UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF
		THE SECURITIES EXCHANGE ACT OF 1934
		FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF
		THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 000-31248

 

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 Northbrook, Illinois		60062
(Address of principal executive offices)		(Zip code)
Registrant’s telephone number, including area code: 847/402-5000

 

Indicate by check mark whether 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 for 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 ý

No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o

No ý

 

As of April 29, 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 QUARTERLY REPORT ON FORM 10-Q

March 31, 2005

 

PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2005 and 2004 (unaudited)		1
		Condensed Consolidated Statements of Financial Position as of March 31, 2005 (unaudited) and December 31, 2004		2
		Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2005 and 2004 (unaudited)		3
		Notes to Condensed Consolidated Financial Statements (unaudited)		4
		Report of Independent Registered Public Accounting Firm		10
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 4.		Controls and Procedures		24
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings		25
Item 6.		Exhibits		25

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Three Months Ended March 31,
(in millions)		2005			2004
		(Unaudited)
Revenues
Premiums (net of reinsurance ceded of $147 and $140)		$	142		$	151
Contract charges		259			234
Net investment income		888			783
Realized capital gains and losses		1			(27		)
		1,290			1,141
Costs and expenses
Contract benefits		347			336
Interest credited to contractholder funds		576			449
Amortization of deferred policy acquisition costs		169			115
Operating costs and expenses		116			102
		1,208			1,002
Loss on disposition of operations		(5		)	(3		)
Income from operations before income tax expense and cumulative effect of change in accounting principle, after-tax		77			136
Income tax expense		9			45
Income before cumulative effect of change in accounting principle, after-tax		68			91
Cumulative effect of change in accounting principle, after-tax		—			(175		)
Net income (loss)		$	68		$	(84	)

 

See notes to condensed consolidated financial statements.

 

1

 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

(in millions, except par value data)		March 31, 2005			December 31, 2004
		(Unaudited)
Assets
Investments
Fixed income securities, at fair value (amortized cost $58,263 and $55,964)		$	60,768		$	59,291
Mortgage loans		7,538			7,318
Equity securities		228			214
Short-term		1,630			1,440
Policy loans		719			722
Other		623			704
Total investments		71,506			69,689
Cash		162			241
Deferred policy acquisition costs		3,582			3,176
Reinsurance recoverables, net		1,586			1,507
Accrued investment income		641			593
Other assets		726			818
Separate Accounts		14,087			14,377
Total assets		$	92,290		$	90,401
Liabilities
Contractholder funds		$	55,666		$	53,939
Reserve for life-contingent contract benefits		11,558			11,203
Unearned premiums		31			31
Payable to affiliates, net		90			79
Other liabilities and accrued expenses		4,399			3,721
Deferred income taxes		358			638
Short-term debt		75			—
Long-term debt		98			104
Separate Accounts		14,087			14,377
Total liabilities		86,362			84,092
Commitments and Contingent Liabilities (Note 3)
Shareholder’s Equity
Redeemable preferred stock – series A, $100 par value, 1,500,000 shares authorized, 49,230 shares issued and outstanding		5			5
Redeemable preferred stock – series B, $100 par value, 1,500,000 shares authorized, none issued		—			—
Common stock, $227 par value, 23,800 shares authorized and outstanding		5			5
Additional capital paid-in		1,108			1,108
Retained income		4,188			4,178
Accumulated other comprehensive income:
Unrealized net capital gains and losses		622			1,013
Total accumulated other comprehensive income		622			1,013
Total shareholder’s equity		5,928			6,309
Total liabilities and shareholder’s equity		$	92,290		$	90,401

See notes to condensed consolidated financial statements.

 

2

 

ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Three Months Ended March 31,
(in millions)		2005			2004
		(Unaudited)
Cash flows from operating activities
Net income (loss)		$	68		$	(84	)
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and other non-cash items		(46		)	(32		)
Realized capital gains and losses		(1		)	27
Loss on disposition of operations		5			3
Cumulative effect of change in accounting principle		—			175
Interest credited to contractholder funds		576			449
Changes in:
Contract benefit and other insurance reserves		(17		)	(65		)
Unearned premiums		—			—
Deferred policy acquisition costs		(26		)	(52		)
Reinsurance recoverables, net		(80		)	(46		)
Income taxes payable		(36		)	42
Other operating assets and liabilities		(29		)	(10		)
Net cash provided by operating activities		414			407
Cash flows from investing activities
Proceeds from sales
Fixed income securities		2,366			1,571
Equity securities		16			26
Investment collections
Fixed income securities		1,036			946
Mortgage loans		153			161
Investment purchases
Fixed income securities		(5,068		)	(4,112		)
Equity securities		(32		)	(89		)
Mortgage loans		(402		)	(362		)
Change in short-term investments, net		(121		)	182
Change in other investments, net		22			(21		)
Net cash used in investing activities		(2,030		)	(1,698		)
Cash flows from financing activities
Change in short-term debt, net		75			—
Redemption of mandatorily redeemable preferred stock		(6		)	—
Contractholder fund deposits		3,255			2,743
Contractholder fund withdrawals		(1,787		)	(1,396		)
Dividends paid		—			(25		)
Net cash provided by financing activities		1,537			1,322
Net (decrease) increase in cash		(79		)	31
Cash at beginning of the period		241			121
Cash at end of period		$	162		$	152

See notes to condensed consolidated financial statements.

 

3

 

ALL STATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.              Basis of Presentation

 

The accompanying condensed consolidated financial statements include the accounts of Allstate Life Insurance Company (“ALIC”) and its wholly owned subsidiaries (together with ALIC, the “Company”). ALIC is wholly owned by Allstate Insurance Company (“AIC”), a wholly owned subsidiary of The Allstate Corporation (the “Corporation”).

 

The condensed consolidated financial statements and notes as of March 31, 2005 and for the three-month periods ended March 31, 2005 and 2004 are unaudited.  The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods.  These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

 

To conform to the 2005 presentation, certain amounts in the prior year’s condensed consolidated financial statements and notes have been reclassified.

 

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 $41 million and $42 million, and cost of $34 million and $33 million at March 31, 2005 and December 31, 2004, respectively.  Investments in limited partnership interests had a carrying value of $187 million and $172 million at March 31, 2005 and December 31, 2004, respectively.

 

Non-cash investment exchanges and modifications, which primarily reflect refinancings of fixed income securities, totaled $5 million and $1 million for the three months ended March 31, 2005 and 2004, respectively.

 

Pending accounting standard

 

Financial Accounting Standards Board Staff Position re. Emerging Issues Task Force 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 Financial Accounting Standards Board (“FASB”) issued proposed FSP EITF 03-1-a to address the application of paragraph 16 of Emerging Issues Task Force Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“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 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 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 Condensed Consolidated Statements of Operations but is not expected to have a material impact on the Company’s Condensed Consolidated Statements of Financial Position as fluctuations in fair value are already recorded in accumulated other comprehensive income.

 

4

 

2.              Related Party Transactions

 

Reinsurance

 

In the first quarter of 2005, the Company received fixed income securities with a fair value and amortized cost of $381 million and $358 million, respectively, and $5 million of accrued investment income for the settlement of a $386 million premium receivable due from American Heritage Life Insurance Company (“AHL”), an unconsolidated affiliate of the Company.  The receivable related to two coinsurance agreements entered into in 2004 whereby the Company assumed certain interest-sensitive life and fixed annuity insurance contracts from AHL.  Since the transaction was between affiliates under common control, the securities were recorded at amortized cost as of the date of settlement.  The difference between the amortized cost and fair value of the securities was recorded as a non-cash dividend of $23 million ($15 million, after-tax).

 

Investments

 

In the first quarter of 2005, the Company purchased fixed income securities from AIC.  The Company paid $655 million in cash for the securities, which includes the fair value of the securities of $649 million and $6 million for accrued investment income.  Since the transaction was between affiliates under common control, the securities were recorded at the amortized cost of $623 million as of the date of sale.  The difference between the amortized cost and fair value of the securities was recorded as a dividend of $26 million ($16 million, after-tax).

 

Debt

 

The Company issued $75 million of short-term debt to the Corporation with a weighted average interest rate of 2.86% in the first quarter of 2005 pursuant to an intercompany loan agreement.

