UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
Commission file number 1-11840
THE ALLSTATE CORPORATION (Exact name of registrant as specified in its charter)
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 ý No o
As of July 31, 2003, the registrant had 703,720,048 common shares, $.01 par value, outstanding.
THE ALLSTATE CORPORATIONINDEX TO QUARTERLY REPORT ON FORM 10-QJune 30, 2003
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE ALLSTATE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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THE ALLSTATE CORPORATION AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
1. Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of The Allstate Corporation and its wholly owned subsidiaries, primarily Allstate Insurance Company, a property-liability insurance company with various property-liability and life and investment subsidiaries, including Allstate Life Insurance Company ("ALIC") (collectively referred to as the "Company" or "Allstate").
The condensed consolidated financial statements and notes as of June 30, 2003, and for the three-month and six-month periods ended June 30, 2003 and 2002 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 Appendix D of the Notice of Annual Meeting and Proxy Statement dated March 28, 2003. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.
Non-cash investment exchanges and modifications, which primarily reflect refinancings of fixed income securities and mergers completed with equity securities, totaled $46 million and $112 million for the six months ended June 30, 2003 and 2002, respectively.
Adopted accounting standards
In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement on Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure", which amends SFAS No. 123, "Accounting for Stock-Based Compensation". This amendment enables companies that choose to adopt the fair value based method to report the full effect of employee stock options in their financial statements immediately upon adoption. The statement sets forth clearer and more prominent disclosures about the cost of employee stock options and increases the frequency of those disclosures to include publication in quarterly financial statements. Beginning January 1, 2003, the Company began expensing the fair value of all stock options granted on or after January 1, 2003. Based on estimated 2003 stock option grants, the impact to the Company's Consolidated Statements of Operations for the year ending December 31, 2003 is expected to be approximately $6 million, after-tax.
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The following table illustrates the effect on net income and earnings per share as if the fair value based method, adopted prospectively by the Company on January 1, 2003, had been applied to all outstanding and unvested awards in each period.
Pending accounting standards
In January 2003, the FASB issued Financial Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities". FIN 46 addresses issues related to the consolidation of variable interest entities ("VIEs"). The effective date of this interpretation is the first fiscal year or interim period beginning after June 15, 2003. The Company has four unconsolidated special purpose entities ("SPEs") and two consolidated SPEs that fall within the scope of FIN 46. Of the unconsolidated SPEs, two are used to hold assets under the management of an affiliate on behalf of third-party investors, another was used to acquire a headquarters office building and up to 38 automotive collision repair stores, and the remaining unconsolidated SPE is used to issue Global Medium Term Notes ("GMTNs") to unrelated third parties. Of the consolidated SPEs, one was used to issue Euro Medium Term Notes ("EMTNs") and the other to issue Mandatorily Redeemable Preferred Securities. The Company is in the process of assessing whether its investment management SPEs will require consolidation under FIN 46. The SPE used to acquire the headquarters office building and up to 38 automotive collision repair stores will likely require consolidation; however, the SPE used to issue GMTNs will likely not require consolidation as described below. The Company believes the SPEs currently consolidated under existing authoritative accounting guidance will be deconsolidated under FIN 46 as described below.
Allstate issues funding agreements to an SPE (which the Company believes would be considered a VIE under FIN 46) used to issue GMTNs to unrelated third parties. The Company believes the GMTNs and certain equity interests issued by the SPE, to the extent they are exposed to all the risks and rewards of the funding agreements that collateralize the GMTNs, would be considered variable interests in a VIE. Applying the FIN 46 consolidation model, any entity exposed to a majority of the residual risks or possessing rights to a majority of the residual returns of the VIE is required to consolidate the entity. Because the Company owns none of the variable interests issued by the VIE it should not be required to consolidate the SPE but rather would continue to classify funding agreements issued to the VIE as a component of Contractholder funds. The same FIN 46 consolidation determination will apply to the Company's Euro Medium Term Notes program as of July 1, 2003, and consistent with the GMTN program, will result in the deconsolidation of the EMTNs and recognition of the funding agreements issued to the VIE as a component of Contractholder funds, which is equivalent to the existing accounting for this program.
Excluding the SPE used to issue GMTNs, the assets and liabilities of the Company's three remaining unconsolidated SPEs totaled $816 million and $797 million, respectively, at June 30, 2003. The Company's maximum exposure to loss from the investment management SPEs is its current carrying value of $11 million. The Company's maximum exposure of loss to the SPE used to acquire a headquarters office building is $85 million both in the form of a residual value guarantee and a guarantee of the SPE's notes. Upon adoption of FIN 46, the Company's debt-to-capital ratio would be negatively impacted if any of the Company's SPEs, with the exception of the SPE used to issue GMTNs
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for which the Company already reports the liability for the funding agreements as a component of Contractholder funds, is determined to be a VIE requiring consolidation; however, the impact is not anticipated to affect the Company's compliance with existing debt covenants.
In addition to the preceding, the Company has one SPE, used to issue $200 million of Mandatorily Redeemable Preferred Securities of Subsidiary Trust, that is currently consolidated pursuant to existing authoritative accounting guidance, but will be de-consolidated upon adoption of FIN 46. Under FIN 46, the nominal equity capital of the SPE together with other attributes result in the designation of the SPE as a VIE. The Mandatorily Redeemable Preferred Securities of Subsidiary Trust issued to un-related third parties are considered the principal variable interests issued by the VIE. The Company does not own any of the Mandatorily Redeemable Preferred Securities of Subsidiary Trust issued by the VIE and as a result will not be designated its primary beneficiary and will not be required to consolidate the VIE upon adoption of FIN 46. The adoption of FIN 46, effective July 1, 2003, will result in deconsolidation of the Mandatorily Redeemable Preferred Securities of Subsidiary Trust and simultaneous recognition of an equivalent note payable, previously issued by the Company to the SPE and held as collateral for the Mandatorily Redeemable Preferred Securities of Subsidiary Trust, as a component of Long-term debt. The impact of this reclassification will not be material to the Company's Consolidated Statements of Financial Position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". The statement amends, clarifies and codifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and utilized for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The statement applies only to certain derivative contracts and embedded derivatives entered into after June 30, 2003. The impact of adopting the provisions of the statement will not be material to the Company's Consolidated Statements of Operations or Financial Position.
In July 2003, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 03-01 entitled "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts". The accounting guidance contained in the SOP applies to several of the Company's insurance products and product features. The effective date of the SOP is for fiscal years beginning after December 15, 2003, with earlier adoption encouraged. If adopted early, the provisions of the SOP must be applied as of the beginning of the fiscal year. Accordingly, if the SOP were adopted during an interim period of 2003, prior interim periods would be restated. A provision of the SOP requires the establishment of a liability in addition to the account balance for contracts and contract features that provide guaranteed death or other insurance benefits and guaranteed income benefits. These liabilities are not currently recognized by the Company, and their establishment may have a material impact on the Condensed Consolidated Statements of Operations depending on the market conditions at the time of adoption, but is not expected to have a material impact on the Company's Condensed Consolidated Statements of Financial Position.
