filings.toolsItem 8. Financial Statements and Supplementary Data
463K characters. Original on sec.gov · Markdown
Item 8. Financial Statements and Supplementary Data
| Consolidated Financial Statements | Page | |
| Consolidated Statements of Operations | 123 | |
| Consolidated Statements of Comprehensive Income | 124 | |
| Consolidated Statements of Financial Position | 125 | |
| Consolidated Statements of Shareholders’ Equity | 126 | |
| Consolidated Statements of Cash Flows | 127 | |
| Notes to Consolidated Financial Statements (Notes) | 128 | |
| Report of Independent Registered Public Accounting Firm | 209 |
122 
www.allstate.com
Financial Statements 2017 Form 10-K
The Allstate Corporation and Subsidiaries
Consolidated Statements of Operations
| Years Ended December 31, | ||||||||||||
| ($ in millions, except per share data) | 2017 | 2016 | 2015 | |||||||||
| Revenues | ||||||||||||
| Property and casualty insurance premiums (net of reinsurance ceded of $971, $987 and $1,006) | $ | 32,300 | $ | 31,307 | $ | 30,309 | ||||||
| Life premiums and contract charges (net of reinsurance ceded of $303, $309 and $332) | 2,378 | 2,275 | 2,158 | |||||||||
| Net investment income | 3,401 | 3,042 | 3,156 | |||||||||
| Realized capital gains and losses: | ||||||||||||
| Total other-than-temporary impairment (“OTTI”) losses | (146 | ) | (313 | ) | (452 | ) | ||||||
| OTTI losses reclassified to other comprehensive income | (4 | ) | 10 | 36 | ||||||||
| Net OTTI losses recognized in earnings | (150 | ) | (303 | ) | (416 | ) | ||||||
| Sales and other realized capital gains and losses | 595 | 213 | 446 | |||||||||
| Total realized capital gains and losses | 445 | (90 | ) | 30 | ||||||||
| Total revenues | 38,524 | 36,534 | 35,653 | |||||||||
| Costs and expenses | ||||||||||||
| Property and casualty insurance claims and claims expense (net of reinsurance ceded of $1,807, $1,116 and $602) | 21,929 | 22,221 | 21,034 | |||||||||
| Life contract benefits (net of reinsurance ceded of $179, $208 and $219) | 1,923 | 1,857 | 1,803 | |||||||||
| Interest credited to contractholder funds (net of reinsurance ceded of $25, $26 and $25) | 690 | 726 | 761 | |||||||||
| Amortization of deferred policy acquisition costs | 4,784 | 4,550 | 4,364 | |||||||||
| Operating costs and expenses | 4,658 | 4,106 | 4,081 | |||||||||
| Restructuring and related charges | 109 | 30 | 39 | |||||||||
| Goodwill impairment | 125 | — | — | |||||||||
| Interest expense | 335 | 295 | 292 | |||||||||
| Total costs and expenses | 34,553 | 33,785 | 32,374 | |||||||||
| Gain on disposition of operations | 20 | 5 | 3 | |||||||||
| Income from operations before income tax expense | 3,991 | 2,754 | 3,282 | |||||||||
| Income tax expense | 802 | 877 | 1,111 | |||||||||
| Net income | 3,189 | 1,877 | 2,171 | |||||||||
| Preferred stock dividends | 116 | 116 | 116 | |||||||||
| Net income applicable to common shareholders | $ | 3,073 | $ | 1,761 | $ | 2,055 | ||||||
| Earnings per common share: | ||||||||||||
| Net income applicable to common shareholders per common share - Basic | $ | 8.49 | $ | 4.72 | $ | 5.12 | ||||||
| Weighted average common shares - Basic | 362.0 | 372.8 | 401.1 | |||||||||
| Net income applicable to common shareholders per common share - Diluted | $ | 8.36 | $ | 4.67 | $ | 5.05 | ||||||
| Weighted average common shares - Diluted | 367.8 | 377.3 | 406.8 | |||||||||
| Cash dividends declared per common share | $ | 1.48 | $ | 1.32 | $ | 1.20 |
See notes to consolidated financial statements.
The Allstate Corporation 123
2017 Form 10-K Financial Statements
The Allstate Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
| Years Ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Net income | $ | 3,189 | $ | 1,877 | $ | 2,171 | ||||||
| Other comprehensive income (loss), after-tax | ||||||||||||
| Changes in: | ||||||||||||
| Unrealized net capital gains and losses | 319 | 433 | (1,306 | ) | ||||||||
| Unrealized foreign currency translation adjustments | 47 | 10 | (58 | ) | ||||||||
| Unrecognized pension and other postretirement benefit cost | 307 | (104 | ) | 48 | ||||||||
| Other comprehensive income (loss), after-tax | 673 | 339 | (1,316 | ) | ||||||||
| Comprehensive income | $ | 3,862 | $ | 2,216 | $ | 855 |
See notes to consolidated financial statements.
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Financial Statements 2017 Form 10-K
The Allstate Corporation and Subsidiaries
Consolidated Statements of Financial Position
| December 31, | ||||||||
| ($ in millions, except par value data) | 2017 | 2016 | ||||||
| Assets | ||||||||
| Investments | ||||||||
| Fixed income securities, at fair value (amortized cost $57,525 and $56,576) | $ | 58,992 | $ | 57,839 | ||||
| Equity securities, at fair value (cost $5,461 and $5,157) | 6,621 | 5,666 | ||||||
| Mortgage loans | 4,534 | 4,486 | ||||||
| Limited partnership interests | 6,740 | 5,814 | ||||||
| Short-term, at fair value (amortized cost $1,944 and $4,288) | 1,944 | 4,288 | ||||||
| Other | 3,972 | 3,706 | ||||||
| Total investments | 82,803 | 81,799 | ||||||
| Cash | 617 | 436 | ||||||
| Premium installment receivables, net | 5,786 | 5,597 | ||||||
| Deferred policy acquisition costs | 4,191 | 3,954 | ||||||
| Reinsurance recoverables, net | 8,921 | 8,745 | ||||||
| Accrued investment income | 569 | 567 | ||||||
| Property and equipment, net | 1,072 | 1,065 | ||||||
| Goodwill | 2,181 | 1,219 | ||||||
| Other assets | 2,838 | 1,835 | ||||||
| Separate Accounts | 3,444 | 3,393 | ||||||
| Total assets | $ | 112,422 | $ | 108,610 | ||||
| Liabilities | ||||||||
| Reserve for property and casualty insurance claims and claims expense | $ | 26,325 | $ | 25,250 | ||||
| Reserve for life-contingent contract benefits | 12,549 | 12,239 | ||||||
| Contractholder funds | 19,434 | 20,260 | ||||||
| Unearned premiums | 13,473 | 12,583 | ||||||
| Claim payments outstanding | 875 | 879 | ||||||
| Deferred income taxes | 782 | 487 | ||||||
| Other liabilities and accrued expenses | 6,639 | 6,599 | ||||||
| Long-term debt | 6,350 | 6,347 | ||||||
| Separate Accounts | 3,444 | 3,393 | ||||||
| Total liabilities | 89,871 | 88,037 | ||||||
| Commitments and Contingent Liabilities (Note 7, 8 and 14) | ||||||||
| Shareholders’ equity | ||||||||
| Preferred stock and additional capital paid-in, $1 par value, 25 million shares authorized, 72.2 thousand issued and outstanding, $1,805 aggregate liquidation preference | 1,746 | 1,746 | ||||||
| Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 355 million and 366 million shares outstanding | 9 | 9 | ||||||
| Additional capital paid-in | 3,313 | 3,303 | ||||||
| Retained income | 43,162 | 40,678 | ||||||
| Deferred ESOP expense | (3 | ) | (6 | ) | ||||
| Treasury stock, at cost (545 million and 534 million shares) | (25,982 | ) | (24,741 | ) | ||||
| Accumulated other comprehensive income: | ||||||||
| Unrealized net capital gains and losses: | ||||||||
| Unrealized net capital gains and losses on fixed income securities with OTTI | 85 | 57 | ||||||
| Other unrealized net capital gains and losses | 1,981 | 1,091 | ||||||
| Unrealized adjustment to DAC, DSI and insurance reserves | (404 | ) | (95 | ) | ||||
| Total unrealized net capital gains and losses | 1,662 | 1,053 | ||||||
| Unrealized foreign currency translation adjustments | (9 | ) | (50 | ) | ||||
| Unrecognized pension and other postretirement benefit cost | (1,347 | ) | (1,419 | ) | ||||
| Total accumulated other comprehensive income (loss) (“AOCI”) | 306 | (416 | ) | |||||
| Total shareholders’ equity | 22,551 | 20,573 | ||||||
| Total liabilities and shareholders’ equity | $ | 112,422 | $ | 108,610 |
See notes to consolidated financial statements.
The Allstate Corporation 125
2017 Form 10-K Financial Statements
The Allstate Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Equity
| Years Ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Preferred stock par value | $ | — | $ | — | $ | — | ||||||
| Preferred stock additional capital paid-in | 1,746 | 1,746 | 1,746 | |||||||||
| Common stock | 9 | 9 | 9 | |||||||||
| Additional capital paid-in | ||||||||||||
| Balance, beginning of year | 3,303 | 3,245 | 3,199 | |||||||||
| Forward contract on accelerated share repurchase agreement | (45 | ) | — | — | ||||||||
| Equity incentive plans activity | 55 | 58 | 46 | |||||||||
| Balance, end of year | 3,313 | 3,303 | 3,245 | |||||||||
| Retained income | ||||||||||||
| Balance, beginning of year | 40,678 | 39,413 | 37,842 | |||||||||
| Net income | 3,189 | 1,877 | 2,171 | |||||||||
| Dividends on common stock | (540 | ) | (496 | ) | (484 | ) | ||||||
| Dividends on preferred stock | (116 | ) | (116 | ) | (116 | ) | ||||||
| Reclassification of tax effects due to change in accounting principle | (49 | ) | — | — | ||||||||
| Balance, end of year | 43,162 | 40,678 | 39,413 | |||||||||
| Deferred ESOP expense | ||||||||||||
| Balance, beginning of year | (6 | ) | (13 | ) | (23 | ) | ||||||
| Payments | 3 | 7 | 10 | |||||||||
| Balance, end of year | (3 | ) | (6 | ) | (13 | ) | ||||||
| Treasury stock | ||||||||||||
| Balance, beginning of year | (24,741 | ) | (23,620 | ) | (21,030 | ) | ||||||
| Shares acquired | (1,423 | ) | (1,341 | ) | (2,804 | ) | ||||||
| Shares reissued under equity incentive plans, net | 182 | 220 | 214 | |||||||||
| Balance, end of year | (25,982 | ) | (24,741 | ) | (23,620 | ) | ||||||
| Accumulated other comprehensive income (loss) | ||||||||||||
| Balance, beginning of year | (416 | ) | (755 | ) | 561 | |||||||
| Change in unrealized net capital gains and losses | 319 | 433 | (1,306 | ) | ||||||||
| Change in unrealized foreign currency translation adjustments | 47 | 10 | (58 | ) | ||||||||
| Change in unrecognized pension and other postretirement benefit cost | 307 | (104 | ) | 48 | ||||||||
| Reclassification of tax effects due to change in accounting principle | 49 | — | — | |||||||||
| Balance, end of year | 306 | (416 | ) | (755 | ) | |||||||
| Total shareholders’ equity | $ | 22,551 | $ | 20,573 | $ | 20,025 |
See notes to consolidated financial statements.
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Financial Statements 2017 Form 10-K
The Allstate Corporation and Subsidiaries
Consolidated Statements of Cash Flows
| Years Ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Cash flows from operating activities | ||||||||||||
| Net income | $ | 3,189 | $ | 1,877 | $ | 2,171 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation, amortization and other non-cash items | 483 | 382 | 371 | |||||||||
| Realized capital gains and losses | (445 | ) | 90 | (30 | ) | |||||||
| Gain on disposition of operations | (20 | ) | (5 | ) | (3 | ) | ||||||
| Interest credited to contractholder funds | 690 | 726 | 761 | |||||||||
| Goodwill Impairment | 125 | — | — | |||||||||
| Changes in: | ||||||||||||
| Policy benefits and other insurance reserves | 302 | 631 | 473 | |||||||||
| Unearned premiums | 463 | 362 | 638 | |||||||||
| Deferred policy acquisition costs | (214 | ) | (165 | ) | (239 | ) | ||||||
| Premium installment receivables, net | (131 | ) | (42 | ) | (134 | ) | ||||||
| Reinsurance recoverables, net | (211 | ) | (264 | ) | (178 | ) | ||||||
| Income taxes | (245 | ) | 417 | (119 | ) | |||||||
| Other operating assets and liabilities | 328 | (16 | ) | (95 | ) | |||||||
| Net cash provided by operating activities | 4,314 | 3,993 | 3,616 | |||||||||
| Cash flows from investing activities | ||||||||||||
| Proceeds from sales | ||||||||||||
| Fixed income securities | 25,341 | 25,061 | 28,693 | |||||||||
| Equity securities | 6,504 | 5,546 | 3,754 | |||||||||
| Limited partnership interests | 1,125 | 881 | 1,101 | |||||||||
| Mortgage loans | — | — | 6 | |||||||||
| Other investments | 274 | 262 | 545 | |||||||||
| Investment collections | ||||||||||||
| Fixed income securities | 4,194 | 4,533 | 4,432 | |||||||||
| Mortgage loans | 600 | 501 | 538 | |||||||||
| Other investments | 642 | 421 | 293 | |||||||||
| Investment purchases | ||||||||||||
| Fixed income securities | (31,145 | ) | (27,990 | ) | (30,758 | ) | ||||||
| Equity securities | (6,585 | ) | (5,950 | ) | (4,960 | ) | ||||||
| Limited partnership interests | (1,440 | ) | (1,450 | ) | (1,343 | ) | ||||||
| Mortgage loans | (646 | ) | (646 | ) | (687 | ) | ||||||
| Other investments | (999 | ) | (885 | ) | (902 | ) | ||||||
| Change in short-term investments, net | 2,610 | (2,446 | ) | 385 | ||||||||
| Change in other investments, net | (30 | ) | (51 | ) | (52 | ) | ||||||
| Purchases of property and equipment, net | (299 | ) | (313 | ) | (303 | ) | ||||||
| Acquisition of operations | (1,356 | ) | — | — | ||||||||
| Net cash (used in) provided by investing activities | (1,210 | ) | (2,526 | ) | 742 | |||||||
| Cash flows from financing activities | ||||||||||||
| Proceeds from issuance of long-term debt | — | 1,236 | — | |||||||||
| Repayments of long-term debt | — | (17 | ) | (20 | ) | |||||||
| Contractholder fund deposits | 1,025 | 1,049 | 1,052 | |||||||||
| Contractholder fund withdrawals | (1,890 | ) | (2,087 | ) | (2,327 | ) | ||||||
| Dividends paid on common stock | (525 | ) | (486 | ) | (483 | ) | ||||||
| Dividends paid on preferred stock | (116 | ) | (116 | ) | (116 | ) | ||||||
| Treasury stock purchases | (1,495 | ) | (1,337 | ) | (2,808 | ) | ||||||
| Shares reissued under equity incentive plans, net | 135 | 164 | 130 | |||||||||
| Excess tax benefits on share-based payment arrangements | — | 32 | 45 | |||||||||
| Other | (57 | ) | 36 | 7 | ||||||||
| Net cash used in financing activities | (2,923 | ) | (1,526 | ) | (4,520 | ) | ||||||
| Net increase (decrease) in cash | 181 | (59 | ) | (162 | ) | |||||||
| Cash at beginning of year | 436 | 495 | 657 | |||||||||
| Cash at end of year | $ | 617 | $ | 436 | $ | 495 |
See notes to consolidated financial statements.
The Allstate Corporation 127
2017 Form 10-K Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
| Note 1 | General |
Basis of presentation
The accompanying consolidated financial statements include the accounts of The Allstate Corporation (the “Corporation”) and its wholly owned subsidiaries, primarily Allstate Insurance Company (“AIC”), a property and casualty insurance company with various property and casualty and life and investment subsidiaries, including Allstate Life Insurance Company (“ALIC”) (collectively referred to as the “Company” or “Allstate”). These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
In fourth quarter 2017, the Company revised its reportable segments. For additional information on impacts of the revised segments, see Notes 2, 4 and 9. To conform to the current year presentation, certain amounts in the prior years’ notes have been updated to reflect changes in reportable segments.
Nature of operations
Allstate is engaged, principally in the United States, in the property and casualty insurance and life insurance business. Allstate was the country’s second largest personal property and casualty insurer as of December 31, 2016. Allstate is organized into seven reportable segments: Allstate Protection, Discontinued Lines and Coverages, Service Businesses, Allstate Life, Allstate Benefits, Allstate Annuities, and Corporate and Other.
Allstate’s primary business is the sale of private passenger auto and homeowners insurance. The Company also offers several other personal property and casualty insurance products, select commercial property and casualty coverages, consumer product protection plans, device and mobile data collection services and analytic solutions, roadside assistance, finance and insurance products, life insurance and voluntary accident and health insurance. Allstate primarily distributes its products through exclusive agencies, financial specialists, independent agencies and brokers, major retailers, contact centers and the internet.
Risks and uncertainties
Allstate has exposure to catastrophes, an inherent risk of the property and casualty insurance business, which have contributed, and will continue to contribute, to material year-to-year fluctuations in the Company’s results of operations and financial position (see Note 8). The nature and level of catastrophic loss caused by natural events (high winds, winter storms, tornadoes, hailstorms, wildfires, tropical storms, hurricanes, earthquakes and volcanoes) and man-made events (terrorism and industrial accidents) experienced in any period cannot be predicted and could be material to results of operations and financial position. The Company considers the greatest areas of potential catastrophe losses due to hurricanes to generally be major metropolitan centers in counties along the eastern and gulf coasts of the United States. The Company considers the greatest areas of potential catastrophe losses due to earthquakes and fires following earthquakes to be major metropolitan areas near fault lines in the states of California, Oregon, Washington, South Carolina, Missouri, Kentucky and Tennessee. The Company also has exposure to asbestos, environmental and other discontinued lines claims (see Notes 8 and 14).
| Note 2 | Summary of Significant Accounting Policies |
Investments
Fixed income securities include bonds, asset-backed securities (“ABS”), residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and redeemable preferred stocks. Fixed income securities, which may be sold prior to their contractual maturity, are designated as available for sale and are carried at fair value. The difference between amortized cost and fair value, net of deferred income taxes and related life and annuity deferred policy acquisition costs (“DAC”), deferred sales inducement costs (“DSI”) and reserves for life-contingent contract benefits, is reflected as a component of accumulated other comprehensive income (“AOCI”). Cash received from calls and make-whole payments is reflected as a component of proceeds from sales and cash received from maturities
and pay-downs is reflected as a component of investment collections within the Consolidated Statements of Cash Flows.
Equity securities primarily include common stocks, exchange traded and mutual funds, non-redeemable preferred stocks and real estate investment trust equity investments. Certain exchange traded and mutual funds have fixed income securities as their underlying investments. Equity securities are designated as available for sale and are carried at fair value. The difference between cost and fair value, net of deferred income taxes, is reflected as a component of AOCI.
Mortgage loans are carried at unpaid principal balances, net of unamortized premium or discount and valuation allowances. Valuation allowances are
128 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
established for impaired loans when it is probable that contractual principal and interest will not be collected.
Investments in limited partnership interests include interests in private equity funds, real estate funds and other funds. Where the Company’s interest is so minor that it exercises virtually no influence over operating and financial policies, investments in limited partnership interests are accounted for in accordance with the cost method of accounting; all other investments in limited partnership interests are accounted for in accordance with the equity method of accounting (“EMA”).
Short-term investments, including commercial paper, U.S. Treasury bills, money market funds and other short-term investments, are carried at fair value. Other investments primarily consist of bank loans, policy loans, agent loans, real estate and derivatives. Bank loans are primarily senior secured corporate loans and are carried at amortized cost. Policy loans are carried at unpaid principal balances and were $905 million and $904 million as of December 31, 2017 and 2016, respectively. Agent loans are loans issued to exclusive Allstate agents and are carried at unpaid principal balances, net of valuation allowances and unamortized deferred fees or costs. Real estate is carried at cost less accumulated depreciation. Derivatives are carried at fair value.
Investment income primarily consists of interest, dividends, income from limited partnership interests, rental income from real estate, and income from certain derivative transactions. Interest is recognized on an accrual basis using the effective yield method and dividends are recorded at the ex-dividend date. Interest income for ABS, RMBS and CMBS is determined considering estimated pay-downs, including prepayments, obtained from third party data sources and internal estimates. Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. For ABS, RMBS and CMBS of high credit quality with fixed interest rates, the effective yield is recalculated on a retrospective basis. For all others, the effective yield is recalculated on a prospective basis. Accrual of income is suspended for other-than-temporarily impaired fixed income securities when the timing and amount of cash flows expected to be received is not reasonably estimable. Accrual of income is suspended for mortgage loans, bank loans and agent loans that are in default or when full and timely collection of principal and interest payments is not probable. Cash receipts on investments on nonaccrual status are generally recorded as a reduction of carrying value. Income from cost method limited partnership interests is recognized upon receipt of amounts distributed by the partnerships. Income from EMA limited partnership interests is recognized based on the Company’s share of the partnerships’ earnings and unrealized gains and losses resulting from valuation changes of the underlying investments, and is generally recognized on a three month delay due to the availability of the related financial statements.
Realized capital gains and losses include gains and losses on investment sales, write-downs in value due to other-than-temporary declines in fair value, adjustments to valuation allowances on mortgage loans and agent loans, periodic changes in fair value and settlements of certain derivatives including hedge ineffectiveness and valuation changes in public securities held in certain limited partnerships. Realized capital gains and losses on investment sales are determined on a specific identification basis.
Derivative and embedded derivative financial instruments
Derivative financial instruments include interest rate swaps, credit default swaps, futures (interest rate and equity), options (including swaptions), interest rate caps, warrants and rights, foreign currency swaps, foreign currency forwards and certain investment risk transfer reinsurance agreements. Derivatives required to be separated from the host instrument and accounted for as derivative financial instruments (“subject to bifurcation”) are embedded in equity-indexed life and annuity contracts, reinsured variable annuity contracts and certain funding agreements.
All derivatives are accounted for on a fair value basis and reported as other investments, other assets, other liabilities and accrued expenses or contractholder funds. Embedded derivative instruments subject to bifurcation are also accounted for on a fair value basis and are reported together with the host contract. The change in fair value of derivatives embedded in life and annuity product contracts and subject to bifurcation is reported in life and annuity contract benefits or interest credited to contractholder funds. Cash flows from embedded derivatives subject to bifurcation and derivatives receiving hedge accounting are reported consistently with the host contracts and hedged risks, respectively, within the Consolidated Statements of Cash Flows. Cash flows from other derivatives are reported in cash flows from investing activities within the Consolidated Statements of Cash Flows.
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. The hedged item may be either all or a specific portion of a recognized asset, liability or an unrecognized firm commitment attributable to a particular risk for fair value hedges. At the inception of the hedge, the Company formally documents the hedging relationship and risk management objective and strategy. The documentation identifies the hedging instrument, the hedged item, the nature of the risk being hedged and the methodology used to assess the effectiveness of the hedging instrument in offsetting the exposure to changes in the hedged item’s fair value attributable to the hedged risk. For a cash flow hedge, this documentation includes the exposure to changes in the variability in cash flows attributable to the hedged risk. The Company does not exclude any component of the change in fair value of the hedging instrument from the effectiveness assessment. At each reporting date, the Company confirms that the hedging
The Allstate Corporation 129
2017 Form 10-K Notes to Consolidated Financial Statements
instrument continues to be highly effective in offsetting the hedged risk. Ineffectiveness in fair value hedges and cash flow hedges, if any, is reported in realized capital gains and losses.
Fair value hedges The change in fair value of hedging instruments used in fair value hedges of investment assets or a portion thereof is reported in net investment income, together with the change in fair value of the hedged items. The change in fair value of hedging instruments used in fair value hedges of contractholder funds liabilities or a portion thereof is reported in interest credited to contractholder funds, together with the change in fair value of the hedged items. Accrued periodic settlements on swaps are reported together with the changes in fair value of the swaps in net investment income or interest credited to contractholder funds. The amortized cost for fixed income securities, the carrying value for mortgage loans or the carrying value of the hedged liability is adjusted for the change in fair value of the hedged risk.
Cash flow hedges For hedging instruments used in cash flow hedges, the changes in fair value of the derivatives representing the effective portion of the hedge are reported in AOCI. Amounts are reclassified to net investment income, realized capital gains and losses or interest expense as the hedged or forecasted transaction affects income. Accrued periodic settlements on derivatives used in cash flow hedges are reported in net investment income. The amount reported in AOCI for a hedged transaction is limited to the lesser of the cumulative gain or loss on the derivative less the amount reclassified to 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 AOCI to income. If the Company expects at any time that the loss reported in AOCI 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 AOCI 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 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 value of the hedged liability, is amortized over the remaining life of the hedged asset, liability or portion thereof, and reflected in net investment income or interest credited to contractholder funds beginning in the period that hedge accounting is no longer applied. If the hedged item in a fair value hedge is an asset that 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 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 AOCI to income as the hedged risk impacts income. If the derivative 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 instrument used in a cash flow hedge of a forecasted transaction is terminated because it is probable the forecasted transaction will not occur, the gain or loss recognized on the derivative is immediately reclassified from AOCI to realized capital gains and losses in the period that hedge accounting is no longer applied.
Non-hedge derivative financial instruments For derivatives for which hedge accounting is not applied, the income statement effects, including fair value gains and losses and accrued periodic settlements, are reported either in realized capital gains and losses or in a single line item together with the results of the associated asset or liability for which risks are being managed.
Securities loaned
The Company’s business activities include securities lending transactions, which are used primarily to generate net investment income. The proceeds received in conjunction with securities lending transactions are reinvested in short-term investments or fixed income securities. These transactions are short-term in nature, usually 30 days or less.
The Company receives cash collateral for securities loaned in an amount generally equal to 102% and 105% of the fair value of domestic and foreign securities, respectively, and records the related obligations to return the collateral in other liabilities and accrued expenses. The carrying value of these obligations approximates fair value because of their relatively short-term nature. The Company monitors the market value of securities loaned on a daily basis and obtains additional collateral as necessary under the terms of the agreements to mitigate counterparty credit risk. The Company maintains the right and ability to repossess the securities loaned on short notice.
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Recognition of premium revenues and contract charges, and related benefits and interest credited
Property and casualty insurance premiums include premiums from personal lines policies, protection plans, and other contracts (primarily related to finance and insurance products) backed by insurance. Personal lines and protection plans insurance premiums are deferred and earned on a pro-rata basis over the terms of the policies, typically periods of six or twelve months for personal lines policies and one to five years for protection plans. Other contracts (primarily related to finance and insurance products) premiums are deferred and earned over the terms of the contract, generally one to five years, aligned with the costs of performing services under the contract. The portion of premiums written applicable to the unexpired terms of the policies is recorded as unearned premiums. Premium installment receivables, net, represent premiums written and not yet collected, net of an allowance for uncollectible premiums. The Company regularly evaluates premium installment receivables and adjusts its valuation allowance as appropriate. The valuation allowance for uncollectible premium installment receivables was $77 million and $84 million as of December 31, 2017 and 2016, respectively.
Traditional life insurance products consist principally of products with fixed and guaranteed premiums and benefits, primarily term and whole life insurance products. Voluntary accident and health insurance products are expected to remain in force for an extended period and therefore are primarily classified as long-duration contracts. Premiums from these products are recognized as revenue when due from policyholders. Benefits are reflected in contract benefits and recognized over the life of the policy in relation to premiums.
Immediate annuities with life contingencies, including certain structured settlement annuities, provide insurance protection over a period that extends beyond the period during which premiums are collected. Premiums from these products are recognized as revenue when received at the inception of the contract. Benefits and expenses are recognized in relation to premiums. Profits from these policies come primarily from investment income, which is recognized over the life of the contract.
Interest-sensitive life contracts, such as universal life and single premium life, are insurance contracts whose terms are not fixed and guaranteed. The terms that may be changed include premiums paid by the contractholder, interest credited to the contractholder account balance and contract charges assessed against the contractholder account balance. Premiums from these contracts are reported as contractholder fund deposits. Contract charges consist of fees assessed against the contractholder account balance for the cost of insurance (mortality risk), contract administration and surrender of the contract prior to contractually specified dates. These contract charges are recognized as revenue when assessed against the contractholder account balance. Contract benefits
include life-contingent benefit payments in excess of the contractholder account balance.
Contracts that do not subject the Company to significant risk arising from mortality or morbidity are referred to as investment contracts. Fixed annuities, including market value adjusted annuities, equity-indexed annuities and immediate annuities without life contingencies, and funding agreements (primarily backing medium-term notes) are considered investment contracts. Consideration received for such contracts is reported as contractholder fund deposits. Contract charges for investment contracts consist of fees assessed against the contractholder account balance for maintenance, administration and surrender of the contract prior to contractually specified dates, and are recognized when assessed against the contractholder account balance.
Interest credited to contractholder funds represents interest accrued or paid on interest-sensitive life and investment contracts. Crediting rates for certain fixed annuities and interest-sensitive life contracts are adjusted periodically by the Company to reflect current market conditions subject to contractually guaranteed minimum rates. Crediting rates for indexed life and annuities and indexed funding agreements are generally based on a specified interest rate index or an equity index, such as the Standard & Poor’s 500 Index (“S&P 500”). Interest credited also includes amortization of DSI expenses. DSI is amortized into interest credited using the same method used to amortize DAC.
Contract charges for variable life and variable annuity products consist of fees assessed against the contractholder account balances for contract maintenance, administration, mortality, expense and surrender of the contract prior to contractually specified dates. Contract benefits incurred for variable annuity products include guaranteed minimum death, income, withdrawal and accumulation benefits. Substantially all of the Company’s variable annuity business is ceded through reinsurance agreements and the contract charges and contract benefits related thereto are reported net of reinsurance ceded.
Deferred policy acquisition and sales inducement costs
Costs that are related directly to the successful acquisition of new or renewal insurance policies and investment contracts are deferred and recorded as DAC. These costs are principally agents’ and brokers’ remuneration, premium taxes and certain underwriting expenses. DSI costs, which are deferred and recorded as other assets, relate to sales inducements offered on sales to new customers, principally on fixed annuity and interest-sensitive life contracts. These sales inducements are primarily in the form of additional credits to the customer’s account balance or enhancements to interest credited for a specified period which are in excess of the rates currently being credited to similar contracts without sales inducements. DSI is amortized into income using the same methodology and assumptions as DAC and is included in interest credited to contractholder funds.
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All other acquisition costs are expensed as incurred and included in operating costs and expenses.
For property and casualty insurance, DAC is amortized into income as premiums are earned, typically over periods of six or twelve months for personal lines policies or generally one to five years for protection plans and other contracts (primarily related to finance and insurance products), and is included in amortization of deferred policy acquisition costs. DAC associated with property and casualty insurance is periodically reviewed for recoverability and adjusted if necessary. Future investment income is considered in determining the recoverability of DAC.
For traditional life and voluntary accident and health insurance, DAC is amortized over the premium paying period of the related policies in proportion to the estimated revenues on such business. Assumptions used in the amortization of DAC and reserve calculations are established at the time the policy is issued and are generally not revised during the life of the policy. Any deviations from projected business in force resulting from actual policy terminations differing from expected levels and any estimated premium deficiencies may result in a change to the rate of amortization in the period such events occur. Generally, the amortization periods for these policies approximates the estimated lives of the policies. The Company periodically reviews the recoverability of DAC for these policies using actual experience and current assumptions. Prior to fourth quarter 2017, the Company evaluated traditional life insurance products and immediate annuities with life contingencies on an aggregate basis. In conjunction with the segment changes in fourth quarter 2017, traditional life insurance products, immediate annuities with life contingencies, and voluntary accident and health insurance products are reviewed individually. If actual experience and current assumptions are adverse compared to the original assumptions and a premium deficiency is determined to exist, any remaining unamortized DAC balance would be expensed to the extent not recoverable and the establishment of a premium deficiency reserve may be required.
For interest-sensitive life insurance and fixed annuities, DAC and DSI are 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 the rate of customer surrenders, partial withdrawals and deaths generally results in the majority of the DAC being amortized during the surrender charge period, which is typically 10-20 years for interest-sensitive life and 5-10 years for fixed annuities. The rate of DAC and DSI amortization is reestimated and adjusted by a cumulative charge or credit to income 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. When DAC or DSI amortization or a component of gross profits for a quarterly period is potentially negative (which would result in an increase of the DAC or DSI balance) as a result of negative AGP, the specific facts and circumstances surrounding the potential negative amortization are considered to determine whether it is appropriate for recognition in the consolidated financial statements. Negative amortization is only recorded when the increased DAC or DSI balance is determined to be recoverable based on facts and circumstances. Recapitalization of DAC and DSI is limited to the originally deferred costs plus interest.
AGP and EGP primarily consist of the following components: contract charges for the cost of insurance less mortality costs and other benefits; investment income and realized capital gains and losses less interest credited; and surrender and other contract charges less maintenance expenses. The principal assumptions for determining the amount of EGP are mortality, persistency, expenses, investment returns, including capital gains and losses on assets supporting contract liabilities, interest crediting rates to contractholders, and the effects of any hedges. For products whose supporting investments are exposed to capital losses in excess of the Company’s expectations which may cause periodic AGP to become temporarily negative, EGP and AGP utilized in DAC and DSI amortization may be modified to exclude the excess capital losses.
The Company performs quarterly reviews of DAC and DSI recoverability for interest-sensitive life and fixed annuity contracts using current assumptions. If a change in the amount of EGP is significant, it could result in the unamortized DAC or DSI not being recoverable, resulting in a charge which is included as a component of amortization of deferred policy acquisition costs or interest credited to contractholder funds, respectively.
The DAC and DSI balances presented include adjustments to reflect the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized capital gains or losses in the respective product investment portfolios were actually realized. The adjustments are recorded net of tax in AOCI. DAC, DSI and deferred income taxes determined on unrealized capital gains and losses and reported in AOCI recognize the impact on shareholders’ equity consistently with the amounts that would be recognized in the income statement on realized capital gains and losses.
Customers of the Company may exchange one insurance policy or investment contract for another offered by the Company, or make modifications to an existing investment, life or property and casualty contract issued by the Company. These transactions are identified as internal replacements for accounting purposes. Internal replacement transactions determined to result in replacement contracts that are substantially unchanged from the replaced contracts are accounted for as continuations of the replaced contracts. Unamortized DAC and DSI related to the
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replaced contracts continue to be deferred and amortized in connection with the replacement contracts. For interest-sensitive life and investment contracts, the EGP of the replacement contracts are treated as a revision to the EGP of the replaced contracts in the determination of amortization of DAC and DSI. For traditional life and property and casualty insurance policies, any changes to unamortized DAC that result from replacement contracts are treated as prospective revisions. Any costs associated with the issuance of replacement contracts are characterized as maintenance costs and expensed as incurred. Internal replacement transactions determined to result in a substantial change to the replaced contracts are accounted for as an extinguishment of the replaced contracts, and any unamortized DAC and DSI related to the replaced contracts are eliminated with a corresponding charge to amortization of deferred policy acquisition costs or interest credited to contractholder funds, respectively.
The costs assigned to the right to receive future cash flows from certain business purchased from other insurers are also classified as DAC in the Consolidated Statements of Financial Position. The costs capitalized represent the present value of future profits expected to be earned over the lives of the contracts acquired. These costs are amortized as profits emerge over the lives of the acquired business and are periodically evaluated for recoverability. The present value of future profits was $47 million and $53 million as of December 31, 2017 and 2016, respectively. Amortization expense of the present value of future profits was $6 million, $5 million and $8 million in 2017, 2016 and 2015, respectively.
Reinsurance
In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The Company has also used reinsurance to effect the disposition of certain blocks of business. The Company also participates in various reinsurance mechanisms, including industry pools and facilities, which are backed by the financial resources of the property and casualty insurance company market participants. The amounts reported as reinsurance recoverables include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities and contractholder funds that have not yet been paid. Reinsurance recoverables on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverables. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. For catastrophe coverage, the cost of reinsurance premiums is recognized ratably over the contract period to the extent coverage remains available. Reinsurance does not extinguish the Company’s primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers,
including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance as appropriate.
Goodwill
Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets acquired, less any impairment of goodwill recognized. The Company’s goodwill reporting units are equivalent to its reportable segments, Allstate Protection, Service Businesses, Allstate Life and Allstate Benefits to which goodwill has been assigned.
| Goodwill by reporting unit | ||||
| ($ in millions) | December 31, 2017 | |||
| Allstate Protection | $ | 810 | ||
| Service Businesses | 1,100 | |||
| Allstate Life | 175 | |||
| Allstate Benefits | 96 | |||
| Total | $ | 2,181 |
Goodwill is recognized when acquired and allocated to reporting units based on which unit is expected to benefit from the synergies of the business combination. Goodwill is not amortized but is tested for impairment at least annually. The Company performs its annual goodwill impairment testing during the fourth quarter of each year based upon data as of the close of the third quarter. The Company also reviews goodwill for impairment whenever events or changes in circumstances, such as deteriorating or adverse market conditions, indicate that it is more likely than not that the carrying amount of goodwill may exceed its implied fair value. The goodwill impairment analysis is performed at the reporting unit level.
In fourth quarter 2017, the Company adopted new reportable segments, which required the Company to evaluate goodwill, including the allocation of goodwill to any new reporting units on a relative fair value basis. The reallocation was computed using fair values for the goodwill reporting units determined using discounted cash flow (“DCF”) calculations and market to book multiples derived from a peer company analysis as described below. In conjunction with the reallocation of goodwill, the Company recognized $125 million of goodwill impairment related to the goodwill allocated to the Allstate Annuities reporting unit reflecting a market-based valuation. The fair value of the Company’s remaining goodwill reporting units exceeded their carrying values. To periodically estimate the fair value of its goodwill reporting units, the Company may utilize a combination of widely accepted valuation techniques including a stock price and market capitalization analysis, DCF calculations and market to book multiples derived from a peer company analysis. The stock price and market capitalization analysis takes into consideration the quoted market price of the Company’s outstanding common stock and includes a control premium, derived from relevant historical acquisition activity, in determining the estimated fair value of the consolidated entity before allocating that fair value to
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individual reporting units. The DCF analysis utilizes long term assumptions for revenues, investment income, benefits, claims, other operating expenses and income taxes to produce projections of both income and cash flows available for dividends that are present valued using weighted average cost of capital. Market to book multiples represent the mean market to book multiple for selected peer companies with operations similar to the Company’s goodwill reporting units to which the multiple is applied. The outputs from these methods are weighted based on the nature of the business and the relative amount of market observable assumptions supporting the estimates. The computed values are then weighted to reflect the fair value estimate based on the specific attributes of each goodwill reporting unit.
