and life insurance and annuity
products. Congress and various state legislatures have considered proposals
that, if enacted, could impose a greater tax burden on the Company or could have
an adverse impact on the tax treatment of some insurance products offered by the
Company, including favorable policyholder tax treatment currently applicable to
life insurance and annuities. Legislation that reduced the federal income tax
rates applicable to certain dividends and capital gains realized by individuals,
or other proposals, if adopted, that reduce the taxation, or permit the
establishment, of certain products or investments that may compete with life
insurance or annuities could have an adverse effect on the Company's financial
position 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 have negatively affected the demand for the types of life insurance
used in estate planning.

52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

INVESTMENTS

Fixed income securities include bonds, mortgage-backed and asset-backed
securities, and redeemable preferred stocks. Fixed income securities are carried
at fair value and may be sold prior to their contractual maturity ("available
for sale"). The fair value of publicly traded fixed income securities is based
upon independent market quotations. The fair value of non-publicly traded
securities is based on either widely accepted pricing valuation models which use
internally developed ratings and independent third party data (e.g., term
structures and current publicly traded bond prices) as inputs or independent
third party pricing sources. The valuation models use indicative information
such as ratings, industry, coupon, and maturity along with related third party
data and publicly traded bond prices to determine security specific spreads.
These spreads are then adjusted for illiquidity based on historical analysis and
broker surveys. Periodic changes in fair values, net of deferred income taxes,
certain deferred policy acquisition costs, certain deferred sales inducement
costs, and certain reserves for life-contingent contract benefits, are reflected
as a component of other comprehensive income. Cash received from calls,
principal payments and make-whole payments is reflected as a component of
proceeds from sales. Cash received from maturities and pay-downs is reflected as
a component of investment collections.

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.

Equity securities include common stocks, non-redeemable preferred stocks
and limited partnership interests. Common stocks and non-redeemable preferred
stocks had a carrying value of $42 million and $83 million, and cost of $33
million and $79 million at December 31, 2004 and 2003, respectively. Common
stocks and non-redeemable preferred stocks 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. Investments in limited partnership interests had a
carrying value of $172 million and $81 million at December 31, 2004 and
2003, respectively, and are accounted for in accordance with the equity method
of accounting except for instances in which the Company's interest is so minor
that it exercises virtually no influence over operating and financial policies,
in which case, the Company applies the cost method of accounting.

Short-term investments are carried at cost or amortized cost that
approximates fair value, and include the reinvestment of collateral received in
connection with certain securities included in repurchase, resale and lending
activities and collateral posted by counterparties in derivative transactions.
For these transactions, the Company records an offsetting liability in other
liabilities and accrued expenses for the Company's obligation to repay the
collateral.

Policy loans are carried at the unpaid principal balances. Other
investments consist primarily of derivative financial instruments and real
estate investments. Real estate investments are accounted for by the equity
method if held for investment, or depreciated cost, net of valuation allowances,
if the Company has an active plan to sell.

Investment income consists primarily of interest and dividends, net
investment income from partnership interests and income from certain derivative
transactions. Interest is recognized on an accrual basis and dividends are
recorded at the ex-dividend date. Interest income on mortgage-backed and
asset-backed securities is determined using the effective yield method, based on
estimated principal repayments. Interest income on certain beneficial interests
in securitized financial assets is determined using the prospective yield
method, based upon projections of expected future cash flows. Income from
investments in partnership interests, accounted for on the cost basis, is
recognized upon receipt of amounts distributed by the partnerships as income.
Accrual of income is suspended for fixed income securities and mortgage loans
that are in default or when the receipt of interest payments is in doubt.

Realized capital gains and losses include gains and losses on investment
dispositions, write-downs in value due to other than temporary declines in fair
value and changes in the fair value of certain derivatives including related
periodic and final settlements. Realized capital gains and losses on investment
dispositions are determined on a specific identification basis.

The Company writes down, to fair value, fixed income and equity securities
that are classified as other than temporarily impaired in the period the
security is deemed to be other than temporarily impaired (see Note 6).

53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DERIVATIVE AND EMBEDDED DERIVATIVE FINANCIAL INSTRUMENTS

Derivative financial instruments include swaps, futures, options, interest
rate caps and floors, warrants, certain forward contracts for purchases of
to-be-announced ("TBA") mortgage securities, and certain investment risk
transfer reinsurance agreements. Derivatives that are required to be separated
from the host instrument and accounted for as derivative financial instruments
("subject to bifurcation") are embedded in convertible and other fixed income
securities, equity-indexed life and annuity contracts and certain variable life
and annuity contracts (see Note 7).

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 the fair value of derivatives embedded in assets and
subject to bifurcation is reported in realized capital gains and losses. The
change in the fair value of derivatives embedded in liabilities and subject to
bifurcation is reported in contract benefits or realized capital gains and
losses.

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. 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 how effective the hedging instrument is in offsetting
the exposure to changes in the hedged item's fair value attributable to the
hedged risk, or in the case of a cash flow hedge, the exposure to changes in the
hedged item's or transaction's 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 is reported in realized capital gains and losses.
For the years ended December 31, 2004, 2003 and 2002, the hedge ineffectiveness
reported as realized capital gains and losses amounted to losses of $8 million,
gains of $16 million and losses of $15 million, respectively.

FAIR VALUE HEDGES The Company 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.

For hedging instruments used in fair value hedges, when the hedged items
are investment assets or a portion thereof, the change in the fair value of the
derivatives is reported in net investment income, together with the change in
the fair value of the hedged items. The change in the fair value of hedging
instruments used in fair value hedges of contractholder funds liabilities or a
portion thereof are reported in contract benefits, together with the change in
the fair value of the hedged item. Accrued periodic settlements on swaps are
reported together with the changes in fair value of the swaps in net investment
income, contract benefits or interest expense. The book value of the hedged
asset or liability is adjusted for the change in the fair value of the hedged
risk.

CASH FLOW HEDGES The Company 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. The Company's cash flow exposure may be
associated with an existing asset, liability, or a forecasted transaction.
Anticipated transactions must be probable of occurrence and their significant
terms and specific characteristics must be identified.

For hedging instruments used in cash flow hedges, the changes in fair value
of the derivatives are reported in accumulated other comprehensive income as
unrealized net capital gains and losses. Amounts are reclassified to net
investment income or realized capital gains and losses as the hedged transaction
affects net income or when the forecasted transaction affects net 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 net
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 net 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

54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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 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 financial 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 a
non-hedge, or when the derivative has been terminated, the gain or loss
recognized on the item being hedged and used to adjust the book value of the
asset, liability or portion thereof is amortized over the remaining life of the
hedged item to net investment income or contract benefits, beginning in the
period that hedge accounting is no longer applied. If the hedged item of a fair
value hedge is an asset which has become impaired, the adjustment made to the
book value of the asset is subject to the accounting policies applied to
impaired assets. When a derivative financial 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 net income as the hedged risk impacts net income,
beginning in the period hedge accounting is no longer applied or the derivative
instrument is terminated. If the derivative financial 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 financial instrument used in a cash flow hedge of a
forecasted transaction is terminated because the forecasted transaction is no
longer probable 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. If
the cash flow hedge is no longer effective, the gain or loss recognized on the
derivative is reclassified from accumulated other comprehensive income to net
income as the remaining hedged item affects net income.

NON-HEDGE DERIVATIVE FINANCIAL INSTRUMENTS The Company also has certain
derivatives that are used in interest rate, equity price and credit risk
management strategies for which hedge accounting is not applied. These
derivatives primarily consist of indexed instruments, certain interest rate swap
agreements and financial futures contracts, interest rate cap and floor
agreements, certain forward contracts for TBA mortgage securities and credit
default swaps. Based upon the type of derivative instrument and strategy, the
income statement effects of these derivatives are reported in a single line
item, with the results of the associated risk. Therefore, the derivatives' fair
value gains and losses and accrued periodic settlements are recognized together
in one of the following during the reporting period: net investment income,
realized capital gains and losses, or contract benefits.

The Company also uses derivatives to replicate returns of fixed income
securities that are either unavailable or more expensive in the cash market.
These replicated securities are comprised of a credit default swap and a highly
rated fixed income security that when combined replicate a third security.
Premiums on credit default swaps over the life of the contract and changes in
fair value are recorded in realized capital gains and losses.

SECURITY REPURCHASE AND RESALE AND SECURITIES LOANED

Securities purchased under agreements to resell and securities sold under
agreements to repurchase, including a mortgage dollar roll program, are treated
as financing arrangements and the related obligations to return the collateral
are carried at the amounts at which the securities will be subsequently resold
or reacquired, including accrued interest, as specified in the respective
agreements. The Company's policy is to take possession or control of securities
purchased under agreements to resell. Assets to be repurchased are the same, or
substantially the same, as the assets transferred and the transferor, through
the right of substitution, maintains the right and ability to redeem the
collateral on short notice. The market value of securities to be repurchased or
resold is monitored, and additional collateral is obtained, where appropriate,
to protect against credit exposure.

Securities loaned are treated as financing arrangements and the collateral
received is recorded in short-term investments, fixed income securities and
other liabilities and accrued expenses. The Company obtains collateral in an
amount equal to 102% of the fair value of securities. The Company monitors the
market value of securities loaned on a daily basis and obtains additional
collateral as necessary. Substantially all of the Company's securities loaned
are placed with large brokerage firms.

55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Security repurchase and resale agreements and securities lending
transactions are used to generate net investment income. The cash received from
repurchase and resale agreements also provide a source of liquidity. These
instruments are short-term in nature (usually 30 days or less) and are
collateralized principally by Corporate, U.S. Government and mortgage-backed
securities. The carrying values of these instruments approximate fair value
because of their relatively short-term nature.

RECOGNITION OF PREMIUM REVENUES AND CONTRACT CHARGES AND RELATED BENEFITS AND
INTEREST CREDITED

Traditional life insurance products consist principally of products with
fixed and guaranteed premiums and benefits, primarily term and whole life
insurance products. Premiums from these products are recognized as revenue when
due. Benefits are recognized in relation to such revenue so as to result in the
recognition of profits over the life of the policy and are reflected in contract
benefits.

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 due, at the inception of the contract.
Benefits and expenses are recognized in relation to such revenue such that
profits are recognized over the lives of the contracts.