Proposed standards
The Emerging Issues Task Force ("EITF") issued Topic No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments", which attempts to define other-than-temporary impairment and highlight its application to investment securities accounted for under both SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stocks". The current issue summary, which has yet to be finalized, proposes that if, at the evaluation date, the fair value of an investment security is less than its carrying value then an impairment exists for which a determination must be made as to whether that impairment is other-than-temporary. If it is determined that an impairment is other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment's carrying value and its fair value at the reporting date. In its most recent deliberations, the EITF discussed different models to assess whether impairment is other-than-temporary for different types of investments (e.g. SFAS 115 marketable equity securities, SFAS 115 debt securities, and equity and cost method investments subject to APB Opinion No. 18). Due to the uncertainty of the final model or models that may be adopted, the estimated impact to the Company's Condensed Consolidated Statements of Operations and Financial Position is presently not determinable.
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2. Earnings per share
Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common and dilutive potential common shares outstanding. For Allstate, dilutive potential common shares consist of the common shares underlying outstanding stock options.
The computations of basic and diluted earnings per share are presented in the following table.
Options to purchase 11.3 million and 9.0 million Allstate common shares, with exercise prices ranging from $36.30 to $50.72 and $38.69 to $50.72, were outstanding at June 30, 2003 and 2002, respectively, but were not included in the computation of diluted earnings per share for the three-month periods ended June 30, 2003 and 2002 since inclusion of these options would have an anti-dilutive effect as the options' exercise prices exceeded the average market price of Allstate common shares in the three-month period. Options to purchase 11.3 million and 11.3 million Allstate common shares, with exercise prices ranging from $35.17 to $50.72 and $36.61 to $50.72, were outstanding at June 30, 2003 and 2002, respectively, but were not included in the computation of diluted earnings per share for the six-month periods ended June 30, 2003 and 2002 since inclusion of these options would have an anti-dilutive effect.
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3. Reserve for Property-Liability Insurance Claims and Claims Expense
The Company establishes reserves for claims and claims expense on reported and unreported claims of insured losses. These reserve estimates are based on known facts and interpretations of circumstances and internal factors including the Company's experience with similar cases, historical trends involving claim payment patterns, loss payments, pending levels of unpaid claims, loss management programs and product mix. In addition, the reserve estimates are influenced by external factors including law changes, court decisions, changes to regulatory requirements, economic conditions, and public attitudes. The Company, in the normal course of business, may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.
Because reserves are based on estimations of future losses, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain process. The ultimate costs of losses may vary materially from recorded amounts, which are based on management's best estimates of future losses. Allstate regularly updates its reserve estimates as new information becomes available and as events unfold that may impact the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reflected in the results of operations in the period such changes are determinable.
Management believes that the reserve for claims and claims expense, net of reinsurance recoverables, at June 30, 2003 is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by the date.
Allstate's reserves for asbestos claims were $680 million and $635 million, net of reinsurance recoverables of $313 million and $269 million at June 30, 2003 and December 31, 2002, respectively. Reserves for environmental claims were $292 million and $304 million, net of reinsurance recoverables of $80 million and $89 million at June 30, 2003 and December 31, 2002, respectively. Approximately 52% and 54% of the total net asbestos and environmental reserves at June 30, 2003 and December 31, 2002, respectively, were for incurred but not reported estimated losses.
Allstate's reserves for asbestos and environmental exposures could be affected by tort reform, class action litigation, and other potential legislation and judicial decisions. Environmental exposures could also be affected by a change in the existing federal Superfund law and similar state statutes. There can be no assurance that any reform legislation will be enacted or that any such legislation will provide for a fair, effective and cost-efficient system for settlement of asbestos or environmental claims. Management is unable to determine the effect, if any, that such legislation will have on results of operations or financial position.
Management believes its net loss reserves for environmental, asbestos and other discontinued lines exposures are appropriately established based on available facts, technology, laws and regulations. However, due to the inconsistencies of court coverage decisions, unresolved legal issues regarding policy coverage, unresolved legal issues regarding the determination, availability and timing of exhaustion of policy limits, evolving and plaintiffs' expanded theories of liability, the risks inherent in major litigation, availability and collectibility of recoveries from reinsurance, retrospectively determined premiums and other contractual agreements, and estimating the extent and timing of any contractual liability, and other uncertainties, the ultimate cost of these claims may vary materially from the amounts currently recorded, resulting in an increase in loss reserves. In addition, while the Company believes that improved actuarial techniques and databases have assisted in its ability to estimate asbestos, environmental, and other discontinued lines net loss reserves, these refinements may subsequently prove to be inadequate indicators of the extent of probable losses. Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserves that may be required.
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4. Reinsurance
Property-liability insurance premiums and life and annuity premiums and contract charges are net of the following reinsurance ceded:
Property-liability insurance claims and claims expense and life and annuity contract benefits are net of the following reinsurance recoveries:
5. Regulation, Legal Proceedings and Guarantees
Regulation
The Company is subject to changing social, economic and regulatory conditions. State and federal regulatory initiatives and proceedings have varied and have included efforts to adversely influence and restrict premium rates including requiring the return of excess profits, to restrict the Company's ability to cancel policies, to impose underwriting standards, to remove barriers preventing banks from engaging in the securities and insurance businesses, to change tax laws affecting the taxation of insurance companies and the tax treatment of insurance products which may impact the relative desirability of various personal investment products and to expand overall regulation. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.
Legal proceedings
There are two active nationwide class action lawsuits against Allstate regarding its specification of after-market (non-original equipment manufacturer) replacement parts in the repair of insured vehicles. One of these suits alleges that the specification of such parts constitutes breach of contract and fraud, and this suit mirrors to a large degree lawsuits filed against other carriers in the industry. The plaintiffs allege that after-market parts are not "of like kind and quality" as required by the insurance policy, and they are seeking actual and punitive damages. In the second lawsuit, plaintiffs allege that Allstate and three co-defendants have violated federal antitrust laws by conspiring to manipulate the price of auto physical damage coverages in such a way that not all savings realized by the use of aftermarket parts are passed on to the policyholders. The plaintiffs seek actual and treble damages. In November 2002, a nationwide class was certified in this case. The defendants filed a petition to appeal the certification, and the Eleventh Circuit Court of Appeals granted review of the certification. The Company has been vigorously defending both of these lawsuits, and their outcome is uncertain.
There are a number of statewide and nationwide class action lawsuits pending against Allstate alleging that its failure to pay "inherent diminished value" to insureds under the collision, comprehensive, uninsured motorist property damage, or auto property damage liability provisions of auto policies constitutes breach of contract and fraud. Plaintiffs
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define "inherent diminished value" as the difference between the market value of the insured automobile before an accident and the market value after repair. Plaintiffs allege that they are entitled to the payment of inherent diminished value under the terms of the policy. To a large degree, these lawsuits mirror similar lawsuits filed against other carriers in the industry. These lawsuits are pending in various state and federal courts, and they are in various stages of development. A class has been certified in only one case, a multi-state class action. The Company has been vigorously defending these lawsuits and, since 1998, has been implementing policy language in a majority of states reaffirming that its collision and comprehensive coverages do not include diminished value claims. In addition, there are three statewide putative class action lawsuits pending against Allstate alleging that it improperly deducts betterment in connection with the repair of vehicles. The outcome of these disputes is currently uncertain.
