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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 711 High Street, 42-1520346
(State or other Des Moines, Iowa 50392 (I.R.S. Employer
jurisdiction of (Address of principal Identification Number)
incorporation or executive offices)
organization) (515) 247-5111
(Registrant's telephone number,
including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, par value $0.01 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant Item 405 of
Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment of this Form 10-K. |X|
As of February 28, 2002, there were outstanding 360,826,332 shares of Common
Stock, $0.01 par value per share of the Registrant.
The aggregate market value of the shares of the Registrant's common equity held
by non-affiliates of the Registrant was $8,789,729,448 based on the closing
price of $24.36 per share of Common Stock on the New York Stock Exchange on
February 28, 2002.
Documents Incorporated by Reference
The information required to be furnished pursuant to Part III of this Form 10-K
is set forth in, and is hereby incorporated by reference herein from, the
Registrant's definitive proxy statement for the annual meeting of shareholders
to be held on May 20, 2002, to be filed by the Registrant with the Securities
and Exchange Commission pursuant to Regulation 14A not later than 120 days after
the year ended December 31, 2001.
PRINCIPAL FINANCIAL GROUP, INC.
(SUCCESSOR TO PRINCIPAL MUTUAL HOLDING COMPANY)
TABLE OF CONTENTS
PART I........................................................................2
Item 1. Business.............................................................2
Item 2. Properties..........................................................34
Item 3. Legal Proceedings...................................................34
Item 4. Submission of Matters to a Vote of Security Holders.................35
Executive Officers of the Registrant.........................................35
PART II......................................................................36
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters.......................................36
Item 6. Selected Financial Data.............................................37
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................43
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........105
Item 8. Financial Statements and Supplementary Data........................111
Report of Management.....................................................111
Report of Independent Auditors...........................................112
Consolidated Statements of Financial Position............................113
Consolidated Statements of Operations....................................114
Consolidated Statements of Stockholders' Equity..........................115
Consolidated Statements of Cash Flows....................................116
Notes to Consolidated Financial Statements...............................118
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..............................175
PART III....................................................................175
Item 10. Directors and Executive Officers of the Registrant.................175
Item 11. Executive Compensation.............................................175
Item 12. Security Ownership of Certain Beneficial Owners and Management.....175
Item 13. Certain Relationships and Related Transactions.....................175
PART IV.....................................................................176
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....176
Signatures..................................................................178
Report of Independent Auditors on Schedules..............................179
Schedule I - Summary of Investments - Other Than Investments
in Related Parties...............................................180
Schedule II - Condensed Financial Information of Registrant
(Parent Only)....................................................181
Schedule III - Supplementary Insurance Information.......................184
Schedule IV - Reinsurance................................................186
NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including the Management's Discussion and
Analysis of Financial Condition and Results of Operations, contains statements
which constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, including statements relating to
trends in operations and financial results and the business and the products of
the Registrant and its subsidiaries, as well as other statements including words
such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and
other similar expressions. Forward-looking statements are made based upon
management's current expectations and beliefs concerning future developments and
their potential effects on the Company. Such forward-looking statements are not
guarantees of future performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) competition from companies that may have greater financial
resources, broader arrays of products, higher ratings and stronger financial
performance may impair our ability to retain existing customers, attract new
customers and maintain our profitability; (2) a decline or increased volatility
in the securities markets could result in investors withdrawing from the markets
or decreasing their rates of investment, either of which could reduce our net
income, revenues and assets under management; (3) a downgrade in Principal Life
Insurance Company's ("Principal Life") financial strength ratings may increase
policy surrenders and withdrawals, reduce new sales and terminate relationships
with distributors; (4) our efforts to reduce the impact of interest rate changes
on our profitability and surplus may not be effective; (5) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (6) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (7) fluctuations in foreign currency
exchange rates could reduce our profitability; (8) a decline in Australian
equity values may reduce the profitability of BT Financial Group; (9) our
reserves established for future policy benefits and claims may prove inadequate,
requiring us to increase liabilities; (10) our investment portfolio is subject
to several risks which may diminish the value of our invested assets and affect
our sales, profitability and the investment returns credited to our customers;
(11) our ability to pay dividends and meet our obligations may be constrained by
the limitations on dividends Iowa insurance laws impose on Principal Life; (12)
we may need to fund deficiencies in our closed block ("Closed Block"); assets
allocated to the Closed Block benefit only the holders of Closed Block policies;
(13) changes in regulations or accounting standards may reduce our
profitability; (14) a challenge to the Insurance Commissioner of the State of
Iowa's approval of the plan of conversion could put the terms of our
demutualization in question and reduce the market price of our common stock;
(15) litigation and regulatory investigations may harm our financial strength
and reduce our profitability; (16) sales of shares distributed in the
demutualization may reduce the market price of our common stock; (17) applicable
laws and our stockholder rights plan, certificate of incorporation and by-laws
may discourage takeovers and business combinations that our stockholders might
consider in their best interests; (18) a downgrade in our debt ratings may
adversely affect our ability to secure funds; and (19) the impact of September
11, 2001, terrorist attacks and military and other actions may result in
decreases in our net income, revenue and assets under management and may
adversely affect our investment portfolio.
1
PART I
Item 1. Business
The Principal Financial Group is a leading provider of retirement savings,
investment and insurance products and services with $120.2 billion in assets
under management and approximately thirteen million customers worldwide as of
December 31, 2001. We were organized as an individual life insurer in 1879,
formed a mutual insurance holding company in 1998, and Principal Financial
Group, Inc. was organized on April 18, 2001, as a Delaware business corporation.
Our U.S. and international operations concentrate primarily on asset management
and accumulation. In addition, we offer a broad range of individual life and
disability insurance, group life and health insurance, and residential mortgage
loan origination and servicing in the U.S.
We focus on providing retirement products and services to businesses and their
employees. We provided services to more 401(k) plans in the U.S. in 2000 than
any other bank, mutual fund or insurance company, according to surveys conducted
by CFO magazine. We also had the leading market share in 2000 within the 401(k)
market for businesses with less than 500 employees based on number of plans and
number of participants according to the Spectrem Group.
We believe there are attractive growth opportunities in the 401(k) and other
defined contribution pension plan markets in the U.S. and internationally. We
believe our expertise and leadership in serving the U.S. pension plan market
give us a unique competitive advantage in the U.S., as well as in countries with
a trend toward private sector defined contribution pension systems.
Demutualization and Initial Public Offering
The board of directors of Principal Mutual Holding Company, on March 31, 2001,
unanimously adopted a plan of conversion from a mutual insurance holding company
("MIHC") to a stock company (the "Plan"). This process is called
demutualization.
On July 24, 2001, policyholders entitled to vote approved the Plan. A public
hearing was held on the Plan on July 25, 2001, and the Iowa Insurance
Commissioner approved the Plan on August 28, 2001.
Under the terms of the Plan, effective October 26, 2001, Principal Mutual
Holding Company converted from an MIHC to a stock company. All membership
interests in Principal Mutual Holding Company were extinguished on that date and
eligible policyholders received compensation in the form of common stock, cash
or policy credits. In aggregate, 260.8 million shares of common stock, $1,177.5
million of cash and $472.6 million of policy credits were distributed as
demutualization compensation.
In connection with the restructuring effective October 26, 2001, Principal
Mutual Holding Company and two of its subsidiaries, Principal Financial Group,
Inc., an Iowa corporation, and Principal Financial Services, Inc., an Iowa
corporation, merged with and into Principal Iowa Newco, Inc., an Iowa
corporation, which changed its name to Principal Financial Services, Inc.
("PFSI"). PFSI is a wholly-owned subsidiary of Principal Financial Group, Inc.,
a Delaware corporation.
On October 26, 2001, Principal Financial Group completed its initial public
offering ("IPO") in which we issued 100.0 million shares of common stock at a
price of $18.50 per share. Net proceeds from the IPO were $1,753.9 million, of
which $64.2 million was retained by Principal Financial Group, Inc., and
$1,689.7 million was contributed to Principal Life Insurance Company ("Principal
Life") principally to fund demutualization compensation to policyholders
receiving cash or policy credits and to cover certain expenses related to our
demutualization. Proceeds were net of offering costs of $96.5 million and a
related tax benefit of $0.4 million.
On November 9, 2001, Principal Financial Group issued 15.0 million additional
shares of common stock, at a price of $18.50 per share, as a result of the
exercise of over-allotment options granted to underwriters in the IPO. Net
proceeds from the over-allotment were $265.4 million.
Costs relating to the demutualization, excluding costs relating to the IPO, were
$18.6 million and $7.2 million, net of tax, in 2001 and 2000, respectively.
Demutualization expenses consist primarily of printing and mailing costs and our
aggregate cost of engaging independent accounting, actuarial, financial,
investment banking, legal and other consultants to advise us on the
demutualization. In addition, our costs included the costs of the advisors of
2
the Iowa Insurance Commissioner and the New York State Insurance Department,
other regulatory authorities and internal allocated costs for staff and related
costs associated with the demutualization.
Our Operating Segments
We organize our businesses into four operating segments:
o U.S. Asset Management and Accumulation;
o International Asset Management and Accumulation;
o Life and Health Insurance; and
o Mortgage Banking.
We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.
One of the primary measures of our business is assets under management. We
define assets under management to include all assets on which we earn an
asset-based fee or a spread. Further, we measure the composition of assets under
management both by the segment that accumulates the assets and by the entity
that manages the assets. The following table shows the composition of assets
under management by both measures:
Composition of Assets Under Management
As of December 31, 2001
Asset Manager(2)
--------------------------------------------------------------------
Other
Entities of
the
Principal Principal Third-Party Total Assets
Capital BT Financial Financial Asset Under
Management Group Group(3) Managers Management
---------- ------------ ----------- ----------- ------------
(in billions)
Asset Accumulation Source(1)
U.S. Asset Management and
Accumulation...................... $ 73.3 $ - $ 2.4 $ 6.5 $ 82.2
International Asset Management and
Accumulation...................... 0.5 18.9 3.6 2.3 25.3
Life and Health Insurance............ 9.4 - - 0.2 9.6
Mortgage Banking(4).................. - - 0.5 - 0.5
Corporate and Other.................. 2.5 - 0.1 - 2.6
-------- ------- ------- ------- -------
Total............................ $ 85.7 $ 18.9 $ 6.6 $ 9.0 $ 120.2
======== ======= ======= ======= =======
- --------------------
(1) We define "asset accumulation" as the sale of investment-oriented products
and services for which we provide administrative services and/or offer
investment choices. We refer to the segment that sells these products and
services as the "asset accumulation source."
(2) We define "asset management" as the provision of investment advisory
services. We refer to the entity that provides these services as the "asset
manager."
(3) Includes assets managed by Principal Residential Mortgage, Inc., Principal
International and Principal Bank as well as Pension separate account assets
of $1.3 billion, which primarily include shares of our stock allocated to
certain eligible policyholders as a result of our demutualization.
(4) Excludes our mortgage loan servicing portfolio.
When we manage assets, we earn an asset-based fee or a spread. On fee-based
products, we typically pass investment performance through to customers and
bear limited or no investment risk. On spread-based products, we typically
provide a guarantee of return to customers for a specified period of time and
assume the investment risk of the spread, the difference between the investment
3
income we earn and the investment income we credit to customers. Generally,
assets associated with spread-based products are reported on our balance sheet
while assets associated with fee-based products either do not appear on our
balance sheet or are included as separate account assets.
The following table shows by segment the amount of assets on which we earned an
asset-based fee as compared to that on which we earned a spread for the years
indicated:
Assets Under Management
Fee-based/Spread-based Composition
As of December 31,
-------------------------------------------------------------------------------------
2001 2000 1999
------------------------- ------------------------- -------------------------
Fee Spread Total Fee Spread Total Fee Spread Total
------ ------ ------- ------ ------ ------- ------ ------ -------
(in billions)
U.S. Asset Management
and Accumulation... $ 51.1 $ 31.1 $ 82.2 $ 48.9 $ 29.2 $ 78.1 $ 46.9 $ 28.7 $ 75.6
International Asset
Management and
Accumulation....... 22.3 3.0 25.3 25.6 2.8 28.4 28.4 2.2 30.6
Life and Health
Insurance.......... 2.0 7.6 9.6 2.1 7.2 9.3 2.0 6.7 8.7
Mortgage Banking(1)... - 0.5 0.5 - 0.2 0.2 - 0.5 0.5
------ ------ ------- ------ ------ ------- ------ ------ ------
Subtotal........... $ 75.4 $ 42.2 117.6 $ 76.6 $ 39.4 116.0 $ 77.3 $ 38.1 115.4
====== ====== ====== ====== ====== ======
Corporate and Other... 2.6 1.5 1.2
------- ------- ------
Total.............. $ 120.2 $ 117.5 $116.6
======= ======= ======
- ---------------------
(1) Excludes our mortgage loan servicing portfolio.
Our Strategies
We seek to enhance stockholder value by pursuing the most attractive financial
services opportunities consistent with the capabilities of our asset management
and accumulation operations. We intend to accomplish this goal by increasing the
growth and profitability of these businesses through the pursuit of the
following primary strategic initiatives:
Accelerate the growth of our U.S. asset accumulation business. We intend to
strengthen our existing distribution channels and expand into new distribution
channels, further leverage our technology to achieve operating efficiencies,
continue to expand the range of investment options and effectively cross-sell
our products and services.
Increase the growth and profitability of our international asset management and
accumulation business. We will continue to leverage our U.S. product expertise
and operating platforms to strengthen our international operations. We seek to
accelerate the growth of our assets under management by capitalizing on the
international trend toward privatization of public retirement pension systems.
In addition, we intend to continue our progress in managing expenses as we
reduce operating unit costs.
Grow our third-party institutional assets under management. We selectively
target asset classes and customers in the U.S., Australia and globally to
capitalize on the specific strengths of Principal Capital Management and BT
Financial Group. They jointly execute this strategy in their respective markets
and through joint marketing offices in London, Hong Kong and Singapore.
U.S. Asset Management and Accumulation Segment
Our U.S. Asset Management and Accumulation segment consists of:
o asset accumulation operations which provide retirement savings and related
investment products and services to businesses, their employees and other
individuals; and
o Principal Capital Management, our U.S.-based asset manager.
4
The following table shows the operating revenues, operating earnings, assets and
assets under management of our U.S. Asset Management and Accumulation segment
for the years indicated:
U.S. Asset Management and Accumulation
Selected Financial Highlights
As of or for the year ended December 31,
-----------------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
($ in millions)
Operating Revenues(1):
U.S. Asset Accumulation............. $ 3,640.3 96% $ 3,398.1 96% $ 3,348.1 96%
Principal Capital Management........ 194.9 5 174.2 5 156.6 5
Intra-segment eliminations(2)....... (35.2) (1) (38.4) (1) (32.1) (1)
--------- --- --------- --- --------- ---
Total............................. $ 3,800.0 100% $ 3,533.9 100% $ 3,472.6 100%
========= === ========= === ========= ===
Operating Earnings:
U.S. Asset Accumulation............. $ 317.0 90% $ 317.6 89% $ 321.2 90%
Principal Capital Management........ 36.8 10 39.0 11 35.4 10
--------- --- --------- --- --------- ---
Total............................. $ 353.8 100% $ 356.6 100% $ 356.6 100%
========= === ========= === ========= ===
Assets:
U.S. Asset Accumulation(3).......... $67,626.5 99% $64,883.9 99% $64,410.4 99%
Principal Capital Management........ 917.3 1 912.0 1 686.0 1
--------- --- --------- --- --------- ---
Total............................. $68,543.8 100% $65,795.9 100% $65,096.4 100%
========= === ========= === ========= ===
Assets Under Management:
($ in billions)
U.S. Asset Accumulation(3).......... $ 74.6 91% $ 71.0 91% $ 70.3 93%
Principal Capital Management........ 7.6 9 7.1 9 5.3 7
--------- --- --------- --- --------- ---
Total............................. $ 82.2 100% $ 78.1 100% $ 75.6 100%
========= === ========= === ========= ===
- ---------------------
(1) Excludes net realized capital gains (losses) and their impact on recognition
of front-end fee revenues and certain market value adjustments to fee
revenues.
(2) Includes eliminations of amounts related to U.S. asset management fee
revenues received from our U.S. asset accumulation operations.
(3) Assets as of December 31, 2001, include separate account assets of $1.3
billion, which primarily include shares of our stock allocated to certain
eligible policyholders as a result of our demutualization.
U.S. Asset Accumulation
Our asset accumulation activities in the U.S. date back to the 1940s when we
first began providing pension plan products and services. We now offer a
comprehensive portfolio of asset accumulation products and services for
retirement savings and investment:
o To businesses of all sizes, we offer products and services for defined
contribution pension plans, including 401(k) and 403(b) plans, defined
benefit pension plans and non-qualified executive benefit plans. For more
basic needs, we offer SIMPLE IRA and payroll deduction plans;
o To large institutional clients, we also offer investment-only products,
including guaranteed investment contracts and funding agreements; and
o To employees of businesses and other individuals, we offer the ability to
accumulate retirement savings through mutual funds, individual annuities and
bank products.
We organize our U.S. asset accumulation operations into four product and service
categories: pension, mutual funds, individual annuities and Principal Bank.
5
Our pension products and services are further grouped into four categories:
full-service accumulation, full-service payout, investment-only and
administration-only.
The following table shows the operating revenues for our U.S. asset accumulation
operations for the years indicated:
U.S. Asset Accumulation
Operating Revenues
For the year ended December 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Pension.............................. $ 3,249.5 $ 3,012.7 $ 2,980.3
Mutual Funds......................... 108.3 116.0 95.4
Individual Annuities................. 263.5 267.5 270.2
Principal Bank....................... 33.9 9.2 2.2
Eliminations......................... (14.9) (7.3) -
---------- ---------- ----------
U.S. Asset Accumulation........... $ 3,640.3 $ 3,398.1 $ 3,348.1
========== ========== ==========
The following table shows the asset flow summary for our U.S. asset
accumulation operations for the years indicated:
U.S. Asset Accumulation
Asset Flow Summary
As of or for the year ended
December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(in billions)
Assets Under Management, beginning
of year................................. $ 71.0 $ 70.3 $ 63.5
Deposits................................ 16.1 14.6 14.7
Withdrawals............................. (12.7) (14.3) (11.9)
Investment Performance.................. (0.6) 1.0 5.6
Other................................... 0.8 (0.6) (1.6)
-------- -------- --------
Assets Under Management, end of year....... $ 74.6 $ 71.0 $ 70.3
======== ======== ========
Pension Services and Products
We offer a wide variety of investment and administrative products and services
for defined contribution pension plans, including 401(k) and 403(b) plans,
defined benefit pension plans and non-qualified executive benefit plans. A
403(b) plan is a plan described in section 403(b) of the Internal Revenue Code
that provides retirement benefits for employees of tax exempt organizations and
public schools.
Pension Services
Our investment and administrative products and services respond to a broad range
of employer-sponsored pension plan needs and are available both on a stand-alone
basis or combined to meet the various needs of our customers.
Administrative Services. We believe our ability to minimize the plan sponsor's
administrative tasks has contributed to our success, particularly among small
and medium-sized businesses. We differentiate ourselves from our competitors by
providing every plan administrative service that is generally required or
desired by a pension plan sponsor, regardless of the type or size of the plan.
The following table describes the primary administrative services we offer to
both plan sponsors and plan participants in defined contribution plans and
defined benefit plans:
6
Services Offered to Plan Sponsors
---------------------------------
Defined Contribution Plans o Government compliance and
documentation
o Fund accounting
Defined Benefit Plans o Actuarial valuation services
o Government compliance and
documentation
o Fund accounting
Services Offered to Plan Participants
-------------------------------------
Defined Contribution Plans o Account recordkeeping
o Education and reporting
o Phone center
o Internet access and transaction
capabilities
o Voice response system
o Benefit planning and benefit
distribution
Defined Benefit Plans o Benefit determination and benefit
distribution
o Education and reporting
o Phone center
o Internet access and transaction
capabilities
Investment Services. We provide a full range of guaranteed investment contracts,
money market, equity, fixed income, balanced, indexed and real estate investment
options to our customers. We provide these services through our affiliated asset
managers, Principal Capital Management and BT Financial Group, and through
third-party asset managers. Our affiliate, Principal Financial Advisors, Inc.,
provides asset allocation services to our defined benefit clients. As of
December 31, 2001, we had approximately 229 investment options available,
including U.S. and international fixed income and equity investment options. Our
variable investment options are either in the form of a separate account or a
mutual fund.
Pension Products
The following table shows pension asset flows for the years indicated:
U.S. Asset Accumulation
Pension Asset Flow Summary
As of or for the year ended
December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(in billions)
Assets Under Management, beginning of year... $ 61.7 $ 61.3 $ 55.2
Deposits................................... 13.5 12.2 12.9
Withdrawals................................ (11.0) (12.4) (10.2)
Investment Performance..................... (0.1) 0.9 5.4
Other...................................... 0.6 (0.3) (2.0)
-------- -------- --------
Assets Under Management, end of year......... $ 64.7 $ 61.7 $ 61.3
======== ======== ========
Full-service Accumulation. Full-service accumulation products respond to the
needs of plan sponsors seeking both administrative and investment services for
defined contribution plans or defined benefit plans. The investment component of
our defined contribution plans may be in the form of a group annuity contract or
a mutual fund. The investment component of our defined benefit plans is
available only in the form of a group annuity contract.
As of December 31, 2001, we provided full-service accumulation products to
33,282 defined contribution pension plans, of which 25,289 were 401(k) plans,
covering 1.9 million plan participants, and to 3,148 defined benefit pension
plans, covering 240,047 plan participants. As of December 31, 2001,
approximately 89% of our pension assets under management were managed by
Principal Capital Management or BT Financial Group. Third-party asset managers
provide asset management services with respect to a majority of the remaining
assets.
Prior to 2001, annuities were the only product through which we delivered both
administrative and investment services to our defined contribution plan and
7
defined benefit plan customers. Under U.S. federal securities laws, neither the
annuity nor the underlying investment options are required to be registered with
the SEC. Beginning January 2001, we began to offer administrative and investment
services to defined contribution plan customers through Principal Advantage, a
new 401(k) product based on our recently expanded mutual fund, Principal
Investors Fund. We offer funds covering the full range of stable value, equity,
fixed income and international investment options managed by our affiliated
asset managers, Principal Capital Management and BT Financial Group, as well as
third-party asset managers.
Full-service Payout. Full-service payout products respond to the needs of
pension plan participants who, upon retirement or termination of their
employment, leave their pension plans, and who seek both administrative and
investment services for distributions from the plans they are leaving. Plan
participants who seek these services include those departing pension plans we
service, as well as pension plans other providers service. We offer both
flexible income option products and single premium group annuities. Flexible
income option products allow the customer to control the rate of distribution,
or payout, and provide limited performance guarantees. Single premium group
annuities are immediate or deferred annuities that provide a current or future
specific income amount, fully guaranteed by us. Both products are available to
defined contribution and defined benefit plan participants. For both products,
we make regular payments to individuals, invest the underlying assets on their
behalf and provide tax reporting to them.
Single premium group annuities are traditionally used in conjunction with
defined benefit plans, particularly those where the plan is being terminated. In
such instances, the plan sponsor transfers all its obligations under the plan to
an insurer by paying a single premium. Increasingly, these products are
purchased by defined contribution plan participants who reach retirement age.
Plan sponsors restrict their purchases to insurance companies with superior or
excellent financial quality ratings because the Department of Labor has mandated
that annuities be purchased only from the "safest available" insurer. In 2000,
we received $498.3 million of single premium group annuities annualized new
deposits, ranking us second in the U.S. according to LIMRA International, Inc.'s
2000 U.S. Institutional Pension Sales and Assets report.
Deposits to full-service payout products are in the form of single payments. As
a result, the level of new deposits can fluctuate depending on the number of
retirements and large-scale annuity sales in a particular fiscal quarter. Assets
under management relating to single premium group annuities generate a spread
between the investment income earned by us and the amount credited to the
customer. Assets under management relating to flexible income option products
may generate either spread or fee revenue depending on the investment options
elected by the customer.
Investment-Only. The three primary products for which we provide investment-only
services are: guaranteed investment contracts; funding agreements; and other
investment-only products.
Guaranteed investment contracts ("GICs") and funding agreements pay a specified
rate of return. The rate of return can be a floating rate based on an external
market index or a fixed rate. Some of these investment-only products provide a
feature which permits plan participants to redeem or transfer funds in their
accounts at book value during the term of the contract. All of our
investment-only products contain provisions limiting early surrenders, including
penalties for early surrenders and minimum notice requirements. Put provisions
give customers the option to terminate a contract prior to maturity, provided
they give us a minimum notice period.
The following table breaks down by notice period the put provisions of our
guaranteed investment contracts and funding agreements:
8
U.S. Asset Accumulation
U.S. GAAP Reserves for Guaranteed Investment
Contracts and Funding Agreements by
Withdrawal Provisions
As of December 31, 2001
-----------------------
(in millions)
Book Value Out(1):
Puttable:
Less than 30 days' put....................... $ -
30-89 days' put.............................. -
90-180 days' put............................. -
More than 180 days' put...................... 55.1
No active put provision(2)................... -
-----------------------
Total puttable............................. 55.1
Surrenderable:
Book value out without surrender charge...... 22.9
Book value out with surrender charge......... 396.3
-----------------------
Total surrenderable........................ 419.2
-----------------------
Total book value out.............................. 474.3
Market Value Out(3):
Less than 30 days' notice......................... 26.9
30-89 days' notice................................ 281.9
90-180 days' notice............................... 1,133.6
More than 180 days' notice........................ 4,795.6
No active surrender provision..................... 238.5
-----------------------
Total market value out..................... 6,476.5
Not puttable or surrenderable.............. 11,502.1
-----------------------
Total GICs and funding agreements.......... $ 18,452.9
=======================
- ---------------------
(1) Book Value Out: The amount equal to the sum of deposits less withdrawals
with interest accrued at the contractual interest rate.
(2) Contracts currently in initial lock-out period but which will become
puttable with 90 days' notice at some time in the future.
(3) Market Value Out: The amount equal to the book value out plus a market
value adjustment to adjust for changes in interest rates.
Deposits to investment-only products are predominantly in the form of single
payments. As a result, the level of new deposits can fluctuate from one fiscal
quarter to another. Assets invested in guaranteed investment contracts and
funding agreements generate a spread between the investment income earned by us
and the amount credited to the customer. Our other investment-only products
consist of separate accounts invested in either equities or fixed income
instruments.
Administration-Only. We provide fee-based administrative services for defined
contribution plans, including 401(k) plans, where a third-party provides the
investment choices. As of December 2001, we provided administration-only
services to 3,454 defined contribution plans covering approximately 183,000
employees. In addition to defined contribution plans, we currently provide
administration-only services to 317,884 individual retirement accounts.
Managing Risk in Spread-Based Products
Because of the significant guarantees we provide as part of our spread-based
asset accumulation products, risk management is particularly important in this
line of business. To facilitate risk management, we segregate and manage the
assets supporting our spread-based products separately from the rest of our
general account. Our risk management strategy is more fully described in Part
II, Item 7A, "Quantitative and Qualitative Information about Market Risk."
9
The following table illustrates, for the years indicated, gross new deposits
under management and reserves for the spread-based products in our U.S. asset
accumulation pension operations:
U.S. Asset Accumulation
Pension Spread-Based Products Selected Financial Data
As of or for the year ended
December 31,
----------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Gross New Deposits Under Management:
Guaranteed investment contracts.......... $ 2,456.6 $ 1,685.2 $ 3,221.1
Funding agreements....................... 911.1 1,416.0 1,381.0
Full-service Payout...................... 752.4 519.7 562.4
---------- ---------- ----------
Total.................................. $ 4,120.1 $ 3,620.9 $ 5,164.5
========== ========== ==========
Reserves:
Guaranteed investment contracts.......... $ 13,750.0 $ 14,327.1 $ 15,520.7
Funding agreements....................... 4,329.4 3,247.4 1,881.9
Full-service Payout...................... 5,393.9 4,762.2 4,390.4
Separate Account GICs.................... 373.5 373.8 319.1
---------- ---------- ----------
Total.................................. $ 23,846.8 $ 22,710.5 $ 22,112.1
========== ========== ==========
Markets and Distribution
We offer our pension products and services to employer-sponsored pension plans,
including qualified and non-qualified defined contribution plans, qualified
defined benefit plans and institutional investors. Our primary target market is
pension plans sponsored by small and medium-sized businesses, which we believe
remains under-penetrated. Only 17% of businesses with less than 100 employees,
and 38% of businesses with between 100 and 500 employees, offered a 401(k) plan
in 2000, according to the Spectrem Group. The same study indicates that 87% of
employers with 500 or more employees offered a 401(k) plan in 2000. The
following tables break down, for the years indicated, the number of plans and
assets under management for our full-service accumulation business by employer
size:
U.S. Asset Accumulation
Pension Full-service Accumulation Data by Employer Size
As of December 31,
------------------------------
2001 2000 1999
-------- -------- --------
Number of Plans:
1 - 99 employees........................... 29,529 30,110 32,096
100 - 499 employees.......................... 3,212 3,228 3,123
500 - 999 employees.......................... 333 348 316
1000+ employees.............................. 208 195 205
-------- -------- --------
Number of Defined Contribution Plans...... 33,282 33,881 35,740
Number of Defined Benefit Plans........... 3,148 3,286 3,425
-------- -------- --------
Total.................................. 36,430 37,167 39,165
======== ======== ========
Average Number of Employees Per Plan......... 65 63 61
10
As of December 31,
---------------------------
2001 2000 1999
------- ------- -------
(in billions)
Assets under Management:
1 - 99 employees.......................... $ 17.6 $ 16.7 $ 17.9
100 - 499 employees......................... 10.4 10.2 10.7
500 - 999 employees......................... 3.2 3.1 3.1
1000+ employees............................. 6.0 5.6 5.7
------- ------- -------
Defined Contribution Assets Under
Management............................. 37.2 35.6 37.4
Defined Benefit Assets Under
Management............................. 5.6 6.4 5.9
------- ------- -------
Total................................. $ 42.8 $ 42.0 $ 43.3
======= ======= =======
Full-service Accumulation. We sell our full-service accumulation products and
services nationally, primarily through a captive retirement services sales
force. As of December 31, 2001, 122 retirement services sales representatives in
53 offices, operating as a wholesale distribution network, maintained
relationships with approximately 13,000 independent brokers, consultants and
agents. Retirement services sales representatives are an integral part of the
sales process alongside the referring consultant or independent broker. We
compensate retirement services sales representatives through a blend of salary
and production-based incentives, while we pay independent brokers, consultants
and agents a commission or fee.
