Allstate 2012 Annual Report Download - page 217

containing equity call options, which provide a coupon payout that is determined using one or more equity-based
indices; credit default swaps in synthetic collateralized debt obligations, which provide enhanced coupon rates as a
result of selling credit protection; and conversion options in fixed income securities, which provide the Company with
the right to convert the instrument into a predetermined number of shares of common stock.
When derivatives meet specific criteria, they may be designated as accounting hedges and accounted for as fair
value, cash flow, foreign currency fair value or foreign currency cash flow hedges. Allstate Financial designates certain of
its interest rate and foreign currency swap contracts and certain investment risk transfer reinsurance agreements as fair
value hedges when the hedging instrument is highly effective in offsetting the risk of changes in the fair value of the
hedged item. Allstate Financial designates certain of its foreign currency swap contracts as cash flow hedges when the
hedging instrument is highly effective in offsetting the exposure of variations in cash flows for the hedged risk that could
affect net income. Amounts are reclassified to net investment income or realized capital gains and losses as the hedged
item affects net income.
The notional amounts specified in the contracts are used to calculate the exchange of contractual payments under
the agreements and are generally not representative of the potential for gain or loss on these agreements. However, the
notional amounts specified in credit default swaps where the Company has sold credit protection represent the
maximum amount of potential loss, assuming no recoveries.
Fair value, which is equal to the carrying value, is the estimated amount that the Company would receive or pay to
terminate the derivative contracts at the reporting date. The carrying value amounts for OTC derivatives are further
adjusted for the effects, if any, of legally enforceable master netting agreements and are presented on a net basis, by
counterparty agreement, in the Consolidated Statements of Financial Position. For certain exchange traded derivatives,
the exchange requires margin deposits as well as daily cash settlements of margin accounts. As of December 31, 2011,
the Company pledged $11 million of securities in the form of margin deposits.
For those derivatives which qualify for fair value hedge accounting, net income includes the changes in the fair value
of both the derivative instrument and the hedged risk, and therefore reflects any hedging ineffectiveness. For cash flow
hedges, gains and losses are amortized from accumulated other comprehensive income and are reported in net income
in the same period the forecasted transactions being hedged impact net income. For embedded derivatives in fixed
income securities, net income includes the change in fair value of the embedded derivative and accretion income related
to the host instrument.
Non-hedge accounting is generally used for ‘‘portfolio’’ level hedging strategies where the terms of the individual
hedged items do not meet the strict homogeneity requirements to permit the application of hedge accounting. For
non-hedge derivatives, net income includes changes in fair value and accrued periodic settlements, when applicable.
With the exception of non-hedge derivatives used for asset replication and non-hedge embedded derivatives, all of the
Company’s derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative
financial instruments on at least a quarterly basis.
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