UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-11840

THE ALLSTATE CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:   847/402-5000

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý       No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý       No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o       No ý

As of October 28, 2005, the registrant had 648,640,752 common shares, $.01 par value, outstanding.

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

September 30, 2005

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to condensed consolidated financial statements.

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THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

See notes to condensed consolidated financial statements.

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THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to condensed consolidated financial statements.

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THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.              General

Basis of presentation

The accompanying condensed consolidated financial statements include the accounts of The Allstate Corporation and its wholly owned subsidiaries, primarily Allstate Insurance Company (“AIC”), a property-liability insurance company with various property-liability and life and investment subsidiaries, including Allstate Life Insurance Company (“ALIC”) (collectively referred to as the “Company” or “Allstate”).

The condensed consolidated financial statements and notes as of September 30, 2005, and for the three-month and nine-month periods ended September 30, 2005 and 2004 are unaudited.  The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals), which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods.  These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

To conform to the 2005 presentation, certain amounts in the prior year’s condensed consolidated financial statements and notes have been reclassified.

Non-cash investment exchanges and modifications, which primarily reflect refinancings of fixed income securities and mergers completed with equity securities, totaled $36 million and $86 million for the nine months ended September 30, 2005 and 2004, respectively.

Adopted accounting standard

Financial Accounting Standards Board Staff Position Nos. FAS 106-1 and FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP FAS 106-1” and “FSP FAS
106-2”)

In May 2004, the Financial Accounting Standards Board (“FASB”) issued FSP FAS 106-2, which supersedes FSP FAS 106-1, to provide guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“Act”).  FSP FAS 106-2, which the Company adopted in the third quarter of 2004, required reporting entities that elected deferral under FSP FAS 106-1 and were able to determine if their plans are actuarially equivalent to recognize the impact of the Act no later than the first interim or annual reporting period beginning after June 15, 2004.  In January 2005, the Center for Medicare and Medicaid Services issued the final regulations for the Act including the determination of actuarial equivalence.  In the first quarter of 2005, the Company determined that its plans are actuarially equivalent. As a result of the recognition of the subsidy provided by the Act, the Company’s accumulated postretirement benefit obligation (“APBO”) was reduced by $115 million for benefits attributable to past service and the estimated annual net periodic postretirement benefit cost for 2005 will be reduced by $17 million, of which $8 million is amortization of the actuarial experience gain attributable to past service, $4 million is a reduction of current period service cost, and $5 million is the reduction in interest cost on the APBO (see Note 7).

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Pending accounting standards

Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”)

  In October 2005, the American Institute of Certified Public Accountants issued SOP 05-1.  SOP 05-1 provides accounting guidance for deferred policy acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”) No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.  SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract.  Internal replacement contracts are those that are substantially changed from the replaced contract and are accounted for as an extinguishment of the replaced contract.  Nonintegrated contract features are accounted for as separately issued contracts.  Modifications resulting from the election of a feature or coverage within a contract or from an integrated contract feature generally do not result in an internal replacement contract subject to SOP 05-1 provided certain conditions are met. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006.  The Company’s accounting policy for internal replacements is generally consistent with the accounting guidance prescribed in SOP 05–1; therefore, the SOP is not expected to have a material impact on the Company’s Condensed Consolidated Statements of Operations or Financial Position.

Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”)

In May 2005, the FASB issued SFAS No. 154, which replaces Accounting Principles Board (“APB”) Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements.  SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless determination of either the period specific effects or the cumulative effect of the change is impracticable.  SFAS No. 154 is effective for fiscal years beginning after December 15, 2005.  SFAS No. 154 is not expected to have a material impact on the Company’s Condensed Consolidated Statements of Operations or Financial Position.

Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”)

In December 2004, the FASB issued SFAS No. 123R, which revises SFAS No. 123 and supersedes APB 25.  SFAS No. 123R requires all share-based payment transactions to be accounted for using a fair value based method.  In addition, although it does not require use of a binomial lattice model, SFAS No. 123R indicates that a binomial lattice model may be more effective in valuing employee stock options than the Black-Scholes model, which was primarily developed to value publicly traded options.  In the first quarter of 2005, the Company began using a binomial lattice model in place of the Black-Scholes model to determine the fair value of employee stock options.  In April 2005, the Securities and Exchange Commission deferred the effective date of SFAS No. 123R from the first interim or annual period beginning after June 15, 2005 to the next fiscal year beginning after June 15, 2005.  SFAS No. 123R is not expected to have a material impact on the Company’s Condensed Consolidated Statements of Operations or Financial Position.