As of December 31, 2001, we had a separate staff of 151 service representatives
located in the sales offices who play a key role in the ongoing servicing of
pension plans by: providing local services to our customers, such as renewing
contracts, revising plans and solving any administration problems; communicating
the customers' needs and feedback to us; and helping employees understand the
benefits of their pension plans.
We believe that our approach to pension plan services distribution gives us a
local sales and service presence that differentiates us from many of our
competitors. We have also recently established a number of marketing and
distribution relationships to increase the sales of our accumulation products
with firms such as Frank Russell Investment Management Company, A.G. Edwards and
AON.
We sell our annuity-based products through sales representatives, agents and
brokers who are not required to register with the SEC.
Principal Advantage, our mutual fund-based product, is targeted at defined
contribution plans with over $3.0 million of assets. We sell Principal Advantage
through affiliated registered representatives, stockbrokers, registered
investment advisors and fee-based consultants through sales agreements with
non-affiliated broker-dealers. Principal Advantage gives us access to
SEC-registered distributors who are not traditional sellers of annuity-based
products and opens new opportunities for us in the investment advisor and
broker-dealer distribution channels.
We significantly expanded our marketing and product development efforts into the
"not-for-profit" market in 1999, with the acquisition of Professional Pensions,
Inc., which specializes in providing full-service accumulation 403(b) pension
plans to 501(c)(3) not-for-profit organizations. As of December 31, 2001, we
provided pension products and services to 851 pension plans sponsored by
educational and not-for-profit organizations with $1,355.8 million of assets
under management.
Impact401k.com is our self-service Internet site, through which plan sponsors
can handle the purchase, enrollment and administration of a 401(k) pension plan
entirely through the Internet. Impact401k.com allows plan participants to gain
on-line access to their accounts, transfer funds between accounts and review
customized investment options. Accordingly, our employees do not have to perform
any administrative activities. Impact401k.com is targeted at smaller businesses
that seek a low cost product, as well as businesses of any size that prefer to
handle administrative activities through the Internet.
Full-service Payout and Investment-Only. Our primary distribution channel for
full-service payout and investment-only products was comprised of 13 specialized
home office marketers as of December 31, 2001, working through consultants and
brokers that specialize in this type of business. Our home office marketers also
make sales directly to institutions. Our nationally dispersed retirement
services sales representatives act as a secondary distribution channel for these
11
products. Principal Connection also distributes full-service payout products to
participants in plans we service who are terminating employment or retiring.
We market guaranteed investment contracts and funding agreements primarily to
pension plan sponsors and other institutions. We also offer them as part of our
full-service accumulation products. We sell our guaranteed investment contracts
primarily to plan sponsors for funding of tax-qualified retirement plans. We
sell our funding agreements to institutions that may or may not be pension
funds. Our primary market for funding agreements is institutional investors in
the U.S. and around the world. These investors purchase debt obligations from a
special purpose vehicle which, in turn, purchases a funding agreement from us
with terms similar to those of the debt obligations. The strength of this market
is dependent on debt capital market conditions. As a result, our sales through
this channel can vary widely from one quarter to another.
Administration-Only. We sell our defined contribution plan administration-only
services primarily through business relationships with investment management
firms and insurance companies. These organizations package our administrative
services with their proprietary pension plan investment services for sale
through their own distribution channels. We have a small number of regional
consultants who facilitate sales of our defined contribution plan administrative
services by these organizations. Our administration-only individual retirement
account services are distributed by a specialized home office marketer who
establishes business relationships with security brokerage firms that offer
individual retirement account programs directly to the public.
Mutual Funds
We have been providing mutual funds to customers since 1969. We offer mutual
funds to individuals and businesses, for use within variable life and variable
annuity contracts and for use in employer-sponsored pension plans.
Products and Services
We were ranked in the top quartile among U.S. mutual fund managers in terms of
total mutual fund assets under management as of December 31, 2001, according to
the Investment Company Institute. The value of our mutual fund assets we managed
was $6.5 billion as of December 31, 2001. We provide accounting, compliance,
corporate governance, product development and transfer agency functions for all
mutual funds we organize. As of December 31, 2001, our mutual fund operations
served approximately 637,300 mutual fund shareholder accounts.
Principal Mutual Funds. Principal Mutual Funds is a family of mutual funds
offered to individuals and businesses, with 26 mutual funds and $3.6 billion in
assets under management as of December 31, 2001. We report the results for these
funds in this segment under "Mutual Funds".
Principal Variable Contracts Fund. Principal Variable Contracts Fund is a series
mutual fund which, as of December 31, 2001, provided 26 investment options for
use as funding choices in variable annuity and variable life insurance contracts
issued by Principal Life. As of December 31, 2001, this fund had $2.3 billion in
assets under management. We report the results for the funds backing variable
annuity contracts in this segment under "Individual Annuities." We report the
results for the funds backing variable life insurance contracts in the Life and
Health Insurance segment.
Principal Investors Fund. Principal Investors Fund is a recently expanded series
mutual fund which, as of December 31, 2001, offered 44 investment options. This
fund acts as the funding vehicle for Principal Advantage, the defined
contribution product described above under "U.S. Asset Management and
Accumulation Segment-U.S. Asset Accumulation-Pension Services and
Products-Pension Products-Full-service Accumulation." This fund also offers a
retail class of shares to primarily individuals for IRA rollovers. As of
December 31, 2001, this retail class of shares had $128.9 million in assets
under management. We report the results for this fund, excluding the retail
class of shares, under "Pension". We report the results of the retail class of
shares in this segment under "Mutual Funds."
The following table shows our mutual funds asset flow summary for the years
indicated:
12
U.S. Asset Accumulation
Retail Mutual Funds Asset Flow Summary(1)
As of or for the year ended
December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(in billions)
Assets Under Management, beginning of year.... $ 3.9 $ 4.1 $ 3.7
Deposits.................................... 1.3 1.3 1.3
Withdrawals................................. (1.1) (1.4) (1.1)
Investment Performance...................... (0.4) (0.1) 0.2
-------- -------- --------
Assets Under Management, end of year.......... $ 3.7 $ 3.9 $ 4.1
======== ======== ========
- ---------------------
(1) Includes asset flows for the Principal Mutual Funds and the retail share
class of the Principal Investors Fund.
Markets and Distribution
Our markets for retail mutual funds are individuals seeking to accumulate
savings for retirement and other purposes and small businesses seeking to use
mutual funds as the funding vehicle for pension plans, as well as non-qualified
individual savings plans utilizing payroll deductions. We also market our retail
mutual funds to participants in pension plans who are departing their plans and
reinvesting their retirement assets into individual retirement accounts.
Our retail mutual funds are sold primarily through our affiliated financial
representatives, independent brokers registered with our securities
broker-dealer Princor Financial Services Corporation, ("Princor"), registered
representatives from other broker-dealers, direct deposits from our employees
and others and Principal Connection. Princor, as the marketing arm of our mutual
fund business, recruits, trains and supervises registered representatives
selling our products.
The following table shows sales, as measured by deposits, of our retail mutual
funds by distribution channel for the years indicated:
U.S. Asset Accumulation
Retail Mutual Funds Sales by Distribution Channel(1)
For the year ended December 31,
-------------------------------
2001 2000 1999
-------- -------- ---------
(in millions)
Affiliated financial representatives....... $ 311.0 $ 326.9 $ 442.0
Principal Connection....................... 192.4 141.5 114.2
Independent brokers and registered
representatives of Princor............... 15.2 13.6 3.3
Other (non-affiliated) broker-dealers...... 93.0 66.9 40.4
Direct deposits(2)......................... 38.9 18.6 25.9
-------- -------- ---------
Total.................................... $ 650.5 $ 567.5 $ 625.8
======== ======== =========
- ---------------------
(1) Excludes deposits to money market funds totaling $686.0 million in 2001,
$732.8 million in 2000 and $621.3 million in 1999.
(2) Direct deposits from the Principal Financial Group employees and others.
Individual Annuities
Individual annuities offer a tax-deferred means of accumulating retirement
savings and provide a tax-efficient source of income during the payout period.
13
Products and Services
We offer both fixed and variable annuities to individuals. Individual annuities
may be deferred, in which case assets accumulate until the contract is
surrendered, the customer dies or the customer begins receiving benefits under
an annuity payout option, or immediate, in which case payments begin within one
year of issue and continue for a fixed period of time or for life.
Fixed Annuities. Our individual fixed annuities are predominantly single premium
deferred annuity contracts. These contracts are savings vehicles through which
the customer makes a single deposit with us. Under the contract, the principal
amount is guaranteed and for a specified time period, typically one year, we
credit the customer's account at a fixed interest rate. Thereafter, we reset,
typically annually, the interest rate credited to the contract based upon market
and other conditions. Our major source of income from fixed annuities is the
spread between the investment income we earn on the underlying general account
assets and the interest rate we credit to customers' accounts. We bear the
investment risk because, while we credit customers' accounts with a stated
interest rate, we cannot be certain the investment income we earn on our general
account assets will exceed that rate.
Variable Annuities. Our individual variable annuity products consist almost
entirely of flexible premium deferred variable annuity contracts. These
contracts are savings vehicles through which the customer makes a single deposit
or a series of deposits of varying amounts and intervals. Customers have the
flexibility to allocate their deposits to investment sub-accounts managed by
Principal Capital Management, or third-party asset managers including Fidelity
Investments, AIM Advisors, Inc., Morgan Stanley Asset Management, J.P. Morgan
Investment Management, Inc., Janus Capital Corporation, Neuberger Berman
Management, Inc., The Dreyfus Corporation, Templeton Global Advisors Limited,
American Century Investment Management, INVESCO Funds Group, Goldman Sachs Asset
Management, Duncan-Hurst Capital Management, Inc., Turner Investment Partners,
Inc., and Berger, LLC. As of December 31, 2001, 58% of our $2.4 billion in
variable annuity account balances was allocated to investment sub-accounts
managed by Principal Capital Management, 30% to investment sub-accounts managed
by third-party asset managers and 12% to our general account, also managed by
Principal Capital Management. The customers bear the investment risk and have
the right to allocate their assets among various separate investment
sub-accounts. The value of the annuity fluctuates in accordance with the
experience of the investment sub-accounts chosen by the customer. Customers have
the option to allocate all or a portion of their account to our general account,
in which case we credit interest at rates we determine, subject to contractual
minimums. Customers may also elect death benefit guarantees. Our major source of
revenue from variable annuities is mortality and expense fees we charge to the
customer, generally determined as a percentage of the market value of the assets
held in a separate investment sub-account.
Markets and Distribution
Our target markets for individual annuities include owners, executives and
employees of small and medium-sized businesses, and individuals seeking to
accumulate and/or eventually receive distributions of assets for retirement. We
market both fixed and variable annuities to both qualified and non-qualified
pension plans.
We sell our individual annuity products largely through our affiliated financial
representatives, who accounted for 74%, 82% and 79% of annuity sales for the
years ended December 31, 2001, 2000 and 1999, respectively. The remaining sales
were made through brokerage general agencies, banks, Principal Connection and
unaffiliated broker-dealer firms.
The following table shows sales of our individual annuities by distribution
channel for the years indicated:
14
U.S. Asset Accumulation
Individual Annuity Sales by Distribution Channel(1)
For the year ended
December 31,
---------------------------
2001 2000 1999
------- ------- -------
(in millions)
Affiliated financial representatives.......... $ 520.6 $ 499.4 $ 409.0
Independent brokers and registered
representatives of Princor................ 77.6 35.4 38.8
Other (non-affiliated) broker dealers......... 5.3 18.3 14.9
Banks......................................... 76.6 30.2 32.8
Principal Connection.......................... 22.3 22.7 23.5
------- ------- -------
Total..................................... $ 702.4 $ 606.0 $ 519.0
======= ======= =======
- --------------------
(1) Excludes deposits related to rollovers from Principal draft account
products.
Principal Bank
Principal Bank, our electronic banking operation, is a federal savings bank that
began its activities in February 1998. It offers traditional retail banking
products and services via the telephone, Internet, ATM or by mail. Our current
products and services offering includes checking and savings accounts,
certificates of deposit, consumer loans, first mortgage loans, home equity
loans, credit cards, debit cards, money market accounts and a college savings
program. As of December 31, 2001, Principal Bank had 61,771 customers and
$1,109.7 million in assets, primarily generated by saving account deposits and
certificates of deposit.
We market our Principal Bank products and services primarily through Principal
Connection to our existing customers, especially pension plan participants and
mortgage customers. Through Principal Bank, we also pursue asset retention
strategies with our existing customers who seek to transfer assets from our
other asset accumulation products by offering them our banking products and
services.
Principal Capital Management
In 1999, we established Principal Capital Management to consolidate our
extensive investment management expertise and to focus on marketing our asset
management services to third-party institutional clients. Principal Capital
Management provides asset management services to our U.S. asset accumulation
businesses and third-party institutional clients, as well as our other
U.S.-based segments. Principal Capital Management provides a full range of asset
management services with emphasis on three primary asset classes: (1) equity
investments; (2) fixed income investments; and (3) real estate investments.
Principal Capital Management manages both U.S. and international assets.
As of December 31, 2001, Principal Capital Management, through its affiliates,
Invista Capital Management, Principal Capital Income Investors, Principal
Capital Real Estate Investors and Spectrum Asset Management, managed $85.7
billion in assets. Our third-party institutional assets were $7.3 billion as of
December 31, 2001, compared to $3.5 billion on January 1, 1999, the date
Principal Capital Management was established.
The following table shows Principal Capital Management's assets under management
by asset class for the years indicated:
15
Principal Capital Management
Assets Under Management by Asset Class
As of December 31,
----------------------------------------
2001 2000 1999
------------ ------------ ------------
($ in billions)
U.S. Equity......................... $ 19.5 23% $ 22.4 27% $ 25.9 32%
International Equity................ 4.1 5 5.6 7 6.3 8
Fixed Income........................ 40.3 47 33.7 40 28.4 34
Commercial Mortgages................ 13.7 16 14.1 17 14.8 18
Commercial Real Estate Equity....... 5.5 6 5.6 7 5.5 7
Other............................... 2.6 3 1.8 2 1.3 1
------ ---- ------ ---- ------ ----
Total............................. $ 85.7 100% $ 83.2 100% $ 82.2 100%
====== ==== ====== ==== ====== ====
The following table shows our asset flow summary for Principal Capital
Management operations for the years indicated:
Principal Capital Management
Asset Flow Summary
As of or for the year ended
December 31,
-----------------------------
2001 2000 1999
------- ------- ---------
(in billions)
Assets Under Management, beginning of year.. $ 83.2 $ 82.2 $ 77.1(1)
Deposits.................................. 16.9 17.4 16.3
Withdrawals............................... (15.3) (15.9) (12.9)
Investment Performance.................... 0.9 1.1 6.7
Other..................................... (1.0) (1.6) (5.0)
Operations acquired....................... 1.0 - -
------- ------- ---------
Assets Under Management, end of year........ $ 85.7 $ 83.2 $ 82.2
======= ======= =========
- -------------------
(1) Includes assets managed by Invista Capital Management and the former
investment department of Principal Life prior to the formation of Principal
Capital Management, effective January 1, 1999.
Products and Services
Principal Capital Management provides a full range of asset management services,
with emphasis on three asset classes through a range of vehicles including
separate accounts, mutual funds, institutional accounts, collateralized debt
securities and Principal Life's general account:
Equity Investments. Principal Capital Management, through its affiliate, Invista
Capital Management, manages equity portfolios, which represented $23.6 billion
in assets as of December 31, 2001. Invista Capital Management provides our
clients with access to a broad array of domestic, international and emerging
markets equity capabilities. The domestic equity products are organized across
growth and value styles, with portfolios targeted to distinct capitalization
ranges. As of December 31, 2001, 76% of Invista Capital Management's assets
under management were derived from our pension products, 18% from other products
of the Principal Financial Group, and the remaining 6% from third-party
institutional clients.
Fixed Income Investments. Principal Capital Management, through its affiliates,
Principal Capital Income Investors and Spectrum Asset Management, manages $40.3
billion in fixed income assets as of December 31, 2001. Principal Capital Income
Investors and Spectrum Asset Management provide our clients with access to
investment-grade corporate debt, mortgage-backed, asset-backed and commercial
mortgage-backed securities, high yield and municipal bonds, private and
syndicated debt instruments and preferred securities. As of December 31, 2001,
68% of these assets were derived from our pension products, 27% from other
products of the Principal Financial Group, and the remaining 5% from third-party
institutional clients.
16
Real Estate Investments. Principal Capital Management, through its affiliate,
Principal Capital Real Estate Investors, manages a commercial real estate
portfolio of $19.2 billion of assets as of December 31, 2001. Principal Capital
Real Estate Investors provides our clients with a broad range of real estate
investment options, including private real estate equity, commercial mortgages,
credit tenant debt, construction-permanent financing, bridge/mezzanine loans,
commercial mortgage-backed securities and real estate investment trusts.
Principal Capital Management had $0.7 billion of assets under management as of
December 31, 2001, from bridge/mezzanine loans and commercial mortgages which
appear on its balance sheet. The commercial mortgages represent the source of
mortgages for our commercial mortgage-backed securitization program. As of
December 31, 2001, 52% of the commercial real estate portfolio was derived from
our pension products, 31% from other products of the Principal Financial Group,
and the remaining 17% from third-party institutional clients.
Markets and Distribution
Principal Capital Management employed 47 institutional sales, relationship
management and client service professionals as of December 31, 2001, who worked
with consultants and directly with large investors to acquire and retain
third-party institutional clients. For the year ended December 31, 2001,
approximately 36% of new institutional clients were originated through direct
client contact by Principal Capital Management representatives, with the balance
derived from consultants.
We also market the combined expertise of Principal Capital Management and BT
Financial Group to third-party institutional clients through joint marketing
offices in London, Hong Kong and Singapore. BT Financial Group's asset
management expertise is complementary to the expertise of Principal Capital
Management.
International Asset Management and Accumulation Segment
Our International Asset Management and Accumulation segment consists of BT
Financial Group and Principal International. As of December 31, 2001, BT
Financial Group was the tenth largest asset manager in Australia according to
ASSIRT. As of December 31, 2001, BT Financial Group had accumulated $21.6
billion of assets under management and provided investment advisory services to
clients with $18.9 billion in assets. Principal International has subsidiaries
in Argentina, Chile, Mexico and Hong Kong and joint ventures in Brazil, Japan
and India. We focus on countries with favorable demographics and a trend toward
private sector defined contribution pension systems. We entered these countries
through acquisitions, start-up operations and joint ventures.
Our International Asset Management and Accumulation segment generated 8%, 7% and
4% of our total operating revenues and $(8.9) million, $(8.5) million and
$(38.4) million of our total operating earnings for the years ended December 31,
2001, 2000 and 1999, respectively.
The following table shows the operating revenues, operating earnings (loss),
assets and assets under management of our International Asset Management and
Accumulation segment for the years indicated:
17
International Asset Management and Accumulation
Selected Financial Highlights
As of or for the year ended December 31,
----------------------------------------------
2001 2000 1999(3)
-------------- -------------- --------------
($ in millions)
Operating Revenues(1):
BT Financial Group......... $ 220.9 30% $ 285.3 45% $ 113.8 30%
Principal International.... 513.1 70 345.4 55 265.8 70
-------- --- -------- --- -------- ---
Total.................... $ 734.0 100% $ 630.7 100% $ 379.6 100%
======== === ======== === ======== ===
Operating Earnings (Loss):
BT Financial Group(2)...... $ (14.8) N/A $ 6.3 N/A $ (4.8) N/A
Principal International.... 5.9 N/A (14.8) N/A (33.6) N/A
-------- --- -------- --- -------- ---
Total.................... $ (8.9) N/A $ (8.5) N/A $ (38.4) N/A
======== === ======== === ======== ===
Assets:
BT Financial Group......... $2,974.3 60% $3,716.8 67% $4,472.8 75%
Principal International.... 1,982.6 40 1,809.1 33 1,454.0 25
-------- --- -------- --- -------- ---
Total.................... $4,956.9 100% $5,525.9 100% $5,926.8 100%
======== === ======== === ======== ===
Assets Under Management:
($ in billions)
BT Financial Group......... $ 21.6 85% $ 25.4 89% $ 28.6 93%
Principal International.... 3.7 15 3.0 11 2.0 7
-------- --- -------- --- -------- ---
Total.................... $ 25.3 100% $ 28.4 100% $ 30.6 100%
======== === ======== === ======== ===
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on recognition
of front-end fee revenues and certain market value adjustments to fee
revenues.
(2) Reflects amortization of goodwill and other intangibles related to the
acquisition of BT Financial Group.
(3) Reflects operations of BT Financial Group from August 31, 1999, the date of
its acquisition.
BT Financial Group
Our acquisition of BT Financial Group was a central element in our expansion of
our international asset management and accumulation businesses.
We measure assets under management in two ways, both by the operation that
accumulates the assets and by the entity that manages the assets. BT Financial
Group both accumulates and manages assets. From an accumulation perspective, BT
Financial Group had assets under management of $21.6 billion as of December 31,
2001. As of that same date, BT Financial Group provided investment advisory
services for $18.9 billion. The difference represents assets accumulated by BT
Financial Group for which another asset manager provides investment advisory
services. BT Financial Group's assets under management decreased A$3.4 billion
from December 31, 2000 to December 31, 2001. However, during the same period the
Australian dollar declined in value relative to the U.S. dollar resulting in a
$3.8 billion decrease in assets under management in U.S. dollar terms.
The following table shows the amount of assets under management by operation for
BT Financial Group for the years indicated:
18
BT Financial Group
Assets Under Management(1)
As of December 31,
---------------------------
2001 2000 1999
------- ------- -------
(in billions)
Retail........................ A$ 18.5 A$ 23.3 A$ 20.9
Institutional................. 16.2 17.5 19.7
Margin Lending................ 1.1 1.1 1.0
Portfolio Services............ 5.2 2.5 0.9
New Zealand................... 1.3 1.1 1.0
Other......................... - 0.2 -
------- ------- -------
Total....................... A$ 42.3 A$ 45.7 A$ 43.5
======= ======= =======
Total....................... $ 21.6 $ 25.4 $ 28.6
======= ======= =======
- --------------------
(1) A$ denotes Australian dollars.
The following table shows BT Financial Group's asset flow summary for the years
indicated:
BT Financial Group
Asset Flow Summary(1)
As of or for the year ended December 31,
-----------------------------------------------------------
2001 2000 1999
----------------- ----------------- ---------------------
(in billions)
Assets Under Management,
beginning of year............... A$ 45.7 $ 25.4 A$ 43.5 $ 28.6 A$ 43.0(2) $ 26.4(2)
Net Deposits and Withdrawals.. (1.3) (0.7) 1.3 0.7 (4.0) (2.7)
Investment Performance........ (1.2) (0.6) 0.9 0.5 4.5 3.0
Effect of Exchange Rates...... - (2.0) - (4.4) - 1.9
Other......................... (0.9) (0.5) - - - -
-------- ------- ------- -------- ---------- ---------
Assets Under Management,
end of year..................... A$ 42.3 $ 21.6 A$ 45.7 $ 25.4 A$ 43.5 $ 28.6
======== ======= ======= ======== ========== =========
- --------------------
(1) A$ denotes Australian dollars.
(2) Includes assets managed by BT Financial Group prior to its acquisition by
the Principal Financial Group. Assets are presented for comparative
purposes only and are not included in segment or consolidated assets under
management amounts reported elsewhere in this document.
Products and Services
BT Financial Group offers a wide range of investment products, margin lending
and portfolio services. BT Financial Group's operations include: retail funds
management, institutional asset management, margin lending, portfolio services
and New Zealand.
Retail Funds Management. To its retail clients, BT Financial Group offers an
extensive range of retirement and investment services, including retail mutual
funds, pensions, annuities and corporate superannuation plans to over 720,000
retail customers as of December 31, 2001. BT Financial Group makes available a
client service call center and the "BT Online" Internet site, both providing
account information and transaction services for investors and financial
intermediaries.
Institutional Asset Management. To its larger institutional clients, both in
Australia and in targeted global markets, BT Financial Group offers products and
services covering a full investment range, including actively managed
diversified and specialist funds, individual client mandates, pooled investment
funds, global equities and fixed income securities, as well as currency and
asset allocation overlays. An overlay is a portfolio strategy that allows an
institution to seek enhanced portfolio returns by changing its exposure to asset
classes without liquidating a portion of its portfolio.
19
Margin Lending. BT Financial Group is one of the largest loan originators in the
Australian market. According to Cannex's November 2001 margin lending report, BT
Financial Group was awarded a four star rating (out of 5) on seven of its margin
lending products and a three star rating on other margin lending products.
Margin lending products assigned four stars are described by Cannex as "Very
good" while those assigned three stars are characterized as "Good." Margin
lending enables investors to borrow up to 70% of the value of mutual funds and
select listed securities. Rising levels of share ownership among Australian
investors has generated increased margin lending, with BT Financial Group's
margin lending portfolio balance of $0.6 billion (A$1.1 billion) as of December
31, 2001. On November 30, 1999, BT Financial Group margin lending operations
securitized its margin lending portfolio with Westpac Banking Corporation, an
Australian Bank. Under the terms of the financing, BT Financial Group margin
lending operations are required to allocate capital equal to approximately 7% of
the outstanding borrowed amount, as a cushion for loan defaults.
Portfolio Services. BT Financial Group is a leading provider of investment
administration and processing in Australia. Wrap is our fastest growing
portfolio services product. It provides independent financial advisors with a
range of investment choices for their clients administered via a central
Internet-based source with a choice of mutual funds and listed equity
securities. This product enables them, on behalf of their clients, to manage all
of a client's investment portfolio. Wrap also provides for custody, settlement
and accounting of all investments with online account capabilities and reporting
to the investor.
New Zealand. BT New Zealand provides a comprehensive range of retail and
institutional asset management services in New Zealand. BT Financial Group's New
Zealand business had $0.6 billion (A$1.3 billion) of assets under management as
of December 31, 2001.
Markets and Distribution
BT Financial Group's products and services are primarily sold throughout
Australia and New Zealand in both the institutional and retail markets. BT
Financial Group also operates institutional asset management offices in Hong
Kong, Singapore and London, as well as a joint venture operation in Malaysia.
As part of its marketing strategy, BT Financial Group has a comprehensive brand
and advertising strategy covering television, print media and the Internet.
Building on its successful brand campaign which positions BT Financial Group in
investment and superannuation, it is now also positioning itself as a leading
provider in the corporate superannuation market. For example, BT Financial Group
developed a television and print campaign to target employers. It focuses on
employee benefits from BT Financial Group's corporate superannuation plan,
referring to corporate sponsored retirement plans. BT Financial Group has
experienced growth in sales of its corporate superannuation plans since the
beginning of 1999. For the year ended December 31, 2001, BT Financial Group had
313 new plans compared to 488 new plans in 2000 and 154 in 1999.
Retail Funds Management. The retail funds management operations of BT Financial
Group provide a number of mutual funds and retirement services, including
superannuation for individuals, small and medium-sized businesses and
institutions, as well as pensions and annuities for retirees. These products are
primarily designed to meet the needs created by the superannuation market in
Australia. BT Financial Group has five investor centers in Australia, which
serve existing clients and advisors and promote BT Financial Group products and
services. Independent financial advisors are the main distribution channel for
retail investment products and superannuation products in Australia. BT
Financial Group also distributes these products through major banks, life
insurers and other mutual fund managers.
Institutional Asset Management. BT Financial Group's institutional products and
services are designed for trustees of corporate superannuation funds
institutions, large corporations and quasi-governmental entities. BT Financial
Group distributes the majority of its institutional asset management products
and services through consultants such as Towers Perrin, Mercer, Watson Wyatt,
Frank Russell and others.
Margin Lending. BT Financial Group's margin lending services target retail
clients and independent financial advisors. These services are marketed through
independent financial advisors and retail investor centers in addition to other
brokers. BT Financial Group's margin lending services allow independent
financial advisors to provide their clients a full range of financial services.
Portfolio Services. BT Financial Group provides portfolio services to large
institutions, corporations and mutual fund managers. Wrap is marketed to
independent financial advisors and other financial intermediaries for a fee.
20
New Zealand. BT Financial Group's New Zealand operations provide a comprehensive
group of products and services across both the retail and institutional markets.
Retail products are distributed through independent financial advisors while
institutional products are distributed through consultants.
Principal International
The activities of Principal International reflect our efforts to accelerate the
growth of our assets under management by capitalizing on the international trend
toward private sector defined contribution pension systems. Through Principal
International, we offer retirement products and services, annuities, mutual
funds and life insurance. We operate through subsidiaries in Argentina, Chile,
Mexico and Hong Kong and joint ventures in Brazil, Japan and India.
The following table shows the asset flow summary for Principal International for
the years indicated:
Principal International
Asset Flow Summary
As of or for the year
ended December 31,
------------------------
2001 2000 1999
------ ------ ------
(in billions)
Assets Under Management, beginning of year..... $ 3.0 $ 2.0 $ 1.2
Deposits..................................... 2.2 1.2 0.4
Withdrawals.................................. (1.2) (0.5) (0.1)
Investment Performance....................... 0.3 0.2 0.1
Operations Acquired.......................... - 0.2 0.6
Other........................................ (0.2) 0.1 (0.1)
Effect of Exchange Rates..................... (0.4) (0.2) (0.1)
------ ------ ------
Assets Under Management, end of year........... $ 3.7 $ 3.0 $ 2.0
====== ====== ======
Products and Services
Through Principal International, we offer retirement products and services,
annuities, mutual funds and life insurance.