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 any amounts 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 cost of insurance
(mortality risk), contract administration and early surrender. These revenues
are recognized when assessed against the contractholder account balance.
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, funding agreements (primarily
backing medium-term notes) and certain guaranteed investment contracts ("GICs")
are considered investment contracts. Deposits received for such contracts are
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 based on a specified index, such as
LIBOR, or an equity index, such as the S&P 500. Pursuant to the adoption of
Statement of Position No. 03-1, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts" ("SOP 03-1") in 2004, interest credited also includes amortization of
deferred sales inducement ("DSI") expenses. DSI is amortized into interest
credited using the same method used for deferred policy acquisition costs.

Separate account products include variable annuities and variable life
insurance contracts. The assets supporting these products are legally segregated
and available only to settle separate account contract obligations. Deposits
received are reported as separate accounts liabilities. Contract charges for
these products consist of fees assessed against the contractholder account
values for contract maintenance, administration, mortality, expense and early
surrender. Contract benefits incurred include guaranteed minimum death, income
and accumulation benefits incurred on variable annuity and life insurance
contracts.

DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS

Costs that vary with and are primarily related to acquiring life insurance
and investment contracts are deferred and recorded as deferred policy
acquisition costs ("DAC"). These costs are principally agents' and brokers'
remuneration and certain underwriting costs. DSI costs related to sales
inducements offered on sales to new customers, principally on investment
contracts and primarily in the form of additional credits to the customer's
account value or enhancements to interest credited for a specified period, which
are beyond amounts currently being credited to existing contracts, are deferred
and recorded as other assets. All other acquisition costs are expensed as
incurred and included in operating costs and expenses on the Consolidated
Statements of Operations and Comprehensive Income. DAC is amortized to income
and included in amortization of deferred policy acquisition costs on the
Consolidated Statements of Operations and Comprehensive Income. DSI is amortized
to income using the same methodology and

56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

assumptions as DAC and is included in interest credited to contractholder funds
on the Consolidated Statements of Operations and Comprehensive Income. DAC and
DSI associated with life insurance and investment contracts is periodically
reviewed for recoverability and written down when necessary.

For traditional life insurance and other premium paying contracts, DAC is
amortized in proportion to the estimated revenues on such business. Assumptions
used in amortization of DAC and reserve calculations are determined based upon
conditions as of the date of policy issue 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 change the rate of amortization in the period
such events occur. Generally, the amortization period for these contracts
approximates the estimated lives of the policies.

For internal exchanges of traditional life insurance, the unamortized
balance of costs previously deferred under the original contracts are charged to
income. The new costs associated with the exchange are deferred and amortized to
income.

For interest-sensitive life, variable annuities and investment contracts,
DAC and DSI are amortized in proportion to the incidence of the present value of
estimated gross profits ("EGP") on such business over the estimated lives of the
contracts. Generally, the amortization period ranges from 15-30 years; however,
estimates of customer surrender rates result in the majority of deferred costs
being amortized over the surrender charge period. The rate of amortization
during this term is matched to the pattern of EGP. EGP consists of estimates of
the following components: benefit margins, primarily from mortality, including
guaranteed minimum death, income, and accumulation benefits; investment margin
including realized capital gains and losses; and contract administration,
surrender and other contract charges, less maintenance expenses.

DAC and DSI amortization for variable annuity and life contracts is
estimated using stochastic modeling and is significantly impacted by the return
on the underlying funds. The Company's long-term expectation of separate
accounts fund performance net of fees was approximately 8%. Whenever actual
separate accounts fund performance based on the two most recent years varies
from the 8% expectation, the Company projects performance levels over the next
five years such that the mean return over that seven year period equals the
long-term 8% expectation. This approach is commonly referred to as "reversion to
the mean" and is commonly used by the life insurance industry as an appropriate
method for amortizing variable annuity and life DAC and DSI. In applying the
reversion to the mean process, the Company does not allow the future mean rates
of return after fees projected over the five-year period to exceed 12.75% or
fall below 0%. The Company periodically evaluates the results of utilization of
this process to confirm that it is reasonably possible that variable annuity and
life fund performance will revert to the expected long-term mean within this
time horizon.

Changes in the amount or timing of EGP result in adjustments to the
cumulative amortization of DAC and DSI. All such adjustments are reflected in
the current results of operations.

The Company performs quarterly reviews of DAC and DSI recoverability for
interest-sensitive life, variable annuities and 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 and 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, on the Consolidated Statements of Operations
and Comprehensive Income.

The cost assigned to the right to receive future cash flows from certain
business purchased from other insurers is also classified as deferred policy
acquisition costs in the Consolidated Statements of Financial Position. The
costs capitalized represent the present value of future profits expected to be
earned over the life of the contracts acquired. These costs are amortized as
profits emerge over the life of the acquired business and are periodically
evaluated for recoverability. Present value of future profits was $45 million
and $27 million at December 31, 2004 and 2003, respectively. Amortization
expense on present value of future profits was $6 million, $36 million and $15
million for the years ended December 31, 2004, 2003 and 2002, respectively.

57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

REINSURANCE RECOVERABLE

In the normal course of business, the Company seeks to limit aggregate and
single exposure to losses on large risks by purchasing reinsurance from
reinsurers (see Note 9). The amounts reported in the Consolidated Statements of
Financial Position include amounts billed to reinsurers on losses paid as well
as estimates of amounts expected to be recovered from reinsurers on incurred
losses 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 contract. Insurance
liabilities are reported gross of reinsurance recoverables. Prepaid reinsurance
premiums are deferred and reflected in income in a manner consistent with the
recognition of premiums on the reinsured contracts. Reinsurance does not
extinguish the Company's primary liability under the policies written.
Therefore, the Company regularly evaluates the financial condition of the
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 Company adopted the
provisions of Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and other Intangible Assets", effective January 1, 2002. The statement
eliminates the requirement to amortize goodwill and requires that goodwill and
separately identified intangible assets with indefinite lives be evaluated for
impairment on an annual basis (or more frequently if impairment indicators
arise) on a fair value basis.

The Company annually tests goodwill for impairment using a trading multiple
analysis, which is a widely accepted valuation technique, to estimate the fair
value of its SFAS No. 142 reporting unit. Based on the Company's decision to
sell two life insurance companies for their licenses, the Company recognized an
aggregate goodwill and other intangible assets impairment loss of $4 million ($2
million after-tax) in 2004.

Goodwill impairment testing indicated no impairment at December 31, 2003
and 2002.

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
unrealized capital gains and losses on certain investments, insurance reserves
and deferred policy acquisition costs. A deferred tax asset valuation allowance
is established when there is uncertainty that such assets would be realized.

RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS

The reserve for life-contingent contract benefits, which relates to
traditional life and accident and health insurance and immediate annuities with
life contingencies, is computed on the basis of long-term actuarial assumptions
as to future investment yields, mortality, morbidity, 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 such characteristics as type of coverage, year of issue and policy
duration. Detailed reserve assumptions and reserve interest rates are outlined
in Note 8. To the extent that unrealized gains on fixed income securities would
result in a premium deficiency had those gains actually been realized, the
related increase in reserves for certain immediate annuities with life
contingencies is recorded net of tax as a reduction of the 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, fixed annuities and
funding agreements. Contractholder funds are comprised primarily of 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. Detailed
information on crediting rates and surrender and withdrawal provisions on
contractholder funds are outlined in Note 8.

SEPARATE ACCOUNTS

The Company issues variable annuities and variable life insurance
contracts, the assets and liabilities of which are legally segregated and
recorded as assets and liabilities of the separate accounts. The assets of the
separate accounts are carried at fair value. Separate accounts liabilities
represent the contractholders' claims to the related

58

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

assets and are carried at the fair value of the 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 and Comprehensive Income. Revenues to the
Company from the separate accounts consist of contract charges for maintenance,
administration, cost of insurance and surrender of the contract prior to the
contractually specified dates and are reflected in premiums and contract
charges. Deposits to the separate accounts are not included in consolidated cash
flows.

Absent any contract provision wherein the Company guarantees either a
minimum return or account value upon death, a specified contract anniversary
date, 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
contracts' separate accounts with guarantees included $13.41 billion of equity,
fixed income and balanced mutual funds and $279 million of money market mutual
funds at December 31, 2004.

LIABILITIES FOR VARIABLE CONTRACT GUARANTEES

The Company offers various guarantees to variable annuity contractholders
including a return of no less than (a) total deposits made on the contract less
any customer withdrawals, (b) total deposits made on the contract less any
customer withdrawals plus a minimum return or (c) the highest contract value on
a specified anniversary date minus any customer withdrawals following the
contract anniversary. These guarantees include benefits that are payable in the
event of death (death benefits), upon annuitization (income benefits), or at
specified dates during the accumulation period (accumulation benefits).
Liabilities for variable contract guarantees related to death benefits are
included in reserve for life-contingent contract benefits and the liabilities
related to the income and accumulation benefits are included in contractholder
funds in the Consolidated Statements of Financial Position. Detailed information
regarding the Company's variable contracts with guarantees is outlined in Note
8.

Pursuant to the adoption of SOP 03-1 in 2004, the liability for death and
income benefit guarantees is established equal to a benefit ratio multiplied by
the cumulative contract charges earned, plus accrued interest less contract
benefit payments. The benefit ratio is calculated as the estimated present value
of all expected contract benefits divided by the present value of all expected
contract charges. The establishment of reserves for these guarantees requires
the projection of future separate account fund performance, mortality,
persistency and customer benefit utilization rates. These assumptions are
periodically reviewed and updated. For guarantees related to death benefits,
benefits represent the current guaranteed minimum death benefit payments in
excess of the current account balance. For guarantees related to income
benefits, benefits represent the present value of the minimum guaranteed
annuitization benefits in excess of the current account balance.

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 contract benefits.

Guarantees related to accumulation benefits are considered to be derivative
financial instruments; therefore, the liability for accumulation benefits is
established based on its fair value.

CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("VIES")

The Company consolidates VIEs when it is the primary beneficiary of a VIE
and if it has a variable interest that will absorb a majority of the expected
losses if they occur, receive a majority of the entity's expected returns, or
both (see Note 13).

59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS

Commitments to invest, commitments to purchase private placement
securities, commitments to extend mortgage 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.
The contractual amounts and fair values of these instruments are outlined in
Note 7.