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2.              Earnings per share

Basic earnings per share is computed based on the weighted average number of common shares outstanding.  Diluted earnings per share is computed based on weighted average number of common and dilutive potential common shares outstanding.  For Allstate, dilutive potential common shares consist of the common shares underlying outstanding stock options and restricted stock units.

The computation of basic and diluted earnings per share is presented in the following table.

As a result of the third quarter 2005 net loss, weighted average dilutive potential common shares outstanding, resulting from stock options and restricted stock units of 5.1 million and .5 million, respectively, were not included in the computation of diluted earnings per share for the three-month period ended September 30, 2005 since inclusion of these securities would have an anti-dilutive effect.  In the absence of the net loss, weighted average common and dilutive potential common shares outstanding would have totaled 660.4 million.

Options to purchase 290.4 thousand and 33.5 thousand Allstate common shares, with exercise prices ranging from $58.47 to $61.90 and $47.26 to $50.72, were outstanding at September 30, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per share for the three-month periods ended September 30, 2005 and 2004 since inclusion of these options would have an anti-dilutive effect as the options’ exercise prices exceeded the average market price of Allstate common shares in the three-month period.  Options to purchase 481.9 thousand and 4.0 million Allstate common shares, with exercise prices ranging from $56.25 to $61.90 and $45.96 to $50.72, were outstanding at September 30, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per share for the nine-month periods ended September 30, 2005 and 2004 since inclusion of these options would have an anti-dilutive effect.

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3.              Reserve for Property-Liability Insurance Claims and Claims Expense

The Company establishes reserves for claims and claims expense (“loss”) 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, law changes, court decisions, changes to regulatory requirements 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, 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 losses that have occurred, including incurred but not reported (“IBNR”) losses, the establishment of appropriate reserves, including reserves for catastrophes, 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 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 period reserve estimates, which may be material, are reported in property-liability insurance claims and claims expenses in the Condensed Consolidated Statements of Operations in the period such changes are determined.

Losses in the third quarter of 2005 include estimates of $3.68 billion related to Hurricane Katrina and $850 million, net of reinsurance recoverable of $205 million, related to Hurricane Rita.  The reinsurance is recoverable by Allstate Texas Lloyd’s (“ATL”), a syndicate insurance company.  ATL also has a 100% reinsurance agreement with AIC providing net benefits to AIC as reinsurer.  These estimates include losses on the Company’s standard auto, non-standard auto, homeowners, commercial and other products from approximately 216,000 and 90,000 expected claims of which over 178,000 and 66,000 claims have been reported as of October 28, 2005, related to Hurricanes Katrina and Rita, respectively.  Loss estimates also include an accrual of $37 million for anticipated assessments from various state facilities, including $33 million for a regular assessment from the Louisiana Citizens Property Insurance Corporation (see Note 6).

The Company’s estimates of losses for Hurricanes Katrina and Rita are generally based on claim adjuster inspections and the application of historical loss development factors to the extent the Company has been able to complete inspections in areas impacted by the hurricanes.  However, in areas where the Company has not yet been able to complete inspections, or the Company has reason to believe that its historical loss development factors may not be predictive, the Company has relied on analysis of actual claim notices received compared to the total policies in force, as well as visual, governmental and third party information including aerial photos, area observations and data on wind speeds and flood depth to the extent available.

The Company’s loss estimates for Hurricanes Katrina and Rita are calculated in accordance with the coverage provided by its policies.  The Company’s homeowners policies specifically exclude coverage for losses caused by flood, but generally provide coverage for physical damage caused by wind or wind driven rain.  The Company’s homeowners estimates, therefore, do not include estimates for losses caused by flood.  Auto policyholders generally have coverage for physical damage due to flood if they have purchased optional auto comprehensive coverage.

