Allstate 2008 Annual Report Download - page 127

Management’s Discussion and Analysis
of Financial Condition and Results of Operations–(Continued)
balance is insufficient to absorb the deficiency. In 2008, for traditional life insurance and immediate annuities with
life contingencies, an aggregate premium deficiency of $336 million pre-tax ($219 million after-tax) resulted
primarily from a study indicating that the annuitants on certain life-contingent contracts are projected to live
longer than we anticipated when the contracts were issued and, to a lesser degree, a reduction in the related
investment portfolio yield. The deficiency was recorded through a reduction in DAC. In 2007 and 2006, our reviews
concluded that no premium deficiency adjustments were necessary, primarily due to projected income from
traditional life insurance more than offsetting the projected deficiency in immediate annuities with life
contingencies.
DAC related to interest-sensitive life, annuities and other investment contracts is amortized in proportion to
the incidence of the total present value of gross profits, which includes both actual historical gross profits (‘‘AGP’’)
and estimated future gross profits (‘‘EGP’’) expected to be earned over the estimated lives of the contracts. The
amortization is net of interest on the prior period DAC balance using rates established at the inception of the
contracts. Actual amortization periods generally range from 15-30 years; however, incorporating estimates of
customer surrender rates, partial withdrawals and deaths generally results in the majority of the DAC being
amortized during the surrender charge period. The cumulative DAC amortization is reestimated and adjusted by a
cumulative charge or credit to results of operations when there is a difference between the incidence of actual
versus expected gross profits in a reporting period or when there is a change in total EGP.
AGP and EGP consist primarily of the following components: contract charges for the cost of insurance less
mortality costs and other benefits (benefit margin); investment income and realized capital gains and losses less
interest credited (investment margin); and surrender and other contract charges less maintenance expenses
(expense margin). The amount of EGP is principally dependent on assumptions for investment returns, including
capital gains and losses on assets supporting contract liabilities, interest crediting rates to contractholders, and
the effects of persistency, mortality, expenses, and hedges if applicable, and these assumptions are reasonably
likely to have the greatest impact on the amount of DAC amortization. Changes in these assumptions can be
offsetting and the Company is unable to reasonably predict their future movements or offsetting impacts over
time.
Each reporting period, DAC amortization is recognized in proportion to AGP for that period adjusted for
interest on the prior period DAC balance. This amortization process includes an assessment of AGP compared to
EGP, the actual amount of business remaining in-force and realized capital gains and losses on investments
supporting the product liability. The impact of realized capital gains and losses on amortization of DAC depends
upon which product liability is supported by the assets that give rise to the gain or loss. If the AGP is less than
EGP in the period, but the total EGP is unchanged, the amount of DAC amortization will generally decrease,
resulting in a current period increase to earnings. The opposite result generally occurs when the AGP exceeds the
EGP in the period, but the total EGP is unchanged.
Annually, we review all assumptions underlying the projections of EGP, including investment returns,
comprising investment income and realized capital gains and losses, interest crediting rates, persistency, mortality,
and expenses. Management annually updates assumptions used in the calculation of EGP. At each reporting
period, we assess whether any revisions to assumptions used to determine DAC amortization are required. These
reviews and updates may result in amortization acceleration or deceleration, which are commonly referred to as
‘‘DAC unlocking’’.
If the update of assumptions causes total EGP to increase, the rate of DAC amortization will generally
decrease, resulting in a current period increase to earnings. A decrease to earnings generally occurs when the
assumption update causes the total EGP to decrease.
Over the past three years, our most significant DAC assumption updates that resulted in a change to EGP
and the amortization of DAC have been revisions to expected future investment returns, primarily realized capital
losses, expenses, mortality and the number of contracts in force or persistency resulting in net DAC amortization
acceleration of $327 million in 2008, deceleration of $14 million in 2007 and acceleration of $2 million in 2006.
The following table provides the effect on DAC amortization of changes in assumptions relating to the gross
profit components of investment margin, benefit margin and expense margin during the years ended
December 31.
2008 2007 2006
($ in millions)
Investment margin $(303) $ 11 $ 15
Benefit margin 35 34 (13)
Expense margin (59) (31) (4)
Net (acceleration) deceleration $(327) $ 14 $ (2)
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MD&A