Markets and Distribution
Asia/Pacific Region
Hong Kong. Our subsidiary in Hong Kong is actively competing in the defined
contribution plan market. The government requires employers and employees each
to contribute 5% of an employee's income to a Mandatory Provident Fund. We
target small and medium-sized employers and distribute products through
strategic alliances with insurance companies, mutual funds or banks, direct
marketing and through our own sales representatives. Our strategic partners help
distribute our Mandatory Provident Fund products and services, or use our
administrative and investment services in their own products. Our Mandatory
Provident Fund products and services are marketed by agents under the various
distribution arrangements we have with our strategic partners.
India. We own 50% of IDBI-Principal Asset Management Company, Ltd.,
("IDBI-Principal"), a mutual fund company. Our joint venture partner is the
Industrial Development Bank of India, ("IDBI"), a premier development bank in
India. In addition to the current mutual fund business, we are positioning
IDBI-Principal to compete in the emerging pension and long-term savings market
in India. We sell our mutual funds through regional offices located throughout
India and IDBI's banking offices.
Japan. We own 50% of ING/Principal Pensions Company, Ltd., which will sell a new
defined contribution plan, as a result of legislation adopted in June 2001. This
company will target small and medium-sized businesses and offer full-service
record-keeping and plan administration. Our joint venture partner is ING
Insurance International B.V., a member of the ING Group. Our pension sales
representatives distribute our products through ING Life's independent agents to
existing ING Life business clients and also through additional third-party
distribution relationships developed by ING/Principal Pensions Company, Ltd.
21
Latin America
Argentina. We own a life insurance company and a retirement annuity company (our
"Companies"). Principal Life Compania de Seguros, S.A., our life insurance
company, targets small and medium-sized employers. We sell group and individual
life insurance products through independent brokers and through bank branches of
Societe Generale, with which we have an alliance. Societe Generale is a leading
French banking institution with offices throughout Argentina through which we
distribute our products. Principal Retiro Compania de Seguros de Retiro, S.A.,
our annuity company, provides annuities to individuals exiting the compulsory
private pre-retirement asset accumulation system. We distribute annuity products
through dedicated sales representatives who sell directly to customers and
through independent brokers in Argentina. While recent adverse economic and
political events in Argentina are expected to impact our ongoing operations, we
have been positioning our Companies to work through this environment since
mid-2001 and expect to manage revenues and expenses accordingly.
Brazil. We own 46% of BrasilPrev, a private pension company in Brazil, through a
joint venture arrangement with Banco do Brasil, Brazil's largest bank. We are
Banco do Brasil's exclusive partner for distributing pension products.
BrasilPrev provides defined contribution products for the retirement needs of
employers and individuals. Banco do Brasil's employees sell directly to
individual clients through its bank branches. In addition, BrasilPrev reaches
corporate clients through two wholesale distribution channels: (1) a wholesale
distribution channel distributes products through a network of independent
brokers who sell to the public, and (2) another channel coordinates with Banco
do Brasil's corporate account executives to reach Banco do Brasil's existing
corporate clients.
Chile. We own Principal Compania de Seguros de Vida Chile S.A., a Chilean
insurance company, that primarily sells retirement annuities to individuals
exiting the pre-retirement accumulation system. In July 1998, we acquired
Compania de Seguros de Vida El Roble, S.A., or El Roble, a Chilean life
insurance company. We have fully integrated the operations of El Roble with
those of Principal Compania de Seguros de Vida Chile S.A. We distribute our
annuity products through a network that consisted of over 65 captive agents and
approximately 300 independent agents as of December 31, 2001. We also utilize
sales representatives who sell through brokers. We also market life and health
insurance products to small and medium-sized businesses and to individuals
through brokers. Based upon assets, we were ranked as the fourth largest life
insurance company in Chile as of September 30, 2001, according to the
Superintendencia de Valores y Seguros, the Chilean regulatory agency for
insurance companies. We also own 60% of Andueza & Principal Creditos
Hipotecarios S.A., in a joint partnership arrangement with Andueza y Compania
Agentes de Mutuos Hipotecarios S.A. Through this business, we originate, sell
and service mortgage loans in Chile. In November 2001, we acquired 70% of Tanner
Administradora de Fondos Mutuos S.A., a well-known Chilean Mutual Funds
Administrator, as part of our strategy to enter the Voluntary Defined
Contribution Market.
Mexico. We own Principal Mexico Compania de Seguros S.A. de C.V., ("Principal
Seguros"), a life insurance company, Principal Afore S.A. de C.V., a private
pension company which manages and administers individual retirement accounts
under the mandatory privatized social security system in effect for all
employees in Mexico, and Principal Pensiones S.A. de C.V., ("Principal
Pensiones"), an annuity company. Our focus is on both pre-retirement and
post-retirement savings plans. We distributed Principal Afore S.A. de C.V.'s
products and services through a dedicated sales force of approximately 650 sales
representatives as of December 31, 2001, who sold directly to individuals. As of
December 31, 2001, Principal Pensiones used 132 employed sales representatives
and independent brokers to distribute annuities directly to customers. Our life
insurance company, Principal Seguros, distributes its products through an array
of independent agents and brokers.
22
Life and Health Insurance Segment
Our Life and Health Insurance segment offers (1) individual life and disability
insurance and (2) group life and health insurance throughout the U.S.
Our Life and Health Insurance segment contributed 42%, 47% and 48% of our total
operating revenues and 28%, 26% and 19% of our total operating earnings for the
years ended December 31, 2001, 2000 and 1999, respectively. The following table
shows the total operating revenues, operating earnings and assets of our Life
and Health Insurance segment, by individual life and disability insurance, and
group life and health insurance, respectively, for the years indicated:
Life and Health Insurance
Selected Financial Highlights
As of or for the year ended December 31,
--------------------------------------------------
2001 2000 1999
--------------- --------------- ----------------
(in millions)
Operating Revenues(1):
Individual Life and Disability Insurance.. $ 1,508.4 38% $ 1,472.9 36% $ 1,409.8 35%
Group Life and Health Insurance........... 2,438.0 62 2,649.7 64 2,575.7 65
--------- --- --------- --- ---------- ---
Total................................... $ 3,946.4 100% $ 4,122.6 100% $ 3,985.5 100%
========= === ========= === ========== ===
Operating Earnings:
Individual Life and Disability Insurance.. $ 97.7 49% $ 54.9 34% $ 86.8 96%
Group Life and Health Insurance........... 103.5 51 107.4 66 3.9 4
--------- --- --------- --- ---------- ---
Total................................... $ 201.2 100% $ 162.3 100% $ 90.7 100%
========= === ========= === ========== ===
Assets:
Individual Life and Disability Insurance.. $ 9,094.0 84% $ 8,682.1 82% $ 8,086.1 80%
Group Life and Health Insurance........... 1,682.2 16 1,886.9 18 1,984.7 20
--------- --- --------- --- ---------- ---
Total................................... $10,776.2 100% $10,569.0 100% $ 10,070.8 100%
========= === ========= === ========== ===
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
Individual Life and Disability Insurance
We began as an individual life insurer in 1879. Our U.S. operations served
approximately 758,000 individual policyholders with $84.5 billion of life
insurance in force as of December 31, 2001. Individual life and disability
insurance contributed 16%, 17% and 17% of our consolidated operating revenues
for the years ended December 31, 2001, 2000 and 1999, respectively.
We offer a wide array of individual life and disability insurance products aimed
at serving our customers' financial needs throughout their lives.
The following table shows selected U.S. GAAP financial information regarding our
individual insurance products for the years indicated:
23
Individual Life and Disability Insurance
Selected Product Highlights
As of or for the year ended
December 31,
----------------------------------
2001 2000 1999
---------- ---------- ----------
($ in millions)
Interest-sensitive life insurance:
Number of policies............................. 95,695 90,682 80,459
First-year premiums/Deposits................... $ 58.9 $ 65.0 $ 47.9
Premiums/Deposits.............................. 270.1 374.2 178.6
Future policy benefits/Policy account balance.. 1,748.4 1,567.6 1,237.2
Life insurance in force........................ 22,212.0 19,566.8 15,633.2
Traditional life insurance:
Number of policies............................. 591,797 609,326 632,551
First-year premiums/Deposits................... $ 27.3 $ 27.0 $ 32.2
Premiums/Deposits.............................. 766.2 772.8 780.8
Future policy benefits/Policy account balance.. 5,712.7 5,522.7 5,331.6
Life insurance in force........................ 62,308.5 60,389.0 59,581.1
Disability insurance:
Number of policies............................. 70,453 65,497 59,729
New sales (annualized first-year premium)...... $ 17.9 $ 17.2 $ 15.1
Premiums/Deposits.............................. 83.2 74.2 64.6
Future policy benefits/Policy account balance.. 381.5 338.9 262.6
Products and Services
Our individual life and disability insurance products include:
interest-sensitive life insurance, including universal life and variable
universal life; traditional life insurance and disability insurance.
Interest-Sensitive Life Insurance. Interest-sensitive life products include
universal life and variable universal life insurance and offer life insurance
protection for which both the premium and the death benefit may be adjusted by
the policyholder. Our growth in individual life and disability insurance sales
through December 31, 2001, has come mainly from variable universal life
insurance products. Variable universal life insurance products represented 65%
of our interest-sensitive life insurance premiums for the year ended December
31, 2001. We credit premiums, net of specified expenses, to an account
maintained for the policyholder. Specific charges are made against the account
for the cost of insurance protection and expenses. For universal life contracts,
the entire account balance is invested in our general account. Interest is
credited to the policyholder's account based on the earnings on general account
investments. For variable universal life contracts, the policyholder may
allocate the account balance among our general account and a variety of separate
account choices. Interest is credited on amounts allocated to the general
account in the same manner as for universal life. Net investment performance on
separate account investments is allocated directly to the policyholder accounts.
The policyholder bears the investment risk on separate account investments. Our
profitability is based on charging sufficient asset-based, premium-based and
risk-based fees to cover the cost of insurance and expenses.
Traditional Life Insurance. Traditional life insurance includes participating
whole life, adjustable life products and term life insurance products.
Participating products and term life insurance products represented 15% and 4%,
respectively, of our individual life and disability insurance sales for the year
ended December 31, 2001. Adjustable life insurance products provide a guaranteed
benefit in return for the payment of a fixed premium and allow the policyholder
to change the premium and face amount combination. Participating policyholders
may receive policy dividends as declared by the board of directors of Principal
Life if the combined result of experience factors, including interest earnings,
mortality experience and expenses is better than the assumptions used in setting
the premium. Our profitability is based on keeping a portion of the favorable
experience before crediting the remainder to policyholders. Term insurance
products provide a guaranteed benefit for a specified period of time in return
for the payment of a fixed premium. Policy dividends are not paid on term
insurance. Our profitability is based on charging a premium that is sufficient
to cover the cost of insurance and expenses while providing us with an
appropriate return.
Disability Insurance. Individual disability insurance products provide a benefit
in the event of the disability of the insured. In most instances, this benefit
is in the form of a monthly income. Disability insurance products represented
11% of our individual life and disability insurance sales for the year ended
December 31, 2001. In addition to income replacement, we offer products to pay
business overhead expenses for a disabled business owner, and for the purchase
24
by the other business owners of the disabled business owner's interests in the
business. Our profitability is based on charging a premium that is sufficient to
cover claims and expenses while providing us with an appropriate return.
Markets and Distribution
We sell our individual products in all 50 states and the District of Columbia.
Our target market is owners and executives of small and medium-sized businesses,
as well as other individuals. Cash value life insurance provides valuable
benefits at death and funding for needs prior to death, including funding
employee benefit liabilities, estate planning, business continuation or buy-out.
We design, market and administer our products to meet these needs. We have also
recently established a number of marketing and distribution alliances to
increase the sales of individual insurance products with firms such as AXA,
Highland Capital, AG Edwards, Wells Fargo, Piper Jaffrey, and BISYS. Variable
universal life insurance is popular for many reasons, including higher
historical performance of equity investments resulting in a lower cost of
insurance and an increase in values available while still alive. We also offer
products specifically designed to meet the estate planning needs of business
executives. Our individual disability products are also tailored to the needs of
this market. Small and medium-sized businesses, their owners and executives
represented 62% of individual life insurance sales and 47% of individual
disability sales for the year ended December 31, 2001, based on first-year
annualized premium.
We distribute our individual insurance products primarily through our affiliated
financial representatives and secondarily through independent brokers.
Affiliated financial representatives were responsible for 74% of individual life
insurance sales, based on first-year annualized premium for the year ended
December 31, 2001. We had 1,155 affiliated financial representatives in 49
offices as of December 31, 2001. Although they are independent contractors, we
have a close tie with affiliated financial representatives and offer them
benefits, training and access to tools and expertise. Independent brokers
represented a larger percentage of individual disability sales with 48% of
first-year annualized premium for the year ended December 31, 2001.
Group Life and Health Insurance
We began offering group insurance in 1941. We served approximately 79,000
employers and provided products and services to 4.7 million covered members as
of December 31, 2001. We were the 11th largest writer of group insurance in the
U.S. based on combined group life and health premium for 2000, according to the
2001 National Underwriter Life and Health Statistical Report. We offer a broad
array of group insurance products including medical, life, disability, dental
and vision insurance. In addition, we also offer administrative services on a
fee-for-service basis to large employers in the U.S.
The following tables show the premium and premium equivalents, reserves and the
incurred loss ratios for our group insurance products sold in the U.S. for the
years indicated:
25
Group Life and Health Insurance
Premium and Premium Equivalents
For the year ended December 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Life Insurance................... $ 221.8 $ 277.7 $ 273.6
Disability Insurance............. 98.2 94.5 86.8
Medical Insurance(1)............. 1,610.3 1,815.6 1,876.7
Dental and Vision Insurance...... 351.1 340.4 270.0
Fee-for-service.................. 1,828.2 1,502.2 1,287.6
--------- --------- ---------
Total.......................... $ 4,109.6 $ 4,030.4 $ 3,794.7
========= ========= =========
- --------------------
(1) Includes $98.4 million and $164.6 million of Medicare Supplement insurance,
for the years ended December 31, 2000 and 1999, respectively, all of which
we reinsured effective July 1, 2000.
Group Life and Health Insurance
Reserves and Incurred Loss Ratios
As of or for the year ended
December 31,
---------------------------
2001 2000 1999
------- ------- -------
($ in millions)
Reserves:
Life Insurance...................... $ 259.5 $ 259.5 $ 262.2
Disability Insurance................ 286.7 269.0 259.5
Medical Insurance(1)................ 292.8 316.5 396.7
Dental and Vision Insurance......... 26.1 28.2 23.8
------- ------- -------
Total Reserves................... $ 865.1 $ 873.2 $ 942.2
======= ======= =======
Incurred Loss Ratios:
Life Insurance...................... 71% 70% 71%
Disability Insurance................ 89 85 80
Medical Insurance................... 79 83 90
Dental and Vision Insurance......... 75 76 77
- --------------------
(1) Includes $43.0 million, $46.7 million and $68.2 million of Medicare
Supplement insurance, as of December 31, 2001, 2000 and 1999, respectively,
all of which we reinsured effective July 1, 2000.
Products and Services
Our U.S. group insurance products and services include - life insurance,
disability insurance, medical insurance, dental and vision insurance and
fee-for-service.
Group Life Insurance. Group life insurance provides coverage to employees and
their dependents for a specified period. As of December 31, 2001, we had $70.3
billion of group life insurance in force covering 2.6 million individuals. We
carry both traditional group life insurance that does not provide for
accumulation of cash values and interest-sensitive group life insurance,
commonly known as group universal life, which provides for accumulation of cash
values. Our group life insurance business remains focused on the traditional
annually renewable term product. Group term life and group universal life
accounted for 90% and 10%, respectively, of our total group life insurance in
force as of December 31, 2001. According to the 2000 LIMRA International, Inc.
Sales and In Force Reports, we were ranked first in the U.S. in terms of the
number of contracts/employer groups for both sales and existing business in
2000.
Group Disability Insurance. Group disability insurance provides partial
replacement of earnings to insured employees who become disabled. Our group
26
disability products include both short-term and long-term disability. Long-term
disability represented 58% of our group disability premiums for the year ended
December 31, 2001. In addition, we provide disability management services, or
rehabilitation services, to assist individuals in returning to work as quickly
as possible following disability. We also work with disability claimants to
improve the approval rate of Social Security benefits, thereby reducing payment
of benefits by the amount of Social Security payments received. For claims
incurred more than two years prior to December 31, 2001, we achieved an 87%
approval rate for such Social Security benefits. Our group disability business
was ranked seventh in the U.S. as of December 31, 2000, in terms of number of
contracts/employer groups in force, according to the 2000 LIMRA International,
Inc. Sales and In Force Reports.
Group Medical Insurance. Group medical insurance provides partial reimbursement
of medical expenses for insured employees and their dependents. Employees are
responsible for deductibles, co-payments and co-insurance. We believe our
products are well-positioned to address our customers' preference for a variety
of provider choices and preferred provider discounts. We do not offer
unrestricted indemnity and no longer offer the pure HMO model. As of January 1,
2002, we entered into a reinsurance agreement to reduce the volatility of our
group medical insurance earnings.
Group Dental and Vision Insurance. Group dental and vision insurance plans
provide partial reimbursement for dental and vision expenses. As of December 31,
2001, we had over 35,000 group dental and vision insurance plans in force. As of
December 31, 2000, we were the largest group indemnity dental insurer in terms
of 2000 sales based on total indemnity, and the largest in terms of number of
contracts/employer groups in force in 2000 based on total indemnity, according
to the 2000 LIMRA International, Inc. Sales and In Force Reports.
Fee-For-Service. We offer administration of group disability, medical, dental
and vision services on a fee basis to larger employers.
Markets and Distribution
We market our group life, disability, medical, dental and vision insurance
products to small and medium-sized businesses to complement our retirement
services and individual insurance products. We market our fee-for-service
administration capabilities to larger employers that self-insure their
employees' health insurance benefits.
We sell our group life, disability, dental and vision coverages in all 50 states
and the District of Columbia. We have chosen to market our medical insurance in
36 states which we believe have attractive market conditions. We consider a
market to be attractive if there is a lack of deep penetration by HMOs and a
favorable regulatory environment. We continually adapt our products and pricing
to meet local market conditions.
We distribute our group insurance products through independent benefit brokers,
consultants, financial planners and the same channels that sell our U.S. asset
accumulation products. To reach these independent benefit brokers, consultants
and financial planners, we employ three types of wholesale distributors - our
medical sales representatives, our non-medical sales representatives and an
independent wholesale organization, Rogers Benefit Group, dedicated to marketing
group life, health and disability insurance products. An additional way we reach
brokers is through our relationships with AON, Lockton, and Brown & Brown.
As of December 31, 2001, we had 112 medical and non-medical sales
representatives and 38 service representatives in 53 offices. Our medical and
non-medical sales representatives accounted for 64%, 60% and 64% of our group
insurance sales for the years ended December 31, 2001, 2000 and 1999,
respectively. These representatives act as a unique combination of wholesalers
and brokers. They are an integral part of the sales process alongside the agent
or independent broker. In addition to a high level of involvement in the sales
process, the group sales force plays a key role in the ongoing servicing of the
case by: providing local, responsive services to our customers, such as renewing
contracts, revising plans and solving any administrative issues; communicating
the customers' needs and feedback to us; and helping employees understand the
benefits of their plan. Compensation for the group sales force is a blend of
salary and production-based incentives.
Rogers Benefit Group is a marketing and service organization that represents
major high quality insurance carriers specializing in individual and group
medical programs, and group life, disability and dental plans. Our relationship
with Rogers Benefit Group dates back to its creation in 1970. It accounted for
36%, 40% and 36% of our group insurance sales for the years ended December 31,
2001, 2000 and 1999, respectively.
27
Mortgage Banking Segment
We began our residential lending activities in 1936. Our Mortgage Banking
segment is primarily engaged in residential loan production and loan servicing
in the U.S. Through our wholly-owned subsidiary, Principal Residential Mortgage,
Inc., ("PRMI"), we originate, purchase, sell and service mortgage loans. We
principally originate "A" quality home mortgages and do not originate subprime
mortgages to any material degree, nor do we service or purchase any subprime
mortgage loans. "A" quality loans are generally defined as loans eligible for
sale to the Federal National Mortgage Association, ("Fannie Mae"), Federal Home
Loan Mortgage Corporation, ("Freddie Mac") and the Government National Mortgage
Association, ("Ginnie Mae"). According to Inside Mortgage Finance, based on the
unpaid balance of $80.5 billion in mortgage loans in its servicing block, PRMI
was ranked as the thirteenth largest mortgage servicer in the U.S. as of
December 31, 2001, and was ranked twelfth in production with
$37.8 billion of new loans for the year ended December 31, 2001.
Our Mortgage Banking segment contributed 8%, 4% and 5% of our total operating
revenues and 18%, 8% and 12% of our total operating earnings for the years ended
December 31, 2001, 2000 and 1999, respectively. The following table shows
operating revenues, operating earnings and assets of our Mortgage Banking
segment by loan servicing and loan production for the years indicated:
Mortgage Banking
Selected Financial Highlights
As of or for the year ended December 31,
----------------------------------------------
2001 2000 1999
-------------- -------------- --------------
($ in millions)
Operating Revenues(1):
Loan Servicing............... $ 403.0 53% $ 313.8 87% $ 286.5 72%
Loan Production.............. 354.4 47 46.0 13 111.8 28
-------- --- -------- --- -------- ---
Total...................... $ 757.4 100% $ 359.8 100% $ 398.3 100%
======== === ======== === ======== ===
Operating Earnings (Loss):
Loan Servicing............... $ (4.7) N/A $ 63.9 N/A $ 29.3 52%
Loan Production.............. 131.4 N/A (13.9) N/A 27.5 48
-------- --- -------- --- -------- ---
Total...................... $ 126.7 N/A $ 50.0 N/A $ 56.8 100%
======== === ======== === ======== ===
Assets:
Total...................... $2,718.8 100% $1,556.3 100% $1,737.7 100%
======== === ======== === ======== ===
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
Loan Production
Our loan production strategy is to manage our four distribution channels,
correspondent lending, retail origination, wholesale lending and Mortgage
Direct, in a manner that is consistent with our loan servicing strategy. We
obtain new customers through each of our four distribution channels, with the
majority being obtained through our correspondent lending and wholesale lending
operations. Our Mortgage Direct operation, which is primarily involved with the
retention of current servicing portfolio customers, refinances current loans and
makes new loans to customers on new properties they purchase.
We originate and purchase conventional mortgage loans, mortgage loans insured by
the Federal Housing Administration, ("FHA"), and mortgage loans partially
guaranteed by the Department of Veterans Affairs, ("VA"). A majority of our
conventional loans are conforming loans that qualify for inclusion in guarantee
programs sponsored by Fannie Mae or Freddie Mac. The remainder of the
conventional loans are non-conforming loans, such as jumbo loans with an
original balance in excess of $300,700 or other loans that do not meet Fannie
Mae or Freddie Mac guidelines. We neither originate nor purchase "B" or "C"
mortgages, defined as lower credit quality loans. However, we are beginning to
originate or purchase "A-" quality residential loans that are eligible for sale
to Fannie Mae or Freddie Mac. We believe this segment presents opportunities to
further penetrate the expanding U.S. housing market without presenting the types
of risks inherent in the subprime sector.
28
The following table shows our loan production by loan type for the years
indicated:
Mortgage Banking
Loan Production by Loan Type
For the year ended December 31,
-------------------------------------
2001 2000 1999
----------- ----------- -----------
($ in millions)
Conventional Loans:
Number of loans................... 190,382 35,418 56,731
Volume of loans .................. $ 27,717.4 $ 4,969.1 $ 7,307.4
Percent of total volume........... 73% 60% 55%
FHA/VA Loans:
Number of loans................... 85,207 31,093 57,592
Volume of loans................... $ 10,053.9 $ 3,342.7 $ 5,999.9
Percent of total volume........... 27% 40% 45%
Total Loans:
Number of loans................... 275,589 66,511 114,323
Volume of loans................... $ 37,771.3 $ 8,311.8 $ 13,307.3
Average loan amount
($ in thousands).................. $ 137.1 $ 125.0 $ 116.4
The following table shows our loan production by purpose and by interest rate
type for the years indicated:
Mortgage Banking
Loan Production by Purpose and Interest Rate Type
For the year ended December 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Purchase............. $ 17,047.2 $ 6,930.1 $ 9,106.8
Refinance............ 20,724.1 1,381.7 4,200.5
---------- ---------- ----------
Total.............. $ 37,771.3 $ 8,311.8 $ 13,307.3
========== ========== ==========
Fixed Rate........... $ 37,021.2 $ 7,400.7 $ 12,449.4
Adjustable Rate...... 378.2 854.1 683.8
Balloon.............. 371.9 57.0 174.1
---------- ---------- ----------
Total.............. $ 37,771.3 $ 8,311.8 $ 13,307.3
========== ========== ==========
We are actively engaged in the loan production business via the following
distribution channels: correspondent lending; retail origination; wholesale and
Mortgage Direct.
The following table shows our loan production by distribution channel for the
years indicated:
29
Mortgage Banking
Loan Production by Distribution Channel
For the year ended December 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Volume of Loans:
Correspondent Lending......... $ 28,471.5 $ 6,378.6 $ 10,545.4
Retail Origination............ 2,393.6 734.4 1,088.8
Wholesale..................... 6,213.8 1,079.7 1,247.1
Mortgage Direct............... 692.4 119.1 426.0
---------- ---------- ----------
Total....................... $ 37,771.3 $ 8,311.8 $ 13,307.3
========== ========== ==========
Correspondent Lending. As of December 31, 2001, we had contracts with 517
lending institutions across the U.S. to purchase prime credit quality loans on
an ongoing basis. According to Inside Mortgage Finance, as of December 31, 2001,
we were the sixth largest correspondent lender in the U.S. High quality
financial institutions are approved to do business with us only after we review
their reputation, financial strength and lending expertise. Our "Correspondent
Lending Service Center" on the Internet currently offers online access to loan
registration, an interactive sellers' procedure manual, seller-specific
rate/price quotations and simplified contact information. We are developing
online technologies to offer automated underwriting systems, pipeline reporting
and account management tools and electronic business-to-business capabilities
for our correspondent sellers. Additionally, we are forging numerous alliances
with third-party service providers to further streamline processes, improve
productivity and provide outstanding customer service.
Retail Origination. Our retail channel originates prime credit quality mortgages
through referrals from real estate agents, builders and personal contact with
consumers through our nationwide network, which was comprised of 258 mortgage
loan officers located in 60 offices as of December 31, 2001. We are developing
automated exchange service agreements which will allow retail loan officers to
establish reciprocal agreements with partners including realtors, builders,
attorneys, title companies and others to and from our Internet website. This
will enable us to build better relationships with such partners by providing
access to relevant information via the Internet for their convenience.
Wholesale. Our wholesale channel, which we acquired in 1998, originates or
purchases prime credit quality loans through 13 regional offices that worked
directly with 1,964 participating mortgage loan brokers across the U.S. as of
December 31, 2001. Mortgage loan brokers are approved only after a review of
their reputation and mortgage lending expertise and financials. Through the
"Wholesale Lending Service Center" on our Internet website, wholesale lenders
can retrieve contact information and seller specific interest rate quotations.
We have developed plans and are working to provide online registration,
automated underwriting system, pipeline reporting and account management
services to our brokers. We are also developing electronic document delivery and
execution capabilities for wholesale sellers to exchange secure documents with
wholesale purchasers.
Mortgage Direct. Our Mortgage Direct channel originates prime credit quality
mortgage loans through direct contact with current and new customers via
telephone and the Internet. The goal of our Internet channel is to give our
current customers access to a customer-focused website, allowing them to obtain
home financing quickly, confidently and at an attractive value, while preserving
acceptable profit margins for us. We believe that providing current customers
with choice, ease of access, convenient processes and simplified procedures will
cause a growing percentage of our customers to choose us for all of their home
financing needs.
Loan Underwriting
Our guidelines for underwriting conventional conforming loans comply with the
underwriting criteria employed by Fannie Mae and Freddie Mac. Our guidelines for
underwriting FHA-insured and VA-guaranteed loans comply with the criteria
established by those government entities. Our underwriting guidelines and
property standards for conventional non-conforming loans are based on the
underwriting standards employed by private investors for such loans. In
addition, conventional loans having a loan-to-value ratio greater than 80% at
origination, which are originated or purchased by us, are required to have
private mortgage insurance. Insurance is either paid by the borrower or the
lender. Our underwriting standards generally allow loan-to-value at origination
of up to 97% for mortgage loans with an original principal balance of up to
$300,700. To determine whether a prospective borrower has sufficient monthly
30
income available to meet: (1) the borrower's monthly obligation on the proposed
mortgage loan and (2) monthly housing expenses and other financial obligations,
we generally use the guidelines, techniques and technology tools provided by our
investors.
Sale of Loans
As a mortgage banker, substantially all loans we originate or purchase are sold
without recourse, subject in the case of VA loans to the limits of the VA's
guaranty. Conforming conventional loans are generally pooled by us and exchanged
for securities guaranteed by Fannie Mae or Freddie Mac. These securities are
then sold to national or regional broker-dealers. Substantially all conventional
loans securitized through Fannie Mae or Freddie Mac are sold, subject to
representations and warranties made by us on a non-recourse basis, whereby
foreclosure losses are generally a liability of Fannie Mae or Freddie Mac.
Substantially all of our FHA-insured and VA-guaranteed mortgage loans sold are
securitized through Ginnie Mae. The FHA insures us against foreclosure loss and
the VA provides partial guarantees against foreclosure loss. To guarantee timely
and full payment of principal and interest on Fannie Mae, Freddie Mac and Ginnie
Mae securities, we pay guarantee fees to these agencies.
Loan Servicing
We service residential mortgages in return for a servicing fee. Our servicing
division receives and processes mortgage payments for home owners, remits
payments to investors and others, holds escrow funds, contacts delinquent
borrowers, supervises foreclosures and property dispositions and performs other
miscellaneous duties related to loan administration. We acquire only "A" or "A-"
quality home mortgages for servicing. This practice simplifies the systems
necessary for servicing and reduces the amount of time and money spent on
collections and foreclosure administration activities. Our goal is to service,
on a non-recourse basis, a majority of the loans that we originate. In addition,
we periodically purchase bulk-servicing contracts, also on a non-recourse basis
to us, on prime quality mortgage loans originated by other lenders. Our bulk
purchases focus primarily on the acquisition of agency servicing packages.