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Management believes the estimated losses for Hurricanes Katrina and Rita are appropriately established and recorded based on available facts, information, laws and regulations.  However, actual results may differ materially from the amounts recorded because the estimation of the amount and extent of damage for the approximately 306,000 expected claims has been complicated by difficulties such as: the short amount of time that elapsed since these hurricane events occurred and the end of the quarter; the assessment of the extent of damage in the initial stages of adjusting residential property losses is particularly difficult; the policyholders’ ability to report claims and the Company’s ability to adjust claims have been impeded by the extent and nature of the devastation and certain restrictions on access to the affected areas;  increased costs due to the effects of increased demand for services and supplies in the affected areas could occur at a higher level than estimated; increased pressure on the Company’s catastrophe claims settlement management process due to the number and nature of the claims; and litigation recently filed by several parties including policyholders and state attorneys general (see Note 6).  In addition, the number of IBNR claims may be greater or less than anticipated.

The Company calculates and records a single best reserve estimate for losses from catastrophes, in conformance with generally accepted actuarial principles, and 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 practicable to develop a meaningful range for any such changes in losses incurred.

Management believes that the reserve for claims and claims expense, net of reinsurance recoverables, at September 30, 2005 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 that date based on available facts, technology, laws and regulations.

Subsequent Event

On October 24, 2005, Hurricane Wilma made landfall in Florida.  Allstate Floridian Insurance Company and its subsidiaries (“AFIC”), subsidiaries of the Company, write property and casualty insurance in Florida.  AFIC maintains separate group ratings and is not reinsured by other Allstate subsidiaries that are not part of AFIC.  However, AIC has committed to make up to $375 million of additional capital available to AFIC through May of 2006 under specified circumstances.  In the event of a qualifying catastrophe, AFIC has access to reimbursement provided by the Florida Hurricane Catastrophe Fund (“FHCF”), for 90% of qualifying losses that exceed its retention of $233 million for the two largest hurricanes and $78 million for other hurricanes, up to an estimated maximum of $871 million.  As of September 30, 2005, none of the 2005 hurricanes covered by AFIC’s insurance policies have qualified for reimbursement from the FHCF as the estimated losses were below AFIC’s retention.  AFIC also has a multi-year reinsurance treaty that covers excess catastrophe losses in Florida whereby AFIC cedes 90% of losses in excess of the FHCF reimbursement up to $900 million and AFIC has reinsurance with Universal Insurance Company of North America (see Note 4).  Management believes it is not practicable, at the present time, to develop a meaningful loss estimate for Hurricane Wilma due to the short amount of time that has elapsed since this event.  In addition, the ultimate impact of Hurricane Wilma on Citizens Property Insurance Corporation (“Citizens”) is currently uncertain, but could result in Citizens recognizing a financial deficit.  Citizens may, in turn, levy a regular or emergency assessment on participating companies when the financial deficit occurs, adversely affecting the Company’s results of operations (see Note 6). The ultimate net cost of this event may be material to the Company’s Condensed Consolidated Statements of Operations.

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4.              Reinsurance

Property-liability insurance premiums and life and annuity premiums and contract charges are net of the following reinsurance ceded:

Property-liability insurance claims and claims expense and life and annuity contract benefits are net of the following reinsurance recoveries:

(1)          Effective January 1, 2004, the Company adopted Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for certain Nontraditional Long Duration Contracts and for Separate Accounts” and, in connection therewith, recorded a cumulative effect of change in accounting principle due to an increase in benefit reserves of $94 million, after-tax ($145 million, pre-tax).  The increase in benefit reserves was comprised of direct, assumed and ceded benefit reserves of $155 million, $4 million and $14 million, respectively.

Effective June 1, 2005, multi-year reinsurance treaties cover excess catastrophe losses in seven states: Connecticut, New Jersey, New York, North Carolina, South Carolina, Texas and Florida.  These reinsurance treaties replaced the reinsurance contracts entered into in 2004 that reinsured losses from future catastrophic events in the state of Florida, which expired in May 2005, and five three-year cancelable excess of loss reinsurance contracts that reinsured personal property losses in other states.  In the three-month and nine-month periods ended September 30, 2005, the Company ceded $48 million and $64 million of premiums earned under the new reinsurance treaties, respectively.  The Company ceded $37 million of premiums earned under the expiring and cancelled programs in the nine-month period ended September 30, 2005.

