Allstate 2008 Annual Report Download - page 195

Management’s Discussion and Analysis
of Financial Condition and Results of Operations–(Continued)
Short-term investments Our short-term investment portfolio was $8.91 billion and $3.06 billion at
December 31, 2008 and 2007, respectively. The increase in short-term investments was primarily due to liquidity
management actions. We invest available cash balances primarily in taxable short-term securities having a final
maturity date or redemption date of less than one year.
Other investments Our other investments as of December 31, 2008 are comprised primarily of $1.04 billion
of bank loans, $1.14 billion of policy loans and $301 million of certain derivatives, including credit default swaps.
Bank loans are comprised primarily of senior secured corporate loans and are carried at amortized cost. Policy
loans are carried at the unpaid principal balances.
Credit default swaps (‘‘CDS’’) are utilized for both buying and selling credit protection against a specified
credit event. In selling protection, CDS are used to replicate fixed income securities and to complement the cash
market when credit exposure to certain issuers is not available or when the derivative alternative is less expensive
than the cash market alternative. We are not selling protection to acquire revenues as a business activity. When
buying protection, the objective is to mitigate credit risk on fixed income holdings in our portfolio. Credit risk
includes both default risk and market value exposure due to spread widening. CDS typically have a five-year term.
The following table shows the CDS notional amounts and fair value of protection bought or sold as of
December 31, 2008.
Fair
Notional amounts value
Property- Allstate Fair to notional
Liability Financial Total value(1) amount
($ in millions)
Buying protection (recoverable)
Single name $ 436 $ 422 $ 858 $ 37 4.3%
Index 638 723 1,361 37 2.7
Total buying protection $1,074 $1,145 $2,219 $ 74 3.3
Selling protection (payable)
Single name $ 200 $ 272 $ 472 $ (50) (10.6)
First-to-default — 245 245 (48) (19.6)
Index 339 — 339 (16) (4.7)
Total selling protection $ 539 $ 517 $1,056 $(114) (10.8)
(1) Included as a component of other investments and other liabilities and accrued expenses on the Consolidated Statements of Financial
Position.
In buying and selling protection CDS, we buy or sell credit protection on an identified single name, a basket
of names in a first-to-default (‘‘FTD’’) structure or credit derivative index (‘‘CDX’’) that is generally investment
grade, and in return pay or receive periodic premiums through expiration or termination of the agreement. With
single name CDS, the premium or credit spread generally corresponds to the difference between the yield on the
referenced name’s public fixed maturity cash instruments and swap rates, at the time the agreement is executed.
With FTD baskets, because of the additional credit risk inherent in a basket of named credits, the premium
generally corresponds to a high proportion of the sum of the credit spreads of the names in the basket and
correlation between the names. CDX index is utilized to take a position on multiple (generally 125) credit entities.
Credit events are typically defined as bankruptcy, failure to pay, or restructuring, depending on the nature of the
reference credit. If a credit event occurs, we settle with the counterparty, either through physical settlement or
cash settlement. In a physical settlement, a reference asset is delivered by the buyer of protection to the seller of
protection, in exchange for cash payment at par, while in a cash settlement, the seller pays the difference
between par and the prescribed value of the reference asset. When such an event occurs in a single name or FTD
basket (for FTD, the first such event occurring for any one name in the basket), the contract terminates at time of
settlement. For CDX index, the reference entity’s name incurring the credit event is removed from the index while
the contract continues until expiration. The maximum payout on a CDS is the contract notional amount. For all
CDS, once a credit event and settlement has occurred, there may be subsequent recoveries. Recovery amounts, if
any, vary and they may reduce the ultimate amount of net gain or loss.
Unrealized net capital losses See Note 5 of the consolidated financial statements for further disclosures
regarding unrealized losses on fixed income and equity securities and factors considered in determining whether
securities are other-than-temporarily impaired. The unrealized net capital losses totaled $8.81 billion as of
December 31, 2008, compared to unrealized net capital gains of $1.91 billion at December 31, 2007 as a result of
significantly widening credit spreads and declining equity markets.
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MD&A