Derivative Financial Instruments and Off-balance Sheet Financial Instruments

12 Months Ended

Dec. 31, 2023

Derivative Financial Instruments and Off-balance sheet Financial Instruments

Derivative Financial Instruments and Off-balance Sheet Financial Instruments

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, index total return swap, options, futures, 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, index total return swaps, 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. Fixed income index total return swaps are used to offset valuation losses in the fixed income portfolio during periods of declining market values. Credit default swaps are typically used to mitigate the credit risk within the Property-Liability fixed income portfolio. Equity index total return swaps, 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.

In 2022, the Company also had a derivative embedded in a non-derivative host contract that was required to be separated from the host contract and accounted for at fair value with changes in fair value of the embedded derivative reported in net income.

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 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 those derivatives which qualify and have been designated as fair value accounting hedges, net income includes the changes in the fair value of both the derivative instrument and the hedged risk. 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.

In connection with the sale of ALIC and certain affiliates in 2021, the sale agreement included a provision related to contingent consideration that may be earned over a ten-year period with the first potential payment date commencing on January 1, 2026 and a final potential payment date of January 1, 2035. The contingent consideration is determined annually based on the average ten-year Treasury rate over the preceding three-year period compared to a designated rate. The contingent consideration meets the definition of a derivative and is accounted for on a fair value basis with periodic changes in fair value reflected in earnings. There are no collateral requirements related to the contingent consideration.

Summary of the volume and fair value positions of derivative instruments as of December 31, 2023
		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
Futures	Other assets	n/a		20,479	$	2	$	2	$	—
Equity and index contracts
Options	Other investments	n/a		32	—		—		—
Futures	Other assets	n/a		1,305	1		1		—
Foreign currency contracts
Foreign currency forwards	Other investments	$	278	n/a	(2)		2		(4)
Contingent consideration	Other assets	250		n/a	118		118		—
Credit default contracts
Credit default swaps – buying protection	Other investments	34		n/a	(1)		—		(1)
Total asset derivatives		$	562	21,816	$	118	$	123	$	(5)
Liability derivatives
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Futures	Other liabilities & accrued expenses	n/a		2,175	$	(1)	$	—	$	(1)
Equity and index contracts
Futures	Other liabilities & accrued expenses	n/a		980	(1)		—		(1)
Foreign currency contracts
Foreign currency forwards	Other liabilities & accrued expenses	$	306	n/a	(3)		1		(4)
Credit default contracts
Credit default swaps – buying protection	Other liabilities & accrued expenses	19		n/a	(1)		—		(1)
Total liability derivatives		325		3,155	(6)		$	1	$	(7)
Total derivatives		$	887	24,971	$	112

(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)

Summary of the volume and fair value positions of derivative instruments as of December 31, 2022
		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
Futures	Other assets	n/a		24,380	$	3	$	3	$	—
Equity and index contracts
Futures	Other assets	n/a		343	—		—		—
Foreign currency contracts
Foreign currency forwards	Other investments	$	354	n/a	1		14		(13)
Contingent consideration	Other assets	250		n/a	103		103		—
Credit default contracts
Credit default swaps – buying protection	Other investments	24		n/a	—		1		(1)
Total asset derivatives		$	628	24,723	$	107	$	121	$	(14)
Liability derivatives
Derivatives not designated as accounting hedging instruments
Interest rate contracts
Futures	Other liabilities & accrued expenses	n/a		1,624	$	—	$	—	$	—
Equity and index contracts
Futures	Other liabilities & accrued expenses	n/a		1,229	(1)		—		(1)
Foreign currency contracts
Foreign currency forwards	Other liabilities & accrued expenses	$	283	n/a	—		7		(7)
Credit default contracts
Credit default swaps – buying protection	Other liabilities & accrued expenses	525		n/a	(3)		1		(4)
Total liability derivatives		808		2,853	(4)		$	8	$	(12)
Total derivatives		$	1,436	27,576	$	103

(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, 2023
Asset derivatives	$	3	$	(6)	$	4	$	1	$	—	$	1
Liability derivatives	(10)		6		2		(2)		—		(2)
December 31, 2022
Asset derivatives	$	23	$	(22)	$	—	$	1	$	—	$	1
Liability derivatives	(22)		22		(1)		(1)		—		(1)

(1)All OTC derivatives are subject to enforceable master netting agreements.