There are a number of state and nationwide class action lawsuits pending in various state courts challenging the legal propriety of Allstate's medical bill review processes on a number of grounds, including, among other things, the manner in which Allstate determines reasonableness and necessity. One nationwide class action has been certified. These lawsuits, which to a large degree mirror similar lawsuits filed against other carriers in the industry, allege these processes result in a breach of the insurance policy as well as fraud. The Company denies those allegations and has been vigorously defending these lawsuits. The outcome of these disputes is currently uncertain.
A number of nationwide and statewide putative class actions are pending against Allstate, which challenge Allstate's use of certain automated database vendors in valuing total loss automobiles. To a large degree, these lawsuits mirror similar lawsuits filed against other carriers in the industry. Plaintiffs allege that flaws in these databases result in valuations to the detriment of insureds. The plaintiffs are seeking actual and punitive damages. The lawsuits are in various stages of development and Allstate has been vigorously defending them, but the outcome of these disputes is currently uncertain.
One putative statewide and a number of putative nationwide class action lawsuits have been filed in various courts seeking actual and punitive damages from Allstate and alleging that Allstate violated the Fair Credit Reporting Act or state law by failing to provide appropriate notices to applicants and/or policyholders when adverse action was taken as a result of information in a consumer report or by ordering consumer reports without a permissible purpose. These cases are all pending in federal courts, and all but one, recently filed in federal court in Louisiana, have been centralized in the federal court in Nashville, Tennessee. The Company is also defending a putative nationwide class action that alleges that the Company discriminates against non-Caucasian policyholders, through underwriting and rate-making practices including the use of credit by charging them higher premiums. The Company is also defending two putative statewide class actions challenging its use of credit under certain state insurance statutes. The Company denies these allegations and has been vigorously defending these lawsuits. The outcome of these disputes is currently uncertain.
Allstate is defending various lawsuits involving worker classification issues. Examples of these lawsuits include a number of putative class actions challenging the overtime exemption claimed by the Company under the Fair Labor Standards Act or state wage and hour laws. These class actions mirror similar lawsuits filed recently against other carriers in the industry and other employers. Another example involves the worker classification of staff working in agencies. In this putative class action, plaintiffs seek damages under the Employee Retirement Income Security Act ("ERISA") and the Racketeer Influenced and Corrupt Organizations Act alleging that agency secretaries were terminated as employees by Allstate and rehired by agencies through outside staffing vendors for the purpose of avoiding the payment of employee benefits. A putative nationwide class action filed by former employee agents also 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. Allstate has been vigorously defending these and various other worker classification lawsuits. The outcome of these disputes is currently uncertain.
The Company is also defending certain matters relating to the Company's agency program reorganization announced in 1999. These matters include an investigation by the U.S. Department of Labor and a lawsuit filed in December 2001 by the U.S. Equal Employment Opportunity Commission ("EEOC") with respect to allegations of retaliation under the Age Discrimination in Employment Act, the Americans with Disabilities Act and Title VII of the Civil Rights Act of 1964. A putative nationwide class action has also been filed by former employee agents alleging various violations of ERISA, breach of contract and age discrimination. Allstate has been vigorously defending these lawsuits and other matters related to its agency program reorganization. In addition, Allstate is defending certain matters
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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. Allstate is cooperating fully 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 various lawsuits and regulatory proceedings that allege that it engaged in business or sales practices inconsistent with state or federal law. The Company has been vigorously defending these matters, but their outcome is currently uncertain.
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 an increasing number of class action lawsuits and other types of litigation, some of which involve claims for substantial and/or indeterminate amounts (including punitive and treble damages) and the outcomes of which are unpredictable. This litigation is based on a variety of issues including insurance and claim settlement practices. 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.
Shared markets
As a condition of maintaining its licenses to write personal property and casualty insurance in various states, the Company is required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations that provide various types of insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Underwriting results related to these arrangements, which tend to be adverse, have been immaterial to the results of operations.
Guarantees
The Company has guaranteed debt issued by the Allstate Real Estate Trust, an unconsolidated SPE, from which it leases a headquarters office building and up to 38 Sterling Collision centers. The lease contains a residual value guarantee for the properties covered by the lease. The maximum amount of potential future payments for the guarantee of the debt or the residual value guarantee or the combined debt and residual value guarantee was $85 million at June 30, 2003. The guarantees for the headquarters office building and Sterling Collision centers expire December 28, 2006. The Company also provides residual value guarantees on leased automobiles. If all outstanding leases were terminated effective June 30, 2003, the Company's maximum potential amount of future payments, assuming the automobiles have no residual value, is $24 million at June 30, 2003. The term of each residual value guarantee is equal to the term of the underlying lease which range from less than one year to three years. Historically, the Company has not made any material payments pursuant to these guarantees.
The Company owns certain fixed income securities which contain credit default swaps or credit guarantees which contain obligations 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 of a specified credit event, the Company's maximum amount at risk, assuming the value of the referenced credits become worthless, is $112 million at June 30, 2003. The credit default swaps and credit guarantees contained in these fixed income securities expire at various times during the next four 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 which is fully collateralized by the cash surrender value of the universal life insurance contracts. At June 30, 2003, the amount due under the commercial paper program is $299 million and the cash surrender value of the policies is $306 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 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
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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. Because the obligated amounts of the indemnifications are not explicitly stated in many cases, 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.
In addition, the Company and its subsidiaries indemnify their respective directors, officers, non-officer employees and other individuals serving at the request of the Company as a director or officer or in a similar capacity in another entity to the extent provided in their charters and by-laws. Since these indemnifications are generally not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount due under these indemnifications.
The aggregate liability balance related to all guarantees was not material as of June 30, 2003.
6. Business Segments
Summarized revenue data for each of the Company's business segments are as follows:
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Summarized financial performance data for each of the Company's reportable segments are as follows:
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7. Other Comprehensive Income
The components of other comprehensive income on a pretax and after-tax basis are as follows:
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8. Company Restructuring
In the first six months of 2003, the Company recorded restructuring and related charges of $37 million pretax ($24 million after-tax). The charges include employee termination and relocation benefits and a non-cash charge resulting from pension benefit payments made to agents in connection with the 1999 reorganization of employee agents to a single exclusive agency independent contractor program.
In 2001, the Company announced new strategic initiatives to improve the efficiency of its claims handling and certain other back-office processes primarily through a consolidation and reconfiguration of field claim offices, customer information centers and satellite offices. This restructuring program involves a reduction of the total number of field claim offices and an increase in the average size per claim office. In addition, two customer information centers and two satellite offices were closed. As part of the program, employees working in facilities to be closed will elect to either relocate or collect severance benefits. The Company anticipates the plan will produce approximately $140 million of annual pretax expense reductions. The implementation of the plan is expected to be substantially complete by year-end 2003.