AFIC reached a definitive agreement for a portion of its existing customers to have new policies available from Universal Insurance Company of North America when their existing policies expire and are not renewed.  AFIC is also ceding premiums and losses on these policies through their expiration date under an indemnity reinsurance agreement. In the nine-months ended September 30, 2005, AFIC ceded $32 million of unearned premiums on the policies subject to the agreement as of the agreement’s inception date and $34 million of premiums written since the inception date through September 30, 2005.  AFIC ceded $23 million and $37 million of premiums earned related to these policies in the three-month and nine-month periods ended September 30, 2005, respectively.

5.              Company Restructuring

The Company undertakes various programs to reduce expenses and increase productivity.  These programs generally involve a reduction in staffing levels, and in certain cases, office closures.  Restructuring and related charges include employee termination and relocation benefits, and post-exit rent expenses in connection with these programs, and a non-cash charge resulting from pension benefit payments made to agents in connection with the 1999 reorganization of Allstate’s multiple agency programs to a single exclusive agency program.

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The following table illustrates the inception to date change in the restructuring liability at September 30, 2005:

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.

6.              Guarantees and Contingent Liabilities

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.  Because of the Company’s participation, the Company may be exposed to losses that surpass the capitalization of these facilities and/or to assessments from these facilities.

AFIC is subject to assessments from Citizens, which was created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market.  Citizens, at the discretion and direction of its Board of Governors (“Citizens Board”), can levy a regular assessment on participating companies for a deficit in any calendar year up to the greater of 10% of the deficit or 10% of Florida property premiums industry-wide for the prior year.  An insurer may recoup a regular assessment through a surcharge to policyholders.  In order to recoup its Citizens regular assessment, an insurer must file for a policy surcharge with the Florida Department of Insurance at least fifteen days prior to imposing the surcharge on policies.  If a deficit remains after the regular assessment, Citizens can also fund the remaining deficit by issuing bonds.  The costs of these bonds are then funded through emergency assessments in subsequent years.  Companies are required to collect the emergency assessments directly from residential property policyholders and remit them to Citizens as they are collected.  Participating companies are obligated to purchase any unsold bonds issued by Citizens.

Citizens reported losses from the hurricanes that struck Florida in the third quarter of 2004 and a deficit for the 2004 plan year.  When the Citizens Board met on April 21, 2005, they declared a deficit.  In August 2005, the Citizens Board declared and the Florida Office of Insurance Regulation approved a $515 million industry assessment to cover the deficit of which $43 million was assessed to the Company.  The Company accrued a liability of $43 million in the second quarter of 2005 based on the available information at that time since the state of Florida legislative session concluded on May 6, 2005 without adopting any legislative alternatives to an industry assessment by Citizens to eliminate the deficit, and the Board deferred any decision on assessment at their June 8, 2005 meeting until new Board members were installed in August 2005.  This assessment was paid in September 2005 and is expected to be partially recouped through premiums written in Florida in the fourth quarter of 2005 and in 2006.  These recoupments will be recorded in the consolidated financial statements as the related premiums are written.

The Company is also subject to assessments from the Louisiana Citizens Property Insurance Corporation (“LA Citizens”).  LA Citizens was created to provide insurance coverage to individuals or entities that otherwise are unable to purchase such coverage from private insurers.  LA Citizens has estimated plan losses due to losses incurred from the hurricanes that struck Louisiana in the third quarter of 2005, and is thereby able to levy a regular and emergency assessment to participating companies and policyholders, respectively.  Based on information available through September 30, 2005, regarding the amount of the estimated deficiency and the Company’s market share, the Company accrued a liability of $33 million in the third quarter of 2005 for a regular assessment from LA Citizens.  Insurers are permitted to recoup a regular assessment through a surcharge to policyholders.  These recoupments will be recorded in the consolidated financial statements as the related premiums are written.  Insurers are required to collect emergency assessments, of which there have been none, directly from residential property policyholders and remit them to LA Citizens as they are collected.

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The Company is currently monitoring developments with respect to various state facilities such as guaranty funds, LA Citizens, the Mississippi Windstorm Underwriting Association, the Mississippi Residential Underwriting Association, the Alabama Insurance Underwriting Association, the Texas FAIR Plan Association and the Texas Windstorm Insurance Association.  The ultimate impact of Hurricanes Katrina and Rita on these facilities is currently uncertain, but could result in the facilities recognizing a financial deficit different than the level currently estimated.  They may, in turn, have the ability to assess participating insurers when financial deficits occur, adversely affecting the Company’s results of operations.