Factors which influence the management of the servicing portfolio include the
expected long-term and short-term profitability of the servicing rights,
customer retention objectives and the potential cross-selling of retirement
investments and insurance and other products to home owners. Servicing contracts
acquired through bulk purchases accounted for 23% of our mortgage servicing
portfolio as of December 31, 2001.
The following table shows the composition of our servicing portfolio by type and
performance for the years indicated:
Mortgage Banking
Composition of Servicing Portfolio by Type and Performance
As of December 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
($ in millions)
Conventional Mortgage Loans............... $55,525.9 $34,396.3 $30,679.4
FHA-Insured Mortgage Loans................ 18,523.6 15,463.8 15,028.8
VA-Guaranteed Mortgage Loans.............. 6,481.0 6,127.3 6,167.3
--------- --------- ---------
Total Servicing Portfolio............ $80,530.5 $55,987.4 $51,875.5
========= ========= =========
Delinquent Mortgage Loans and
Pending Foreclosures at Period End(1):
30 Days................................. 3.8% 4.4% 3.4%
60 Days................................. 1.0 1.2 1.1
90 Days or more......................... 0.4 0.5 0.5
--------- --------- ---------
Total Delinquencies.................. 5.2% 6.1% 5.0
========= ========= =========
Foreclosures Pending...................... 1.0% 1.3% 1.1%
- --------------------
(1) Expressed as a percentage of the total number of loans serviced excluding
sub-serviced loans.
The following table shows the composition of our servicing portfolio by interest
rate as of December 31, 2001:
31
Mortgage Banking
Servicing Portfolio by Interest Rate
As of December 31, 2001
Average Maturity
Interest Rate Principal Percentage of Total (Years)
- ----------------------- ---------- ------------------- ----------------
($ in millions)
7% and under........... $ 46,554.3 58% 24.8
7.01 - 8%.............. 29,521.5 37 26.4
8.01 - 9%.............. 4,218.1 5 24.9
9.01 - 10%............. 201.2 - 18.0
Over 10%............... 35.4 - 12.2
---------- -------------------
Total................ $ 80,530.5 100% 25.4
========== ===================
The weighted-average interest rate in our servicing portfolio as of December 31,
2001 was 7.09%. As of December 31, 2001, fixed rate loans comprised 97% of the
servicing portfolio and the weighted-average interest rate of the fixed-rate
loans was 7.09%.
Risk Management
Because mortgage lending is subject to asset valuation risk associated with
changes in interest rates, we manage and hedge our servicing assets and our "in
process" mortgage loan production pipeline. Using a balanced blend of
proprietary analytical models and purchased interest rate risk management tools,
we have developed a risk management protocol designed to reduce volatility.
We use derivatives, such as interest rate swaps and floors, principal-only
swaps, Treasury futures contracts and options on Treasury futures contracts to
hedge a portion of our portfolio of mortgage servicing rights from prepayment
risk associated with changes in interest rates. To further minimize our exposure
to interest rate fluctuations, we seek a balance between loan servicing and loan
production, which are counter cyclical in nature. Historically, during periods
of low interest rates and the resulting increase in refinancings, revenue
generated by mortgage originations generally offsets revenue loss related to
prepayment of mortgages for which we provide servicing.
In the normal course of business, our Mortgage Banking segment protects its
position in mortgages by taking positions in the options, futures and cash
markets. We hedge in the cash market by entering into forward delivery
contracts, which require us to deliver loans or mortgage-backed securities at a
future date at a preset price. All risk management activity is reviewed and
approved by a committee of Principal Residential Mortgage Inc. senior
management.
Seasonality
The mortgage banking industry is generally subject to seasonal trends. These
trends reflect the general national pattern of selling and reselling of homes,
although refinancings tend to be less seasonal and more closely related to
changes in interest rates. This activity typically peaks during the spring and
summer seasons and declines to lower levels from mid-November through February.
Corporate and Other Segment
Our Corporate and Other segment holds the assets in excess of those needed by
the four operating segments. These assets are primarily comprised of fixed
income securities, common stock and real estate investments. All long-term debt
and inter-segment eliminations are included in this segment.
Our Corporate and Other segment generated 1%, 1% and 1% of our total operating
revenues and 5%, 10% and 2% in total operating earnings for the years ended
December 31, 2001, 2000 and 1999, respectively.
The following table shows operating revenues, operating earnings and assets for
our Corporate and Other segment for the years indicated:
32
Corporate and Other
Selected Financial Highlights
As of or for the year ended
December 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Operating Revenues(1):.... $ 100.8 $ 97.1 $ 61.9
========= ========= =========
Operating Earnings:....... $ 38.1 $ 67.7 $ 9.5
========= ========= =========
Assets:................... $ 1,354.8 $ 957.8 $ 1,121.5
========= ========= =========
- --------------------
(1) Total revenues, excluding net realized capital gains (losses) and their
impact on recognition of front-end fee revenues and certain market value
adjustment to fee revenues.
Competition
Competition in our operating segments is based on a number of factors, including
service, product features, price, investment performance, commission structure,
distribution capacity, financial strength ratings and name recognition. We
compete for customers and distributors with a large number of financial services
companies such as banks, mutual funds, broker-dealers, insurers and asset
managers. Some of these companies offer a broader array of products, more
competitive pricing, greater diversity of distribution sources, better brand
recognition or, with respect to insurers, higher financial strength ratings.
Some may also have greater financial resources with which to compete or may have
better investment performance at various times.
Competition in the retirement services market is very fragmented. Our main
competitors in this market include Fidelity, Nationwide, AXA, Mass Mutual and
Manulife. We believe the infrastructure and system support needed to meet the
needs of the small and medium-sized business market is a significant barrier to
entry for our competitors. Many of our competitors in the mutual fund industry
are larger, have been established for a longer period of time, offer less
expensive products, have deeper penetration in key distribution channels and
have more resources than we do. There were over 8,171 mutual funds in the U.S.
as of December 31, 2000, according to the Investment Company Institute 2001
Mutual Fund Fact Book. The institutional asset management market has grown at a
rapid pace over the last decade. Our primary competitors in this market are
large institutional asset management firms, such as J.P. Morgan Chase, Morgan
Stanley Asset Management and T. Rowe Price, many of which offer a broader array
of investment products and services and are better known. The asset management
business has relatively few barriers to entry and continually attracts new
entrants. The variable annuity market is also highly competitive. As we expand
into additional distribution channels for this product, we will face strong
competition from Nationwide and Hartford. Competition in the international
markets in which we operate comes primarily from local financial services firms
and other international companies operating on a stand-alone basis or in a
partnership with local firms, including ING, AXA, Allianz and AIG. In the highly
competitive life and health insurance business, our competitors include other
insurers such as UNUM, Guardian, The Northwestern Mutual Life Insurance Company,
Manulife, Blue Cross and Blue Shield organizations, and health maintenance
organizations such as United HealthCare and Aetna. The mortgage banking industry
is also highly competitive and fragmented and we compete with other mortgage
bankers, commercial banks, savings and loan associations, credit unions and
insurance companies such as Countrywide and Wells Fargo.
We believe we distinguish ourselves from our competitors through our:
o full-service platform;
o strong customer relationships;
o focus on financial performance; and
o performance-oriented culture.
On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley
Act of 1999, implementing fundamental changes in the regulation of the financial
services industry in the U.S. The Act permits mergers that combine commercial
banks, insurers and securities firms under one holding company. Under the Act,
national banks retain their existing ability to sell insurance products in some
circumstances. In addition, bank holding companies that qualify and elect to be
33
treated as "financial holding companies" may engage in activities, and acquire
companies engaged in activities, that are "financial" in nature or "incidental"
or "complementary" to such financial activities. This includes acting as
principal, agent or broker in selling life, property and casualty and other
forms of insurance, including annuities. A financial holding company can own any
kind of insurance company or insurance broker or agent, but its bank subsidiary
cannot own the insurance company. Under state law, the financial holding company
would need to apply to the insurance commissioner in the insurer's state of
domicile for prior approval of the acquisition of the insurer. With the passage
of the Gramm-Leach-Bliley Act, among other things, bank holding companies may
acquire insurers, and insurance holding companies may acquire banks. The ability
of banks to affiliate with insurance companies in the U.S. may materially
adversely affect all of our product lines by substantially increasing the
number, size and financial strength of potential competitors.
Employees
As of December 31, 2001, we had 17,138 employees. None of our employees is
subject to collective bargaining agreements governing employment with us. We
believe that our employee relations are satisfactory.
Item 2. Properties
We own 26 properties in our home office complex in Des Moines, Iowa and in
various other locations. We occupy approximately 94% of the 4.29 million gross
square feet of space in these buildings. The balance of the space in these
buildings is rented to commercial tenants. We lease office space for various
offices located throughout the U.S. and internationally. We believe that our
owned and leased properties are suitable and adequate for our current business
operations.
Item 3. Legal Proceedings
We are regularly involved in litigation, both as a defendant and as a plaintiff
but primarily as a defendant. Litigation naming us as a defendant ordinarily
arises out of our business operations as a provider of medical insurance, life
insurance, annuities and residential mortgages. In addition, regulatory bodies,
such as state insurance departments, the SEC, the National Association of
Securities Dealers, Inc., the Department of Labor and other regulatory bodies
regularly make inquiries and conduct examinations or investigations concerning
our compliance with, among other things, insurance laws, securities laws, ERISA
and laws governing the activities of broker-dealers.
Recently, companies in the life insurance business have faced extensive claims,
including class-action lawsuits, alleging improper life insurance sales
practices. Principal Life is currently a defendant in two purported class-action
lawsuits alleging improper sales practices. We have reached an agreement in
principle to settle both of those lawsuits. The settlement has received court
approval. We have established reserves at a level we believe sufficient to cover
the cost of the settlement. A number of persons and entities who were eligible
to be class members have excluded themselves from the class (or "opted out"), as
the law permits them to do. Some of those class members have filed lawsuits and
we have been notified that others who opted out from the class will file
lawsuits and make claims similar to those addressed by the settlement. Similar
opt-out lawsuits have been brought against other life insurance companies as a
result of settlement of similar class-action lawsuits. Defense of these lawsuits
may cause us to incur significant costs. At this time, we are not able to
estimate the number of such lawsuits that may be filed, the costs of defending
the lawsuits or whether our defense will be successful.
A lawsuit was filed on September 27, 2001, in the United States District Court
for the Northern District of Illinois, seeking damages and other relief on
behalf of a putative class of policyholders based on allegations that the plan
of conversion of Principal Mutual Holding Company from a mutual insurance
holding company into a stock company violates the United States Constitution.
The action is captioned Esther L. Gayman v. Principal Mutual Holding Company, et
al. We believe there are meritorious defenses to the plaintiff's claims and we
intend to vigorously contest all of the plaintiff's claims. We are not presently
aware of any other lawsuits challenging the plan of conversion. There can be no
assurance, however, that additional lawsuits will not be commenced.
While we cannot predict the outcome of any pending or future litigation,
examination or investigation, we do not believe any pending matter will have a
material adverse effect on our business, financial condition or results of
operations.
34
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders of Principal Financial
Group, Inc. during the fourth quarter of the fiscal year covered by this report.
Executive Officers of the Registrant
The following information is furnished with respect to each of the executive
officers of the Company, each of whom is elected by and serves at the
pleasure of the Board of Directors.
J. Barry Griswell, 53, has been Chairman, President and Chief Executive Officer
of the Company and Principal Life Insurance Company since January 1, 2002, a
director of the Company since April 24, 2001, and a Principal Life director
since March 1998. Prior thereto, he had been President and Chief Executive
Officer of the Company since April 25, 2001, and President and Chief Executive
Officer of Principal Life since January 2000. Prior to January 2000, Mr.
Griswell held the following positions with Principal Life: President from
1998-2000 and Executive Vice President from 1996-1998. He is a Chartered Life
Underwriter, a Chartered Financial Consultant and a LIMRA Leadership Institute
Fellow. He is Chair of the Executive and Board-Management Committees of the
Company.
David J. Drury, 57, has been a director of the Company since April 24, 2001, and
a Principal Life director since 1993. He will retire from Principal Life on
March 31, 2002, and was Chairman of the Company and Principal Life until
December 31, 2001. Prior to December 31, 2001, he was Chairman of the Company
since April 25, 2001, and Chairman of Principal Life since January 2000. Prior
to 2000, Mr. Drury was Chairman and Chief Executive Officer of Principal Life
from 1995 to 1999. He is a Fellow of the Society of Actuaries and a member of
the American Academy of Actuaries. He is a member of the Executive Committee of
the board of directors of the Company.
John E. Aschenbrenner, 52, who heads the Life and Health Insurance and Mortgage
Banking segments of our operations has been Executive Vice President of the
Company since April 25, 2001, and Executive Vice President of Principal Life
since January 2000. From 1996-1999, he was Senior Vice President of Principal
Life. Mr. Aschenbrenner serves as a director of the 28 mutual funds that
comprise the Principal Family of Mutual Funds.
Michael T. Daley, 45, who heads Marketing and Distribution has been Executive
Vice President of the Company since April 25, 2001, and Executive Vice President
of Principal Life since June 2000. From 1997-2000, he was Senior Vice President
of CIGNA Retirement and Investment Services and from 1992-1997, he was Managing
Director of Bankers Trust Company.
Dennis P. Francis, 58, has been Chief Executive Officer of Principal Capital
Management since 1999. He has been Senior Vice President of the Company since
April 25, 2001, and Senior Vice President and Chief Investment Officer of
Principal Life since 1998. From 1990-1997, he was Vice President--Commercial
Real Estate of Principal Life.
Michael H. Gersie, 53, has been Executive Vice President and Chief Financial
Officer of the Company since April 25, 2001, and Executive Vice President and
Chief Financial Officer of Principal Life since January 2000. From 1994-1999, he
was Senior Vice President of Principal Life.
Ellen Z. Lamale, 48, has been Senior Vice President and Chief Actuary of the
Company since April 25, 2001, and Senior Vice President and Chief Actuary of
Principal Life since June 1999. From 1992-1999, she was Vice President and Chief
Actuary of Principal Life.
Mary A. O'Keefe, 45, who heads Corporate Relations and Human Resources has been
Senior Vice President of the Company since April 25, 2001, and Senior Vice
President of Principal Life since January 1998. From 1994-1997, she was Vice
President--Corporate Relations of Principal Life.
Karen E. Shaff, 47, has been Senior Vice President and General Counsel of the
Company since April 25, 2001, and Senior Vice President and General Counsel of
Principal Life since January 2000. From June 1999-December 1999, she was Senior
Vice President and Deputy General Counsel of Principal Life, and from 1995-May
1999, she was Vice President and Associate General Counsel of Principal Life.
She is a director of HealthExtras, Inc., a provider of health and disability
insurance.
35
Norman R. Sorensen, 56, has been President of Principal International, Inc.
since 1998 and has been Senior Vice President of Principal Financial Group, Inc.
since April 25, 2001, and Senior Vice President of Principal Life since December
1998. From 1989-November 1998, he was Vice President and Senior Executive--Latin
America, American International Group.
Carl C. Williams, 64, has been Senior Vice President and Chief Information
Officer of Principal Financial Group, Inc. since April 25, 2001, and Senior Vice
President and Chief Information Officer of Principal Life since July 1997. From
1993-1997, he was Vice President--Information Technology of Amoco Oil.
Larry D. Zimpleman, 50, has been the head of our U. S. Asset Accumulation
business since February 2002, and Executive Vice President of the Company and
Principal Life since August 25, 2001. Prior to his current position, Mr.
Zimpleman was Senior Vice President of Principal Life from June 1999-August
2001, Vice President from 1998-1999 and Vice President--Pension from 1994-1998.
Mr. Zimpleman serves as Chairman of the Board and a director of the 28 mutual
funds that comprise the Principal Family of Mutual Funds.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock began trading on the New York Stock Exchange ("NYSE") under the
symbol "PFG" on October 23, 2001. The high and low closing prices for our common
stock on the NYSE for the period from October 23 to December 31, 2001 were
$24.75 and $20.40, respectively. On March 8, 2002, there were approximately
635,001 stockholders of record of our common stock.
Future dividend decisions will be based on and affected by a number of factors,
including the operating results and financial requirements of the company and
the impact of regulatory restrictions. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" for a discussion of regulatory restrictions on Principal
Life's ability to pay us dividends.
The effective date of our registration statement on Form S-1, as amended (File
No. 333-62558), relating to the IPO of our common stock was October 22, 2001. A
total of 100.0 million shares of our common stock were sold to an underwriting
syndicate on October 23, 2001. In addition, the underwriters exercised their
over-allotment options to purchase an additional 15.0 million shares, effective
November 9, 2001. The lead managing underwriters for the U.S. offering were
Goldman, Sachs & Co., Credit Suisse First Boston Corporation, Merrill Lynch,
Pierce, Fenner & Smith Incorporated, Salomon Smith Barney Inc., Banc of America
Securities LLC, Bear, Stearns & Co. Inc., A.G. Edwards & Sons, Inc., Fox-Pitt,
Kelton Inc., J.P. Morgan Securities Inc., Lehman Brothers Inc., Samuel A.
Ramirez & Company, Inc., and UBS Warburg LLC. ABN AMRO Rothschild, BNP Paribas,
Commerzbank Aktiengesellschaft and Credit Lyonnais also served as underwriters
for the international offering.
The IPO commenced on October 23, 2001, at a price of $18.50 per share and
terminated upon the sale of all of the 115.0 million shares of common stock that
were registered (including 15.0 million shares sold pursuant to the
underwriters' over-allotment options). The IPO resulted in gross proceeds of
$2,127.5 million, including $277.5 million of gross proceeds attributable to the
underwriters' exercise of the over-allotment options. We incurred total offering
expenses of $108.6 million, including $92.6 million of underwriting discounts
and commissions, and $16.0 million of other expenses. We recognized a related
tax benefit of $0.4 million. Net proceeds equaled $2,019.3 million, of which
$329.6 million was retained by Principal Financial Group, Inc. for working
capital, payment of dividends, and other general corporate purposes, and
$1,689.7 million was contributed to Principal Life Insurance Company principally
to fund demutualization compensation to policyholders in the form of policy
credits and cash, and to cover certain expenses related to the demutualization.
In connection with the IPO, we did not make any payments, directly or
indirectly, to any of our directors or officers, or, to our knowledge, any of
their associates, other than as demutualization compensation payable to
policyholders pursuant to the plan of conversion, or to any person owning ten
percent or more of any class of our equity securities, or (except as set forth
in the preceding sentence) to any of our affiliates.
36
In addition to the shares of our common stock distributed in the IPO, many
policyholders entitled to receive compensation in the demutualization received
shares of our common stock distributed in connection with the demutualization,
as well as cash or policy credits as compensation for extinguishment of their
membership interests in Principal Mutual Holding Company. Shares received by
policyholders as demutualization compensation are exempt from registration
pursuant to Section 3(a)(10) of the Securities Act of 1933, as amended. None of
Principal Financial Group, Inc., Principal Financial Services, Inc. or Principal
Life received any proceeds from the issuance of our common stock to
policyholders entitled to receive compensation in the demutualization for the
extinguishment of their membership interests in Principal Mutual Holding Company
or to the policy credits separate account.
Item 6. Selected Financial Data
The following table sets forth certain selected historical consolidated
financial information of Principal Financial Group, Inc., the successor to
Principal Mutual Holding Company, following our demutualization effective
October 26, 2001. We derived the consolidated financial information for each of
the years ended December 31, 2001, 2000 and 1999 and as of December 31, 2001 and
2000 from our audited consolidated financial statements and notes to the
financial statements included in this Form 10-K. We derived the consolidated
financial information for the years ended December 31, 1998 and 1997 and as of
December 31, 1999, 1998 and 1997 from our audited consolidated financial
statements not included in this Form 10-K. The following summary consolidated
financial information, other than the Principal Life statutory data, has been
prepared in accordance with U.S. GAAP.
The following is a summary of financial information. In order to fully
understand our consolidated financial information, you should also read Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the notes to the
financial statements included in this Form 10-K. The results for past accounting
periods are not necessarily indicative of the results to be expected for any
future accounting period.
As of or for the year ended December 31,
---------------------------------------------------------
2001(2) 2000(2) 1999(2) 1998(2) 1997(2)
--------- --------- --------- --------- ---------
($ in millions, except per share data)
Income Statement Data(1):
Revenues:
Premiums and other considerations...... $4,122.3 $3,996.4 $3,937.6 $3,818.4 $4,667.8
Fees and other revenues................ 1,814.7 1,576.3 1,287.3 978.8 881.9
Net investment income.................. 3,394.5 3,172.3 3,072.0 2,933.9 2,936.6
Net realized capital gains (losses).... (514.0) 139.9 404.5 465.8 175.3
--------- --------- --------- --------- ---------
Total revenues..................... 8,817.5 8,884.9 8,701.4 8,196.9 8,661.6
Expenses:
Benefits, claims and settlement
expenses............................. 5,482.1 5,232.3 5,260.9 5,089.0 5,632.5
Dividends to policyholders............. 313.7 312.7 304.6 298.7 299.3
Operating expenses..................... 2,573.2 2,479.4 2,070.3 2,074.0 2,035.5
--------- --------- --------- --------- ---------
Total expenses..................... 8,369.0 8,024.4 7,635.8 7,461.7 7,967.3
--------- --------- --------- --------- ---------
Income before income taxes and
cumulative effect of
accounting change...................... 448.5 860.5 1,065.6 735.2 694.3
Income taxes.............................. 79.0 240.3 323.5 42.2 240.8
--------- --------- --------- --------- ---------
Income before cumulative effect of
accounting change...................... 369.5 620.2 742.1 693.0 453.5
Cumulative effect of accounting
change, net of related income taxes.... (10.7) - - - -
--------- --------- --------- --------- ---------
Net income................................ $ 358.8 $ 620.2 $ 742.1 $ 693.0 $ 453.5
========= ========= ========= ========= =========
37
As of or for the year ended December 31,
--------------------------------------------------------
2001(2) 2000(2) 1999(2) 1998(2) 1997(2)
--------- --------- --------- --------- ---------
($ in millions, except per share data)
Earnings per Share Data(3):
Income before cumulative effect of
accounting change per share:
Basic.................................. $ 1.02 N/A N/A N/A N/A
Diluted................................ $ 1.02 N/A N/A N/A N/A
Cumulative effect of accounting change
per share, net of related income taxes:
Basic.................................. $ (0.03) N/A N/A N/A N/A
Diluted................................ $ (0.03) N/A N/A N/A N/A
Net income per share:
Basic.................................. $ 0.99 N/A N/A N/A N/A
Diluted................................ $ 0.99 N/A N/A N/A N/A
Common shares outstanding at year-end
(in millions).......................... 360.1 N/A N/A N/A N/A
Weighted-average common shares
outstanding for the year (in millions). 362.4 N/A N/A N/A N/A
Weighted-average common shares and
potential common shares outstanding
for the year for computation of diluted
earnings per share (in millions)....... 362.4 N/A N/A N/A N/A
Cash dividends per share.................. - N/A N/A N/A N/A
Balance Sheet Data(1):
Invested assets........................... $44,772.9 $42,090.6 $41,343.2 $40,686.7 $39,572.2
Separate account assets(4)................ 35,864.8 34,916.2 34,992.3 29,009.3 23,560.1
All other assets.......................... 7,712.8 7,398.1 7,617.7 4,350.7 4,002.9
--------- --------- --------- --------- ---------
Total assets....................... $88,350.5 $84,404.9 $83,953.2 $74,046.7 $67,135.2
========= ========= ========= ========= =========
Policyholder liabilities.................. $39,308.1 $38,243.6 $37,808.9 $35,885.1 $35,306.1
Separate account liabilities.............. 35,864.8 34,916.2 34,992.3 29,009.3 23,560.1
Short-term debt........................... 511.6 459.5 547.3 290.9 313.7
Long-term debt............................ 1,378.4 1,336.5 1,492.9 670.9 458.9
All other liabilities..................... 4,467.3 3,196.6 3,558.9 2,523.3 2,212.2
--------- --------- --------- --------- ---------
Total liabilities.................. $81,530.2 $78,152.4 $78,400.3 $68,379.5 $61,851.0
========= ========= ========= ========= =========
Common stock(5)........................... $ 3.8 $ - $ - $ - $ -
Additional paid-in capital(6)............. 7,072.5 - - - -
Retained earnings (deficit)(7)............ (29.1) 6,312.5 5,692.3 4,950.2 4,257.2
Accumulated other comprehensive
income (loss).......................... 147.5 (60.0) (139.4) 717.0 1,027.0
Treasury stock(8)......................... (374.4) - - - -
--------- --------- --------- --------- ---------
Total stockholders' equity......... $ 6,820.3 $ 6,252.5 $ 5,552.9 $ 5,667.2 $ 5,284.2
========= ========= ========= ========= =========
Principal Life Statutory Data(9):
Premiums and deposits(10)................. $ 4,743.9 $15,653.3 $15,709.8 $14,120.3 $12,710.9
Net income(11)............................ 415.0 912.6 713.7 511.4 432.2
Statutory capital and surplus(12)...... $ 3,483.8 $ 3,356.4 $ 3,151.9 $ 3,031.5 $ 2,811.1
Asset valuation reserve................ 767.4 919.8 953.8 966.9 1,087.9
--------- --------- --------- --------- ---------
Statutory capital and surplus
and asset valuation reserve... $ 4,251.2 $ 4,276.2 $ 4,105.7 $ 3,998.4 $ 3,899.0
========= ========= ========= ========= =========
38
As of or for the year ended December 31,
---------------------------------------------------------
2001(2) 2000(2) 1999(2) 1998(2) 1997(2)
--------- --------- --------- --------- ---------
($ in millions, except per share data)
Other Supplemental Data:
Net income................................ $ 358.8 $ 620.2 $ 742.1 $ 693.0 $ 453.5
Less:
Net realized capital gains (losses), as
adjusted(13)........................... (321.0) 93.1 266.9 320.7 111.4
Non-recurring items(14)................... (31.1) (101.0) - 104.8 -
--------- --------- --------- --------- ---------
Operating earnings................. $ 710.9 $ 628.1 $ 475.2 $ 267.5 $ 342.1
========= ========= ========= ========= =========
Operating return on average equity(15).... 10.9% 10.5% 8.9% 5.8% 8.5%
Total return on average equity(16)........ 5.5% 10.3% 13.9% 15.1% 11.3%
Operating earnings before amortization of
goodwill and other intangibles......... $ 751.3 $ 670.8 $ 492.0 $ 304.0 $ 352.0
Assets under management ($ in billions)... $ 120.2 $ 117.5 $ 116.6 $ 80.4 $ 72.1
Number of employees (actual).............. 17,138 17,473 17,129 15,970 17,637
- --------------------
(1) We have reclassified periods prior to December 31, 2001, to conform to the
presentation for that period.
(2) Our consolidated financial information was affected by the following
transactions that affect year-to-year comparability:
o On October 1, 2001, Spectrum Asset Management became an affiliate of
Principal Capital Management, LLC. The acquisition was accounted for using
the purchase method and the results of operations of the acquired business
have been included in the financial statements from the date of acquisition.
We included revenues of $0.8 million in 2001 in our consolidated results of
operations and $5.5 million of total assets as of December 31, 2001, in our
consolidated financial position.
o On September 25, 2001, we disposed of all the stock of PT Asuransi Jiwa
Principal Indonesia, our subsidiary in Indonesia. We currently have no
business operations in Indonesia. We received nominal proceeds, which
resulted in a realized capital loss of $6.7 million. Total assets of our
operations in Indonesia as of December 31, 2000, were $3.2 million. We
included nominal revenues and net loss from our operations in Indonesia in
our consolidated results of operations for the years ended December 31,
2001, 2000, 1999, 1998 and 1997.
o On February 15, 2001, we disposed of all of the stock of Principal
International Espana, S.A. de Seguros de Vida, our subsidiary in Spain, for
nominal proceeds, resulting in a net realized capital loss of $38.4 million,
or $21.0 million net of tax, ceasing our business operations in Spain. Total
assets of our operations in Spain as of December 31, 2000, were $222.7
million. We included revenues of $49.4 million, $51.7 million and $46.0
million in our results of operations for the years ended December 31, 2000,
1999 and 1998, respectively. We included a net loss of $1.2 million and net
income of $0.9 million and $2.8 million in our results of operations for the
years ended December 31, 2000, 1999 and 1998, respectively. We did not
include revenues or net income from our operations in Spain in our
consolidated results of operations for the year ended December 31, 2001.
o On August 31, 1999, we acquired the outstanding stock of several companies
affiliated with Bankers Trust Australia Group from Deutsche Bank AG at a
purchase price of $1.4 billion. We issued unsecured long-term debt of
$665.0 million to partially fund the acquisition. We report this debt and
related interest expense in our Corporate and Other segment. The acquired
companies now operate under the name BT Financial Group. We accounted for
the acquisition using the purchase method. We included the results of
operations of the acquired companies in our International Asset Management
and Accumulation segment and our consolidated financial statements from the
date of acquisition. We included revenues of $220.9 million, $285.5 million
and $116.5 million in our consolidated results of operations for the years
ended December 31, 2001, 2000 and 1999, respectively. We included net loss
of $14.8 million, net income of $6.5 million and net loss of $3.1 million
in our consolidated results of operations for the years ended December 31,
2001, 2000 and 1999, respectively. We accounted for the purchase price as
follows: $897.4 million of identifiable intangibles, consisting primarily
of management rights for the fund management business and the BT brand
39
name, $38.5 million of workforce intangibles and $408.6 million of
resulting goodwill, which are being amortized on a straight line basis over
40, 8 and 25 years, respectively.
o We acquired Compania de Seguros de Vida El Roble S.A., or El Roble, a
Chilean life insurance company, for a purchase price of $73.4 million in
July 1998. We included El Roble's financial results in our International
Asset Management and Accumulation segment. We combined the operations of our
existing Chilean life insurance affiliate with the operations of El Roble to
form Principal International de Chile. Our consolidated financial results
related to these companies' combined operations included: total revenues of
$217.4 million, $200.2 million, $178.1 million and $155.2 million for the
years ended December 31, 2001, 2000, 1999 and 1998, respectively; and net
income of $15.0 million, $10.2 million, $0.5 million and $17.0 million for
the years ended December 31, 2001, 2000, 1999 and 1998, respectively.
o In July 1998, we established our residential mortgage loan wholesale
distribution system, a new distribution channel, by acquiring ReliaStar
Mortgage Corporation for a purchase price of $18.6 million. We have
integrated the operations of ReliaStar Mortgage Corporation into Principal
Residential Mortgage, Inc., as part of our Mortgage Banking segment.
o Effective April 1, 1998, we transferred substantially all of our managed
care operations, to Coventry Corporation in exchange for a 42% non-majority
ownership position in the resulting entity, Coventry Health Care, Inc.