The Company completed its program announced on November 10, 1999 to aggressively expand its selling and service capabilities and reduce current annual expenses by approximately $600 million. The reduction in expenses was achieved through field realignment, the reorganization of employee agents to a single exclusive agency independent contractor program, the closing of a field support center and four regional offices, and reduced employee related expenses and professional services as a result of reductions in force, attrition and consolidations.
As a result of the 1999 program, Allstate established a $69 million restructuring liability during the fourth quarter of 1999 for certain employee termination costs and qualified exit costs. Additionally, during 2001, an additional $96 million was accrued in connection with the new program for certain employee termination costs and qualified exit costs.
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The following table illustrates the inception to date change in the restructuring liability at June 30, 2003:
The payments applied against the liability for employee costs primarily reflect severance costs, and the payments for exit costs generally consist of post-exit rent expenses and contract termination penalties.
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INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Shareholders ofThe Allstate Corporation:
We have reviewed the accompanying condensed consolidated statement of financial position of The Allstate Corporation and subsidiaries (the "Company") as of June 30, 2003, and the related condensed consolidated statements of operations for the three-month and six-month periods ended June 30, 2003 and 2002, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2003 and 2002. These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, 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 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 auditing standards generally accepted in the United States of America, the consolidated statement of financial position of The Allstate Corporation and subsidiaries as of December 31, 2002, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for the year then ended, not presented herein. In our report dated February 5, 2003, which report includes an explanatory paragraph as to a change in the Company's method of accounting for goodwill and other intangible assets in 2002, 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, 2002 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, IllinoisAugust 11, 2003
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 2003 AND 2002
The following discussion highlights significant factors influencing results of operations and changes in financial position of The Allstate Corporation (the "Company" or "Allstate"). 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 Corporation Annual Report on Form 10-K for 2002 and in Appendix D of the Notice of Annual Meeting and Proxy Statement dated March 28, 2003.
The Company has four reporting segments: Allstate Protection, Discontinued Lines and Coverages, Allstate Financial and Corporate and Other. Property-Liability operations include the Allstate Protection and the Discontinued Lines and Coverages segments.
HIGHLIGHTS
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CONSOLIDATED NET INCOME
Summarized financial data and Net income by business unit are shown in the following table.
CONSOLIDATED REVENUES
Consolidated revenues increased 6.0% in the second quarter of 2003 when compared to the second quarter of 2002 and increased 6.8% for the six months ended June 30, 2003 from the first six months of 2002. The increases are primarily due to higher Property-Liability insurance premiums and decreased Realized capital gains and losses as compared to the same periods of 2002.
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PROPERTY-LIABILITY HIGHLIGHTS
PROPERTY-LIABILITY OPERATIONS
Summarized financial data, key operating ratios and a reconciliation of Underwriting income to Net income for Allstate's Property-Liability operations are presented in the following table.
Underwriting income (loss) is Premiums earned, less Claims and claims expense ("losses"), Amortization of DAC, Operating costs and expenses and Restructuring and related charges as determined using GAAP. Management uses this measure in its evaluation of results of operations to analyze the profitability of the Property-Liability insurance operations separately from investment results. It is also an integral component of incentive compensation. It is useful for investors to evaluate the components of income separately and in the aggregate when reviewing performance. Underwriting income (loss) should not be considered as a substitute for Net income and does not reflect the overall profitability of the business. Net income is the most directly comparable GAAP measure.
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ALLSTATE PROTECTION SEGMENT
Premiums written, an operating measure, is the amount of premiums charged for policies issued during a fiscal period. Premiums earned is a GAAP measure. Premiums are considered earned and are included in financial results on a pro-rata basis over the policy period. The portion of Premiums written applicable to the unexpired terms of the policies is recorded as Unearned premiums on the Company's Consolidated Statements of Financial Position.
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The following table presents the reconciliation of Premiums written to Premiums earned for the three months and six months ended June 30.
Premiums written by brand for the Allstate Protection segment are shown in the following table.
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The following table presents Allstate Protection Premiums written by product, showing new and renewal business.
Standard auto premiums written increased 6.4% for Allstate Protection to $3.68 billion in the second quarter of 2003 from $3.46 billion in the same period of 2002 and standard auto premiums written increased 5.3% during the first six months of 2003 as compared to the first six months of last year.
The Allstate brand standard auto results are shown in the following table.
The increases in Allstate brand standard auto average premium in the second quarter 2003 and in the first six months of 2003 compared to the same periods of 2002 were primarily due to higher average renewal premiums. Despite declining at June 30, 2003 compared to June 30, 2002, Allstate brand standard auto PIF increased 0.4% at June 30, 2003 compared to March 31, 2003. Positive sequential quarterly growth was achieved in 35 states representing 74.1% of total PIF.
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Allstate continues to implement administrative and risk management strategies, including premium rate increases, down payment requirements and other underwriting changes, to improve the standard auto loss ratio in certain markets including the states of California, Texas and Florida. As implemented strategies continue to improve the profitability of these standard auto markets, the potential for profitable growth of these markets is evaluated and pursued when deemed appropriate. The Allstate brand standard auto results, excluding the states of California, Texas and Florida, are shown in the following table. Collectively, these states represent 28.6% of Allstate brand standard auto premiums written at June 30, 2003.
Excluding the states of California, Texas and Florida, the renewal ratio for Allstate brand standard auto increased 0.3 points in the second quarter of 2003 as compared to the second quarter of 2002; increased 0.1 points in the first six months of 2003 as compared to the first six months of 2002; and increased 0.3 points in the first six months of 2003 as compared to the fourth quarter of 2002. Excluding the states of California, Texas and Florida, at June 30, 2003, Allstate brand standard auto PIF increased 0.8% compared to March 31, 2003.
The Ivantage standard auto results are shown in the following table.
Management expects Ivantage standard auto PIF to continue to decline as the Company pursues actions to improve profitability. At June 30, 2003, Ivantage standard auto PIF decreased 2.0% compared to March 31, 2003.
Increases in standard auto average premium in both the Allstate brand and Ivantage were due to rate actions taken during 2002 and the first six months of 2003, and to a lesser degree due to a normal shift to newer and more expensive autos by Allstate brand policyholders. The following table shows the net rate changes that were approved during the second quarter and first six months of 2003.
Non-standard auto premiums written decreased 13.4% for Allstate Protection to $543 million in the second quarter of 2003 from $627 million in the same period of 2002 and 12.4% during the first six months of 2003 as compared to the first six months of 2002. Declines during the second quarter and first six months of 2003 compared to the same periods in 2002 were primarily due to the continuation of programs to address
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adverse profitability trends for both the Allstate brand and Ivantage. These programs vary by state and include changes such as additional premium down payment requirements, tighter underwriting requirements, rate increases, policy non-renewal and certain other administrative actions.
The Allstate brand non-standard auto results are shown in the following table.
The increase in Allstate brand non-standard auto average premium during the second quarter of 2003 and first six months of 2003 was due primarily to higher average renewal premiums. Management expects Allstate brand non-standard auto PIF to continue to decline as the Company evaluates opportunities to sustain profitability in certain large markets such as the states of New York, Texas, and Florida. At June 30, 2003, Allstate brand non-standard auto PIF decreased 4.0% compared to March 31, 2003.