These facilities are generally designed so that the ultimate cost is borne by policyholders, however the exposure to assessments and the availability of recoupments or premium rate increases may not offset each other in the Company’s financial statements.  Moreover, even if they do offset each other, they may not offset each other in the 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 that affected policies will not be renewed in subsequent years.

Guarantees

The Company provides residual value guarantees on Company leased automobiles.  If all outstanding leases were terminated effective September 30, 2005, the Company’s maximum obligation pursuant to these guarantees, assuming the automobiles have no residual value, would be $18 million at September 30, 2005.  The remaining term of each residual value guarantee is equal to the term of the underlying lease that range from less than one year to three years.  Historically, the Company has not made any material payments pursuant to these guarantees.

The Company owns certain fixed income securities that obligate the Company to exchange credit risk or to forfeit principal due, depending on the nature or occurrence of specified credit events for the referenced entities.  In the event all such specified credit events were to occur, the Company’s maximum amount at risk on these fixed income securities, as measured by their par value was $173 million at September 30, 2005.  The obligations associated with these fixed income securities expire at various times during the next seven years.

Lincoln Benefit Life Company (“LBL”), a wholly owned subsidiary of ALIC, has issued universal life insurance contracts to third parties who finance the premium payments on the universal life insurance contracts through a commercial paper program.  LBL has issued a repayment guarantee on the outstanding commercial paper balance that is fully collateralized by the cash surrender value of the universal life insurance contracts.  At September 30, 2005, the amount due under the commercial paper program was $302 million and the cash surrender value of the policies was $307 million.  The repayment guarantee expires April 30, 2006.

In the normal course of business, the Company provides standard indemnifications to counterparties in contracts in connection with numerous transactions, including acquisitions and divestitures.  The types of indemnifications typically provided 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 were 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 September 30, 2005.

Regulation

The Company is subject to changing social, economic and regulatory conditions.  From time to time regulatory authorities seek to influence and restrict premium rates, require premium refunds to policyholders, restrict the ability of insurers to cancel or non-renew policies, limit insurers’ ability to impose underwriting standards, impose additional regulations regarding agent and broker compensation and otherwise expand overall regulation of insurance products and the insurance industry.  The ultimate changes and eventual effects of these initiatives on the Company’s business, if any, are uncertain.

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Legal and regulatory proceedings and inquiries

Background

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.  As background to the “Proceedings” sub-section below, please note the following:

•                  These matters raise difficult and complicated factual and legal issues and are subject to many uncertainties and complexities, including but not limited to, the underlying facts of each matter; novel legal issues; variations between jurisdictions in which matters are being litigated, heard or investigated; differences in applicable laws and judicial interpretations; the length of time before many of these matters might be resolved by settlement, through litigation or otherwise and, in some cases, the timing of their resolutions relative to other similar matters involving other companies; the fact that many 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 many 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 current challenging legal environment faced by large corporations and insurance companies.

•                  In the lawsuits, plaintiffs seek a variety of remedies including 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 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 our 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.

•                  For the reasons specified above, it is not possible at this time to make meaningful estimates of the amount or range of loss that could result from the matters described below in the “Proceedings” subsection.  The Company reviews these matters on an on-going basis and follows the provisions of SFAS No. 5, “Accounting for Contingencies” when making accrual and disclosure decisions.  When assessing reasonably possible and probable outcomes, the Company bases its decisions on its assessment of the ultimate outcome following all appeals.

•                  In the opinion of the Company’s management, while the ultimate liability in some of the matters described below in the “Proceedings” subsection in excess of amounts currently reserved may be material to the Company’s operating results for any particular period if an unfavorable outcome results, none will have a material adverse effect on the consolidated financial condition of the Company.