 

3.              Reinsurance

 

The effects of reinsurance on premiums and contract charges are as follows:

 

		Three months ended March 31,
(in millions)		2005			2004
Premiums and contract charges
Direct		$	538		$	516
Assumed
Affiliate		4			5
Non-affiliate		6			4
Ceded-non-affiliate		(147		)	(140		)
Premiums and contract charges, net of reinsurance		$	401		$	385

 

5

 

The effects of reinsurance on contract benefits are as follows:

 

		Three months ended March 31,
(in millions)		2005			2004
Contract benefits
Direct		$	487		$	415
Assumed
Affiliate		3			2
Non-affiliate		4			—
Ceded
Non-affiliate		(147		)	(81		)
Contract benefits, net of reinsurance		$	347		$	336

 

Effective January 1, 2004, the Company adopted Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for certain Nontraditional Long Duration Contracts and for Separate Accounts” and, in connection therewith, recorded a cumulative effect of change in accounting principle due to an increase in benefit reserves of $94 million, after-tax ($145 million, pre-tax).  The increase in benefit reserves was comprised of direct, assumed non-affiliate and ceded non-affiliate benefit reserves of $155 million, $4 million and $14 million, respectively.

 

4.              Guarantees and Contingent Liabilities

 

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 $143 million at March 31, 2005.  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 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 March 31, 2005, the amount due under the commercial paper program is $301 million and the cash surrender value of the policies is $307 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 March 31, 2005.

 

6

 

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.

 

Legal and Regulatory Proceedings and Inquiries

 

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 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 Statement of Financial Accounting Standards 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

 

7

 

employees for benefit purposes.  This matter was dismissed with prejudice by the trial court, was the subject of further proceedings on appeal, and has been reversed and remanded to the trial court in April 2005.  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 program reorganization.  These plaintiffs have asserted claims under ERISA, and are seeking 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 by the trial court, was the subject of further proceedings on appeal, and has been reversed and remanded to the trial court in April 2005.  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 has been defending certain matters relating to its life agency program reorganization announced in 2000. These matters have been the subject of an investigation by the EEOC with respect to allegations of age discrimination and retaliation and conciliation discussions between Allstate and the EEOC.  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 subsidiaries, including the Company, have received interrogatories and demands for information from regulatory and enforcement authorities relating to various insurance products and practices.  The areas of inquiry include variable annuity market timing, late trading and the issuance of funding agreements backing medium-term notes.  The Corporation and some of its subsidiaries, including the Company, have also received interrogatories and demands for information from authorities seeking information relevant to on-going investigations into the possible violation of antitrust or insurance laws by unnamed parties and, in particular, seeking information as to whether any person engaged in activities for the purpose of price fixing, market allocation, or bid rigging.  The Company believes that these inquiries are similar to those made to many financial services companies as part of industry-wide investigations by various authorities into the practices, policies and procedures relating to insurance and financial services products.  The Corporation and its subsidiaries have responded and will continue to respond to these inquiries.

 

8

 

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 proceedings, some of which involve claims for substantial or indeterminate amounts.  These actions are based on a variety of issues and target 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 the actions described in this “Other Matters” subsection in excess of amounts currently reserved is not expected to have a material effect on the results of operations, liquidity or financial condition of the Company.

 

5.  Other Comprehensive Income

 

The components of other comprehensive income on a pretax and after-tax basis are as follows:

 

		Three months ended March 31,
		2005									2004
(in millions)		Pretax			Tax			After- tax			Pretax			Tax			After- tax
Unrealized holding gains (losses) arising during the period		$	(697	)	$	244		$	(453	)	$	224		$	(78	)	$	146
Less: reclassification adjustments		(95		)	33			(62		)	(27		)	10			(17		)
Other comprehensive income (loss)		$	(602	)	$	211		(391		)	$	251		$	(88	)	163
Net income (loss)								68									(84		)
Comprehensive income (loss)								$	(323	)							$	79

 

9

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholder of

Allstate Life Insurance Company:

 

We have reviewed the accompanying condensed consolidated statement of financial position of Allstate Life Insurance Company and subsidiaries (the “Company”, an affiliate of The Allstate Corporation) as of March 31, 2005, and the related condensed consolidated statements of operations and cash flows for the three-month periods ended March 31, 2005 and 2004.  These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

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

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of Allstate Life Insurance Company and subsidiaries as of December 31, 2004, and the related consolidated statements of operations and comprehensive income, shareholder’s equity, and cash flows for the year then ended, not presented herein.  In our report dated February 24, 2005, which report includes an explanatory paragraph relating to a change in the Company’s method of accounting for certain nontraditional long-duration contracts and separate accounts in 2004 and changes in the methods of accounting for embedded derivatives in modified coinsurance agreements and variable interest entities in 2003, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 2004 is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived.