The Ivantage non-standard auto results are shown in the following table.
Ivantage non-standard auto operating results grew in the current year due to Deerbrook's re-entry into the non-standard market in 19 states as of June 30, 2003. At June 30, 2003, Ivantage non-standard auto PIF increased 12.6% compared to March 31, 2003.
Fluctuations in Allstate brand and Ivantage non-standard auto average premium were partially due to rate actions taken for both the Allstate brand and Ivantage during 2002 and the first six months of 2003. The following table shows the net rate changes that were approved in the second quarter and first six months of 2003.
Homeowners premiums written increased 11.9% for Allstate Protection to $1.50 billion in the second quarter of 2003 from $1.34 billion in the same period of 2002 and homeowners premiums increased 10.9% during the first six months of 2003 as compared to the first six months of last year.
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The Allstate brand homeowners results are shown in the following table.
The increase in Allstate brand homeowners average premium during the second quarter and first six months of 2003 was primarily due to higher average renewal premiums. Allstate brand homeowners PIF increased 0.6% at June 30, 2003 compared to March 31, 2003. Positive sequential quarterly growth was achieved in 32 states representing 83.3% of Allstate brand homeowners PIF.
The Ivantage homeowners results are shown in the following table.
Management expects Ivantage homeowners PIF to continue to decline as the Company pursues actions to improve profitability. At June 30, 2003, Ivantage homeowners PIF decreased 1.1% compared to March 31, 2003.
Increases in Allstate brand and Ivantage homeowners average premium were due to rate actions taken during 2002 and the first six months of 2003. The following table shows the net rate changes that were approved during the second quarter and first six months of 2003.
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Premiums earned by brand for the Allstate Protection segment are shown in the following table.
Underwriting Results for Allstate Protection are shown in the following table.
Allstate Protection generated underwriting income of $234 million during the second quarter of 2003 compared to an underwriting loss of $15 million in the second quarter of 2002. For the six month period ended June 30, 2003, Allstate Protection generated underwriting income of $685 million compared to $32 million for the first half of last year. The increase in Underwriting income during both periods was the result of increased Premiums earned, continued improvement in auto and homeowners claim frequency (rate of claim occurrence), lower prior year reserve reestimates, partially offset by increased catastrophe losses, current year claim severity (average cost per claim) and operating expenses. Increased catastrophe losses were due to a large number of tornadoes with resulting damage to properties in many markets.
Claim severity was impacted by inflationary pressures in medical costs and auto repair and home repair costs. Increased severity was offset by lower auto and homeowner claim frequencies, excluding catastrophe claims. If future development of current year claim severity differs from the current reserve expectations by 1%, reserve reestimates would impact Net income by approximately $98 million. The following tables show the net reserves representing the estimated cost of outstanding claims as they were recorded at the beginning of
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years 2003 and 2002, and the impact of prior year reserve reestimates on Claims and claims expense and the loss ratio.
For Allstate Protection, there were no material reestimates of prior year reserves in the second quarter and first six months of 2003. In 2002, reestimates of prior year reserves were primarily due to increasing claim severities, mold claims in the state of Texas and late reported losses, which were greater than trends anticipated in reserve estimates as of January 1, 2002.
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Allstate Protection loss, expense and combined ratio statistics are shown in the following table. The loss ratio, which is the percentage of losses to Premiums earned, is a measure of profitability.
Standard auto loss ratio for Allstate Protection decreased 1.4 points in the second quarter of 2003 and 2.2 points during the first six months of 2003, as compared to the same periods last year. The standard auto loss ratio declines were due to increased premiums earned, favorable claim frequency and reduced reserve reestimates related to prior years, partially offset by a moderate increase in claim severity in the current year.
Non-standard auto loss ratio for Allstate Protection decreased 4.0 points in the second quarter and 2.1 points during the first six months of 2003 as compared to the same periods last year. The decrease in the non-standard auto loss ratio during both periods was due to lower claim frequency, partly offset by lower premiums earned and a moderate increase in claim severity in the current year.
Homeowners loss ratio for Allstate Protection decreased 17.5 points in the second quarter and 22.3 points during the first six months of 2003 as compared to the same periods last year. The homeowners loss ratio decreased during both periods due to increased premiums earned, lower mold losses in the state of Texas, lower prior year reserve reestimates and lower current year claim frequency, partially offset by higher catastrophe losses and an increase in current year claim severity. Due to actions taken in 2002 and 2001 to improve the profitability of homeowners, the loss ratio is now at the current targeted level. Allstate
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plans to continue the programs implemented in prior years to maintain profitability, although management will continue to evaluate the appropriate target.
Because Allstate includes catastrophe losses in claims and claims expense, catastrophe losses affect both the underwriting results and loss ratios. For the second quarter of 2003, catastrophe losses totaled $566 million compared with $288 million for the same period in 2002 and for the first six months of 2003, catastrophe losses totaled $699 million, compared with $398 million for the same period in 2002.
The impact of catastrophe losses on the loss ratio is shown in the following table.
Expense ratio for Allstate Protection increased 0.4 points in the second quarter and 0.9 points in the first six months of 2003 compared to the same periods last year, due to higher pension expenses, employee and agent incentives and guaranty fund expenses. In addition, the Company expects advertising expenses in 2003 to exceed prior year advertising expenses by approximately $75 million to $125 million.
The impacts of specific costs and expenses on the expense ratio are included in the following table.
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DISCONTINUED LINES AND COVERAGES SEGMENT
Summarized underwriting results for the Discontinued Lines and Coverages segment are presented in the following table.
During the second quarter of 2003, underwriting losses of $53 million were primarily related to a reestimate of asbestos reserves totaling $38 million and a $12 million reestimate of the allowance for future uncollectible reinsurance recoverables. The reestimate of asbestos reserves was to reserve the policy limits for an excess insurance policyholder who submitted new and unanticipated claims that were for previously not designated, and therefore unexpected, coverage years. Underwriting losses in the first six months of 2003 were primarily due to reestimates of asbestos reserves. As of June 30, 2003, reserves estimates for asbestos and environmental claims incurred but not yet reported represented approximately 51.6% of total asbestos and environmental reserves of $972 million.
Property-Liability net investment income decreased 2.6% in the second quarter and 0.2% for the first six months of 2003 as compared to the same period last year due to the effects of lower portfolio yields, partially offset by higher portfolio balances due to positive cash flows from operations. Lower portfolio yields were due to new investments being made at rates lower than current portfolio yields as a result of the low interest rate environment.
Property-Liability income tax expense reflects the positive impact of a $31 million adjustment for prior year tax liabilities.
Property-Liability realized capital gains and losses are described in the following table.
For a further discussion of realized capital gains and losses, see "Investments".
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ALLSTATE CANADA
Allstate Protection includes property and casualty insurance sold in Canada. The underwriting results of the Canadian business are included in the Allstate brand results. The impacts to the Property-Liability results are presented separately in the following table.
The decreases in the total Canada loss ratio for the second quarter and first six months of 2003 are related to increases in premiums earned and lower prior year reserve reestimates. The following table shows the net rate changes that were approved for Allstate Canada in the second quarter and first six months of 2003.