Property and equipment
Property and equipment is carried at cost less accumulated depreciation. Included in property and equipment are capitalized costs related to computer software licenses and software developed for internal use. These costs generally consist of certain external payroll and payroll related costs. Property and equipment depreciation is calculated using the straight-line method over the estimated useful lives of the assets, generally 3 to 10 years for equipment and 40 years for real property. Depreciation expense is reported in operating costs and expenses. Accumulated depreciation on property and equipment was $2.27 billion and $2.16 billion as of December 31, 2017 and 2016, respectively. Depreciation expense on property and equipment was $290 million, $267 million and $255 million in 2017, 2016 and 2015, respectively. The Company reviews its property and equipment for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Income taxes
The income tax provision is calculated under the liability method. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are DAC, unearned premiums, unrealized capital gains and losses and insurance reserves. A deferred tax asset valuation allowance is established when there is uncertainty that such assets will be realized.
Reserve for property and casualty insurance claims and claims expense
The reserve for property and casualty insurance claims and claims expense is the estimate of amounts necessary to settle all reported and unreported claims for the ultimate cost of insured property and casualty losses, based upon the facts of each case and the Company’s experience with similar cases. Estimated amounts of salvage and subrogation are deducted from the reserve for claims and claims expense. The establishment of appropriate reserves, including reserves for catastrophe losses, is an inherently uncertain and complex process. Reserve estimates are primarily derived using an actuarial estimation process
in which historical loss patterns are applied to actual paid losses and reported losses (paid losses plus individual case reserves established by claim adjusters) for an accident or report year to create an estimate of how losses are likely to develop over time. Development factors are calculated quarterly and periodically throughout the year for data elements such as claims reported and settled, paid losses, and paid losses combined with case reserves. The historical development patterns for these data elements are used as the assumptions to calculate reserve estimates, including the reserves for reported and unreported claims. Reserve estimates are regularly reviewed and updated, using the most current information available. Any resulting reestimates are reflected in current results of operations.
Reserve for life-contingent contract benefits
The reserve for life-contingent contract benefits payable under insurance policies, including traditional life insurance, life-contingent immediate annuities and voluntary accident and health insurance products, is computed on the basis of long-term actuarial assumptions of future investment yields, mortality, morbidity, policy terminations and expenses. These assumptions, which for traditional life insurance are applied using the net level premium method, include provisions for adverse deviation and generally vary by characteristics such as type of coverage, year of issue and policy duration. The assumptions are established at the time the policy is issued and are generally not changed during the life of the policy. The Company periodically reviews the adequacy of reserves for these policies using actual experience and current assumptions. If actual experience and current assumptions are adverse compared to the original assumptions and a premium deficiency is determined to exist, any remaining unamortized DAC balance would be expensed to the extent not recoverable and the establishment of a premium deficiency reserve may be required. Prior to fourth quarter 2017, the Company evaluated traditional life insurance products and immediate annuities with life contingencies on an aggregate basis. In conjunction with the Company’s segment changes in fourth quarter 2017, traditional life insurance products, immediate annuities with life contingencies, and voluntary accident and health insurance are reviewed individually. The Company also reviews these policies for circumstances where projected profits would be recognized in early years followed by projected losses in later years. If this circumstance exists, the Company will accrue a liability, during the period of profits, to offset the losses at such time as the future losses are expected to commence using a method updated prospectively over time. To the extent that unrealized gains on fixed income securities would result in a premium deficiency if those gains were realized, the related increase in reserves for certain immediate annuities with life contingencies is recorded net of tax as a reduction of unrealized net capital gains included in AOCI.
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Contractholder funds
Contractholder funds represent interest-bearing liabilities arising from the sale of products such as interest-sensitive life insurance, fixed annuities and funding agreements. Contractholder funds primarily comprise cumulative deposits received and interest credited to the contractholder less cumulative contract benefits, surrenders, withdrawals, maturities and contract charges for mortality or administrative expenses. Contractholder funds also include reserves for secondary guarantees on interest-sensitive life insurance and certain fixed annuity contracts and reserves for certain guarantees on reinsured variable annuity contracts.
Separate accounts
Separate accounts assets are carried at fair value. The assets of the separate accounts are legally segregated and available only to settle separate accounts contract obligations. Separate accounts liabilities represent the contractholders’ claims to the related assets and are carried at an amount equal to the separate accounts assets. Investment income and realized capital gains and losses of the separate accounts accrue directly to the contractholders and therefore are not included in the Company’s Consolidated Statements of Operations. Deposits to and surrenders and withdrawals from the separate accounts are reflected in separate accounts liabilities and are not included in consolidated cash flows.
Absent any contract provision wherein the Company provides a guarantee, variable annuity and variable life insurance contractholders bear the investment risk that the separate accounts’ funds may not meet their stated investment objectives. Substantially all of the Company’s variable annuity business was reinsured beginning in 2006.
Legal contingencies
The Company reviews its lawsuits, regulatory inquiries, and other legal proceedings on an ongoing basis. The Company establishes accruals for such matters at management’s best estimate when the Company assesses that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company’s assessment of whether a loss is reasonably possible or probable is based on its assessment of the ultimate outcome of the matter following all appeals. The Company does not include potential recoveries in its estimates of reasonably possible or probable losses. Legal fees are expensed as incurred.
Long-term debt
Long-term debt includes senior notes, senior debentures, subordinated debentures and junior subordinated debentures issued by the Corporation. Unamortized debt issuance costs are reported in long-term debt and are amortized over the expected period the debt will remain outstanding.
Deferred Employee Stock Ownership Plan (“ESOP”) expense
Deferred ESOP expense represents the remaining unrecognized cost of shares acquired by the Allstate ESOP to pre-fund a portion of the Company’s contribution to the Allstate 401(k) Savings Plan.
Equity incentive plans
The Company has equity incentive plans under which the Company grants nonqualified stock options, restricted stock units and performance stock awards (“equity awards”) to certain employees and directors of the Company. The Company measures the fair value of equity awards at the award date and recognizes the expense over the shorter of the period in which the requisite service is rendered or retirement eligibility is attained. The expense for performance stock awards is adjusted each period to reflect the performance factor most likely to be achieved at the end of the performance period. The Company uses a binomial lattice model to determine the fair value of employee stock options.
Off-balance sheet financial instruments
Commitments to invest, commitments to purchase private placement securities, commitments to extend loans, financial guarantees and credit guarantees have off-balance sheet risk because their contractual amounts are not recorded in the Company’s Consolidated Statements of Financial Position (see Notes 7 and 14).
Consolidation of variable interest entities (“VIEs”)
The Company consolidates VIEs when it is the primary beneficiary. A primary beneficiary is the variable interest holder in a VIE with both the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE.
Foreign currency translation
The local currency of the Company’s foreign subsidiaries is deemed to be the functional currency of the country in which these subsidiaries operate. The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect at the end of a reporting period for assets and liabilities and at average exchange rates during the period for results of operations. The unrealized gains and losses from the translation of the net assets are recorded as unrealized foreign currency translation adjustments and included in AOCI. Changes in unrealized foreign currency translation adjustments are included in other comprehensive income. Gains and losses from foreign currency transactions are reported in operating costs and expenses and have not been material.
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Earnings per common share
Basic earnings per common share is computed using the weighted average number of common shares outstanding, including vested unissued participating restricted stock units. Diluted earnings per common share is computed using the weighted average number of common and dilutive potential common shares outstanding. For the Company, dilutive potential common shares consist of outstanding stock options and unvested non-participating restricted stock units and contingently issuable performance stock awards.
| Computation of basic and diluted earnings per common share | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions, except per share data) | 2017 | 2016 | 2015 | |||||||||
| Numerator: | ||||||||||||
| Net income | $ | 3,189 | $ | 1,877 | $ | 2,171 | ||||||
| Less: Preferred stock dividends | 116 | 116 | 116 | |||||||||
| Net income applicable to common shareholders (1) | $ | 3,073 | $ | 1,761 | $ | 2,055 | ||||||
| Denominator: | ||||||||||||
| Weighted average common shares outstanding | 362.0 | 372.8 | 401.1 | |||||||||
| Effect of dilutive potential common shares: | ||||||||||||
| Stock options | 4.3 | 3.2 | 4.0 | |||||||||
| Restricted stock units (non-participating) and performance stock awards | 1.5 | 1.3 | 1.7 | |||||||||
| Weighted average common and dilutive potential common shares outstanding | 367.8 | 377.3 | 406.8 | |||||||||
| Earnings per common share – Basic | $ | 8.49 | $ | 4.72 | $ | 5.12 | ||||||
| Earnings per common share – Diluted | $ | 8.36 | $ | 4.67 | $ | 5.05 |
| (1) | Net income applicable to common shareholders is net income less preferred stock dividends. |
The effect of dilutive potential common shares does not include the effect of options with an anti-dilutive effect on earnings per common share because their exercise prices exceed the average market price of Allstate common shares during the period or for which the unrecognized compensation cost would have an anti-dilutive effect. Options to purchase 1.5 million, 3.8 million and 2.2 million Allstate common shares, with exercise prices ranging from $70.71 to $102.84, $53.91 to $71.29 and $57.98 to $71.29, were outstanding in 2017, 2016 and 2015, respectively, but were not included in the computation of diluted earnings per common share in those years.
Adopted accounting standards
Employee Share-Based Payment Accounting
Effective January 1, 2017, the Company adopted new Financial Accounting Standards Board (“FASB”) guidance that amends the accounting for share-based payments on a prospective basis. Under the new guidance, reporting entities are required to recognize all tax effects related to share-based payments at settlement or expiration through the income statement and the requirement to delay recognition of certain tax benefits until they reduce current taxes payable is eliminated. The new guidance also permits employers to withhold shares issued in connection with an employee’s exercise of options or the settlement of stock awards, up to the employee’s maximum individual statutory tax rate, to meet tax withholding requirements without causing liability classification of the award. In addition, all tax-related cash flows resulting from share-based payments are reported as operating activities on the statement of cash flows whereas cash payments made to taxing authorities on
an employee’s behalf for withheld shares are presented as financing activities. The adoption of this guidance had no impact on the Company’s results of operations or financial position on the date of adoption, but resulted in a $63 million benefit to net income applicable to common shareholders in 2017.
Transition to Equity Method Accounting
Effective January 1, 2017, the Company adopted new FASB guidance amending the accounting requirements for transitioning to the equity method of accounting (“EMA”), including a transition from the cost method. The guidance requires the cost of acquiring an additional interest in an investee to be added to the existing carrying value to establish the initial basis of the EMA investment. Under the new guidance, no retroactive adjustment is required when an investment initially qualifies for EMA treatment. The guidance is applied prospectively to investments that qualify for EMA after application of the cost method of accounting. Accordingly, the adoption of this guidance had no impact on the Company’s results of operations or financial position.
Application of Income Tax Guidance to Certain U.S. Tax Reform Provisions
In February 2018, the FASB issued guidance permitting reclassification of the effects of the new corporate tax rate in the Tax Cuts and Jobs Act of 2017 (“Tax Legislation”) on balances presented net of tax in AOCI. Upon enactment of the Tax Legislation in December 2017, existing accounting guidance required the revaluation of all deferred tax balances to the newly enacted tax rate by adjustment to income tax expense whereas a corresponding adjustment of the
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balances presented in AOCI was prohibited. The new guidance permits reclassification of the impact of the newly enacted tax rates in the Tax Legislation on balances presented net of tax in AOCI to retained income. The guidance, which may be adopted for any period for which financial statements have not yet been issued, is effective for fiscal years beginning after December 15, 2018, and may be applied retrospectively to the date of enactment or the beginning of a reporting period. The Company elected to early adopt the new guidance as of December 31, 2017. Upon adoption of the guidance, amounts are recognized after-tax in AOCI using the newly established 21% corporate income tax rate. The net impact of adoption was a $49 million increase in AOCI and a corresponding decrease in retained income. The $49 million increase in AOCI is comprised of a $290 million increase in unrealized net capital gains and losses, a $6 million decrease in unrealized foreign currency translation adjustment and a $235 million decrease in unrecognized pension and other postretirement benefit cost.
Pending accounting standards
Revenue from Contracts with Customers
In May 2014, the FASB issued guidance which revises the criteria for revenue recognition. Insurance contracts are excluded from the scope of the new guidance. Under the guidance, the transaction price is attributed to underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. Incremental costs of obtaining a contract may be capitalized to the extent the entity expects to recover those costs. The guidance is effective for reporting periods beginning after December 15, 2017 and is to be applied either on a full or modified retrospective basis.
The Company will apply the modified retrospective approach as of January 1, 2018, which results in the recognition of a cumulative effect of adoption as an adjustment to the beginning balance of retained income at the date of initial application. The Company’s principal activities impacted by the standard are those related to the issuance of protection plans for consumer products and automobiles and service contracts that provide roadside assistance. The impacts include an increase in deferred revenue with a corresponding increase in deferred costs for protection plans that are sold directly to retailers for which Allstate is deemed to be the principal in the transaction. The anticipated impacts of these adjustments offset and will not impact net income, but result in an increase in unearned premiums and deferred policy acquisition costs of approximately $160 million, pre-tax. The Company expects to recognize a cumulative effect adjustment related to the accounting for variable consideration, the deferral of certain costs associated with acquiring service contracts that provide roadside assistance, and other items, the net impact of which is not expected to materially reduce shareholders’ equity at the date of adoption. Based on the Company’s assessment, the total impact of adoption will not be
material to the Company’s results of operations or financial position.
Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued guidance requiring equity investments, including equity securities and limited partnership interests that are not accounted for under the equity method of accounting or result in consolidation to be measured at fair value with changes in fair value recognized in net income. Equity investments without readily determinable fair values may be measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. When a qualitative assessment of equity investments without readily determinable fair values indicates that an impairment exists, the carrying value is required to be adjusted to fair value, if lower. The guidance clarifies that an entity should evaluate the realizability of a deferred tax asset related to available-for-sale fixed income securities in combination with the entity’s other deferred tax assets. The guidance also changes certain disclosure requirements. The guidance is effective for interim and annual periods beginning after December 15, 2017, and is to be applied through a cumulative-effect adjustment to beginning retained income which results in no impact to the Company’s results of operations at the date of adoption.
The new guidance related to equity investments without readily determinable fair values is applied prospectively as of the date of adoption. The most significant impacts relate to the change in accounting for equity securities, where $1.16 billion of pre-tax unrealized net capital gains will be reclassified on January 1, 2018 from AOCI to retained income and cost method limited partnership interests (excluding limited partnership interests accounted for on a cost recovery basis) where the carrying value of these investments will increase by approximately $224 million, pre-tax on January 1, 2018, with the offsetting after-tax adjustment recognized in retained income. The after-tax change in accounting for equity securities will not affect the Company’s shareholders’ equity and the unrealized net capital gains reclassified to retained income will never be recognized in net income. The after-tax change in accounting for cost method limited partnerships will increase the Company’s shareholders’ equity, while also decreasing net income return on shareholders’ equity. The amount by which the fair value of cost method limited partnerships exceeds their carrying value will never be recognized in net income, negatively impacting the calculations of returns on equity.
Accounting for Leases
In February 2016, the FASB issued guidance revising the accounting for leases. Under the new guidance, lessees will be required to recognize a right-of-use asset and lease liability for all leases other than those that meet the definition of a short-term lease. The lease liability will be equal to the present value of lease payments. A right-of-use asset will be based on
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the lease liability adjusted for qualifying initial direct costs. Recognition of the lease liability and right-of-use asset will result in an increase in total assets and liabilities in the Consolidated Statement of Financial Position. The expense of operating leases under the new guidance will be recognized in the income statement on a straight-line basis after combining the lease expense components (interest expense on the lease liability and amortization of the right-of-use asset) over the term of the lease. For finance leases, the expense components are computed separately and produce greater up-front expense compared to operating leases as interest expense on the lease liability is higher in early years and the right-of-use asset is amortized on a straight-line basis. Lease classification will be based on criteria similar to those currently applied. The accounting model for lessors will be similar to the current model with modifications to reflect definition changes for components such as initial direct costs. Lessors will continue to classify leases as operating, direct financing, or sales-type. The guidance is effective for reporting periods beginning after December 15, 2018 using a modified retrospective approach applied at the beginning of the earliest period presented. The FASB has exposed for comment an optional simplified transition approach that would allow application of the transition provisions at the effective date instead of the earliest date presented. The Company is in the process of evaluating the impact of adoption, which is not expected to be material to the Company’s results of operations or financial position.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued guidance which revises the credit loss recognition criteria for certain financial assets measured at amortized cost, including reinsurance recoverables. The new guidance replaces the existing incurred loss recognition model with an expected loss recognition model. The objective of the expected credit loss model is for the reporting entity to recognize its estimate of expected credit losses for affected financial assets in a valuation allowance deducted from the amortized cost basis of the related financial assets that results in presenting the net carrying value of the financial assets at the amount expected to be collected. The reporting entity must consider all relevant information available when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts over the life of an asset. Financial assets may be evaluated individually or on a pooled basis when they share similar risk characteristics. The measurement of credit losses for available-for-sale debt securities measured at fair value is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the carrying value adjustment is recognized through a valuation allowance and not as a direct write-down. The guidance is effective for interim and annual periods beginning after December 15, 2019, and for most affected instruments must be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to beginning
retained income. The Company is in the process of evaluating the impact of adoption.
Goodwill Impairment
In January 2017, the FASB issued guidance to simplify the accounting for goodwill impairment which removes the second step of the goodwill impairment test that requires a hypothetical purchase price allocation. Under the new guidance, goodwill impairment will be measured and recognized as the amount by which a reporting unit’s carrying value, including goodwill, exceeds its fair value, not to exceed the carrying amount of goodwill allocated to the reporting unit. The revised guidance does not affect a reporting entity’s ability to first assess qualitative factors by reporting unit to determine whether to perform the quantitative goodwill impairment test. The guidance is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. The guidance is to be applied on a prospective basis, with the effects, if any, recognized in net income in the period of adoption. The impact to the Company upon adoption is dependent upon the excess, if any, of carrying value of the Company’s reporting units, including goodwill, over their respective fair values, a measure that is not currently determinable.
Presentation of Net Periodic Pension and Postretirement Benefits Costs
In March 2017, the FASB issued guidance to improve the presentation of net periodic pension and postretirement benefits costs that requires the service cost component to be reported in operating expenses together with other employee compensation costs and all other components of net periodic pension and postretirement benefits costs reported in non-operating expenses. If the reporting entity does not separately report operating and non-operating expenses on the statement of operations it is required to identify, on the statement of operations or in disclosures, the line items in which the components of net periodic pension and postretirement benefits costs are presented. The new guidance permits only the service cost component to be eligible for capitalization where applicable. The guidance is effective for annual periods beginning after December 15, 2017 and for interim periods within those annual periods. The guidance is to be applied on a prospective basis for capitalization of service costs where applicable and on a retrospective basis for the presentation of the service cost and other components of net periodic pension benefit costs in the statements of operations or in disclosures. The impact of adoption is not expected to be material to the Company’s results of operations or financial position.
Accounting for Hedging Activities
In August 2017, the FASB issued amendments intended to better align hedge accounting with an organization’s risk management activities. The amendments expand hedge accounting for nonfinancial and financial risk components and revise the measurement methodologies to better align with an organization’s risk management activities. Separate
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Notes to Consolidated Financial Statements 2017 Form 10-K
presentation of hedge ineffectiveness is eliminated to provide greater transparency of the full impact of hedging by requiring presentation of the results of the hedged item and hedging instrument in a single financial statement line item. In addition, the amendments reduce complexity by simplifying the manner in which assessments of hedge effectiveness may be performed. The guidance is effective for
annual periods beginning after December 15, 2018 and for interim periods within those annual periods. The presentation and disclosure guidance is effective on a prospective basis. The impact of adoption is not expected to be material to the Company’s results of operations or financial position.
| Note 3 | Acquisition |
On January 3, 2017, the Company acquired SquareTrade Holding Company, Inc. (“SquareTrade”), a consumer product protection plan provider that distributes through many of America’s major retailers and Europe’s mobile operators, for $1.4 billion in cash. SquareTrade is a provider of consumer electronics and appliance protection plans, covering products including TVs, smartphones and computers. This acquisition broadens Allstate’s unique product offerings to better meet consumers’ needs.
In connection with the acquisition, the Company recorded goodwill of $1.09 billion, commissions paid to retailers (reported in deferred policy acquisition costs) of $66 million, other intangible assets (reported in other assets) of $555 million, contractual liability insurance policy premium expenses (reported in other assets) of $205 million, unearned premiums of $389 million, and net deferred income tax liability of $138 million. These amounts reflect re-measurement adjustments to the fair value of the opening balance sheet assets and liabilities.
Of the $555 million assigned to other intangible assets, $465 million is attributable to acquired customer relationships. The value of the customer
relationships intangible asset was determined using an income approach that considered cash flows and profits expected to be generated by the acquired relationships, a discount rate reflecting the relative risk of achieving the anticipated cash flows and profits and the time value of money, and other factors. The estimated useful life of the customer relationship intangible asset is 10 years. The $555 million assigned to other intangible assets also included $69 million assigned to the SquareTrade trade name which is considered to have an indefinite useful life. The amortization expense of intangible assets in 2017 was $92 million.
| Amortization expense of intangible assets for the next five years and thereafter | ||||
| ($ in millions) | ||||
| 2018 | $ | 82 | ||
| 2019 | 72 | |||
| 2020 | 62 | |||
| 2021 | 52 | |||
| 2022 | 42 | |||
| Thereafter | 84 | |||
| Total amortization | $ | 394 |
| Note 4 | Reportable Segments |
Beginning in fourth quarter 2017, the Company’s chief operating decision maker reviews financial performance and makes decisions about the allocation of resources based on the following seven reportable segments: Allstate Protection, Discontinued Lines and Coverages, Service Businesses, Allstate Life, Allstate Benefits, Allstate Annuities, and Corporate and Other. These segments are described below and align with the Company’s key product and service offerings, including the acquisition of SquareTrade and the strategic focus and expansion of Arity and other service businesses.
Allstate Protection principally offers private passenger auto and homeowners insurance in the United States and Canada, with earned premiums accounting for 82% of Allstate’s 2017 consolidated revenues. Allstate Protection is authorized to sell certain property and casualty products in all 50 states, the District of Columbia, Puerto Rico and Canada. For 2017, the top U.S. geographic locations for premiums earned by the Allstate Protection segment were Texas, California, New York and Florida. No other jurisdiction accounted for more than 5% of premium earned for Allstate Protection. Revenues from external customers generated outside the United States were $1.11 billion,
$1.06 billion and $1.03 billion in 2017, 2016 and 2015, respectively.
Discontinued Lines and Coverages includes property and casualty insurance coverage that primarily relates to policies written during the 1960s through the mid-1980s. Our exposure to asbestos, environmental and other discontinued lines claims arises principally from direct excess commercial insurance, assumed reinsurance coverage, direct primary commercial insurance and other businesses in run-off.
Service Businesses comprise SquareTrade, Arity, Allstate Roadside Services and Allstate Dealer Services and offer consumer product protection plans, device and mobile data collection services and analytic solutions, roadside assistance, and finance and insurance products (including vehicle service contracts, guaranteed asset protection waivers, road hazard tire and wheel and paintless dent repair protection). The Service Businesses primarily operate in the U.S., with certain businesses offering services in Europe, Canada and Puerto Rico. Revenues from external customers generated outside the United States relate to consumer product protection plans sold primarily in the European Union and were $35 million in 2017.
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2017 Form 10-K Notes to Consolidated Financial Statements
Allstate Life offers traditional, interest-sensitive and variable life insurance products. Allstate Life is authorized to sell life insurance products in all 50 states, the District of Columbia and Puerto Rico. For 2017, the top geographic locations for statutory direct life insurance premiums were New York, California, Texas, Florida and Illinois. No other jurisdiction accounted for more than 5% of statutory direct life insurance premiums.
Allstate Benefits offers voluntary benefits products, including life, accident, critical illness, short-term disability and other health products. Allstate Benefits is authorized to sell its products in all 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam and Canada. For 2017, the top geographic locations for statutory direct accident and health insurance premiums were Florida, Texas, North Carolina and Georgia. No other jurisdiction accounted for more than 5% of statutory direct accident and health insurance premiums. Revenues from external customers generated outside the United States relate to voluntary accident and health insurance sold in Canada and were not material.
Allstate Annuities consists of deferred fixed annuities and immediate annuities (including standard and sub-standard structured settlements). This segment is in run-off. The Company also previously offered institutional products consisting of funding agreements sold to unaffiliated trusts that used them to back medium-term notes. There were no institutional products outstanding as of December 31, 2017 or 2016.
Corporate and Other comprises holding company activities and certain non-insurance operations.
Allstate Protection and Discontinued Lines and Coverages segments comprise Property-Liability. The Company does not allocate investment income, realized capital gains and losses, or assets to the Allstate Protection and Discontinued Lines and Coverages segments. Management reviews assets at the Property-Liability, Service Businesses, Allstate Life, Allstate Benefits, Allstate Annuities, and Corporate and Other levels for decision-making purposes.
The accounting policies of the reportable segments are the same as those described in Note 2.
The effects of intersegment transactions are eliminated in the segment results, except for services provided by the Service Businesses to Allstate Protection that are not eliminated as management considers those transactions in assessing the results of the respective segments.
Measuring segment profit or loss
The measure of segment profit or loss used in evaluating performance is underwriting income for the Allstate Protection and Discontinued Lines and Coverages segments and adjusted net income for the Service Businesses, Allstate Life, Allstate Benefits, Allstate Annuities, and Corporate and Other segments. A reconciliation of these measures to net income applicable to common shareholders is provided below.
Underwriting income is calculated as premiums earned, less claims and claims expenses (“losses”), amortization of DAC, operating costs and expenses, and restructuring and related charges as determined using GAAP.
Adjusted net income is net income applicable to common shareholders, excluding:
| • Realized capital gains and losses, after-tax, except for periodic settlements and accruals on non-hedge derivative instruments, which are reported with realized capital gains and losses but included in adjusted net income |
| • Valuation changes on embedded derivatives not hedged, after-tax |
| • Amortization of DAC and DSI, to the extent they resulted from the recognition of certain realized capital gains and losses or valuation changes on embedded derivatives not hedged, after-tax |
| • Business combination expenses and the amortization of purchased intangible assets, after-tax |
| • Gain (loss) on disposition of operations, after-tax |
| • Adjustments for other significant non-recurring, infrequent or unusual items, when (a) the nature of the charge or gain is such that it is reasonably unlikely to recur within two years, or (b) there has been no similar charge or gain within the prior two years |
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Notes to Consolidated Financial Statements 2017 Form 10-K
| Reportable segments revenue information | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Property-Liability | ||||||||||||
| Insurance premiums | ||||||||||||
| Auto | $ | 21,878 | $ | 21,264 | $ | 20,410 | ||||||
| Homeowners | 7,310 | 7,257 | 7,136 | |||||||||
| Other personal lines | 1,750 | 1,700 | 1,692 | |||||||||
| Commercial lines | 495 | 506 | 510 | |||||||||
| Allstate Protection | 31,433 | 30,727 | 29,748 | |||||||||
| Discontinued Lines and Coverages | — | — | — | |||||||||
| Total property-liability insurance premiums | 31,433 | 30,727 | 29,748 | |||||||||
| Net investment income | 1,478 | 1,253 | 1,226 | |||||||||
| Realized capital gains and losses | 401 | (6 | ) | (237 | ) | |||||||
| Total Property-Liability | 33,312 | 31,974 | 30,737 | |||||||||
| Service Businesses | ||||||||||||
| Consumer product protection plans | 295 | — | — | |||||||||
| Roadside assistance | 268 | 310 | 340 | |||||||||
| Finance and insurance products | 304 | 270 | 221 | |||||||||
| Intersegment premiums and service fees (1) | 110 | 105 | 42 | |||||||||
| Net investment income | 16 | 13 | 11 | |||||||||
| Total Service Businesses | 993 | 698 | 614 | |||||||||
| Allstate Life | ||||||||||||
| Traditional life insurance premiums | 568 | 533 | 505 | |||||||||
| Accident and health insurance premiums | 2 | 2 | 2 | |||||||||
| Interest-sensitive life insurance contract charges | 710 | 715 | 716 | |||||||||
| Net investment income | 489 | 482 | 490 | |||||||||
| Realized capital gains and losses | 5 | (38 | ) | 2 | ||||||||
| Total Allstate Life | 1,774 | 1,694 | 1,715 | |||||||||
| Allstate Benefits | ||||||||||||
| Traditional life insurance premiums | 42 | 40 | 37 | |||||||||
| Accident and health insurance premiums | 928 | 857 | 778 | |||||||||
| Interest-sensitive life insurance contract charges | 114 | 114 | 106 | |||||||||
| Net investment income | 72 | 71 | 71 | |||||||||
| Realized capital gains and losses | 1 | (5 | ) | 1 | ||||||||
| Total Allstate Benefits | 1,157 | 1,077 | 993 | |||||||||
| Allstate Annuities | ||||||||||||
| Fixed annuities contract charges | 14 | 14 | 14 | |||||||||
| Net investment income | 1,305 | 1,181 | 1,323 | |||||||||
| Realized capital gains and losses | 44 | (38 | ) | 264 | ||||||||
| Total Allstate Annuities | 1,363 | 1,157 | 1,601 | |||||||||
| Corporate and Other | ||||||||||||
| Net investment income | 41 | 42 | 35 | |||||||||
| Realized capital gains and losses | (6 | ) | (3 | ) | — | |||||||
| Total Corporate and Other | 35 | 39 | 35 | |||||||||
| Intersegment eliminations (1) | (110 | ) | (105 | ) | (42 | ) | ||||||
| Consolidated revenues | $ | 38,524 | $ | 36,534 | $ | 35,653 |
(1) Intersegment insurance premiums and service fees are primarily related to Arity and Allstate Roadside Services and are eliminated in the consolidated financial statements.
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2017 Form 10-K Notes to Consolidated Financial Statements
| Reportable segments financial performance | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Property-Liability | ||||||||||||
| Allstate Protection | $ | 2,111 | $ | 1,327 | $ | 1,621 | ||||||
| Discontinued Lines and Coverages | (99 | ) | (107 | ) | (55 | ) | ||||||
| Total underwriting income | 2,012 | 1,220 | 1,566 | |||||||||
| Net investment income | 1,478 | 1,253 | 1,226 | |||||||||
| Income tax expense on operations | (1,119 | ) | (812 | ) | (922 | ) | ||||||
| Realized capital gains and losses, after-tax | 272 | — | (154 | ) | ||||||||
| Gain on disposition of operations, after-tax | 9 | — | — | |||||||||
| Change in accounting for investments in qualified affordable housing projects | — | — | (28 | ) | ||||||||
| Tax Legislation expense | (65 | ) | — | — | ||||||||
| Property-Liability net income applicable to common shareholders | 2,587 | 1,661 | 1,688 | |||||||||
| Service Businesses | ||||||||||||
| Adjusted net (loss) income | (59 | ) | 3 | 2 | ||||||||
| Amortization of purchased intangible assets, after-tax | (60 | ) | — | — | ||||||||
| Tax Legislation benefit | 134 | — | — | |||||||||
| Service Businesses net income applicable to common shareholders | 15 | 3 | 2 | |||||||||
| Allstate Life | ||||||||||||
| Adjusted net income | 253 | 247 | 239 | |||||||||
| Realized capital gains and losses, after-tax | 2 | (24 | ) | 1 | ||||||||
| DAC and DSI amortization related to realized capital gains and losses, after-tax | (10 | ) | (4 | ) | (4 | ) | ||||||
| Loss on disposition of operations, after-tax | — | — | (1 | ) | ||||||||
| Change in accounting for investments in qualified affordable housing projects | — | — | (6 | ) | ||||||||
| Tax Legislation benefit | 332 | — | — | |||||||||
| Allstate Life net income applicable to common shareholders | 577 | 219 | 229 | |||||||||
| Allstate Benefits | ||||||||||||
| Adjusted net income | 95 | 100 | 104 | |||||||||
| Realized capital gains and losses, after-tax | — | (4 | ) | — | ||||||||
| Tax Legislation benefit | 51 | — | — | |||||||||
| Allstate Benefits net income applicable to common shareholders | 146 | 96 | 104 | |||||||||
| Allstate Annuities | ||||||||||||
| Adjusted net income | 204 | 101 | 166 | |||||||||
| Realized capital gains and losses, after-tax | 28 | (26 | ) | 172 | ||||||||
| Valuation changes on embedded derivatives not hedged, after-tax | — | (2 | ) | (1 | ) | |||||||
| DAC and DSI amortization related to realized capital gains and losses and valuation changes on embedded derivatives not hedged, after-tax | — | — | 1 | |||||||||
| Gain on disposition of operations, after-tax | 4 | 3 | 3 | |||||||||
| Change in accounting for investments in qualified affordable housing projects | — | — | (11 | ) | ||||||||
| Tax Legislation benefit | 182 | — | — | |||||||||
| Allstate Annuities net income applicable to common shareholders | 418 | 76 | 330 | |||||||||
| Corporate and Other | ||||||||||||
| Adjusted net loss | (399 | ) | (292 | ) | (298 | ) | ||||||
| Realized capital gains and losses, after-tax | (4 | ) | (2 | ) | — | |||||||
| Goodwill impairment | (125 | ) | — | — | ||||||||
| Business combination expenses, after-tax | (14 | ) | — | — | ||||||||
| Tax Legislation expense | (128 | ) | — | — | ||||||||
| Corporate and Other net loss applicable to common shareholders | (670 | ) | (294 | ) | (298 | ) | ||||||
| Consolidated net income applicable to common shareholders | $ | 3,073 | $ | 1,761 | $ | 2,055 |
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| Additional significant financial performance data | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Amortization of DAC | ||||||||||||
| Property-Liability | $ | 4,205 | $ | 4,053 | $ | 3,933 | ||||||
| Service Businesses | 296 | 214 | 169 | |||||||||
| Allstate Life | 134 | 131 | 133 | |||||||||
| Allstate Benefits | 142 | 145 | 124 | |||||||||
| Allstate Annuities | 7 | 7 | 5 | |||||||||
| Consolidated | $ | 4,784 | $ | 4,550 | $ | 4,364 | ||||||
| | | | | |||||||||
| Income tax expense (benefit) | ||||||||||||
| Property-Liability | $ | 1,318 | $ | 806 | $ | 867 | ||||||
| Service Businesses | (193 | ) | — | 2 | ||||||||
| Allstate Life | (224 | ) | 91 | 108 | ||||||||
| Allstate Benefits | 1 | 51 | 55 | |||||||||
| Allstate Annuities | (58 | ) | 36 | 188 | ||||||||
| Corporate and Other | (42 | ) | (107 | ) | (109 | ) | ||||||
| Consolidated | $ | 802 | $ | 877 | $ | 1,111 |
| Impacts of Tax Legislation | ||||||||||||
| For the year ended December 31, 2017 | ||||||||||||
| ($ in millions) | Income tax expense (benefit) before Tax Legislation | Tax Legislation expense (benefit) | Income tax expense (benefit) after Tax Legislation | |||||||||
| Income tax expense (benefit) | ||||||||||||
| Property-Liability | $ | 1,253 | $ | 65 | $ | 1,318 | ||||||
| Service Businesses | (59 | ) | (134 | ) | (193 | ) | ||||||
| Allstate Life | 108 | (332 | ) | (224 | ) | |||||||
| Allstate Benefits | 52 | (51 | ) | 1 | ||||||||
| Allstate Annuities | 124 | (182 | ) | (58 | ) | |||||||
| Corporate and Other | (170 | ) | 128 | (42 | ) | |||||||
| Consolidated | $ | 1,308 | $ | (506 | ) | $ | 802 |
Interest expense is primarily incurred in the Corporate and Other segment. Capital expenditures for long-lived assets are generally made in Property-Liability as the Company does not allocate assets to the Allstate Protection and Discontinued Lines and Coverages segments. A portion of these long-lived assets are used by entities included in the Service Businesses, Allstate Life, Allstate Benefits, Allstate Annuities and Corporate and Other segments and, accordingly, are charged to expenses in proportion to their use.