ADOPTED ACCOUNTING STANDARDS

EMERGING ISSUES TASK FORCE ISSUE NO. 03-1, "THE MEANING OF OTHER-THAN-TEMPORARY
IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS" ("EITF 03-1") AND FSP
EITF 03-1-1, "EFFECTIVE DATE OF PARAGRAPHS 10-20 OF EITF ISSUE NO. 03-1, THE
MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN
INVESTMENTS" ("FSP EITF 03-1-1")

In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF 03-1, which was to be effective for fiscal periods beginning
after June 15, 2004. EITF 03-1 requires that when the fair value of an
investment security is less than its carrying value an impairment exists for
which a determination must be made as to whether the impairment is temporary or
other-than-temporary. In September 2004, the Financial Accounting Standards
Board ("FASB") issued, and the Company adopted, FSP EITF Issue 03-1-1, which
deferred the effective date of the impairment measurement and recognition
provisions contained in paragraphs 10-20 of EITF 03-1 until proposed FSP EITF
03-1-a is issued as final guidance (See Pending Accounting Standard). The
disclosure requirements of EITF 03-1 were previously adopted by the Company as
of December 31, 2003 for investments accounted for under SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities". For all
other investments within the scope of EITF 03-1, the disclosures are effective
and have been adopted by the Company as of December 31, 2004.

SOP03-1, "ACCOUNTING AND REPORTING BY INSURANCE ENTERPRISES FOR CERTAIN
NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE ACCOUNTS" ("SOP
03-1")

On January 1, 2004, the Company adopted SOP 03-1. The major provisions of
the SOP affecting the Company require:

- Establishment of reserves primarily related to death benefit and
income benefit guarantees provided under variable annuity contracts;

- Deferral of sales inducements that meet certain criteria, and
amortization using the same method used for DAC; and

- Reporting and measuring assets and liabilities of certain separate
accounts products as investments and contractholder funds rather than
as separate accounts assets and liabilities when specified criteria
are present.

The cumulative effect of the change in accounting principle from
implementing SOP 03-1 was a loss of $175 million, after-tax ($269 million,
pre-tax). It was comprised of an increase in benefit reserves (primarily for
variable annuity contracts) of $145 million, pre-tax, and a reduction in DAC and
DSI of $124 million, pre-tax.

The SOP requires consideration of a range of potential results to estimate
the cost of variable annuity death benefits and income benefits, which generally
necessitates the use of stochastic modeling techniques. To maintain consistency
with the assumptions used in the establishment of reserves for variable annuity
guarantees, the Company utilized the results of this stochastic modeling to
estimate expected gross profits, which form the basis for determining the
amortization of DAC and DSI. This new modeling approach resulted in a lower
estimate of expected gross profits, and therefore resulted in a write-down of
DAC and DSI.

In 2004, DSI and related amortization is classified within the Consolidated
Statements of Financial Position and Operations and Comprehensive Income as
other assets and interest credited to contractholder funds, respectively. The
amounts are provided in Note 10. Pursuant to adopting this guidance, the Company
also reclassified $204 million of separate accounts assets and liabilities to
investments and contractholder funds, respectively.

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS ("AICPA") TECHNICAL PRACTICE
AID ("TPA") RE. SOP 03-1

In September 2004, the staff of the AICPA, aided by industry experts,
issued a set of technical questions and answers on financial accounting and
reporting issues related to SOP 03-1 that will be included in the AICPA's TPAs.
The TPA addresses a number of issues related to SOP 03-1 including when it is
necessary to establish a liability in addition to the account balance for
certain contracts such as single premium and universal life that meet the

60

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

the definition of an insurance contract and have amounts assessed against the
contractholder in a manner that is expected to result in profits in earlier
years and losses in subsequent years from the insurance benefit function. The
impact of adopting the provisions of the TPA was not material to the
Company's Consolidated Statements of Operations and Comprehensive Income or
Financial Position.

FASB INTERPRETATION NO. 46 AND 46R, "CONSOLIDATION OF VARIABLE INTEREST
ENTITIES" ("FIN 46" AND "FIN 46R")

In December 2003, the FASB revised FIN 46, which was originally
issued in January 2003. FIN 46R addressed whether certain types of entities,
referred to as variable interest entities ("VIEs"), should be consolidated in a
company's financial statements. A company must consolidate a VIE if it has a
variable interest that will absorb a majority of the expected losses if they
occur, receive a majority of the entity's expected returns, or both. The Company
elected to adopt FIN 46 as of July 1, 2003 for its existing VIEs. See Note 13
for the impact of adoption.

SFAS NO. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES" ("SFAS NO. 149")

In April 2003, the FASB issued SFAS No. 149, which amends, clarifies and
codifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and used
for hedging activities under SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). While this statement
applies primarily to certain derivative contracts and embedded derivatives
entered into or modified after June 30, 2003, it also codifies conclusions
previously reached by the FASB at various dates on certain implementation
issues. The impact of adopting the provisions of the statement was not material
to the Company's Consolidated Statements of Operations and Comprehensive Income
or Financial Position.

DERIVATIVES IMPLEMENTATION GROUP STATEMENT 133 IMPLEMENTATION ISSUE NO. B36,
"EMBEDDED DERIVATIVES: MODIFIED COINSURANCE ARRANGEMENTS AND DEBT INSTRUMENTS
THAT INCORPORATE CREDIT RISK EXPOSURES THAT ARE UNRELATED OR ONLY PARTIALLY
RELATED TO THE CREDITWORTHINESS OF THE OBLIGOR UNDER THOSE
INSTRUMENTS"("IMPLEMENTATION ISSUE B36")

In April 2003, the FASB issued Implementation Issue B36, which became
effective October 1, 2003. Implementation Issue B36 was applied to two of the
Company's modified coinsurance agreements, and as a result, the embedded
derivatives were bifurcated from the agreements and marked to market value at
October 1, 2003. The effect of adopting Implementation Issue B36 was the
recognition of a loss of $13 million, after-tax, which is reflected as a
cumulative effect of a change in accounting principle on the Consolidated
Statements of Operations and Comprehensive Income.

PENDING ACCOUNTING STANDARD

FSP EITF ISSUE 03-1-A, "IMPLEMENTATION GUIDANCE FOR THE APPLICATION OF PARAGRAPH
16 OF EITF ISSUE NO. 03-1, "THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND
ITS APPLICATION TO CERTAIN INVESTMENTS" ("FSP EITF ISSUE 03-1-A").

In September 2004, the FASB issued proposed FSP EITF 03-1-a to address the
application of paragraph 16 of EITF Issue 03-1 to debt securities that are
impaired because of increases in interest rates, and/or sector spreads.
Thereafter, in connection with its decision to defer the effective date of
paragraphs 10-20 of EITF 03-1 through the issuance of FSP EITF Issue 03-1-1, the
FASB requested from its constituents comments on the issues set forth in FSP
EITF 03-1-a and the issues that arose during the comment letter process for FSP
EITF 03-1-b, "Effective Date of Paragraph 16 of EITF Issue No. 03-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments".

Due to the uncertainty as to how the outstanding issues will be resolved,
the Company is unable to determine the impact of adopting paragraphs 10-20 of
EITF 03-1 until final implementation guidance is issued. Adoption of paragraphs
10-20 of EITF 03-1 may have a material impact on the Company's Consolidated
Statements of Operations and Comprehensive Income but is not expected to have a
material impact on the Company's Consolidated Statements of Financial Position
as fluctuations in fair value are already recorded in accumulated other
comprehensive income.

3. DISPOSITIONS

In 2003, the Company announced its intention to exit its direct response
distribution business and, based on its decision to sell the business, reached a
measurement date that resulted in the recognition of an estimated loss on the
disposition of $44 million ($29 million, after-tax). In 2004, the Company
disposed of substantially all of its direct response distribution business
pursuant to reinsurance transactions with subsidiaries of Citigroup and Scottish
Re (U.S.)

61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Inc. In connection with the disposal activities related to the direct response
business, the Company recorded an additional loss on disposition of $21 million
pretax ($14 million after-tax) in 2004 (see Notes 9 and 10).

4. SUPPLEMENTAL CASH FLOW INFORMATION

Non-cash investment exchanges and modifications, which primarily reflect
refinancing of fixed income securities and mergers completed with equity
securities, totaled $79 million, $41 million and $98 million for the years ended
December 31, 2004, 2003 and 2002, respectively.

The Company paid $24 million and $98 million in dividends of investment
securities to AIC in 2004 and 2003, respectively. The Company received non-cash
capital contributions of $41 million related to certain reinsurance transactions
with American Heritage Life Insurance Company ("AHL"), an unconsolidated
affiliate of the Company, and Columbia Universal Life Insurance Company
("Columbia"), a former unconsolidated affiliate of the Company, in 2004 (see
Note 5).

Secured borrowing reinvestment transactions excluded from cash flows from
investing activities in the Consolidated Statements of Cash Flows for the years
ended December 31 are as follows:

5. RELATED PARTY TRANSACTIONS

BUSINESS OPERATIONS

The Company uses services performed by its affiliates, AIC and Allstate
Investments LLC, and business facilities owned or leased and operated by AIC in
conducting its business activities. In addition, the Company shares the services
of employees with AIC. The Company reimburses its affiliates for the operating
expenses incurred on behalf of the Company. The Company is charged for the cost
of these operating expenses based on the level of services provided. Operating
expenses, including compensation, retirement and other benefit programs
allocated to the Company (see Note 15), were $322 million, $299 million, and
$238 million in 2004, 2003 and 2002, respectively. A portion of these expenses
relate to the acquisition of business, which is deferred and amortized into
income.

STRUCTURED SETTLEMENT ANNUITIES

The Company issued $98 million, $119 million and $133 million of structured
settlement annuities, a type of immediate annuity, in 2004, 2003 and 2002,
respectively, at prices determined based upon interest rates in effect at the
time of purchase, to fund structured settlements in matters involving AIC. Of
these amounts, $27 million, $21 million and $27 million relate to structured
settlement annuities with life contingencies and are included in premium income
for 2004, 2003, and 2002, respectively. In most cases, these annuities were
issued under a "qualified assignment," whereby Allstate Settlement Corporation
("ASC"), a wholly-owned subsidiary of ALIC, purchased annuities from the
Company and assumed AIC's obligation to make the future payments.