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ALLSTATE FINANCIAL HIGHLIGHTS
ALLSTATE FINANCIAL OPERATIONS
Summarized financial data and key operating measures for Allstate Financial's operations are presented in the following table.
Life and annuity premiums and contract charges, included in the Condensed Consolidated Statements of Operations, represent premiums generated from traditional life and other insurance products and immediate annuities with life contingencies that have significant mortality or morbidity risk. Contract charges are generated from interest-sensitive life products, variable annuities, fixed annuities and other investment products for which deposits are classified as Contractholder funds or Separate Accounts liabilities.
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Contract charges are assessed against the contractholder account balance for maintenance, administration, cost of insurance and surrender prior to contractually specified dates.
The following table summarizes premiums and contract charges.
Total Life and annuity premiums decreased 14.7% to $297 million in the second quarter of 2003 from $348 million in the second quarter of 2002. The decline is due to lower sales of immediate annuities with life contingencies, the discontinuance of direct-marketed credit life insurance and reduced traditional whole life premiums due to lower business in force, partially offset by growth in Allstate Workplace Division products. The decline in sales of immediate annuities with life contingencies is due to consumer preference and market and competitive conditions that drive the level and mix of immediate annuities sold with or without life contingencies.
Total Life and annuity contract charges were $236 million in the second quarter of 2003 compared to $234 million in the second quarter of 2002. Higher interest-sensitive life insurance contract charges offset a decline in variable annuities. Variable annuity average account values during the second quarter of 2003 were lower than the average account values during the second quarter of 2002, as poor equity market performance during the prior year and surrenders offset growth from new business.
For the first six months of 2003, Life and annuity premiums and contract charges increased 4.6% compared to the first six months of 2002. The increase is due to increased sales of immediate annuities and growth in Allstate Workplace Division products, partially offset by a decline due to the discontinuance of direct-marketed credit life insurance and reduced traditional whole life insurance premiums due to lower business in force.
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The following table summarizes Life and annuity premiums and contract charges by distribution channel.
Policy and contractholder obligations, included on the Condensed Consolidated Statements of Financial Position, reflect the trends in Allstate Financial product deposits and sales of insurance products. The following table shows the balances of these obligations.
The following table shows changes in these obligations.
Reserve for life-contingent contract benefits increased at a higher rate in the second quarter of 2003 and the first six months of 2003 compared to the same periods in the prior year primarily due to sales of immediate annuities with life contingencies and Allstate Workplace Division products, partially offset by benefit payments.
Contractholder funds increased at a lower rate in the second quarter of 2003 and the first six months of 2003 compared to the same periods in the prior year primarily due to lower deposits and higher maturities of funding agreements backing medium term notes, partially offset by higher deposits from fixed annuities. Deposits from funding agreements backing medium term notes reflect management's assessment of market conditions and are only pursued when profit expectations can be met, therefore the level of deposits fluctuates significantly from period to period. The increase in Contractholder funds due to fixed annuities reflects deposits and interest credited to contracts, partially offset by surrenders and maturities of in-force
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contracts during both periods. Fixed annuity deposits include deposits from the Allstate® Treasury-Linked Annuity and, although management constrained deposits of the Allstate® Treasury-Linked Annuity due to the low interest rate environment, deposits in the second quarter of 2003 were comparable to the first quarter of 2003. The Allstate® Treasury-Linked Annuity was introduced late in the first quarter of 2002, resulting in significant increases in deposits during 2003 relative to the prior year.
Separate Accounts increased in the second quarter of 2003 and in the first six months of 2003 after declining in the comparable periods last year. These increases were due to favorable equity market performance compared to the prior year and variable annuity deposits, partially offset by surrenders and withdrawals. The level of variable annuity deposits declined in both periods when compared to prior year, reflecting consumers' preferences for fixed rate guarantees over variable annuities during this period of uncertain equity market performance. The ongoing introduction of the Allstate® Advisor Variable annuity suite of products and the improved equity market performance in the second quarter of 2003 have resulted in six sequential monthly increases in variable annuity deposits in 2003. Monthly variable annuity deposits are now at a level comparable to the end of the second quarter of last year.
Net investment income for Allstate Financial increased 3.0% in the second quarter and 5.4% in the first six months of 2003, compared to the same periods last year. The increase in both periods was due to higher portfolio balances resulting from positive cash flows from product sales and deposits, partially offset by lower portfolio yields. Lower portfolio yields result when new investments are made at rates lower than the current portfolio yields, reflecting the low interest rate environment. The Allstate Financial portfolio balance as of June 30, 2003, excluding assets invested in Separate Accounts and unrealized net capital gains on fixed income securities, increased 14.0% from June 30, 2002.
Analysis of net income for the Allstate Financial segment is presented in the following table.
Investment margin, which represents the excess of investment income earned over interest credited to policyholders and contractholders and interest expense, decreased 4.1% in the second quarter of 2003 compared to the same period in 2002 and increased 0.7% in the first six months of 2003 compared to the first six months of 2002. Management actions to reduce crediting rates on in-force contracts with discretionary crediting rates have partially offset the decline in Allstate Financial's investment portfolio yield. These actions, however, have not been sufficient to offset the overall portfolio yield decline as crediting rates on certain of the Company's products cannot be adjusted and reductions in the yield on assets supporting the Company's capital, traditional life and other products directly impact investment margin.
For interest-sensitive fixed annuities and life products where management has the ability to modify crediting rates, the rolling weighted average interest crediting rate is approximately 100 basis points above the long-term underlying guaranteed rate as of June 30, 2003.
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The following table summarizes the annualized weighted average investment yield, interest crediting rates and investment spreads for the three months ended June 30.
The following table summarizes the annualized weighted average investment yield, interest crediting rates and investment spreads for the six months ended June 30.
The following table summarizes Contractholder funds and the Reserve for life-contingent contract benefits associated with the weighted average investment yield and weighted average interest crediting rates at June 30.
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The following table summarizes investment margin by product group.
Mortality margin, which represents premiums and cost of insurance charges less related policy benefits was $21 million or 13.6% lower in the second quarter of 2003 compared to the second quarter of 2002. Variable annuity guaranteed minimum death benefits ("GMDB") payments and mortality losses on life contingent immediate annuities drove the decrease as these factors more than offset growth from new business. GMDB payments of $27 million net of reinsurance, hedging losses and other contractual arrangements ("net GMDB payments") in the second quarter of 2003 increased $18 million compared to the same period in 2002 and increased $6 million from the first quarter of 2003.
The overall objective of the GMDB hedging program, the results of which are included in net GMDB payments, is to reduce the impact of changing equity markets on the mortality margin. For example, in rising equity markets, the Company's GMDB exposure declines, however the hedging program is expected to result in realized losses. Hedging losses were $7 million in the second quarter of 2003 compared to hedging gains of $6 million in the second quarter of 2002 and $2 million in the first quarter of 2003.
For the first six months of 2003, mortality margin was $51 million or 16.0% below the first six months of 2002. GMDBs in the first six months of 2003 compared to the same period of 2002 represent $44 million of this decline. In addition to the unfavorable variable annuity product performance in the first six months of 2003, a high level of life claims in the first quarter of 2003 offset the expected growth in the mortality margin during the first six months from new business.