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2017 Form 10-K Notes to Consolidated Financial Statements
| Reportable segment total assets and investments as of December 31, 2017 (1) | ||||
| ($ in millions) | ||||
| Assets (2) | ||||
| Property-Liability | $ | 60,197 | ||
| Service Businesses | 4,531 | |||
| Allstate Life | 14,107 | |||
| Allstate Benefits | 2,766 | |||
| Allstate Annuities | 28,836 | |||
| Corporate and Other | 1,985 | |||
| Consolidated | $ | 112,422 | ||
| | | |||
| Investments (3) | ||||
| Property-Liability | $ | 43,183 | ||
| Service Businesses | 954 | |||
| Allstate Life | 11,210 | |||
| Allstate Benefits | 1,776 | |||
| Allstate Annuities | 23,722 | |||
| Corporate and Other | 1,958 | |||
| Consolidated | $ | 82,803 |
| (1) | The balances above reflect the elimination of related party investments between segments. |
| (2) | Due to the changes in reportable segments, prior year total assets are not available for the new segments as it was impracticable to calculate. Total assets for previously reported Property-Liability, Allstate Financial, and Corporate and Other segments were $60.39 billion, $45.95 billion and $2.27 billion as of December 31, 2016, respectively, and $55.67 billion, $46.34 billion and $2.64 billion as of December 31, 2015, respectively. |
| (3) | Due to the changes in reportable segments, prior year investments balances are not available for the new segments as it was impracticable to calculate. Total investments for previously reported Property-Liability, Allstate Financial, and Corporate and Other segments were $42.72 billion, $36.84 billion and $2.24 billion as of December 31, 2016, respectively, and $38.48 billion, $36.79 billion and $2.49 billion as of December 31, 2015, respectively. |
| Note 5 | Investments |
| Amortized cost, gross unrealized gains and losses and fair value for fixed income securities | ||||||||||||||||
| Amortized cost | Gross unrealized | Fair value | ||||||||||||||
| ($ in millions) | Gains | Losses | ||||||||||||||
| December 31, 2017 | ||||||||||||||||
| U.S. government and agencies | $ | 3,580 | $ | 56 | $ | (20 | ) | $ | 3,616 | |||||||
| Municipal | 8,053 | 311 | (36 | ) | 8,328 | |||||||||||
| Corporate | 42,996 | 1,234 | (204 | ) | 44,026 | |||||||||||
| Foreign government | 1,005 | 27 | (11 | ) | 1,021 | |||||||||||
| ABS | 1,266 | 13 | (7 | ) | 1,272 | |||||||||||
| RMBS | 480 | 101 | (3 | ) | 578 | |||||||||||
| CMBS | 124 | 6 | (2 | ) | 128 | |||||||||||
| Redeemable preferred stock | 21 | 2 | — | 23 | ||||||||||||
| Total fixed income securities | $ | 57,525 | $ | 1,750 | $ | (283 | ) | $ | 58,992 | |||||||
| December 31, 2016 | ||||||||||||||||
| U.S. government and agencies | $ | 3,572 | $ | 74 | $ | (9 | ) | $ | 3,637 | |||||||
| Municipal | 7,116 | 304 | (87 | ) | 7,333 | |||||||||||
| Corporate | 42,742 | 1,178 | (319 | ) | 43,601 | |||||||||||
| Foreign government | 1,043 | 36 | (4 | ) | 1,075 | |||||||||||
| ABS | 1,169 | 13 | (11 | ) | 1,171 | |||||||||||
| RMBS | 651 | 85 | (8 | ) | 728 | |||||||||||
| CMBS | 262 | 17 | (9 | ) | 270 | |||||||||||
| Redeemable preferred stock | 21 | 3 | — | 24 | ||||||||||||
| Total fixed income securities | $ | 56,576 | $ | 1,710 | $ | (447 | ) | $ | 57,839 |
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| Scheduled maturities for fixed Income securities | ||||||||
| As of December 31, 2017 | ||||||||
| ($ in millions) | Amortized cost | Fair value | ||||||
| Due in one year or less | $ | 4,771 | $ | 4,783 | ||||
| Due after one year through five years | 28,736 | 29,080 | ||||||
| Due after five years through ten years | 16,956 | 17,278 | ||||||
| Due after ten years | 5,192 | 5,873 | ||||||
| 55,655 | 57,014 | |||||||
| ABS, RMBS and CMBS | 1,870 | 1,978 | ||||||
| Total | $ | 57,525 | $ | 58,992 |
Actual maturities may differ from those scheduled as a result of calls and make-whole payments by the issuers. ABS, RMBS and CMBS are shown separately because of the potential for prepayment of principal prior to contractual maturity dates.
| Net investment income | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Fixed income securities | $ | 2,078 | $ | 2,060 | $ | 2,218 | ||||||
| Equity securities | 174 | 137 | 110 | |||||||||
| Mortgage loans | 206 | 217 | 228 | |||||||||
| Limited partnership interests | 889 | 561 | 549 | |||||||||
| Short-term investments | 30 | 16 | 9 | |||||||||
| Other | 236 | 222 | 192 | |||||||||
| Investment income, before expense | 3,613 | 3,213 | 3,306 | |||||||||
| Investment expense | (212 | ) | (171 | ) | (150 | ) | ||||||
| Net investment income | $ | 3,401 | $ | 3,042 | $ | 3,156 |
| Realized capital gains and losses by asset type | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Fixed income securities | $ | 94 | $ | (91 | ) | $ | 212 | |||||
| Equity securities | 255 | 23 | (50 | ) | ||||||||
| Mortgage loans | 1 | — | 6 | |||||||||
| Limited partnership interests | 132 | (21 | ) | (93 | ) | |||||||
| Derivatives | (46 | ) | 3 | (21 | ) | |||||||
| Other | 9 | (4 | ) | (24 | ) | |||||||
| Realized capital gains and losses | $ | 445 | $ | (90 | ) | $ | 30 |
| Realized capital gains and losses by transaction type | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Impairment write-downs | $ | (102 | ) | $ | (234 | ) | $ | (195 | ) | |||
| Change in intent write-downs | (48 | ) | (69 | ) | (221 | ) | ||||||
| Net other-than-temporary impairment losses recognized in earnings | (150 | ) | (303 | ) | (416 | ) | ||||||
| Sales and other | 641 | 213 | 470 | |||||||||
| Valuation and settlements of derivative instruments | (46 | ) | — | (24 | ) | |||||||
| Realized capital gains and losses | $ | 445 | $ | (90 | ) | $ | 30 |
Gross gains of $737 million, $631 million and $915 million and gross losses of $276 million, $461 million and $399 million were realized on sales of fixed income and equity securities during 2017, 2016 and 2015, respectively.
The Allstate Corporation 145
2017 Form 10-K Notes to Consolidated Financial Statements
| Other-than-temporary impairment losses by asset type | ||||||||||||||||||||||||||||||||||||
| For the years ended December 31, | ||||||||||||||||||||||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||||
| Gross | Included in OCI | Net | Gross | Included in OCI | Net | Gross | Included in OCI | Net | ||||||||||||||||||||||||||||
| Fixed income securities: | ||||||||||||||||||||||||||||||||||||
| Municipal | $ | (1 | ) | $ | (3 | ) | $ | (4 | ) | $ | — | $ | — | $ | — | $ | (17 | ) | $ | 4 | $ | (13 | ) | |||||||||||||
| Corporate | (9 | ) | 3 | (6 | ) | (33 | ) | 9 | (24 | ) | (61 | ) | 11 | (50 | ) | |||||||||||||||||||||
| ABS | (1 | ) | (2 | ) | (3 | ) | (6 | ) | — | (6 | ) | (33 | ) | 22 | (11 | ) | ||||||||||||||||||||
| RMBS | (2 | ) | (3 | ) | (5 | ) | — | (1 | ) | (1 | ) | 1 | (1 | ) | — | |||||||||||||||||||||
| CMBS | (9 | ) | 1 | (8 | ) | (15 | ) | 2 | (13 | ) | (1 | ) | — | (1 | ) | |||||||||||||||||||||
| Total fixed income securities | (22 | ) | (4 | ) | (26 | ) | (54 | ) | 10 | (44 | ) | (111 | ) | 36 | (75 | ) | ||||||||||||||||||||
| Equity securities | (86 | ) | — | (86 | ) | (194 | ) | — | (194 | ) | (279 | ) | — | (279 | ) | |||||||||||||||||||||
| Mortgage loans | (1 | ) | — | (1 | ) | — | — | — | 4 | — | 4 | |||||||||||||||||||||||||
| Limited partnership interests | (32 | ) | — | (32 | ) | (56 | ) | — | (56 | ) | (51 | ) | — | (51 | ) | |||||||||||||||||||||
| Other | (5 | ) | — | (5 | ) | (9 | ) | — | (9 | ) | (15 | ) | — | (15 | ) | |||||||||||||||||||||
| Other-than-temporary impairment losses | $ | (146 | ) | $ | (4 | ) | $ | (150 | ) | $ | (313 | ) | $ | 10 | $ | (303 | ) | $ | (452 | ) | $ | 36 | $ | (416 | ) |
| OTTI losses included in AOCI at the time of impairment for fixed income securities | ||||||||
| ($ in millions) | December 31, 2017 | December 31, 2016 | ||||||
| Municipal | $ | (5 | ) | $ | (8 | ) | ||
| Corporate | — | (7 | ) | |||||
| ABS | (15 | ) | (21 | ) | ||||
| RMBS | (77 | ) | (90 | ) | ||||
| CMBS | (4 | ) | (7 | ) | ||||
| Total | $ | (101 | ) | $ | (133 | ) |
The amounts exclude $208 million and $221 million as of December 31, 2017 and 2016, respectively, of net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.
| Rollforward of the cumulative credit losses recognized in earnings for fixed income securities held | ||||||||||||
| As of December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Beginning balance | $ | (318 | ) | $ | (392 | ) | $ | (380 | ) | |||
| Additional credit loss for securities previously other-than-temporarily impaired | (18 | ) | (21 | ) | (30 | ) | ||||||
| Additional credit loss for securities not previously other-than-temporarily impaired | (8 | ) | (23 | ) | (45 | ) | ||||||
| Reduction in credit loss for securities disposed or collected | 116 | 117 | 60 | |||||||||
| Change in credit loss due to accretion of increase in cash flows | 2 | 1 | 3 | |||||||||
| Ending balance | $ | (226 | ) | $ | (318 | ) | $ | (392 | ) |
The Company uses its best estimate of future cash flows expected to be collected from the fixed income security, discounted at the security’s original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, foreign exchange rates, the financial condition and future earnings potential of
the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration of underlying collateral, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate recovery value if the Company determines that the security is dependent on the liquidation of collateral for ultimate settlement. If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an other-than-temporary impairment for the difference between
146 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
the estimated recovery value and amortized cost is recorded in earnings. The portion of the unrealized loss related to factors other than credit remains classified in AOCI. If the Company determines that the fixed income security does not have sufficient cash
flow or other information to estimate a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.
| Unrealized net capital gains and losses included in AOCI | ||||||||||||||||
| ($ in millions) | Fair value | Gross unrealized | Unrealized net gains (losses) | |||||||||||||
| December 31, 2017 | Gains | Losses | ||||||||||||||
| Fixed income securities | $ | 58,992 | $ | 1,750 | $ | (283 | ) | $ | 1,467 | |||||||
| Equity securities (1) | 6,621 | 1,172 | (12 | ) | 1,160 | |||||||||||
| Short-term investments | 1,944 | — | — | — | ||||||||||||
| Derivative instruments (2) | 2 | 2 | (3 | ) | (1 | ) | ||||||||||
| EMA limited partnerships (3) | 1 | |||||||||||||||
| Unrealized net capital gains and losses, pre-tax | 2,627 | |||||||||||||||
| Amounts recognized for: | ||||||||||||||||
| Insurance reserves (4) | (315 | ) | ||||||||||||||
| DAC and DSI (5) | (196 | ) | ||||||||||||||
| Amounts recognized | (511 | ) | ||||||||||||||
| Deferred income taxes (6) | (454 | ) | ||||||||||||||
| Unrealized net capital gains and losses, after-tax | $ | 1,662 |
| (1) | Beginning January 1, 2018, due to the adoption of the new accounting standard for the recognition and measurement of financial assets and liabilities, equity securities will be measured at fair value with changes in fair value recognized in net income. The existing unrealized net capital gains and losses, after-tax, will be reclassified to retained income through a cumulative effect adjustment. See Note 2 for additional details on the new accounting standard. |
| (2) | Included in the fair value of derivative instruments is $2 million classified as liabilities. |
| (3) | Unrealized net capital gains and losses for limited partnership interests represent the Company’s share of EMA limited partnerships’ other comprehensive income. Fair value and gross unrealized gains and losses are not applicable. |
| (4) | The insurance reserves adjustment represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency. This adjustment primarily relates to structured settlement annuities with life contingencies (a type of immediate fixed annuities). |
| (5) | The DAC and DSI adjustment balance represents the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized gains or losses in the respective product portfolios were realized. |
| (6) | Unrealized net capital gains and losses were reduced by deferred income taxes at the newly enacted 21% U.S. corporate tax rate. |
| Unrealized net capital gains and losses included in AOCI | ||||||||||||||||
| ($ in millions) | Fair value | Gross unrealized | Unrealized net gains (losses) | |||||||||||||
| December 31, 2016 | Gains | Losses | ||||||||||||||
| Fixed income securities | $ | 57,839 | $ | 1,710 | $ | (447 | ) | $ | 1,263 | |||||||
| Equity securities | 5,666 | 594 | (85 | ) | 509 | |||||||||||
| Short-term investments | 4,288 | — | — | — | ||||||||||||
| Derivative instruments (1) | 5 | 5 | (3 | ) | 2 | |||||||||||
| EMA limited partnerships | (4 | ) | ||||||||||||||
| Unrealized net capital gains and losses, pre-tax | 1,770 | |||||||||||||||
| Amounts recognized for: | ||||||||||||||||
| Insurance reserves | — | |||||||||||||||
| DAC and DSI | (146 | ) | ||||||||||||||
| Amounts recognized | (146 | ) | ||||||||||||||
| Deferred income taxes (2) | (571 | ) | ||||||||||||||
| Unrealized net capital gains and losses, after-tax | $ | 1,053 |
| (1) | Included in the fair value of derivative instruments is $5 million classified as assets. |
| (2) | Unrealized net capital gains and losses were reduced by deferred income taxes at the 35% corporate tax rate. |
The Allstate Corporation 147
2017 Form 10-K Notes to Consolidated Financial Statements
| Change in unrealized net capital gains and losses | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Fixed income securities | $ | 204 | $ | 516 | $ | (2,021 | ) | |||||
| Equity securities | 651 | 233 | (136 | ) | ||||||||
| Derivative instruments | (3 | ) | (4 | ) | 8 | |||||||
| EMA limited partnerships | 5 | — | 1 | |||||||||
| Total | 857 | 745 | (2,148 | ) | ||||||||
| Amounts recognized for: | ||||||||||||
| Insurance reserves | (315 | ) | — | 28 | ||||||||
| DAC and DSI | (50 | ) | (79 | ) | 112 | |||||||
| Amounts recognized | (365 | ) | (79 | ) | 140 | |||||||
| Deferred income taxes | 117 | (233 | ) | 702 | ||||||||
| Increase (decrease) in unrealized net capital gains and losses, after-tax | $ | 609 | $ | 433 | $ | (1,306 | ) |
Portfolio monitoring
The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income and equity security whose carrying value may be other-than-temporarily impaired.
For each fixed income security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made the decision to sell or whether it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, the security’s decline in fair value is considered other than temporary and is recorded in earnings.
If the Company has not made the decision to sell the fixed income security and it is not more likely than not the Company will be required to sell the fixed income security before recovery of its amortized cost basis, the Company evaluates whether it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security. The Company calculates the estimated recovery value by discounting the best estimate of future cash flows at the security’s original or current effective rate, as appropriate, and compares this to the amortized cost of the security. If the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors recognized in other comprehensive income.
For equity securities, the Company considers various factors, including whether it has the intent and ability to hold the equity security for a period of time sufficient to recover its cost basis. Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended,
the equity security’s decline in fair value is considered other than temporary and is recorded in earnings.
For fixed income and equity securities managed by third parties, either the Company has contractually retained its decision making authority as it pertains to selling securities that are in an unrealized loss position or it recognizes any unrealized loss at the end of the period through a charge to earnings.
The Company’s portfolio monitoring process includes a quarterly review of all securities to identify instances where the fair value of a security compared to its amortized cost (for fixed income securities) or cost (for equity securities) is below established thresholds. The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and payment defaults. The securities identified, in addition to other securities for which the Company may have a concern, are evaluated for potential other-than-temporary impairment using all reasonably available information relevant to the collectability or recovery of the security. Inherent in the Company’s evaluation of other-than-temporary impairment for these fixed income and equity securities are assumptions and estimates about the financial condition and future earnings potential of the issue or issuer. Some of the factors that may be considered in evaluating whether a decline in fair value is other than temporary are: 1) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; 2) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity; and 3) the length of time and extent to which the fair value has been less than amortized cost or cost.
148 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
| Gross unrealized losses and fair value by type and length of time held in a continuous unrealized loss position | ||||||||||||||||||||||||||
| ($ in millions) | Less than 12 months | 12 months or more | ||||||||||||||||||||||||
| Number of issues | Fair value | Unrealized losses | Number of issues | Fair value | Unrealized losses | Total unrealized losses | ||||||||||||||||||||
| December 31, 2017 | ||||||||||||||||||||||||||
| Fixed income securities | ||||||||||||||||||||||||||
| U.S. government and agencies | 66 | $ | 2,829 | $ | (18 | ) | 18 | $ | 182 | $ | (2 | ) | $ | (20 | ) | |||||||||||
| Municipal | 1,756 | 3,143 | (24 | ) | 165 | 349 | (12 | ) | (36 | ) | ||||||||||||||||
| Corporate | 781 | 11,616 | (102 | ) | 208 | 3,289 | (102 | ) | (204 | ) | ||||||||||||||||
| Foreign government | 45 | 580 | (10 | ) | 5 | 44 | (1 | ) | (11 | ) | ||||||||||||||||
| ABS | 57 | 476 | (3 | ) | 9 | 34 | (4 | ) | (7 | ) | ||||||||||||||||
| RMBS | 118 | 35 | (1 | ) | 181 | 50 | (2 | ) | (3 | ) | ||||||||||||||||
| CMBS | 2 | 1 | — | 6 | 23 | (2 | ) | (2 | ) | |||||||||||||||||
| Redeemable preferred stock | 1 | — | — | — | — | — | — | |||||||||||||||||||
| Total fixed income securities | 2,826 | 18,680 | (158 | ) | 592 | 3,971 | (125 | ) | (283 | ) | ||||||||||||||||
| Equity securities | 127 | 369 | (12 | ) | 2 | — | — | (12 | ) | |||||||||||||||||
| Total fixed income and equity securities | 2,953 | $ | 19,049 | $ | (170 | ) | 594 | $ | 3,971 | $ | (125 | ) | $ | (295 | ) | |||||||||||
| Investment grade fixed income securities | 2,706 | $ | 17,668 | $ | (134 | ) | 535 | $ | 3,751 | $ | (98 | ) | $ | (232 | ) | |||||||||||
| Below investment grade fixed income securities | 120 | 1,012 | (24 | ) | 57 | 220 | (27 | ) | (51 | ) | ||||||||||||||||
| Total fixed income securities | 2,826 | $ | 18,680 | $ | (158 | ) | 592 | $ | 3,971 | $ | (125 | ) | $ | (283 | ) | |||||||||||
| December 31, 2016 | ||||||||||||||||||||||||||
| Fixed income securities | ||||||||||||||||||||||||||
| U.S. government and agencies | 46 | $ | 943 | $ | (9 | ) | — | $ | — | $ | — | $ | (9 | ) | ||||||||||||
| Municipal | 1,310 | 3,073 | (76 | ) | 8 | 29 | (11 | ) | (87 | ) | ||||||||||||||||
| Corporate | 862 | 13,343 | (256 | ) | 83 | 678 | (63 | ) | (319 | ) | ||||||||||||||||
| Foreign government | 41 | 225 | (4 | ) | — | — | — | (4 | ) | |||||||||||||||||
| ABS | 31 | 222 | (1 | ) | 14 | 109 | (10 | ) | (11 | ) | ||||||||||||||||
| RMBS | 89 | 53 | (1 | ) | 179 | 91 | (7 | ) | (8 | ) | ||||||||||||||||
| CMBS | 15 | 59 | (4 | ) | 4 | 15 | (5 | ) | (9 | ) | ||||||||||||||||
| Redeemable preferred stock | 1 | — | — | — | — | — | — | |||||||||||||||||||
| Total fixed income securities | 2,395 | 17,918 | (351 | ) | 288 | 922 | (96 | ) | (447 | ) | ||||||||||||||||
| Equity securities | 195 | 654 | (56 | ) | 46 | 165 | (29 | ) | (85 | ) | ||||||||||||||||
| Total fixed income and equity securities | 2,590 | $ | 18,572 | $ | (407 | ) | 334 | $ | 1,087 | $ | (125 | ) | $ | (532 | ) | |||||||||||
| Investment grade fixed income securities | 2,202 | $ | 15,678 | $ | (293 | ) | 201 | $ | 493 | $ | (51 | ) | $ | (344 | ) | |||||||||||
| Below investment grade fixed income securities | 193 | 2,240 | (58 | ) | 87 | 429 | (45 | ) | (103 | ) | ||||||||||||||||
| Total fixed income securities | 2,395 | $ | 17,918 | $ | (351 | ) | 288 | $ | 922 | $ | (96 | ) | $ | (447 | ) |
As of December 31, 2017, $269 million of the $295 million unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost or cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired. Of the $269 million, $219 million are related to unrealized losses on investment grade fixed income securities and $11 million are related to equity securities. Of the remaining $39 million, $22 million have been in an unrealized loss position for less than 12 months. Investment grade is defined as a security having a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from S&P Global Ratings (“S&P”), a comparable rating from another nationally recognized rating agency, or a comparable internal rating if an externally provided rating is not available. Market prices for certain securities may have credit spreads which imply higher or lower credit quality than the current third party rating. Unrealized losses on investment grade securities are principally related to an increase in market yields which may
include increased risk-free interest rates and/or wider credit spreads since the time of initial purchase.
As of December 31, 2017, the remaining $26 million of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost. Investment grade fixed income securities comprising $13 million of these unrealized losses were evaluated based on factors such as discounted cash flows and the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations. Of the $26 million, $12 million are related to below investment grade fixed income securities and $1 million are related to equity securities. Of these amounts, $2 million are related to below investment grade fixed income securities that had been in an unrealized loss position greater than or equal to 20% of amortized cost for a period of twelve or more consecutive months as of December 31, 2017.
The Allstate Corporation 149
2017 Form 10-K Notes to Consolidated Financial Statements
ABS, RMBS and CMBS in an unrealized loss position were evaluated based on actual and projected collateral losses relative to the securities’ positions in the respective securitization trusts, security specific expectations of cash flows, and credit ratings. This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, and (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread. Municipal bonds in an unrealized loss position were evaluated based on the underlying credit quality of the primary obligor, obligation type and quality of the underlying assets. Unrealized losses on equity securities are primarily related to temporary equity market fluctuations of securities that are expected to recover.
As of December 31, 2017, the Company has not made the decision to sell and it is not more likely than not the Company will be required to sell fixed income securities with unrealized losses before recovery of the amortized cost basis. As of December 31, 2017, the Company had the intent and ability to hold equity securities with unrealized losses for a period of time sufficient for them to recover.
Limited partnerships
As of December 31, 2017 and 2016, the carrying value of equity method limited partnerships totaled $5.41 billion and $4.53 billion, respectively. Principal factors influencing carrying value appreciation or decline include operating performance, comparable public company earnings multiples, capitalization rates and the economic environment. The Company recognizes an impairment loss for equity method limited partnerships when evidence demonstrates that the loss is other than temporary. Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of
the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.
As of December 31, 2017 and 2016, the carrying value for cost method limited partnerships was $1.33 billion and $1.28 billion, respectively. To determine if an other-than-temporary impairment has occurred, the Company evaluates whether an impairment indicator has occurred in the period that may have a significant adverse effect on the carrying value of the investment. Impairment indicators may include: significantly reduced valuations of the investments held by the limited partnerships; actual recent cash flows received being significantly less than expected cash flows; reduced valuations based on financing completed at a lower value; completed sale of a material underlying investment at a price significantly lower than expected; or any other adverse events since the last financial statements received that might affect the fair value of the investee’s capital. Additionally, the Company’s portfolio monitoring process includes a quarterly review of all cost method limited partnerships to identify instances where the net asset value is below established thresholds for certain periods of time, as well as investments that are performing below expectations, for further impairment consideration. If a cost method limited partnership is other-than-temporarily impaired, the carrying value is written down to fair value, generally estimated to be equivalent to the reported net asset value.
Mortgage loans
The Company’s mortgage loans are commercial mortgage loans collateralized by a variety of commercial real estate property types located across the United States and totaled, net of valuation allowance, $4.53 billion and $4.49 billion as of December 31, 2017 and 2016, respectively. Substantially all of the commercial mortgage loans are non-recourse to the borrower.
| Principal geographic distribution of commercial real estate exceeding 5% of the mortgage loans portfolio | ||||||
| As of December 31, | ||||||
| (% of mortgage loan portfolio carrying value) | 2017 | 2016 | ||||
| California | 19.9 | % | 19.3 | % | ||
| Texas | 13.0 | 10.5 | ||||
| New Jersey | 7.6 | 8.2 | ||||
| Illinois | 7.1 | 6.7 | ||||
| Florida | 6.4 | 5.4 |
| Types of properties collateralizing the mortgage loan portfolio | ||||||
| As of December 31, | ||||||
| (% of mortgage loan portfolio carrying value) | 2017 | 2016 | ||||
| Apartment complex | 30.9 | % | 27.6 | % | ||
| Office buildings | 23.8 | 23.9 | ||||
| Retail | 18.0 | 20.4 | ||||
| Warehouse | 15.7 | 17.0 | ||||
| Other | 11.6 | 11.1 | ||||
| Total | 100.0 | % | 100.0 | % |
150 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
| Contractual maturities of the mortgage loan portfolio | ||||||||||
| As of December 31, 2017 | ||||||||||
| ($ in millions) | Number of loans | Carrying value | Percent | |||||||
| 2018 | 17 | $ | 169 | 3.7 | % | |||||
| 2019 | 10 | 268 | 5.9 | |||||||
| 2020 | 14 | 192 | 4.2 | |||||||
| 2021 | 43 | 625 | 13.8 | |||||||
| Thereafter | 201 | 3,280 | 72.4 | |||||||
| Total | 285 | $ | 4,534 | 100.0 | % |
Mortgage loans are evaluated for impairment on a specific loan basis through a quarterly credit monitoring process and review of key credit quality indicators. Mortgage loans are considered impaired when it is probable that the Company will not collect the contractual principal and interest. Valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral less costs to sell or the present value of the loan’s expected future repayment cash flows discounted at the loan’s original effective interest rate. Impaired mortgage loans may not have a valuation allowance when the fair value of the collateral less costs to sell is higher than the carrying value. Valuation allowances are adjusted for subsequent changes in the fair value of the collateral less costs to sell or present value of the loan’s expected future repayment cash flows. Mortgage loans are charged off against their corresponding valuation allowances when there is no reasonable expectation of recovery. The impairment evaluation is non-statistical in respect to
the aggregate portfolio but considers facts and circumstances attributable to each loan. It is not considered probable that additional impairment losses, beyond those identified on a specific loan basis, have been incurred as of December 31, 2017.
Accrual of income is suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable. Cash receipts on mortgage loans on nonaccrual status are generally recorded as a reduction of carrying value.
Debt service coverage ratio is considered a key credit quality indicator when mortgage loans are evaluated for impairment. Debt service coverage ratio represents the amount of estimated cash flows from the property available to the borrower to meet principal and interest payment obligations. Debt service coverage ratio estimates are updated annually or more frequently if conditions are warranted based on the Company’s credit monitoring process.
| Carrying value of non-impaired mortgage loans summarized by debt service coverage ratio distribution | ||||||||||||||||||||||||
| As of December 31, | ||||||||||||||||||||||||
| ($ in millions) | 2017 | 2016 | ||||||||||||||||||||||
| Debt Service Coverage Ratio Distribution | Fixed rate mortgage loans | Variable rate mortgage loans | Total | Fixed rate mortgage loans | Variable rate mortgage loans | Total | ||||||||||||||||||
| Below 1.0 | $ | 3 | $ | — | $ | 3 | $ | 60 | $ | — | $ | 60 | ||||||||||||
| 1.0 - 1.25 | 345 | — | 345 | 324 | — | 324 | ||||||||||||||||||
| 1.26 - 1.50 | 1,141 | 30 | 1,171 | 1,293 | — | 1,293 | ||||||||||||||||||
| Above 1.50 | 2,949 | 62 | 3,011 | 2,765 | 39 | 2,804 | ||||||||||||||||||
| Total non-impaired mortgage loans | $ | 4,438 | $ | 92 | $ | 4,530 | $ | 4,442 | $ | 39 | $ | 4,481 |
Mortgage loans with a debt service coverage ratio below 1.0 that are not considered impaired primarily relate to instances where the borrower has the financial capacity to fund the revenue shortfalls from the properties for the foreseeable term, the decrease in cash flows from the properties is considered temporary, or there are other risk mitigating circumstances such as additional collateral, escrow balances or borrower guarantees.
| Net carrying value of impaired mortgage loans | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Impaired mortgage loans with a valuation allowance | $ | 4 | $ | 5 | ||||
| Impaired mortgage loans without a valuation allowance | — | — | ||||||
| Total impaired mortgage loans | $ | 4 | $ | 5 | ||||
| Valuation allowance on impaired mortgage loans | $ | 3 | $ | 3 |
The average balance of impaired loans was $7 million, $6 million and $11 million during 2017, 2016 and 2015, respectively.
The Allstate Corporation 151
2017 Form 10-K Notes to Consolidated Financial Statements
| Rollforward of the valuation allowance on impaired mortgage loans | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Beginning balance | $ | 3 | $ | 3 | $ | 8 | ||||||
| Net increase (decrease) in valuation allowance | 1 | — | (4 | ) | ||||||||
| Charge offs | (1 | ) | — | (1 | ) | |||||||
| Ending balance | $ | 3 | $ | 3 | $ | 3 |
Payments on all mortgage loans were current as of December 31, 2017, 2016 and 2015.
Municipal bonds
The Company maintains a diversified portfolio of municipal bonds.
| Principal geographic distribution of municipal bond issuers exceeding 5% of the portfolio | ||||||
| As of December 31, | ||||||
| (% of municipal bond portfolio carrying value) | 2017 | 2016 | ||||
| Texas | 9.6 | % | 10.0 | % | ||
| California | 7.0 | 7.2 | ||||
| New York | 6.9 | 6.8 | ||||
| Florida | 6.5 | 5.7 | ||||
| Washington | 5.4 | 5.6 | ||||
| Michigan | 4.2 | 5.4 |
Concentration of credit risk
As of December 31, 2017, the Company is not exposed to any credit concentration risk of a single issuer and its affiliates greater than 10% of the Company’s shareholders’ equity, other than the U.S. government and its agencies.
Securities loaned
The Company’s business activities include securities lending programs with third parties, mostly large banks. As of December 31, 2017 and 2016, fixed income and equity securities with a carrying value of $1.09 billion and $1.08 billion, respectively, were on loan under these agreements. Interest income on collateral, net of fees, was $7 million, $6 million and $2 million in 2017, 2016 and 2015, respectively.
Other investment information
Included in fixed income securities are below investment grade assets totaling $7.57 billion and $8.62 billion as of December 31, 2017 and 2016, respectively.
As of December 31, 2017, fixed income securities and short-term investments with a carrying value of $154 million were on deposit with regulatory authorities as required by law.
As of December 31, 2017, the carrying value of fixed income securities and other investments that were non-income producing was $51 million.
| Note 6 | Fair Value of Assets and Liabilities |
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Assets and liabilities recorded on the Consolidated Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
Level 1: Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.
Level 2: Assets and liabilities whose values are based on the following:
| (a) | Quoted prices for similar assets or liabilities in active markets; |
| (b) | Quoted prices for identical or similar assets or liabilities in markets that are not active; or |
| (c) | Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability. |
Level 3: Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.
The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair
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value requires more judgment. The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy. The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.
The Company is responsible for the determination of fair value and the supporting assumptions and methodologies. The Company gains assurance that assets and liabilities are appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards. For fair values received from third parties or internally estimated, the Company’s processes and controls are designed to ensure that the valuation methodologies are appropriate and consistently applied, the inputs and assumptions are reasonable and consistent with the objective of determining fair value, and the fair values are accurately recorded. For example, on a continuing basis, the Company assesses the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers or brokers or derived from internal models. The Company performs procedures to understand and assess the methodologies, processes and controls of valuation service providers. In addition, the Company may validate the reasonableness of fair values by comparing information obtained from valuation service providers or brokers to other third party valuation sources for selected securities. The Company performs ongoing price validation procedures such as back-testing of actual sales, which corroborate the various inputs used in internal models to market observable data. When fair value determinations are expected to be more variable, the Company validates them through reviews by members of management who have relevant expertise and who are independent of those charged with executing investment transactions.
The Company has two types of situations where investments are classified as Level 3 in the fair value hierarchy. The first is where specific inputs significant to the fair value estimation models are not market observable. This primarily occurs in the Company’s use of broker quotes to value certain securities where the inputs have not been corroborated to be market observable, and the use of valuation models that use significant non-market observable inputs. The second situation where the Company classifies securities in Level 3 is where quotes continue to be received from independent third-party valuation service providers and all significant inputs are market observable; however, there has been a significant decrease in the volume and level of activity for the asset when compared to normal
market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate. The indicators considered in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, the level of credit spreads over historical levels, applicable bid-ask spreads, and price consensus among market participants and other pricing sources.
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans, cost method limited partnership interests, bank loans, agent loans and policy loans. Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting remeasurement is reflected in the consolidated financial statements.
In determining fair value, the Company principally uses the market approach which generally utilizes market transaction data for the same or similar instruments. To a lesser extent, the Company uses the income approach which involves determining fair values from discounted cash flow methodologies. For the majority of Level 2 and Level 3 valuations, a combination of the market and income approaches is used.
Summary of significant valuation techniques for assets and liabilities measured at fair value on a recurring basis
Level 1 measurements
| • | Fixed income securities: Comprise certain U.S. Treasury fixed income securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access. |
| • | Equity securities: Comprise actively traded, exchange-listed equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access. |
| • | Short-term: Comprise U.S. Treasury bills valued based on unadjusted quoted prices for identical assets in active markets that the Company can access and actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access. |
| • | Separate account assets: Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access. Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers. |
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Level 2 measurements
| • | Fixed income securities: |
U.S. government and agencies: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
Municipal: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
Corporate - public: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
Corporate - privately placed: Valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data. The primary inputs to the discounted cash flow model include an interest rate yield curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.
Foreign government: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.
ABS - collateralized debt obligations (“CDO”) and ABS - consumer and other: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads. Certain ABS - CDO and ABS - consumer and other are valued based on non-binding broker quotes whose inputs have been corroborated to be market observable.
RMBS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.
CMBS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, collateral performance and credit spreads.
Redeemable preferred stock: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, underlying stock prices and credit spreads.
| • | Equity securities: The primary inputs to the valuation include quoted prices or quoted net asset |
values for identical or similar assets in markets that are not active.
| • | Short-term: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads. For certain short-term investments, amortized cost is used as the best estimate of fair value. |
| • | Other investments: Free-standing exchange listed derivatives that are not actively traded are valued based on quoted prices for identical instruments in markets that are not active. |
Over-the-counter (“OTC”) derivatives, including interest rate swaps, foreign currency swaps, foreign exchange forward contracts, certain options and certain credit default swaps, are valued using models that rely on inputs such as interest rate yield curves, implied volatilities, currency rates, and credit spreads that are observable for substantially the full term of the contract. The valuation techniques underlying the models are widely accepted in the financial services industry and do not involve significant judgment.
Level 3 measurements
| • | Fixed income securities: |
Municipal: Comprise municipal bonds that are not rated by third party credit rating agencies. The primary inputs to the valuation of these municipal bonds include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields and credit spreads. Also included are municipal bonds valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and municipal bonds in default valued based on the present value of expected cash flows.
Corporate - public and Corporate - privately placed: Primarily valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable. Other inputs include an interest rate yield curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.
ABS - CDO, ABS - consumer and other, RMBS and CMBS: Valued based on non-binding broker quotes received from brokers who are familiar with the investments and where the inputs have not been corroborated to be market observable.
| • | Equity securities: The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements. |
| • | Other investments: Certain OTC derivatives, such as interest rate caps, certain credit default swaps and certain options (including swaptions), are valued using models that are widely accepted in |
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the financial services industry. These are categorized as Level 3 as a result of the significance of non-market observable inputs such as volatility. Other primary inputs include interest rate yield curves and credit spreads.
| • | Contractholder funds: Derivatives embedded in certain life and annuity contracts are valued internally using models widely accepted in the financial services industry that determine a single best estimate of fair value for the embedded derivatives within a block of contractholder liabilities. The models primarily use stochastically determined cash flows based on the contractual elements of embedded derivatives, projected option cost and applicable market data, such as |
interest rate yield curves and equity index volatility assumptions. These are categorized as Level 3 as a result of the significance of non-market observable inputs.
Assets and liabilities measured at fair value on a non-recurring basis
Mortgage loans written-down to fair value in connection with recognizing impairments are valued based on the fair value of the underlying collateral less costs to sell. Limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments are generally valued using net asset values.
| Assets and liabilities measured at fair value on a recurring and non-recurring basis | ||||||||||||||||||||
| As of December 31, 2017 | ||||||||||||||||||||
| ($ in millions) | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | Counterparty and cash collateral netting | Balance as of December 31, 2017 | |||||||||||||||
| Assets | ||||||||||||||||||||
| Fixed income securities: | ||||||||||||||||||||
| U.S. government and agencies | $ | 3,079 | $ | 537 | $ | — | $ | 3,616 | ||||||||||||
| Municipal | — | 8,227 | 101 | 8,328 | ||||||||||||||||
| Corporate - public | — | 31,963 | 108 | 32,071 | ||||||||||||||||
| Corporate - privately placed | — | 11,731 | 224 | 11,955 | ||||||||||||||||
| Foreign government | — | 1,021 | — | 1,021 | ||||||||||||||||
| ABS - CDO | — | 480 | 99 | 579 | ||||||||||||||||
| ABS - consumer and other | — | 645 | 48 | 693 | ||||||||||||||||
| RMBS | — | 578 | — | 578 | ||||||||||||||||
| CMBS | — | 102 | 26 | 128 | ||||||||||||||||
| Redeemable preferred stock | — | 23 | — | 23 | ||||||||||||||||
| Total fixed income securities | 3,079 | 55,307 | 606 | 58,992 | ||||||||||||||||
| Equity securities | 6,032 | 379 | 210 | 6,621 | ||||||||||||||||
| Short-term investments | 264 | 1,660 | 20 | 1,944 | ||||||||||||||||
| Other investments: Free-standing derivatives | — | 132 | 1 | (6 | ) | 127 | ||||||||||||||
| Separate account assets | 3,444 | — | — | 3,444 | ||||||||||||||||
| Other assets | — | — | — | — | ||||||||||||||||
| Total recurring basis assets | 12,819 | 57,478 | 837 | (6 | ) | 71,128 | ||||||||||||||
| Non-recurring basis (1) | — | — | 3 | 3 | ||||||||||||||||
| Total assets at fair value | $ | 12,819 | $ | 57,478 | $ | 840 | $ | (6 | ) | $ | 71,131 | |||||||||
| % of total assets at fair value | 18.0 | % | 80.8 | % | 1.2 | % | — | % | 100.0 | % | ||||||||||
| Liabilities | ||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | — | $ | (286 | ) | $ | (286 | ) | ||||||||||
| Other liabilities: Free-standing derivatives | (1 | ) | (83 | ) | — | $ | 14 | (70 | ) | |||||||||||
| Total liabilities at fair value | $ | (1 | ) | $ | (83 | ) | $ | (286 | ) | $ | 14 | $ | (356 | ) | ||||||
| % of total liabilities at fair value | 0.3 | % | 23.3 | % | 80.3 | % | (3.9 | )% | 100.0 | % |
| (1) | Includes $3 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments. |
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2017 Form 10-K Notes to Consolidated Financial Statements
| Assets and liabilities measured at fair value on a recurring and non-recurring basis | ||||||||||||||||||||
| As of December 31, 2016 | ||||||||||||||||||||
| ($ in millions) | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | Counterparty and cash collateral netting | Balance as of December 31, 2016 | |||||||||||||||
| Assets | ||||||||||||||||||||
| Fixed income securities: | ||||||||||||||||||||
| U.S. government and agencies | $ | 2,918 | $ | 719 | $ | — | $ | 3,637 | ||||||||||||
| Municipal | — | 7,208 | 125 | 7,333 | ||||||||||||||||
| Corporate - public | — | 31,414 | 78 | 31,492 | ||||||||||||||||
| Corporate - privately placed | — | 11,846 | 263 | 12,109 | ||||||||||||||||
| Foreign government | — | 1,075 | — | 1,075 | ||||||||||||||||
| ABS - CDO | — | 650 | 27 | 677 | ||||||||||||||||
| ABS - consumer and other | — | 452 | 42 | 494 | ||||||||||||||||
| RMBS | — | 727 | 1 | 728 | ||||||||||||||||
| CMBS | — | 248 | 22 | 270 | ||||||||||||||||
| Redeemable preferred stock | — | 24 | — | 24 | ||||||||||||||||
| Total fixed income securities | 2,918 | 54,363 | 558 | 57,839 | ||||||||||||||||
| Equity securities | 5,247 | 256 | 163 | 5,666 | ||||||||||||||||
| Short-term investments | 850 | 3,423 | 15 | 4,288 | ||||||||||||||||
| Other investments: Free-standing derivatives | — | 119 | 1 | (9 | ) | 111 | ||||||||||||||
| Separate account assets | 3,393 | — | — | 3,393 | ||||||||||||||||
| Other assets | — | — | 1 | 1 | ||||||||||||||||
| Total recurring basis assets | 12,408 | 58,161 | 738 | (9 | ) | 71,298 | ||||||||||||||
| Non-recurring basis (1) | — | — | 24 | 24 | ||||||||||||||||
| Total assets at fair value | $ | 12,408 | $ | 58,161 | $ | 762 | $ | (9 | ) | $ | 71,322 | |||||||||
| % of total assets at fair value | 17.4 | % | 81.5 | % | 1.1 | % | — | % | 100.0 | % | ||||||||||
| Liabilities | ||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | — | $ | (290 | ) | $ | (290 | ) | ||||||||||
| Other liabilities: Free-standing derivatives | (1 | ) | (68 | ) | (3 | ) | $ | 28 | (44 | ) | ||||||||||
| Total liabilities at fair value | $ | (1 | ) | $ | (68 | ) | $ | (293 | ) | $ | 28 | $ | (334 | ) | ||||||
| % of total liabilities at fair value | 0.3 | % | 20.4 | % | 87.7 | % | (8.4 | )% | 100.0 | % |
| (1) | Includes $24 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments. |
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| Quantitative information about the significant unobservable inputs used in Level 3 fair value measurements | ||||||||||||
| ($ in millions) | Fair value | Valuation technique | Unobservable input | Range | Weighted average | |||||||
| December 31, 2017 | ||||||||||||
| Derivatives embedded in life and annuity contracts – Equity-indexed and forward starting options | $ | (252 | ) | Stochastic cash flow model | Projected option cost | 1.0 - 2.2% | 1.74% | |||||
| December 31, 2016 | ||||||||||||
| Derivatives embedded in life and annuity contracts – Equity-indexed and forward starting options | $ | (247 | ) | Stochastic cash flow model | Projected option cost | 1.0 - 2.2% | 1.75% |
The embedded derivatives are equity-indexed and forward starting options in certain life and annuity products that provide customers with interest crediting rates based on the performance of the S&P 500. If the projected option cost increased (decreased), it would result in a higher (lower) liability fair value.