AIC issued surety bonds to guarantee the payment of structured settlement
benefits assumed by Allstate Assignment Company ("AAC"), a wholly-owned
subsidiary of ALIC, (from both AIC and non-related parties) and funded by
certain annuity contracts issued by the Company through June 30, 2001. AAC
entered into a General Indemnity Agreement pursuant to which it indemnified AIC
for any liabilities associated with the surety bonds and gave AIC certain
collateral security rights with respect to the annuities and certain other
rights in the event of any defaults covered by the surety bonds. For contracts
written on or after July 1, 2001, AIC no longer issues surety bonds to guarantee
the payment of structured settlement benefits. Alternatively, ALIC guarantees
the payment of structured settlement benefits on all contracts issued on or
after July 1, 2001.

Reserves recorded by the Company for annuities that are guaranteed by the
surety bonds of AIC were $4.96 billion and $5.00 billion at December 31, 2004
and 2003, respectively.

BROKER/DEALER AGREEMENT

The Company receives underwriting and distribution services from Allstate
Financial Services, LLC ("AFS"), an

62

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

affiliated broker/dealer company, for certain variable annuity and variable life
insurance contracts sold by Allstate exclusive agencies. The Company incurred
$44 million, $38 million and $35 million of commission and other distribution
expenses for the years ending December 31, 2004, 2003 and 2002, respectively.

ALIC received underwriting and distribution services from Allstate
Distributors, LLC ("ADLLC"), a broker/dealer company, for certain variable
annuity contracts. Effective September 30, 2002, ALIC and Putnam Investments
terminated a joint venture agreement and ADLLC became a consolidated wholly
owned subsidiary of ALIC as a result of ALIC's purchase of Putnam's 50%
ownership therein. ALIC incurred $32 million of commission and other
distribution expenses from ADLLC for the year ended December 31, 2002.

REINSURANCE TRANSACTIONS

As of December 31, 2004, the Company entered into two coinsurance
agreements with AHL, an unconsolidated affiliate of the Company, to assume
certain interest-sensitive life and fixed annuity insurance contracts. As a
result of the transaction, the Company recorded a premium receivable of $386
million, settled in January 2005, DAC of $24 million, policy loans of $16
million, and contractholder funds of $379 million. Since the Company received
assets in excess of net liabilities from an affiliate under common control, the
Company recognized a gain of $47 million ($31 million, after-tax), which was
recorded as a non-cash capital contribution.

The Company has reinsurance contracts with Columbia, a former
unconsolidated affiliate of the Company. In November 2004, the Corporation
disposed of Columbia pursuant to a stock purchase agreement with Verde Financial
Corporation. As of June 1, 2004, the Company converted a modified coinsurance
contract with Columbia to a coinsurance contract to assume 100% of fixed annuity
business in force as of June 30, 2000 and new business written prior to the
disposition of Columbia. In addition, the Company entered into a coinsurance
contract with Columbia to assume 100% of traditional life and accident and
health business in force as of June 1, 2004. As a result of these transactions,
the Company received assets in excess of net liabilities from an affiliate under
common control and recognized a gain of $15 million ($10 million, after-tax),
which was recorded as a non-cash capital contribution. Both agreements are
continuous but may be terminated by the Company in the event of Columbia's
non-payment of reinsurance amounts due. As of May 31, 2001, Columbia ceased
issuing new contracts. During 2004 (prior to the disposition of Columbia), 2003
and 2002, the Company assumed $14 million, $17 million and $19 million,
respectively, in premiums and contract charges from Columbia.

The Company had a modified coinsurance contract with Allstate Reinsurance,
Ltd. ("Allstate Re"), an unconsolidated affiliate of the Company, to cede 50% of
certain fixed annuity business issued under a distribution agreement with PNC
Bank NA. Under the terms of the contract, a trust was established to provide
protection for ceded liabilities. This agreement was terminated in 2004. During
2003 and 2002, the Company ceded $0.4 million and $0.3 million, respectively, in
contract charges to Allstate Re.

The Company has a contract to assume 100% of all credit insurance written
by AIC. This agreement is continuous but may be terminated by either party with
60 days notice. The Company assumed premiums from AIC in the amount of $0.3
million, $2 million and $18 million in 2004, 2003 and 2002, respectively.

ALIC enters into certain intercompany reinsurance transactions with its
wholly owned subsidiaries. ALIC enters into these transactions in order to
maintain underwriting control and spread 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.

INCOME TAXES

The Company is a party to a federal income tax allocation agreement with
the Corporation (Note 12).

DEBT

As of December 31, 2004 and 2003, the Company has $57 million and $82
million, respectively, of redeemable preferred stock - Series A issued to The
Northbrook Corporation, a wholly owned subsidiary of the Corporation. As of
December 31, 2004, the preferred stock was mandatorily redeemable and, as a
result, it was classified as debt (see Note 13).

The Company has entered into an intercompany loan agreement with the
Corporation. The amount of intercompany loans available to the Company 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 Company had no amounts outstanding under
the intercompany loan agreement during the three years ended December 31, 2004.
The Corporation uses commercial paper borrowings, bank lines of credit and
repurchase

63

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

agreements to fund intercompany borrowings.

6. INVESTMENTS

FAIR VALUES

The amortized cost, gross unrealized gains and losses, and fair value for
fixed income securities are as follows:

SCHEDULED MATURITIES

The scheduled maturities for fixed income securities are as follows at
December 31, 2004:

Actual maturities may differ from those scheduled as a result of
prepayments by the issuers. Because of the potential for prepayment on mortgage-
and asset-backed securities, they are not categorized by contractual maturity.
The commercial mortgage-backed securities are categorized by contractual
maturity because they generally are not subject to prepayment risk.

64

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NET INVESTMENT INCOME

Net investment income for the years ended December 31 is as follows:

Net investment income from equity securities includes income from
partnership interests of $19 million, $7 million and $16 million for the years
ended December 31, 2004, 2003 and 2002, respectively.

REALIZED CAPITAL GAINS AND LOSSES, AFTER-TAX

Realized capital gains and losses by security type for the years ended
December 31 are as follows:

Realized capital gains and losses by transaction type for the years ended
December 31 are as follows:

(1) Dispositions include sales and other transactions such as calls and
prepayments.

Excluding the effects of calls and prepayments, gross gains of $189
million, $173 million and $137 million and gross losses of $157 million, $184
million and $327 million were realized on sales of fixed income securities
during 2004, 2003 and 2002, respectively.

UNREALIZED NET CAPITAL GAINS AND LOSSES

Unrealized net capital gains and losses on fixed income, equity securities
and derivative instruments included in accumulated other comprehensive income at
December 31, 2004 are as follows:

65

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

At December 31, 2003, equity securities had gross unrealized gains of $4
million and no gross unrealized losses.

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:

PORTFOLIO MONITORING

Inherent in the Company's evaluation of a particular security are
assumptions and estimates about the operations of the issuer and its future
earnings potential. Some of the factors considered in evaluating whether a
decline in fair value is other than temporary are: 1) the Company's ability and
intent to retain the investment for a period of time sufficient to allow for an
anticipated recovery in value; 2) the recoverability of principal and interest;
3) the duration and extent to which the fair value has been less than cost for
equity securities or amortized cost for fixed income securities; 4) the
financial condition, near-term and long-term prospects of the issuer, including
relevant industry conditions and trends, and implications of rating agency
actions and offering prices; and 5) the specific reasons that a security is in a
significant unrealized loss position, including market conditions which could
affect access to liquidity.

66

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table summarizes the gross unrealized losses and fair value
of fixed income securities by the length of time that individual securities have
been in a continuous unrealized loss position.

As of December 31, 2004 and 2003, $151 million and $220 million,
respectively, of unrealized losses related to securities with an unrealized loss
position less than 20% of cost or amortized cost, the degree of which suggests
that these securities do not pose a high risk of being other than temporarily
impaired. Of the $151 million and $220 million, $131 million and $198 million,
respectively, related to unrealized losses on investment grade fixed income
securities. Investment grade is defined as a security having a rating from the
National Association of Insurance Commissioners ("NAIC") of 1 or 2; a rating of
Aaa, Aa, A or Baa from Moody's; a rating of AAA, AA, A or BBB from Standard &
Poor's ("S&P"), Fitch or Dominion; or a comparable internal rating if an
externally provided rating is not available. Unrealized losses on investment
grade securities are principally related to changes in interest rates or changes
in issuer and sector related credit spreads since the securities were acquired.

As of December 31, 2004, the remaining $12 million of unrealized losses
were below investment grade fixed income securities that were in unrealized loss
positions greater than or equal to 20% of cost or amortized cost. Of this
amount, $8 million had been in an unrealized loss position for a period of
twelve months or more as of December 31, 2004. Additionally, $11 million of the
unrealized losses were airline industry issues.

As of December 31, 2003, the remaining $74 million of unrealized losses
related to securities in unrealized loss positions greater than or equal to 20%
of cost or amortized cost. Of the $74 million, $23 million related to investment
grade fixed income securities and $51 million related to below investment grade
fixed income securities. Of these amounts, $10 million and $26 million,
respectively, had been in an unrealized loss position for a period of twelve
months or more as of December 31, 2003. Additionally, $13 million of the
unrealized losses from below investment grade securities were airline industry
issues.

67

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of December 31, 2004 and 2003, the securities comprising the $12 million
and $74 million, respectively, of unrealized losses were evaluated based on
factors such as the financial condition and near-term and long-term prospects of
the issuer and were determined to have adequate resources to fulfill contractual
obligations, such as recent financings or bank loans, cash flows from
operations, collateral or the position of a subsidiary with respect to its
parent's bankruptcy.

As of December 31, 2004 and 2003, the Company had the intent and ability to
hold these investments for a period of time sufficient for them to recover in
value.

As of December 31, 2004, the carrying value for cost method investments was
$130 million, which primarily included limited partnership interests in fund
investments. Each cost method investment was evaluated utilizing certain
criteria such as a measurement of the Company's percentage share of the
investee's equity relative to the carrying value and certain financial trends to
determine if an event or change in circumstance occurred that could indicate an
other-than-temporary impairment existed. Investments meeting any one of these
criteria were further evaluated and, if it was determined that an
other-than-temporary impairment existed, the investment was written down to the
estimated fair value. The estimated fair value was generally based on the fair
value of the underlying investments in the limited partnership funds. It is not
practicable to estimate the fair value of each cost method investment in
accordance with paragraphs 14 and 15 of SFAS 107, "Disclosures about Fair Value
of Financial Instruments" because the investments are private in nature and do
not trade frequently. In addition, the information that would be utilized to
estimate fair value is not readily available. The Company had write-downs of $2
million related to cost method investments that were other-than-temporarily
impaired in 2004.