Gains (losses) from valuation and settlements reported on derivatives not designated as accounting hedges
($ in millions)	Net gains (losses) on investments and derivatives		Accident, health and other policy benefits		Operating costs and expenses		(Loss) income from discontinued operations		Total gain (loss) recognized in net income on derivatives
2023
Interest rate contracts	$	(8)	$	—	$	—	$	—	$	(8)
Equity and index contracts	(32)		—		28		—		(4)
Contingent consideration	—		—		15		—		15
Foreign currency contracts	(14)		—		—		—		(14)
Credit default contracts	(30)		—		—		—		(30)
Other contracts	—		—		(1)		—		(1)
Total	$	(84)	$	—	$	42	$	—	$	(42)
2022
Interest rate contracts	$	737	$	—	$	—	$	—	$	737
Equity and index contracts	94		—		(43)		—		51
Contingent consideration	—		—		38		—		38
Foreign currency contracts	47		—		(6)		—		41
Credit default contracts	(4)		—		—		—		(4)
Other contracts	—		—		(1)		—		(1)
Total	$	874	$	—	$	(12)	$	—	$	862
2021
Interest rate contracts	$	22	$	—	$	—	$	—	$	22
Equity and index contracts	(7)		27		45		—		65
Contingent consideration	—		—		—		65		65
Foreign currency contracts	32		—		—		—		32
Credit default contracts	7		—		—		—		7
Total return swaps - fixed income	4		—		—		—		4
Total	$	58	$	27	$	45	$	65	$	195

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.

OTC cash and securities collateral pledged
($ in millions)	December 31, 2023
Pledged by the Company	$	6
Pledged to the Company (1)	—

(1)$5 million of collateral was posted under MNAs for contracts containing credit-risk-contingent provisions that are in a liability provision.

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.

OTC derivatives counterparty credit exposure by counterparty credit rating
($ in millions)	December 31, 2023							December 31, 2022
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)
A+	—	$	—	$	—	$	—	1	$	128	$	5	$	—
A	—	—		—		—		1	192		7		—
Total	—	$	—	$	—	$	—	2	$	320	$	12	$	—

(1)Allstate uses the lower of S&P’s or Moody’s long-term debt issuer ratings.

(2)Only OTC derivatives with a net positive fair value are included for each counterparty.

For certain exchange traded and cleared derivatives, margin deposits are required as well as daily cash settlements of margin accounts.

Exchange traded and cleared margin deposits
($ in millions)	December 31, 2023
Pledged by the Company	$	66
Received by the Company	—

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 transactions contain credit-risk-contingent termination events and cross-default provisions. Credit-risk-contingent termination events allow the counterparties to terminate the derivative agreement or a specific trade on certain dates if AIC’s 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.

The following table summarizes the fair value of derivative instruments with termination, cross-default or collateral credit-risk-contingent features that are in a liability position, 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)	December 31, 2023		December 31, 2022
Gross liability fair value of contracts containing credit-risk-contingent features	$	10	$	21
Gross asset fair value of contracts containing credit-risk-contingent features and subject to MNAs	(3)		(11)
Collateral posted under MNAs for contracts containing credit-risk-contingent features	(5)		(10)
Maximum amount of additional exposure for contracts with credit-risk-contingent features if all features were triggered concurrently	$	2	$	—

Off-balance sheet financial instruments

Commitments to invest, commitments to purchase private placement securities, commitments to fund 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.

Contractual amounts of off-balance sheet financial instruments
	As of December 31,
($ in millions)	2023		2022
Commitments to invest in limited partnership interests	$	2,941	$	2,778
Private placement commitments	62		114
Other loan commitments	18		10

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. Unless unconditionally cancellable, the Company recognizes a credit loss allowance on such commitments. Commitments have either fixed or varying expiration dates or other termination clauses. The fair value of these commitments is insignificant.