As of December 31, 2017 and 2016, Level 3 fair value measurements of fixed income securities total $606 million and $558 million, respectively, and include $271 million and $307 million, respectively, of securities valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and $58 million and $80 million,
respectively, of municipal fixed income securities that are not rated by third party credit rating agencies. The Company does not develop the unobservable inputs used in measuring fair value; therefore, these are not included in the table above. However, an increase (decrease) in credit spreads for fixed income securities valued based on non-binding broker quotes would result in a lower (higher) fair value, and an increase (decrease) in the credit rating of municipal bonds that are not rated by third party credit rating agencies would result in a higher (lower) fair value.
The Allstate Corporation 157
2017 Form 10-K Notes to Consolidated Financial Statements
| Rollforward of level 3 assets and liabilities held at fair value on a recurring basis during the period | ||||||||||||||||||||||
| December 31, 2017 | ||||||||||||||||||||||
| Balance as of December 31, 2016 | Total gains (losses) included in: | Transfers into Level 3 | Transfers out of Level 3 | |||||||||||||||||||
| ($ in millions) | Net income (1) | OCI | ||||||||||||||||||||
| Assets | ||||||||||||||||||||||
| Fixed income securities: | ||||||||||||||||||||||
| Municipal | $ | 125 | $ | (1 | ) | $ | 7 | $ | — | $ | (6 | ) | ||||||||||
| Corporate - public | 78 | — | — | 4 | (30 | ) | ||||||||||||||||
| Corporate - privately placed | 263 | 8 | (2 | ) | 30 | (49 | ) | |||||||||||||||
| ABS - CDO | 27 | — | 6 | 60 | (190 | ) | ||||||||||||||||
| ABS - consumer and other | 42 | — | — | — | (90 | ) | ||||||||||||||||
| RMBS | 1 | — | — | — | — | |||||||||||||||||
| CMBS | 22 | — | — | — | — | |||||||||||||||||
| Total fixed income securities | 558 | 7 | 11 | 94 | (365 | ) | ||||||||||||||||
| Equity securities | 163 | 13 | 4 | — | (4 | ) | ||||||||||||||||
| Short-term investments | 15 | — | — | — | — | |||||||||||||||||
| Free-standing derivatives, net | (2 | ) | 3 | — | — | — | ||||||||||||||||
| Other assets | 1 | (1 | ) | — | — | — | ||||||||||||||||
| Total recurring Level 3 assets | $ | 735 | $ | 22 | $ | 15 | $ | 94 | $ | (369 | ) | |||||||||||
| Liabilities | ||||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | (290 | ) | $ | — | $ | — | $ | — | $ | — | |||||||||||
| Total recurring Level 3 liabilities | $ | (290 | ) | $ | — | $ | — | $ | — | $ | — | |||||||||||
| Purchases | Sales | Issues | Settlements | Balance as of December 31, 2017 | ||||||||||||||||||
| Assets | ||||||||||||||||||||||
| Fixed income securities: | ||||||||||||||||||||||
| Municipal | $ | 8 | $ | (29 | ) | $ | — | $ | (3 | ) | $ | 101 | ||||||||||
| Corporate - public | 60 | — | — | (4 | ) | 108 | ||||||||||||||||
| Corporate - privately placed | 44 | (30 | ) | — | (40 | ) | 224 | |||||||||||||||
| ABS - CDO | 219 | — | — | (23 | ) | 99 | ||||||||||||||||
| ABS - consumer and other | 103 | — | — | (7 | ) | 48 | ||||||||||||||||
| RMBS | — | — | — | (1 | ) | — | ||||||||||||||||
| CMBS | 6 | — | — | (2 | ) | 26 | ||||||||||||||||
| Total fixed income securities | 440 | (59 | ) | — | (80 | ) | 606 | |||||||||||||||
| Equity securities | 48 | (14 | ) | — | — | 210 | ||||||||||||||||
| Short-term investments | 45 | (40 | ) | — | — | 20 | ||||||||||||||||
| Free-standing derivatives, net | — | — | — | — | 1 | (2 | ) | |||||||||||||||
| Other assets | — | — | — | — | — | |||||||||||||||||
| Total recurring Level 3 assets | $ | 533 | $ | (113 | ) | $ | — | $ | (80 | ) | $ | 837 | ||||||||||
| Liabilities | ||||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | — | $ | (2 | ) | $ | 6 | $ | (286 | ) | ||||||||||
| Total recurring Level 3 liabilities | $ | — | $ | — | $ | (2 | ) | $ | 6 | $ | (286 | ) |
| (1) | The effect to net income totals $22 million and is reported in the Consolidated Statements of Operations as follows: $4 million in realized capital gains and losses, $19 million in net investment income, $(10) million in interest credited to contractholder funds and $9 million in life contract benefits. |
| (2) | Comprises $1 million of assets. |
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| Rollforward of level 3 assets and liabilities held at fair value on a recurring basis during the period | |||||||||||||||||||||
| December 31, 2016 | |||||||||||||||||||||
| Balance as of December 31, 2015 | Total gains (losses) included in: | Transfers into Level 3 | Transfers out of Level 3 | ||||||||||||||||||
| ($ in millions) | Net income (1) | OCI | |||||||||||||||||||
| Assets | |||||||||||||||||||||
| Fixed income securities: | |||||||||||||||||||||
| U.S. government and agencies | $ | 5 | $ | — | $ | — | $ | — | $ | (4 | ) | ||||||||||
| Municipal | 161 | 12 | (10 | ) | 6 | (23 | ) | ||||||||||||||
| Corporate - public | 46 | — | — | 41 | (43 | ) | |||||||||||||||
| Corporate - privately placed | 502 | 15 | 18 | 16 | (398 | ) | |||||||||||||||
| ABS - CDO | 61 | 1 | 6 | 10 | (43 | ) | |||||||||||||||
| ABS - consumer and other | 50 | — | (3 | ) | 3 | (35 | ) | ||||||||||||||
| RMBS | 1 | 1 | — | — | — | ||||||||||||||||
| CMBS | 20 | — | — | — | (1 | ) | |||||||||||||||
| Total fixed income securities | 846 | 29 | 11 | 76 | (547 | ) | |||||||||||||||
| Equity securities | 133 | (32 | ) | 12 | — | (12 | ) | ||||||||||||||
| Short-term investments | — | — | — | — | — | ||||||||||||||||
| Free-standing derivatives, net | (7 | ) | 6 | — | — | — | |||||||||||||||
| Other assets | 1 | — | — | — | — | ||||||||||||||||
| Total recurring Level 3 assets | $ | 973 | $ | 3 | $ | 23 | $ | 76 | $ | (559 | ) | ||||||||||
| Liabilities | |||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | (299 | ) | $ | 5 | $ | — | $ | — | $ | — | ||||||||||
| Total recurring Level 3 liabilities | $ | (299 | ) | $ | 5 | $ | — | $ | — | $ | — | ||||||||||
| Purchases | Sales | Issues | Settlements | Balance as of December 31, 2016 | |||||||||||||||||
| Assets | |||||||||||||||||||||
| Fixed income securities: | |||||||||||||||||||||
| U.S. government and agencies | $ | — | $ | — | $ | — | $ | (1 | ) | $ | — | ||||||||||
| Municipal | 22 | (40 | ) | — | (3 | ) | 125 | ||||||||||||||
| Corporate - public | 47 | (11 | ) | — | (2 | ) | 78 | ||||||||||||||
| Corporate - privately placed | 181 | (15 | ) | — | (56 | ) | 263 | ||||||||||||||
| ABS - CDO | 40 | (3 | ) | — | (45 | ) | 27 | ||||||||||||||
| ABS - consumer and other | 35 | (5 | ) | — | (3 | ) | 42 | ||||||||||||||
| RMBS | — | (1 | ) | — | — | 1 | |||||||||||||||
| CMBS | 5 | — | — | (2 | ) | 22 | |||||||||||||||
| Total fixed income securities | 330 | (75 | ) | — | (112 | ) | 558 | ||||||||||||||
| Equity securities | 65 | (4 | ) | — | 1 | 163 | |||||||||||||||
| Short-term investments | 15 | — | — | — | 15 | ||||||||||||||||
| Free-standing derivatives, net | — | — | — | (1 | ) | (2 | ) | (2) | |||||||||||||
| Other assets | — | — | — | — | 1 | ||||||||||||||||
| Total recurring Level 3 assets | $ | 410 | $ | (79 | ) | $ | — | $ | (112 | ) | $ | 735 | |||||||||
| Liabilities | |||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | — | $ | (3 | ) | $ | 7 | $ | (290 | ) | |||||||||
| Total recurring Level 3 liabilities | $ | — | $ | — | $ | (3 | ) | $ | 7 | $ | (290 | ) |
| (1) | The effect to net income totals $8 million and is reported in the Consolidated Statements of Operations as follows: $(9) million in realized capital gains and losses, $12 million in net investment income, $(4) million in interest credited to contractholder funds and $9 million in life contract benefits. |
| (2) | Comprises $1 million of assets and $3 million of liabilities. |
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2017 Form 10-K Notes to Consolidated Financial Statements
| Rollforward of level 3 assets and liabilities held at fair value on a recurring basis during the period | |||||||||||||||||||||
| December 31, 2015 | |||||||||||||||||||||
| Total gains (losses) included in: | |||||||||||||||||||||
| ($ in millions) | Balance as of December 31, 2014 | Net income (1) | OCI | Transfers into Level 3 | Transfers out of Level 3 | ||||||||||||||||
| Assets | |||||||||||||||||||||
| Fixed income securities: | |||||||||||||||||||||
| U.S. government and agencies | $ | 6 | $ | — | $ | — | $ | — | $ | — | |||||||||||
| Municipal | 270 | (4 | ) | (7 | ) | 3 | (2 | ) | |||||||||||||
| Corporate - public | 214 | — | — | — | (175 | ) | |||||||||||||||
| Corporate - privately placed | 677 | 13 | (20 | ) | 13 | (106 | ) | ||||||||||||||
| ABS - CDO | 104 | (1 | ) | 4 | 43 | (52 | ) | ||||||||||||||
| ABS - consumer and other | 92 | (1 | ) | — | — | (98 | ) | ||||||||||||||
| RMBS | 1 | — | — | — | — | ||||||||||||||||
| CMBS | 23 | — | — | — | — | ||||||||||||||||
| Total fixed income securities | 1,387 | 7 | (23 | ) | 59 | (433 | ) | ||||||||||||||
| Equity securities | 83 | (3 | ) | (5 | ) | — | — | ||||||||||||||
| Short-term investments | 5 | — | — | — | — | ||||||||||||||||
| Free-standing derivatives, net | (7 | ) | 1 | — | — | — | |||||||||||||||
| Other assets | 1 | — | — | — | — | ||||||||||||||||
| Total recurring Level 3 assets | $ | 1,469 | $ | 5 | $ | (28 | ) | $ | 59 | $ | (433 | ) | |||||||||
| Liabilities | |||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | (323 | ) | $ | 19 | $ | — | $ | — | $ | — | ||||||||||
| Total recurring Level 3 liabilities | $ | (323 | ) | $ | 19 | $ | — | $ | — | $ | — | ||||||||||
| Purchases | Sales | Issues | Settlements | Balance as of December 31, 2015 | |||||||||||||||||
| Assets | |||||||||||||||||||||
| Fixed income securities: | |||||||||||||||||||||
| U.S. government and agencies | $ | — | $ | — | $ | — | $ | (1 | ) | $ | 5 | ||||||||||
| Municipal | — | (91 | ) | — | (8 | ) | 161 | ||||||||||||||
| Corporate - public | 11 | — | — | (4 | ) | 46 | |||||||||||||||
| Corporate - privately placed | 79 | (74 | ) | — | (80 | ) | 502 | ||||||||||||||
| ABS - CDO | — | (2 | ) | — | (35 | ) | 61 | ||||||||||||||
| ABS - consumer and other | 70 | (5 | ) | — | (8 | ) | 50 | ||||||||||||||
| RMBS | — | — | — | — | 1 | ||||||||||||||||
| CMBS | 12 | — | — | (15 | ) | 20 | |||||||||||||||
| Total fixed income securities | 172 | (172 | ) | — | (151 | ) | 846 | ||||||||||||||
| Equity securities | 69 | (11 | ) | — | — | 133 | |||||||||||||||
| Short-term investments | 35 | (40 | ) | — | — | — | |||||||||||||||
| Free-standing derivatives, net | — | — | — | (1 | ) | (7 | ) | (2) | |||||||||||||
| Other assets | — | — | — | — | 1 | ||||||||||||||||
| Total recurring Level 3 assets | $ | 276 | $ | (223 | ) | $ | — | $ | (152 | ) | $ | 973 | |||||||||
| Liabilities | |||||||||||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | — | $ | (2 | ) | $ | 7 | $ | (299 | ) | |||||||||
| Total recurring Level 3 liabilities | $ | — | $ | — | $ | (2 | ) | $ | 7 | $ | (299 | ) |
| (1) | The effect to net income totals $24 million and is reported in the Consolidated Statements of Operations as follows: $(8) million in realized capital gains and losses, $13 million in net investment income, $26 million in interest credited to contractholder funds and $(7) million in life contract benefits. |
| (2) | Comprises $1 million of assets and $8 million of liabilities. |
Transfers between level categorizations may occur due to changes in the availability of market observable inputs, which generally are caused by changes in
market conditions such as liquidity, trading volume or bid-ask spreads. Transfers between level categorizations may also occur due to changes in the
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Notes to Consolidated Financial Statements 2017 Form 10-K
valuation source. For example, in situations where a fair value quote is not provided by the Company’s independent third-party valuation service provider and as a result the price is stale or has been replaced with a broker quote whose inputs have not been corroborated to be market observable, the security is transferred into Level 3. Transfers in and out of level categorizations are reported as having occurred at the beginning of the quarter in which the transfer occurred. Therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the Level 3 rollforward table.
There were no transfers between Level 1 and Level 2 during 2017, 2016 or 2015.
Transfers into Level 3 during 2017, 2016 and 2015 included situations where a fair value quote was not provided by the Company’s independent third-party valuation service provider and as a result the price was stale or had been replaced with a broker quote where the inputs had not been corroborated to be market observable resulting in the security being classified as Level 3. Transfers out of Level 3 during 2017, 2016 and 2015 included situations where a broker quote was used in the prior period and a fair value quote became available from the Company’s independent third-party valuation service provider in the current period. A quote utilizing the new pricing source was not available as of the prior period, and any gains or losses related to the change in valuation source for individual securities were not significant.
| Change in unrealized gains and losses included in net income for level 3 assets and liabilities held as of | ||||||||||||
| December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Assets | ||||||||||||
| Fixed income securities: | ||||||||||||
| Municipal | $ | (3 | ) | $ | 2 | $ | (12 | ) | ||||
| Corporate | 1 | 2 | 11 | |||||||||
| ABS | — | — | 2 | |||||||||
| Total fixed income securities | (2 | ) | 4 | 1 | ||||||||
| Equity securities | 13 | (32 | ) | (4 | ) | |||||||
| Free-standing derivatives, net | — | 5 | 1 | |||||||||
| Other assets | (1 | ) | — | — | ||||||||
| Total recurring Level 3 assets | $ | 10 | $ | (23 | ) | $ | (2 | ) | ||||
| Liabilities | ||||||||||||
| Contractholder funds: Derivatives embedded in life and annuity contracts | $ | — | $ | 5 | $ | 19 | ||||||
| Total recurring Level 3 liabilities | $ | — | $ | 5 | $ | 19 |
The amounts in the table above represent the change in unrealized gains and losses included in net income for the period of time that the asset or liability was held and determined to be in Level 3. These gains and losses total $10 million in 2017 and are reported as follows: $(8) million in realized capital gains and losses, $19 million in net investment income, $(10) million in interest credited to contractholder funds and $9 million in life contract benefits. These gains and losses total $(18) million in 2016 and are reported as follows: $(36)
million in realized capital gains and losses, $13 million in net investment income, $(4) million in interest credited to contractholder funds and $9 million in life contract benefits. These gains and losses total $17 million in 2015 and are reported as follows: $(20) million in realized capital gains and losses, $18 million in net investment income, $26 million in interest credited to contractholder funds and $(7) million in life contract benefits.
Financial assets
| Carrying values and fair value estimates of financial instruments not carried at fair value | ||||||||||||||||
| As of December 31, 2017 | As of December 31, 2016 | |||||||||||||||
| ($ in millions) | Carrying value | Fair value | Carrying value | Fair value | ||||||||||||
| Mortgage loans | $ | 4,534 | $ | 4,732 | $ | 4,486 | $ | 4,514 | ||||||||
| Cost method limited partnerships (1) | 1,327 | 1,569 | 1,282 | 1,493 | ||||||||||||
| Bank loans | 1,702 | 1,704 | 1,669 | 1,677 | ||||||||||||
| Agent loans | 538 | 536 | 467 | 467 |
| (1) | Beginning January 1, 2018, due to the adoption of the new accounting standard for the recognition and measurement of financial assets and liabilities, cost method limited partnerships (excluding limited partnership interests accounted for on a cost recovery basis) will be measured at fair value with changes in fair value recognized in net income. The existing carrying value of these investments will increase to fair value with the offsetting adjustment recognized in retained income through a cumulative effect adjustment. See Note 2 for additional details on the new accounting standard. |
The Allstate Corporation 161
2017 Form 10-K Notes to Consolidated Financial Statements
The fair value of mortgage loans is based on discounted contractual cash flows or, if the loans are impaired due to credit reasons, the fair value of collateral less costs to sell. Risk adjusted discount rates are selected using current rates at which similar loans would be made to borrowers with similar characteristics, using similar types of properties as collateral. The fair value of cost method limited partnerships is determined using reported net asset values. The fair value of bank loans, which are reported in other investments, is based on broker quotes from
brokers familiar with the loans and current market conditions. The fair value of agent loans, which are reported in other investments, is based on discounted cash flow calculations. Risk adjusted discount rates are selected using current rates at which similar loans would be made to borrowers with similar characteristics. The fair value measurements for mortgage loans, cost method limited partnerships, bank loans and agent loans are categorized as Level 3.
Financial liabilities
| Carrying values and fair value estimates of financial instruments not carried at fair value | ||||||||||||||||
| As of December 31, 2017 | As of December 31, 2016 | |||||||||||||||
| ($ in millions) | Carrying value | Fair value | Carrying value | Fair value | ||||||||||||
| Contractholder funds on investment contracts | $ | 10,367 | $ | 11,071 | $ | 11,313 | $ | 12,009 | ||||||||
| Long-term debt | 6,350 | 7,199 | 6,347 | 6,920 | ||||||||||||
| Liability for collateral | 1,124 | 1,124 | 1,129 | 1,129 |
The fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts incorporating current market-based crediting rates for similar contracts that reflect the Company’s own credit risk. Deferred annuities classified in contractholder funds are valued based on discounted cash flow models that incorporate current market-based margins and reflect the Company’s own credit risk. Immediate annuities without life contingencies are valued based on discounted cash flow models that incorporate current market-based implied interest rates and reflect the Company’s own credit risk. The fair value measurement for
contractholder funds on investment contracts is categorized as Level 3.
The fair value of long-term debt is based on market observable data (such as the fair value of the debt when traded as an asset) or is determined using discounted cash flow calculations based on current interest rates for instruments with comparable terms and considers the Company’s own credit risk. The liability for collateral is valued at carrying value due to its short-term nature. The fair value measurements for long-term debt and liability for collateral are categorized as Level 2.
| Note 7 | Derivative Financial Instruments and Off-balance sheet Financial Instruments |
The Company uses derivatives for risk reduction and to increase investment portfolio returns through asset replication. Risk reduction activity is focused on managing the risks with certain assets and liabilities arising from the potential adverse impacts from changes in risk-free interest rates, changes in equity market valuations, increases in credit spreads and foreign currency fluctuations.
Asset replication refers to the “synthetic” creation of assets through the use of derivatives. The Company replicates fixed income securities using a combination of a credit default swap or a foreign currency forward contract and one or more highly rated fixed income securities, primarily investment grade host bonds, to synthetically replicate the economic characteristics of one or more cash market securities. The Company replicates equity securities using futures and options to increase equity exposure.
Property-Liability may use interest rate swaps, swaptions, futures and options to manage the interest rate risks of existing investments. These instruments are utilized to change the duration of the portfolio in order to offset the economic effect that interest rates would otherwise have on the fair value of its fixed income securities. Credit default swaps are typically used to mitigate the credit risk within the Property-Liability fixed income portfolio. Equity index futures
and options are used by Property-Liability to offset valuation losses in the equity portfolio during periods of declining equity market values. In addition, equity futures are used to hedge the market risk related to deferred compensation liability contracts. Forward contracts are primarily used by Property-Liability to hedge foreign currency risk associated with holding foreign currency denominated investments and foreign operations.
The Company utilizes several derivative strategies to manage risk in Allstate Life and Allstate Annuities. Asset-liability management is a risk management strategy that is principally employed by Allstate Life and Allstate Annuities to balance the respective interest-rate sensitivities of its assets and liabilities. Depending upon the attributes of the assets acquired and liabilities issued, derivative instruments such as interest rate swaps, caps, swaptions and futures are utilized to change the interest rate characteristics of existing assets and liabilities to ensure the relationship is maintained within specified ranges and to reduce exposure to rising or falling interest rates. Credit default swaps are typically used to mitigate the credit risk within the Allstate Life and Allstate Annuities fixed income portfolios. Futures and options are used for hedging the equity exposure contained in equity indexed life and annuity product contracts that offer
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Notes to Consolidated Financial Statements 2017 Form 10-K
equity returns to contractholders. In addition, the Company uses equity index futures to offset valuation losses in the equity portfolio during periods of declining equity market values. Foreign currency swaps and forwards are primarily used to reduce the foreign currency risk associated with holding foreign currency denominated investments.
The Company also has derivatives embedded in non-derivative host contracts that are required to be separated from the host contracts and accounted for at fair value with changes in fair value of embedded derivatives reported in net income. The Company’s primary embedded derivatives are equity options in life and annuity product contracts, which provide equity returns to contractholders.
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. The Company designates 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. The Company 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 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 and cleared derivatives, margin deposits are required as well as daily cash settlements of margin accounts. As of December 31, 2017, the Company pledged $10 million in the form of margin deposits.
For those derivatives which qualify for fair value hedge accounting, net income includes the changes in the fair value of both the derivative instrument and the hedged risk, and therefore reflects any hedging ineffectiveness. For cash flow hedges, gains and losses are amortized from AOCI and are reported in net income in the same period the forecasted transactions being hedged impact net income.
Non-hedge accounting is generally used for “portfolio” level hedging strategies where the terms of the individual hedged items do not meet the strict homogeneity requirements to permit the application of hedge accounting. For non-hedge derivatives, net income includes changes in fair value and accrued periodic settlements, when applicable. With the exception of non-hedge derivatives used for asset replication and non-hedge embedded derivatives, all of the Company’s derivatives are evaluated for their ongoing effectiveness as either accounting hedge or non-hedge derivative financial instruments on at least a quarterly basis.
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2017 Form 10-K Notes to Consolidated Financial Statements
| Summary of the volume and fair value positions of derivative instruments as of December 31, 2017 | ||||||||||||||||||||
| Volume (1) | ||||||||||||||||||||
| ($ in millions, except number of contracts) | Balance sheet location | Notional amount | Number of contracts | Fair value, net | Gross asset | Gross liability | ||||||||||||||
| Asset derivatives | ||||||||||||||||||||
| Derivatives not designated as accounting hedging instruments | ||||||||||||||||||||
| Interest rate contracts | ||||||||||||||||||||
| Interest rate cap agreements | Other investments | $ | 15 | n/a | $ | — | $ | — | $ | — | ||||||||||
| Equity and index contracts | ||||||||||||||||||||
| Options | Other investments | — | 6,316 | 125 | 125 | — | ||||||||||||||
| Financial futures contracts | Other assets | — | 289 | — | — | — | ||||||||||||||
| Foreign currency contracts | ||||||||||||||||||||
| Foreign currency forwards | Other investments | 52 | n/a | 1 | 1 | — | ||||||||||||||
| Credit default contracts | ||||||||||||||||||||
| Credit default swaps – buying protection | Other investments | 105 | n/a | (1 | ) | — | (1 | ) | ||||||||||||
| Credit default swaps – selling protection | Other investments | 80 | n/a | 1 | 1 | — | ||||||||||||||
| Other contracts | ||||||||||||||||||||
| Other contracts | Other assets | 3 | n/a | — | — | — | ||||||||||||||
| Total asset derivatives | $ | 255 | 6,605 | $ | 126 | $ | 127 | $ | (1 | ) | ||||||||||
| Liability derivatives | ||||||||||||||||||||
| Derivatives designated as accounting hedging instruments | ||||||||||||||||||||
| Foreign currency swap agreements | Other liabilities & accrued expenses | $ | 19 | n/a | $ | 2 | $ | 2 | $ | — | ||||||||||
| Derivatives not designated as accounting hedging instruments | ||||||||||||||||||||
| Interest rate contracts | ||||||||||||||||||||
| Interest rate cap agreements | Other liabilities & accrued expenses | 30 | n/a | 1 | 1 | — | ||||||||||||||
| Equity and index contracts | ||||||||||||||||||||
| Options and futures | Other liabilities & accrued expenses | — | 7,128 | (58 | ) | — | (58 | ) | ||||||||||||
| Foreign currency contracts | ||||||||||||||||||||
| Foreign currency forwards | Other liabilities & accrued expenses | 650 | n/a | (17 | ) | 3 | (20 | ) | ||||||||||||
| Embedded derivative financial instruments | ||||||||||||||||||||
| Guaranteed accumulation benefits | Contractholder funds | 225 | n/a | (22 | ) | — | (22 | ) | ||||||||||||
| Guaranteed withdrawal benefits | Contractholder funds | 274 | n/a | (12 | ) | — | (12 | ) | ||||||||||||
| Equity-indexed and forward starting options in life and annuity product contracts | Contractholder funds | 1,774 | n/a | (252 | ) | — | (252 | ) | ||||||||||||
| Credit default contracts | ||||||||||||||||||||
| Credit default swaps – buying protection | Other liabilities & accrued expenses | 136 | n/a | (5 | ) | — | (5 | ) | ||||||||||||
| Credit default swaps – selling protection | Other liabilities & accrued expenses | 25 | n/a | — | — | — | ||||||||||||||
| Subtotal | 3,114 | 7,128 | (365 | ) | 4 | (369 | ) | |||||||||||||
| Total liability derivatives | 3,133 | 7,128 | (363 | ) | $ | 6 | $ | (369 | ) | |||||||||||
| Total derivatives | $ | 3,388 | 13,733 | $ | (237 | ) |
| (1) | Volume for OTC and cleared derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable) |
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| Summary of the volume and fair value positions of derivative instruments as of December 31, 2016 | ||||||||||||||||||||
| Volume (1) | ||||||||||||||||||||
| ($ in millions, except number of contracts) | Balance sheet location | Notional amount | Number of contracts | Fair value, net | Gross asset | Gross liability | ||||||||||||||
| Asset derivatives | ||||||||||||||||||||
| Derivatives designated as accounting hedging instruments | ||||||||||||||||||||
| Foreign currency swap agreements | Other investments | $ | 49 | n/a | $ | 5 | $ | 5 | $ | — | ||||||||||
| Derivatives not designated as accounting hedging instruments | ||||||||||||||||||||
| Interest rate contracts | ||||||||||||||||||||
| Interest rate cap agreements | Other investments | 65 | n/a | 1 | 1 | — | ||||||||||||||
| Equity and index contracts | ||||||||||||||||||||
| Options | Other investments | — | 3,972 | 88 | 88 | — | ||||||||||||||
| Financial futures contracts | Other assets | — | 261 | — | — | — | ||||||||||||||
| Foreign currency contracts | ||||||||||||||||||||
| Foreign currency forwards | Other investments | 759 | n/a | — | 24 | (24 | ) | |||||||||||||
| Credit default contracts | ||||||||||||||||||||
| Credit default swaps – buying protection | Other investments | 87 | n/a | (4 | ) | — | (4 | ) | ||||||||||||
| Credit default swaps – selling protection | Other investments | 140 | n/a | 2 | 2 | — | ||||||||||||||
| Other contracts | ||||||||||||||||||||
| Other contracts | Other assets | 3 | n/a | 1 | 1 | — | ||||||||||||||
| Subtotal | 1,054 | 4,233 | 88 | 116 | (28 | ) | ||||||||||||||
| Total asset derivatives | $ | 1,103 | 4,233 | $ | 93 | $ | 121 | $ | (28 | ) | ||||||||||
| | | | | | | |||||||||||||||
| Liability derivatives | ||||||||||||||||||||
| Derivatives not designated as accounting hedging instruments | ||||||||||||||||||||
| Equity and index contracts | ||||||||||||||||||||
| Options and futures | Other liabilities & accrued expenses | $ | — | 4,848 | $ | (39 | ) | $ | — | $ | (39 | ) | ||||||||
| Embedded derivative financial instruments | ||||||||||||||||||||
| Guaranteed accumulation benefits | Contractholder funds | 391 | n/a | (34 | ) | — | (34 | ) | ||||||||||||
| Guaranteed withdrawal benefits | Contractholder funds | 290 | n/a | (9 | ) | — | (9 | ) | ||||||||||||
| Equity-indexed and forward starting options in life and annuity product contracts | Contractholder funds | 1,751 | n/a | (247 | ) | — | (247 | ) | ||||||||||||
| Credit default contracts | ||||||||||||||||||||
| Credit default swaps – buying protection | Other liabilities & accrued expenses | 136 | n/a | (2 | ) | — | (2 | ) | ||||||||||||
| Credit default swaps – selling protection | Other liabilities & accrued expenses | 105 | n/a | (3 | ) | — | (3 | ) | ||||||||||||
| Total liability derivatives | 2,673 | 4,848 | (334 | ) | $ | — | $ | (334 | ) | |||||||||||
| Total derivatives | $ | 3,776 | 9,081 | $ | (241 | ) |
| (1) | Volume for OTC and cleared derivative contracts is represented by their notional amounts. Volume for exchange traded derivatives is represented by the number of contracts, which is the basis on which they are traded. (n/a = not applicable) |
| Gross and net amounts for OTC derivatives (1) | ||||||||||||||||||||||||
| Offsets | ||||||||||||||||||||||||
| ($ in millions) | Gross amount | Counter- party netting | Cash collateral (received) pledged | Net amount on balance sheet | Securities collateral (received) pledged | Net amount | ||||||||||||||||||
| December 31, 2017 | ||||||||||||||||||||||||
| Asset derivatives | $ | 8 | $ | (7 | ) | $ | 1 | $ | 2 | $ | — | $ | 2 | |||||||||||
| Liability derivatives | (26 | ) | 7 | 7 | (12 | ) | 3 | (9 | ) | |||||||||||||||
| December 31, 2016 | ||||||||||||||||||||||||
| Asset derivatives | $ | 31 | $ | (28 | ) | $ | 19 | $ | 22 | $ | (9 | ) | $ | 13 | ||||||||||
| Liability derivatives | (33 | ) | 28 | — | (5 | ) | 4 | (1 | ) |
| (1) | All OTC derivatives are subject to enforceable master netting agreements. |
The Allstate Corporation 165
2017 Form 10-K Notes to Consolidated Financial Statements
| Summary of the impacts of the foreign currency contracts in cash flow hedging relationships | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| (Loss) gain recognized in OCI on derivatives during the period | $ | (2 | ) | $ | — | $ | 10 | |||||
| (Loss) gain recognized in OCI on derivatives during the term of the hedging relationship | (1 | ) | 2 | 6 | ||||||||
| Gain (loss) reclassified from AOCI into income (net investment income) | 1 | 1 | (1 | ) | ||||||||
| Gain reclassified from AOCI into income (realized capital gains and losses) | — | 3 | 3 |
Amortization of net gains from AOCI related to cash flow hedges is expected to be a gain of $2 million during the next twelve months. There was no hedge ineffectiveness reported in realized gains and losses in 2017, 2016 or 2015.
| Gains and losses from valuation and settlements reported on derivatives not designated as accounting hedges | ||||||||||||||||||||
| ($ in millions) | Realized capital gains and losses | Life contract benefits | Interest credited to contractholder funds | Operating costs and expenses | Total gain (loss) recognized in net income on derivatives | |||||||||||||||
| 2017 | ||||||||||||||||||||
| Equity and index contracts | $ | (15 | ) | $ | — | $ | 47 | $ | 28 | $ | 60 | |||||||||
| Embedded derivative financial instruments | — | 9 | (6 | ) | — | 3 | ||||||||||||||
| Foreign currency contracts | (27 | ) | — | — | 6 | (21 | ) | |||||||||||||
| Credit default contracts | (4 | ) | — | — | — | (4 | ) | |||||||||||||
| Total | $ | (46 | ) | $ | 9 | $ | 41 | $ | 34 | $ | 38 | |||||||||
| 2016 | ||||||||||||||||||||
| Equity and index contracts | $ | (12 | ) | $ | — | $ | 18 | $ | 19 | $ | 25 | |||||||||
| Embedded derivative financial instruments | — | 9 | — | — | 9 | |||||||||||||||
| Foreign currency contracts | 17 | — | — | (35 | ) | (18 | ) | |||||||||||||
| Credit default contracts | (5 | ) | — | — | — | (5 | ) | |||||||||||||
| Total | $ | — | $ | 9 | $ | 18 | $ | (16 | ) | $ | 11 | |||||||||
| 2015 | ||||||||||||||||||||
| Interest rate contracts | $ | 1 | $ | — | $ | — | $ | — | $ | 1 | ||||||||||
| Equity and index contracts | 1 | — | (9 | ) | (1 | ) | (9 | ) | ||||||||||||
| Embedded derivative financial instruments | — | (7 | ) | 31 | — | 24 | ||||||||||||||
| Foreign currency contracts | (24 | ) | — | — | (8 | ) | (32 | ) | ||||||||||||
| Credit default contracts | (2 | ) | — | — | — | (2 | ) | |||||||||||||
| Total | $ | (24 | ) | $ | (7 | ) | $ | 22 | $ | (9 | ) | $ | (18 | ) |
In 2017, 2016 and 2015, the Company had no derivatives used in fair value hedging relationships.
The Company manages its exposure to credit risk by utilizing highly rated counterparties, establishing risk control limits, executing legally enforceable master netting agreements (“MNAs”) and obtaining collateral where appropriate. The Company uses MNAs for OTC derivative transactions that permit either party to net payments due for transactions and collateral is either pledged or obtained when certain predetermined exposure limits are exceeded. As of December 31, 2017, counterparties pledged $3 million in cash to the Company, and the Company pledged $14 million in cash and securities to counterparties which includes $6 million of collateral posted under MNAs for contracts containing credit-risk contingent provisions that are in a liability position and $8 million of collateral posted under MNAs for contracts without credit-risk-
contingent features. The Company has not incurred any losses on derivative financial instruments due to counterparty nonperformance. Other derivatives, including futures and certain option contracts, are traded on organized exchanges which require margin deposits and guarantee the execution of trades, thereby mitigating any potential credit risk.
Counterparty credit exposure represents the Company’s potential loss if all of the counterparties concurrently fail to perform under the contractual terms of the contracts and all collateral, if any, becomes worthless. This exposure is measured by the fair value of OTC derivative contracts with a positive fair value at the reporting date reduced by the effect, if any, of legally enforceable master netting agreements.
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Notes to Consolidated Financial Statements 2017 Form 10-K
| OTC derivatives counterparty credit exposure by counterparty credit rating | ||||||||||||||||||||||||||||||
| ($ in millions) | 2017 | 2016 | ||||||||||||||||||||||||||||
| Rating (1) | Number of counter-parties | Notional amount (2) | Credit exposure (2) | Exposure, net of collateral (2) | Number of counter-parties | Notional amount (2) | Credit exposure (2) | Exposure, net of collateral (2) | ||||||||||||||||||||||
| AA– | 1 | $ | 18 | $ | 1 | $ | — | 2 | $ | 80 | $ | 2 | $ | 2 | ||||||||||||||||
| A+ | 3 | 90 | 3 | 1 | 5 | 698 | 20 | 9 | ||||||||||||||||||||||
| A– | — | — | — | — | 1 | 110 | 1 | 1 | ||||||||||||||||||||||
| Total | 4 | $ | 108 | $ | 4 | $ | 1 | 8 | $ | 888 | $ | 23 | $ | 12 |
| (1) | Rating is the lower of S&P or Moody’s ratings. |
| (2) | Only OTC derivatives with a net positive fair value are included for each counterparty. |
Market risk is the risk that the Company will incur losses due to adverse changes in market rates and prices. Market risk exists for all of the derivative financial instruments the Company currently holds, as these instruments may become less valuable due to adverse changes in market conditions. To limit this risk, the Company’s senior management has established risk control limits. In addition, changes in fair value of the derivative financial instruments that the Company uses for risk management purposes are generally offset by the change in the fair value or cash flows of the hedged risk component of the related assets, liabilities or forecasted transactions.