MORTGAGE LOAN IMPAIRMENT

A mortgage loan is impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement.

The net carrying value of impaired loans at December 31, 2004 and 2003 was
$22 million and $4 million, respectively. No valuation allowances were held at
December 31, 2004 and 2003 because the fair value of the collateral was greater
than the recorded investment in the loans.

Interest income for impaired loans is recognized on an accrual basis if
payments are expected to continue to be received; otherwise the cash basis is
used. The Company recognized interest income on impaired loans of $2 million, $2
million and $1 million during 2004, 2003 and 2002, respectively. The average
balance of impaired loans was $29 million, $23 million and $16 million during
2004, 2003 and 2002, respectively.

Valuation allowances charged to operations during 2004, 2003 and 2002 were
$1 million, $3 million and $0 million, respectively. Direct write-downs charged
against the allowances were $0 million, $3 million and $5 million for the years
ended December 31, 2004, 2003 and 2002, respectively, and in 2004, $1 million of
a balance previously written off was recovered.

INVESTMENT CONCENTRATION FOR MUNICIPAL BOND AND COMMERCIAL MORTGAGE PORTFOLIOS
AND OTHER INVESTMENT INFORMATION

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. No other state represented more
than 5.0% of the portfolio at December 31, 2004 and 2003.

68

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company's mortgage loans are collateralized by a variety of commercial
real estate property types located throughout the United States. 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 portfolio. No other state
represented more than 5.0% of the portfolio at December 31, 2004 and 2003.

The types of properties collateralizing the commercial mortgage loans at
December 31 are as follows:

The contractual maturities of the commercial mortgage loan portfolio as of
December 31, 2004 for loans that were not in foreclosure are as follows:

($ IN MILLIONS) NUMBER OF CARRYING
LOANS VALUE PERCENT
---------- ---------- ----------

2005 44 $ 329 4.5%
2006 83 642 8.8
2007 96 817 11.1
2008 98 753 10.3
2009 121 1,148 15.7
Thereafter 459 3,629 49.6
---------- ---------- ----------
Total 901 $ 7,318 100.0%
========== ========== ==========

In 2004, $239 million of commercial mortgage loans were contractually due.
Of these, 64% were paid as due, 25% were refinanced at prevailing market terms
and 11% were extended for one year or less. None were foreclosed or in the
process of foreclosure, and none were in the process of refinancing or
restructuring discussions.

Included in fixed income securities are below investment grade assets
totaling $3.72 billion and $3.69 billion at December 31, 2004 and 2003,
respectively.

At December 31, 2004, the carrying value of investments that were
non-income producing, excluding equity securities, was $3 million.

At December 31, 2004, fixed income securities with a carrying value of $71
million were on deposit with regulatory authorities as required by law.

SECURITY REPURCHASE AND RESALE AND SECURITIES LOANED

The Company participates in securities lending programs with third parties,
mostly large brokerage firms. At December 31, 2004 and 2003, fixed income
securities with a carrying value of $1.67 billion and $949 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 $4 million, $4
million and $5 million, for the years ended December 31, 2004, 2003 and 2002,
respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company participates in programs to purchase securities under
agreements to resell and programs to sell securities under agreements to
repurchase, primarily including a mortgage dollar roll program. At the end of
December 31, 2004 and 2003, the Company had $492 million and $501 million of
securities that were subject to these agreements. In return, the Company
receives cash collateral that it invests and includes in short-term 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 recorded as a result of the program was $23 million,
$13 million, and $20 million for the years ended December 31, 2004, 2003 and
2002, respectively.

7. FINANCIAL INSTRUMENTS

In the normal course of business, the Company invests in various financial
assets, incurs various financial liabilities and enters into agreements
involving derivative financial instruments and other off-balance-sheet financial
instruments. The fair value estimates of financial instruments presented below
are not necessarily indicative of the amounts the Company might pay or receive
in actual market transactions. Potential taxes and other transaction costs have
not been considered in estimating fair value. The disclosures that follow do not
reflect the fair value of the Company as a whole since a number of the Company's
significant assets (including DAC and reinsurance recoverables, net) and
liabilities (including reserve for life-contingent contract benefits,
contractholder funds pertaining to interest-sensitive life contracts and
deferred income taxes) are not considered financial instruments and are not
carried at fair value. Other assets and liabilities considered financial
instruments such as accrued investment income and cash are generally of a
short-term nature. Their carrying values are deemed to approximate fair value.

FINANCIAL ASSETS

The carrying value and fair value of financial assets at December 31 are as
follows:

Fair values of publicly traded fixed income securities are based upon
quoted market prices or dealer quotes. The fair value of non-publicly traded
securities, primarily privately placed corporate obligations, is based on
either widely accepted pricing valuation models, which use internally
developed ratings and independent third party data (e.g., term structures and
current publicly traded bond prices) as inputs, or independent third party
pricing sources. Mortgage loans are valued based on discounted contractual
cash flows. Discount rates are selected using current rates at which similar
loans would be made to borrowers with similar characteristics, using similar
properties as collateral. Loans that exceed 100% loan-to-value are valued at
the estimated fair value of the underlying collateral. At December 31, 2004
and 2003, equity securities include $172 million and $81 million,
respectively, of limited partnership interests, which are accounted for based
on the cost method or equity method of accounting (See Notes 2 and 6). The
remaining equity securities are valued based principally on quoted market
prices. Short-term investments are highly liquid investments with maturities
of less than one year whose carrying values are deemed to approximate fair
value. The carrying value of policy loans is deemed to approximate fair
value. Separate accounts assets are carried in the Consolidated Statements of
Financial Position at fair value based on quoted market prices.

FINANCIAL LIABILITIES

The carrying value and fair value of financial liabilities at December 31
are as follows:

Contractholder funds include interest-sensitive life insurance contracts
and investment contracts. Interest-sensitive life insurance contracts are not
considered to be financial instruments subject to fair value disclosure
requirements. The fair value of investment contracts is based on the terms of
the underlying contracts. Fixed annuities are valued at the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

account balance less surrender charges. Immediate annuities without life
contingencies, funding agreements and GICs are valued at the present value of
future benefits using current interest rates. Market value adjusted annuities'
fair value is estimated to be the market adjusted surrender value.
Equity-indexed annuity contracts' fair value approximates carrying value since
the embedded equity options are carried at fair value in the consolidated
financial statements.

The fair value of long-term debt is determined using discounted cash flow
calculations. Security repurchase agreements are valued at carrying value due to
their short-term nature. Separate accounts liabilities are carried at the fair
value of the underlying assets.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company primarily uses derivative financial instruments to reduce its
exposure to market risk (principally interest rate, equity price and foreign
currency risk), to replicate fixed income securities, and in conjunction with
asset/liability management.

The following table summarizes the notional amounts, fair value and
carrying value of the Company's derivative financial instruments at December 31,
2004:

(1) Carrying value includes the effects of legally enforceable master netting
agreements. Fair value and carrying value of the assets and liabilities
exclude accrued periodic settlements, which are reported in accrued
investment income or other invested assets.

The notional amounts specified in the contracts are used to calculate the
exchange of contractual payments under the agreements, and are not
representative of the potential for gain or loss on these agreements.

Fair value, which is equal to the carrying value, is the estimated amount
that the Company would receive (pay) to terminate the derivative contracts at
the reporting date. For exchange traded derivative contracts, the fair value is
based on dealer or exchange quotes. The fair value of non-exchange traded
derivative contracts, including embedded derivative financial instruments
subject to bifurcation, is based on either independent third party pricing
sources, including broker quotes, or widely accepted pricing and valuation
models which use independent third party data as inputs.

The Company manages its exposure to credit risk by utilizing highly rated
counterparties, establishing risk control limits, executing legally enforceable
master netting agreements and obtaining collateral where appropriate. The
Company uses master netting agreements for over-the-counter derivative
transactions, including interest rate swap, foreign currency swap, interest rate
cap, interest rate floor and credit default swap agreements. These agreements
permit either party to net payments due for transactions covered by the
agreements. Under the provisions of the agreements, collateral is either pledged
or obtained when certain predetermined exposure limits are exceeded. As of
December 31, 2004, counterparties pledged $490 million in cash to the Company
under these agreements. To date, 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 associated potential credit risk.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Credit exposure represents the Company's potential loss if all of the
counterparties failed to perform under the contractual terms of the contracts
and all collateral, if any, became worthless. This exposure is measured by the
fair value of freestanding derivative contracts with a positive fair value at
the reporting date reduced by the effect, if any, of master netting agreements.

The following table summarizes the counterparty credit exposure by
counterparty credit rating at December 31, as it relates to interest rate swap,
currency swap, interest rate cap, interest rate floor and replication credit
default swap agreements.

($ IN MILLIONS)

(1) Rating is the lower of Standard & Poor's or Moody's ratings.
(2) For each counterparty, only over-the-counter derivatives with a net
positive market value are included.

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 the
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.

The Company reclassified pretax net gains of $3 million and net losses of
$1 million related to cash flow hedges to net income from accumulated other
comprehensive income during 2004 and 2003, respectively. At December 31, 2004,
there is no remaining accumulated other comprehensive income to amortize to net
income during 2005.

73

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table presents information about the nature and accounting
treatment of the Company's primary derivative instruments. Included in the table
is a description of the individual derivative instruments, the risk management
strategies to which they relate, and the financial statement reporting for the
derivative instruments in the Company's consolidated financial statements.
Amounts reported are in millions on a pre-tax basis.

74

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

75

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS

The contractual amounts and fair values of off-balance-sheet financial
instruments at December 31 are as follows:

Except for credit guarantees, 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.

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.

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 these agreements to commit to future loan fundings at a
predetermined interest rate. Commitments generally have fixed expiration dates
or other termination clauses. Commitments to extend mortgage loans, which are
secured by the underlying properties, are valued based on estimates of fees
charged by other institutions to make similar commitments to similar borrowers.