Proceedings

There is one active nationwide class action lawsuit pending against Allstate regarding its specification of after-market (non-original equipment manufacturer) replacement parts in the repair of insured vehicles.  This suit alleges that the specification of such parts constitutes breach of contract and fraud. The suit mirrors to a large degree lawsuits filed against other carriers in the industry.  The plaintiffs allege that after-market parts are not “of like kind and quality” as required by the insurance policy, and they are seeking actual and punitive damages.  The Company has been vigorously defending this lawsuit, but its outcome is uncertain.  A second aftermarket parts lawsuit has now been dismissed.  In that case, plaintiffs had alleged that Allstate and three co-defendants violated federal antitrust laws by conspiring to manipulate the price of auto physical damage coverages in such a way that not all savings realized by the use of aftermarket parts are passed on to the policyholders.  In a related development, the Illinois Supreme Court recently reversed the billion-dollar judgment entered against State Farm in a nationwide aftermarket parts class action, Avery

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v. State Farm.  The Company believes that the Avery decision will be useful in its defense of the remaining aftermarket parts case discussed above, which is pending in Illinois.

There are several statewide and nationwide class action lawsuits pending against Allstate alleging that its failure to pay “inherent diminished value” to insureds under the collision, comprehensive, uninsured motorist property damage, or auto property damage liability provisions of auto policies constitutes breach of contract and fraud.  Plaintiffs define “inherent diminished value” as the difference between the market value of the insured automobile before an accident and the market value after repair.  Plaintiffs allege that they are entitled to the payment of inherent diminished value under the terms of the policy.  To a large degree, these lawsuits mirror similar lawsuits filed against other carriers in the industry.  These lawsuits are pending in various state and federal courts, and they are in various stages of development.  Classes have been certified in only two cases.  Both are multi-state class actions.  A trial in one of these multi-state class action cases involving collision and comprehensive coverage concluded on April 29, 2004, with a jury verdict in favor of the Company.  The plaintiffs made a motion for a new trial, which was denied, and have now filed an appeal from the judgment.  In the other certified class action lawsuit, which involves uninsured motorist property damage coverage, the appellate court granted the Company’s petition for review of the order of certification.  That appeal has been briefed and argued, and the Company is awaiting a decision by the court.  The Company has been vigorously defending all of these lawsuits and, since 1998, has been implementing policy language in more than 40 states reaffirming that its collision and comprehensive coverages do not include diminished value claims.  The outcome of these disputes remains uncertain.

There are a number of state and nationwide class action lawsuits pending in various state courts challenging the legal propriety of Allstate’s medical bill review processes on a number of grounds, including, among other things, the manner in which Allstate determines reasonableness and necessity.  One nationwide class action has been certified.  These lawsuits, which to a large degree mirror similar lawsuits filed against other carriers in the industry, allege these processes result in a breach of the insurance policy as well as fraud.  Plaintiffs seek monetary damages in the form of contractual and extra-contractual damages.  The Company denies these allegations and has been vigorously defending these lawsuits.  The outcome of these disputes is currently uncertain.

A number of nationwide and statewide putative class actions are pending against Allstate that challenge Allstate’s use of certain automated database vendors in valuing total loss automobiles.  To a large degree, these lawsuits mirror similar lawsuits filed against other carriers in the industry.  Plaintiffs allege that flaws in these databases result in valuations to the detriment of insureds.  The plaintiffs are seeking actual and punitive damages. The lawsuits are in various stages of development and Allstate has been vigorously defending them, but the outcome of these disputes is currently uncertain.

The Company is defending a putative nationwide class action that alleges that the Company discriminates against non-Caucasian policyholders, through underwriting and rate-making practices including the use of credit information, by charging them higher premiums.  The Company is also defending a putative statewide class action challenging its use of credit information under certain state insurance statutes.  The plaintiffs in these cases seek monetary and equitable relief, including actual and punitive damages and injunctive relief.  The Company removed the statewide class action to federal court. The Fifth Circuit Court of Appeals has recently affirmed the trial court’s denial of the plaintiff’s motion to remand to state court.  The Company denies these allegations and has been vigorously defending these lawsuits.  The outcome of these disputes is currently uncertain.