Certain of the Company’s derivative instruments contain credit-risk-contingent termination events, cross-default provisions and credit support annex agreements. Credit-risk-contingent termination events allow the counterparties to terminate the derivative agreement or a specific trade on certain dates if AIC’s, ALIC’s or Allstate Life Insurance Company of New
York’s (“ALNY”) financial strength credit ratings by Moody’s or S&P fall below a certain level. Credit-risk-contingent cross-default provisions allow the counterparties to terminate the derivative agreement if the Company defaults by pre-determined threshold amounts on certain debt instruments. Credit-risk-contingent credit support annex agreements specify the amount of collateral the Company must post to counterparties based on AIC’s, ALIC’s or ALNY’s financial strength credit ratings by Moody’s or S&P, or in the event AIC, ALIC or ALNY are no longer rated by either Moody’s or S&P.
The following summarizes the fair value of derivative instruments with termination, cross-default or collateral credit-risk-contingent features that are in a liability position as of December 31, as well as the fair value of assets and collateral that are netted against the liability in accordance with provisions within legally enforceable MNAs.
| ($ in millions) | 2017 | 2016 | ||||||
| Gross liability fair value of contracts containing credit-risk-contingent features | $ | 28 | $ | 9 | ||||
| Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs | (17 | ) | (7 | ) | ||||
| Collateral posted under MNAs for contracts containing credit-risk-contingent features | (6 | ) | — | |||||
| Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently | $ | 5 | $ | 2 |
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2017 Form 10-K Notes to Consolidated Financial Statements
Credit derivatives – selling protection
A credit default swap (“CDS”) is a derivative instrument, representing an agreement between two parties to exchange the credit risk of a specified entity (or a group of entities), or an index based on the credit risk of a group of entities (all commonly referred to as the “reference entity” or a portfolio of “reference entities”), in return for a periodic premium. In selling
protection, CDS’s 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. CDS’s typically have a five-year term.
| CDS notional amounts by credit rating and fair value of protection sold | ||||||||||||||||||||||||
| Notional amount | ||||||||||||||||||||||||
| ($ in millions) | AA | A | BBB | BB and lower | Total | Fair value | ||||||||||||||||||
| December 31, 2017 | ||||||||||||||||||||||||
| Single name | ||||||||||||||||||||||||
| Corporate debt | $ | — | $ | 10 | $ | 10 | $ | 5 | $ | 25 | $ | — | ||||||||||||
| Index | ||||||||||||||||||||||||
| Corporate debt | 1 | 19 | 45 | 15 | 80 | 1 | ||||||||||||||||||
| Total | $ | 1 | $ | 29 | $ | 55 | $ | 20 | $ | 105 | $ | 1 | ||||||||||||
| December 31, 2016 | ||||||||||||||||||||||||
| Single name | ||||||||||||||||||||||||
| Corporate debt | $ | 20 | $ | 10 | $ | 35 | $ | — | $ | 65 | $ | 1 | ||||||||||||
| First-to-default Basket | ||||||||||||||||||||||||
| Municipal | — | — | 100 | — | 100 | (3 | ) | |||||||||||||||||
| Index | ||||||||||||||||||||||||
| Corporate debt | 1 | 19 | 50 | 10 | 80 | 1 | ||||||||||||||||||
| Total | $ | 21 | $ | 29 | $ | 185 | $ | 10 | $ | 245 | $ | (1 | ) |
In selling protection with CDS, the Company sells 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 receives periodic premiums through expiration or termination of the agreement. With single name CDS, this premium or credit spread generally corresponds to the difference between the yield on the reference entity’s public fixed maturity cash instruments and swap rates at the time the agreement is executed. With a FTD basket, because of the additional credit risk inherent in a basket of named reference entities, the premium generally corresponds to a high proportion of the sum of the credit spreads of the names in the basket and the correlation between the names. CDX is utilized to take a position on multiple (generally 125) reference entities. Credit events are typically defined as bankruptcy, failure to pay, or restructuring, depending on the nature of the reference entities. If a credit event occurs, the Company settles 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 Company, in exchange for cash payment at par, whereas in a cash settlement, the Company pays the difference between par and the prescribed value of the reference asset. When a credit event occurs in a single name or FTD basket (for FTD, the first credit event occurring for any one name in the basket), the contract terminates at the time of settlement. For CDX, 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. A physical settlement may afford the Company with recovery rights as the new owner of the asset.
The Company monitors risk associated with credit derivatives through individual name credit limits at both a credit derivative and a combined cash instrument/credit derivative level. The ratings of individual names for which protection has been sold are also monitored.
Off-balance sheet financial instruments
| Contractual amounts of off balance sheet financial instruments | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Commitments to invest in limited partnership interests | $ | 3,121 | $ | 2,979 | ||||
| Private placement commitments | 96 | 69 | ||||||
| Other loan commitments | 97 | 83 |
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Notes to Consolidated Financial Statements 2017 Form 10-K
In the preceding table, the contractual amounts represent the amount at risk if the contract is fully drawn upon, the counterparty defaults and the value of any underlying security becomes worthless. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk.
Commitments to invest in limited partnership interests represent agreements to acquire new or additional participation in certain limited partnership investments. The Company enters into these agreements in the normal course of business. Because the investments in limited partnerships are not actively traded, it is not practical to estimate the fair value of these commitments.
Private placement commitments represent commitments to purchase private placement debt and
private equity securities at a future date. The Company enters into these agreements in the normal course of business. The fair value of the debt commitments generally cannot be estimated on the date the commitment is made as the terms and conditions of the underlying private placement securities are not yet final. Because the private equity securities are not actively traded, it is not practical to estimate fair value of the commitments.
Other loan commitments are agreements to lend to a borrower provided there is no violation of any condition established in the contract. The Company enters into these agreements to commit to future loan fundings at predetermined interest rates. Commitments have either fixed or varying expiration dates or other termination clauses. The fair value of these commitments is insignificant.
| Note 8 | Reserve for Property and Casualty Insurance Claims and Claims Expense |
The Company establishes reserves for claims and claims expense on reported and unreported claims of insured losses. The Company’s reserving process takes into account known facts and interpretations of circumstances and factors including the Company’s experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. In the normal course of business, the Company may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.
Because reserves are estimates of unpaid portions of losses that have occurred, including incurred but not
reported (“IBNR”) losses, the establishment of appropriate reserves, including reserves for catastrophes and reserves and reinsurance recoverables for Discontinued Lines and Coverages, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimates. The highest degree of uncertainty is associated with reserves for losses incurred in the current reporting period as it contains the greatest proportion of losses that have not been reported or settled. The Company regularly updates its reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reported in property and casualty insurance claims and claims expense in the Consolidated Statements of Operations in the period such changes are determined.
| Rollforward of reserve for property and casualty insurance claims and claims expense | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Balance as of January 1 | $ | 25,250 | $ | 23,869 | $ | 22,923 | ||||||
| Less reinsurance recoverables | 6,184 | 5,892 | 5,694 | |||||||||
| Net balance as of January 1 | 19,066 | 17,977 | 17,229 | |||||||||
| SquareTrade acquisition as of January 3, 2017 | 17 | — | — | |||||||||
| Incurred claims and claims expense related to: | ||||||||||||
| Current year | 22,432 | 22,238 | 20,953 | |||||||||
| Prior years | (503 | ) | (17 | ) | 81 | |||||||
| Total incurred | 21,929 | 22,221 | 21,034 | |||||||||
| Claims and claims expense paid related to: | ||||||||||||
| Current year | 14,194 | 14,222 | 13,660 | |||||||||
| Prior years | 6,964 | 6,910 | 6,626 | |||||||||
| Total paid | 21,158 | 21,132 | 20,286 | |||||||||
| Net balance as of December 31 | 19,854 | 19,066 | 17,977 | |||||||||
| Plus reinsurance recoverables | 6,471 | 6,184 | 5,892 | |||||||||
| Balance as of December 31 | $ | 26,325 | $ | 25,250 | $ | 23,869 |
Incurred claims and claims expense represents the sum of paid losses and reserve changes in the calendar year. This expense includes losses from catastrophes of $3.23 billion, $2.57 billion and $1.72 billion in 2017,
2016 and 2015, respectively, net of reinsurance and other recoveries (see Note 10). Catastrophes are an inherent risk of the property and casualty insurance business that have contributed to, and will continue to
The Allstate Corporation 169
2017 Form 10-K Financial Statements
contribute to, material year-to-year fluctuations in the Company’s results of operations and financial position.
The Company calculates and records a single best reserve estimate for losses from catastrophes, in conformance with generally accepted actuarial standards. As a result, management believes that no other estimate is better than the recorded amount. Due to the uncertainties involved, including the factors described above, the ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimates. Accordingly, management believes that it is not practical to develop a meaningful range for any such changes in losses incurred.
During 2017, incurred claims and claims expense related to prior years was primarily comprised of net decreases in auto and homeowners reserves of $490 million and $131 million, respectively, primarily related to a reduction in claim severity estimates for liability coverages, net increases in Discontinued Lines and Coverages of $96 million and net increases in other reserves of $22 million. Incurred claims and claims expense includes favorable catastrophe loss reestimates of $18 million, net of reinsurance and other recoveries.
During 2016, incurred claims and claims expense related to prior years was primarily composed of net decreases in auto reserves of $155 million primarily due to claim severity development for bodily injury coverage that was better than expected, net decreases in homeowners reserves of $24 million due to favorable non-catastrophe reserve reestimates, net increases in other reserves of $57 million primarily due to unfavorable commercial business non-catastrophe losses, and net increases in Discontinued Lines and Coverages reserves of $105 million. Incurred claims and claims expense includes unfavorable catastrophe loss reestimates of $6 million, net of reinsurance and other recoveries.
During 2015, incurred claims and claims expense related to prior years was primarily composed of net increases in auto reserves of $30 million primarily due to claim severity development for bodily injury coverage that was more than expected and litigation settlements, net decreases in homeowners reserves of $24 million due to favorable non-catastrophe reserve reestimates, net increases in other reserves of $22 million, and net increases in Discontinued Lines and Coverages reserves of $53 million. Incurred claims and claims expense includes favorable catastrophe loss reestimates of $15 million, net of reinsurance and other recoveries.
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Notes to Consolidated Financial Statements 2017 Form 10-K
The following presents information about incurred and paid claims development as of December 31, 2017, net of reinsurance, as well as the cumulative number of reported claims and the total of IBNR reserves plus expected development on reported claims included in the net incurred claims amounts. See Note 2 for the accounting policy and methodology for determining reserves for claims and claims expense, including both reported and IBNR claims. The cumulative number of reported claims is identified by coverage and excludes reported claims for industry pools and facilities where information is not available. The information about incurred and paid claims development for the 2013 to 2017 years, and the average annual percentage payout of incurred claims by age as of December 31, 2017, is presented as required supplementary information.
Auto insurance – liability coverage
| ($ in millions, except number of reported claims) | Incurred claims and allocated claim adjustment expenses, net of reinsurance | IBNR reserves plus expected development on reported claims | Cumulative number of reported claims | ||||||||||||||||||||||||
| For the years ended December 31, | As of December 31, 2017 | ||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 7,461 | $ | 7,429 | $ | 7,446 | $ | 7,387 | $ | 7,317 | $ | 513 | 2,114,149 | ||||||||||||||
| 2014 | — | 7,889 | 7,955 | 7,882 | 7,785 | 951 | 2,194,476 | ||||||||||||||||||||
| 2015 | — | — | 8,896 | 8,816 | 8,721 | 1,828 | 2,380,096 | ||||||||||||||||||||
| 2016 | — | — | — | 9,169 | 8,926 | 3,149 | 2,387,023 | ||||||||||||||||||||
| 2017 | — | — | — | — | 8,621 | 5,465 | 2,112,379 | ||||||||||||||||||||
| Total | $ | 41,370 | |||||||||||||||||||||||||
| Cumulative paid claims and allocated claims adjustment expenses, net of reinsurance | |||||||||||||||||||||||||||
| For the years ended December 31, | |||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 2,955 | $ | 4,993 | $ | 5,946 | $ | 6,493 | $ | 6,804 | |||||||||||||||||
| 2014 | — | 3,177 | 5,322 | 6,265 | 6,834 | ||||||||||||||||||||||
| 2015 | — | — | 3,529 | 5,846 | 6,893 | ||||||||||||||||||||||
| 2016 | — | — | — | 3,491 | 5,777 | ||||||||||||||||||||||
| 2017 | — | — | — | — | 3,156 | ||||||||||||||||||||||
| Total | $ | 29,464 | |||||||||||||||||||||||||
| All outstanding liabilities before 2013, net of reinsurance | 1,275 | ||||||||||||||||||||||||||
| Liabilities for claims and claim adjustment expenses, net of reinsurance | $ | 13,181 |
| Average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31, 2017 | |||||||||||||||
| 1 year | 2 years | 3 years | 4 years | 5 years | |||||||||||
| Auto insurance – liability coverage | 40.2 | % | 27.4 | % | 12.5 | % | 8.0 | % | 4.7 | % |
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2017 Form 10-K Financial Statements
Auto insurance – physical damage coverage
| ($ in millions, except number of reported claims) | Incurred claims and allocated claim adjustment expenses, net of reinsurance | IBNR reserves plus expected development on reported claims | Cumulative number of reported claims | ||||||||||||||||||||||||
| For the years ended December 31, | As of December 31, 2017 | ||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 3,894 | $ | 3,866 | $ | 3,854 | $ | 3,844 | $ | 3,842 | $ | 1 | 3,777,287 | ||||||||||||||
| 2014 | — | 4,308 | 4,296 | 4,270 | 4,273 | 3 | 4,144,310 | ||||||||||||||||||||
| 2015 | — | — | 4,663 | 4,688 | 4,676 | 11 | 4,388,829 | ||||||||||||||||||||
| 2016 | — | — | — | 5,136 | 5,058 | 19 | 4,426,714 | ||||||||||||||||||||
| 2017 | — | — | — | — | 5,131 | 278 | 4,075,755 | ||||||||||||||||||||
| Total | $ | 22,980 | |||||||||||||||||||||||||
| Cumulative paid claims and allocated claims adjustment expenses, net of reinsurance | |||||||||||||||||||||||||||
| For the years ended December 31, | |||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 3,718 | $ | 3,848 | $ | 3,841 | $ | 3,841 | $ | 3,841 | |||||||||||||||||
| 2014 | — | 4,148 | 4,281 | 4,273 | 4,270 | ||||||||||||||||||||||
| 2015 | — | — | 4,513 | 4,679 | 4,665 | ||||||||||||||||||||||
| 2016 | — | — | — | 4,895 | 5,039 | ||||||||||||||||||||||
| 2017 | — | — | — | — | 4,853 | ||||||||||||||||||||||
| Total | $ | 22,668 | |||||||||||||||||||||||||
| All outstanding liabilities before 2013, net of reinsurance | 9 | ||||||||||||||||||||||||||
| Liabilities for claims and claim adjustment expenses, net of reinsurance | $ | 321 |
| Average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31, 2017 | |||||||||||||||
| 1 year | 2 years | 3 years | 4 years | 5 years | |||||||||||
| Auto insurance – physical damage coverage | 96.6 | % | 3.2 | % | (0.2 | )% | — | % | — | % |
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Notes to Consolidated Financial Statements 2017 Form 10-K
Homeowners insurance
| ($ in millions, except number of reported claims) | Incurred claims and allocated claim adjustment expenses, net of reinsurance | IBNR reserves plus expected development on reported claims | Cumulative number of reported claims | ||||||||||||||||||||||||
| For the years ended December 31, | As of December 31, 2017 | ||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 3,098 | $ | 3,170 | $ | 3,163 | $ | 3,142 | $ | 3,121 | $ | 51 | 682,873 | ||||||||||||||
| 2014 | — | 3,608 | 3,651 | 3,653 | 3,621 | 88 | 765,001 | ||||||||||||||||||||
| 2015 | — | — | 3,572 | 3,622 | 3,560 | 158 | 720,102 | ||||||||||||||||||||
| 2016 | — | — | — | 3,972 | 4,001 | 319 | 809,045 | ||||||||||||||||||||
| 2017 | — | — | — | — | 4,490 | 1,260 | 840,254 | ||||||||||||||||||||
| Total | $ | 18,793 | |||||||||||||||||||||||||
| Cumulative paid claims and allocated claims adjustment expenses, net of reinsurance | |||||||||||||||||||||||||||
| For the years ended December 31, | |||||||||||||||||||||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | ||||||||||||||||||||||||
| Accident year | 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||||||||
| 2013 | $ | 2,288 | $ | 2,885 | $ | 2,998 | $ | 3,045 | $ | 3,070 | |||||||||||||||||
| 2014 | — | 2,736 | 3,365 | 3,481 | 3,533 | ||||||||||||||||||||||
| 2015 | — | — | 2,589 | 3,299 | 3,402 | ||||||||||||||||||||||
| 2016 | — | — | — | 2,950 | 3,682 | ||||||||||||||||||||||
| 2017 | — | — | — | — | 3,230 | ||||||||||||||||||||||
| Total | $ | 16,917 | |||||||||||||||||||||||||
| All outstanding liabilities before 2013, net of reinsurance | 173 | ||||||||||||||||||||||||||
| Liabilities for claims and claim adjustment expenses, net of reinsurance | $ | 2,049 |
| Average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31, 2017 | |||||||||||||||
| 1 year | 2 years | 3 years | 4 years | 5 years | |||||||||||
| Homeowners insurance | 74.6 | % | 18.6 | % | 2.9 | % | 1.3 | % | 0.7 | % |
The Allstate Corporation 173
2017 Form 10-K Financial Statements
| Reconciliation of the net incurred and paid claims development tables above to the reserve for property and casualty insurance claims and claims expense | ||||
| ($ in millions) | As of December 31, 2017 | |||
| Net outstanding liabilities: | ||||
| Allstate Protection | ||||
| Auto insurance - Liability coverage | $ | 13,181 | ||
| Auto insurance - Physical damage coverage | 321 | |||
| Homeowners insurance | 2,049 | |||
| Other personal lines | 1,311 | |||
| Commercial lines | 593 | |||
| Service Businesses | 86 | |||
| Discontinued Lines and Coverages (1) | 1,335 | |||
| Unallocated loss adjustment expenses | 978 | |||
| Net reserve for property and casualty insurance claims and claims expense | 19,854 | |||
| Reinsurance recoverable: | ||||
| Allstate Protection | ||||
| Auto insurance - Liability coverage | 5,715 | |||
| Auto insurance - Physical damage coverage | — | |||
| Homeowners insurance | 23 | |||
| Other personal lines | 214 | |||
| Commercial lines | 20 | |||
| Service Businesses | 10 | |||
| Discontinued Lines and Coverages | 485 | |||
| Unallocated loss adjustment expenses | 4 | |||
| Total reinsurance recoverable | 6,471 | |||
| Gross reserve for property and casualty insurance claims and claims expense | $ | 26,325 |
| (1) | Discontinued Lines and Coverages includes business in run-off. All of the claims primarily relate to accident years more than 30 years ago. IBNR reserves represent $733 million of the total reserves as of December 31, 2017. |
Management believes that the reserve for property and casualty insurance claims and claims expense, net of reinsurance recoverables, is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by the date of the Consolidated Statements of Financial Position based on available facts, technology, laws and regulations.
Allstate’s reserves for asbestos claims were $884 million and $912 million, net of reinsurance recoverables of $412 million and $444 million, as of December 31, 2017 and 2016, respectively. Reserves for environmental claims were $166 million and $179 million, net of reinsurance recoverables of $33 million and $40 million, as of December 31, 2017 and 2016, respectively. For further discussion of asbestos and environmental reserves, see Note 14.
| Note 9 | Reserve for Life-Contingent Contract Benefits and Contractholder Funds |
| Reserve for life-contingent contract benefits | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Immediate fixed annuities: | ||||||||
| Structured settlement annuities | $ | 6,994 | $ | 6,681 | ||||
| Other immediate fixed annuities | 1,855 | 1,941 | ||||||
| Traditional life insurance | 2,722 | 2,643 | ||||||
| Accident and health insurance | 893 | 873 | ||||||
| Other | 85 | 101 | ||||||
| Total reserve for life-contingent contract benefits | $ | 12,549 | $ | 12,239 |
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Notes to Consolidated Financial Statements 2017 Form 10-K
| Key assumptions generally used in calculating the reserve for life-contingent contract benefits | ||||||
| Product | Mortality | Interest rate | Estimation method | |||
| Structured settlement annuities | U.S. population with projected calendar year improvements; mortality rates adjusted for each impaired life based on reduction in life expectancy | Interest rate assumptions range from 2.9% to 9.0% | Present value of contractually specified future benefits | |||
| Other immediate fixed annuities | 1983 group annuity mortality table with internal modifications; 1983 individual annuity mortality table; Annuity 2000 mortality table with internal modifications; Annuity 2000 mortality table; 1983 individual annuity mortality table with internal modifications | Interest rate assumptions range from 0% to 11.5% | Present value of expected future benefits based on historical experience | |||
| Traditional life insurance | Actual company experience plus loading | Interest rate assumptions range from 2.5% to 11.3% | Net level premium reserve method using the Company’s withdrawal experience rates; includes reserves for unpaid claims | |||
| Accident and health insurance | Actual company experience plus loading | Interest rate assumptions range from 3.0% to 7.0% | Unearned premium; additional contract reserves for mortality risk and unpaid claims | |||
| Other: Variable annuity guaranteed minimum death benefits (1) | Annuity 2012 mortality table with internal modifications | Interest rate assumptions range from 2.0% to 5.8% | Projected benefit ratio applied to cumulative assessments |
| (1) | In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with The Prudential Insurance Company of America, a subsidiary of Prudential Financial, Inc. (collectively “Prudential”). |
The Company records an adjustment to the reserve for life-contingent contract benefits that represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product investment portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency. The offset to this liability is recorded as a reduction of the unrealized net capital gains included in AOCI.
In conjunction with the segment changes in 2017, the Company evaluated the need for a reserve adjustment separately for traditional life insurance and immediate annuities with life contingencies. As of December 31, 2017, the Company recorded a $315 million increase to the reserve for life-contingent contract benefits and a $249 million decrease to unrealized net capital gains, after-tax, included in shareholders’ equity. This liability was zero as of December 31, 2016.
| Contractholder funds | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Interest-sensitive life insurance | $ | 8,190 | $ | 8,062 | ||||
| Investment contracts: | ||||||||
| Fixed annuities | 10,828 | 11,933 | ||||||
| Other investment contracts | 416 | 265 | ||||||
| Total contractholder funds | $ | 19,434 | $ | 20,260 |
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| Key contract provisions of contractholder funds | ||||
| Product | Interest rate | Withdrawal/surrender charges | ||
| Interest-sensitive life insurance | Interest rates credited range from 0% to 10.5% for equity-indexed life (whose returns are indexed to the S&P 500) and 1.0% to 6.0% for all other products | Either a percentage of account balance or dollar amount grading off generally over 20 years | ||
| Fixed annuities | Interest rates credited range from 0% to 9.8% for immediate annuities; (8.0)% to 12.3% for equity-indexed annuities (whose returns are indexed to the S&P 500); and 0.1% to 6.0% for all other products | Either a declining or a level percentage charge generally over ten years or less. Additionally, approximately 16.7% of fixed annuities are subject to market value adjustment for discretionary withdrawals | ||
| Other investment contracts: Guaranteed minimum income, accumulation and withdrawal benefits on variable (1) and fixed annuities and secondary guarantees on interest-sensitive life insurance and fixed annuities | Interest rates used in establishing reserves range from 1.5% to 10.3% | Withdrawal and surrender charges are based on the terms of the related interest-sensitive life insurance or fixed annuity contract |
| (1) | In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with Prudential. |
| Contractholder funds activity | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Balance, beginning of year | $ | 20,260 | $ | 21,295 | $ | 22,529 | ||||||
| Deposits | 1,130 | 1,164 | 1,203 | |||||||||
| Interest credited | 687 | 722 | 760 | |||||||||
| Benefits | (901 | ) | (966 | ) | (1,077 | ) | ||||||
| Surrenders and partial withdrawals | (999 | ) | (1,053 | ) | (1,278 | ) | ||||||
| Maturities of and interest payments on institutional products | — | (86 | ) | (1 | ) | |||||||
| Contract charges | (826 | ) | (829 | ) | (818 | ) | ||||||
| Net transfers from separate accounts | 5 | 5 | 7 | |||||||||
| Other adjustments | 78 | 8 | (30 | ) | ||||||||
| Balance, end of year | $ | 19,434 | $ | 20,260 | $ | 21,295 |
The Company offered various guarantees to variable annuity contractholders. In 2006, the Company disposed of substantially all of its variable annuity business through reinsurance agreements with Prudential. Liabilities for variable contract guarantees related to death benefits are included in the reserve for life-contingent contract benefits and the liabilities related to the income, withdrawal and accumulation benefits are included in contractholder funds. All liabilities for variable contract guarantees are reported on a gross basis on the balance sheet with a corresponding reinsurance recoverable asset for those contracts subject to reinsurance.
Absent any contract provision wherein the Company guarantees either a minimum return or account value upon death, a specified contract anniversary date, partial withdrawal or annuitization, variable annuity and variable life insurance contractholders bear the investment risk that the separate accounts’ funds may not meet their stated investment objectives. The account balances of variable annuities contracts’ separate accounts with guarantees included $3.02 billion and $2.93 billion of equity, fixed income and balanced mutual funds and $322 million and $364 million of money market mutual funds as of December 31, 2017 and 2016, respectively.
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The table below presents information regarding the Company’s variable annuity contracts with guarantees. The Company’s variable annuity contracts may offer more than one type of guarantee in each contract; therefore, the sum of amounts listed exceeds the total account balances of variable annuity contracts’ separate accounts with guarantees.
| ($ in millions) | As of December 31, | |||||||
| 2017 | 2016 | |||||||
| In the event of death | ||||||||
| Separate account value | $ | 3,344 | $ | 3,298 | ||||
| Net amount at risk (1) | $ | 454 | $ | 585 | ||||
| Average attained age of contractholders | 70 years | 70 years | ||||||
| At annuitization (includes income benefit guarantees) | ||||||||
| Separate account value | $ | 944 | $ | 915 | ||||
| Net amount at risk (2) | $ | 202 | $ | 265 | ||||
| Weighted average waiting period until annuitization options available | None | None | ||||||
| For cumulative periodic withdrawals | ||||||||
| Separate account value | $ | 253 | $ | 267 | ||||
| Net amount at risk (3) | $ | 10 | $ | 10 | ||||
| Accumulation at specified dates | ||||||||
| Separate account value | $ | 170 | $ | 310 | ||||
| Net amount at risk (4) | $ | 17 | $ | 26 | ||||
| Weighted average waiting period until guarantee date | 5 years | 3 years |
| (1) | Defined as the estimated current guaranteed minimum death benefit in excess of the current account balance as of the balance sheet date. |
| (2) | Defined as the estimated present value of the guaranteed minimum annuity payments in excess of the current account balance. |
| (3) | Defined as the estimated current guaranteed minimum withdrawal balance (initial deposit) in excess of the current account balance as of the balance sheet date. |
| (4) | Defined as the estimated present value of the guaranteed minimum accumulation balance in excess of the current account balance. |
The liability for death and income benefit guarantees is equal to a benefit ratio multiplied by the cumulative contract charges earned, plus accrued interest less contract excess guarantee benefit payments. The benefit ratio is calculated as the estimated present value of all expected contract excess guarantee benefits divided by the present value of all expected contract charges. The establishment of reserves for these guarantees requires the projection of future fund values, mortality, persistency and customer benefit utilization rates. These assumptions are periodically reviewed and updated. For guarantees related to death benefits, benefits represent the projected excess guaranteed minimum death benefit payments. For guarantees related to income benefits, benefits represent the present value of the minimum guaranteed annuitization benefits in excess of the projected account balance at the time of annuitization.
Projected benefits and contract charges used in determining the liability for certain guarantees are developed using models and stochastic scenarios that are also used in the development of estimated expected gross profits. Underlying assumptions for the liability related to income benefits include assumed future annuitization elections based on factors such as the extent of benefit to the potential annuitant, eligibility conditions and the annuitant’s attained age. The liability for guarantees is re-evaluated periodically, and adjustments are made to the liability balance through a charge or credit to life and annuity contract benefits.
Guarantees related to the majority of withdrawal and accumulation benefits are considered to be derivative financial instruments; therefore, the liability for these benefits is established based on its fair value.
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| Summary of liabilities for guarantees | ||||||||||||||||
| ($ in millions) | Liability for guarantees related to death benefits and interest-sensitive life products | Liability for guarantees related to income benefits | Liability for guarantees related to accumulation and withdrawal benefits | Total | ||||||||||||
| Balance, December 31, 2016 (1) | $ | 244 | $ | 44 | $ | 77 | $ | 365 | ||||||||
| Less reinsurance recoverables | 101 | 40 | 43 | 184 | ||||||||||||
| Net balance as of December 31, 2016 | 143 | 4 | 34 | 181 | ||||||||||||
| Incurred guarantee benefits | 34 | — | 11 | 45 | ||||||||||||
| Paid guarantee benefits | (2 | ) | — | — | (2 | ) | ||||||||||
| Net change | 32 | — | 11 | 43 | ||||||||||||
| Net balance as of December 31, 2017 | 175 | 4 | 45 | 224 | ||||||||||||
| Plus reinsurance recoverables | 87 | 25 | 34 | 146 | ||||||||||||
| Balance, December 31, 2017 (2) | $ | 262 | $ | 29 | $ | 79 | $ | 370 | ||||||||
| Balance, December 31, 2015 (3) | $ | 223 | $ | 68 | $ | 75 | $ | 366 | ||||||||
| Less reinsurance recoverables | 106 | 64 | 52 | 222 | ||||||||||||
| Net balance as of December 31, 2015 | 117 | 4 | 23 | 144 | ||||||||||||
| Incurred guarantee benefits | 26 | — | 11 | 37 | ||||||||||||
| Paid guarantee benefits | — | — | — | — | ||||||||||||
| Net change | 26 | — | 11 | 37 | ||||||||||||
| Net balance as of December 31, 2016 | 143 | 4 | 34 | 181 | ||||||||||||
| Plus reinsurance recoverables | 101 | 40 | 43 | 184 | ||||||||||||
| Balance, December 31, 2016 (1) | $ | 244 | $ | 44 | $ | 77 | $ | 365 |
| (1) | Included in the total liability balance as of December 31, 2016 are reserves for variable annuity death benefits of $100 million, variable annuity income benefits of $40 million, variable annuity accumulation benefits of $34 million, variable annuity withdrawal benefits of $9 million and other guarantees of $182 million. |
| (2) | Included in the total liability balance as of December 31, 2017 are reserves for variable annuity death benefits of $85 million, variable annuity income benefits of $26 million, variable annuity accumulation benefits of $22 million, variable annuity withdrawal benefits of $12 million and other guarantees of $225 million. |
| (3) | Included in the total liability balance as of December 31, 2015 are reserves for variable annuity death benefits of $105 million, variable annuity income benefits of $65 million, variable annuity accumulation benefits of $38 million, variable annuity withdrawal benefits of $14 million and other guarantees of $144 million. |
| Note 10 | Reinsurance |
| Effects of reinsurance on property and casualty premiums written and earned and life premiums and contract charges | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Property and casualty insurance premiums written | ||||||||||||
| Direct | $ | 33,685 | $ | 32,614 | $ | 31,924 | ||||||
| Assumed | 64 | 47 | 39 | |||||||||
| Ceded | (1,007 | ) | (1,061 | ) | (1,092 | ) | ||||||
| Property and casualty insurance premiums written, net of reinsurance | $ | 32,742 | $ | 31,600 | $ | 30,871 | ||||||
| Property and casualty insurance premiums earned | ||||||||||||
| Direct | $ | 33,221 | $ | 32,249 | $ | 31,274 | ||||||
| Assumed | 50 | 45 | 41 | |||||||||
| Ceded | (971 | ) | (987 | ) | (1,006 | ) | ||||||
| Property and casualty insurance premiums earned, net of reinsurance | $ | 32,300 | $ | 31,307 | $ | 30,309 | ||||||
| Life premiums and contract charges | ||||||||||||
| Direct | $ | 1,894 | $ | 1,766 | $ | 1,641 | ||||||
| Assumed | 787 | 818 | 849 | |||||||||
| Ceded | (303 | ) | (309 | ) | (332 | ) | ||||||
| Life premiums and contract charges, net of reinsurance | $ | 2,378 | $ | 2,275 | $ | 2,158 |
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Notes to Consolidated Financial Statements 2017 Form 10-K
Property and casualty
Property and casualty reinsurance is in place for the Allstate Protection, Discontinued Lines and Coverages and Service Businesses segments. The Company purchases reinsurance after evaluating the financial condition of the reinsurer, as well as the terms and price of coverage. Developments in the insurance and reinsurance industries have fostered a movement to segregate asbestos, environmental and other discontinued lines exposures into separate legal entities with dedicated capital. Regulatory bodies in certain cases have supported these actions. The Company is unable to determine the impact, if any, that these developments will have on the collectability of reinsurance recoverables in the future.
Property and casualty reinsurance recoverable
Total amounts recoverable from reinsurers as of December 31, 2017 and 2016 were $6.57 billion and $6.28 billion, respectively, including $96 million and $93 million, respectively, related to property and casualty losses paid by the Company and billed to reinsurers, and $6.47 billion and $6.18 billion, respectively, estimated by the Company with respect to ceded unpaid losses (including IBNR), which are not billable until the losses are paid.
With the exception of the recoverable balances from the Michigan Catastrophic Claims Association (“MCCA”), Lloyd’s of London, New Jersey Property-Liability Insurance Guaranty Association (“PLIGA”) and other industry pools and facilities, the largest reinsurance recoverable balance the Company had outstanding was $61 million from Westport Insurance Corporation as of both December 31, 2017 and 2016. No other amount due or estimated to be due from any single reinsurer was in excess of $31 million and $35 million as of December 31, 2017 and 2016, respectively.
The allowance for uncollectible reinsurance was $70 million and $84 million as of December 31, 2017 and 2016, respectively, and is primarily related to the Company’s Discontinued Lines and Coverages segment.
Industry pools and facilities
Reinsurance recoverable on paid and unpaid claims including IBNR as of December 31, 2017 and 2016 includes $5.26 billion and $4.95 billion, respectively, from the MCCA. The MCCA is a state-mandated indemnification mechanism for personal injury protection losses that exceed a retention level which is adjusted upward every other MCCA fiscal year by the lesser of 6% or the increase in the Consumer Price Index. The retention level is currently $555 thousand per claim for the fiscal two-years ending June 30, 2019 compared to $545 thousand per claim for the fiscal two-years ending June 30, 2017. The MCCA is obligated to fund the ultimate liability for member companies (companies actively writing motor vehicle coverage in Michigan and those with runoff policies) qualifying claims and claims expenses. The MCCA operates similar to a reinsurance program and is annually funded by participating member companies (companies actively writing motor vehicle coverage in
Michigan) through a per vehicle annual assessment that is currently $170 per coverage. The assessment is incurred by the Company as polices are written and recovered as a component of premiums from our customers.
The MCCA has been legally authorized to annually assess participating member companies pursuant to enabling legislation that describes both the annual determination and assessment. This assessment is recorded as a component of the premiums charged to the Company’s customers. These assessments paid to the MCCA provide funds for the indemnification for losses described above. The MCCA is required to assess an amount each year sufficient to cover members’ actuarially determined present value of expected payments on lifetime claims of all persons expected to be catastrophically injured in that year, its operating expenses, and adjustments for the amount of excesses or deficiencies in prior assessments.
The MCCA prepares statutory-basis financial statements in conformity with accounting practices prescribed or permitted by the State of Michigan Department of Insurance and Financial Services (“MI DOI”). The MI DOI has granted the MCCA a statutory permitted practice that expires in 2019 to discount its liabilities for loss and loss adjustment expense. As of June 30, 2017, the date of its most recent annual financial report, the MCCA had cash and invested assets of $19.60 billion and an accumulated deficit of $2.63 billion. The permitted practice reduced the accumulated deficit by $46.08 billion.
Allstate sells and administers policies as a participant in the National Flood Insurance Program (“NFIP”). The amounts recoverable as of December 31, 2017 and 2016 were $88 million and $77 million, respectively. Ceded premiums earned include $263 million, $274 million and $293 million in 2017, 2016 and 2015, respectively. Ceded losses incurred include $1.12 billion, $537 million and $120 million in 2017, 2016 and 2015, respectively. Under the arrangement, the Federal Government pays all covered claims and certain qualifying claim expenses.
The PLIGA, as the statutory administrator of the New Jersey Unsatisfied Claim and Judgment Fund (“UCJF”), provides compensation to qualified claimants for personal injury protection, bodily injury, or death caused by private passenger automobiles operated by uninsured or “hit and run” drivers. The UCJF also provides private passenger stranger pedestrian personal injury protection benefits when no other coverage is available. The fund provides reimbursement to insurers for the medical benefits portion of personal injury protection coverage paid in excess of $75,000 with no limits for policies issued or renewed prior to January 1, 1991 and paid in excess of $75,000 and capped at $250,000 for policies issued or renewed from January 1, 1991 to December 31, 2003. PLIGA annually assesses all admitted property and casualty insurers writing motor vehicle liability insurance in New Jersey for PLIGA expenses. A significant portion of the incurred claim reserves and the recoverable can be attributed to a small number of catastrophic claims. Assessments paid to PLIGA for
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the UCJF program totaled $8.9 million in 2017. The amounts of paid and unpaid recoverable as of December 31, 2017 and 2016 were $493 million and $506 million, respectively.
Ceded premiums earned under the Florida Hurricane Catastrophe Fund (“FHCF”) agreement were $11 million, $12 million and $13 million in 2017, 2016 and 2015, respectively. Ceded losses in 2017 were $19 million. There were no ceded losses incurred in 2016 or 2015. The Company has access to reimbursement provided by the FHCF for 90% of qualifying personal property losses that exceed its current retention of $56 million for the 2 largest hurricanes and $19 million for other hurricanes, up to a maximum total of $187 million effective from June 1, 2017 to May 31, 2018. As of December 31, 2017 recoverable from the FHCF totaled $19 million. There were no amounts recoverable from the FHCF as of December 31, 2016.
Catastrophe reinsurance
The Company’s reinsurance program is designed to provide reinsurance protection for catastrophes resulting from multiple perils including hurricanes, windstorms, hail, tornadoes, fires following earthquakes, earthquakes and wildfires.
| • | The majority of our program comprises multi-year contracts, primarily placed in the traditional reinsurance market, such that one third of the program is renewed every year. |
| • | Coverage is generally purchased on a broad geographic, product line and multiple peril loss basis. |
| • | The Company purchases reinsurance from traditional reinsurance companies as well as the insurance linked securities market (e.g. “PCS Agreements”). |
| • | Florida property and New Jersey property and auto are each covered by separate agreements, as the risk of loss is different and our subsidiaries operating in these states are separately capitalized. |
The Company has the following catastrophe reinsurance agreements in effect as of December 31, 2017:
The Nationwide Per Occurrence Excess Catastrophe Reinsurance Program (the “Nationwide Program”) provides $4.42 billion of reinsurance coverage subject to a $500 million retention and is subject to the amount of reinsurance placed in each of its nine layers. The Nationwide Program comprises three agreements: The Per Occurrence Excess Agreement, the 2014-1 Property Claim Services (“PCS”) Agreement, and the 2017-1 Excess Catastrophe Reinsurance Contract.