Credit guarantees represent conditional commitments included in certain
fixed income securities owned by the Company, and exclude those credit
guarantees reported as derivatives under SFAS No. 133. These commitments provide
for obligations to exchange credit risk or to forfeit principal due, depending
on the nature or occurrence of credit events for the referenced entities. The
Company enters into these transactions in order to achieve higher yields than
direct investment in referenced entities. The fees for assuming the conditional
commitments are reflected in the interest receipts reported in net investment
income over the lives of the contracts. The fair value of the credit guarantees
are estimates of the conditional commitments only and are calculated using
quoted market prices or valuation models, which

76

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

incorporate external market data.

In the event of bankruptcy or other default of the referenced entities, the
Company's maximum amount at risk, assuming the value of the referenced credits
becomes worthless, is the fair value of the subject fixed income securities,
which totaled $146 million at December 31, 2004. The Company includes the impact
of credit guarantees in its analysis of credit risk, and the referenced credits
were current to their contractual terms at December 31, 2004.

8. RESERVE FOR LIFE-CONTINGENT CONTRACT BENEFITS AND CONTRACTHOLDER FUNDS

At December 31, the reserve for life-contingent contract benefits consists
of the following:

The following table highlights the key assumptions generally used in
calculating the reserve for life-contingent contract benefits:

To the extent the unrealized gains on fixed income securities would result
in a premium deficiency had those gains actually been realized, a premium
deficiency reserve has been recorded for certain immediate annuities with life
contingencies. A liability of $1.09 billion and $932 million is included in the
reserve for life-contingent contract benefits with respect to this deficiency as
of December 31, 2004 and 2003, respectively. The offset to this liability is

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

recorded as a reduction of the unrealized net capital gains included in
accumulated other comprehensive income.

At December 31, contractholder funds consists of the following:

The following table highlights the key contract provisions that determine
contractholder funds:

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.

78

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Contractholder funds activity for the years ended December 31 is as
follows:

(1) Defined as the estimated current guaranteed minimum death benefit in
excess of the current account balance at 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 present value of the guaranteed minimum
accumulation balance in excess of the current account balance.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table summarizes the liabilities for guarantees:

(1) Included in the total liability balance are reserves for variable annuity
death benefits of $79 million, variable annuity income benefits of $18 million,
variable annuity accumulation benefits of $ (1) million and other guarantees of
$43 million.

9. REINSURANCE

The Company reinsures certain of its risks to other insurers primarily
under yearly renewable term and coinsurance agreements. These agreements result
in a passing of the agreed-upon percentage of risk to the reinsurer in exchange
for negotiated reinsurance premium payments.

For discussion of reinsurance agreements with related parties, see Note 5.

The Company cedes 100% of the morbidity risk on its long-term care
contracts. The Company ceded specified percentages of the mortality risk on
certain life policies, depending upon the issue date and product, to a pool of
thirteen unaffiliated reinsurers. Since November 1998, the Company ceded
mortality risk on new life contracts that exceeded $2 million per life for
individual coverage. For business sold prior to October 1998, the Company ceded
mortality risk in excess of specific amounts up to $1 million per life for
individual coverage. Also, on certain in-force variable annuity contracts the
Company cedes 100% of the mortality and certain other risks related to product
features.

In addition, the Company has used reinsurance to effect the acquisition or
disposition of certain blocks of business. As of December 31, 2004, the Company
ceded $169 million to subsidiaries of Citigroup and Scottish Re (U.S.) Inc. in
connection with the disposition of substantially all of the direct response
distribution business (see Note 3).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

As of December 31, 2004, the gross life insurance in force was $413.72
billion of which $205.60 billion was ceded to the unaffiliated reinsurers.

The effects of reinsurance on premiums and contract charges for the years
ended December 31 are as follows:

The effects of reinsurance on contract benefits for the years ended
December 31 are as follows:

Reinsurance recoverables at December 31 are summarized in the following
table.

At December 31, 2004 and 2003, approximately 80% and 97%, respectively, of
reinsurance recoverables are due from companies rated A- or better by S&P.

81

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. DEFERRED POLICY ACQUISITION AND SALES INDUCEMENT COSTS

Deferred policy acquisition costs for the years ended December 31 are as
follows:

(1) The impact of adoption of SOP 03-1 includes a write-down in variable annuity
DAC of $108 million, the reclassification of DSI from DAC to other assets
resulting in a decrease to DAC of $44 million, and an increase to DAC of $8
million for an adjustment to the effect of unrealized capital gains and losses.

(2) In 2004, DAC was reduced by $238 million related to the disposition of
substantially all of the Company's direct response distribution business (see
Note 3).

(3) In 2004, DAC was increased by $40 million as a result of certain reinsurance
transactions with AHL and Columbia (see Note 5).

Amortization charged to income includes $120 million, $46 million and $2
million in 2004, 2003 and 2002, respectively, due to realized capital gains and
losses.

In 2004, DSI and related amortization is classified within the Consolidated
Statements of Financial Position and Operations and Comprehensive Income as
other assets and interest credited to contractholder funds, respectively.
Deferred sales inducement activity for the twelve months ended December 31, 2004
was as follows:

(1) The January 1, 2004 balance includes a $16 million write-down of DSI
due to the adoption of SOP 03-1 (see Note 2).

11. COMMITMENTS, GUARANTEES AND CONTINGENT LIABILITIES

The Company leases certain office facilities and computer equipment. Total
rent expense for all leases was $1 million, $2 million and $2 million in 2004,
2003 and 2002, respectively.

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 a
particular state. The Company's expenses related to these funds have been
immaterial.

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 referenced 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 their par value was $146
million at December 31, 2004. The obligations associated with these fixed income
securities expire at various times during the next seven years.

Lincoln Benefit Life Company ("LBL"), a wholly owned subsidiary of ALIC,
has issued universal life insurance

82

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

contracts to third parties who finance the premium payments on the universal
life insurance contracts through a commercial paper program. LBL has issued a
repayment guarantee on the outstanding commercial paper balance that is fully
collateralized by the cash surrender value of the universal life insurance
contracts. At December 31, 2004, the amount due under the commercial paper
program is $301 million and the cash surrender value of the policies is $305
million. The repayment guarantee expires April 30, 2006.

In the normal course of business, the Company provides standard
indemnifications to counterparties in contracts 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 were 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, 2004.

REGULATION

The Company is subject to changing social, economic and regulatory
conditions. Recent state and federal regulatory initiatives and proceedings have
included efforts to impose additional regulations regarding agent and broker
compensation and otherwise expand overall regulation of insurance products and
the insurance industry. The ultimate changes and eventual effects of these
initiatives on the Company's business, if any, are uncertain.

Regulatory bodies have contacted the Company and some of its subsidiaries
and have requested information relating to variable insurance products,
including such areas as market timing and late trading and sales practices.
The Company believes that these inquiries are similar to those made to many
financial services companies as part of an industry-wide investigation by
various regulatory agencies into the practices, policies and procedures
relating to variable insurance products sales and subaccount trading
practices. The Company and its subsidiaries have responded and will
continue to respond to these information requests and investigations. The
Company at the present time is not aware of any systemic problems with respect
to such matters that may have a material adverse effect on the Company's
consolidated financial position.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

LEGAL PROCEEDINGS

BACKGROUND

The Company and certain of its affiliates are named as defendants in a
number of lawsuits and other legal proceedings arising out of various aspects of
its business. As background to the "Proceedings" sub-section below, please note
the following:

- These matters raise difficult and complicated factual and legal issues
and are subject to many uncertainties and complexities, including but
not limited to, the underlying facts of each matter, novel legal
issues, variations between jurisdictions in which matters are being
litigated, differences in applicable laws and judicial
interpretations, the length of time before many of these matters might
be resolved by settlement or through litigation and, in some cases,
the timing of their resolutions relative to other similar cases
brought against other companies, the fact that some of these matters
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 these matters 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.

- In these matters, plaintiffs seek a variety of remedies including
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 include punitive
or treble damages or are not specified. Often more specific
information beyond the type of relief sought is not available because
plaintiffs have not requested more specific relief in their court
pleadings. In those cases where plaintiffs have made a specific demand
for monetary damages, they often specify damages just below a
jurisdictional limit regardless of the facts of the case. This
represents the maximum they can seek without risking removal from
state court to federal court. In our experience, monetary demands in
plaintiffs' court pleadings bear little relation to the ultimate loss,
if any, to the Company.

- For the reasons specified above, it is not possible to make meaningful
estimates of the amount or range of loss that could result from these
matters at this time. The Company reviews these matters on an on-going
basis and follows the provisions of SFAS No. 5, "Accounting for
Contingencies" when making accrual and disclosure decisions. When
assessing reasonably possible and probable outcomes, the Company bases
its decisions on its assessment of the ultimate outcome following all
appeals.

- In the opinion of the Company's management, while some of these
matters may be material to the Company's operating results for any
particular period if an unfavorable outcome results, none will have a
material adverse effect on the consolidated financial condition of the
Company.

PROCEEDINGS

Legal proceedings involving Allstate agencies and AIC may impact the
Company, even when the Company is not directly involved, because the Company
sells its products through a variety of distribution channels including Allstate
agencies. Consequently, information about the more significant of these
proceedings is provided below.

AIC is defending various lawsuits involving worker classification issues. A
putative nationwide class action filed by former employee agents includes a
worker classification issue; these agents are challenging certain amendments to
the Agents Pension Plan and are seeking to have exclusive agent independent
contractors treated as employees for benefit purposes. This matter was dismissed
with prejudice in late March 2004 by the trial court but is the subject of
further proceedings on appeal. AIC has been vigorously defending this and
various other worker classification lawsuits. The outcome of these disputes is
currently uncertain.