The following table summarizes mortality margin by product group.
Amortization of DAC for Allstate Financial decreased 19.3% in the second quarter of 2003 compared to the same period in 2002 as lower than expected margins, primarily from the unfavorable mortality results on variable annuities, slowed the DAC amortization. Amortization of DAC increased 18.9% in the first six months of 2003 compared to the first six months of 2002 due to the acceleration of amortization, commonly known as DAC unlocking, in the first quarter of 2003 and ongoing growth of business, partially offset by lower than expected margins.
Operating costs and expenses for Allstate Financial decreased 1.2% during the second quarter of 2003 compared to the second quarter of 2002. Although investments in technology and employee related benefit expenses were higher in the second quarter of 2003, the increase was more than offset by lower litigation expenses. Operating costs and expenses increased 5.1% during the first six months of 2003 compared to
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the same period of 2002 due to increased continuing investments in technology and employee related benefit expenses.
Allstate Financial realized capital gains and losses are presented in the following table. After-tax realized capital gains and losses are presented net of the effects of DAC amortization to the extent that such amortization effects resulted from the recognition of realized capital gains and losses.
INVESTMENTS
The composition of the investment portfolio at June 30, 2003 is presented in the following table.
Total investments increased to $99.21 billion at June 30, 2003 from $90.65 billion at December 31, 2002 due to positive cash flows from operating and financing activities, increased unrealized gains on fixed income securities generated in a lower interest rate environment and increased funds associated with securities lending and dollar roll programs.
Property-Liability investments were $36.34 billion at June 30, 2003 compared to $34.25 billion at December 31, 2002, due to positive cash flows from operations partially offset by dividends paid by Allstate Insurance Company ("AIC") to The Allstate Corporation.
Allstate Financial investments were $61.51 billion at June 30, 2003 compared to $55.26 billion at December 31, 2002. The increase in Allstate Financial investments was primarily due to positive cash flows from operating and financing activities, increased funds associated with securities lending and dollar roll programs and increased unrealized gains on fixed income securities.
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Total investment balances related to funds associated with securities lending and dollar roll programs increased to $4.68 billion at June 30, 2003, from $2.98 billion at December 31, 2002.
The Unrealized net capital gains on fixed income and equity securities at June 30, 2003 were $7.55 billion, an increase of $2.06 billion or 37.5% since December 31, 2002. The net unrealized gain for the fixed income portfolio totaled $6.76 billion, comprised of $7.09 billion of unrealized gains and $327 million of unrealized losses at June 30, 2003, compared to a net unrealized gain for the fixed income portfolio totaling $5.03 billion at December 31, 2002, comprised of $5.51 billion of unrealized gains and $481 million of unrealized losses. At June 30, 2003, the unrealized losses for the fixed income portfolio were concentrated in the corporate fixed income portfolio. Corporate fixed income net unrealized gains totaled $2.99 billion comprised of $3.17 billion of unrealized gains and $183 million of unrealized losses. The unrealized losses for the corporate fixed income portfolio were concentrated in the transportation, basic industry, public utilities and capital goods sectors. These sectors comprised $106 million or 57.9% of the unrealized losses and $1.27 billion or 40.0% of the unrealized gains in the corporate fixed income portfolio.
The net unrealized gain for the equity portfolio totaled $791 million, comprised of $827 million of unrealized gains and $36 million of unrealized losses at June 30, 2003, compared to a net unrealized gain for the equity portfolio totaling $460 million at December 31, 2002, comprised of $562 million of unrealized gains and $102 million of unrealized losses. At June 30, 2003, the unrealized losses for the equity portfolio were concentrated in the technology, real estate, capital goods and consumer non-cyclical sectors. These sectors comprised $20 million or 55.6% of the unrealized losses and $482 million or 58.3% of the unrealized gains in the equity portfolio.
Securities with an unrealized loss greater than or equal to 20% of cost for equity securities or amortized cost for fixed income securities for a period of six or more consecutive months but less than 12 consecutive months had unrealized losses of $52 million at June 30, 2003, compared to $67 million of unrealized losses at December 31, 2002. This decrease was primarily related to a decline in unrealized losses for the utility and technology sectors, partially offset by an increase in unrealized losses for the transportation sector. Securities with an unrealized loss greater than or equal to 20% of cost for equity securities or amortized cost for fixed income securities for 12 or more consecutive months had unrealized losses of $4 million at June 30, 2003 compared to unrealized losses of $15 million at December 31, 2002.
Approximately 93.6% of the Company's fixed income securities portfolio is rated investment grade, which is defined by the Company as a security having a rating from the National Association of Insurance Commissioners ("NAIC") of 1 or 2, a Moody's equivalent rating of Aaa, Aa, A or Baa, a Standard & Poor's equivalent rating of AAA, AA, A or BBB, or a comparable Company internal rating.
Allstate monitors the quality of its fixed income portfolio, in part, by categorizing certain investments as problem, restructured or potential problem. Problem fixed income securities are securities in default with respect to principal and/or interest and/or securities issued by companies that have gone into bankruptcy subsequent to Allstate's acquisition of the security. Restructured fixed income securities have modified terms and conditions that were not at current market rates or terms 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, management has serious concerns regarding the borrower's ability to pay future principal and interest in accordance with the contractual terms of the security, which causes management 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.
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As of June 30, 2003, the balance of fixed income securities that the Company categorizes as potential problem declined from the balance as of year-end 2002. The decrease was related to the sale of holdings in this category due to specific developments in the first six months of the year causing a change in Allstate's outlook and intent to hold those securities, and an improvement in conditions for certain other holdings previously classified in this category. The Company expects the eventual recovery of these securities but evaluated each security through its watch list process at June 30, 2003 and recorded write-downs where appropriate. Approximately $37 million of net unrealized losses at June 30, 2003 are related to securities that the Company has included in the problem, restructured or potential problem categories. These securities represent 0.9% of the fixed income portfolio. The Company concluded, through its watch list monitoring process, that these unrealized losses were temporary in nature. While it is possible for these balances to increase in the future if economic conditions are unfavorable, the total amount of securities in these categories is expected to remain a relatively low percentage of the total fixed income securities portfolio.
The following table describes the components of realized capital gains and losses.
Sales of fixed income securities in the second quarter and first six months of 2003 resulted from actions taken to reduce credit exposure to certain issuers or industries and to provide liquidity for the purchase of investments that better meet certain investment objectives. Sales also include fees received from prepayments of fixed income securities and mortgage loans totaling $20 million and $25 million for the second quarter and first six months of 2003, respectively, compared to $22 million and $33 million for the same periods of 2002, respectively.
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CAPITAL RESOURCES AND LIQUIDITY
Capital Resources consist of shareholders' equity, mandatorily redeemable preferred securities and debt, representing funds deployed or available to be deployed to support business operations. The following table summarizes Allstate's capital resources.