Per Occurrence Excess Agreement, which is placed in the traditional reinsurance market, reinsures personal lines property and automobile excess catastrophe losses caused by multiple perils in every state except New Jersey and only includes personal lines automobile excess catastrophe losses in Florida. The agreement comprises layers one through six and
portions of layers eight and nine. Coverage for each of the first through fifth layers comprises three contracts, with each contract providing one-third of 95% of the total layer limit and expiring May 31, 2018, May 31, 2019 and May 31, 2020. The contracts expiring May 31, 2019 and May 31, 2020, include coverage for automobile losses in Florida, while the contract expiring May 31, 2018 does not include such provision. The sixth layer and eighth layer contracts placed in the traditional reinsurance market contain comparable contract terms and conditions as layers one through five.
The sixth layer is 95% placed and comprises one contract expiring May 31, 2022. The contracts for layers one through six provide $3.07 billion in per occurrence reinsurance limits subject to a $500 million retention. Coverage for a portion of the eighth layer is provided by one contract expiring May 31, 2022. The contract provides a $446 million limit and is 29.37% placed. Unlike layer one through five contracts, the sixth and eighth layer contracts each contain an annual variable reset option which allows for the adjustment of each contract’s attachment and exhaustion levels within specified limits. The variable reset option requires a premium adjustment. The contracts for each of the first through fifth layers include one reinstatement of limits per year, with premium required. The sixth and eighth layer contracts each contain one reinstatement of limits over their seven year term with premium required. Reinsurance premiums for all contracts are subject to redetermination for exposure changes on an annual basis.
Another contract forming a portion of layers eight and nine provides a $25 million limit in excess of a $2.75 billion retention, is 100% placed and expires May 31, 2018. Reinsurance limits of 5% of $1.67 billion in excess of $2.75 billion are deemed in place. In addition, recoveries from contracts in layers six through and including layer nine inure to the benefit of this contract.
2014-1 PCS Excess Agreement reinsures personal lines property and automobile excess catastrophe losses caused by hurricanes in 29 states and the District of Columbia, and earthquakes, including fires following earthquakes, in California, New York and Washington. The agreement comprises three contracts with each contract’s risk period beginning on May 22, 2014. Two of the three contracts’ risk periods expire on May 21, 2018 and one contract’s risk period expires on May 21, 2019. The placement of these three contracts achieves, for the perils of hurricanes, earthquakes and fires following earthquakes, $305 million limit (or 95% of $321 million) between $3.07 billion to $3.40 billion seventh layer; $115 million limit (or 26% of $446 million) between $3.40 billion to $3.84 billion eighth layer; and $330 million limit (or 57% of $578 million) between $3.84 billion to $4.42 billion ninth layer. The contracts comprising the agreement contain a variable reset option which the ceding entities may invoke for risk periods subsequent to the first risk period and which allows for the annual adjustment of each contract’s attachment and exhaustion levels within specified limits. The variable reset option
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requires a premium adjustment. The contracts do not include a reinstatement of limits.
2017-1 Excess Catastrophe Reinsurance Contract reinsures personal lines property and automobile excess losses in 48 states and the District of Columbia, excluding Florida and New Jersey, caused by hurricanes, severe thunderstorms, earthquakes including fire following winter storms, volcanic eruptions, and meteorite impacts. The contract reinsures actual losses to personal lines property business located in the covered territory and arising out of a covered event. Amounts payable for automobile losses are based on insured industry losses as reported by PCS and further indexed by annual payout factors specific to automobile exposures in the contract’s covered areas. Reinsurance recoveries under the contract are limited to our ultimate net loss from a covered event subject to the contract’s limit. The contract’s risk period began March 31, 2017 and terminates on November 30, 2021. The contract provides a $375 million limit (or 37% of $1.02 billion) between a $3.40 billion to $4.42 billion layer. The contract contains a variable reset option, which the ceding entities may invoke for risk periods subsequent to the first risk period and which allows for the annual adjustment of the contract’s attachment and exhaustion levels within specified limits. The variable reset option requires a premium. The contract does not include a restatement of limits.
The following programs are designed apart from the Nationwide Program to address distinct exposures in certain states and markets. These programs are described below and are disregarded when determining coverage under the contracts included in the Nationwide Program.
The Company has a separate reinsurance program in Florida designed to cover personal lines property policies in Florida written through its separately capitalized wholly-owned subsidiaries Castle Key Insurance Company (“CKIC”) and Castle Key Indemnity Company (“CKI”, and together with CKIC, “Castle Key”).
Florida Excess Catastrophe Reinsurance Agreement comprises five contracts, as described below, which reinsure Castle Key for personal lines property excess catastrophe losses in Florida. The agreement includes two contracts placed in the traditional market, CKIC’s and CKI’s reimbursement contracts with the Florida Hurricane Catastrophe Fund (“Mandatory FHCF contracts”), and the Sanders Re 2017-2 Contract (“Sanders Re 2017-2 contract”) placed in the ILS markets.
Below FHCF Contract reinsures personal lines property excess catastrophe losses caused by multiple perils in Florida. The contract is 100% placed and provides three separate limits of $38 million in excess of a $20 million retention for each occurrence, of which two limits remain outstanding. One limit of $38 million was exhausted from the impact of Hurricane Irma. The first reinstatement of limits is prepaid and the second or final reinstatement requires additional premium. Reinsurance premium is subject to redetermination for exposure changes.
Mandatory FHCF Contracts reinsures qualifying personal lines property losses caused by storms the National Hurricane Center declares to be hurricanes. The contracts provide 90% of $187 million of limits in excess of retention with no reinstatement of limits. The limits and retentions of the mandatory FHCF contracts are calculated independently for CKIC and CKI and are subject to re-measurement based on June 30, 2017 exposure data. For each of the two largest hurricanes, the retention is $56 million and retention equal to one third of that amount, or approximately $19 million, is applicable to all other hurricanes for the season beginning June 1, 2017. In addition, the FHCF’s retention is subject to adjustment upward or downward to an actual retention based on submitted exposures to the FHCF by all participants. $19 million of limit was exhausted from the impact of Hurricane Irma and $168 million of the limit remains outstanding.
Excess contract reinsures personal lines property excess catastrophe losses caused by multiple perils in Florida. The contract provides one limit of $231 million in excess of a $20 million retention and is 100% placed. Recoveries from the Below FHCF contract and Mandatory FHCF contracts inure to the benefit of this contract, resulting in the Excess contract providing reinsurance for loss occurrences not subject to reimbursement under the FHCF contracts but reinsured under the multiple peril Excess contract. The contract does not include a reinstatement of limits. $27 million of limit was exhausted for Hurricane Irma. Reinsurance premium is subject to redetermination for exposure.
Sanders Re 2017-2 is a three-year term contract with a risk period effective June 1, 2017 through May 31, 2020. It reinsures qualifying personal lines property losses caused by a named storm event, a severe thunderstorm event, an earthquake event, a wildfire event, a volcanic eruption event, or a meteorite impact event in Florida as events declared by various reporting agencies, including PCS and as defined in the contract. The contract provides limits of $200 million in excess of a $20 million retention and in excess of “stated reinsurance.” For the June 1, 2017 to May 31, 2018 risk period, stated reinsurance is defined to include the Below FHCF contract, the Mandatory FHCF contracts, which are deemed to exhaust due to loss occurrences subject to the non-FHCF contracts, and the Excess contract. Stated reinsurance is deemed to be provided on a multiple peril basis under the terms of the non-FHCF contracts and includes an erosion feature, which provides that upon the exhaustion of a portion of the stated reinsurance, coverage under the Sanders Re contract shall be concurrently placed above and contiguous to the unexhausted portion of the stated reinsurance, if any. The Sanders Re 2017-2 contract contains a variable reset option, which Castle Key may invoke for risk periods subsequent to the first risk period and which allows for the annual adjustment of the contract’s attachment and exhaustion levels. The variable reset option requires a premium. The contract does not contain a restatement of limits.
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The Company’s New Jersey, Pennsylvania, Kentucky, Florida and Southeast States and California reinsurance agreements are described below.
New Jersey Excess Catastrophe Reinsurance Agreement comprises three contracts that reinsure personal lines property and automobile excess catastrophe losses in New Jersey caused by multiple perils. The contracts expire May 31, 2018 May 31, 2019 and May 31, 2020, and provide 31.67%, 31.67% and 31.66%, respectively, of $400 million of limits excess of a provisional $150 million retention, a $144 million retention, and a $165 million retention, respectively. Each contract includes one reinstatement of limits per contract year with premium due. The reinsurance premium and retention are subject to redetermination for exposure changes on an annual basis.
Pennsylvania Excess Catastrophe Reinsurance Contract comprises a three-year term contract that reinsures personal lines property excess catastrophe losses in Pennsylvania caused by multi-perils. The contract expires May 31, 2018 and provides three limits of $100 million excess of a $100 million retention subject to two limits being available in any one contract year and is 95% placed. The reinsurance premium and retention are not subject to redetermination for exposure changes.
Kentucky Earthquake Excess Catastrophe Reinsurance Contract is a three-year contract that reinsures personal lines property excess catastrophe losses in Kentucky caused by earthquakes and fires following earthquakes. The contract expires May 31, 2020 and provides three limits of $28 million in excess of a $2 million retention with two limits being available in any one contract year and is 95% placed. The reinsurance premium and retention are not subject to redetermination for exposure changes.
Aggregate Excess Catastrophe Florida and Southeast States Reinsurance Contract provides $200 million of reinsurance limits for losses to personal lines automobile business (physical damage only) arising out of multiple perils and provided such losses arise out of a company declared catastrophe and result in qualifying losses in the State of Florida. Once qualifying losses are incurred in the State of Florida, coverage also is provided for losses to personal lines automobile business (physical damage only) arising from the same catastrophe and occurring in Alabama, Georgia, Louisiana, Mississippi, North Carolina and South Carolina. The $200 million of reinsurance limits is subject to a $300 million aggregate retention for losses arising out of one or all qualifying catastrophes commencing during the contract’s one-year term. The contract does not include a restatement of limits.
California E&S Earthquake Contract comprises one contract which reinsures personal lines property catastrophe losses in California caused by the peril of earthquake and insured by our excess and surplus lines insurer. The contract expires June 30, 2018. Unlike the contracts comprising the Nationwide Program, the E&S Earthquake agreement provides reinsurance on a 100% quota share basis with no retention. The agreement reinsures only shake damage resulting from the earthquake peril.
The Company ceded premiums earned of $344 million, $381 million and $414 million under catastrophe reinsurance agreements in 2017, 2016 and 2015, respectively.
Asbestos, environmental and other
Reinsurance recoverables include $167 million and $174 million from Lloyd’s of London as of December 31, 2017 and 2016, respectively. Lloyd’s of London, through the creation of Equitas Limited, implemented a restructuring to solidify its capital base and to segregate claims for years prior to 1993. In 2007, Berkshire Hathaway’s subsidiary, National Indemnity Company, assumed responsibility for the Equitas claim liabilities through a loss portfolio transfer reinsurance agreement and continues to runoff the Equitas claims.
Life and annuity products
The Company reinsures certain life insurance and annuity risks to other insurers primarily under yearly renewable term, coinsurance, modified coinsurance and coinsurance with funds withheld agreements. These agreements result in a passing of the agreed-upon percentage of risk to the reinsurer in exchange for negotiated reinsurance premium payments. Modified coinsurance and coinsurance with funds withheld are similar to coinsurance, except that the cash and investments that support the liability for contract benefits are not transferred to the assuming company and settlements are made on a net basis between the companies.
For certain term life insurance policies issued prior to October 2009, the Company ceded up to 90% of the mortality risk depending on the year of policy issuance under coinsurance agreements to a pool of fourteen unaffiliated reinsurers. Effective October 2009, mortality risk on term business is ceded under yearly renewable term agreements under which the Company cedes mortality in excess of its retention, which is consistent with how the Company generally reinsures its permanent life insurance business.
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| Retention limits by period of policy issuance | ||
| Period | Retention limits | |
| April 2015 through current | Single life: $2 million per life Joint life: no longer offered | |
| April 2011 through March 2015 | Single life: $5 million per life, $3 million age 70 and over, and $10 million for contracts that meet specific criteria Joint life: $8 million per life, and $10 million for contracts that meet specific criteria | |
| July 2007 through March 2011 | $5 million per life, $3 million age 70 and over, and $10 million for contracts that meet specific criteria | |
| September 1998 through June 2007 | $2 million per life, in 2006 the limit was increased to $5 million for instances when specific criteria were met | |
| August 1998 and prior | Up to $1 million per life |
In addition, the Company has used reinsurance to effect the disposition of certain blocks of business. The Company had reinsurance recoverables of $1.35 billion and $1.41 billion as of December 31, 2017 and 2016, respectively, due from Prudential related to the disposal of substantially all of its variable annuity business that was effected through reinsurance agreements. In 2017, premiums and contract charges of $76 million, contract benefits of $7 million, interest credited to contractholder funds of $20 million, and operating costs and expenses of $15 million were ceded to Prudential. In 2016, premiums and contract charges of $78 million, contract benefits of $21 million, interest credited to contractholder funds of $20 million, and operating costs and expenses of $15 million were ceded to Prudential. In 2015, premiums and contract charges of $94 million, contract benefits of $40 million, interest credited to contractholder funds of $21 million, and operating costs and expenses of $18 million were ceded to Prudential. In addition, as of December 31, 2017 and 2016, the Company had reinsurance recoverables of $139 million and $144 million,
respectively, due from subsidiaries of Citigroup (Triton Insurance and American Health and Life Insurance) and Scottish Re (U.S.) Inc. in connection with the disposition of substantially all of the direct response distribution business in 2003.
The Company is the assuming reinsurer for Lincoln Benefit Life Company’s (“LBL’s”) life insurance business sold through the Allstate agency channel and LBL’s payout annuity business in force prior to the sale of LBL on April 1, 2014. Under the terms of the reinsurance agreement, the Company is required to have a trust with assets greater than or equal to the statutory reserves ceded by LBL to the Company, measured on a monthly basis. As of December 31, 2017, the trust held $5.89 billion of investments, which are reported in the Consolidated Statement of Financial Position.
As of December 31, 2017, the gross life insurance in force was $447.86 billion of which $86.64 billion was ceded to the unaffiliated reinsurers.
| Reinsurance recoverables on paid and unpaid benefits | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Annuities | $ | 1,370 | $ | 1,424 | ||||
| Life insurance | 817 | 860 | ||||||
| Other | 167 | 184 | ||||||
| Total | $ | 2,354 | $ | 2,468 |
As of both December 31, 2017 and 2016, approximately 92% of the reinsurance recoverables are due from companies rated A- or better by S&P.
| Note 11 | Deferred Policy Acquisition and Sales Inducement Costs |
| Deferred policy acquisition costs activity | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Balance, beginning of year | $ | 3,954 | $ | 3,861 | $ | 3,525 | ||||||
| SquareTrade acquisition | 66 | — | — | |||||||||
| Acquisition costs deferred | 5,001 | 4,717 | 4,596 | |||||||||
| Amortization charged to income | (4,784 | ) | (4,550 | ) | (4,364 | ) | ||||||
| Effect of unrealized gains and losses | (46 | ) | (74 | ) | 104 | |||||||
| Balance, end of year | $ | 4,191 | $ | 3,954 | $ | 3,861 |
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| Deferred sales inducement costs activity (1) | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Balance, beginning of year | $ | 40 | $ | 45 | $ | 44 | ||||||
| Sales inducements deferred | — | 1 | 3 | |||||||||
| Amortization charged to income | (4 | ) | (5 | ) | (4 | ) | ||||||
| Effect of unrealized gains and losses | — | (1 | ) | 2 | ||||||||
| Balance, end of year | $ | 36 | $ | 40 | $ | 45 |
| (1) | Deferred sales inducement costs primarily relate to fixed annuities and interest-sensitive life contracts. |
| Note 12 | Capital Structure |
| Total debt outstanding | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| 6.75% Senior Debentures, due 2018 | $ | 176 | $ | 176 | ||||
| 7.45% Senior Notes, due 2019 (1) | 317 | 317 | ||||||
| Due after one year through five years | 493 | 493 | ||||||
| 3.15% Senior Notes, due 2023 (1) | 500 | 500 | ||||||
| 3.28% Senior Notes, due 2026 (1) | 550 | 550 | ||||||
| Due after five years through ten years | 1,050 | 1,050 | ||||||
| 6.125% Senior Notes, due 2032 (1) | 159 | 159 | ||||||
| 5.35% Senior Notes due 2033 (1) | 323 | 323 | ||||||
| 5.55% Senior Notes due 2035 (1) | 546 | 546 | ||||||
| 5.95% Senior Notes, due 2036 (1) | 386 | 386 | ||||||
| 6.90% Senior Debentures, due 2038 | 165 | 165 | ||||||
| 5.20% Senior Notes, due 2042 (1) | 62 | 62 | ||||||
| 4.50% Senior Notes, due 2043 (1) | 500 | 500 | ||||||
| 4.20% Senior Notes, due 2046 (1) | 700 | 700 | ||||||
| 5.10% Subordinated Debentures, due 2053 | 500 | 500 | ||||||
| 5.75% Subordinated Debentures, due 2053 | 800 | 800 | ||||||
| 6.125% Junior Subordinated Debentures, due 2067 | 224 | 224 | ||||||
| 6.50% Junior Subordinated Debentures, due 2067 | 500 | 500 | ||||||
| Due after ten years | 4,865 | 4,865 | ||||||
| Long-term debt total principal | 6,408 | 6,408 | ||||||
| Debt issuance costs | (58 | ) | (61 | ) | ||||
| Total long-term debt | 6,350 | 6,347 | ||||||
| Short-term debt (2) | — | — | ||||||
| Total debt | $ | 6,350 | $ | 6,347 |
| (1) | Senior Notes are subject to redemption at the Company’s option in whole or in part at any time at the greater of either 100% of the principal amount plus accrued and unpaid interest to the redemption date or the discounted sum of the present values of the remaining scheduled payments of principal and interest and accrued and unpaid interest to the redemption date. |
| (2) | The Company classifies any borrowings which have a maturity of twelve months or less at inception as short-term debt. |
| Debt maturities for each of the next five years and thereafter | ||||
| ($ in millions) | ||||
| 2018 | $ | 176 | ||
| 2019 | 317 | |||
| 2020 | — | |||
| 2021 | — | |||
| 2022 | — | |||
| Thereafter | 5,915 | |||
| Total long-term debt principal | $ | 6,408 |
On December 8, 2016, the Company issued $550 million of 3.28% Senior Notes due 2026 and $700 million of 4.20% Senior Notes due 2046. The proceeds of this issuance were used for general corporate purposes, including in part to fund the purchase price for the acquisition of SquareTrade.
During 2016 and 2015, the Company repurchased principal debt amounts of $17 million and $11 million, respectively.
The Subordinated Debentures may be redeemed (i) in whole at any time or in part from time to time on or after January 15, 2023 for the 5.10% Subordinated
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Debentures and August 15, 2023 for the 5.75% Subordinated Debentures at their principal amount plus accrued and unpaid interest to, but excluding, the date of redemption; provided that if the Subordinated Debentures are not redeemed in whole, at least $25 million aggregate principal amount must remain outstanding, or (ii) in whole, but not in part, prior to January 15, 2023 for the 5.10% Subordinated Debentures and August 15, 2023 for the 5.75% Subordinated Debentures, within 90 days after the occurrence of certain tax and rating agency events, at their principal amount or, if greater, a make-whole redemption price, plus accrued and unpaid interest to, but excluding, the date of redemption. The 5.75% Subordinated Debentures have this make-whole redemption price provision only when a reduction of equity credit assigned by a rating agency has occurred.
Interest on the 5.10% Subordinated Debentures is payable quarterly at the stated fixed annual rate to January 14, 2023, or any earlier redemption date, and then at an annual rate equal to the three-month LIBOR plus 3.165%. Interest on the 5.75% Subordinated Debentures is payable semi-annually at the stated fixed annual rate to August 14, 2023, or any earlier redemption date, and then quarterly at an annual rate equal to the three-month LIBOR plus 2.938%. The Company may elect to defer payment of interest on the Subordinated Debentures for one or more consecutive interest periods that do not exceed five years. During a deferral period, interest will continue to accrue on the Subordinated Debentures at the then-applicable rate and deferred interest will compound on each interest payment date. If all deferred interest on the Subordinated Debentures is paid, the Company can again defer interest payments.
The Company has outstanding $500 million of Series A 6.50% and $224 million of Series B 6.125% Fixed-to-Floating Rate Junior Subordinated Debentures (together the “Debentures”). The scheduled maturity dates for the Debentures are May 15, 2057 and May 15, 2037 for Series A and Series B, respectively, with a final maturity date of May 15, 2067. The Debentures may be redeemed (i) in whole or in part, at any time on or after May 15, 2037 or May 15, 2017 for Series A and Series B, respectively, at the principal amount plus accrued and unpaid interest to the date of redemption, or (ii) in certain circumstances, in whole or in part, prior to May 15, 2037 for Series A at the principal amount plus accrued and unpaid interest to the date of redemption or, if greater, a make-whole price.
Interest on the Debentures is payable semi-annually at the stated fixed annual rate to May 15, 2037 and May 15, 2017 for Series A and Series B, respectively, and then payable quarterly at an annual rate equal to the three-month LIBOR plus 2.12% and 1.935% for Series A and Series B, respectively. The Company may elect at one or more times to defer payment of interest on the Debentures for one or more consecutive interest periods that do not exceed 10 years. Interest compounds during such deferral periods at the rate in effect for each period. The interest deferral feature obligates the Company in certain circumstances to
issue common stock or certain other types of securities if it cannot otherwise raise sufficient funds to make the required interest payments. The Company has reserved 75 million shares of its authorized and unissued common stock to satisfy this obligation.
The terms of the Company’s outstanding subordinated debentures prohibit the Company from declaring or paying any dividends or distributions on common or preferred stock or redeeming, purchasing, acquiring, or making liquidation payments on common stock or preferred stock if the Company has elected to defer interest payments on the subordinated debentures, subject to certain limited exceptions.
In connection with the issuance of the Debentures, the Company entered into replacement capital covenants (“RCCs”). These covenants were not intended for the benefit of the holders of the Debentures and could not be enforced by them. Rather, they were for the benefit of holders of one or more other designated series of the Company’s indebtedness (“covered debt”), currently the 5.75% Subordinated Debentures due 2053. Pursuant to the Series A RCCs, the Company has agreed that it will not repay, redeem, or purchase the Series A Debentures on or before May 15, 2067 (or such earlier date on which the RCCs terminate by their terms) unless, subject to certain limitations, the Company has received net cash proceeds in specified amounts from the sale of common stock or certain other qualifying securities. The promises and covenants contained in the RCC will not apply if (i) S&P upgrades the Company’s issuer credit rating to A or above, (ii) the Company redeems the Debentures due to a tax event, (iii) after notice of redemption has been given by the Company and a market disruption event occurs preventing the Company from raising proceeds in accordance with the RCCs, or (iv) the Company repurchases or redeems up to 10% of the outstanding principal of the Debentures in any one-year period, provided that no more than 25% will be so repurchased, redeemed or purchased in any ten-year period.
On May 16, 2017, a Redesignation Date occurred in accordance with the Series A RCCs. As a result, the Corporation’s 7.45% Senior Notes due 2019 were no longer the covered debt under the Series A RCCs, and the 5.75% Subordinated Debentures due 2053 became the new covered debt. On May 16, 2017, the Series B RCCs terminated pursuant to the terms of the Series B RCCs, and the obligations of the Corporation pursuant to the Series B RCCs expired.
The Series A RCCs terminate in 2067. The RCCs will terminate prior to their scheduled termination date if (i) the applicable series of Debentures is no longer outstanding and the Company has fulfilled its obligations under the RCCs or they are no longer applicable, (ii) the holders of a majority of the then-outstanding principal amount of the then-effective series of covered debt consent to agree to the termination of the RCCs, (iii) the Company does not have any series of outstanding debt that is eligible to be treated as covered debt under the RCCs, (iv) the applicable series of Debentures is accelerated as a result of an event of default, (v) certain rating agency or
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change in control events occur, (vi) S&P, or any successor thereto, no longer assigns a solicited rating on senior debt issued or guaranteed by the Company, or (vii) the termination of the RCCs would have no effect on the equity credit provided by S&P with respect to the Debentures. An event of default, as defined by the supplemental indenture, includes default in the payment of interest or principal and bankruptcy proceedings.
To manage short-term liquidity, the Company maintains a commercial paper program and a credit facility as a potential source of funds. These include a $1.00 billion unsecured revolving credit facility and a commercial paper program with a borrowing limit of $1.00 billion. In April 2016, the Company extended the maturity date of the facility to April 2021. This facility contains an increase provision that would allow up to an additional $500 million of borrowing. This facility has a financial covenant requiring the Company not to exceed a 37.5% debt to capitalization ratio as defined in the agreement. Although the right to borrow under the facility is not subject to a minimum rating requirement, the costs of maintaining the facility and borrowing under it are based on the ratings of the Company’s senior unsecured, unguaranteed long-term debt. The total amount outstanding at any point in time under the combination of the commercial paper program and the credit facility cannot exceed the amount that can be borrowed under the credit facility. No amounts were outstanding under the credit facility as of December 31, 2017 or 2016. The Company had no commercial paper outstanding as of December 31, 2017 or 2016.
The Company paid $332 million, $287 million and $289 million of interest on debt in 2017, 2016 and 2015, respectively.
The Company had $169 million and $132 million of investment-related debt that is reported in other liabilities and accrued expenses as of December 31, 2017 and 2016, respectively. Of the $132 million, $45 million related to a commitment to fund a limited partnership as of December 31, 2016.
During 2015, the Company filed a universal shelf registration statement with the Securities and Exchange Commission (“SEC”) that expires in 2018. The registration statement covers an unspecified amount of securities and can be used to issue debt securities, common stock, preferred stock, depositary shares, warrants, stock purchase contracts, stock purchase units and securities of trust subsidiaries.
Common stock The Company had 900 million shares of issued common stock of which 355 million shares were outstanding and 545 million shares were held in treasury as of December 31, 2017. In 2017, the Company reacquired 16 million shares at an average cost of $89.95 and reissued 5 million net shares under equity incentive plans.
Preferred stock All outstanding preferred stock represents noncumulative perpetual preferred stock with a $1.00 par value per share and a liquidation preference of $25,000 per share.
| Outstanding preferred stock as of December 31, 2017 | ||||||||||||||||||||||||||||||||||
| Aggregate liquidation preference | Dividend per share | Aggregate dividend payment ($ in millions) | ||||||||||||||||||||||||||||||||
| Shares | Dividend rate | 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||
| Series A | 11,500 | $ | 287.5 | 5.625 | % | $ | 1.41 | $ | 1.41 | $ | 1.41 | $ | 16 | $ | 16 | $ | 16 | |||||||||||||||||
| Series C | 15,400 | 385.0 | 6.750 | % | 1.69 | 1.69 | 1.69 | 26 | 26 | 26 | ||||||||||||||||||||||||
| Series D | 5,400 | 135.0 | 6.625 | % | 1.66 | 1.66 | 1.66 | 9 | 9 | 9 | ||||||||||||||||||||||||
| Series E | 29,900 | 747.5 | 6.625 | % | 1.66 | 1.66 | 1.66 | 49 | 49 | 49 | ||||||||||||||||||||||||
| Series F | 10,000 | 250.0 | 6.250 | % | 1.56 | 1.56 | 1.56 | 16 | 16 | 16 | ||||||||||||||||||||||||
| Total | 72,200 | $ | 1,805 | $ | 116 | $ | 116 | $ | 116 |
The preferred stock ranks senior to the Company’s common stock with respect to the payment of dividends and liquidation rights. The Company will pay dividends on the preferred stock on a noncumulative basis only when, as and if declared by the Company’s board of directors (or a duly authorized committee of the board) and to the extent that the Company has legally available funds to pay dividends. If dividends are declared on the preferred stock, they will be payable quarterly in arrears at an annual fixed rate. Dividends on the preferred stock are not cumulative. Accordingly, in the event dividends are not declared on the preferred stock for payment on any dividend payment date, then those dividends will cease to be payable. If the Company has not declared a dividend before the dividend payment date for any dividend period, the Company has no obligation to pay dividends for that dividend period, whether or not
dividends are declared for any future dividend period. No dividends may be paid or declared on the Company’s common stock and no shares of the Company’s common stock may be repurchased unless the full dividends for the latest completed dividend period on the preferred stock have been declared and paid or provided for.
The Company is prohibited from declaring or paying dividends on preferred stock in excess of the amount of net proceeds from an issuance of common stock taking place within 90 days before a dividend declaration date if, on that dividend declaration date, either: (1) the risk-based capital ratios of the largest U.S. property-casualty insurance subsidiaries that collectively account for 80% or more of the net written premiums of U.S. property-casualty insurance business on a weighted average basis were less than 175% of
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their company action level risk-based capital as of the end of the most recent year; or (2) consolidated net income for the four-quarter period ending on the preliminary quarter end test date (the quarter that is two quarters prior to the most recently completed quarter) is zero or negative and consolidated shareholders’ equity (excluding AOCI, and subject to certain other adjustments relating to changes in U.S. GAAP) as of each of the preliminary quarter test date and the most recently completed quarter has declined by 20% or more from its level as measured at the end of the benchmark quarter (the date that is ten quarters prior to the most recently completed quarter). If the Company fails to satisfy either of these tests on any dividend declaration date, the restrictions on dividends will continue until the Company is able again to satisfy the test on a dividend declaration date. In addition, in the case of a restriction arising under (2) above, the restrictions on dividends will continue until consolidated shareholders’ equity (excluding AOCI, and subject to certain other adjustments relating to changes in U.S. GAAP) has increased, or has declined by less than 20%, in either case as compared to its level at the end of the benchmark quarter for each dividend payment date as to which dividend restrictions were imposed.
The preferred stock does not have voting rights except with respect to certain changes in the terms of the preferred stock, in the case of certain dividend nonpayments, certain other fundamental corporate
events, mergers or consolidations and as otherwise provided by law. If and when dividends have not been declared and paid in full for at least six quarterly dividend periods or their equivalent (whether or not consecutive), the authorized number of directors then constituting our board of directors will be increased by two. The holders of the preferred stock, together with the holders of all other affected classes and series of voting parity stock, voting as a single class, will be entitled to elect the two additional members of the board of directors of the Company, subject to certain conditions. The board of directors shall at no time have more than two preferred stock directors.
The preferred stock is perpetual and has no maturity date. The preferred stock is redeemable at the Company’s option in whole or in part, on or after June 15, 2018 for Series A, October 15, 2018 for Series C, April 15, 2019 for Series D and E, and October 15, 2019 for Series F, at a redemption price of $25,000 per share of preferred stock, plus declared and unpaid dividends. Prior to June 15, 2018 for Series A, October 15, 2018 for Series C, April 15, 2019 for Series D and E, and October 15, 2019 for Series F, the preferred stock is redeemable at the Company’s option, in whole but not in part, within 90 days of the occurrence of certain rating agency events at a redemption price equal to $25,000 per share or, if greater, a make-whole redemption price, plus declared and unpaid dividends.
| Note 13 | Company Restructuring |
The Company undertakes various programs to reduce expenses. These programs generally involve a reduction in staffing levels, and in certain cases, office closures. Restructuring and related charges primarily include employee severance and relocation benefits, and post-exit rent expenses in connection with these programs, and non-cash charges resulting from pension benefit payments made to agents and certain legal expenses and settlements incurred in connection with the 1999 reorganization of Allstate’s multiple agency programs to a single exclusive agency program. The expenses related to these activities are
included in the Consolidated Statements of Operations as restructuring and related charges, and totaled $109 million, $30 million and $39 million in 2017, 2016 and 2015, respectively. Restructuring expenses in 2017 primarily related to Allstate brand claims process changes and office closures due to increased efficiencies and improvements in digital technology, a voluntary termination program extended to certain employees, outsourcing of certain functions, legal expenses and settlements, as well as realigning or consolidating departments within the Allstate, Esurance and Encompass operations.
| Changes in the restructuring liability | ||||||||||||
| ($ in millions) | Employee costs | Exit costs | Total liability | |||||||||
| Balance as of December 31, 2016 | $ | — | $ | 2 | $ | 2 | ||||||
| Expense incurred | 47 | 42 | 89 | |||||||||
| Adjustments to liability | (3 | ) | — | (3 | ) | |||||||
| Payments applied against liability | (29 | ) | (14 | ) | (43 | ) | ||||||
| Balance as of December 31, 2017 | $ | 15 | $ | 30 | $ | 45 |
The payments applied against the liability for employee costs primarily reflect severance costs, and the payments for exit costs generally consist of post-exit rent expenses and contract termination penalties.
As of December 31, 2017, the cumulative amount incurred to date for active programs totaled $103 million for employee costs and $104 million for exit costs.
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| Note 14 | Commitments, Guarantees and Contingent Liabilities |
Leases
The Company leases certain office facilities, computer and office equipment, aircraft and automobiles. Total rent expense for all leases was $149 million, $147 million and $179 million in 2017, 2016 and 2015, respectively.
Minimum rental commitments under operating leases with an initial or remaining term of more than one year as of December 31, 2017 are in the following table:
| ($ in millions) | ||||
| 2018 | $ | 126 | ||
| 2019 | 113 | |||
| 2020 | 95 | |||
| 2021 | 74 | |||
| 2022 | 60 | |||
| Thereafter | 175 | |||
| Total | $ | 643 |
Shared markets and state facility assessments
The Company is required to participate in assigned risk plans, reinsurance facilities and joint underwriting associations in various states that provide insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers. Underwriting results related to these arrangements, which tend to be adverse, have been immaterial to the Company’s results of operations. Because of the Company’s participation, it may be exposed to losses that surpass the capitalization of these facilities and/or assessments from these facilities.
Florida Citizens Castle Key is subject to assessments from Citizens Property Insurance Corporation in the state of Florida (“FL Citizens”), which was initially created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. FL Citizens, at the discretion and direction of its Board of Governors (“FL Citizens Board”), can levy a regular assessment on assessable insurers and assessable insureds for a deficit in any calendar year up to a maximum of the greater of: 2% of the projected deficit or 2% of the aggregate statewide direct written premium for the prior calendar year. The base of assessable insurers includes all property and casualty premiums in the state, except workers’ compensation, medical malpractice, accident and health insurance and policies written under the NFIP. An insurer may recoup a regular assessment through a surcharge to policyholders. In order to recoup this assessment, an insurer must file for a policy surcharge with the Florida Office of Insurance Regulation (“FL OIR”) at least fifteen days prior to imposing the surcharge on policies. If a deficit remains after the regular assessment, FL Citizens’ can also levy emergency assessments in the current and subsequent years. Companies are
required to collect the emergency assessments directly from residential property policyholders and remit to FL Citizens as collected. Pursuant to an Order issued by the FL OIR, the emergency assessment is zero for all policies issued or renewed on or after July 1, 2015. FL Citizens’s initial estimates indicated sufficient resources to cover the losses from Hurricane Irma which will not result in the levy of an assessment.
Louisiana Citizens The Company is also subject to assessments from Louisiana Citizens Property Insurance Corporation (“LA Citizens”). LA Citizens can levy a regular assessment on participating companies for a deficit in any calendar year up to a maximum of the greater of 10% of the calendar year deficit or 10% of Louisiana direct property premiums industry-wide for the prior calendar year. If the plan year deficit exceeds the amount that can be recovered through Regular Assessments, LA Citizens may fund the remaining deficit by issuing revenue assessment bonds in the capital markets. LA Citizens then declares Emergency Assessments each year to provide debt service on the bonds until they are retired. Companies writing assessable lines must surcharge their policyholders Emergency Assessments in the percentage established annually by LA Citizens and must remit amounts collected to the bond trustee on a quarterly basis. Emergency assessments to pay off bonds issued in 2007 for the hurricanes of 2005 will continue until 2025.
Florida Hurricane Catastrophe Fund Castle Key participates in the mandatory coverage provided by the FHCF and therefore has access to reimbursements on certain qualifying Florida hurricane losses from the FHCF (see Note 10), and has exposure to assessments and pays annual premiums to the FHCF for this reimbursement protection. The FHCF has the authority to issue bonds to pay its obligations to insurers participating in the mandatory coverage in excess of its capital balances. Payment of these bonds is funded by emergency assessments on all property and casualty premiums in the state, except workers’ compensation, medical malpractice, accident and health insurance and policies written under the NFIP. The FHCF emergency assessments are limited to 6% of premiums per year beginning the first year in which reimbursements require bonding, and up to a total of 10% of premiums per year for assessments in the second and subsequent years, if required to fund additional bonding. Pursuant to an Order issued by the FL OIR, the emergency assessment is zero for all policies issued or renewed on or after January 1, 2015. The FHCF issued $2 billion in pre-event bonds in 2013 to build their capacity to reimburse member companies’ claims. The FHCF plans to fund these pre-event bonds through current FHCF cash flows.
Facilities such as FL Citizens, LA Citizens and the FHCF are generally designed so that the ultimate cost is borne by policyholders; however, the exposure to assessments from these facilities and the availability of recoupments or premium rate increases may not offset each other in the Company’s financial statements.
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Moreover, even if they do offset each other, they may not offset each other in financial statements for the same fiscal period due to the ultimate timing of the assessments and recoupments or premium rate increases, as well as the possibility of policies not being renewed in subsequent years.
California Earthquake Authority Exposure to certain potential losses from earthquakes in California is limited by the Company’s participation in the California Earthquake Authority (“CEA”), which provides insurance for California earthquake losses. The CEA is a privately-financed, publicly-managed state agency created to provide insurance coverage for earthquake damage. Insurers selling homeowners insurance in California are required to offer earthquake insurance to their customers either through their company or by participation in the CEA. The Company’s homeowners policies continue to include coverages for losses caused by explosions, theft, glass breakage and fires following an earthquake, which are not underwritten by the CEA.
As of September 30, 2017, the CEA’s capital balance was approximately $5.43 billion. Should losses arising from an earthquake cause a deficit in the CEA, an additional $685 million would be obtained from the proceeds of revenue bonds the CEA may issue, an existing $7.51 billion reinsurance layer, and finally, if needed, assessments on participating insurance companies. Participating insurers are required to pay an assessment, currently estimated not to exceed $1.66 billion, if the capital of the CEA falls below $350 million. Participating insurers are required to pay a second additional assessment, currently estimated not to exceed $54 million, if aggregate CEA earthquake losses exceed $15.33 billion and the capital of the CEA falls below $350 million. Within the limits previously described, the assessment could be intended to restore the CEA’s capital to a level of $350 million. There is no provision that allows insurers to recover assessments through a premium surcharge or other mechanism. The CEA’s projected aggregate claim paying capacity is $15.33 billion as of September 30, 2017 and if an event were to result in claims greater than its capacity, affected policyholders may be paid a prorated portion of their covered losses, paid on an installment basis, or no payments may be made if the claim paying capacity of the CEA is insufficient.