AIC is defending certain matters relating to its agency program
reorganization announced in 1999. These matters include a lawsuit filed in
December 2001 by the U.S. Equal Employment Opportunity Commission ("EEOC")
alleging retaliation under federal civil rights laws, a class action filed in
August 2001 by former employee agents alleging retaliation and age
discrimination under the Age Discrimination in Employment Act, breach of
contract and ERISA violations, and a lawsuit filed in October 2004 by the EEOC
alleging age discrimination with respect to a policy limiting the rehire of
agents affected by the agency program reorganization. AIC is also defending
another action, in which a class was certified in June 2004, filed by former
employee agents who terminated their employment prior to the agency

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

program reorganization. These plaintiffs have asserted claims under ERISA and
for constructive discharge, and are seeking the benefits provided in connection
with the reorganization. In late March 2004, in the first EEOC lawsuit and class
action lawsuit, 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 is voidable at the option of the release signer. The court also
ordered that an agent who voids the release must return to AIC "any and all
benefits received by the [agent] in exchange for signing the release." The court
also "concluded that, on the undisputed facts of record, there is no basis for
claims of age discrimination." The EEOC and plaintiffs have asked the court to
clarify and/or reconsider its memorandum and order. The case otherwise remains
pending. A putative nationwide class action has also been filed by former
employee agents alleging various violations of ERISA. This matter was dismissed
with prejudice in late March 2004 by the trial court but is the subject of
further proceedings on appeal. In these matters, plaintiffs seek compensatory
and punitive damages, and equitable relief. AIC has been vigorously defending
these lawsuits and other matters related to its agency program reorganization.
In addition, AIC is defending certain matters relating to its life agency
program reorganization announced in 2000. These matters include an investigation
by the EEOC with respect to allegations of age discrimination and retaliation.
AIC is cooperating with the agency investigation and will continue to vigorously
defend these and other claims related to the life agency program reorganization.
The outcome of these disputes is currently uncertain.

The Company is defending a number of lawsuits brought by plaintiffs
challenging trading restrictions the Company adopted in an effort to limit
market-timing activity in its variable annuity sub-accounts. In one case,
plaintiffs' motion for summary judgment on their breach of contract claims was
granted and the matter will proceed to trial on damages. In these various
lawsuits, plaintiffs seek a variety of remedies including monetary and equitable
relief. The Company has been vigorously defending these matters, but their
outcome is currently uncertain.

OTHER MATTERS

The Corporation and some of its agents and subsidiaries, including the
Company, have received interrogatories and demands to produce information from
several regulatory and enforcement authorities. These authorities are seeking
information relevant to on-going investigations into the possible violation of
antitrust or insurance laws by unnamed parties and, in particular, are seeking
information as to whether any person engaged in activities for the purpose of
price fixing, market allocation, or bid rigging. Published press reports have
indicated that numerous demands of this nature have been sent to insurance
companies as part of industry-wide investigations. The Corporation has
cooperated and intends to continue to cooperate with these and any similar
requests for information.

Various other legal and regulatory actions are currently pending that
involve the Company and specific aspects of its conduct of business. Like other
members of the insurance industry, the Company is the target of a number of
class action lawsuits and other types of litigation, some of which involve
claims for substantial or indeterminate amounts. This litigation is based on a
variety of issues and targets a range of the Company's practices. The outcome of
these disputes is currently unpredictable. However, at this time, based on their
present status, it is the opinion of management that the ultimate liability, if
any, in one or more of these other actions in excess of amounts currently
reserved is not expected to have a material effect on the results of operations,
liquidity or financial position of the Company.

12. INCOME TAXES

ALIC and its eligible domestic subsidiaries (the "Allstate Life Group")
join with the Corporation (the "Allstate Group") in the filing of a consolidated
federal income tax return and are party to a federal income tax allocation
agreement (the "Allstate Tax Sharing Agreement"). Under the Allstate Tax Sharing
Agreement, the Allstate Life Group pays to or receives from the Corporation the
amount, if any, by which the Allstate Group's federal income tax liability is
affected by virtue of inclusion of the Allstate Life Group in the consolidated
federal income tax return. Effectively, this results in the Allstate Life
Group's annual income tax provision being computed, with adjustments, as if the
Allstate Life Group filed a separate return. Certain domestic subsidiaries are
not eligible to join in the consolidated federal income tax return and file
separate tax returns.

The Internal Revenue Service ("IRS") has completed its review of the
Corporation's federal income tax returns through the 1996 tax year. Any
adjustments that may result from IRS examinations of tax returns are not
expected to have a material impact on the financial position, liquidity or
results of operations of the Company.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The components of the deferred income tax assets and liabilities at
December 31 are as follows:

Although realization is not assured, management believes it is more likely
than not that the deferred tax assets will be realized based on the assumption
that certain levels of income will be achieved.

The components of income tax expense for the years ended December 31 are as
follows:

The Company paid income taxes of $149 million, $161 million and $116
million in 2004, 2003 and 2002, respectively. The Company had a current income
tax payable of $63 million and a current income tax receivable of $24 million at
December 31, 2004 and 2003, 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:

In 2003 and 2002, adjustments to prior year tax liabilities were an
increase in expense of $11 million and a decrease in expense of $39 million,
respectively, which primarily resulted from Internal Revenue Service
developments and reconciliation of deferred taxes.

Prior to January 1, 1984, the Company was entitled to exclude certain
amounts from taxable income and accumulate such amounts in a "policyholder
surplus" account. Pursuant to the American Jobs Creation Act of 2004 ("the 2004
Act"), the Company can reduce the policyholders surplus account in 2005 and 2006
without incurring any tax liability. The aggregate balance in this account at
December 31, 2004 was $94 million, which prior to the 2004 Act would have
resulted in federal income taxes payable of $33 million if such amounts had been
distributed or deemed distributed from the policyholders surplus account. No
provision for taxes has ever been made for this item since the Company had no
intention of distributing such amounts. The Company expects to utilize this
provision, thereby eliminating or substantially reducing this potential tax
liability.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

13. CAPITAL STRUCTURE

DEBT OUTSTANDING

Total debt outstanding at December 31 consisted of the following:

Pursuant to the adoption of FIN 46 in 2003, the Company was determined to
be the primary beneficiary of a consolidated structured investment security VIE.
The Company's Consolidated Statements of Financial Position include $54 million
and $53 million of investments and long term debt of $47 million and $45 million
as of December 31, 2004 and 2003, respectively. The holders of the consolidated
long-term debt have no recourse to the equity of the Company as the sole source
of payment is the assets of the VIE.

As of December 31, 2004, debt includes $57 million of mandatorily
redeemable preferred stock - Series A ("preferred stock") that was
reclassified to long-term debt during the second quarter of 2004 in accordance
with the provisions of Statement of Financial Accounting Standards No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity". The reclassification occurred as a result of changes
to contractual arrangements between the Company and the holders of the
preferred stock resulting in the preferred stock becoming mandatorily
redeemable. As of December 31, 2003, the balance of the preferred stock
subject to reclassification amounted to $77 million. As of December 31, 2004,
$20 million of this preferred stock had been redeemed.

For the redeemable preferred stock-Series A, the Company's Board of
Directors declares and pays a cash dividend from time to time, but not more
frequently than quarterly. The dividend is based on the three month LIBOR
rate. Dividends of $2 million, $2 million and $3 million were paid during
2004, 2003, and 2002, respectively. As a result of the reclassification,
dividends on the reclassified preferred stock, which were previously reported
in retained earnings, are reported in operating costs and expenses since the
second quarter of 2004. There were no accrued and unpaid dividends for the
redeemable preferred stock - Series A at December 31, 2004.

14. STATUTORY FINANCIAL INFORMATION

ALIC and its 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 ("Codification"), subject to any deviations prescribed or
permitted by the applicable insurance commissioner and/or director.

Statutory accounting practices primarily differ from GAAP 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 investments and establishing deferred taxes
on a different basis.

Statutory net income and capital and surplus of ALIC and its insurance
subsidiaries, determined in accordance with statutory accounting practices
prescribed or permitted by insurance regulatory authorities are as follows:

DIVIDENDS

The ability of ALIC to pay dividends is dependent on business conditions,
income, cash requirements of ALIC,

87

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

receipt of dividends from its subsidiaries and other relevant factors. The
payment of shareholder dividends by ALIC to 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. Notification and approval of intercompany lending activities is
also required by the Illinois Department of Insurance ("IL DOI") for
transactions that exceed a level that is based on a formula using statutory
admitted assets and statutory surplus.

In the twelve-month period beginning January 1, 2004, ALIC paid dividends
of $226 million, which was less than the maximum amount allowed under Illinois
insurance law, without the prior approval of the IL DOI based on 2003 formula
amounts. Based on 2004 ALIC statutory capital and surplus, the maximum amount of
dividends ALIC will be able to pay without prior IL DOI approval at a given
point in time during 2005 is $366 million, less dividends paid during the
preceding twelve months measured at that point in time.

15. BENEFIT PLANS

PENSION AND OTHER POSTRETIREMENT PLANS

Defined benefit pension plans, sponsored by AIC, 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. AIC's funding
policy for the pension plans is to make annual contributions in accordance with
regulations under the Internal Revenue Code and in accordance with generally
accepted actuarial principles. The allocated cost to the Company included in net
income for the pension plans in 2004, 2003 and 2002 was $17 million, $22 million
and $11 million, respectively.

AIC also provides certain health care and life insurance subsidies for
employees hired before January 1, 2003 when they retire. Qualified employees may
become eligible for these benefits if they retire in accordance with AIC's
established retirement policy and are continuously insured under AIC's group
plans or other approved plans in accordance with the plan's participation
requirements. AIC shares the cost of the retiree medical benefits with retirees
based on years of service, with AIC's share being subject to a 5% limit on
annual medical cost inflation after retirement. AIC has the right to modify or
terminate these plans. The allocated cost to the Company included in net income
was $8 million, $6 million and $6 million for postretirement benefits other than
pension plans in 2004, 2003 and 2002, respectively.

PROFIT SHARING PLANS

Employees of AIC are eligible to become members of The Savings and Profit
Sharing Fund of Allstate Employees ("Allstate Plan"). The Corporation's
contributions are based on the Corporation's matching obligation and
performance. The Company's allocation of profit sharing expense from the
Corporation was $14 million, $13 million, and $15 million in 2004, 2003 and
2002, respectively.

16. OTHER COMPREHENSIVE INCOME

The components of other comprehensive income (loss) on a pre-tax and
after-tax basis for the years ended December 31 are as follows:

88

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

17. QUARTERLY RESULTS (UNAUDITED)

89

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND SHAREHOLDER OF ALLSTATE LIFE INSURANCE COMPANY

We have audited the accompanying Consolidated Statements of Financial Position
of Allstate Life Insurance Company and subsidiaries (the "Company", an affiliate
of The Allstate Corporation) as of December 31, 2004 and 2003, and the related
Consolidated Statements of Operations and Comprehensive Income, Shareholder's
Equity, and Cash Flows for each of the three years in the period ended December
31, 2004. Our audits also included the consolidated financial statement
schedules listed in the Index at Item 15. These financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements and financial statement schedules 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. The
company is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes 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,
as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2004
and 2003, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. Also, 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.