("Coventry"). Our net equity in the transferred managed care operations
had a carrying value of $170.0 million on April 1, 1998. We sold our
remaining managed care operations in 1998 for $20.5 million resulting in no
realized capital gain or loss. Prior to the transfer to Coventry, our
Corporate and Other segment included $266.7 million of managed care
revenues in our results for 1998. We report our investment in Coventry in
our Corporate and Other segment and account for it using the equity method.
Our share of Coventry's net income was $19.8 million, $20.0 million and
$19.1 million for the years ended December 31, 2001, 2000 and 1999,
respectively. Our share of Coventry's net loss was $9.8 million for the
year ended December 31, 1998. In September 2000, we sold a portion of our
equity ownership position, which reduced our ownership interest to
approximately 25% and resulted in a net realized capital gain of $13.9
million, net of tax. On November 30, 2001, we announced we had entered
into an agreement to sell our remaining stake of approximately 15.0 million
shares of Coventry common stock and a warrant, exercisable for
approximately 3.1 million shares of Coventry common stock. The transaction
was completed on February 1, 2002. The investment in Coventry was $146.0
million and $122.9 million as of December 31, 2001 and 2000, respectively.
(3) Earnings per share information for 2001 represents unaudited pro forma
earnings per common share for the year ended December 31, 2001. For
purposes of calculating pro forma per diluted share information,
weighted-average shares outstanding were used. For the period January 1,
2001 through October 25, 2001, we estimated 360.8 million common shares
were outstanding. This consists of 260.8 million shares issued to eligible
policyholders in our demutualization and the 100.0 million shares issued in
our initial public offering ("IPO") which closed on October 26, 2001. For
the period October 26, 2001 through December 31, 2001, actual shares
outstanding were used in the weighted-average share calculation.
(4) Separate account assets increased $1.3 billion at December 31, 2001,
primarily due to shares of the Principal Financial Group stock allocated to
a separate account, a result of our demutualization. Activity of the
separate account is reflected in both separate account assets and separate
account liabilities and does not impact our results of operations.
(5) During 2001, we issued 260.8 million shares of common stock as compensation
in the demutualization, 100.0 million shares of common stock in our IPO and
15.0 million shares of common stock as a result of the exercise of over-
allotment options granted to underwriters in the IPO. All shares issued
have a $0.01 per share par value.
(6) As of December 31, 2001, represents: a) additional paid-in capital from the
demutualization resulting from the reclassification of residual retained
earnings of Principal Mutual Holding Company, net of common stock issued
($5,047.7 million); b) net proceeds, net of common stock issued, from the
sale of 100.0 million shares of common stock in the IPO ($1,752.9 million);
c) net proceeds, net of common stock issued, from the exercise of over-
allotment options granted to underwriters in the IPO ($265.2 million); and
d) common stock issued and held in a rabbi trust ($6.7 million).
(7) As of December 31, 2001, represents a $29.1 million net loss for the period
October 26, 2001 through December 31, 2001. In addition, as of December 31,
2001, represents pre-demutualization and IPO retained earnings of $6,700.4
40
million less cash ($1,177.5 million) and policy credits ($472.6 million)
distributed as compensation as part of our demutualization and the
reclassification of residual retained earnings of Principal Mutual Holding
Company to additional paid-in capital of Principal Financial Group, Inc.
($5,050.3 million).
(8) During the fourth quarter of 2001, we purchased 15.3 million shares of our
stock at a cost of $367.7 million. The board of directors approved the
repurchase of these shares.
(9) We have provided statutory data from annual statements of Principal Life
filed with insurance regulatory authorities. Certain financial information
for periods beginning on or after January 1, 2001, is not comparable to
information from earlier periods. We prepared statutory data as of or for
the year ended December 31, 2001, in conformity with the NAIC Codification
of Statutory Principles ("Codification"), adopted as prescribed and
permitted by the Insurance Division, Department of Commerce of the State of
Iowa, effective January 1, 2001. As allowed by Codification, we did not
restate prior period information. We prepared statutory data as of or for
the years ended December 31, 2000, 1999, 1998 and 1997 in conformity with
accounting practices prescribed or permitted on the dates thereof by the
Insurance Division, Department of Commerce of the State of Iowa.
(10)Codification, as adopted by Principal Life on January 1, 2001, has
significantly impacted the reporting of Principal Life's statutory premiums
and deposits for the year ended December 31, 2001. Under Codification, we
no longer report amounts received for deposit-type contracts in the
statement of operations as revenue, but rather report these amounts
directly as an increase in an appropriate policy reserve account, a
treatment that is similar to that under U.S. GAAP. This has the effect of
decreasing reported total revenues and total expenses of Principal Life,
with no effect to statutory net income or statutory surplus. Premiums and
deposits for the years ended December 31, 2000, 1999, 1998 and 1997
included amounts received for deposit-type contracts of $11,273.2 million,
$11,571.5 million, $10,312.6 million and $8,694.9 million, respectively.
(11)Codification, as adopted by Principal Life on January 1, 2001, has impacted
the reporting of Principal Life's statutory net income for the year ended
December 31, 2001. Under Codification our net income has been significantly
impacted due to a change in the accounting for undistributed income (loss)
from subsidiaries. We no longer report undistributed income (loss) from
subsidiaries as part of net investment income, but rather report these
amounts as unrealized gains and losses, which are excluded from the
calculation of net income. This has the effect of decreasing reported total
statutory revenues and net income, but has no effect on statutory surplus.
Undistributed income from subsidiaries for the years ended December 31,
2000 and 1999 were $208.9 million and $159.9 million, respectively, and
undistributed loss from subsidiaries for the years ended December 31, 1998
and 1997 were $0.4 million and $41.3 million respectively.
(12)On August 24, 2001, Principal Life paid a statutory dividend of $250.0
million, which reduced its surplus by that amount. On October 26, 2001,
Principal Life received a capital contribution of $1,689.7 million to
reimburse Principal Life for policy credits, cash and expenses paid in
connection with our demutualization.
(13)Net realized capital gains (losses), as adjusted, are net of tax, related
changes in the amortization pattern of deferred policy acquisition costs,
recognition of front-end fee revenues for sales charges on pension products
and services, net realized capital gains credited to customers and certain
market value adjustments to fee revenues. Deferred policy acquisition costs
represent commissions and other selling expenses that vary with and are
directly related to the production of business. These acquisition costs are
deferred and amortized in conformity with U.S. GAAP.
Following is a reconciliation of net realized capital gains (losses) from the
consolidated financial statements and the adjustment made to calculate segment
operating earnings for the years indicated:
41
For the year ended December 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(in millions)
Net realized capital gains (losses)........... $(514.0) $ 139.9 $ 404.5 $ 465.8 $ 175.3
Certain market value
adjustments to fee revenues................. (14.9) - - - -
Recognition of front-end fee
Revenues.................................... 1.5 0.9 (1.0) (1.3) (0.9)
---------- ---------- ---------- ---------- ----------
Net realized capital gains (losses),
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues.............. (527.4) 140.8 403.5 464.5 174.4
Amortization of deferred policy
acquisition costs related to net
realized capital gains (losses)............. 18.6 (0.3) 4.4 5.7 (1.7)
Amounts credited to contractholder
accounts.................................... - - - (26.3) -
Non-recurring net realized capital
losses...................................... - - - (1.7) -
---------- ---------- ---------- ---------- ----------
Net realized capital gains (losses),
Including recognition of front-end
fee revenues, certain market
value adjustments to fee revenues,
net of related amortization of deferred
policy acquisition costs, and amounts
credited to contractholders................. (508.8) 140.5 407.9 442.2 172.7
Income tax effect............................. 187.8 (47.4) (141.0) (121.5) (61.3)
---------- ---------- ---------- ---------- ----------
Net realized capital gains (losses),
as adjusted.............................. $(321.0) $ 93.1 $ 266.9 $ 320.7 $ 111.4
========== ========== ========== ========== ==========
(14)For the year ended December 31, 2001, we excluded $31.1 million of
non-recurring items, net of tax, from net income for the presentation of
operating earnings. The non-recurring items included (a) the negative
effects of: (i) expenses related to our demutualization ($18.6 million);
(ii) a cumulative effect of change in accounting principle related to our
implementation of SFAS 133 ($10.7 million); and (iii) an increase in our
loss contingency reserve for sales practices litigation ($5.9 million) and
(b) the positive effect of investment income generated by the proceeds of
our IPO ($4.1 million).
For the year ended December 31, 2000, we excluded $101.0 million of
non-recurring items, net of tax, from net income for our presentation of
operating earnings. The non-recurring items included the negative effects
of: (a) a loss contingency reserve established for sales practices
litigation ($93.8 million) and (b) expenses related to our demutualization
($7.2 million).
For the year ended December 31, 1998, we excluded $104.8 million of
non-recurring items, net of tax, from net income for our presentation of
operating earnings. The non-recurring items included: (a) the positive
effects of (i) Principal Life's release of tax reserves and related accrued
interest ($164.4 million) and (ii) accounting changes by our international
operations ($13.3 million); and (b) the negative effects of (i) expenses
and adjustments for changes in amortization assumptions for deferred policy
acquisition costs related to our corporate structure change to a mutual
insurance holding company ($27.4 million) and (ii) a contribution related
to permanent endowment of the Principal Financial Group Foundation
($45.5 million).
(15)We define operating return on average equity as operating earnings divided
by average total equity, excluding accumulated other comprehensive income.
We have excluded accumulated other comprehensive income due to its
volatility between periods and because such data is often excluded when
evaluating the overall financial performance of insurers. Operating return
on average equity should not be considered a substitute for any U.S. GAAP
measure of performance.
42
(16)We define total return on average equity as net income divided by average
total equity, excluding accumulated other comprehensive income. We have
excluded accumulated other comprehensive income due to its volatility
between periods and because such data is often excluded when evaluating
the overall financial performance of insurers.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following analysis discusses our financial condition as of December 31,
2001, compared with December 31, 2000, and our consolidated results of
operations for the years ended December 31, 2001, 2000 and 1999, and, where
appropriate, factors that may affect our future financial performance. The
discussion should be read in conjunction with our audited consolidated financial
statements and the related notes to the financial statements and the other
financial information included elsewhere in this Form 10-K.
Forward-Looking Information
Our narrative analysis below contains forward-looking statements intended to
enhance the reader's ability to assess our future financial performance.
Forward-looking statements include, but are not limited to, statements that
represent our beliefs concerning future operations, strategies, financial
results or other developments, and contain words and phrases such as
"anticipate," "believe," "plan," "estimate," "expect," "intend," and similar
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects on us. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) competition from companies that may have greater financial
resources, broader arrays of products, higher ratings and stronger financial
performance may impair our ability to retain existing customers, attract new
customers and maintain our profitability; (2) a decline or increased volatility
in the securities markets could result in investors withdrawing from the markets
or decreasing their rates of investment, either of which could reduce our net
income, revenues and assets under management; (3) a downgrade in Principal Life
Insurance Company's ("Principal Life") financial strength ratings may increase
policy surrenders and withdrawals, reduce new sales and terminate relationships
with distributors; (4) our efforts to reduce the impact of interest rate changes
on our profitability and surplus may not be effective; (5) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (6) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (7) fluctuations in foreign currency
exchange rates could reduce our profitability; (8) a decline in Australian
equity values may reduce the profitability of BT Financial Group; (9) our
reserves established for future policy benefits and claims may prove inadequate,
requiring us to increase liabilities; (10) our investment portfolio is subject
to several risks which may diminish the value of our invested assets and affect
our sales, profitability and the investment returns credited to our customers;
(11) our ability to pay dividends and meet our obligations may be constrained by
the limitations on dividends Iowa insurance laws impose on Principal Life; (12)
we may need to fund deficiencies in our closed block ("Closed Block"); assets
allocated to the Closed Block benefit only the holders of Closed Block policies;
(13) changes in regulations or accounting standards may reduce our
profitability; (14) a challenge to the Insurance Commissioner of the State of
Iowa's approval of the plan of conversion could put the terms of our
demutualization in question and reduce the market price of our common stock;
(15) litigation and regulatory investigations may harm our financial strength
and reduce our profitability; (16) sales of shares distributed in the
demutualization may reduce the market price of our common stock; (17) applicable
laws and our stockholder rights plan, certificate of incorporation and by-laws
may discourage takeovers and business combinations that our stockholders might
consider in their best interests; (18) a downgrade in our debt ratings may
adversely affect our ability to secure funds; and (19) the impact of September
11, 2001, terrorist attacks and military and other actions may result in
decreases in our net income, revenue and assets under management and may
adversely affect our investment portfolio.
Overview
We are a leading provider of retirement savings, investment and insurance
products and services. We have four operating segments:
o U.S. Asset Management and Accumulation, which consists of our asset
accumulation operations which provide products and services, including
retirement savings and related investment products and services, and our
43
asset management operations conducted through Principal Capital Management,
our U.S.-based asset manager. We provide a comprehensive portfolio of asset
accumulation products and services to businesses and individuals in the
U.S., with a concentration on small and medium-sized businesses, which we
define as businesses with fewer than 1,000 employees. We offer to
businesses products and services for defined contribution pension plans,
including 401(k) and 403(b) plans, defined benefit pension plans and
non-qualified executive benefit plans. We also offer annuities, mutual
funds and bank products and services to the employees of our business
customers and other individuals.
o International Asset Management and Accumulation, which consists of BT
Financial Group, our Australia-based asset manager, and Principal
International. Our acquisition of BT Financial Group in 1999 was a central
element in the expansion of our international asset management and
accumulation businesses. Through Principal International, we offer
retirement products and services, annuities, mutual funds and life
insurance through subsidiaries in Argentina, Chile, Mexico and Hong Kong
and joint ventures in Brazil, Japan and India.
o Life and Health Insurance, which provides individual life and disability
insurance as well as group life and health insurance throughout the U.S.
Our individual insurance products include interest-sensitive life,
traditional life and disability insurance. Our group insurance products
include life, disability, medical, dental and vision insurance, and
administrative services.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.
Profitability
Our profitability depends in large part upon our:
o amount of assets under management;
o spreads we earn on our policyholders' general account balances;
o ability to generate fee revenues greater than the amount it costs us to
administer pension products, manage investments for retail and
institutional clients and provide other administrative services;
o ability to price our life and health insurance products at a level that
enables us to earn a margin over the cost of providing benefits and the
expense of acquiring and administering those products, which is primarily a
function of competitive conditions, persistency, our ability to assess and
manage trends in mortality and morbidity experience, our ability to
generate investment earnings and our ability to maintain expenses in
accordance with pricing assumptions;
o ability to effectively monitor and price residential mortgage loans we
originate, purchase, and sell and to manage the expenses we incur in
servicing residential mortgage loans;
o ability to effectively hedge the effect of interest rate changes on our
residential mortgage servicing rights;
o ability to manage our investment portfolio to maximize investment returns
and minimize risks such as interest rate changes or defaults or impairments
of invested assets;
o ability to effectively hedge fluctuations in foreign currency to U.S.
dollar exchange rates; and
o ability to manage our operating expenses.
44
Trends
U.S. Asset Management and Accumulation
Our sales of pension and other asset accumulation products and services in the
U.S. have been affected by overall trends in the U.S. retirement services
industry, as our customers have begun to rely less on defined benefit retirement
plans, social security and other government programs. Current trends in the work
environment include a more mobile workforce and the desire of employers to shift
the market risk of retirement investments to employees by offering defined
contribution plans rather than defined benefit plans. These trends are
increasing the demand for defined contribution pension arrangements such as
401(k) plans, mutual funds or variable annuities. Also, the "baby-boom"
generation of U.S. workers has reached an age at which saving for retirement is
critical and it continues to seek tax-advantaged investment products for
retirement. Considering these trends, assets under management increased as of
December 31, 2001, primarily due to additional gross new deposits, retention of
assets from existing clients, and shares of Principal Financial Group stock
allocated to the separate account as part of our demutualization. The declining
interest rate environment and poor performance in the equity markets in 2001
have decelerated our recent growth in assets under management.
The following table provides a summary of U.S. Asset Accumulation assets under
management as of December 31, 2001, 2000 and 1999:
U.S. Asset Accumulation
As of Total assets under management
- ------------------------------ -------------------------------
(in billions)
December 31, 2001.......... $ 74.6
December 31, 2000.......... 71.0
December 31, 1999.......... 70.3
Asset management services have been among the most profitable and rapidly
growing sectors of the financial services industry, at both the retail and
institutional level. We formally established Principal Capital Management, our
U.S-based asset manager, in 1999 to consolidate our investment operations and to
enter the third-party institutional asset management market. We seek to take
advantage of current trends which indicate that both retail and institutional
investors embrace specialization, providing increased fees to successful active
managers with expertise in specialty and niche areas. Our U.S. third-party
assets under management increased $1.0 billion during 2001 as a result of the
acquisition of Spectrum Asset Management, which became an affiliate of Principal
Capital Management on October 1, 2001.
The following table provides a summary of Principal Capital Management's
affiliated and third-party assets under management as of December 31, 2001, 2000
and 1999:
Principal Capital Management
--------------------------------------------
Affiliated Third-party
assets under assets under Total assets
As of management management under management
- -------------------------- ------------ ------------ ----------------
(in billions)
December 31, 2001......... $ 78.4 $ 7.3 $ 85.7
December 31, 2000......... 76.9 6.3 83.2
December 31, 1999......... 77.5 4.7 82.2
International Asset Management and Accumulation
Our international asset management and accumulation businesses focus on
countries with a trend toward privatization of public retirement pension
systems. Our acquisition of BT Financial Group in August 1999 is consistent with
this strategy. We are seeking to take advantage of an Australian government
requirement for all employers to contribute 8% of an employee's salary to an
employer-sponsored defined contribution retirement plan, referred to as
superannuation. The required employer contribution is scheduled to rise to 9% in
2002.
45
The governments of other countries have also instituted privatized pension
systems requiring employees who join the labor force to contribute to a private
pension system. With variations depending upon the specific country, we have
targeted these markets for sales of retirement and related products and
services, including defined contribution pension plans, annuities and mutual
funds to individuals and businesses. In several of our international markets, we
complement our sales of these products with sales of life insurance products.
We have pursued our international strategy through a combination of start-ups,
acquisitions and joint ventures, which require infusions of capital consistent
with our strategy of long-term growth and profitability.
Life and Health Insurance
Our U.S. individual life insurance premiums have been influenced by both
economic and industry trends. Both fee revenues and policyholder liabilities
related to our interest-sensitive life insurance products have increased due to
customer preference for insurance products with variable investment and
tax-advantaged accumulation product options. Premiums and policyholder
liabilities related to our individual traditional life insurance products have
remained relatively flat.
The following table provides a summary of our individual life insurance fee
revenues, premiums and policyholder liabilities as of or for the years ended
December 31, 2001, 2000 and 1999:
Individual Life Insurance
-------------------------------------------------------------
Interest-sensitive
life insurance Traditional life insurance
----------------------------- ----------------------------
Fee Policyholder Policyholder
As of or for the year ended revenues liabilities(1) Premiums liabilities
- -------------------------------------- ---------- --------------- ---------- --------------
(in millions)
December 31, 2001..................... $ 99.6 $1,748.4 $ 766.2 $ 5,712.7
December 31, 2000..................... 89.1 1,567.6 772.8 5,522.7
December 31, 1999..................... 61.7 1,237.2 780.8 5,331.6
- --------------------
(1) Includes separate account liabilities for policies with variable investment
options.
Improved pricing discipline in our group medical insurance business has affected
pricing of premiums. In general, we reacted faster than the industry in 2000 to
rising healthcare costs, raising our prices. That action depressed sales and
increased lapses, causing a loss of membership and total premiums that continued
into 2001. Our price increases have subsided to match cost trends, and
competitors have increased their pricing more recently. Sales and lapses
improved throughout 2001, and medical premiums grew during the last two quarters
of 2001. Medical premiums were also affected by our decisions to exit
under-performing and non-strategic businesses and markets. Effective January 1,
2000, we ceased new sales of our Medicare supplement insurance product and
effective July 1, 2000, reinsured all existing Medicare supplement business. We
continue to sell group medical business in 36 states. We also offer a complete
array of non-medical products (life, disability, dental and vision) and
administrative services only business in all 50 states and have experienced
growth in these products. Our group life insurance premiums declined in 2001 due
largely to the loss of two large customers.
Our group life and health insurance premiums and premium equivalents for the
years ended December 31, 2001, 2000 and 1999 were as follows:
46
Premiums and premium equivalents
------------------------------------------------------------------
Group
Group dental and
Group life disability Group medical vision
For the year ended insurance insurance insurance(1) insurance Fee-for-service
- ----------------------- ---------- ---------- ------------- ---------- ---------------
(in millions)
December 31, 2001...... $ 221.8 $ 98.2 $ 1,610.3 $ 351.1 $ 1,828.2
December 31, 2000...... 277.7 94.5 1,815.6 340.4 1,502.2
December 31, 1999...... 273.6 86.8 1,876.7 270.0 1,287.6
- ----------
(1) Effective January 1, 2000, we ceased new sales of our Medicare supplement
insurance and effective July 1, 2000, reinsured all existing Medicare
supplement business.
Mortgage Banking
We believe residential mortgages play a central role in the financial planning
activities of individuals in the U.S. As a result, our mortgage banking
operations complement our portfolio of market-driven financial products and
services.
Interest rate trends significantly impact our residential mortgage business.
Through most of 1999, the strong economy coupled with relatively low interest
rates created a favorable real estate market that increased production of
residential mortgage loans throughout the industry and also contributed to an
increase in residential mortgage loan refinancing. Starting late in 1999,
interest rates increased, resulting in decreases in production and refinancing
of residential mortgage loans throughout the industry. This trend reversed in
2001, when interest rates decreased, resulting in significant increases in
mortgage loan production.
We manage growth in the mortgage loan servicing portfolio, through retention of
mortgage loan production and the sale and acquisition of mortgage loan servicing
rights. Our servicing portfolio grew at a compound annual rate of 25% from
December 31, 1999 through December 31, 2001, reflecting our increased retention
of servicing rights of loans produced and acquisition of servicing rights.
Growth in the mortgage loan servicing portfolio was slower in 2000, as a result
of a decrease in mortgage loan production and an increase in sales of mortgage
loan servicing rights. During 2001, the mortgage loan servicing portfolio grew
as a result of an increase in mortgage loan production.
Our residential mortgage loan production and the unpaid principal balances in
our residential mortgage loan servicing portfolio as of or for the years ended
December 31, 2001, 2000 and 1999 were as follows:
Residential mortgage Residential mortgage
As of or for the year ended loan production loan servicing portfolio
- ---------------------------- --------------------- -------------------------
(in millions)
December 31, 2001........... $ 37,771.3 $ 80,530.5
December 31, 2000........... 8,311.8 55,987.4
December 31, 1999........... 13,307.3 51,875.5
Transactions Affecting Comparability of Results of Operations
Acquisitions
We acquired the following businesses, among others, during the past three years:
Spectrum Asset Management. On October 1, 2001, Spectrum Asset Management became
an affiliate of Principal Capital Management, LLC. The acquisition was accounted
for using the purchase method and the results of operations of the acquired
business have been included in our financial statements from the date of
acquisition. We included revenues of $0.8 million in 2001 in our consolidated
results of operations.
BT Financial Group. On August 31, 1999, we acquired the outstanding stock of
several companies affiliated with Bankers Trust Australia Group from Deutsche
Bank AG at a purchase price of $1.4 billion. We issued unsecured long-term debt
of $665.0 million to partially fund the acquisition. We report this debt and
47
related interest expense in our Corporate and Other segment. The acquired
companies now operate under the name of BT Financial Group. We accounted for the
acquisition using the purchase method. The results of operations of the acquired
companies have been included in our consolidated financial statements from the
date of acquisition. We included revenues of $220.9 million, $285.5 million and
$116.5 million in our consolidated results of operations for the years ended
December 31, 2001, 2000 and 1999, respectively. We included net loss of $14.8
million, net income of $6.5 million and net loss of $3.1 million in our
consolidated results of operations for the years ended December 31, 2001, 2000
and 1999, respectively.
We accounted for the purchase price as follows: $897.4 million of identifiable
intangibles; consisting primarily of management rights for the fund management
business and the BT brand name; $38.5 million of workforce intangibles and
$408.6 million of resulting goodwill. We are amortizing these intangible assets
on a straight-line basis over 40, 8 and 25 years, respectively. We report the
goodwill and other intangibles, including the related amortization, in our
International Asset Management and Accumulation segment.
The accounting for business combinations, goodwill and other intangible assets
changed effective January 1, 2002. The accounting change includes the adoption
of a non-amortization, impairment-only model for our goodwill and
indefinite-lived intangible assets and a more stringent impairment test
methodology (fair value based on discounted cash flows) for measuring and
recognizing impairment losses. See "Critical Accounting Policies - Accounting
for Business Combinations" for a discussion of our planned adoption of the new
accounting statements.
Dispositions
We entered into dispositions or disposed of the following businesses, among
others, during the past three years:
Coventry Health Care. Effective April 1, 1998, we transferred substantially all
of our managed care operations to Coventry Corporation in exchange for a 42%
non-majority ownership position in the resulting entity, Coventry Health Care,
Inc. ("Coventry"). In September 2000, we sold a portion of our equity ownership
position, which reduced our ownership to approximately 25% and resulted in a
realized capital gain of $13.9 million, net of tax. The investment in Coventry
was $146.0 million and $122.9 million as of December 31, 2001 and 2000,
respectively.
We report our investment in Coventry in our Corporate and Other segment and
account for it using the equity method. Our share of Coventry's net income was
$19.8 million, $20.0 million and $19.1 million for the years ended December 31,
2001, 2000 and 1999, respectively.
On November 30, 2001, we announced we had entered into an agreement to sell our
remaining stake of approximately 15.0 million shares of Coventry common stock.
The transaction was completed on February 1, 2002.
PT Asuransi Jiwa Principal Indonesia. On September 25, 2001, we disposed of all
the stock of PT Asuransi Jiwa Principal Indonesia, our subsidiary in Indonesia.
We currently have no business operations in Indonesia. We received nominal
proceeds, which resulted in a realized capital loss of $6.7 million. Total
assets of our operations in Indonesia as of December 31, 2000, were $3.2
million. We included nominal revenues and net loss from our operations in
Indonesia in our consolidated results of operations for the years ended December
31, 2001, 2000 and 1999.
Principal International Espana, S.A. de Seguros de Vida. On February 15, 2001,
we disposed of all of the stock of Principal International Espana, S.A. de
Seguros de Vida, our subsidiary in Spain, for nominal proceeds, resulting in a
realized capital loss of $38.4 million, or $21.0 million net of tax, ceasing our
business operations in Spain. Total assets of our operations in Spain as of
December 31, 2000, were $222.7 million.
We included revenues of $49.4 million and $51.7 million from our operations in
Spain in our consolidated results of operations for the years ended December 31,
2000 and 1999, respectively. Our operations in Spain contributed net loss of
$1.2 million and net income of $0.9 million for the years ended December 31,
2000 and 1999, respectively. We did not include revenues or net income from our
operations in Spain in our consolidated results of operations for the year ended
December 31, 2001.
48
Reinsurance Transactions
Effective January 1, 2002, we entered into a reinsurance agreement to reinsure
certain group medical insurance contracts, which should result in reduced
volatility of our group medical insurance earnings.
Effective July 1, 2000, we entered into a reinsurance agreement with General &
Cologne Life Re of America to reinsure 100% of our Medicare supplement insurance
business. Medicare supplement insurance premiums were $98.4 million and $164.6
million for the years ended December 31, 2000 and 1999, respectively.
Operating Earnings and Non-Recurring Items
For the year ended December 31, 2001, we excluded $31.1 million of non-recurring
items, net of tax, from net income for our presentation of consolidated
operating earnings. The non-recurring items included the (1) negative effects
of: (a) expenses related to our demutualization ($18.6 million); (b) a
cumulative effect of change in accounting related to our implementation of
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133") ($10.7 million); and
(c) an increase to our loss contingency reserve for sales practices litigation
($5.9 million) and (2) the positive effect of investment income generated from
the proceeds of our IPO ($4.1 million).
For the year ended December 31, 2000, we excluded $101.0 million of
non-recurring items, net of tax, from net income for our presentation of
consolidated operating earnings. The non-recurring items included the negative
effects of: (1) a loss contingency reserve established for sales practices
litigation ($93.8 million); and (2) expenses related to our demutualization
($7.2 million).
Fluctuations in Foreign Currency to U.S. Dollar Exchange Rates
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
In January 2002, the Argentine government ended its tie of the Argentine peso to
the U.S. dollar, creating a dual currency system with an official fixed exchange
rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and a
"free" floating exchange rate for other transactions, subsequently floating the
Argentine peso in February. The devaluation is not expected to materially impact
our consolidated results of operations.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
operating earnings and net income. Our consolidated operating earnings were
negatively impacted $1.7 million, $0.6 million and $0.3 million for the years
ended December 31, 2001, 2000 and 1999, respectively, as a result of
fluctuations in foreign currency to U.S. dollar exchange rates. For a discussion
of our approaches to foreign currency exchange rate risk, see Part II, Item 7A,
"Quantitative and Qualitative Disclosures about Market Risk."
Enron
In December 2001, Enron Corp., along with certain of its subsidiaries, filed
voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy
Court. As a result, we recognized realized losses in 2001 for other than
temporary impairments of $71.9 million related to our exposure to Enron Corp.
and Enron related entities. Also included in net realized capital gains and
losses in 2001 were losses of $65.8 million related to the sales of Enron
investments. As of December 31, 2001, the remaining carrying amount of our
investment in Enron Corp. and Enron related entities was $45.5 million.
Demutualization and Initial Public Offering
Effective October 26, 2001, Principal Mutual Holding Company converted from a
mutual insurance holding company ("MIHC") to a stock company. All policyholder
membership interests in Principal Mutual Holding Company were extinguished on
that date and eligible policyholders of the MIHC received, in aggregate, 260.8
million shares of common stock, $1,177.5 million of cash and $472.6 million of
policy credits as compensation.
49
In connection with the restructuring effective October 26, 2001, Principal
Mutual Holding Company and two of its subsidiaries, Principal Financial Group,
Inc., an Iowa corporation, and Principal Financial Services, Inc., an Iowa
corporation, merged with and into Principal Iowa Newco, Inc., an Iowa
corporation, which changed its name to Principal Financial Services, Inc.
("PFSI"). PFSI is a wholly-owned subsidiary of Principal Financial Group, Inc.,
a Delaware corporation.
In addition, on October 26, 2001, we completed our initial public offering
("IPO") in which we issued 100.0 million shares of common stock at a price of
$18.50 per share. Net proceeds from the IPO were $1,753.9 million, of which
$64.2 million was retained by Principal Financial Group, Inc., and $1,689.7
million was contributed to Principal Life. Proceeds were net of offering costs
of $96.5 million and a related tax benefit of $0.4 million.
On November 9, 2001, we issued 15.0 million additional shares of common stock,
at a price of $18.50 per share, as a result of the exercise of over-allotment
options granted to underwriters in the IPO. Net proceeds from the over-allotment
were $265.4 million.
Costs relating to the demutualization, excluding costs relating to the IPO,
incurred through December 31, 2001, were $18.6 million and $7.2 million, net of
tax, in 2001 and 2000, respectively. Demutualization expenses consist primarily
of printing and mailing costs and our aggregate cost of engaging independent
accounting, actuarial, financial, investment banking, legal and other
consultants to advise us on the demutualization. In addition, our costs include
the costs of the advisors of the Insurance Commissioner of the State of Iowa and
the New York State Insurance Department, other regulatory authorities and
internal allocated costs for staff and related costs associated with the
demutualization.
Terrorist Attacks in the U.S.
On September 11, 2001, terrorist attacks in the U.S. resulted in significant
loss of life and property, as well as interruption of business activities and an
overall disruption of the world economy. As of December 31, 2001, we recognized
$6.7 million, net of income tax and reinsurance, in our Life and Health
Insurance segment in losses from individual and group life and disability
insurance claims from these events.
The impact of the events of September 11, 2001, reduced our assets under
management as a result of the declines in the U.S., Australian and other stock
markets. These declines in the securities markets and reduced commercial and
economic activity suppressed growth in our operating earnings and revenues
during 2001.
Some of the assets in our investment portfolio may be adversely affected by the
volatility in the securities markets and economic activity caused by the
September 11, 2001 terrorist attacks and heightened security measures. In
particular, this may lead to possible write-downs, loss of value or impairments
with regard to securities issued by companies affected by these events. On
December 31, 2001, we held corporate fixed maturity securities in the following
sectors impacted most significantly by the September 11, 2001, terrorist attacks
(carrying amounts noted in parenthesis): airlines ($245.9 million in public debt
and $208.3 million in private debt), comprised mostly of equipment trust
certificate transactions secured by aircraft; airline manufacturers and
equipment providers ($239.0 million), comprised of public and private unsecured
debt; property and casualty insurance companies ($28.9 million), comprised of
public unsecured debt; and hotels and gaming companies ($168.9 million),
comprised of public and private debt secured by hotel properties. As of December
31, 2001, we have not recognized any related other than temporary impairment of
these assets.
Critical Accounting Policies
The increasing complexity of the business environment and applicable
authoritative accounting guidance requires us to closely monitor our accounting
policies. We have identified four critical accounting policies that are complex
and require significant judgment. A summary of our critical accounting policies
is intended to enhance the reader's ability to assess our financial condition
and results of operations and the potential volatility due to changes in
estimates and changes in guidance.
Accounting for Business Combinations
Our goodwill and other intangibles include the cost of acquired subsidiaries in
excess of the fair value of the tangible net assets recorded in connection with
acquisitions. These assets are amortized on a straight-line basis generally over
8 to 40 years. The carrying amounts of goodwill and other intangibles are
50
reviewed periodically for indicators of impairment in value, which in the view
of management are other than temporary, including unexpected or adverse changes
in the economic or competitive environments in which we operate, and
profitability analyses on the relevant subsidiary. If facts and circumstances
suggest that a subsidiary's goodwill and other intangibles are impaired, we
determine whether the sum of the estimated undiscounted future cash flows of the
subsidiary is less than the carrying value. If the undiscounted future cash
flows are less than the carrying value, an impairment loss is recognized for the
excess of the carrying amount of assets over fair value.
We must exercise certain judgments and make estimates in the application of our
policy for business combinations. We have some discretion in determining the
fair value of assets acquired and liabilities assumed, lives assigned to
acquired intangibles, the resulting amortization period, what indicators will
trigger an impairment, whether those indicators are other than temporary, what
economic or competitive factors affect valuation, valuation methodology, and key
assumptions including discount rates and cash flow estimates.
In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS 141"),
and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS 141 also includes guidance on
the initial recognition and measurement of goodwill and other intangible assets
arising from business combinations completed after June 30, 2001. SFAS 142,
effective January 1, 2002, prohibits the amortization of goodwill and intangible
assets with indefinite useful lives. Intangible assets with finite useful lives
will continue to be amortized over their estimated useful lives. In 2001, our
amortization expense for goodwill and intangible assets was $54.7 million, of
which $48.5 million will not continue after January 1, 2002. Additionally, SFAS
142 requires that goodwill and indefinite-lived intangible assets be reviewed
for impairment at least annually. This includes a more stringent impairment test
methodology (fair value based on discounted cash flows) for measuring and
recognizing impairment losses. We have estimated the impairment amount that will
result from the adoption of SFAS 142 on January 1, 2002, and expect an after-tax
impairment of approximately $300.0 million. The impairment will be recognized in
our first quarter 2002 consolidated financial statements as a cumulative effect
of a change in accounting principle.
Valuation of Invested Assets
Valuation Policies. In accordance with the provisions of SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, we are
required to classify our investments into one of three categories:
held-to-maturity, available-for-sale or trading. We determine the appropriate
classification of fixed maturity securities at the time of purchase. Fixed
maturity securities include bonds, mortgage-backed securities, and redeemable
preferred stock. We classify our fixed maturity securities as either
available-for-sale or trading and, accordingly, carry them at fair value.
Unrealized gains and losses related to available-for-sale securities are
reflected in stockholders' equity net of related deferred policy acquisition
costs and applicable taxes. Unrealized gains and losses related to trading
securities are reflected in net realized capital gains and losses. The cost of
fixed maturity securities is adjusted for amortization of premiums and accrual
of discounts, both computed using the interest method. The cost of fixed
maturity securities is adjusted for declines in value that are other than
temporary. Impairments in value deemed to be other than temporary are reported
as a component of net realized capital gains and losses. For loan-backed and
structured securities, we recognize income using a constant effective yield
based on currently anticipated prepayments as determined by broker-dealer
surveys or internal estimates and the estimated lives of the securities.
Equity securities include common stock and non-redeemable preferred stock. The
cost of equity securities is adjusted for declines in value that are other than
temporary. Impairments in value deemed to be other than temporary are reported
as a component of net realized capital gains and losses. Equity securities are
classified as available-for-sale and, accordingly, are carried at fair value.
Unrealized gains and losses related to available-for-sale securities are
reflected in stockholders' equity net of related deferred policy acquisition
costs and applicable taxes.
Real estate investments are reported at cost less accumulated depreciation. The
initial cost bases of properties acquired through loan foreclosures are the
lower of the fair market values of the properties at the time of foreclosure or
the outstanding loan balance. Buildings and land improvements are generally
depreciated on the straight-line method over the estimated useful life of
improvements, and tenant improvement costs are depreciated on the straight-line
method over the term of the related lease. We recognize impairment losses for
our properties when indicators of impairment are present and a property's
expected undiscounted cash flows are not sufficient to recover the property's
carrying value. In such cases, the cost bases of the properties are reduced to
fair value. Real estate expected to be disposed is carried at the lower of cost
or fair value, less cost to sell, with valuation allowances established
accordingly and depreciation no longer recognized. Any impairment losses and any
changes in valuation allowances are reported as net realized capital losses.
51
Commercial and residential mortgage loans are generally reported at cost
adjusted for amortization of premiums and accrual of discounts, computed using
the interest method, and net of valuation allowances. Any changes in the
valuation allowances are reported as net realized capital gains and losses. We
measure impairment based upon the present value of expected cash flows
discounted at the loan's effective interest rate or the loan's observable market
price. If foreclosure is probable, the measurement of any valuation allowance is
based upon the fair value of the collateral. Residential mortgage loans held for
sale and commercial mortgage loans held for sale are carried at lower of cost or
fair value, less cost to sell, and reported as mortgage loans in the statements
of financial position.
We sell commercial mortgage loans to an unconsolidated trust which then issues
mortgage-backed securities. We may retain interests in the loans by purchasing
portions of the securities from the issuance. Gain or loss on the sales of the
mortgages depends in part on the previous carrying amounts of the financial
assets involved in the transfer, which is allocated between the assets sold and
the retained interests based on their relative fair value at the date of
transfer. Fair values are determined by quoted market prices of external buyers
of each class of security purchased. The retained interests are thereafter
carried at fair value with other fixed maturity investments.
We also sell residential mortgage loans and retain servicing rights which are
retained interests in the sold loans. Gain or loss on the sales of the loans
depends in part on the previous carrying amounts of the financial assets sold
and the retained interests based on their relative fair values at the date of
the transfer. To obtain fair values, quoted market prices are used if available.
However, quotes are generally not available for retained interests, so we
estimate fair value based on the present value of the future expected cash flows
using our best estimates of the key assumptions - prepayment speeds and option
adjusted spreads commensurate with the risks involved.
We have developed a margin lending securitization program whereby we sell
receivables to an unconsolidated trust that packages and sells interests to
investors. We retain interest bearing subordinated tranches. The receivables are
sold at face value, which approximates cost and fair value, to an unconsolidated
trust, with no gain or loss recognized on the sale. Retained interests are
initially carried at cost based on their fair values at the date of transfer,
then carried at fair value thereafter.
We recognize impairment losses for fixed maturities and equity securities when
declines in value are other than temporary.
Corporate private placement bonds represent a primary area of credit risk
exposure. The corporate private placement bond portfolio is diversified by
issuer and industry. We monitor the restrictive bond covenants which are
intended to regulate the activities of issuers and control their leveraging
capabilities.
Mortgage loans on real estate are considered impaired when, based on current
information and events, it is probable that we will be unable to collect all
amounts due according to contractual terms of the loan agreement. When we
determine that a loan is impaired, a provision for loss is established for the
difference between the carrying amount of the mortgage loan and the estimated
value. Estimated value is based on either the present value of the expected
future cash flows discounted at the loan's effective interest rate, the loan's
observable market price or fair value of the collateral. The provision for
losses is reported as a net realized capital loss. Mortgage loans deemed to be
uncollectible are charged against the allowance for losses, and subsequent
recoveries are credited to the allowance for losses. The allowance for losses is
maintained at a level believed adequate by us to absorb estimated probable
credit losses. Our periodic evaluation of the adequacy of the allowance for
losses is based on our past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of the underlying collateral, composition of the loan
portfolio, current economic conditions and other relevant factors. The
evaluation is inherently subjective as it requires estimating the amounts and
timing of future cash flows expected to be received on impaired loans that may
change.
Valuation Models and Assumptions. Since many of the SFAS 115 assets that we
invest in are private market assets, there are not readily available market
quotes available to determine the fair market value of these assets as required
by SFAS 115. These assets are valued by discounting future cash flows. The
discount rate is based on a Treasury curve sourced from Bloomberg, credit
spreads provided by Capital Management Sciences, and a liquidity-spread add-on
determined by us. The spreads used are unique by credit rating for each asset.
We also determine the credit ratings used in the process.
52
We must also determine the fair value of our non-exchange traded derivative
contracts. Many of these values are calculated via models built in Bloomberg and
are validated by confirmations with the counterparties and our valuation model.
Assumptions including prepayment speeds, defaults, and losses are used in the
assessment of both the base case and subsequent testing of yields and valuations
of asset-backed securities and commercial mortgage backed securities.
The assessment of the other than temporary losses and write-downs of invested
assets (private bonds, mortgages, and real estate) also involves significant
judgment. Both the recognition of a triggering event (timing) and the market
value of private assets involves subjective assessments by us. In addition, the
determination of the calculation and the adequacy of the mortgage loan reserve
are also subjective. Our assessment of the adequacy of this reserve is based on
our past experience, known and inherent risks in the portfolio, adverse
situations that may affect a borrower's ability to repay, the estimated value of
the underlying security, composition of the portfolio, and current economic
conditions.
Insurance Reserves and Deferred Policy Acquisition Costs
Insurance reserves. Contractholder and policyholder liabilities (contractholder
funds, future policy benefits and claims and other policyholder funds) include
reserves for investment contracts and reserves for universal life, limited
payment, participating and traditional life insurance policies. Investment
contracts are contractholders' funds on deposit with us and generally include
reserves for pension and annuity contracts. Reserves on investment contracts are
equal to the cumulative deposits less any applicable charges plus credited
interest.
Reserves for universal life insurance contracts are equal to cumulative premiums
less charges plus credited interest which represents the account balances that
accrue to the benefit of the policyholders. Reserves for non-participating term
life insurance contracts are computed on a basis of assumed investment yield,
mortality, morbidity and expenses, including a provision for adverse deviation,
which generally varies by plan, year of issue and policy duration. Investment
yield is based on our experience. Mortality, morbidity and withdrawal rate
assumptions are based on our experience and are periodically reviewed against
both industry standards and experience.
Reserves for participating life insurance contracts are based on the net level
premium reserve for death and endowment policy benefits. This net level premium
reserve is calculated based on dividend fund interest rate and mortality rates
guaranteed in calculating the cash surrender values described in the contract.
The amount of dividends to policyholders is approved annually by Principal
Life's board of directors. The amount of dividends to be paid to policyholders
is determined after consideration of several factors including interest,
mortality, morbidity and other expense experience for the year and judgment as
to the appropriate level of statutory surplus to be retained by Principal Life.
At the end of the reporting period, Principal Life establishes a dividend
liability for the pro-rata portion of the dividends expected to be paid on or
before the next policy anniversary date.
Some of our policies and contracts require payment of fees in advance for
services that will be rendered over the estimated lives of the policies and
contracts. These payments are established as unearned revenue reserves upon
receipt and included in other policyholder funds in the consolidated statements
of financial position. These unearned revenue reserves are amortized to
operations over the estimated lives of these policies and contracts in relation
to the emergence of estimated gross profit margins.
The liability for unpaid accident and health claims is an estimate of the
ultimate net cost of reported and unreported losses not yet settled. This
liability is estimated using actuarial analyses and case basis evaluations.
Although considerable variability is inherent in such estimates, we believe that
the liability for unpaid claims is adequate. These estimates are continually
reviewed and, as adjustments to this liability become necessary, such
adjustments are reflected in current operations.
Reserves are the liabilities held on our books representing estimates of the
amounts that will come due, at some point in our future, to our contractholders.
The methods of establishing reserves are dictated by the FASB and NAIC, allowing
for some degree of managerial judgment. As a basis for making management
decisions, we conduct studies of our experience: mortality, morbidity,
investment and expense. We compare our results to that of the industry to ensure
actuarial credibility. Once this information is gathered, following common
industry practices, the reserves are set. Our reserve levels are reviewed
throughout the year using internal analysis, the annual audit, and statutory
53
asset adequacy analysis. To the extent experience indicates a potential
redundancy/deficiency, reserves would be released/increased.
Deferred policy acquisition costs. Commissions and other costs (underwriting,
issuance and agency expenses and first-year bonus interest) that vary with and
are primarily related to the acquisition of new and renewal insurance policies
and investment contract business are capitalized to the extent recoverable.
Maintenance costs and acquisition costs that are not deferrable are charged to
operations as incurred.
Deferred policy acquisition costs for universal life-type insurance contracts
and participating life insurance policies and investment contracts are being
amortized over the lives of the policies and contracts in relation to the
emergence of estimated gross profit margins. This amortization is adjusted
retrospectively when estimates of current or future gross profits and margins to
be realized from a group of products and contracts are revised. The deferred
policy acquisition costs of non-participating term life insurance policies are
being amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policyholder liabilities.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs would be written off to the extent
that it is determined that future policy premiums and investment income or gross
profit margins would not be adequate to cover related losses and expenses.
The deferred policy acquisition cost asset is amortized in relation to the gross
profits of the underlying policies, over the expected lifetime of these
policies. At issue, the pattern of expected gross profits is established based
on our expectation of future profit margins. These profit margins contain
assumptions relating to mortality, morbidity, investment yield and expenses. As
actual experience emerges, the profit margins may vary from those expected
either in magnitude or timing. For our universal life and investment contracts,
we are required by accounting practice to reflect the actual gross profits of
the underlying policies. In addition, we are required to revise our assumptions
regarding future experience as soon as the current assumptions become no longer
actuarially credible. Both actions, reflecting actual experience and changing
future estimates, can cause changes in the amount of the asset and the pattern
of future amortization.
Mortgage Loan Servicing Rights
Mortgage loan servicing rights represent the cost of purchasing or originating
the right to receive cash flows from servicing mortgage loans. These costs are
capitalized and amortized to operations over the estimated remaining life of the
underlying loans using the interest method and taking into account appropriate
prepayment assumptions. Capitalized mortgage loan servicing rights are
periodically assessed for impairment, which is recognized in the consolidated
statements of operations during the period in which impairment occurs by
establishing a corresponding valuation allowance. For purposes of performing
impairment evaluation, we stratify the servicing portfolio on the basis of
specified predominant risk characteristics, including loan type and note rate. A
valuation model is used to determine the fair value of each stratum. Cash flows
are calculated using an internal prepayment model and discounted at a spread to
London Inter-Bank Offer Rates ("LIBOR"). External valuations are obtained for
comparison purposes.
We must exercise certain judgments and make estimates in the application of this
policy. We have some discretion in determining interest rate assumptions to use
in its estimates, but we are guided by the benchmark curve of LIBOR/Swap term
structure, the volatility of interest rates derived from historical volatility
in LIBOR/Swap rates, and the addition of mortgage spread to the modeled 10-year
swap rate to derive the mortgage refinancing rate.
We develop prepayment models internally by examining the historical prepayment
experience of our portfolio, given the historical interest rate environment.
Servicing cost assumptions are derived from budgeted costs, interest
differential, and foreclosure losses based on historical evidence, and
amortization based on expected non-discounted cash flows. Servicing revenue
assumptions are derived from historical experience and include principal and
interest float, escrow float, prepayment float, late charges collected, and
ancillary income.
Ratings
Insurance companies are assigned financial strength ratings by rating agencies
based upon factors relevant to policyholders. Ratings provide both industry
participants and insurance consumers meaningful information on specific
insurance companies. Higher ratings generally indicate financial stability and a
stronger ability to pay claims.
54
Principal Life has been assigned the following ratings:
Rating Agency Financial Strength Rating Rating Structure
- ------------- ------------------------- ----------------
A.M. Best Company, Inc. A+ ("Superior") with a stable Second highest of
outlook 16 rating levels
Fitch Ratings AA ("Very Strong") with a stable Third highest of
outlook 24 rating levels
Moody's Investors Service Aa2 ("Excellent") with a stable Third highest of
outlook 21 rating levels
Standard & Poor's Rating AA ("Very Strong") with a Third highest of
Services negative outlook 21 rating levels
A.M. Best's ratings for insurance companies range from "A++" to "S". A.M. Best
indicates that "A++" and "A+" ratings are assigned to those companies that in
A.M. Best's opinion have achieved superior overall performance when compared to
the norms of the life insurance industry and have demonstrated a strong ability
to meet their policyholder and other contractual obligations. Fitch's ratings
for insurance companies range from "AAA" to "D". Fitch indicates that "AA"
ratings are assigned to those companies that have demonstrated financial
strength and a very strong capacity to meet policyholder and contractholder
obligations on a timely basis. Moody's ratings for insurance companies range
from "Aaa" to "C". Moody's indicates that "A ("Excellent")" ratings are assigned
to those companies that have demonstrated excellent financial security. Standard
& Poor's ratings for insurance companies range from "AAA" to "R". Standard &
Poor's indicates that "AA" ratings are assigned to those companies that have
demonstrated very strong financial security. In evaluating a company's financial
and operating performance, these rating agencies review its profitability,
leverage and liquidity, as well as its book of business, the adequacy and
soundness of its reinsurance, the quality and estimated market value of its
assets, the adequacy of its policy reserves and the experience and competency of
its management.
We believe that our strong ratings are an important factor in marketing our
products to our distributors and customers, since ratings information is broadly
disseminated and generally used throughout the industry. Our ratings reflect
each rating agency's opinion of our financial strength, operating performance
and ability to meet our obligations to policyholders and are not evaluations
directed toward the protection of investors. Such ratings are neither a rating
of securities nor a recommendation to buy, hold or sell any security, including
our common stock.
Recent Developments
On February 1, 2002, we sold our remaining stake of 15.1 million shares in
Coventry Health Care, Inc. common stock and a warrant, exercisable for
approximately 3.1 million shares of Coventry common stock. Total estimated
proceeds from the completion of this transaction are $325.2 million and we will
recognize an estimated realized capital gain of $183.1 million, $114.6 million
net of tax, during the first quarter of 2002.
On February 11, 2002, Fitch Ratings announced that Principal Life Insurance
Company's financial strength rating had been lowered from "AA+" to "AA". The
"AA" rating is considered to be "Very Strong". The outlook for the rating is
"Stable".
On February 26, 2002, the company's board of directors authorized the repurchase
of up to $450.0 million of the company's common stock. The repurchases will be
made in the open market or through privately negotiated transactions from
time to time, depending upon market conditions. Also on that date, Principal
Life declared an ordinary dividend of $390.0 million payable to its parent on
or about April 5, 2002.
Results of Operations
The following table presents summary consolidated financial information for the
years indicated:
55
For the year ended December 31,
----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Income Statement Data:
Revenues:
Premiums and other considerations........................ $ 4,122.3 $ 3,996.4 $ 3,937.6
Fees and other revenues.................................. 1,814.7 1,576.3 1,287.3
Net investment income.................................... 3,394.5 3,172.3 3,072.0
Net realized capital gains (losses)...................... (514.0) 139.9 404.5
--------- ---------- ---------
Total revenues......................................... 8,817.5 8,884.9 8,701.4
Expenses:
Benefits, claims and settlement expenses............... 5,482.1 5,232.3 5,260.9
Dividends to policyholders............................. 313.7 312.7 304.6
Operating expenses..................................... 2,573.2 2,479.4 2,070.3
--------- --------- ---------
Total expenses......................................... 8,369.0 8,024.4 7,635.8
--------- --------- ---------
Income before income taxes and cumulative effect of
accounting change........................................ 448.5 860.5 1,065.6
Income taxes.............................................. 79.0 240.3 323.5
--------- --------- ---------
Income before cumulative effect of accounting change... 369.5 620.2 742.1
Cumulative effect of accounting change, net of related
income taxes............................................. (10.7) - -
--------- --------- ---------
Net income............................................. $ 358.8 $ 620.2 $ 742.1
========= ========= =========
Other Data:
Net income................................................ $ 358.8 $ 620.2 $ 742.1
Less:
Net realized capital gains (losses), as adjusted........ (321.0) 93.1 266.9
Non-recurring items..................................... (31.1) (101.0) -
--------- --------- ---------
Operating earnings........................................ $ 710.9 $ 628.1 $ 475.2
========= ========= =========
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums and other considerations increased $125.9 million, or 3%, to $4,122.3
million for the year ended December 31, 2001, from $3,996.4 million for the year
ended December 31, 2000. The increase reflected a $240.9 million, or 46%,
increase from the U.S. Asset Management and Accumulation segment, primarily a
result of an increase in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. The premium income we receive from these contracts fluctuates due
to the variability in the number and size of pension plan terminations in the
market, the interest rate environment and our ability to attract new sales. In
addition, a $124.4 million, or 56%, increase from the International Asset
Management and Accumulation segment primarily resulted from the sale of a large
group annuity contract with life contingencies in Mexico. The increases were
partially offset by a $239.4 million, or 7%, decrease from the Life and Health
Insurance segment, related to our decision to reinsure 100% of our group
Medicare supplement insurance business effective July 1, 2000. Life and Health
Insurance segment premiums also decreased due to group medical premium rate
increases in 2000, which led to increased lapses and lower sales in 2001.
Fees and other revenues increased $238.4 million, or 15%, to $1,814.7 million
for the year ended December 31, 2001, from $1,576.3 million for the year ended
December 31, 2000. The increase was primarily due to a $350.8 million, or 93%,
increase from the Mortgage Banking segment primarily resulting from mortgage
loan production fee revenues, reflecting the increase in mortgage loan
production volume. The increase was also due to a $26.7 million, or 12%,
increase from the Life and Health Insurance segment, primarily related to an
increase in group fee-for-service fee revenues, a result of growth in the
business and fee rate increases, and an increase in interest-sensitive life
insurance fee revenues, a result of growth in that block of business. The
increases were partially offset by an $85.8 million, or 12%, decrease from the
U.S. Asset Management and Accumulation segment primarily related to a decrease
in surrender charge and market value adjustment revenues from pension products,
primarily due to a declining interest rate environment and a decrease in the
recognition of front-end fee revenues, a result of changes in assumptions
consistent with unlocking of deferred policy acquisition costs in 2001. The
increases were also partially offset by a $45.1 million, or 15%, decrease from
the International Asset Management and Accumulation segment primarily as a
56
result of declining assets under management for the year ended December 31,
2001, and the weakening of the Australian dollar versus the U.S. dollar.
Net investment income increased $222.2 million, or 7%, to $3,394.5 million for
the year ended December 31, 2001, from $3,172.3 million for the year ended
December 31, 2000. The increase was primarily a result of a $1,742.0 million, or
4%, increase in average invested assets and cash and also from an increase in
investment yields, primarily resulting from our investment policy during 2000 to
reposition the investment portfolio to maximize investment returns by selling
lower yielding fixed income securities to allow for reinvestment in higher
yielding fixed income securities. The yield on average invested assets and cash
was 7.7% for the year ended December 31, 2001, compared to 7.5% for the year
ended December 31, 2000.
Net realized capital gains (losses) decreased $653.9 million to $514.0 million
of net realized capital losses for the year ended December 31, 2001, from $139.9
million of net realized capital gains for the year ended December 31, 2000.
Realized capital losses of $137.7 million related to sales and impairments of
our investment in Enron and related entities. These entities are in the process
of bankruptcy proceedings. We sold our investment in United Payors and United
Providers, and realized a capital gain of $90.6 million during the year ended
December 31, 2000. We realized a capital loss of $38.4 million on the sale of
our operations in Spain in 2001. We realized $22.0 million in losses in our
international operations from the restructuring of government bonds in Argentina
and $6.7 million of realized losses in our U.S. operations related to
Argentine-based-bonds in 2001. The decrease also related to permanent
impairments of other fixed maturity and equity securities which were $152.6
million, during the year ended December 31, 2001.
Benefits, claims and settlement expenses increased $249.8 million, or 5%, to
$5,482.1 million for the year ended December 31, 2001, from $5,232.3 million for
the year ended December 31, 2000. The increase was primarily due to a $272.5
million, or 12%, increase from the U.S. Asset Management and Accumulation
segment, primarily reflecting the increase in reserves resulting from an
increase in sales of single premium group annuities with life contingencies. The
increase was also due to a $145.3 million, or 55%, increase from the
International Asset Management and Accumulation segment due to an increase in
the change in reserves and policy and contract benefit payments, primarily the
result of the sale of a large group annuity contract with life contingencies in
Mexico. The increases were partially offset by a $168.4 million, or 6%, decrease
from the Life and Health Insurance segment, due to a reduction in group medical
insurance business, improved group medical insurance claim experience and our
decision to reinsure 100% of our group Medicare supplement insurance business
effective July 1, 2000.
Dividends to policyholders increased $1.0 million to $313.7 million for the year
ended December 31, 2001, from $312.7 million for the year ended December 31,
2000. The increase was attributable to a $2.1 million, or 46%, increase from the
U.S. Asset Management and Accumulation segment, resulting from an increase in
dividends for our pension full-service accumulation products. The increase was
offset by a $1.1 million decrease from the Life and Health Insurance segment due
to a change in methodology of estimating dividends. Additionally, the dividends
in the Closed Block were reduced due to accumulated experience losses.
Operating expenses increased $93.8 million, or 4%, to $2,573.2 million for the
year ended December 31, 2001, from $2,479.4 million for the year ended December
31, 2000. The increase was primarily due to a $269.6 million, or 95%, increase
from the Mortgage Banking segment primarily resulting from an impairment of
mortgage loan servicing rights and, to a lesser extent, due to growth in the
mortgage loan servicing portfolio and an increase in the mortgage loan
production volume. The increase also reflected a $22.2 million, or 3%, increase
from the U.S. Asset Management and Accumulation segment, primarily reflecting an
increase in Principal Bank operating expenses related to growth in bank
operations and an increase in Principal Capital Management's operating expenses
related to increases in compensation and recruiting costs and depreciation and
securitization expenses. The increases were partially offset by an $89.1
million, or 53%, decrease from the Corporate and Other segment, primarily
related to a non-recurring loss contingency reserve established during the year
ended December 31, 2000, for sales practices litigation. The increases were also
partially offset by a $79.0 million, or 9%, decrease from the Life and Health
Insurance segment due to our decision to reinsure 100% of our group Medicare
supplement insurance business effective July 1, 2000. In addition, the increases
were partially offset by a $29.9 million, or 8%, decrease from the International
Asset Management and Accumulation segment, primarily as a result of the
weakening of the Australian dollar versus the U.S. dollar.
Income taxes decreased $161.3 million, or 67%, to $79.0 million for the year
ended December 31, 2001, from $240.3 million for the year ended December 31,
2000. The effective income tax rate was 18% for the year ended December 31,
2001, and 28% for the year ended December 31, 2000. The effective income tax
57
rates for the years ended December 31, 2001 and 2000, were lower than the
corporate income tax rate of 35% primarily due to income tax deductions allowed
for corporate dividends received. Our effective income tax rate was also reduced
in 2001 due to additional tax benefits related to excess tax over book capital
losses realized from the sales of our operations in Spain and Indonesia. The
decrease in the effective tax rate to 18% in 2001 from 28% in 2000 was primarily
due to the decrease in net income before income taxes relative to our permanent
tax differences which did not decrease.
As a result of the foregoing factors and the inclusion of the cumulative effect
of accounting change, net of related income taxes, net income decreased $261.4
million, or 42%, to $358.8 million for the year ended December 31, 2001, from
$620.2 million for the year ended December 31, 2000. The cumulative effect of
accounting change was related to our implementation of SFAS 133.
For the year ended December 31, 2001, non-recurring items of $31.1 million, net
of tax, included (1) the negative effects of: (a) expenses related to our
demutualization ($18.6 million); (b) a cumulative effect of change in accounting
related to our implementation of SFAS 133 ($10.7 million); and (c) an increase
to our loss contingency reserve for sales practices litigation ($5.9 million)
and (2) the positive effect of investment income generated from the proceeds of
our IPO ($4.1 million). For the year ended December 31, 2000, non-recurring
items of $101.0 million, net of tax, included the negative effects of: (1) a
loss contingency reserve established for sales practices litigation ($93.8
million); and (2) expenses related to our demutualization ($7.2 million).
As a result of the foregoing factors and the exclusion of net realized capital
gains (losses), as adjusted and nonrecurring items, operating earnings increased
$82.8 million, or 13%, to $710.9 million for the year ended December 31, 2001,
from $628.1 million for the year ended December 31, 2000. The increase resulted
from a $76.7 million increase from the Mortgage Banking segment, primarily due
to an increase in mortgage loan production volume. The increase was also due to
a $38.9 million, or 24%, increase from the Life and Health Insurance segment,
primarily a result of individual disability insurance reserve strengthening
during 2000, and improved margins on individual life insurance business
resulting from higher investment yields. The increases were partially offset by
a $29.6 million, or 44%, decrease from the Corporate and Other segment,
primarily due to a net recovery in 2000 of previously paid interest related to a
successful tax audit appeal.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums and other considerations increased $58.8 million, or 1%, to $3,996.4
million for the year ended December 31, 2000, from $3,937.6 million for the year
ended December 31, 1999. The increase reflected a $59.9 million, or 2%, increase
from the Life and Heath Insurance segment, primarily the result of increased
sales of group dental insurance products and an increase in group medical
premiums, primarily attributable to increased sales in 1999 and significant
group medical premium rate increases. In addition, the increase was due to a
$40.6 million, or 23%, increase from the International Asset Management and
Accumulation segment, primarily related to sales of single premium annuities
with life contingencies by new annuity companies we established in Mexico in
July 1999 and in Argentina in August 1999. The increases were partially offset
by a $41.3 million, or 7%, decrease from the U.S. Asset Management and
Accumulation segment, primarily related to a decrease in premiums from single
premium group annuities with life contingencies, which are typically used to
fund defined benefit pension plan terminations. The premium income we receive
from these contracts fluctuates due to the variability in the number and size of
defined benefit pension plan terminations in the market and our ability to
attract new sales.
Fees and other revenues increased $289.0 million, or 22%, to $1,576.3 million
for the year ended December 31, 2000, from $1,287.3 million for the year ended
December 31, 1999. The increase was primarily due to a $199.6 million increase
from the International Asset Management and Accumulation segment, primarily
resulting from the inclusion of fees and other revenues contributed by BT
Financial Group, which we acquired in August 1999. The increase was also due to
a $90.3 million, or 15%, increase from the U.S. Asset Management and
Accumulation segment, primarily attributable to an increase in administrative
fee revenues, reflecting an increase in the amortization of front-end fee
revenues, a result of a change in our assumptions related to amortization of
deferred policy acquisition costs attributable to pension products. We also
received higher fee revenues related to surrender charges, which are fees
charged to policyholders when they surrender an annuity for its cash value. Fee
revenues also increased due to fees from pension customer-directed investment
transfers, reflecting the higher interest rate environment and the resulting
increased customer account activity. Fee revenues for U.S. pension products and
services also increased, reflecting increased assets under management in 1999.
The increase was also due to a $49.8 million, or 28%, increase from the Life and
Health Insurance segment, primarily related to growth in our interest-sensitive
life insurance block of business and increased fee revenues from our group
fee-for-service business, primarily a result of an increase in members and fees.
The increases were partially offset by a $31.2 million decrease from the
Corporate and Other segment, which reflects a change in inter-segment
58
eliminations included in this segment and the termination of a reinsurance and
participation agreement under which we received fee revenues in 1999, but not in
2000. The increases were also partially offset by a $19.5 million, or 5%,
decrease from the Mortgage Banking segment, primarily due to a decrease in
residential mortgage loan production revenues as a result of the decrease in
residential mortgage loan production volume during 2000.
Net investment income increased $100.3 million, or 3%, to $3,172.3 million for
the year ended December 31, 2000, from $3,072.0 million for the year ended
December 31, 1999. The increase was primarily due to an increase in investment
yields due to higher interest rates on new investments. The yield on average
invested assets and cash was 7.5% in 2000, compared to 7.4% in 1999. The
increase was also due to a $934.8 million, or 2%, increase in average invested
assets and cash.
Net realized capital gains decreased $264.6 million, or 65%, to $139.9 million
for the year ended December 31, 2000, from $404.5 million for the year ended
December 31, 1999. The decrease was due in part to a decrease in sales of
invested assets, primarily equity securities, in 2000. In 1999, we sold a
significant portion of our equity securities portfolio to reduce exposure to
common stock and to realize appreciation. We also recognized an increase in net
realized capital losses in 2000, compared to 1999, in our fixed income
securities portfolio, reflecting our investment philosophy to reposition the
investment portfolio to maximize investment returns by selling lower yielding
fixed income securities to allow for reinvestment in higher yielding fixed
income securities. In 1999, we sold a portion of our investment in United Payors
and United Providers, a publicly traded service organization that acts as an
intermediary between health care payors and health care providers, realizing a
capital gain of $27.6 million. In 2000, we sold our remaining investment and
realized a capital gain of $90.6 million.
Benefits, claims and settlement expenses decreased $28.6 million, or 1%, to
$5,232.3 million for the year ended December 31, 2000, from $5,260.9 million for
the year ended December 31, 1999. The decrease was primarily due to a $55.5
million, or 2%, decrease from the Life and Health Insurance segment, primarily
resulting from the release of group medical and group Medicare supplement claim
reserves established in 1999. The claim reserves were established in 1999 as a
result of poor claim experience during the first three quarters of 1999 and an
expectation that claims would continue to increase through the second quarter of
2000. Group Medicare supplement benefits, claims and settlement expenses also
decreased as a result of our decision to cease new sales of group Medicare
supplement insurance effective January 1, 2000, and our decision to reinsure all
existing business as of July 1, 2000. In addition, the decrease was related to a
$24.7 million, or 1%, decrease from the U.S. Asset Management and Accumulation
segment primarily resulting from a decrease in benefit payments and reserve
changes reflecting the decrease in our block of pension experience rated
business and an increase in our guaranteed business. The decreases were
partially offset by a $52.1 million, or 25%, increase from the International
Asset Management and Accumulation segment, primarily due to an increase in the
change in reserves and policy and contract benefit payments, primarily related
to additional sales of annuity products with life contingencies in Mexico,
Argentina and Chile.
Dividends to policyholders increased $8.1 million, or 3%, to $312.7 million for
the year ended December 31, 2000, from $304.6 million for the year ended
December 31, 1999. The increase was primarily attributable to a $12.5 million,
or 4%, increase from the Life and Health Insurance segment due to increased
dividends on traditional individual life insurance products, a result of a
maturing in-force block. The increase was partially offset by a $4.4 million, or
49%, decrease in dividends from the U.S. Asset Management and Accumulation
segment, which reflected a decrease in our block of pension experience rated
business.
Operating expenses increased $409.1 million, or 20%, to $2,479.4 million for the
year ended December 31, 2000, from $2,070.3 million for the year ended December
31, 1999. The increase was primarily due to a $160.2 million, or 76%, increase
from the International Asset Management and Accumulation segment, primarily
resulting from the inclusion of BT Financial Group in our financial results
effective August 1999, including a $23.3 million increase amortization of
goodwill and other intangibles. The increase also reflected a $121.5 million, or
20%, increase from the U.S. Asset Management and Accumulation segment, primarily
due to a change in our assumptions related to amortization of deferred policy
acquisition costs related to pension products and also due to an increase in
pension salary and incentive compensation costs and other pension administrative
expenses. In addition, the increase was due to a $116.0 million increase from
the Corporate and Other segment, primarily related to an increase in our
non-recurring loss contingency reserve for sales practices litigation and
demutualization costs as well as additional interest costs related to private
debt securities and commercial paper issued in connection with our acquisition
of BT Financial Group. The increase was also due to a $39.5 million, or 5%,
increase from the Life and Health Insurance segment, primarily due to expenses
related to our group Medicare supplement business and higher group medical
commissions. The increases were partially offset by a $28.1 million, or 9%,
59
decrease from the Mortgage Banking segment, primarily a result of net gains we
earned on hedges related to our servicing portfolio in 2000.
Income taxes decreased $83.2 million, or 26%, to $240.3 million for the year
ended December 31, 2000, from $323.5 million for the year ended December 31,
1999. The effective income tax rate was 28% for the year ended December 31, 2000
and 30% for the year ended December 31, 1999. The effective income tax rates for
2000 and 1999 were lower than the corporate income tax rate of 35%, primarily
due to income tax deductions allowed for corporate dividends received.
As a result of the foregoing factors, net income decreased $121.9 million, or
16%, to $620.2 million for the year ended December 31, 2000, from $742.1 million
for the year ended December 31, 1999.
For the year ended December 31, 2000, non-recurring items of $101.0 million, net
of tax, included the negative effects of: (1) a loss contingency reserve
established for sales practices litigation ($93.8 million); and (2) expenses
related to our demutualization ($7.2 million).
Operating earnings increased $152.9 million, or 32%, to $628.1 million for the
year ended December 31, 2000, from $475.2 million for the year ended December
31, 1999. The increase resulted from a $71.6 million, or 79%, increase from the
Life and Health Insurance segment, primarily due to improved earnings from our
group medical business. The increase was also due to a $58.2 million increase
from the Corporate and Other segment, primarily due to improved investment
yields and lower expenses due in part to a net recovery of interest expense
related to a successful tax audit appeal. In addition, the increase was due to a
$29.9 million, or 78%, increase from the International Asset Management and
Accumulation segment due to growth in our international operations, due in part
to BT Financial Group, which we acquired in August 1999. Operating earnings from
the U.S. Asset Management and Accumulation segment did not change as increases
in revenues were offset by increases in expenses. These increases were partially
offset by a $6.8 million, or 12%, decrease from the Mortgage Banking segment,
primarily due to a decrease in mortgage loan production earnings, reflecting a
decrease in production volume.
Results of Operations by Segment
We evaluate segment performance by segment operating earnings, which excludes
the effect of net realized capital gains and losses, as adjusted, and
non-recurring events and transactions. Segment operating earnings are determined
by adjusting U.S. GAAP net income for net realized capital gains and losses, as
adjusted, and non-recurring items that we believe are not indicative of overall
operating trends. While these items may be significant components in
understanding and assessing our consolidated financial performance, we believe
the presentation of segment operating earnings enhances the understanding of our
results of operations by highlighting earnings attributable to the normal,
recurring operations of our businesses. However, segment operating earnings are
not a substitute for net income determined in accordance with U.S. GAAP.
The following table presents segment information as of or for the years ended
December 31, 2001, 2000 and 1999:
60
As of or for year ended December 31,
-----------------------------------------------
2001 2000 1999
------------- ------------- -------------
(in millions)
Operating revenues by segment:
U.S. Asset Management and Accumulation................... $ 3,800.0 $ 3,533.9 $ 3,472.6
International Asset Management and Accumulation.......... 734.0 630.7 379.6
Life and Health Insurance................................ 3,946.4 4,122.6 3,985.5
Mortgage Banking......................................... 757.4 359.8 398.3
Corporate and Other(1)................................... 100.8 97.1 61.9
------------- ------------- -------------
Total operating revenues................................. 9,338.6 8,744.1 8,297.9
Net realized capital gains (losses), including
recognition of front-end fee revenues and certain
market value adjustments to fee revenues............... (527.4) 140.8 403.5
Non-recurring interest income(2)......................... 6.3 - -
------------- ------------- -------------
Total consolidated revenues............................ $ 8,817.5 $ 8,884.9 $ 8,701.4
============= ============= =============
Operating earnings (loss) by segment:
U.S. Asset Management and Accumulation .................. $ 353.8 $ 356.6 $ 356.6
International Asset Management and Accumulation.......... (8.9) (8.5) (38.4)
Life and Health Insurance................................ 201.2 162.3 90.7
Mortgage Banking......................................... 126.7 50.0 56.8
Corporate and Other ..................................... 38.1 67.7 9.5
------------- ------------- -------------
Total operating earnings............................... 710.9 628.1 475.2
Net realized capital gains (losses), as adjusted(3)...... (321.0) 93.1 266.9
Non-recurring items(4)................................... (31.1) (101.0) -
------------- ------------- -------------
U.S. GAAP Reported:
Net income............................................. $ 358.8 $ 620.2 $ 742.1
============= ============= =============
U.S. GAAP reported net income (loss) by segment:
U.S. Asset Management and Accumulation .................. $ 178.3 $ 320.7 $ 321.2
International Asset Management and Accumulation.......... (38.1) (7.1) (30.7)
Life and Health Insurance................................ 167.5 209.6 100.8
Mortgage Banking......................................... 126.7 50.0 56.8
Corporate and Other ..................................... (75.6) 47.0 294.0
------------- ------------- -------------
Total net income....................................... $ 358.8 $ 620.2 $ 742.1
============= ============= =============
Total assets by segment:
U.S. Asset Management and Accumulation(5)................ $68,543.8 $65,795.9 $65,096.4
International Asset Management and Accumulation.......... 4,956.9 5,525.9 5,926.8
Life and Health Insurance................................ 10,776.2 10,569.0 10,070.8
Mortgage Banking......................................... 2,718.8 1,556.3 1,737.7
Corporate and Other(6)................................... 1,354.8 957.8 1,121.5
------------- ------------- -------------
Total assets........................................... $88,350.5 $84,404.9 $83,953.2
============= ============= =============
(1) Includes inter-segment eliminations primarily related to internal
investment management fee revenues, commission fee revenues paid to U.S.
Asset Management and Accumulation agents for selling Life and Health
Insurance segment insurance products, and real estate joint venture
rental income. The Corporate and Other segment reported rental income
from real estate joint ventures for office space used by other segments.
(2) For the year ended December 31, 2001, non-recurring interest income
included the positive effect of investment income generated from the
proceeds of our IPO.
(3) Net realized capital gains (losses), as adjusted, are net of tax,
related changes in the amortization pattern of deferred policy
acquisition costs, recognition of front-end fee revenues for sales
charges on pension products and services and certain market value
adjustments to fee revenues.
61
For the year ended December 31,
------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
(in millions)
Net realized capital gains (losses).............. $ (514.0) $ 139.9 $ 404.5
Certain market value adjustments to fee
revenues...................................... (14.9) - -
Recognition of front-end fee revenues............ 1.5 0.9 (1.0)
-------------- -------------- --------------
Net realized capital gains (losses), including
recognition of front-end fee revenues and
certain market value adjustments to fee
revenues.................................... (527.4) 140.8 403.5
Amortization of deferred policy acquisition
costs related to net realized capital gains
(losses)...................................... 18.6 (0.3) 4.4
-------------- -------------- --------------
Net realized capital gains (losses),
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues, net of related
amortization of deferred policy acquisition
costs....................................... (508.8) 140.5 407.9
Income tax effect ............................... 187.8 (47.4) (141.0)
-------------- -------------- --------------
Net realized capital gains (losses), as
adjusted.................................... $ (321.0) $ 93.1 $ 266.9
============== ============== ==============
(4) For the year ended December 31, 2001, non-recurring items of $31.1
million, net of tax, included (a) the negative effects of: (i) expenses
related to our demutualization ($18.6 million); (ii) a cumulative effect
of change in accounting principle related to our implementation of SFAS
133 ($10.7 million); and (iii) an increase to our loss contingency
reserve for sales practices litigation ($5.9 million) and (b) the
positive effect of investment income generated from the proceeds of our
IPO ($4.1 million). For the year ended December 31, 2000, non-recurring
items of $101.0 million, net of tax, included the negative effects of:
(a) a loss contingency reserve established for sales practices
litigation ($93.8 million) and (b) expenses related to our
demutualization ($7.2 million).
(5) U.S. Asset Management and Accumulation assets increased $1.3 billion at
December 31, 2001, primarily due to shares of the Principal Financial
Group stock allocated to a separate account, a result of our
demutualization. Activity of the separate account was reflected in both
separate account assets and separate account liabilities and did not
impact our results of operations.
(6) Includes inter-segment elimination amounts related to internally
generated mortgage loans and an internal line of credit. The U.S. Asset
Management and Accumulation segment and Life and Health Insurance
segment reported mortgage loan assets issued for real estate joint
ventures. These mortgage loans were reported as liabilities in the
Corporate and Other segment. In addition, the Corporate and Other
segment managed a revolving line of credit used by other segments.
U.S. Asset Management and Accumulation Segment
The following table presents certain summary financial data relating to the U.S.
Asset Management and Accumulation segment for the years indicated:
62
For the year ended December 31,
-----------------------------------------------
2001 2000 1999
------------- ------------- -------------
(in millions)
Operating Earnings Data:
Operating revenues(1):
Premiums and other considerations......... $ 766.3 $ 525.4 $ 566.7
Fees and other revenues................... 633.1 704.6 616.2
Net investment income..................... 2,400.6 2,303.9 2,289.7
------------- ------------- -------------
Total operating revenues................ 3,800.0 3,533.9 3,472.6
Expenses:
Benefits, claims and settlement expenses,
including dividends to policyholders....... 2,589.8 2,315.2 2,344.3
Operating expenses........................ 773.9 740.9 626.3
------------- ------------- -------------
Total expenses.......................... 3,363.7 3,056.1 2,970.6
------------- ------------- -------------
Pre-tax operating earnings................. 436.3 477.8 502.0
Income taxes............................... 82.5 121.2 145.4
------------- ------------- -------------
Operating earnings......................... 353.8 356.6 356.6
Net realized capital losses, as adjusted... (164.7) (35.9) (35.4)
Non-recurring items....................... (10.8) - -
------------- ------------- -------------
U.S. GAAP Reported:
Net income................................. $ 178.3 $ 320.7 $ 321.2
============= ============= =============
- --------------------
(1) Excludes net realized capital losses and their impact on recognition of
front-end fee revenues and certain market value adjustments to fee revenues.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums and other considerations increased $240.9 million, or 46%, to $766.3
million for the year ended December 31, 2001, from $525.4 million for the year
ended December 31, 2000. The increase primarily resulted from a $236.5 million
increase in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. Despite a less attractive economic environment in late 2001,
strong sales early in 2001 resulted in increased premiums for the year. Sales
were not as strong late in the year due to poor economic conditions. The premium
income we receive from these contracts fluctuates due to the variability in the
number and size of pension plan terminations in the market, the interest rate
environment and our ability to attract new sales.
Fees and other revenues decreased $71.5 million, or 10%, to $633.1 million for
the year ended December 31, 2001, from $704.6 million for the year ended
December 31, 2000. A decrease of $83.4 million related to a decrease in
surrender charge and market value adjustment revenues from pension products,
primarily due to the declining interest rate environment; a decrease in
recognition of front-end fee revenues due to changes in assumptions consistent
with unlocking of deferred policy acquisition costs during 2001; and a decrease
in fee revenues due to generally poor performance in the equity markets,
resulting in a lower asset base in 2001. A decrease of $7.6 million resulted
from intra-segment eliminations. In addition, a $7.4 million decrease reflected
lower commission fee revenues primarily from sales of variable products and
third-party mutual funds and lower mutual fund fee revenues from a decrease in
mutual fund assets under management. The decreases were partially offset by an
increase of $27.8 million from Principal Capital Management due to commercial
mortgage-backed securitizations.
Net investment income increased $96.7 million, or 4%, to $2,400.6 million for
the year ended December 31, 2001, from $2,303.9 million for the year ended
December 31, 2000. The increase reflects a $1,423.2 million, or 4%, increase in
average invested assets and cash for the segment. The yield on average invested
assets and cash was 7.3% for the years ended December 31, 2001 and 2000.
63
Benefits, claims and settlement expenses, including dividends to policyholders,
increased $274.6 million, or 12%, to $2,589.8 million for the year ended
December 31, 2001, from $2,315.2 million for the year ended December 31, 2000.
An increase of $272.4 million in our pension full-service payout business
reflected the increase in reserves resulting from an increase in sales of single
premium group annuities with life contingencies. An additional $67.1 million
increase from our pension investment-only business related to an increase in
interest credited due to growth in our investment-only business. Partially
offsetting the increases was a $74.6 million decrease in our pension
full-service accumulation business reflecting a decrease in interest credited,
primarily a result of a declining interest rate environment.
Operating expenses increased $33.0 million, or 4%, to $773.9 million for the
year ended December 31, 2001, from $740.9 million for the year ended December
31, 2000. An increase of $36.8 million from Principal Bank resulted primarily
from growth in bank operations. Additionally, an increase of $30.2 million from
Principal Capital Management resulted primarily from an increase in compensation
and recruiting costs due to growth in operations, an increase in depreciation
expense of capitalized system implementation costs, and an increase in
securitization expenses due to an increase in the number of securitization
transactions closed in 2001. The increases were partially offset by an $18.8
million decrease from our pension business due to a decrease in the amortization
of deferred policy acquisition costs from unlocking to reflect changes in
assumptions for equity market performance. The pension expense decrease was
partially offset by increases in expenses for sales and marketing initiatives;
write-off of the remaining goodwill for Trustar, our pension administration only
subsidiary; general growth in operations and amortization of software costs. The
increase in segment operating expenses was also partially offset by a $7.6
million decrease from intra-segment eliminations. Also offsetting the increases
was a $4.4 million decrease from our individual annuity business reflecting
decreases in non-deferrable expenses and amortization of deferred policy
acquisition costs. The amortization of deferred policy acquisition costs was
lower in 2001 as the impact of unlocking the amortization for actual experience
was less in 2001 than in 2000.
Income taxes decreased $38.7 million, or 32%, to $82.5 million for the year
ended December 31, 2001, from $121.2 million for the year ended December 31,
2000. The effective income tax rate for this segment was 19% for the year ended
December 31, 2001, and 25% for the year ended December 31, 2000. The effective
income tax rates for the years ended December 31, 2001 and 2000, were lower than
the corporate income tax rate of 35%, as a result of income tax deductions
allowed for corporate dividends received, for which an estimated benefit
recognition rate increased during 2001 compared to 2000, and other tax-exempt
income.
As a result of the foregoing factors, operating earnings decreased $2.8 million,
or 1%, to $353.8 million for the year ended December 31, 2001, from $356.6
million for the year ended December 31, 2000.
Net realized capital losses, as adjusted, increased $128.8 million to $164.7
million for the year ended December 31, 2001, from $35.9 million for the year
ended December 31, 2000. The increase includes realized capital losses of $62.3
million related to sales and impairments of our investment in Enron and related
entities. These entities are in the process of bankruptcy proceedings. Other
permanent impairments of certain fixed maturity securities were $92.1 million
during the year ended December 31, 2001. The increase also reflects the current
period impact of SFAS 133 for derivatives and fewer real estate sales in the
year ended December 31, 2001, compared to the year ended December 31, 2000. The
increases were partially offset by the positive effects of a change in the
mortgage loan valuation allowance, primarily reflecting the decrease in the
amount invested in commercial mortgage loans.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2001, net income decreased $142.4 million, or
44%, to $178.3 million for the year ended December 31, 2001, from $320.7 million
for the year ended December 31, 2000. Non-recurring items for the year ended
December 31, 2001, had a negative impact on net income of $10.8 million, net of
tax, due to the cumulative effect of accounting change, net of income taxes,
related to our implementation of SFAS 133.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums and other considerations decreased $41.3 million, or 7%, to $525.4
million for the year ended December 31, 2000, from $566.7 million for the year
ended December 31, 1999. The decrease was primarily due to a $43.3 million
decrease in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. The premium income we receive from these contracts fluctuates due
to the variability in the number and size of pension plan terminations in the
market and our ability to attract new sales. This decrease was partially offset
by a $2.0 million increase related to increased sales of our single premium
individual annuities with life contingencies.
64
Fees and other revenues increased $88.4 million, or 14%, to $704.6 million for
the year ended December 31, 2000, from $616.2 million for the year ended
December 31, 1999. The increase was primarily related to a $74.2 million
increase in administrative fee revenues for pension products and services. The
increase in administrative fee revenues reflected an increase in the
amortization of front-end fee revenues, a result of a change in our assumptions
related to amortization of deferred policy acquisition costs attributable to
pension products. We also received higher fee revenues from surrender charges
and pension customer-directed investment transfers, reflecting the higher
interest rate environment and increased customer account activity. The increase
in fee revenues was also due in part to growth in assets under management
related to our pension products in 1999. An increase of $13.0 million was
primarily due to investment management fee revenues from our mutual fund
business and commission fee revenues related to sales of third-party mutual
funds. An increase of $5.6 million in individual annuity fees, primarily a
result of growth in separate account assets related to individual annuity
products, also contributed to the segment increase. The increase in fees and
other revenues was partially offset by a $5.6 million decrease in fee revenues
related to Principal Capital Management, primarily a result of a decrease in
proceeds related to commercial mortgage-backed securitization transactions.
Net investment income increased $14.2 million, or 1%, to $2,303.9 million for
the year ended December 31, 2000, from $2,289.7 million for the year ended
December 31, 1999. The increase was primarily due to a $1,561.6 million, or 5%,
increase in average invested assets and cash for the segment. The yield on
average invested assets and cash was 7.3% for the year ended December 31, 2000,
compared to 7.6% for the year ended December 31, 1999, due to a decrease in
interest credited on assets backing allocated capital. The decrease in interest
credited was partially offset by higher interest rates on fixed income
investments backing product liabilities.
Benefits, claims and settlement expenses, including dividends to policyholders,
decreased $29.1 million, or 1%, to $2,315.2 million for the year ended December
31, 2000, from $2,344.3 million for the year ended December 31, 1999. A decrease
of $26.7 million in benefits and reserve changes, and a $4.5 million decrease in
dividends to policyholders were both related to our full-service pension
accumulation products, reflecting the decrease in our block of pension
experience rated business and an increase in our guaranteed business. An
additional $21.4 million decrease was attributable to decreased sales of single
premium group annuities with life contingencies. Partially offsetting these
decreases was a $19.5 million increase related to our investment-only business,
primarily reflecting an increase in interest credited due to the growth in our
investment-only business. An additional $3.8 million increase was primarily
related to an increase in interest credited on individual fixed annuities and
the fixed component of variable annuities, a result of higher interest crediting
rates during 2000.
Operating expenses increased $114.6 million, or 18%, to $740.9 million for the
year ended December 31, 2000, from $626.3 million for the year ended December
31, 1999. An increase of $57.3 million was primarily due to a change in our
assumptions related to amortization of deferred policy acquisition costs
attributable to pension products. An additional $28.7 million increase was
primarily related to an increase in pension salary and incentive compensation
costs and other pension administrative costs. Operating expenses also increased
$9.7 million for our mutual fund business, primarily the result of increased
sales of third-party mutual funds and also due to other mutual fund operating
expenses. An $8.3 million increase in operating expenses related to our
individual annuity business was primarily due to an increase in amortization of
deferred policy acquisition costs. Additionally, a $6.5 million increase in
operating expenses for Principal Capital Management was primarily related to an
increase in incentive compensation costs.
Income taxes decreased $24.2 million, or 17%, to $121.2 million for the year
ended December 31, 2000, from $145.4 million for the year ended December 31,
1999. The effective income tax rate for this segment was 25% for the year ended
December 31, 2000, and 29% for the year ended December 31, 1999. The effective
income tax rates were lower than the corporate income tax rate of 35%, primarily
due to income tax deductions allowed for corporate dividends received and other
tax-exempt income.
As a result of the foregoing factors, operating earnings were $356.6 million for
the years ended December 31, 2000 and 1999.
Net realized capital losses, as adjusted, increased to $35.9 million for the
year ended December 31, 2000, from $35.4 million for the year ended December 31,
1999. This segment recognized net realized capital losses consistent with our
change in investment philosophy, which increased portfolio activity. We
repositioned the investment portfolio to maximize operating investment returns
by selling lower yielding fixed income securities to allow for reinvestment in
higher yielding fixed income securities. This repositioning of the portfolio
generated net realized capital losses.
65
As a result of the foregoing factors, net income decreased to $320.7 million for
the year ended December 31, 2000, from $321.2 million for the year ended
December 31, 1999.