All future assessments on participating CEA insurers are based on their CEA insurance market share as of December 31 of the preceding year. As of December 31, 2016, the Company’s market share was 11.2%. The Company does not expect its market share to materially change. At this level, the Company’s maximum possible CEA assessment would be $191 million during 2018. These amounts are re-evaluated by the board of directors of the CEA on an annual basis. Accordingly, assessments from the CEA for a particular quarter or annual period may be material to the results of operations and cash flows, but not the financial position of the Company. Management believes the Company’s exposure to earthquake losses in California has been significantly reduced as a result of its participation in the CEA.
Texas Windstorm Insurance Association The Company participates as a member of the Texas Windstorm Insurance Association (“TWIA”), which provides wind and hail property coverage to coastal risks unable to procure coverage in the voluntary market. Wind and hail coverage is written on a TWIA-issued policy. TWIA follows a funding structure first utilizing currently available funds set aside from current and prior years. Under the current law, to the extent losses exceed premiums received from policyholders, TWIA utilizes a combination of reinsurance and TWIA issued securities to fund its payments of losses. Reinsurance is procured annually in an amount determined by the TWIA board. Once those currently available funds and available reinsurance are utilized, TWIA could issue up to $1 billion of securities, which will be repaid by billing policyholders and assessing participating insurers. The Company’s current participation ratio is approximately 13.6% based upon its proportion of the premiums written. Any assessments from TWIA for a particular quarter or annual period may be material to the results of operations and cash flows, but not the financial position of the Company.
Texas Fair Plan Association The Company participates as a member of the Texas Fair Plan Association (“FAIR Plan”), which provides residential property insurance to inland areas designated as underserved by the Commissioner of Insurance and the applicant(s) are unable to procure coverage in the voluntary market. The FAIR Plan issues insurance policies, like an insurance company, and it also functions as a pooling mechanism that allocates premiums, claims and expenses back to the insurance industry. As a result of the losses incurred related to Hurricane Harvey, the FAIR Plan Board unanimously voted to approve its first ever member assessment of which the Company’s share is expected to be $8 million based on total direct premium written in Texas. The Company's portion of the assessment was recorded as a liability as of December 31, 2017. Insurers are permitted to recover the assessment through either a premium surcharge applied to existing customers over a three-year period or increased rates, but the ability to fully recover the assessment may be impacted by market conditions or other factors.
North Carolina Reinsurance Facility The North Carolina Reinsurance Facility (“NCRF”) provides automobile liability insurance to drivers that insurers are not otherwise willing to insure. All insurers licensed to write automobile insurance in North Carolina are members of the NCRF. Premiums, losses and expenses are ceded to the NCRF. North Carolina law allows the NCRF to recoup operating losses for certain insureds through a surcharge to policyholders. As of September 30, 2017, the NCRF reported a deficit of $310 million in members’ equity. The NCRF implemented a loss recoupment surcharge on all private passenger policies becoming effective October 1, 2017 through March 31, 2018. Member companies are assessed the recoupment surcharge. The loss recoupment surcharge will be adjusted at April 1, 2018 and discontinued once losses are recovered. The NCRF results are shared by the member companies in
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proportion to their respective North Carolina automobile liability writings. As a result, the NCRF also has the ability to assess member Companies for recoupment of losses calculated on a pro-rata basis across member companies based on participation ratios, determined annually. For fiscal year ending September 30, 2017, the net loss was $50 million, including $1.0 billion of earned premiums, $173 million of certain private passenger auto risk recoupment and $149 million of member loss recoupments. As of December 31, 2017, the NCRF reinsurance recoverable on paid claims is $12.5 million and reinsurance recoverable on unpaid claims is $73.8 million. Paid recoverable balances, if covered, are typically settled within sixty days of monthly filing.
North Carolina Joint Underwriters Association The North Carolina Joint Underwriters Association (“NCJUA”) was created to provide property insurance for properties (other than the state’s beach and coastal areas) that insurers are not otherwise willing to insure. All insurers licensed to write property insurance in North Carolina are members of the NCJUA. Premiums, losses and expenses of the NCJUA are shared by the member companies in proportion to their respective North Carolina property insurance writings. Member companies participate in plan deficits or surpluses based on their participation ratios, which are determined annually. The Company had a $4.6 million receivable from the NCJUA at December 31, 2017, representing our participation in the NCJUA’s surplus of $37.8 million for all open years.
North Carolina Insurance Underwriting Association The North Carolina Insurance Underwriting Association (“NCIUA”) provides windstorm and hail coverage as well as homeowners policies for properties located in the state’s beach and coastal areas that insurers are not otherwise willing to insure. All insurers licensed to write residential and commercial property insurance in North Carolina are members of the NCIUA. Members are assessed in proportion to their North Carolina residential and commercial property insurance writings, which is determined annually and varies by coverage, for plan deficits. As of December 31, 2017, the NCIUA had a surplus of $1.5 billion. No member company shall be entitled to the distribution of any portion of the Association’s surplus. The Company does not recognize any interest related to this surplus. Legislation in 2009 capped insurers’ assessments for losses incurred in any calendar year at $1 billion. Subsequent to an industry assessment of $1 billion, if the plan continues to require funding, it may authorize insurers to assess a 10% catastrophe recovery charge on each property insurance policy statewide to be remitted to the plan.
Guaranty funds
Under state insurance guaranty fund laws, insurers doing business in a state can be assessed, up to prescribed limits, for certain obligations of insolvent insurance companies to policyholders and claimants. Amounts assessed to each company are typically related to its proportion of business written in each state. The Company’s policy is to accrue assessments when the entity for which the insolvency relates has
met its state of domicile’s statutory definition of insolvency, the amount of the loss is reasonably estimable and the related premium upon which the assessment is based is written. In most states, the definition is met with a declaration of financial insolvency by a court of competent jurisdiction. In certain states there must also be a final order of liquidation. As of December 31, 2017 and 2016, the liability balance included in other liabilities and accrued expenses was $12 million and $4 million, respectively. The related premium tax offsets included in other assets were $19 million and $9 million as of December 31, 2017 and 2016, respectively.
Guarantees
The Company provides residual value guarantees on Company leased automobiles. If all outstanding leases were terminated effective December 31, 2017, the Company’s maximum obligation pursuant to these guarantees, assuming the automobiles have no residual value, would be $27 million as of December 31, 2017. The remaining term of each residual value guarantee is equal to the term of the underlying lease that ranges from less than one year to four years. Historically, the Company has not made any material payments pursuant to these guarantees.
Related to the sale of LBL on April 1, 2014, ALIC agreed to indemnify Resolution Life Holdings, Inc. in connection with certain representations, warranties and covenants of ALIC, and certain liabilities specifically excluded from the transaction, subject to specific contractual limitations regarding ALIC’s maximum obligation. Management does not believe these indemnifications will have a material effect on results of operations, cash flows or financial position of the Company.
Related to the disposal through reinsurance of substantially all of its variable annuity business to Prudential in 2006, the Company and its consolidated subsidiaries, ALIC and ALNY, have agreed to indemnify Prudential for certain pre-closing contingent liabilities (including extra-contractual liabilities of ALIC and ALNY and liabilities specifically excluded from the transaction) that ALIC and ALNY have agreed to retain. In addition, the Company, ALIC and ALNY will each indemnify Prudential for certain post-closing liabilities that may arise from the acts of ALIC, ALNY and their agents, including certain liabilities arising from ALIC’s and ALNY’s provision of transition services. The reinsurance agreements contain no limitations or indemnifications with regard to insurance risk transfer and transferred all of the future risks and responsibilities for performance on the underlying variable annuity contracts to Prudential, including those related to benefit guarantees. Management does not believe this agreement will have a material effect on results of operations, cash flows or financial position of the Company.
In the normal course of business, the Company provides standard indemnifications to contractual counterparties in connection with numerous transactions, including acquisitions and divestitures. The types of indemnifications typically provided
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include indemnifications for breaches of representations and warranties, taxes and certain other liabilities, such as third party lawsuits. The indemnification clauses are often standard contractual terms and are entered into in the normal course of business based on an assessment that the risk of loss would be remote. The terms of the indemnifications vary in duration and nature. In many cases, the maximum obligation is not explicitly stated and the contingencies triggering the obligation to indemnify have not occurred and are not expected to occur. Consequently, the maximum amount of the obligation under such indemnifications is not determinable. Historically, the Company has not made any material payments pursuant to these obligations.
The aggregate liability balance related to all guarantees was not material as of December 31, 2017.
Regulation and compliance
The Company is subject to extensive laws, regulations, administrative directives, and regulatory actions. From time to time, regulatory authorities or legislative bodies seek to influence and restrict premium rates, require premium refunds to policyholders, require reinstatement of terminated policies, prescribe rules or guidelines on how affiliates compete in the marketplace, restrict the ability of insurers to cancel or non-renew policies, require insurers to continue to write new policies or limit their ability to write new policies, limit insurers’ ability to change coverage terms or to impose underwriting standards, impose additional regulations regarding agent and broker compensation, regulate the nature of and amount of investments, impose fines and penalties for unintended errors or mistakes, and otherwise expand overall regulation of insurance products and the insurance industry. In addition, the Company is subject to laws and regulations administered and enforced by federal agencies and other organizations, including but not limited to the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Department of Labor, the U.S. Equal Employment Opportunity Commission, and the U.S. Department of Justice. The Company has established procedures and policies to facilitate compliance with laws and regulations, to foster prudent business operations, and to support financial reporting. The Company routinely reviews its practices to validate compliance with laws and regulations and with internal procedures and policies. As a result of these reviews, from time to time the Company may decide to modify some of its procedures and policies. Such modifications, and the reviews that led to them, may be accompanied by payments being made and costs being incurred. The ultimate changes and eventual effects of these actions on the Company’s business, if any, are uncertain.
Legal and regulatory proceedings and inquiries
The Company and certain subsidiaries are involved in a number of lawsuits, regulatory inquiries, and other legal proceedings arising out of various aspects of its business.
Background These matters raise difficult and complicated factual and legal issues and are subject to many uncertainties and complexities, including the underlying facts of each matter; novel legal issues; variations between jurisdictions in which matters are being litigated, heard, or investigated; changes in assigned judges; differences or developments in applicable laws and judicial interpretations; judges reconsidering prior rulings; the length of time before many of these matters might be resolved by settlement, through litigation, or otherwise; adjustments with respect to anticipated trial schedules and other proceedings; developments in similar actions against other companies; the fact that some of the lawsuits are putative class actions in which a class has not been certified and in which the purported class may not be clearly defined; the fact that some of the lawsuits involve multi-state class actions in which the applicable law(s) for the claims at issue is in dispute and therefore unclear; and the challenging legal environment faced by corporations and insurance companies.
The outcome of these matters may be affected by decisions, verdicts, and settlements, and the timing of such decisions, verdicts, and settlements, in other individual and class action lawsuits that involve the Company, other insurers, or other entities and by other legal, governmental, and regulatory actions that involve the Company, other insurers, or other entities. The outcome may also be affected by future state or federal legislation, the timing or substance of which cannot be predicted.
In the lawsuits, plaintiffs seek a variety of remedies which may include equitable relief in the form of injunctive and other remedies and monetary relief in the form of contractual and extra-contractual damages. In some cases, the monetary damages sought may include punitive or treble damages. Often specific information about the relief sought, such as the amount of damages, is not available because plaintiffs have not requested specific relief in their pleadings. When specific monetary demands are made, they are often set just below a state court jurisdictional limit in order to seek the maximum amount available in state court, regardless of the specifics of the case, while still avoiding the risk of removal to federal court. In Allstate’s experience, monetary demands in pleadings bear little relation to the ultimate loss, if any, to the Company.
In connection with regulatory examinations and proceedings, government authorities may seek various forms of relief, including penalties, restitution, and changes in business practices. The Company may not be advised of the nature and extent of relief sought until the final stages of the examination or proceeding.
Accrual and disclosure policy The Company reviews its lawsuits, regulatory inquiries, and other legal proceedings on an ongoing basis and follows appropriate accounting guidance when making accrual and disclosure decisions. The Company establishes accruals for such matters at management’s best estimate when the Company assesses that it is probable that a loss has been incurred and the amount
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of the loss can be reasonably estimated. The Company does not establish accruals for such matters when the Company does not believe both that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company’s assessment of whether a loss is reasonably possible or probable is based on its assessment of the ultimate outcome of the matter following all appeals. The Company does not include potential recoveries in its estimates of reasonably possible or probable losses. Legal fees are expensed as incurred.
The Company continues to monitor its lawsuits, regulatory inquiries, and other legal proceedings for further developments that would make the loss contingency both probable and estimable, and accordingly accruable, or that could affect the amount of accruals that have been previously established. There may continue to be exposure to loss in excess of any amount accrued. Disclosure of the nature and amount of an accrual is made when there have been sufficient legal and factual developments such that the Company’s ability to resolve the matter would not be impaired by the disclosure of the amount of accrual.
When the Company assesses it is reasonably possible or probable that a loss has been incurred, it discloses the matter. When it is possible to estimate the reasonably possible loss or range of loss above the amount accrued, if any, for the matters disclosed, that estimate is aggregated and disclosed. Disclosure is not required when an estimate of the reasonably possible loss or range of loss cannot be made.
For certain of the matters described below in the “Claims related proceedings” and “Other proceedings” subsections, the Company is able to estimate the reasonably possible loss or range of loss above the amount accrued, if any. In determining whether it is possible to estimate the reasonably possible loss or range of loss, the Company reviews and evaluates the disclosed matters, in conjunction with counsel, in light of potentially relevant factual and legal developments.
These developments may include information learned through the discovery process, rulings on dispositive motions, settlement discussions, information obtained from other sources, experience from managing these and other matters, and other rulings by courts, arbitrators or others. When the Company possesses sufficient appropriate information to develop an estimate of the reasonably possible loss or range of loss above the amount accrued, if any, that estimate is aggregated and disclosed below. There may be other disclosed matters for which a loss is probable or reasonably possible but such an estimate is not possible. Disclosure of the estimate of the reasonably possible loss or range of loss above the amount accrued, if any, for any individual matter would only be considered when there have been sufficient legal and factual developments such that the Company’s ability to resolve the matter would not be impaired by the disclosure of the individual estimate.
The Company currently estimates that the aggregate range of reasonably possible loss in excess of the amount accrued, if any, for the disclosed matters
where such an estimate is possible is zero to $240 million, pre-tax. This disclosure is not an indication of expected loss, if any. Under accounting guidance, an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote” if “the chance of the future event or events occurring is slight.” This estimate is based upon currently available information and is subject to significant judgment and a variety of assumptions, and known and unknown uncertainties. The matters underlying the estimate will change from time to time, and actual results may vary significantly from the current estimate. The estimate does not include matters or losses for which an estimate is not possible. Therefore, this estimate represents an estimate of possible loss only for certain matters meeting these criteria. It does not represent the Company’s maximum possible loss exposure. Information is provided below regarding the nature of all of the disclosed matters and, where specified, the amount, if any, of plaintiff claims associated with these loss contingencies.
Due to the complexity and scope of the matters disclosed in the “Claims related proceedings” and “Other proceedings” subsections below and the many uncertainties that exist, the ultimate outcome of these matters cannot be predicted and in the Company’s judgment, a loss, in excess of amounts accrued, if any, is not probable. In the event of an unfavorable outcome in one or more of these matters, the ultimate liability may be in excess of amounts currently accrued, if any, and may be material to the Company’s operating results or cash flows for a particular quarterly or annual period. However, based on information currently known to it, management believes that the ultimate outcome of all matters described below, as they are resolved over time, is not likely to have a material effect on the financial position of the Company.
Claims related proceedings
The Company is litigating a class action case in California in which the plaintiffs allege off-the-clock wage and hour claims. Plaintiffs seek recovery of unpaid compensation, liquidated damages, penalties, and attorneys’ fees and costs.
The case of Jack Jimenez, et al. v. Allstate Insurance Company was filed in the U.S. District Court for the Central District of California in September 2010. The plaintiffs allege that they worked off-the-clock; they also allege other California Labor Code violations resulting from purported unpaid overtime. In April 2012, the court certified a class that includes all adjusters in the state of California, except auto field adjusters, from September 29, 2006 to final judgment. Allstate appealed the court’s decision to certify the class, first to the Ninth Circuit Court of Appeals and then to the U.S. Supreme Court. The case was scheduled for trial on September 27, 2016. On May 4, 2016, the court vacated that trial date in part because the court had not approved a trial plan. No trial date has been scheduled because the parties continue to wait for the court’s approval of a trial plan.
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In addition to the California class action, the case of Maria Victoria Perez and Kaela Brown, et al. v. Allstate Insurance Company was filed in the U.S. District Court for the Eastern District of New York. Plaintiffs allege that no-fault claim adjusters have been improperly classified as exempt employees under New York Labor Law and the Fair Labor Standards Act. The case was filed in April 2011, and the plaintiffs are seeking unpaid wages, liquidated damages, injunctive relief, compensatory and punitive damages, and attorneys’ fees. On September 16, 2014, the court certified a class of no-fault adjusters under New York Labor Law and refused to decertify a Fair Labor Standards Act class of no-fault adjusters. There are 105 members of the Fair Labor Standards Act class and 137 members of the New York Labor Law class. The parties are concluding discovery and preparing to seek court approval to file motions for summary judgment.
Other proceedings The Company is defending a consolidated proceeding relating to the reorganization of its agent sales force in 2000, when the Company discontinued employee agent programs, terminated the contracts of its employee agents, and offered those agents the opportunity to become Allstate Exclusive Agent independent contractors or to take severance benefits in exchange for a release of claims. The consolidated proceeding, captioned Gene Romero, et al. v. Allstate Insurance Company, et al., is pending in the United States District Court for the Eastern District of Pennsylvania.
This matter has a long and complex history, only relevant portions of which are summarized here. The case began in 2001 as two separate putative class actions filed by approximately 32 former employee agents. In one case, plaintiffs challenged the reorganization alleging claims under the Age Discrimination in Employment Act (“ADEA”), interference with benefits under ERISA, breach of contract, and breach of fiduciary duty. Plaintiffs also challenged the release of claims on various grounds including alleging that the release was retaliatory under the ADEA and ERISA. In the other case, plaintiffs challenged certain amendments to the Agents Pension Plan and sought to have service as Exclusive Agent independent contractors count toward eligibility for benefits. Plaintiffs sought various relief, including back pay, compensatory and punitive damages, liquidated damages, lost investment capital, loss of benefits, repeal of the challenged plan amendments and attorneys’ fees.
In February, 2014, the court addressed the validity and enforceability of the release and determined that the question of whether the releases were voluntarily signed raised disputed issues of fact to be resolved at trial. The court also held that the release, if valid, would bar all claims. In late 2014, the court denied plaintiffs’ motion to certify a class for purposes of determining whether the releases were signed voluntarily and ordered that all statutes of limitations would resume running, after which approximately 460 additional individual plaintiffs filed separate similar lawsuits or sought to intervene.
A jury trial was held in June, 2015, to determine whether the releases of ten plaintiffs were knowingly and voluntarily signed. The jury found that two plaintiffs signed their releases voluntarily and eight plaintiffs did not.
On May 2, 2016, a consolidated amended complaint was filed on behalf of 498 plaintiffs, most of whom had previously filed separate lawsuits or intervened. On July 6, 2016, the court denied the Company’s motion to dismiss plaintiffs’ state law breach of contract and fiduciary duty claims but granted dismissal of plaintiffs’ retaliation claims under the ADEA and ERISA challenging the release of claims.
The court then separated the case into phases to address “common issues” in plaintiffs’ claims, beginning with: (a) “Phase I” addressing claims by 118 plaintiffs alleging that certain plan amendments violated ERISA’s anti-cutback provision by eliminating an accrued benefit and (b) “Phase II” addressing all plaintiffs’ claims for alleged interference with employee benefits under ERISA and disparate impact under the ADEA.
A bench trial on Phase I claims was held in December, 2016. The court ruled that (i) the Company’s 1991 amendments to the Plan did not violate ERISA by improperly cutting back on plaintiffs’ benefits, and (ii) the Company’s interpretation of the Plan’s definition of “retire” violated ERISA’s anti-cutback rule. The court required the parties to provide further information, in the form of an accounting, to determine whether any plaintiffs suffered a loss based on any such cutback. Plaintiffs have asserted that only two of the 118 plaintiffs suffered a loss as a result of the court’s order. The Company contends that no plaintiff suffered a compensable loss and that judgment should be entered in favor of the Company. We await a final ruling by the court.
In Phase II, the court granted the Company’s motion for summary judgment on both the ADEA disparate impact and ERISA interference with benefits claims. This ruling resolved these claims in the trial court as to all plaintiffs.
In June, 2017, the court entered an order establishing Phases III and IV of the litigation. In Phase III, the remaining claims of the eight individual plaintiffs who reside in the Eastern District of Pennsylvania were to be litigated, possibly culminating in two separate jury trials in early 2018. The Company filed several motions for summary judgment on the Phase III claims. The court granted the Company’s motion as to the Phase III plaintiffs’ ADEA disparate treatment claims and as to a retaliation claim that had been asserted by one of the Phase III plaintiffs. The court denied the Company’s motion on the Phase III plaintiffs’ breach of contract and breach of fiduciary duty claims.
The Company and 85 individual plaintiffs, including all eight of the Phase III plaintiffs whose remaining claims were set for trial in early 2018, reached agreements in principle to settle all claims of those plaintiffs on a confidential basis, subject to negotiating and executing appropriate written settlement
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agreements. Four other plaintiffs have voluntarily dismissed their claims leaving 410 plaintiffs in this litigation.
The parties have substantially completed written discovery relating to the claims of the remaining plaintiffs (Phase IV of the litigation). On January 30, 2018, the court decided two separate summary judgment motions filed by the Company with respect to the Phase IV claims. The court (i) granted summary judgment in the Company’s favor on the claims by twenty-seven Phase IV plaintiffs alleging that the Company improperly retaliated against them by filing counterclaims to their original complaint; and (ii) declined to decide whether the remaining Phase IV plaintiffs’ age discrimination (disparate treatment) claims should be dismissed due to plaintiffs’ failure to exhaust administrative remedies, finding that this is not a common issue. The court has yet to decide the proper venue for resolution of the remaining plaintiffs’ individual claims.
The final resolution of these matters is subject to various uncertainties and complexities including how trials, post-trial motions, possible appeals with respect to the validity of the release, and any rulings on the merits will be resolved.
The below shareholder derivative action is disclosed pursuant to SEC disclosure requirements for these types of matters, and the putative class action has been disclosed because both matters involve similar allegations. On August 3, 2017, a plaintiff alleging to be a stockholder in the Company filed a shareholder derivative complaint in the Circuit Court for Cook County, Chancery Division. The action is styled Biefeldt v. Wilson, et al., Case No. 2017 CH 10676 (Cook County, Ill.). In the complaint, plaintiff purports to assert claims on behalf of the Company for alleged breaches of fiduciary duty based on allegations that are similar to those asserted in the securities action described below. The complaint names as defendants the Company’s chairman and chief executive officer, its former president, who retired on February 23, 2018, its former chief financial officer, who is now the Company’s vice chairman and the members of the board of directors during the period of the alleged misstatements or omissions regarding auto claims frequency. Defendants filed a motion to dismiss the complaint on November 13, 2017. The complaint seeks, on behalf of the Company, an unspecified amount of damages and various forms of equitable relief.
In November 2016, a putative class action was filed in the United States District Court for the Northern District of Illinois against the Company and several of its officers asserting claims under the federal securities laws. The action is titled In re The Allstate Corp. Securities Litigation, No. 1:16-cv-10510 (N.D. Ill.). In March 2017, lead plaintiffs filed a consolidated amended complaint. In the complaint, plaintiffs allege that the Company and certain senior officers made allegedly material misstatements or omissions concerning claim frequency statistics and the reasons for a claim frequency increase for Allstate brand auto insurance during the period from October 29, 2014 to August 3, 2015. The complaint further alleges that a
senior officer engaged in stock option exercises and sales during that time allegedly while in possession of information about claim frequency that had not been disclosed. The consolidated amended complaint names as defendants the Company, its chairman and chief executive officer and its former president. Plaintiffs assert claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. On June 1, 2017, all defendants filed motions to dismiss the consolidated amended complaint for failure to state a claim. Briefing on the motion was completed in September 2017. The Company and the other defendants dispute plaintiffs’ allegations that there was any misstatement or omission or other misconduct. The complaint seeks an unspecified amount of damages, costs and attorney’s fees and such other relief as the court deems appropriate.
Asbestos and environmental
Management believes its net loss reserves for asbestos, environmental and other discontinued lines exposures are appropriately established based on available facts, technology, laws and regulations. However, establishing net loss reserves for asbestos, environmental and other discontinued lines claims is subject to uncertainties that are much greater than those presented by other types of claims. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimate. Among the complications are lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure and unresolved legal issues regarding policy coverage; unresolved legal issues regarding the determination, availability and timing of exhaustion of policy limits; plaintiffs’ evolving and expanding theories of liability; availability and collectability of recoveries from reinsurance; retrospectively determined premiums and other contractual agreements; estimates of the extent and timing of any contractual liability; the impact of bankruptcy protection sought by various asbestos producers and other asbestos defendants; and other uncertainties. There are also complex legal issues concerning the interpretation of various insurance policy provisions and whether those losses are covered, or were ever intended to be covered, and could be recoverable through retrospectively determined premium, reinsurance or other contractual agreements. Courts have reached different and sometimes inconsistent conclusions as to when losses are deemed to have occurred and which policies provide coverage; what types of losses are covered; whether there is an insurer obligation to defend; how policy limits are determined; how policy exclusions and conditions are applied and interpreted; and whether clean-up costs represent insured property damage. Further, insurers and claims administrators acting on behalf of insurers are increasingly pursuing evolving and expanding theories of reinsurance coverage for asbestos and environmental losses. Adjudication of reinsurance coverage is predominately decided in confidential arbitration proceedings which may have limited precedential or predictive value further complicating management’s ability to estimate
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probable loss for reinsured asbestos and environmental claims. Management believes these issues are not likely to be resolved in the near future, and the ultimate costs may vary materially from the amounts currently recorded resulting in material changes in loss reserves. In addition, while the Company believes that improved actuarial techniques and databases have assisted in its ability to estimate
asbestos, environmental, and other discontinued lines net loss reserves, these refinements may subsequently prove to be inadequate indicators of the extent of probable losses. Due to the uncertainties and factors described above, management believes it is not practicable to develop a meaningful range for any such additional net loss reserves that may be required.
| Note 15 | Income Taxes |
The Company and its domestic subsidiaries file a consolidated federal income tax return. Tax liabilities and benefits realized by the consolidated group are allocated as generated by the respective entities.
The Internal Revenue Service (“IRS”) is currently examining the Company’s 2013 and 2014 federal income tax returns and the exam is expected to be complete in the first quarter of 2018. The IRS has also begun their examination of the Company’s 2015 and 2016 federal income tax returns. The Company’s tax years prior to 2013 have been examined by the IRS and the statute of limitations has expired on those years. Any adjustments that may result from IRS examinations of the Company’s tax returns are not expected to have a material effect on the results of operations, cash flows or financial position of the Company.
Tax Reform On December 22, 2017, Public Law 115-97, known as the Tax Cuts and Jobs Act of 2017 (“Tax Legislation”) became effective. The Tax Legislation impacts the Company generally in four areas:
| 1. | Amends the U.S. Internal Revenue Code of 1986, as amended, which among other items, permanently reduces the corporate income tax rate from a maximum of 35% to 21% beginning January 1, 2018. |
| 2. | Changes international taxation to a modified territorial tax system whereby profits from non-U.S. subsidiaries will generally be taxed only in their local jurisdictions. |
| 3. | Contains several other provisions, such as limitations of deductibility of executive compensation, meals and entertainment and lobbying expenses and changes to the dividends received deduction. |
| 4. | Affects the timing of certain tax deductions for reserves and deferred acquisition costs, but does not impact the Company’s overall income tax expense. |
Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are adjusted through income tax expense as changes in tax laws or rates are enacted.
The Company revalued its deferred tax assets and liabilities at the new corporate income tax rate. The transition to the modified territorial system for international taxation required the Company to recognize a liability in 2017 based on non-U.S. income from international subsidiaries that had not been repatriated to their U.S. parent company (the “Transition Tax”). The Company recorded a net tax benefit of $506 million, recognized as a reduction to income tax expense in the Company’s Consolidated Statements of Operations for the year ended December 31, 2017. The net benefit was primarily due to re-measurement of the Company’s deferred tax assets and liabilities, partially offset by the impact of the transition tax on deemed repatriation of deferred non-U.S. income. The Company’s effective income tax rate for 2017 was 20.1% and included this one-time benefit of 12.7%.
The impact of the Tax Legislation may differ from the Company’s preliminary estimates due to, among other things, changes in interpretations and assumptions the Company has made, guidance that may be issued and actions the Company may take as a result of the Tax Legislation. The transition tax calculation and the tax expense related to the rate differential on the deferred tax assets and liabilities of the foreign subsidiaries are based on estimated amounts. Any potential adjustments made could be material in relation to the preliminary estimates recorded.
| Reconciliation of the change in the amount of unrecognized tax benefits | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Balance – beginning of year | $ | 10 | $ | 7 | $ | — | ||||||
| Increase for tax positions taken in a prior year | 34 | — | 4 | |||||||||
| Increase for tax positions taken in the current year | 11 | 3 | 3 | |||||||||
| Balance – end of year | $ | 55 | $ | 10 | $ | 7 |
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The Company believes it is reasonably possible that the liability balance will not significantly increase within the next twelve months.
The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. The Company did not record interest income or
expense relating to unrecognized tax benefits in income tax expense in 2017, 2016 or 2015. As of December 31, 2017 and 2016, there was no interest accrued with respect to unrecognized tax benefits. No amounts have been accrued for penalties.
| Components of the deferred income tax assets and liabilities (1) | ||||||||
| As of December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Deferred assets | ||||||||
| Unearned premium reserves | $ | 545 | $ | 819 | ||||
| Accrued compensation | 137 | 203 | ||||||
| Pension | 86 | 294 | ||||||
| Discount on loss reserves | 53 | 188 | ||||||
| Net operating loss carryover | 50 | 15 | ||||||
| Other assets | 49 | 103 | ||||||
| Other postretirement benefits | 48 | 64 | ||||||
| Difference in tax bases of invested assets | — | 78 | ||||||
| Total deferred assets | 968 | 1,764 | ||||||
| Deferred liabilities | ||||||||
| DAC | (770 | ) | (1,211 | ) | ||||
| Unrealized net capital gains | (422 | ) | (529 | ) | ||||
| Life and annuity reserves | (241 | ) | (324 | ) | ||||
| Intangible assets | (113 | ) | (29 | ) | ||||
| Difference in tax bases of invested assets | (106 | ) | — | |||||
| Other liabilities | (98 | ) | (158 | ) | ||||
| Total deferred liabilities | (1,750 | ) | (2,251 | ) | ||||
| Net deferred liability | $ | (782 | ) | $ | (487 | ) |
| (1) | Changes in deferred tax assets and liabilities primarily relate to the Tax Legislation. |
Although realization is not assured, management believes it is more likely than not that the deferred tax assets will be realized based on the Company’s assessment that the deductions ultimately recognized for tax purposes will be fully utilized. As of December 31, 2017, the Company has net operating loss carryforwards of $238 million. The Tax Legislation eliminated the 20-year limitation on carryforwards and made the carryforward period indefinite.
| Components of income tax expense | ||||||||||||
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Current | $ | 1,018 | $ | 654 | $ | 1,033 | ||||||
| Deferred | (216 | ) | 223 | 78 | ||||||||
| Total income tax expense | $ | 802 | $ | 877 | $ | 1,111 |
The Company paid income taxes of $968 million, $359 million and $1.07 billion in 2017, 2016 and 2015, respectively.
The Company had current income tax payable of $44 million and $135 million as of December 31, 2017 and 2016, respectively.
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| Reconciliation of the statutory federal income tax rate to the effective income tax rate | |||||||||
| For the years ended December 31, | |||||||||
| 2017 | 2016 | 2015 | |||||||
| Statutory federal income tax rate on income from operations | 35.0 | % | 35.0 | % | 35.0 | % | |||
| Tax Legislation benefit | (12.7 | ) | — | — | |||||
| Share-based payments (1) | (1.6 | ) | — | — | |||||
| Tax-exempt income | (0.8 | ) | (1.2 | ) | (1.0 | ) | |||
| Tax credits | (0.9 | ) | (1.2 | ) | (0.9 | ) | |||
| Non-deductible goodwill impairment | 1.1 | — | — | ||||||
| Other (2) | — | (0.7 | ) | 0.8 | |||||
| Effective income tax rate on income from operations | 20.1 | % | 31.9 | % | 33.9 | % |
| (1) | Includes a tax benefit of $63 million related to the 2017 adoption of the new accounting standard for share-based payments. |
| (2) | Includes $45 million of income tax expense related to the change in accounting guidance for investments in qualified affordable housing projects adopted in 2015. |
| Note 16 | Statutory Financial Information and Dividend Limitations |
Allstate’s domestic property and casualty and life insurance subsidiaries prepare their statutory-basis financial statements in conformity with accounting practices prescribed or permitted by the insurance department of the applicable state of domicile. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (“NAIC”), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed.
All states require domiciled insurance companies to prepare statutory-basis financial statements in
conformity with the NAIC Accounting Practices and Procedures Manual, subject to any deviations prescribed or permitted by the applicable insurance commissioner and/or director. Statutory accounting practices differ from GAAP primarily since they require charging policy acquisition and certain sales inducement costs to expense as incurred, establishing life insurance reserves based on different actuarial assumptions, and valuing certain investments and establishing deferred taxes on a different basis.
| Statutory net income (loss) and capital and surplus of Allstate’s domestic insurance subsidiaries | ||||||||||||||||||||
| Net income (loss) | Capital and surplus | |||||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||
| Amounts by major business type: | ||||||||||||||||||||
| Property and casualty insurance | $ | 3,050 | $ | 1,520 | $ | 1,826 | $ | 14,903 | $ | 13,436 | ||||||||||
| Life insurance, annuities and voluntary accident and health insurance | 327 | 197 | (56 | ) | 3,727 | 3,383 | ||||||||||||||
| Amount per statutory accounting practices | $ | 3,377 | $ | 1,717 | $ | 1,770 | $ | 18,630 | $ | 16,819 |
Dividend Limitations
There are no regulatory restrictions that limit the payment of dividends by the Corporation, except those generally applicable to corporations incorporated in Delaware. Dividends are payable only out of certain components of shareholders’ equity as permitted by Delaware law. However, the ability of the Corporation to pay dividends is dependent on business conditions, income, cash requirements of the Company, receipt of dividends from AIC and other relevant factors.
The payment of shareholder dividends by AIC without the prior approval of the Illinois Department of Insurance (“IL DOI”) is limited to formula amounts based on net income and capital and surplus, determined in conformity with statutory accounting practices, as well as the timing and amount of dividends paid in the preceding twelve months. AIC paid dividends of $1.56 billion in 2017. The maximum amount of dividends AIC will be able to pay without prior IL DOI approval at a given point in time during
2018 is $2.87 billion, less dividends paid during the preceding twelve months measured at that point in time. The payment of a dividend in excess of this amount requires 30 days advance written notice to the IL DOI. The dividend is deemed approved, unless the IL DOI disapproves it within the 30 day notice period. Additionally, any dividend must be paid out of unassigned surplus excluding unrealized appreciation from investments, which for AIC totaled $11.04 billion as of December 31, 2017, and cannot result in capital and surplus being less than the minimum amount required by law.
Under state insurance laws, insurance companies are required to maintain paid up capital of not less than the minimum capital requirement applicable to the types of insurance they are authorized to write. Insurance companies are also subject to risk-based capital (“RBC”) requirements adopted by state insurance regulators. A company’s “authorized control level RBC” is calculated using various factors applied to
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certain financial balances and activity. Companies that do not maintain adjusted statutory capital and surplus at a level in excess of the company action level RBC, which is two times authorized control level RBC, are required to take specified actions. Company action level RBC is significantly in excess of the minimum capital requirements. Total adjusted statutory capital and surplus and authorized control level RBC of AIC were $17.70 billion and $2.80 billion, respectively, as of December 31, 2017. Substantially all of the Corporation’s insurance subsidiaries are subsidiaries of and/or reinsure all of their business to AIC, including ALIC. AIC’s subsidiaries are included as a component of AIC’s total statutory capital and surplus.
The amount of restricted net assets, as represented by the Corporation’s investment in its insurance subsidiaries, was $26 billion as of December 31, 2017.
Intercompany transactions
Notification and approval of intercompany lending activities is also required by the IL DOI for transactions that exceed a level that is based on a formula using statutory admitted assets and statutory surplus.
| Note 17 | Benefit Plans |
Pension and other postretirement plans
Defined benefit pension plans cover most full-time employees, certain part-time employees and employee-agents. Benefits under the pension plans are based upon the employee’s length of service, eligible annual compensation and, prior to January 1, 2014, either a cash balance or final average pay formula. A cash balance formula applies to all eligible employees hired after August 1, 2002. Eligible employees hired before August 1, 2002 chose between the cash balance formula and the final average pay formula. In July 2013, the Company amended its primary plans effective January 1, 2014 to introduce a new cash balance formula to replace the previous formulas (including the final average pay formula and the previous cash balance formula) under which eligible employees accrue benefits.
The Company also provides a medical coverage subsidy for eligible employees hired before January 1, 2003, including their eligible dependents, when they retire and certain life insurance benefits for eligible retirees (“postretirement benefits”). In July 2013, the Company amended the plan to eliminate the life insurance benefits effective January 1, 2014 for current eligible employees and effective January 1, 2016 for eligible retirees who retired after 1989. In 2017, the Company continues to pay life insurance premiums for certain retiree plaintiffs subject to a court order requiring it to do so until such time as their lawsuit seeking to keep their life insurance benefits intact is resolved. Qualified employees may become eligible for a medical subsidy if they retire in accordance with the terms of the applicable plans and are continuously insured under the Company’s group plans or other approved plans in accordance with the plan’s
participation requirements. The Company shares the cost of retiree medical benefits with non Medicare-eligible retirees based on years of service, with the Company’s share being subject to a 5% limit on future annual medical cost inflation after retirement. For Medicare-eligible retirees, the Company provides a fixed Company contribution based on years of service and other factors, which is not subject to adjustments for inflation.
The Company has reserved the right to modify or terminate its benefit plans at any time and for any reason.
