Allstate 2015 Annual Report Download - page 156

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150 www.allstate.com
Overview In formulating and implementing guidelines for investing funds, we seek to earn returns that enhance our
ability to offer competitive rates and prices to customers while contributing to attractive and stable profits and long-term
capital growth. Accordingly, our investment decisions and objectives are a function of the underlying risks and product
profiles of each business.
Investment policies define the overall framework for managing market and other investment risks, including
accountability and controls over risk management activities. Subsidiaries that conduct investment activities follow
policies that have been approved by their respective boards of directors. These investment policies specify the investment
limits and strategies that are appropriate given the liquidity, surplus, product profile and regulatory requirements of the
subsidiary. Executive oversight of investment activities is conducted primarily through subsidiaries’ boards of directors
and investment committees. For Allstate Financial, its asset-liability management (“ALM”) policies further define the
overall framework for managing market and investment risks. ALM focuses on strategies to enhance yields, mitigate
market risks and optimize capital to improve profitability and returns for Allstate Financial while factoring in future
expected cash requirements to repay liabilities. Allstate Financial ALM activities follow asset-liability policies that have
been approved by their respective boards of directors. These ALM policies specify limits, ranges and/or targets for
investments that best meet Allstate Financial’s business objectives in light of its product liabilities.
We use quantitative and qualitative market-based approaches to measure, monitor and manage market risk. We
evaluate our exposure to market risk through the use of multiple measures including but not limited to duration, value-at-
risk, scenario analysis and sensitivity analysis. Duration measures the price sensitivity of assets and liabilities to changes
in interest rates. For example, if interest rates increase 100 basis points, the fair value of an asset with a duration of 5 is
expected to decrease in value by 5%. Value-at-risk is a statistical estimate of the probability that the change in fair value
of a portfolio will exceed a certain amount over a given time horizon. Scenario analysis estimates the potential changes
in the fair value of a portfolio that could occur under different hypothetical market conditions defined by changes to
multiple market risk factors: interest rates, credit spreads, equity prices or currency exchange rates. Sensitivity analysis
estimates the potential changes in the fair value of a portfolio that could occur under different hypothetical shocks to a
market risk factor. In general, we establish investment portfolio asset allocation and market risk limits for the Property-
Liability and Allstate Financial businesses based upon a combination of duration, value-at-risk, scenario analysis and
sensitivity analysis. The asset allocation limits place restrictions on the total funds that may be invested within an
asset class. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio
managers buy and sell within their respective markets based upon the acceptable boundaries established by investment
policies. For Allstate Financial, this day-to-day management is integrated with and informed by the activities of the ALM
organization. This integration is intended to result in a prudent, methodical and effective adjudication of market risk and
return, conditioned by the unique demands and dynamics of Allstate Financial’s product liabilities and supported by the
continuous application of advanced risk technology and analytics.
Although we apply a similar overall philosophy to market risk, the underlying business frameworks and the accounting
and regulatory environments differ considerably between the Property-Liability and Allstate Financial businesses
affecting investment decisions and risk parameters.
Interest rate risk is the risk that we will incur a loss due to adverse changes in interest rates relative to the characteristics
of our interest bearing assets and liabilities. This risk arises from many of our primary activities, as we invest substantial
funds in interest-sensitive assets and issue interest-sensitive liabilities. Interest rate risk includes risks related to changes in
U.S. Treasury yields and other key risk-free reference yields.
We manage the interest rate risk in our assets relative to the interest rate risk in our liabilities and our assessment
of overall economic and capital risk. One of the measures used to quantify this exposure is duration. The difference in
the duration of our assets relative to our liabilities is our duration gap. To calculate the duration gap between assets and
liabilities, we project asset and liability cash flows and calculate their net present value using a risk-free market interest
rate adjusted for credit quality, sector attributes, liquidity and other specific risks. Duration is calculated by revaluing
these cash flows at alternative interest rates and determining the percentage change in aggregate fair value. The cash
flows used in this calculation include the expected maturity and repricing characteristics of our derivative financial
instruments, all other financial instruments, and certain other items including unearned premiums, property-liability
insurance claims and claims expense reserves, annuity liabilities and other interest-sensitive liabilities. The projections
include assumptions (based upon historical market experience and our experience) that reflect the effect of changing
interest rates on the prepayment, lapse, leverage and/or option features of instruments, where applicable. The preceding
assumptions relate primarily to callable municipal and corporate bonds, fixed rate single and flexible premium deferred
annuities, mortgage-backed securities and municipal housing bonds. Additionally, the calculations include assumptions
regarding the renewal of property-liability policies.