 

 

/s/ Deloitte & Touche LLP

 

Chicago, Illinois

May 6, 2005

 

10

 

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2005 AND 2004

 

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”, or the “Company”). It should be read in conjunction with the condensed consolidated financial statements and notes thereto found under Part I. Item 1. contained herein, and with the discussion, analysis, consolidated financial statements and notes thereto in Part I. Item 1. and Part II. Item 7. and Item 8. of the Allstate Life Insurance Company Annual Report on Form 10-K for 2004.  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.

 

HIGHLIGHTS

 

•                  Revenues increased 13.1% in the first quarter of 2005 compared to the same period of 2004 due to increases in net investment income, higher contract charges and improved realized capital gains and losses.

•                  The annual evaluation of assumptions in our valuation models for all investment products resulted in a net reduction to income before taxes of $16 million in the first quarter of 2005, compared to the 2004 evaluation, which resulted in a net reduction of income before taxes of $0.5 million.

•                  Income before cumulative effect of change in accounting principle, after-tax, decreased 25.3% in the first quarter of 2005 compared to the same period of 2004 as higher gross margin was more than offset by increased deferred policy acquisition costs (“DAC”) and deferred sales inducements (“DSI”) amortization related to realized capital gains and losses and higher operating costs and expenses.

•                  Total investments increased 2.6% to $71.51 billion at March 31, 2005 compared to December 31, 2004, due primarily to contractholder deposits.

•                  Contractholder fund deposits totaled $3.25 billion for the first quarter of 2005 compared to $2.74 billion for the first quarter of 2004.  The increase of $507 million was primarily attributable to deposits from fixed annuities.

 

11

 

OPERATIONS

 

Premiums represent revenues generated from traditional life, immediate annuities with life contingencies and other insurance products that have significant mortality or morbidity risk.

 

Contract charges are revenues generated from interest-sensitive life, variable and fixed annuities and other investment 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.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Premiums
Traditional life		$	64		$	69
Immediate annuities with life contingencies		73			77
Other		5			5
Total premiums		142			151
Contract charges
Interest-sensitive life		177			160
Fixed annuities		17			14
Variable annuities		65			60
Total contract charges		259			234
Total premiums and contract charges		$	401		$	385

 

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

 

		Three Months Ended March 31,
(in millions)		2005			2004
Premiums
Allstate agencies		$	66		$	53
Independent agents		21			20
Specialized brokers		54			63
Other		1			15
Total premiums		142			151
Contract charges
Allstate agencies		131			113
Independent agents		56			59
Broker dealers		52			49
Banks		11			5
Specialized brokers		8			7
Other		1			1
Total contract charges		259			234
Total premiums and contract charges		$	401		$	385

 

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Total premiums decreased 6.0% to $142 million in the first quarter of 2005 compared to the same period of 2004 due to lower premiums on traditional life and immediate annuities with life contingencies.

Contract charges increased 10.7% to $259 million in the first quarter of 2005 compared to the same period of 2004.  The increase was due to higher contract charges on interest-sensitive life and, to a lesser extent, variable and fixed 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 surrenders and benefits.  Higher variable annuity contract charges were the result of increased average account values during the first quarter of 2005 compared to the first quarter of 2004, reflecting positive investment results during 2004 in addition to higher fees for contract guarantees.  Fixed annuity contract charges for the first quarter of 2005 reflect higher surrender charges compared with the first quarter of 2004.

 

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.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Contractholder funds, beginning balance		$	53,939		$	44,914
Impact of adoption of SOP 03-1(1)		—			421
Deposits
Fixed annuities (immediate and deferred)		1,746			1,216
Institutional products (primarily funding agreements)		1,098			1,101
Interest-sensitive life		312			306
Variable annuity and life deposits allocated to fixed accounts		94			120
Total deposits		3,250			2,743
Interest credited		553			444
Maturities, benefits, withdrawals and other adjustments
Maturities of institutional products		(704		)	(511		)
Benefits		(217		)	(167		)
Surrenders and partial withdrawals		(787		)	(588		)
Contract charges		(159		)	(142		)
Net transfers to separate accounts		(78		)	(131		)
Fair value hedge adjustments for institutional products		(120		)	23
Other adjustments		(11		)	(9		)
Total maturities, benefits, withdrawals and other adjustments		(2,076		)	(1,525		)
Contractholder funds, ending balance		$	55,666		$	46,997

 

(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 other guarantees provided under fixed annuity, variable annuity and interest-sensitive life contracts.