Allstate is defending various lawsuits involving worker classification issues.  These lawsuits include a number of putative class actions and one certified class action challenging the overtime exemption claimed by the Company under the Fair Labor Standards Act or state wage and hour laws.  In these cases, plaintiffs seek monetary relief, such as penalties and liquidated damages, and non-monetary relief, such as injunctive relief and an accounting.  These class actions mirror similar lawsuits filed against other carriers in the industry and other employers, some of which have been settled recently.  In the one certified class action against Allstate, based on California law, the parties reached a tentative agreement on June 24, 2005 to settle the case.  The parties executed a definitive settlement agreement on August 30, 2005, which the trial court preliminarily approved.  The settlement is subject to a final fairness hearing and approval by the trial court.  With respect to this matter, Allstate established an accrual in the second quarter of 2005 of $120 million, including attorney fees and other costs. Allstate is continuing to vigorously defend its other worker classification lawsuits.  The outcome of these disputes is currently uncertain.

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The Company is defending certain matters relating to the Company’s agency program reorganization announced in 1999.  These matters include a lawsuit filed in December 2001 by the U.S. Equal Employment Opportunity Commission (“EEOC”) alleging retaliation under federal civil rights laws, a class action filed in August 2001 by former employee agents alleging retaliation and age discrimination under the Age Discrimination in Employment Act, breach of contract and ERISA violations, and a lawsuit filed in October 2004 by the EEOC alleging age discrimination with respect to a policy limiting the rehire of agents affected by the agency program reorganization. The Company is also defending a certified class action filed by former employee agents who terminated their employment prior to the agency program reorganization.  These plaintiffs have asserted breach of contract and ERISA claims and are seeking actual damages including benefits under Allstate employee benefit plans and payments provided in connection with the reorganization, as well as punitive damages.  In late March 2004, in the first EEOC lawsuit and class action lawsuit, the trial court issued a memorandum and order that, among other things, certified classes of agents, including a mandatory class of agents who had signed a release, for purposes of effecting the court’s declaratory judgment that the release is voidable at the option of the release signer.  The court also ordered that an agent who voids the release must return to Allstate “any and all benefits received by the [agent] in exchange for signing the release.”  The court also “concluded that, on the undisputed facts of record, there is no basis for claims of age discrimination.”  The EEOC and plaintiffs have asked the court to clarify and/or reconsider its memorandum and order.  The case otherwise remains pending.  A putative nationwide class action has also been filed by former employee agents alleging various violations of ERISA, including a worker classification issue.  These plaintiffs are challenging certain amendments to the Agents Pension Plan and are seeking to have exclusive agent independent contractors treated as employees for benefit purposes.  This matter was dismissed with prejudice by the trial court, was the subject of further proceedings on appeal, and was reversed and remanded to the trial court in April 2005.  In these matters, plaintiffs seek compensatory and punitive damages, and equitable relief.  Allstate has been vigorously defending these lawsuits and other matters related to its agency program reorganization.  In addition, Allstate has been defending certain matters relating to its life agency program reorganization announced in 2000.  These matters have been the subject of an investigation by the EEOC with respect to allegations of age discrimination and retaliation and conciliation discussions between Allstate and the EEOC.  The outcome of these disputes is currently uncertain.

 The Company has resolved through mediation and settlement all but one of its lawsuits brought by plaintiffs challenging trading restrictions the Company adopted in an effort to limit market-timing activity in its variable annuity sub-accounts.  In the one lawsuit the Company is still defending, the plaintiff seeks a variety of remedies including monetary and equitable relief. The Company has been vigorously defending this matter, but the outcome is currently uncertain.

The Company is defending several matters filed in the aftermath of Hurricanes Katrina and Rita, including several statewide putative class action lawsuits pending in Louisiana, Mississippi, and Texas.  In addition, the Mississippi Attorney General filed a suit asserting that the flood exclusion found in Allstate’s and other insurance companies’ policies is either ambiguous, unenforceable as unconscionable or contrary to public policy, or inapplicable to the damage suffered in the wake of Hurricane Katrina.  These suits seek primarily declaratory relief, and in some cases, actual and punitive damages in an unspecified amount.  Additionally, in connection with a petition for injunctive relief filed by the Texas Attorney General, a temporary injunction was entered against Allstate on October 21, 2005, which prevents it from denying and failing to pay claims for loss of use (additional living expense) caused by Hurricane Rita if the insured property is rendered untenantable, regardless of whether direct physical loss or physical damage to the property occurred.  Allstate denies that there is coverage under these circumstances.  The Texas Court of Appeals stayed the temporary injunction on October 27, 2005, pending disposition of Allstate’s request for immediate review of the temporary injunction.  The matters described in this paragraph are in various stages of development and Allstate intends to vigorously defend them.  The outcome of these disputes is currently uncertain.