As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for certain nontraditional long-duration
contracts and separate accounts in 2004 and methods of accounting for embedded
derivatives in modified coinsurance agreements and variable interest entities in
2003.

/s/ Deloitte & Touche LLP

Chicago, Illinois
February 24, 2005

90

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 made known to
management, including the principal executive officer and the principal
financial officer, as appropriate to allow timely decisions regarding required
disclosure.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. During the fiscal
quarter ended December 31, 2004, 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.

91

PART III

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

(1), (2), (3) AND (4) DISCLOSURE OF FEES -

The following fees have been, or are anticipated to be billed by Deloitte &
Touche LLP, the member firms of Deloitte & Touche Tohmatsu, and their respective
affiliates, for professional services rendered to us for the fiscal year ending
December 31, 2004 and 2003.

(a) Fees for audits of annual financial statements including financial
statements for the separate accounts, reviews of quarterly financial
statements, statutory audits, attest services, comfort letters, consents
and review of documents filed with the Securities and Exchange Commission.

(b) Audit related fees relate to professional services such as accounting
consultations relating to new accounting standards, due diligence
assistance and audits and other attest services of non-consolidated
entities (i.e. various trusts) and are set forth below.

(c) Includes fees for tax compliance.

(d) All other fees include professional fees for consulting services related to
non-financial information technology.

(5)(i) AND (ii) AUDIT COMMITTEE'S PRE-APPROVAL POLICIES AND PROCEDURES -

The Audit Committee of The Allstate Corporation has established
pre-approval policies and procedures for itself and its consolidated
subsidiaries, including Allstate Life. Those policies and procedures are
incorporated into this Item 14 (5) by reference to Exhibit 99 (ii) - The
Allstate Corporation Policy Regarding Pre-Approval of Independent Auditors'
Services. One hundred percent of the services provided by Deloitte & Touche LLP
in 2004 and 2003 were pre-approved by The Allstate Corporation Audit Committee.
Allstate Life's Board of Directors established an audit committee in 2004, and
it also follows The Allstate Corporation Policy Regarding Pre-Approval of
Independent Auditors' Services.

92

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) The following Consolidated Financial Statements, Notes Thereto and
Independent Auditors' Report of Allstate Life Insurance Company are
included in Item 8.

Consolidated Statements of Operations and Comprehensive Income
Consolidated Statements of Financial Position
Consolidated Statements of Shareholder's Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm

(a)(2) The following additional financial statement schedules are furnished
herewith pursuant to the requirements of Form 10-K.

Schedules required to be filed under the provisions of Regulation
S-X Article 7:

Schedule I - Summary of Investment Other than Investments in Related Parties S-1
Schedule III - Supplementary Insurance Information S-2
Schedule IV - Reinsurance S-3
Schedule V - Valuation and Qualifying Accounts S-4

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 notes thereto.

(a)(3) The following is a list of the exhibits filed as part of this Form
10-K. The SEC File Number for the exhibits incorporated by reference
is 0-31248 except as otherwise noted.

93

10.2 Addendum to Service and Expense Agreement between Allstate
Insurance Company and Allstate Assurance Company (f/k/a
Provident National Assurance Company) effective February 1,
2001. Incorporated herein by reference to Exhibit 10.23 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.

10.3 Service Agreement effective as of July 1, 1989 between Allstate
Insurance Company and Allstate Life Insurance Company of New
York. Incorporated herein by reference to Exhibit 10.24 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.

10.4 Administrative Services Agreement between Allstate Insurance
Company and Intramerica Life Insurance Company effective July
1, 1999. Incorporated herein by reference to Exhibit 10.25 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.

10.5 Service Agreement between Lincoln Benefit Life Company and
Allstate Financial Services, LLC (f/k/a Laughlin Group
Advisors, Inc. and LSA Securities, Inc.) effective April 1,
1998. Incorporated herein by reference to Exhibit 10.3 to
Lincoln Benefit Life Company's Quarterly Report on Form 10-Q
for quarter ended June 30, 2002 (SEC File No. 333-59765).

10.6 Selling Agreement between Allstate Life Insurance Company,
ALFS, Inc. (f/k/a Allstate Life Financial Services, Inc.) and
Allstate Financial Services, LLC (f/k/a LSA Securities, Inc.)
effective July 26, 1999. Incorporated herein by reference to
Exhibit 10.6 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2003.

10.7 Amendment effective August 1, 1999 to Selling Agreement between
Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.1 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.

10.8 Amendment effective September 28, 2001 to Selling Agreement
between Allstate Life Insurance Company, ALFS, Inc. and
Allstate Financial Services, LLC effective July 26, 1999.
Incorporated herein by reference to Exhibit 10.2 to Allstate
Life Insurance Company's Quarterly Report on Form 10-Q for
quarter ended September 30, 2004.

10.9 Amendment effective February 15, 2002 to Selling Agreement
between Allstate Life Insurance Company, ALFS, Inc. and
Allstate Financial Services, LLC effective July 26, 1999.
Incorporated herein by reference to Exhibit 10.3 to Allstate
Life Insurance Company's Quarterly Report on Form 10-Q for
quarter ended September 30, 2004.

10.10 Amendment effective April 21, 2003 to Selling Agreement between
Allstate Life Insurance Company, ALFS, Inc. and Allstate
Financial Services, LLC effective July 26, 1999. Incorporated
herein by reference to Exhibit 10.4 to Allstate Life Insurance
Company's Quarterly Report on Form 10-Q for quarter ended
September 30, 2004.

94

10.11 Selling Agreement between Allstate Life Insurance Company of
New York, ALFS, Inc. and Allstate Financial Services, LLC
effective May 17, 2001. Incorporated herein by reference to
Exhibit 10.7 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2003.

10.12 Selling Agreement between Lincoln Benefit Life Company, ALFS,
Inc. (f/k/a Allstate Life Financial Services, Inc.) and
Allstate Financial Services, LLC (f/k/a LSA Securities, Inc.)
effective August 2, 1999. Incorporated herein by reference to
Exhibit 10.8 to Allstate Life Insurance Company's Annual Report
on Form 10-K for 2003.

10.13 Marketing Coordination and Administrative Services Agreement
among Allstate Insurance Company, Allstate Life Insurance
Company and Allstate Financial Services, LLC effective January
1, 2003. Incorporated herein by reference to Exhibit 10.9 to
Allstate Life Insurance Company's Annual Report on Form 10-K
for 2003.

10.14 Investment Management Agreement and Amendment to Certain
Service and Expense Agreements Among Allstate Investments, LLC
and Allstate Insurance Company and The Allstate Corporation and
Certain Affiliates effective as of January 1, 2002.
Incorporated herein by reference to Exhibit 10.28 to Allstate
Life Insurance Company's Form 10 filed on April 24, 2002.

10.15 Investment Advisory Agreement by and between Allstate Insurance
Company and Intramerica Life Insurance Company effective July
1, 1999. Incorporated herein by reference to Exhibit 10.29 to
Allstate Life Insurance Company's Form 10 filed on April 24,
2002.

10.16 Assignment and Assumption Agreement dated as of January 1, 2002
among Allstate Insurance Company, Allstate Investments, LLC and
Intramerica Life Insurance Company. Incorporated herein by
reference to Exhibit 10.30 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.

10.17 Investment Advisory Agreement and Amendment to Service
Agreement as of January 1, 2002 between Allstate Insurance
Company, Allstate Investments, LLC and Allstate Life Insurance
Company of New York. Incorporated herein by reference to
Exhibit 10.31 to Allstate Life Insurance Company's Form 10
filed on April 24, 2002.

10.18 Cash Management Services Master Agreement between Allstate
Insurance Company and Allstate Bank (f/k/a Allstate Federal
Savings Bank) dated March 16, 1999. Incorporated herein by
reference to Exhibit 10.32 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.

10.19 Amendment No. 1 effective January 5, 2001 to Cash Management
Services Master Agreement between Allstate Insurance Company
and Allstate Bank dated March 16, 1999. Incorporated herein by
reference to Exhibit 10.33 to Allstate Life Insurance Company's
Form 10 filed on April 24, 2002.

10.20 Agent Access Agreement among Allstate Insurance Company,
Allstate Life Insurance Company and Allstate Bank effective
January 1, 2002. Incorporated herein by reference to Exhibit
10.17 to Allstate Life Insurance Company's Annual Report on
Form 10-K for 2003.

95

10.21 Tax Sharing Agreement dated as of November 12, 1996 among The
Allstate Corporation and certain affiliates. Incorporated
herein by reference to Exhibit 10.36 to Allstate Life Insurance
Company's Form 10 filed on April 24, 2002.

10.22 Catastrophe Reinsurance Agreement between Allstate Life Insurance
Company and American Heritage Life Insurance Company effective
July 1, 2003. Incorporated herein by reference to Exhibit 10.29
to Allstate Life Insurance Company's Annual Report on Form 10-K
for 2003.

10.23 Retrocessional Reinsurance Agreement between Allstate Life
Insurance Company and American Heritage Life Insurance Company
effective December 31, 2004.

23 Consent of Independent Registered Public Accounting Firm

31.1 Rule 13a-14(a) Certification of Principal Executive Officer

31.2 Rule 13a-14(a) Certification of Principal Financial Officer

32 Section 1350 Certifications

99(ii) The Allstate Corporation Policy Regarding Pre-Approval of
Independent Auditors' Services effective November 10, 2003

(b) The exhibits are listed in Item 15. (a) (3) above.

(c) The financial statement schedules are listed in Item 15. (a) (2) above.

96

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.

ALLSTATE LIFE INSURANCE COMPANY
(Registrant)

March 15, 2005 /s/ SAMUEL H. PILCH
-----------------------------------
By: Samuel H. Pilch
(chief accounting officer and duly
authorized officer of the
registrant)

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.

97

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2004

S-1

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE III--SUPPLEMENTARY INSURANCE INFORMATION

S-2

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE IV--REINSURANCE

(IN MILLIONS)

S-3

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE V--VALUATION AND QUALIFYING ACCOUNTS

(IN MILLIONS)

S-4