 

Contractholder deposits increased 18.5% in the first quarter of 2005 compared to the same period of 2004 due primarily to greater deposits of fixed annuities.  Average contractholder funds, excluding the impact of adopting SOP 03-1, increased 18.7% in the first quarter of 2005 compared to the same period of 2004.  Fixed

 

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annuity deposits increased 43.6% in the first quarter of 2005 compared to the same period in the prior year due to strong consumer demand, competitive pricing and effective distribution efforts in our bank channel.

 

Benefits, surrenders and partial withdrawals increased 33.0% in the first quarter of 2005 compared to the same period of 2004 reflecting an annualized withdrawal rate of 9.6% for the first quarter of 2005 based on the beginning of period contractholder funds balance excluding institutional product reserves.  This compares to an annualized withdrawal rate of 8.9% for the first quarter of 2004.  The increase was primarily attributable to higher surrenders of market value adjusted annuities during the 30-45 day window in which there were no surrender charges or market value adjustments.  Surrenders and withdrawals may vary with changes in interest rates and equity market conditions and the aging of our in-force contracts.

 

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.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Separate accounts liabilities, beginning balance		$	14,377		$	13,425
Impact of adoption of SOP 03-1(1)		—			(204		)
Variable annuity and life deposits		437			487
Variable annuity and life deposits allocated to fixed accounts		(94		)	(120		)
Net deposits		343			367
Investment results		(218		)	316
Contract charges		(67		)	(62		)
Net transfers from fixed accounts		78			131
Surrenders and benefits		(426		)	(423		)
Separate accounts liabilities, ending balance		$	14,087		$	13,550

 

(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 declined $290 million as of March 31, 2005 compared to December 31, 2004.  The decrease was primarily attributable to unfavorable investment results since December 31, 2004.  Net deposits and transfers from fixed accounts were more than offset by contract charges and 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.

 

Net investment income increased 13.4% in the first quarter of 2005 compared to the same period of 2004, primarily due to 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, institutional funding agreements and interest-sensitive life policies.  Investment balances as of March 31, 2005, increased 2.6% from December 31, 2004.  The lower portfolio yields were primarily due to purchases, including reinvestments, of fixed income securities with yields lower than the current portfolio average.

 

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Net income analysis is presented in the following table.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Premiums		$	142		$	151
Contract charges		259			234
Net investment income		888			783
Periodic settlements and accruals on non-hedge derivative instruments(1)		19			6
Contract benefits		(347		)	(336		)
Interest credited to contractholder funds(2)		(537		)	(436		)
Gross margin		424			402
Amortization of DAC and DSI		(114		)	(113		)
Operating costs and expenses		(116		)	(102		)
Income tax expense		(51		)	(63		)
Realized capital gains and losses, after-tax		1			(17		)
DAC and DSI amortization related to realized capital gains and losses, after-tax		(61		)	(10		)
Reclassification of periodic settlements and accruals on non-hedge derivative instruments, after-tax		(12		)	(4		)
Loss on disposition of operations, after-tax		(3		)	(2		)
Cumulative effect of change in accounting principle, after-tax		—			(175		)
Net income (loss)		$	68		$	(84	)

 

(1)          Periodic settlements and accruals on non-hedge derivative instruments are reflected as a component of realized capital gains and losses on the Condensed Consolidated Statements of Operations.

(2)          Amortization of DSI is excluded from interest credited to contractholder funds for purposes of calculating gross margin.  Amortization of DSI totaled $39 million and $13 million in first quarter of 2005 and 2004, respectively.

 

Gross margin, a non-GAAP measure, represents premiums and contract charges, net investment income and periodic settlements and accruals on non-hedge derivative instruments, less contract benefits and interest credited to contractholder funds excluding amortization of DSI.  We reclassify periodic settlements and accruals on non-hedge derivative instruments into gross margin to report them in a manner consistent with the economically hedged investments, replicated assets or product attributes (e.g. net investment income or interest credited to contractholder funds) and by doing so, appropriately reflect trends in product performance.  We use gross margin as a component of our evaluation of the profitability of our 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 three components that are utilized to further analyze the business: investment margin, benefit margin, and contract charges and fees.  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.