Other Matters

The Company and some of its subsidiaries have received interrogatories and demands for information from regulatory and enforcement authorities relating to various insurance products and practices. The areas of inquiry include variable annuity market timing, late trading and the issuance of funding agreements backing medium-term notes.  The Company and some of its subsidiaries have also received interrogatories and demands for information from authorities seeking information relevant to on-going investigations into the possible violation of antitrust or insurance laws by unnamed parties and, in particular, seeking information as to whether any person engaged in activities for the

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purpose of price fixing, market allocation, or bid rigging.  The Company believes that these inquiries are similar to those made to many financial services companies as part of industry-wide investigations by various authorities into the practices, policies and procedures relating to insurance and financial services products.  The Company and its subsidiaries have responded and will continue to respond to these inquiries.

Various other legal and regulatory actions, including state market conduct exams, are currently pending that involve the Company and specific aspects of its conduct of business.  Like other members of the insurance industry, the Company is the target of a number of class action lawsuits and other types of proceedings, some of which involve claims for substantial or indeterminate amounts.  These actions are based on a variety of issues and target a range of the Company’s practices.  The outcome of these disputes is currently unpredictable.

However, at this time, based on their present status, it is the opinion of management that the ultimate liability, if any, in one or more of the actions described in this “Other Matters” subsection in excess of amounts currently reserved is not expected to have a material effect on the results of operations, liquidity or financial condition of the Company.

Asbestos and environmental

Allstate’s reserves for asbestos claims were $1.49 billion and $1.46 billion, net of reinsurance recoverables of $912 million and $963 million at September 30, 2005 and December 31, 2004, respectively.  Reserves for environmental claims were $219 million and $232 million, net of reinsurance recoverables of $44 million and $49 million at September 30, 2005 and December 31, 2004, respectively.  Approximately 66% and 62% of the total net asbestos and environmental reserves at September 30, 2005 and December 31, 2004, respectively, were for incurred but not reported estimated losses.

Management believes its net loss reserves for environmental, asbestos 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 greater than those presented by other types of claims. Among the complications are lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, 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 collectibility of recoveries from reinsurance, retrospectively determined premiums and other contractual agreements, and estimating the extent and timing of any contractual liability, 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.  Management believes these issues are not likely to be resolved in the near future, and the ultimate cost may vary materially from the amounts currently recorded resulting in an increase 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.

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7.              Components of Net Periodic Pension and Postretirement Benefit Costs

The components of net periodic cost for the Company’s pension and postretirement benefit plans are as follows: 

(1) In the three months ended March 31, 2005, the Company recognized $19 million and $4 million pretax for pension and postretirement benefits, respectively, related to a non-recurring increase in liability for future benefits of a discontinued benefit plan.

As a result of the subsidy provided by the Medicare Prescription Drug, Improvement and Modernization Act of 2003, the net periodic postretirement benefit cost for the three-month and nine-month periods ended September 30, 2005 was reduced by $5 million and $11 million, respectively, of which $2 million and $3 million was a reduction of current period service cost, $1 million and $3 million was the reduction in interest cost on the APBO and $2 million and $5 million was amortization of the actuarial experience gain attributable to past service, respectively (see Note 1).

As of September 30, 2005, the Company contributed $70 million to its pension plans.  The Company plans to contribute a total of $356 million to its pension plans in 2005.

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8.              Equity Incentive Plans

The following table illustrates the effect on net income and earnings per share as if the fair value based method, adopted prospectively by the Company on January 1, 2003, had been applied to all outstanding and unvested options in each period.

(1) In the three-month and nine-month periods ended September 30, 2005, the Company recognized a total of $3 million and $19 million after-tax, respectively, related to the acceleration of deferred compensation expense on unvested stock awards granted to retirement eligible employees, including $2 million and $11 million after-tax, respectively, on unvested stock options (included in the table above) and $1 million and $8 million after-tax, respectively, on restricted stock.

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9.              Business Segments

Summarized revenue data for each of the Company’s business segments are as follows: