Allstate 2008 Annual Report Download - page 245

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
reclassified to net income; or the cumulative gain or loss on the derivative needed to offset the cumulative change
in the expected future cash flows on the hedged transaction from inception of the hedge less the derivative gain
or loss previously reclassified from accumulated other comprehensive income to net income. If the Company
expects at any time that the loss reported in accumulated other comprehensive income would lead to a net loss
on the combination of the hedging instrument and the hedged transaction which may not be recoverable, a loss
is recognized immediately in realized capital gains and losses. If an impairment loss is recognized on an asset or
an additional obligation is incurred on a liability involved in a hedge transaction, any offsetting gain in
accumulated other comprehensive income is reclassified and reported together with the impairment loss or
recognition of the obligation.
Termination of hedge accounting If, subsequent to entering into a hedge transaction, the derivative
becomes ineffective (including if the hedged item is sold or otherwise extinguished, the occurrence of a hedged
forecasted transaction is no longer probable, or the hedged asset becomes other-than-temporarily impaired), the
Company may terminate the derivative position. The Company may also terminate derivative instruments or
redesignate them as non-hedge as a result of other events or circumstances. If the derivative financial instrument
is not terminated when a fair value hedge is no longer effective, the future gains and losses recognized on the
derivative are reported in realized capital gains and losses. When a fair value hedge is no longer effective, is
redesignated as non-hedge or when the derivative has been terminated, the fair value gain or loss on the hedged
asset, liability or portion thereof which has already been recognized in income while the hedge was in place and
used to adjust the amortized cost for fixed income securities, the carrying value for mortgage loans or the
carrying amount for the liability, is amortized over the remaining life of the hedged asset, liability, or portion
thereof, and reflected in net investment income, interest credited to contractholder funds or interest expense
beginning in the period that hedge accounting is no longer applied. If the hedged item in a fair value hedge is an
asset which has become other-than-temporarily impaired, the adjustment made to the amortized cost for fixed
income securities or the carrying value for mortgage loans is subject to the accounting policies applied to
other-than-temporarily impaired assets.
When a derivative financial instrument used in a cash flow hedge of an existing asset or liability is no longer
effective or is terminated, the gain or loss recognized on the derivative is reclassified from accumulated other
comprehensive income to net income as the hedged risk impacts net income. If the derivative financial instrument
is not terminated when a cash flow hedge is no longer effective, the future gains and losses recognized on the
derivative are reported in realized capital gains and losses. When a derivative financial instrument used in a cash
flow hedge of a forecasted transaction is terminated because the forecasted transaction is no longer probable, the
gain or loss recognized on the derivative is immediately reclassified from accumulated other comprehensive
income to realized capital gains and losses in the period that hedge accounting is no longer applied. If a cash
flow hedge is no longer effective, the gain or loss recognized on the derivative during the period the hedge was
effective is reclassified from accumulated other comprehensive income to net income as the remaining hedged
item affects net income.
Non-hedge derivative financial instruments The Company also has certain derivatives that are used in
interest rate, equity price, commodity price and credit risk management strategies for which hedge accounting is
not applied. These derivatives primarily consist of certain interest rate swap agreements, equity options and
futures, commodity and financial futures contracts, interest rate cap and floor agreements, swaptions, foreign
currency forward and option contracts and credit default swaps.
In addition to the use of credit default swaps for credit risk management strategies, the Company replicates
fixed income securities using a combination of a credit default swap and one or more highly rated fixed income
securities to synthetically replicate the economic characteristics of one or more cash market securities. Fixed
income securities are replicated when they are either unavailable in the cash market or are more economical to
acquire in synthetic form.
The Company obtains commodity-based investment exposure through the use of excess return swaps whose
return is tied to a commodity-based index. The Company also uses certain commodity futures to periodically
rebalance its exposure under commodity-indexed excess return swaps as they are typically very liquid and highly
correlated with the commodity-based index.
Based upon the type of derivative instrument and strategy, the income statement effects of these derivatives
are reported in a single line item with the results of the associated risk. Therefore, the derivatives’ fair value gains
and losses and accrued periodic settlements are recognized together in one of the following during the reporting
period: net investment income, realized capital gains and losses, operating costs and expenses, life and annuity
contract benefits or interest credited to contractholder funds.
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Notes