 

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

 

		Three Months Ended March 31,
		Investment Margin						Benefit Margin						Contract Charges and Fees						Gross Margin
(in millions)		2005			2004 (3)			2005			2004 (3)			2005			2004 (3)			2005			2004
Premiums		$	—		$	—		$	142		$	151		$	—		$	—		$	142		$	151
Contract charges		—			—			150			129			109			105			259			234
Net investment
income		888			783			—			—			—			—			888			783
Periodic settlements and accruals on non-hedge derivative instruments  (1)		19			6			—			—			—			—			19			6
Contract benefits		(134		)	(131		)	(213		)	(205		)	—			—			(347		)	(336		)
Interest credited to contractholder funds(2)		(537		)	(436		)	—			—			—			—			(537		)	(436		)
		$	236		$	222		$	79		$	75		$	109		$	105		$	424		$	402

 

(1) Periodic settlements and accruals on non-hedge derivative instruments are reflected as a component of realized capital gains and losses on the Condensed Consolidated Statements of Operations.

 

(2) Amortization of DSI is excluded from interest credited to contractholder funds for purposes of calculating gross margin.  Amortization of DSI totaled $39 million in the first quarter of 2005 and $13 million in the first quarter of 2004.

 

(3) The prior period has been restated to conform to the current period presentation.  In connection therewith, contract charges related to guaranteed minimum death, income, accumulation and withdrawal benefits on variable annuities have been reclassified to benefit margin from maintenance charges.  Additionally, amounts previously presented as maintenance charges and surrender charges are now presented in the aggregate as contract charges and fees.  These reclassifications did not result in a change in gross margin.

 

Gross margin increased 5.5% in the first quarter of 2005 compared to the same period of 2004 as growth from new business resulted in increased investment margin, benefit margin and contract charges and fees.

 

Investment margin is a component of gross margin, both of which are non-GAAP measures.  Investment margin represents the excess of net investment income and periodic settlements and accruals on non-hedge derivative instruments over interest credited to contractholder funds excluding amortization of DSI 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.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Annuities		$	159		$	148
Life insurance		47			44
Institutional products		30			30
Total investment margin		$	236		$	222

 

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Investment margin increased 6.3% in the first quarter of 2005 compared to the same period of 2004 due to higher average contractholder funds, partially offset by lower portfolio yields resulting in lower weighted average investment spreads on
interest-sensitive life and deferred fixed annuity contracts.  Although the weighted average investment spreads for the first quarter of 2005 are lower than the first quarter of 2004, the spreads on interest-sensitive life and deferred fixed annuity contracts have stabilized and are consistent with the fourth quarter of 2004. As of March 31, 2005, 77% of our interest-sensitive life and fixed annuity contracts, excluding market value adjusted annuities and equity indexed annuities, have a guaranteed crediting rate of 3% or higher.  Of these contracts, 76% have crediting rates that are at the minimum as of March 31, 2005.  For all interest-sensitive life and fixed annuity contracts, excluding market value adjusted annuities and equity indexed annuities, the approximate difference between the weighted average crediting rate and the average guaranteed crediting rate is 51 basis points as of March 31, 2005 compared to 52 basis points as of December 31, 2004.

 

The following table summarizes the annualized weighted average investment yield, interest crediting rates and investment spreads for the three months ended March 31.

 

		Weighted Average Investment Yield				Weighted Average Interest Crediting Rate				Weighted Average Investment Spreads
		2005		2004		2005		2004		2005		2004
Interest-sensitive life		6.3	%	6.5	%	4.7	%	4.6	%	1.6	%	1.9	%
Fixed annuities – deferred annuities		5.6		5.9		4.0		4.1		1.6		1.8
Fixed annuities – immediate annuities with and without life contingencies		7.4		7.5		6.8		6.9		0.6		0.6
Institutional		4.0		3.0		3.0		2.0		1.0		1.0
Investments supporting capital, traditional life and other products		6.9		7.2		N/A		N/A		N/A		N/A

 

The following table summarizes the liabilities for these contracts and policies.

 

		Three Months Ended March 31,
(in millions)		2005			2004
Fixed annuities – immediate annuities with life contingencies		$	7,774		$	7,496
Other life contingent contracts and other		3,784			3,423
Reserve for life-contingent contract benefits		$	11,558		$	10,919
Interest-sensitive life		$	7,691		$	6,613
Fixed annuities – deferred annuities		32,368			26,566
Fixed annuities – immediate annuities without life contingencies		3,289			2,952
Institutional		11,759			10,215
Market value adjustments related to derivative instruments and other		559			651
Contractholder funds		$	55,666		$	46,997

 

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, cost of insurance contract charges and variable annuity contract charges for contract guarantees less contract benefits.  Benefit margin excludes the implied interest on life-contingent immediate annuities, which is included in the calculation of investment margin.  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.

 

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