Shareholders' equity increased $1.86 billion in the first six months of 2003 when compared to year-end 2002, as Net income and unrealized net capital gains on investments were partially offset by dividends paid to shareholders. During the first six months of 2003, the Company acquired 1.92 million shares of its stock at a cost of $61.68 million primarily as part of the current 3-year $500 million stock repurchase program. This program was 12.3% complete at June 30, 2003.
Debt decreased in the first six months of 2003 compared to December 31, 2002 due to declines in short-term borrowings outstanding partly offset by increases in long-term borrowings outstanding. In June 2003, the Company issued $400 million of 5.350% Senior Notes due in 2033, utilizing the registration statement filed with the Securities and Exchange Commission ("SEC") in June 2000. The proceeds of this issuance were used to redeem the $300 million of 63/4% Notes due 2003 and for general corporate purposes.
At June 30, 2003, the Company had outstanding commercial paper borrowings of $95 million.
Financial Ratings and Strength In June 2003, Standard & Poor's revised the insurance financial strength rating of Allstate Life Insurance Company ("ALIC") and its rated subsidiaries and affiliates from AA+ to AA and revised the rating outlook from negative to stable. Standard & Poor's stated that the rating change was due to several factors including their negative outlook on the life insurance industry, the recent decline in ALIC's Net income and their view that a subsidiary's rating cannot exceed the rating of its parent. ALIC's rating is now the same rating as AIC, its parent. Moody's and A.M. Best's insurance financial strength ratings of ALIC and AIC remain unchanged. In reaffirming the A+ ratings of ALIC and AIC, A.M. Best assigned a positive outlook for these companies' ratings.
Liquidity The following table summarizes consolidated cash flow activities by business segment for the first six months of 2003.
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The Company's operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet the liquidity requirements of the Company. The Corporate and Other segment also includes $1.18 billion of investments held by the Company's subsidiary, Kennett Capital.
The payment of dividends by AIC is limited by Illinois insurance law to formula amounts based on statutory net income and statutory surplus, as well as the timing and amount of dividends paid in the preceding twelve months. In the twelve-month period ending July 31, 2003, AIC paid dividends of $1.00 billion. Based on the greater of 2002 statutory net income or 10% of statutory surplus, the maximum amount of dividends AIC is able to pay without prior Illinois Department of Insurance approval at a given point in time during 2003 is $1.43 billion, less dividends paid during the preceding twelve months measured at that point in time. Notification and approval of inter-company lending activities is also required by the Illinois Department of Insurance for those transactions that exceed formula amounts based on statutory admitted assets and statutory surplus.
A portion of Allstate Financial's diversified product portfolio, primarily fixed annuity and interest-sensitive life insurance products, is subject to surrender and withdrawal at the discretion of contractholders. The total amount of surrenders and withdrawals for Allstate Financial for the three-month and six-month periods ending June 30, 2003 were $697 million and $1.30 billion compared with $474 million and $969 million for the same periods last year. The total amount of surrenders and withdrawals for the first six months of 2003 represented 3.0% of the Contractholder funds balance at June 30, 2003, compared to 2.6% in the first six months of last year.
The Company has access to additional borrowing to support liquidity as follows:
OFF-BALANCE SHEET ARRANGEMENTS
The Company's use of off-balance sheet arrangements is limited to the following four special purpose entities ("SPEs"), none of which have been invested in by members of management:
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The Company is in the process of assessing if the SPEs used to hold assets managed by Allstate Investment Management Company on behalf of unrelated third-party investors meet the criteria to be considered variable interest entities pursuant to the pending accounting guidance of Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities" and will require consolidation. The SPE used in connection with a synthetic lease will likely require consolidation, however, the SPE used to issue GMTNs will likely not require consolidation.
FORWARD-LOOKING STATEMENTS
This document contains "forward-looking statements" that anticipate results based on management's 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. Allstate assumes 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," "expects," "will," "anticipates," "estimates," "intends," "believes," "likely" and other words with similar meanings. These statements may address, among other things, the Company's strategy for growth, product development, regulatory approvals, market position, expenses, financial results and reserves. Management believes that these statements are based on reasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements. In addition to the normal risks of business, Allstate is subject to significant risks and uncertainties, including those listed below which apply to it as an insurance business and a provider of other financial services.
RISK FACTORS
The following risk factor should be considered in addition to the risk factors identified in the Management's Discussion and Analysis of Financial Condition and Results of Operations, under the heading "Forward-Looking Statements and Risk Factors Affecting Allstate," in Appendix D to the Company's Notice of Annual Meeting and Proxy Statement dated March 28, 2003.
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identifying, discussing, and resolving accounting and reporting issues within the framework of existing authoritative accounting literature, is currently deliberating Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The EITF's current issue summary, which has yet to be finalized, proposes that if, at the evaluation date, the fair value of an investment security is less than its carrying value, then an impairment exists for which a determination must be made as to whether that impairment is other-than-temporary. In the event the EITF enacts this summary as its final conclusion, the Company may be required to recognize certain pre-tax unrealized losses as realized losses. The estimated impact to the Company's Condensed Consolidated Statements of Operations and Financial Position is not determinable until such time as a final conclusion is reached.
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Item 4. Controls and Procedures
With the participation of our principal executive officer and principal financial officer, we carried out an evaluation of the effectiveness of the design and operation 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 timely alerting them to material information required to be included in our periodic reports filed with the Securities and Exchange Commission. However, the design of any system of controls and procedures is based in part upon assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and are effective at the "reasonable assurance" level.
During the last fiscal quarter, 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.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The discussion "Regulation, Legal Proceedings and Guarantees" in Part I, Item 1, Note 5 of this Form 10-Q is incorporated herein by reference.
Item 2. Changes in Securities and Use of Proceeds
Under an arrangement pursuant to which the two non-employee directors of Allstate Bank receive Allstate common stock as a portion of their compensation for their services as directors, in May 2003, The Allstate Corporation issued 500 shares of reacquired Allstate common stock in transactions exempt from registration under Section 4(2) of the Securities Act of 1933.
Item 4. Submission of Matters to a Vote of Security Holders
On May 20, 2003, Allstate held its annual meeting of stockholders. Thirteen board nominees for director were elected for terms expiring at the 2004 annual meeting of stockholders. In addition, the stockholders ratified the appointment of Deloitte & Touche LLP as independent auditors for 2003. There were two stockholder proposals presented and voted on at the meeting. A stockholder proposal regarding cumulative voting in the election of directors did not receive a majority vote of the shares represented and entitled to vote at the meeting. The stockholder proposal regarding the shareholder rights plan did receive a majority vote of the shares represented and entitled to vote at the meeting.
Election of Directors.
Ratify appointment of Deloitte & Touche LLP as the Company's auditors for 2003.
Stockholder proposal for cumulative voting in the election of directors.
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Stockholder proposal concerning the rights plan.
Item 6. Exhibits and Reports on Form 8-K
An Exhibit Index has been filed as part of this report on page E-1.
April 16, 2003, Items 7 and 9, regarding results of operations and financial condition for the quarter ended March 31, 2003
May 30, 2003, Items 5 and 7, regarding the underwritten public offering of $400 million principal amount of 5.350% Senior Notes due 2033
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SIGNATURE
Pursuant to the requirements 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.
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E-1
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