Obligations and funded status
The Company calculates benefit obligations based upon generally accepted actuarial methodologies using the projected benefit obligation (“PBO”) for pension plans and the accumulated postretirement benefit obligation (“APBO”) for other postretirement plans. The determination of pension costs and other postretirement obligations are determined using a December 31 measurement date. The benefit obligations represent the actuarial present value of all benefits attributed to employee service rendered as of the measurement date. The PBO is measured using the pension benefit formulas and assumptions as to future compensation levels. A plan’s funded status is calculated as the difference between the benefit obligation and the fair value of plan assets. The Company’s funding policy for the pension plans is to make contributions at a level in accordance with regulations under the Internal Revenue Code (“IRC”) and generally accepted actuarial principles. The Company’s other postretirement benefit plans are not funded.
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| Components of the pension and other postretirement plans’ funded status reflected in the Consolidated Statements of Financial Position | ||||||||||||||||
| As of December 31, | ||||||||||||||||
| Pension benefits | Postretirement benefits | |||||||||||||||
| ($ in millions) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
| Fair value of plan assets | $ | 6,284 | $ | 5,650 | $ | — | $ | — | ||||||||
| Less: Benefit obligation | 6,815 | 6,591 | 386 | 373 | ||||||||||||
| Funded status | $ | (531 | ) | $ | (941 | ) | $ | (386 | ) | $ | (373 | ) | ||||
| Items not yet recognized as a component of net periodic cost: | ||||||||||||||||
| Net actuarial loss (gain) | $ | 2,224 | $ | 2,807 | $ | (218 | ) | $ | (251 | ) | ||||||
| Prior service credit | (254 | ) | (310 | ) | (37 | ) | (62 | ) | ||||||||
| Unrecognized pension and other postretirement benefit cost, pre-tax | 1,970 | 2,497 | (255 | ) | (313 | ) | ||||||||||
| Deferred income tax (1) | (419 | ) | (874 | ) | 51 | 109 | ||||||||||
| Unrecognized pension and other postretirement benefit cost | $ | 1,551 | $ | 1,623 | $ | (204 | ) | $ | (204 | ) |
| (1) | Components of the pension plan and other postretirement benefits were reduced by deferred income taxes at the newly enacted 21% U.S. corporate tax rate as of December 31, 2017 and 35% as of December 31, 2016. |
The $583 million decrease in the pension net actuarial loss during 2017 is primarily related to gains from favorable asset performance, a settlement loss and the amortization of unrecognized pension costs to net periodic pension cost, partially offset by a decrease in the discount rate and lump sum conversion rates. The majority of the $2.22 billion net actuarial pension benefit losses not yet recognized in 2017 reflects decreases in the discount rate. The $33 million decrease in the OPEB net actuarial gain during 2017 primarily related to amortization of net actuarial gains.
The primary qualified employee plan represents 73% of the pension benefits’ underfunded status as of December 31, 2017.
The change in items not yet recognized as a component of net periodic cost is recorded in unrecognized pension and other postretirement benefit cost.
| Changes in items not yet recognized as a component of net periodic cost | ||||||||
| ($ in millions) | Pension benefits | Postretirement benefits | ||||||
| Items not yet recognized as a component of net periodic cost – December 31, 2016 | $ | 2,497 | $ | (313 | ) | |||
| Net actuarial (gain) loss arising during the period | (247 | ) | 8 | |||||
| Net actuarial (loss) gain amortized to net periodic benefit cost | (342 | ) | 24 | |||||
| Prior service credit amortized to net periodic benefit cost | 56 | 25 | ||||||
| Translation adjustment and other | 6 | 1 | ||||||
| Items not yet recognized as a component of net periodic cost – December 31, 2017 | $ | 1,970 | $ | (255 | ) |
The net actuarial loss (gain) and prior service credit is recognized as a component of net periodic cost amortized over the average remaining service period of active employees expected to receive benefits.
| Estimates of 2018 net actuarial loss (gain) and prior service credit | ||||||||
| ($ in millions) | Pension benefits | Postretirement benefits | ||||||
| Net actuarial loss (gain) | $ | 177 | $ | (22 | ) | |||
| Prior service credit | (56 | ) | (22 | ) |
The accumulated benefit obligation (“ABO”) for all defined benefit pension plans was $6.74 billion and $6.52 billion as of December 31, 2017 and 2016, respectively. The ABO is the actuarial present value of all benefits attributed by the pension benefit formula to employee service rendered at the measurement date. However, it differs from the PBO due to the exclusion of an assumption as to future compensation levels.
The PBO, ABO and fair value of plan assets for the Company’s pension plans with an ABO in excess of plan assets were $6.42 billion, $6.36 billion and $5.89 billion, respectively, as of December 31, 2017 and $6.24 billion, $6.18 billion and $5.30 billion, respectively, as of December 31, 2016. Included in the accrued benefit cost of the pension benefits are certain unfunded non-qualified plans with accrued benefit costs of $140 million and $141 million for 2017 and 2016, respectively.
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| Changes in benefit obligations for all plans | ||||||||||||||||
| Pension benefits | Postretirement benefits | |||||||||||||||
| ($ in millions) | 2017 | 2016 | 2017 | 2016 | ||||||||||||
| Benefit obligation, beginning of year | $ | 6,591 | $ | 6,130 | $ | 373 | $ | 405 | ||||||||
| Service cost | 114 | 113 | 8 | 9 | ||||||||||||
| Interest cost | 264 | 286 | 15 | 17 | ||||||||||||
| Participant contributions | — | 1 | 12 | 16 | ||||||||||||
| Actuarial loss (gain) | 395 | 387 | 8 | (14 | ) | |||||||||||
| Benefits paid (1) | (553 | ) | (301 | ) | (35 | ) | (41 | ) | ||||||||
| Plan amendments | — | — | — | (22 | ) | |||||||||||
| Translation adjustment and other | 4 | (25 | ) | 5 | 3 | |||||||||||
| Benefit obligation, end of year | $ | 6,815 | $ | 6,591 | $ | 386 | $ | 373 |
| (1) | Benefits paid include lump sum distributions, a portion of which triggered settlement accounting treatment. |
| Components of net periodic cost | ||||||||||||||||||||||||
| For the years ended December 31, | ||||||||||||||||||||||||
| Pension benefits | Postretirement benefits | |||||||||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | ||||||||||||||||||
| Service cost | $ | 114 | $ | 113 | $ | 114 | $ | 8 | $ | 9 | $ | 12 | ||||||||||||
| Interest cost | 264 | 286 | 258 | 15 | 17 | 23 | ||||||||||||||||||
| Expected return on plan assets | (409 | ) | (398 | ) | (424 | ) | — | — | — | |||||||||||||||
| Amortization of: | ||||||||||||||||||||||||
| Prior service credit | (56 | ) | (56 | ) | (56 | ) | (25 | ) | (21 | ) | (22 | ) | ||||||||||||
| Net actuarial loss (gain) | 189 | 174 | 190 | (24 | ) | (24 | ) | (9 | ) | |||||||||||||||
| Settlement loss | 153 | 27 | 31 | — | — | — | ||||||||||||||||||
| Net periodic cost (credit) | $ | 255 | $ | 146 | $ | 113 | $ | (26 | ) | $ | (19 | ) | $ | 4 |
The service cost component is the actuarial present value of the benefits attributed by the plans’ benefit formula to services rendered by the employees during the period. Interest cost is the increase in the PBO in the period due to the passage of time at the discount rate. Interest cost fluctuates as the discount rate changes and is also impacted by the related change in the size of the PBO. The decrease or increase in the PBO due to an increase or decrease in the discount rate is deferred and decreases or increases the net actuarial loss. It is recorded in AOCI as unrecognized pension benefit cost and may be amortized.
The expected return on plan assets is determined as the product of the expected long-term rate of return on plan assets and the adjusted fair value of plan assets, referred to as the market-related value of plan assets. To determine the market-related value, the fair value of plan assets is adjusted annually so that differences between changes in the fair value of equity securities and the expected long-term rate of return on these securities are recognized into the market-related value of plan assets over a five-year period. We believe this is consistent with the long-term nature of pension obligations.
When the actual return on plan assets exceeds the expected return it reduces the net actuarial loss recorded in AOCI; when the expected return exceeds the actual return it increases the net actuarial loss. These amounts are recorded in AOCI as unrecognized pension benefit cost and may be amortized. The market-related value adjustment represents the current difference between actual returns and expected returns on equity securities and hedge fund
limited partnerships recognized over a five-year period. The market-related value adjustment is a deferred net gain of $403 million as of December 31, 2017. The expected return on plan assets fluctuates when the market-related value of plan assets changes and when the expected long-term rate of return on plan assets assumption changes.
Net actuarial loss fluctuations are due to changes in discount rate, differences between actual return on plan assets and expected long-term rate of return on plan assets, and differences between actual plan experience and other actuarial assumptions when there is an excess sufficient to qualify for amortization.
Amortization of net actuarial loss in pension cost is recorded when the net actuarial loss excluding the unamortized market-related value adjustment exceeds 10% of the greater of the PBO or the market-related value of plan assets. The amount of amortization is equal to the excess divided by the average remaining service period for active employees for each plan, which approximates 10 years for Allstate’s largest plan. As a result, the effect of changes in the PBO due to changes in the discount rate and changes in the fair value of plan assets may be experienced in our net periodic pension cost in periods subsequent to those in which the fluctuations actually occur.
Settlement losses are non-cash charges that accelerate the recognition of unrecognized pension benefit cost that would have been incurred in subsequent periods, when plan payments, primarily lump sums from qualified pension plans, exceed a threshold of service plus interest cost for the period. The value of lump sums paid in 2017 was higher than in
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Notes to Consolidated Financial Statements 2017 Form 10-K
2016 and exceeded the settlement charge threshold, in the primary employee plan, due to higher-than-expected retirement levels, higher prescribed IRS lump sum interest rates that reduce future benefit lump sum payments and reductions in force. As a result, a
pension settlement loss of $122 million, pre-tax, was recorded as part of operating costs and expenses in the Corporate and Other segment.
| Weighted average assumptions used to determine net pension cost and net postretirement benefit cost | ||||||||||||||||||
| For the years ended December 31, | ||||||||||||||||||
| Pension benefits | Postretirement benefits | |||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | 2015 | ||||||||||||
| Discount rate | 4.15 | % | 4.83 | % | 4.10 | % | 3.63 | % | 4.59 | % | 3.97 | % | ||||||
| Rate of increase in compensation levels | 3.20 | 3.20 | 3.50 | n/a | n/a | n/a | ||||||||||||
| Expected long-term rate of return on plan assets | 7.31 | 7.30 | 7.33 | n/a | n/a | n/a |
| Weighted average assumptions used to determine benefit obligations | ||||||||||||
| For the years ended December 31, | ||||||||||||
| Pension benefits | Postretirement benefits | |||||||||||
| 2017 | 2016 | 2017 | 2016 | |||||||||
| Discount rate | 3.68 | % | 4.15 | % | 4.06 | % | 4.07 | % | ||||
| Rate of increase in compensation levels | 3.20 | 3.20 | n/a | n/a |
The weighted average health care cost trend rate used in measuring the accumulated postretirement benefit cost is 6.1% for 2018, gradually declining to 4.5% in 2038 and remaining at that level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement health care plans. A one percentage-point increase in assumed health care cost trend rates would increase the total of the service and interest
cost components of net periodic benefit cost of other postretirement benefits and APBO by $2 million and $26 million, respectively. A one percentage-point decrease in assumed health care cost trend rates would decrease the total of the service and interest cost components of net periodic benefit cost of other postretirement benefits and APBO by $2 million and $23 million, respectively.
Pension plan assets
| Change in pension plan assets | ||||||||
| For the years ended December 31, | ||||||||
| ($ in millions) | 2017 | 2016 | ||||||
| Fair value of plan assets, beginning of year | $ | 5,650 | $ | 5,353 | ||||
| Actual return on plan assets | 1,051 | 491 | ||||||
| Employer contribution | 131 | 131 | ||||||
| Benefits paid | (553 | ) | (301 | ) | ||||
| Translation adjustment and other | 5 | (24 | ) | |||||
| Fair value of plan assets, end of year | $ | 6,284 | $ | 5,650 |
In general, the Company’s pension plan assets are managed in accordance with investment policies approved by pension investment committees. The purpose of the policies is to ensure the plans’ long-term ability to meet benefit obligations by prudently investing plan assets and Company contributions, while taking into consideration regulatory and legal requirements and current market conditions. The investment policies are reviewed periodically and specify target plan asset allocation by asset category. In addition, the policies specify various asset allocation and other risk limits. The target asset allocation takes the plans’ funding status into consideration, among other factors, including anticipated demographic changes or liquidity requirements that may affect the funding status such as the potential impact of lump sum settlements as well as existing or expected market conditions. In general, the allocation has a
lower overall investment risk when a plan is in a stronger funded status position since there is less economic incentive to take risk to increase the expected returns on the plan assets. As a result, the primary employee plan has a greater allocation to equity securities than the employee-agent plan. The primary qualified employee plan comprises 81% of total plan assets and 86% of equity securities. The pension plans’ asset exposure within each asset category is tracked against widely accepted established benchmarks for each asset class with limits on variation from the benchmark established in the investment policy. Pension plan assets are regularly monitored for compliance with these limits and other risk limits specified in the investment policies.
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2017 Form 10-K Notes to Consolidated Financial Statements
| Weighted average target asset allocation and actual percentage of plan assets by asset category | ||||||||
| As of December 31, 2017 | ||||||||
| Target asset allocation (1) | Actual percentage of plan assets | |||||||
| Pension plan’s asset category | 2017 | 2017 | 2016 | |||||
| Equity securities (2) | 43 - 62% | 58 | % | 62 | % | |||
| Fixed income securities | 34 - 44% | 34 | 29 | |||||
| Limited partnership interests | 0 - 13% | 6 | 7 | |||||
| Short-term investments and other | — | 2 | 2 | |||||
| Total without securities lending (3) | 100 | % | 100 | % |
| (1) | The target asset allocation considers risk based exposure while the actual percentage of plan assets utilizes a financial reporting view excluding exposure provided through derivatives. |
| (2) | The actual percentage of plan assets for equity securities include private equity investments that are subject to the limited partnership interests target allocation of 2% and 1% in 2017 and 2016, respectively, fixed income mutual funds that are subject to the fixed income securities target allocation of 3% for both 2017 and 2016 as well as 1% of equity exposure created through a derivative which is not included in the actual allocations in 2017. |
| (3) | Securities lending collateral reinvestment of $202 million and $143 million is excluded from the table above in 2017 and 2016, respectively. |
The target asset allocation for an asset category may be achieved either through direct investment holdings, through replication using derivative instruments (e.g., futures or swaps) or net of hedges using derivative instruments to reduce exposure to an asset category. The net notional amount of derivatives used for replication and hedges is limited to 105% or 115% of total plan assets depending on the plan. Market performance of the different asset categories may, from time to time, cause deviation from the target
asset allocation. The asset allocation mix is reviewed on a periodic basis and rebalanced to bring the allocation within the target ranges.
Outside the target asset allocation, the pension plans participate in a securities lending program to enhance returns. As of December 31, 2017, U.S. government fixed income securities and U.S. equity securities are lent out and cash collateral is invested in short-term investments.
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| Fair values of pension plan assets as of December 31, 2017 | ||||||||||||||||
| ($ in millions) | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | Balance as of December 31, 2017 | ||||||||||||
| Equity securities | $ | 126 | $ | 264 | $ | 29 | $ | 419 | ||||||||
| Fixed income securities: | ||||||||||||||||
| U.S. government and agencies | 174 | 420 | — | 594 | ||||||||||||
| Corporate | — | 1,543 | 10 | 1,553 | ||||||||||||
| Short-term investments | 97 | 197 | — | 294 | ||||||||||||
| Cash and cash equivalents | 21 | — | — | 21 | ||||||||||||
| Free-standing derivatives: | ||||||||||||||||
| Assets | — | 1 | — | 1 | ||||||||||||
| Total plan assets at fair value | $ | 418 | $ | 2,425 | $ | 39 | 2,882 | |||||||||
| % of total plan assets at fair value | 14.5 | % | 84.1 | % | 1.4 | % | 100.0 | % | ||||||||
| Investments measured using the net asset value practical expedient (1) | 3,598 | |||||||||||||||
| Securities lending obligation (2) | (216 | ) | ||||||||||||||
| Other net plan assets (3) | 20 | |||||||||||||||
| Total reported plan assets | $ | 6,284 |
| (1) | In 2017, the Company retrospectively adopted a new accounting standard for pension plans which eliminates the requirement to include investments in the fair value hierarchy for which fair value is measured using net asset value (“NAV”) per share practical expedient. As a result, certain pension plan investments that are measured at fair value using the NAV per share practical expedient have not been classified in the fair value hierarchy, including the related rollforward of Level 3 plan assets presented below. These investments comprised of $3.20 billion of equity investments and $402 million of limited partnerships. |
| (2) | The securities lending obligation represents the plan’s obligation to return securities lending collateral received under a securities lending program. The terms of the program allow both the plan and the counterparty the right and ability to redeem/return the securities loaned on short notice. Due to its relatively short-term nature, the outstanding balance of the obligation approximates fair value. |
| (3) | Other net plan assets represent interest and dividends receivable and net receivables related to settlements of investment transactions, such as purchases and sales. |
| Fair values of pension plan assets as of December 31, 2016 | ||||||||||||||||
| ($ in millions) | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | Balance as of December 31, 2016 | ||||||||||||
| Equity securities | $ | 155 | $ | 147 | $ | — | $ | 302 | ||||||||
| Fixed income securities: | ||||||||||||||||
| U.S. government and agencies | 30 | 285 | — | 315 | ||||||||||||
| Corporate | — | 1,309 | 10 | 1,319 | ||||||||||||
| Short-term investments | 144 | 121 | — | 265 | ||||||||||||
| Cash and cash equivalents | 32 | — | — | 32 | ||||||||||||
| Free-standing derivatives: | ||||||||||||||||
| Assets | (1 | ) | 1 | — | — | |||||||||||
| Total plan assets at fair value | $ | 360 | $ | 1,863 | $ | 10 | 2,233 | |||||||||
| % of total plan assets at fair value | 16.1 | % | 83.4 | % | 0.5 | % | 100.0 | % | ||||||||
| Investments measured using the Net Asset Value practical expedient | 3,525 | |||||||||||||||
| Securities lending obligation | (158 | ) | ||||||||||||||
| Other net plan assets | 50 | |||||||||||||||
| Total reported plan assets | $ | 5,650 |
The fair values of pension plan assets are estimated using the same methodologies and inputs as those used to determine the fair values for the respective asset category of the Company. These methodologies and inputs are disclosed in Note 6.
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2017 Form 10-K Notes to Consolidated Financial Statements
| Rollforward of level 3 plan assets during December 31, 2017 | ||||||||||||||||||||||||
| Actual return on plan assets: | ||||||||||||||||||||||||
| ($ in millions) | Balance as of December 31, 2016 | Relating to assets sold during the period | Relating to assets still held at the reporting date | Purchases, sales and settlements, net | Net transfers in and/or (out) of Level 3 | Balance as of December 31, 2017 | ||||||||||||||||||
| Equity securities | $ | — | $ | — | $ | — | $ | 29 | $ | — | $ | 29 | ||||||||||||
| Fixed income securities: | ||||||||||||||||||||||||
| Corporate | 10 | — | — | — | — | 10 | ||||||||||||||||||
| Total Level 3 plan assets | $ | 10 | $ | — | $ | — | $ | 29 | $ | — | $ | 39 |
| Rollforward of level 3 plan assets during December 31, 2016 | ||||||||||||||||||||||||
| Actual return on plan assets: | ||||||||||||||||||||||||
| ($ in millions) | Balance as of December 31, 2015 | Relating to assets sold during the period | Relating to assets still held at the reporting date | Purchases, sales and settlements, net | Net transfers in and/or (out) of Level 3 | Balance as of December 31, 2016 | ||||||||||||||||||
| Equity securities | $ | 1 | $ | (1 | ) | $ | — | $ | — | $ | — | $ | — | |||||||||||
| Fixed income securities: | ||||||||||||||||||||||||
| Municipal | 7 | — | — | (7 | ) | — | — | |||||||||||||||||
| Corporate | 10 | — | — | (5 | ) | 5 | 10 | |||||||||||||||||
| Total Level 3 plan assets | $ | 18 | $ | (1 | ) | $ | — | $ | (12 | ) | $ | 5 | $ | 10 |
| Rollforward of level 3 plan assets during December 31, 2015 | ||||||||||||||||||||||||
| Actual return on plan assets: | ||||||||||||||||||||||||
| ($ in millions) | Balance as of December 31, 2014 | Relating to assets sold during the period | Relating to assets still held at the reporting date | Purchases, sales and settlements, net | Net transfers in and/or (out) of Level 3 | Balance as of December 31, 2015 | ||||||||||||||||||
| Equity securities | $ | 1 | $ | 1 | $ | (1 | ) | $ | — | $ | — | $ | 1 | |||||||||||
| Fixed income securities: | ||||||||||||||||||||||||
| Municipal | 14 | — | — | (7 | ) | — | 7 | |||||||||||||||||
| Corporate | 12 | — | — | — | (2 | ) | 10 | |||||||||||||||||
| Total Level 3 plan assets | $ | 27 | $ | 1 | $ | (1 | ) | $ | (7 | ) | $ | (2 | ) | $ | 18 |
The expected long-term rate of return on plan assets reflects the average rate of earnings expected on plan assets. The Company’s assumption for the expected long-term rate of return on plan assets is reviewed annually giving consideration to appropriate financial data including, but not limited to, the plan asset allocation, forward-looking expected returns for the period over which benefits will be paid, historical returns on plan assets and other relevant market data. Given the long-term forward looking nature of this assumption, the actual returns in any one year do not immediately result in a change. In giving consideration to the targeted plan asset allocation, the Company evaluated returns using the same sources it has used historically which include: historical average asset class returns from an independent nationally recognized vendor of this type of data blended together using the asset allocation policy weights for the Company’s pension plans; asset class return forecasts from a large global independent asset management firm that specializes in providing multi-asset class investment fund products which were blended together using the asset allocation policy weights; and expected portfolio returns from a proprietary simulation methodology of a widely recognized external investment consulting firm that performs asset allocation and actuarial services for corporate pension plan sponsors. This same methodology has been applied on a consistent basis
each year. All of these were consistent with the Company’s weighted average long-term rate of return on plan assets assumption of 7.31% used for 2017 and 7.32% that will be used for 2018. The assumption for the primary qualified employee plan is 7.75% and the employee-agent plan is 5.75% for both years. The employee-agent plan assumption is lower than the primary qualified employee plan assumption due to a lower investment allocation to equity securities and a higher allocation to fixed income securities. As of the 2017 measurement date, the arithmetic average of the annual actual return on plan assets for the most recent 10 and 5 years was 6.8% and 9.9%, respectively.
Cash flows
There was no required cash contribution necessary to satisfy the minimum funding requirement under the Internal Revenue Code for the tax qualified pension plans as of December 31, 2017. The Company currently plans to contribute $133 million to its pension plans in 2018.
The Company contributed $23 million and $25 million to the postretirement benefit plans in 2017 and 2016, respectively. Contributions by participants were $12 million and $16 million in 2017 and 2016, respectively.
204 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
| Estimated future benefit payments expected to be paid in the next 10 years | ||||||||
| As of December 31, 2017, | ||||||||
| ($ in millions) | Pension benefits | Postretirement benefits | ||||||
| 2018 | $ | 426 | $ | 22 | ||||
| 2019 | 463 | 24 | ||||||
| 2020 | 485 | 24 | ||||||
| 2021 | 514 | 25 | ||||||
| 2022 | 533 | 26 | ||||||
| 2023-2027 | 2,477 | 136 | ||||||
| Total benefit payments | $ | 4,898 | $ | 257 |
Allstate 401(k) Savings Plan
Employees of the Company, with the exception of those employed by the Company’s international, SquareTrade, Esurance and Answer Financial subsidiaries, are eligible to become members of the Allstate 401(k) Savings Plan (“Allstate Plan”). The Company’s contributions are based on the Company’s matching obligation. The Company is responsible for funding its anticipated contribution to the Allstate Plan, and may, at the discretion of management, use the ESOP to pre-fund certain portions. In connection with the Allstate Plan, the Company has a note from the ESOP with a principal balance of $2 million as of
December 31, 2017. The ESOP note has a fixed interest rate of 7.9% and matures in 2019. The Company records dividends on the ESOP shares in retained income and all the shares held by the ESOP are included in basic and diluted weighted average common shares outstanding.
The Company’s contribution to the Allstate Plan was $81 million, $80 million and $79 million in 2017, 2016 and 2015, respectively. These amounts were reduced by the ESOP benefit.
| ESOP benefit | ||||||||||||
| For the years December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Interest expense recognized by ESOP | $ | — | $ | 1 | $ | 1 | ||||||
| Less: dividends accrued on ESOP shares | (1 | ) | (3 | ) | (3 | ) | ||||||
| Cost of shares allocated | 3 | 7 | 10 | |||||||||
| Compensation expense | 2 | 5 | 8 | |||||||||
| Reduction of defined contribution due to ESOP | 38 | 60 | 73 | |||||||||
| ESOP benefit | $ | (36 | ) | $ | (55 | ) | $ | (65 | ) |
The Company made $1 million, $2 million and $2 million in contributions to the ESOP in 2017, 2016 and 2015, respectively. As of December 31, 2017, total committed to be released, allocated and unallocated ESOP shares were 0.4 million, 38 million and 0.4 million, respectively.
Allstate’s Canadian, SquareTrade, Esurance and Answer Financial subsidiaries sponsor defined contribution plans for their eligible employees. Expense for these plans was $12 million, $10 million and $10 million in 2017, 2016 and 2015, respectively.
| Note 18 | Equity Incentive Plans |
The Company currently has equity incentive plans under which the Company grants nonqualified stock options, restricted stock units and performance stock awards to certain employees and directors of the Company. The total compensation expense related to equity awards was $106 million, $80 million and $81 million and the total income tax benefits were $22 million, $28 million and $28 million for 2017, 2016 and 2015, respectively. Total cash received from the exercise of options was $178 million, $187 million and $187 million for 2017, 2016 and 2015, respectively. Total tax benefit realized on options exercised and the release of stock restrictions was $96 million, $61 million and $82 million for 2017, 2016 and 2015, respectively.
The Company records compensation expense related to awards under these plans over the shorter of the period in which the requisite service is rendered or
retirement eligibility is attained. Compensation expense for performance share awards is based on the probable number of awards expected to vest using the performance level most likely to be achieved at the end of the performance period. As of December 31, 2017, total unrecognized compensation cost related to all nonvested awards was $84 million, of which $26 million related to nonqualified stock options which are expected to be recognized over the weighted average vesting period of 1.67 years, $25 million related to restricted stock units which are expected to be recognized over the weighted average vesting period of 1.82 years and $33 million related to performance stock awards which are expected to be recognized over the weighted average vesting period of 1.65 years.
Options are granted to employees with exercise prices equal to the closing share price of the
The Allstate Corporation 205
2017 Form 10-K Notes to Consolidated Financial Statements
Company’s common stock on the applicable grant date. Options granted to employees on or after February 18, 2014 vest ratably over a three-year period. Options granted prior to February 18, 2014 vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date. Vesting is subject to continued service, except for employees who are retirement eligible and in certain other limited circumstances. Options may be exercised once vested and will expire no later than ten years after the date of grant.
Restricted stock units for directors vest immediately and convert into shares of stock on the earlier of the day of the third anniversary of the grant date or the date the director’s service terminates, unless a deferred period of restriction is elected. Restricted stock units granted to directors prior to June 1, 2016 convert upon leaving the board. Restricted stock units granted to employees on or after February 18, 2014 vest on the day prior to the third anniversary of the grant date. Awards granted to employees prior to February 18, 2014 vest 50% on the day prior to the second anniversary of the grant date and 25% on each of the days prior to the third and fourth anniversaries of the grant date. Restricted stock units granted to employees subsequently convert into shares of stock on the day of the respective anniversary of the grant date. Vesting is subject to continued service, except for employees who are retirement eligible and in certain other limited circumstances.
Performance stock awards vest into shares of stock on the day prior to the third anniversary of the grant date. Vesting of the number of performance
stock awards earned based on the attainment of performance goals for each of the performance periods is subject to continued service, except for employees who are retirement eligible and in certain other limited circumstances, and achievement of performance goals. Performance stock awards subsequently convert into shares of stock in full the day of the anniversary of the grant date.
A total of 98.0 million shares of common stock were authorized to be used for awards under the plans, subject to adjustment in accordance with the plans’ terms. As of December 31, 2017, 18.3 million shares were reserved and remained available for future issuance under these plans. The Company uses its treasury shares for these issuances.
The fair value of each option grant is estimated on the date of grant using a binomial lattice model. The Company uses historical data to estimate option exercise and employee termination within the valuation model. In addition, separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the binominal lattice model and represents the period of time that options granted are expected to be outstanding. The expected volatility of the price of the underlying shares is implied based on traded options and historical volatility of the Company’s common stock. The expected dividends were based on the current dividend yield of the Company’s stock as of the date of the grant. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
| Option grant assumptions | |||||||||
| 2017 | 2016 | 2015 | |||||||
| Weighted average expected term | 6.1 years | 5.0 years | 6.5 years | ||||||
| Expected volatility | 15.7 - 32.7% | 16.0 - 34.3% | 16.0 - 37.8% | ||||||
| Weighted average volatility | 21.0 | % | 24.3 | % | 24.7 | % | |||
| Expected dividends | 1.4 - 1.9% | 1.9 - 2.1% | 1.6 - 2.1% | ||||||
| Weighted average expected dividends | 1.9 | % | 2.1 | % | 1.7 | % | |||
| Risk-free rate | 0.5 - 2.5% | 0.2 - 2.4% | 0.0 - 2.4% |
| Summary of option activity | |||||||||||||
| For the year ended December 31, 2017 | |||||||||||||
| Number (in 000s) | Weighted average exercise price | Aggregate intrinsic value (in 000s) | Weighted average remaining contractual term (years) | ||||||||||
| Outstanding as of January 1, 2017 | 13,560 | $ | 50.01 | ||||||||||
| Granted | 2,631 | 78.93 | |||||||||||
| Exercised | (4,688 | ) | 44.91 | ||||||||||
| Forfeited | (229 | ) | 70.85 | ||||||||||
| Expired | (12 | ) | 59.91 | ||||||||||
| Outstanding as of December 31, 2017 | 11,262 | 58.46 | $ | 520,900 | 6.5 | ||||||||
| Outstanding, net of expected forfeitures | 11,140 | 58.27 | 517,276 | 6.5 | |||||||||
| Outstanding, exercisable (“vested”) | 6,314 | 47.83 | 359,121 | 5.1 |
The weighted average grant date fair value of options granted was $14.60, $12.25 and $15.45 during 2017, 2016 and 2015, respectively. The intrinsic value, which is the difference between the fair value and the exercise price, of options exercised was $199 million, $119 million and $117 million during 2017, 2016 and 2015, respectively.
206 www.allstate.com
Notes to Consolidated Financial Statements 2017 Form 10-K
| Changes in restricted stock units | |||||||
| For the year ended December 31, 2017 | |||||||
| Number (in 000s) | Weighted average grant date fair value | ||||||
| Nonvested as of January 1, 2017 | 1,679 | $ | 58.49 | ||||
| Granted | 333 | 80.12 | |||||
| Vested | (718 | ) | 51.42 | ||||
| Forfeited | (53 | ) | 69.19 | ||||
| Nonvested as of December 31, 2017 | 1,241 | 67.93 |
The fair value of restricted stock units is based on the market value of the Company’s stock as of the date of the grant. The market value in part reflects the payment of future dividends expected. The weighted average grant date fair value of restricted stock units granted was $80.12, $63.51 and $69.25 during 2017, 2016 and 2015, respectively. The total fair value of restricted stock units vested was $58 million, $29 million and $63 million during 2017, 2016 and 2015, respectively.
| Changes in performance stock awards | |||||||
| For the year ended December 31, 2017 | |||||||
| Number (in 000s) | Weighted average grant date fair value | ||||||
| Nonvested as of January 1, 2017 | 919 | $ | 61.50 | ||||
| Granted | 458 | 78.47 | |||||
| Adjustment for performance achievement | (33 | ) | 52.75 | ||||
| Vested | (213 | ) | 52.52 | ||||
| Forfeited | (41 | ) | 69.30 | ||||
| Nonvested as of December 31, 2017 | 1,090 | 70.35 |
The change in PSA’s comprises those initially granted in 2017 and the adjustment to previously granted PSA’s for performance achievement. The fair value of performance stock awards is based on the market value of the Company’s stock as of the date of the grant. The market value in part reflects the payment of future dividends expected. The weighted average grant date fair value of performance stock awards granted was $78.47, $62.32 and $70.37 during 2017, 2016 and 2015, respectively. The total fair value of performance stock awards vested was $17 million, $28 million and $56 million during 2017, 2016 and 2015, respectively.
Under the new employee share-based payment accounting standard adopted in 2017, the Company recognizes all tax effects related to share-based payments at settlement or expiration through the income statement. Prior to the adoption, the Company recognized excess tax effects through the statement of shareholders’ equity. The tax benefit recognized through the statement of shareholders’ equity related to tax deductions from stock option exercises was $23 million in each of 2016 and 2015. The tax benefit recognized through shareholders’ equity in 2016 and 2015 related to all stock-based compensation was $30 million and $46 million, respectively.
| Note 19 | Supplemental Cash Flow Information |
Non-cash investing activities include $106 million, $326 million and $131 million related to mergers and exchanges completed with equity securities and modifications of certain mortgage loans, fixed income securities and other investments in 2017, 2016 and 2015, respectively, and a $89 million obligation to fund a limited partnership investment in 2015. Non-cash financing activities include $43 million, $41 million and $74 million related to the issuance of Allstate common shares for vested equity awards in 2017, 2016 and 2015, respectively. Non-cash financing activities also include $90 million and $34 million related to debt acquired in conjunction with purchases of investments in 2017 and 2016, respectively.
Liabilities for collateral received in conjunction with the Company’s securities lending program were $1.12 billion, $1.12 billion and $829 million as of December 31, 2017, 2016 and 2015, respectively, and are reported in other liabilities and accrued expenses. Obligations to return cash collateral for OTC and cleared derivatives were $3 million, $5 million and $11 million as of December 31, 2017, 2016 and 2015, respectively, and are reported in other liabilities and accrued expenses or other investments.
The Allstate Corporation 207
2017 Form 10-K Notes to Consolidated Financial Statements
The accompanying cash flows are included in cash flows from operating activities in the Consolidated Statements of Cash Flows along with the activities resulting from management of the proceeds, which for the years ended December 31 are as follows:
| For the years ended December 31, | ||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||
| Net change in proceeds managed | ||||||||||||
| Net change in fixed income securities | $ | 259 | $ | (584 | ) | $ | — | |||||
| Net change in short-term investments | (255 | ) | 295 | (59 | ) | |||||||
| Operating cash flow provided (used) | 4 | (289 | ) | (59 | ) | |||||||
| Net change in cash | 1 | — | 1 | |||||||||
| Net change in proceeds managed | $ | 5 | $ | (289 | ) | $ | (58 | ) | ||||
| Cash flows from operating activities | ||||||||||||
| Net change in liabilities | ||||||||||||
| Liabilities for collateral, beginning of year | $ | (1,129 | ) | $ | (840 | ) | $ | (782 | ) | |||
| Liabilities for collateral, end of year | (1,124 | ) | (1,129 | ) | (840 | ) | ||||||
| Operating cash flow (used) provided | $ | (5 | ) | $ | 289 | $ | 58 |
| Note 20 | Other Comprehensive Income |
| Components of other comprehensive income (loss) on a pre-tax and after-tax basis | ||||||||||||||||||||||||||||||||||||
| For the years ended December 31, | ||||||||||||||||||||||||||||||||||||
| ($ in millions) | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||||
| Pre-tax | Tax | After-tax | Pre-tax | Tax | After-tax | Pre-tax | Tax | After-tax | ||||||||||||||||||||||||||||
| Unrealized net holding gains and losses arising during the period, net of related offsets | $ | 866 | $ | (304 | ) | $ | 562 | $ | 486 | $ | (170 | ) | $ | 316 | $ | (1,896 | ) | $ | 663 | $ | (1,233 | ) | ||||||||||||||
| Less: reclassification adjustment of realized capital gains and losses | 374 | (131 | ) | 243 | (180 | ) | 63 | (117 | ) | 112 | (39 | ) | 73 | |||||||||||||||||||||||
| Unrealized net capital gains and losses | 492 | (173 | ) | 319 | 666 | (233 | ) | 433 | (2,008 | ) | 702 | (1,306 | ) | |||||||||||||||||||||||
| Unrealized foreign currency translation adjustments | 72 | (25 | ) | 47 | 15 | (5 | ) | 10 | (89 | ) | 31 | (58 | ) | |||||||||||||||||||||||
| Unrecognized pension and other postretirement benefit cost arising during the period | 232 | (79 | ) | 153 | (263 | ) | 94 | (169 | ) | (64 | ) | 25 | (39 | ) | ||||||||||||||||||||||
| Less: reclassification adjustment of net periodic cost recognized in operating costs and expenses | (237 | ) | 83 | (154 | ) | (100 | ) | 35 | (65 | ) | (134 | ) | 47 | (87 | ) | |||||||||||||||||||||
| Unrecognized pension and other postretirement benefit cost | 469 | (162 | ) | 307 | (163 | ) | 59 | (104 | ) | 70 | (22 | ) | 48 | |||||||||||||||||||||||
| Other comprehensive income (loss) | $ | 1,033 | $ | (360 | ) | $ | 673 | $ | 518 | $ | (179 | ) | $ | 339 | $ | (2,027 | ) | $ | 711 | $ | (1,316 | ) |
| Note 21 | Quarterly Results (unaudited) |
| First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||||||||||||||||||||||||||
| ($ in millions, except per share data) | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | ||||||||||||||||||||||||
| Revenues | $ | 9,434 | $ | 8,871 | $ | 9,587 | $ | 9,164 | $ | 9,660 | $ | 9,221 | $ | 9,843 | $ | 9,278 | ||||||||||||||||
| Net income applicable to common shareholders | 666 | 217 | 550 | 242 | 637 | 491 | 1,220 | 811 | ||||||||||||||||||||||||
| Net income applicable to common shareholders earnings per common share - Basic | 1.82 | 0.57 | 1.51 | 0.65 | 1.76 | 1.32 | 3.41 | 2.20 | ||||||||||||||||||||||||
| Net income applicable to common shareholders earnings per common share - Diluted | 1.79 | 0.57 | 1.49 | 0.64 | 1.74 | 1.31 | 3.35 | 2.18 |
208 www.allstate.com
2017 Form 10-K
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
The Allstate Corporation
Northbrook, Illinois 60062
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying Consolidated Statements of Financial Position of The Allstate Corporation and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related Consolidated Statements of Operations, Comprehensive Income, Shareholders’ Equity, and Cash Flows for each of the three years in the period ended December 31, 2017, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission – (“COSO”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A. Controls and Procedures. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
February 26, 2018
We have served as the Company's auditor since 1992.
The Allstate Corporation 209
2017 Form 10-K
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