International Asset Management and Accumulation Segment
The following table presents certain summary financial data relating to the
International Asset Management and Accumulation segment for the years indicated:
For the year ended December 31,
-----------------------------------------------
2001 2000 1999
------------- ------------- -------------
(in millions)
Operating Earnings Data:
Operating revenues(1):
Premiums and other considerations.................. $ 344.9 $ 220.5 $ 179.9
Fees and other revenues............................ 260.1 305.2 105.6
Net investment income.............................. 129.0 105.0 94.1
------------- ------------- -------------
Total operating revenues........................ 734.0 630.7 379.6
Expenses:
Benefits, claims and settlement expenses........... 407.5 262.2 210.1
Operating expenses................................. 342.4 372.3 212.1
------------- ------------- -------------
Total expenses.................................. 749.9 634.5 422.2
------------- ------------- -------------
Pre-tax operating loss............................... (15.9) (3.8) (42.6)
Income taxes (benefits).............................. (7.0) 4.7 (4.2)
------------- ------------- -------------
Operating loss....................................... (8.9) (8.5) (38.4)
Net realized capital gains (losses), as adjusted..... (29.2) 1.4 7.7
Non-recurring items.................................. - - -
------------- ------------- -------------
U.S. GAAP Reported:
Net loss............................................. $ (38.1) $ (7.1) $ (30.7)
============= ============= =============
Other Data:
Operating earnings (loss):
Principal International.......................... $ 5.9 $ (14.8) $ (33.6)
BT Financial Group............................... (14.8) 6.3 (4.8)
Operating earnings (loss) before amortization of
goodwill and other intangibles:
Principal International.......................... $ 14.3 $ (3.9) $ (31.3)
BT Financial Group............................... 11.9 32.4 6.7
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on recognition
of front-end fee revenues and certain market value adjustments to fee
revenues.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums and other considerations increased $124.4 million, or 56%, to $344.9
million for the year ended December 31, 2001, from $220.5 million for the year
ended December 31, 2000. An increase of $166.4 million in Mexico was the result
of increased sales of single premium annuities with life contingencies,
primarily resulting from the sale of a large group annuity contract. The
increase was partially offset by the loss of $36.4 million of premiums and other
considerations due to the February 2001 divestiture of our operations in Spain.
Fees and other revenues decreased $45.1 million, or 15%, to $260.1 million for
the year ended December 31, 2001, from $305.2 million for the year ended
December 31, 2000. A decrease of $61.7 million of fee revenues contributed by BT
Financial Group resulted from declining assets under management for the year
ended December 31, 2001, the weakening of the Australian dollar versus the U.S.
dollar and divestiture of non-core businesses in 2001. The decrease was
66
partially offset by a $16.6 million increase in Principal International fee
revenues, primarily a result of an increase in the number of retirement plan
participants in Mexico and deposits growth in Hong Kong resulting from sales to
plans established under the new Mandatory Provident Fund that started in
December 2000.
Net investment income increased $24.0 million, or 23%, to $129.0 million for the
year ended December 31, 2001, from $105.0 million for the year ended December
31, 2000. An increase of $36.1 million from Principal International related to a
21% increase in average invested assets and cash and an increase in investment
yields. The yield on average invested assets and cash was 9.6% for the year
ended December 31, 2001, compared to 8.0% for the year ended December 31, 2000.
The increase in investment yields was partially due to the impact of inflation
on nominal yields in Chile, which was offset by a corresponding increase in
reserve changes. The increase in net investment income was partially offset by
the $8.7 million loss of net investment income resulting from the divestiture of
our operations in Spain and a $2.7 million decrease related to BT Financial
Group.
Benefits, claims and settlement expenses increased $145.3 million, or 55%, to
$407.5 million for the year ended December 31, 2001, from $262.2 million for the
year ended December 31, 2000. An increase in reserve changes and policy and
contract benefit payments of $171.6 million in Mexico was primarily the result
of the sale of a large group annuity contract with life contingencies. An
increase of $15.1 million in Chile primarily related to an increase in reserve
changes to reflect the impact of inflation adjustments. The increases were
partially offset by the loss of $43.8 million of benefits, claims and settlement
expenses resulting from the divestiture of our operations in Spain.
Operating expenses decreased $29.9 million, or 8%, to $342.4 million for the
year ended December 31, 2001, from $372.3 million for the year ended December
31, 2000. Operating expenses incurred by BT Financial Group decreased $26.6
million, primarily resulting from the weakening of the Australian dollar versus
the U.S. dollar. In addition, staff restructuring efforts undertaken to reduce
ongoing operating expenses resulted in a 37% decrease of staff levels and a
resulting decrease in salary and incentive costs. The decreases were partially
offset by an increase in costs associated with the restructuring efforts and an
increase in amortization of goodwill and other intangibles.
Income tax expense (benefits) decreased $11.7 million to a $7.0 million income
tax benefit for the year ended December 31, 2001, from $4.7 million of income
tax expense for the year ended December 31, 2000. A $16.7 million decrease was
primarily due to a decrease in pre-tax operating earnings from BT Financial
Group. The decrease was offset by a $5.0 million increase primarily due to an
increase in pre-tax operating earnings from Principal International.
As a result of the foregoing factors, operating loss increased $0.4 million, or
5%, to $8.9 million for the year ended December 31, 2001, from $8.5 million for
the year ended December 31, 2000.
Net realized capital gains (losses), as adjusted, decreased $30.6 million to
$29.2 million of net realized capital losses for the year ended December 31,
2001, from $1.4 million of net realized capital gains for the year ended
December 31, 2000. The decrease was primarily due to a $21.0 million after-tax
net realized capital loss on the February 2001 sale of our operations in Spain.
In addition, a $13.9 million decrease related to losses resulting from the
permanent impairment of certain fixed maturity securities in Argentina.
As a result of the foregoing factors, net loss increased $31.0 million to $38.1
million for the year ended December 31, 2001, from $7.1 million for the year
ended December 31, 2000.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums and other considerations increased $40.6 million, or 23%, to $220.5
million for the year ended December 31, 2000, from $179.9 million for the year
ended December 31, 1999. Increases of $16.9 million in Mexico, $16.7 million in
Argentina and $5.9 million in Chile were primarily a result of increased sales
of single premium annuities with life contingencies. The increased sales in
Mexico were primarily a result of sales by Principal Pensiones, S.A. de C.V., an
annuity company we established in July 1999. The increased sales in Argentina
primarily resulted from sales by an annuity company we established in August
1999.
Fees and other revenues increased $199.6 million to $305.2 million for the year
ended December 31, 2000, from $105.6 million for the year ended December 31,
1999. The increase was primarily related to a $180.2 million increase resulting
from the contribution of fee revenues by BT Financial Group, which we acquired
in August 1999. In addition, an $8.1 million increase was primarily due to lower
fees and other revenues recognized for the year ended December 31, 1999, related
to El Roble in Chile. An additional $6.5 million increase was primarily
attributable to higher fee revenues from administering retirement funds in
67
Mexico, due to the implementation of a more attractive pricing structure for our
customers, which also resulted in increased retention of existing accounts and
an increased number of covered lives.
Net investment income increased $10.9 million, or 12%, to $105.0 million for the
year ended December 31, 2000, from $94.1 million for the year ended December 31,
1999. An $11.3 million increase was primarily attributable to an increase in
average invested assets in Principal International. In addition, an $11.2
million increase resulted from our equity method investment gains related to our
pro rata share of net income, excluding the effect of goodwill amortization, of
BrasilPrev Previdencia Privada S.A., a pension company in Brazil in which we
acquired a minority interest in October 1999. The increases were partially
offset by an $8.7 million decrease related to the inclusion of BT Financial
Group, primarily related to its margin lending business. The margin lending
business was securitized in late 1999, which resulted in a shift of income
generation from net investment income to fee revenues in 2000. The increases
were also partially offset by a $3.1 million equity method investment loss
related to our pro rata share of net loss of ING/Principal Pensions Co., Ltd., a
pension company in Japan in which we acquired a minority interest in January
2000.
Benefits, claims and settlement expenses increased $52.1 million, or 25%, to
$262.2 million for the year ended December 31, 2000, from $210.1 million for the
year ended December 31, 1999. The increase was primarily due to an increase in
reserve changes and policy and contract benefit payments of $18.5 million in
Mexico and $18.4 million in Argentina, the result of increased sales of single
premium annuities with life contingencies. In addition, a $13.4 million increase
in reserve changes and policy and contract benefit payments in Chile primarily
resulted from the increased sales of annuity products and the implementation of
a new reserve calculation method to refine reserve calculations.
Operating expenses increased $160.2 million, or 76%, to $372.3 million for the
year ended December 31, 2000, from $212.1 million for the year ended December
31, 1999. The increase was primarily due to a $151.1 million increase resulting
from the inclusion of operating expenses incurred by BT Financial Group,
including a $23.3 million increase in amortization of goodwill and other
intangibles. The increase also included $6.0 million of amortization of goodwill
and present value of future profits related to BrasilPrev, which we acquired in
October 1999.
Income tax expense (benefits) increased $8.9 million to $4.7 million of income
tax expense for the year ended December 31, 2000, from a $4.2 million income tax
benefit for the year ended December 31, 1999. The increase was primarily due to
$9.1 million of income tax expense related to an increase in pre-tax operating
earnings from BT Financial Group.
As a result of the foregoing factors, operating loss decreased $29.9 million, or
78%, to $8.5 million for the year ended December 31, 2000, from $38.4 million
for the year ended December 31, 1999.
Net realized capital gains, as adjusted, decreased $6.3 million, or 82%, to $1.4
million for the year ended December 31, 2000, from $7.7 million for the year
ended December 31, 1999. The decrease was primarily due to a $4.7 million
decrease in net realized capital gains in Principal International, resulting
from repositioning of investment portfolios to better match long-term
liabilities and assets for the year ended December 31, 1999. In addition, net
realized capital gains, as adjusted, in 1999 included a $1.7 million gain on the
sale of minority interest in a capital management company, which was sold
following the acquisition of BT Financial Group.
As a result of the foregoing factors, net loss decreased $23.6 million, or 77%,
to $7.1 million for the year ended December 31, 2000, from $30.7 million for the
year ended December 31, 1999.
Life and Health Insurance Segment
The following table presents certain summary financial data relating to the Life
and Health Insurance segment for the years indicated:
68
For the year ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
(in millions)
Operating Earnings Data:
Operating Revenues(1):
Premiums and other considerations........... $3,011.1 $3,250.5 $3,190.6
Fees and other revenues..................... 256.7 230.0 180.2
Net investment income....................... 678.6 642.1 614.7
-------- -------- --------
Total operating revenues.................. 3,946.4 4,122.6 3,985.5
Expenses:
Benefits, claims and settlement expenses.... 2,491.0 2,659.4 2,714.9
Dividends to policyholders.................. 307.0 308.1 295.6
Operating expenses.......................... 842.7 913.6 872.0
-------- -------- --------
Total expenses............................ 3,640.7 3,881.1 3,882.5
-------- -------- --------
Pre-tax operating earnings.................... 305.7 241.5 103.0
Income taxes.................................. 104.5 79.2 12.3
-------- -------- --------
Operating earnings............................ 201.2 162.3 90.7
Net realized capital gains (losses),
as adjusted................................. (33.8) 47.3 10.1
Non-recurring items........................... 0.1 - -
-------- -------- --------
U.S. GAAP Reported:
Net income.................................... $ 167.5 $ 209.6 $ 100.8
======== ======== ========
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on recognition
of front-end fee revenues and certain market value adjustments to fee
revenues.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Premiums and other considerations decreased $239.4 million, or 7%, to $3,011.1
million for the year ended December 31, 2001, from $3,250.5 million for the year
ended December 31, 2000. Group Medicare supplement insurance premiums decreased
$98.4 million, resulting from our decision to reinsure 100% of this business
effective July 1, 2000. Group medical premium rate increases in 2000 led to
increased lapses and lower sales, which resulted in a $95.0 million decrease in
premiums. Group life insurance premiums decreased $55.8 million, primarily due
to the loss of two large customers and, to a lesser extent, a result of declines
in sales during 2001 as we transitioned to a newly established dedicated
non-medical sales force. Group life sales also decreased as a result of pricing
actions on our group medical business, as these products are often sold
together. Increases in group dental premiums of $11.3 million partially offset
the declines in other products. The increases were primarily due to a larger
membership base early in the year due to an increase in sales in 2000 and also
due to increases in dental premium rates.
Fees and other revenues increased $26.7 million, or 12%, to $256.7 million for
the year ended December 31, 2001, from $230.0 million for the year ended
December 31, 2000. Fee revenues from our group fee-for-service business
increased $23.6 million, primarily due to growth in that business and, to a
lesser extent, increases in fee rates. Fee revenues from individual
interest-sensitive life insurance products increased $10.5 million, a result of
continued growth in that business. The growth reflected a continued shift in
customer preference from individual traditional life insurance products to
individual universal life and individual variable universal life insurance
products. The increases were partially offset by a $6.8 million decrease in
individual traditional life insurance fee revenues, primarily related to
classifying fees from reinsurance ceded for traditional life insurance as
operating expenses. The fees from reinsurance were previously reported as fee
revenues.
Net investment income increased $36.5 million, or 6%, to $678.6 million for the
year ended December 31, 2001, from $642.1 million for the year ended December
31, 2000. The increase was primarily due to a $265.1 million, or 3%, increase in
69
average invested assets and cash for the segment. Net investment income also
increased due to an increase in average investment yields for the segment. The
yield on average invested assets and cash was 7.6% for the year ended December
31, 2001, compared to 7.4% for the year ended December 31, 2000.
Benefits, claims and settlement expenses decreased $168.4 million, or 6%, to
$2,491.0 million for the year ended December 31, 2001, from $2,659.4 million for
the year ended December 31, 2000. Group medical insurance benefits, claims and
settlement expenses decreased $61.1 million, due to a reduction in business and
to improved claim experience, partially offset by reserve releases during the
year ended December 31, 2000. Group Medicare supplement insurance benefits,
claims and settlement expenses decreased $59.3 million, resulting from our
decision to reinsure 100% of this business effective July 1, 2000. Group life
insurance benefits, claims and settlement expenses decreased $48.0 million due
to the loss of two large customers and an overall decline in business.
Individual disability benefits, claims and settlement expenses decreased $29.8
million, primarily a result of claim reserve strengthening during 2000.
Dividends to policyholders decreased $1.1 million to $307.0 million for the year
ended December 31, 2001, from $308.1 million for the year ended December 31,
2000. The decrease was primarily a result of a change in methodology of
estimating dividends. Additionally, the dividends in the Closed Block were
reduced due to accumulated experience losses.
Operating expenses decreased $70.9 million, or 8%, to $842.7 million for the
year ended December 31, 2001, from $913.6 million for the year ended December
31, 2000. Group life and health insurance operating expenses decreased $57.5
million, primarily due to our decision to reinsure 100% of our group Medicare
supplement insurance business effective July 1, 2000, and due to expense
management in response to an overall decline in group life and health insurance
business. Individual life and disability insurance operating expenses decreased
$13.4 million primarily due to a decrease in commission expense resulting from
classifying fees from reinsurance ceded for traditional life insurance as
operating expenses. The fees from reinsurance were previously reported as fee
revenues. Operating expenses also decreased due to unlocking of individual
disability insurance deferred policy acquisition costs in 2000, a result of
changes in profitability assumptions. The decreases were partially offset by
lower capitalization of deferred policy acquisition costs related to lower sales
of individual life insurance.
Income taxes increased $25.3 million, or 32%, to $104.5 million for the year
ended December 31, 2001, from $79.2 million for the year ended December 31,
2000. The effective income tax rate for the segment was 34% for the year ended
December 31, 2001, and 33% for the year ended December 31, 2000. The effective
income tax rate for the year ended December 31, 2001, was lower than the
corporate income tax rate of 35% primarily due to tax-exempt income. The
effective income tax rate for the year ended December 31, 2000, was lower than
the corporate income tax rate of 35%, primarily due to tax-exempt income and a
reduction in a tax reserve as a result of a favorable IRS audit event.
As a result of the foregoing factors, operating earnings increased $38.9
million, or 24%, to $201.2 million for the year ended December 31, 2001, from
$162.3 million for the year ended December 31, 2000.
Net realized capital gains (losses), as adjusted, decreased $81.1 million to
$33.8 million of net realized capital losses for the year ended December 31,
2001, from $47.3 million of net realized capital gains for the year ended
December 31, 2000. The decrease primarily related to the sale of our investment
in United Payors and United Providers. In 2000, we sold our remaining investment
and realized an after-tax capital gain of $58.9 million. To a lesser extent, the
decrease was due to an increase in losses from permanent impairments of fixed
maturity securities during 2001, including $16.6 million of net realized capital
losses related to our investment in Enron and related entities.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2001, net income decreased $42.1 million, or
20%, to $167.5 million for the year ended December 31, 2001, from $209.6 million
for the year ended December 31, 2000. Non-recurring items for the year ended
December 31, 2001, had a positive impact on net income of $0.1 million, net of
tax, due to the cumulative effect of accounting change, net of income taxes,
related to our implementation of SFAS 133.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Premiums and other considerations increased $59.9 million, or 2%, to $3,250.5
million for the year ended December 31, 2000, from $3,190.6 million for the year
ended December 31, 1999. Group dental insurance premiums increased $72.3
million, primarily resulting from increased sales of group dental insurance
products. Group medical premiums increased $38.3 million, primarily related to
an increase in the premium base due to increased sales in late 1999, and
70
significant group medical premium rate increases. Also contributing to the
increase was a $9.6 million increase in individual disability insurance premiums
due to continued growth in sales. Group disability insurance premiums increased
$8.4 million due to an increase in long-term disability covered members and an
increase in short-term disability premium per member. These increases were
partially offset by a $66.2 million decrease in group Medicare supplement
premium, resulting from our decision to cease new sales of group Medicare
supplement insurance in January 2000 and our decision to reinsure 100% of this
business effective July 1, 2000.
Fees and other revenues increased $49.8 million, or 28%, to $230.0 million for
the year ended December 31, 2000, from $180.2 million for the year ended
December 31, 1999. Fee revenues from individual interest-sensitive life
insurance products increased $27.4 million, a result of growth in that block of
business. The growth reflects a continued shift in customer preference from
individual traditional life insurance products to individual universal life and
individual variable life insurance products. Fee revenues from our group
fee-for-service business increased $20.3 million, primarily due to increases in
members and fees.
Net investment income increased $27.4 million, or 4%, to $642.1 million for the
year ended December 31, 2000, from $614.7 million for the year ended December
31, 1999. The increase was primarily due to a $483.9 million, or 6%, increase in
average invested assets and cash for the segment. The increase in net investment
income due to asset growth was partially offset by a decrease in average
investment yields for the segment. The yield on average invested assets and cash
was 7.4% for the year ended December 31, 2000, compared to 7.5% for the year
ended December 31, 1999, due to a decrease in interest credited on assets
backing allocated capital. The decrease in interest credited was partially
offset by higher interest rates on fixed income investments backing product
liabilities.
Benefits, claims and settlement expenses decreased $55.5 million, or 2%, to
$2,659.4 million for the year ended December 31, 2000, from $2,714.9 million for
the year ended December 31, 1999. Group medical insurance benefits claims and
settlement expenses decreased $108.6 million, primarily resulting from the
release of claim reserves established in 1999. The claim reserves were
established in 1999 as a result of poor claim experience during the year and an
expectation that claims would continue to increase through the second quarter of
2000. This decrease was partially offset by an increase in claims due to rising
medical costs. Benefits, claims and settlement expenses also decreased $102.8
million for group Medicare supplement insurance, as a result of our reinsuring
this business effective July 1, 2000, improved claim experience during the first
half of the year and the release of reserves established in 1999, for the same
reasons previously described for our group medical business. These decreases
were partially offset by a $56.1 million increase in group dental benefits,
claims and settlement expenses, primarily due to growth in that block of
business. Individual disability insurance claims and reserves increased $49.5
million, primarily due to less favorable morbidity experience and related
increases in reserves for claims and incurred but not reported claims.
Individual interest-sensitive life insurance benefits and claims increased $40.2
million, primarily due to an increase in both interest credited and mortality
costs, primarily resulting from growth in the block of business and reserve
adjustments. Group disability claims and reserves increased $9.5 million,
primarily a result of less favorable morbidity experience and an increase in
covered members.
Dividends to policyholders increased $12.5 million, or 4%, to $308.1 million for
the year ended December 31, 2000, from $295.6 million for the year ended
December 31, 1999. The increase was due to increased dividends on traditional
individual life insurance products, a result of a maturing in-force block.
Operating expenses increased $41.6 million, or 5%, to $913.6 million for the
year ended December 31, 2000, from $872.0 million for the year ended December
31, 1999. Group life and health insurance operating expenses increased $26.0
million, primarily due to expenses related to our group Medicare supplement
business, and a write-down of goodwill related to group Medicare supplement
insurance. Group life and health insurance operating expenses also increased due
to an increase in commissions, resulting from higher commission scales, an
increase in premium, and settlements with wholesale distributors related to
discontinued group health business. These increases were offset by a decrease in
general expenses related to both our group medical and group Medicare supplement
insurance products. Individual life and disability insurance operating expenses
also increased $15.6 million, primarily due to an increase in amortization of
deferred policy acquisition costs related to individual disability insurance.
Income taxes increased $66.9 million to $79.2 million for the year ended
December 31, 2000, from $12.3 million for the year ended December 31, 1999. The
effective income tax rate for this segment was 33% for the year ended December
31, 2000 and 12% for the year ended December 31, 1999. The effective income tax
rate for 2000 was lower than the corporate income tax rate of 35% due to
tax-exempt income. The effective income tax rate for 1999 was lower than the
corporate income tax rate of 35%, primarily resulting from overestimated
deferred taxes related to health insurance reserves in 1998, the effects of
which were reversed in 1999 and also due to tax-exempt income.
71
As a result of the foregoing factors, operating earnings increased $71.6
million, or 79%, to $162.3 million for the year ended December 31, 2000, from
$90.7 million for the year ended December 31, 1999.
Net realized capital gains, as adjusted, increased $37.2 million to $47.3
million for the year ended December 31, 2000, from $10.1 million for the year
ended December 31, 1999. The increase was primarily due to net realized capital
gains, as adjusted, related to the sale of our investment in United Payors and
United Providers. We sold a portion of our investment in 1999, realizing an
after-tax capital gain of $17.9 million. In 2000, we sold our remaining
investment and realized an after-tax capital gain of $58.9 million. The increase
in capital gains was partially offset by a $2.3 million increase in net realized
capital losses on sales of fixed income securities, as a result of our
investment portfolio repositioning strategy to sell lower yielding fixed income
securities to allow for reinvestment in higher yielding fixed income securities.
As a result of the foregoing factors, net income increased $108.8 million, or
108%, to $209.6 million for the year ended December 31, 2000, from $100.8
million for the year ended December 31, 1999.
Mortgage Banking Segment
The following table presents certain summary financial data relating to the
Mortgage Banking segment for the years indicated:
For the year ended
December 31,
---------------------------
2001 2000 1999
------- ------- -------
(in millions)
Operating Earnings Data:
Operating Revenues(1):
Loan servicing......................... $ 403.0 $ 313.8 $ 286.5
Loan production........................ 354.4 46.0 111.8
------- ------- -------
Total operating revenues............ 757.4 359.8 398.3
Expenses:
Loan servicing......................... 407.3 215.3 241.3
Loan production........................ 145.0 67.4 69.5
------- ------- -------
Total expenses...................... 552.3 282.7 310.8
------- ------- -------
Pre-tax operating earnings............... 205.1 77.1 87.5
Income taxes............................. 78.4 27.1 30.7
------- ------- -------
Operating earnings....................... 126.7 50.0 56.8
Net realized capital gains (losses), as
adjusted.............................. - - -
Non-recurring items...................... - - -
------- ------- -------
U.S. GAAP Reported:
Net income............................... $ 126.7 $ 50.0 $ 56.8
======= ======= =======
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Total operating revenues increased $397.6 million to $757.4 million for the year
ended December 31, 2001, from $359.8 million for the year ended December 31,
2000. A $308.4 million increase in mortgage loan production revenues reflects
the increase in mortgage loan production volume during the year ended December
31, 2001. In addition, an increase of $89.2 million in mortgage loan servicing
revenues reflects the growth in the mortgage loan servicing portfolio. The
decline in interest rates in 2001 resulted in mortgage loan production of $37.8
billion for the year ended December 31, 2001, compared to $8.3 billion for the
same period a year ago. The average balance of the servicing portfolio was $65.8
billion for the year ended December 31, 2001, compared to $52.6 billion for the
same period a year ago.
72
Total expenses increased $269.6 million, or 95%, to $552.3 million for the year
ended December 31, 2001, from $282.7 million for the year ended December 31,
2000. A $192.0 million increase in mortgage loan servicing expenses was
primarily a result of an impairment of capitalized mortgage loan servicing
rights and, to a lesser extent, due to growth in the mortgage loan servicing
portfolio. The impairment was partially offset by an increase in net gains on
servicing hedge activity recognized in the year ended December 31, 2001,
compared to the year ended December 31, 2000. Mortgage loan production expenses
increased $77.6 million, reflecting the increase in mortgage loan production
volume.
Income taxes increased $51.3 million to $78.4 million for the year ended
December 31, 2001, from $27.1 million for the year ended December 31, 2000. The
effective income tax rate for this segment was 38% for the year ended December
31, 2001, and 35% for the year ended December 31, 2000. The effective income tax
rate for the year ended December 31, 2001, was higher that the corporate income
tax rate of 35% due to the allocation of deferred state taxes, relating to both
current and prior years, recorded in 2001. This allocation will increase the
effective income tax rate for this segment to 37% for future reporting periods.
As a result of the foregoing factors, operating earnings and net income
increased $76.7 million to $126.7 million for the year ended December 31, 2001,
from $50.0 million for the year ended December 31, 2000.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Total operating revenues decreased $38.5 million, or 10%, to $359.8 million for
the year ended December 31, 2000, from $398.3 million for the year ended
December 31, 1999. The decrease was primarily due to a $65.8 million decrease in
mortgage loan production revenues, reflecting the decrease in mortgage loan
production volume during 2000. The decrease in total revenues was partially
offset by a $27.3 million increase in mortgage loan servicing revenues,
primarily due to growth in the average balance of the mortgage loan servicing
portfolio. Additionally, an increase in mortgage loan servicing fee revenues was
the result of the sale of mortgage loan servicing rights, representing
approximately $1.0 billion from the mortgage loan servicing portfolio, as part
of our mortgage loan servicing strategy.
Total expenses decreased $28.1 million, or 9%, to $282.7 million for the year
ended December 31, 2000, from $310.8 million for the year ended December 31,
1999. The decrease was primarily due to a $26.0 million decrease in expenses
related to mortgage loan servicing, primarily a result of net gains we earned on
hedges related to our servicing portfolio in 2000. In the second quarter of
2000, we shifted our servicing hedge portfolio from U.S. Treasury-related
instruments to London Inter-Bank Offer Rate based hedges including swaps and
swaptions, which resulted in net gains of $10.2 million. The decrease was also
due to a $2.1 million decrease in mortgage loan production expenses related to
the decrease in mortgage loan production volume during 2000.
Income taxes decreased $3.6 million, or 12%, to $27.1 million for the year ended
December 31, 2000, from $30.7 million for the year ended December 31, 1999. The
effective income tax rate for this segment was 35% for the years ended December
31, 2000 and 1999.
As a result of the foregoing factors, operating earnings and net income
decreased $6.8 million, or 12%, to $50.0 million for the year ended December 31,
2000, from $56.8 million for the year ended December 31, 1999.
Corporate and Other Segment
The following table presents certain summary financial data relating to the
Corporate and Other segment for the years indicated:
73
For the year ended
December 31,
-------------------------
2001 2000 1999
------- ------- -------
(in millions)
Operating Earnings Data:
Operating Revenues(1):
Total operating revenues...................... $ 100.8 $ 97.1 $ 61.9
Expenses:
Total expenses................................ 43.3 14.4 54.1
------- ------- -------
Pre-tax operating earnings......................... 57.5 82.7 7.8
Income taxes (benefits)............................ 19.4 15.0 (1.7)
------- ------- -------
Operating earnings................................. 38.1 67.7 9.5
Net realized capital gains (losses), as adjusted... (93.3) 80.3 284.5
Non-recurring items................................ (20.4) (101.0) -
------- ------- -------
U.S. GAAP Reported:
Net income (loss).................................. $ (75.6) $ 47.0 $ 294.0
======= ======= =======
- --------------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Total operating revenues increased $3.7 million, or 4%, to $100.8 million for
the year ended December 31, 2001, from $97.1 million for the year ended December
31, 2000. Net investment income increased $14.0 million, reflecting an increase
in average invested assets and cash. In addition, inter-segment eliminations
included in this segment resulted in a $1.7 million increase, which was offset
by a corresponding change in total expenses. The increases were partially offset
by an $11.2 million decrease in net investment income due to a decrease in
average investment yields for the segment.
Total expenses increased $28.9 million to $43.3 million for the year ended
December 31, 2001, from $14.4 million for the year ended December 31, 2000.
Interest expense increased $32.3 million, primarily due to a net recovery in
2000 of previously paid interest related to a successful tax audit appeal. An
increase of $6.8 million related to the write-off of a non-invested asset.
Interest expense on short-term borrowings increased $3.1 million. Inter-segment
eliminations included in this segment resulted in a $1.7 million increase. The
increases were partially offset by a $9.3 million decrease of interest expense
as a result of extinguishment of commercial real estate debt on home office
properties. In addition, interest expense on private debt securities and
commercial paper issued in connection with the acquisition of BT Financial Group
decreased $5.9 million, a result of the impact of the weakening of the
Australian dollar versus the U.S. dollar and repayment of the commercial paper.
Income tax expense increased $4.4 million, or 29%, to $19.4 million for the year
ended December 31, 2001, from $15.0 million for the year ended December 31,
2000. The effective income tax rates for this segment were 34% for the year
ended December 31, 2001, and 18% for the year ended December 31, 2000. The
effective income tax rate for 2001 was lower than the corporate income tax rate
of 35% primarily due to tax-exempt income, which was partially offset by an
increase in income tax reserves established for contested IRS tax audit matters.
The effective income tax rate for 2000 was lower than the corporate income tax
rate of 35% primarily due to tax-exempt income, and, to a lesser extent, due to
a decrease in income tax reserves established for contested IRS tax audit
matters.
As a result of the foregoing factors, operating earnings decreased $29.6
million, or 44%, to $38.1 million for the year ended December 31, 2001, from
$67.7 million for the year ended December 31, 2000.
Net realized capital gains (losses), as adjusted, decreased $173.6 million to
$93.3 million of net realized capital losses for the year ended December 31,
2001, from $80.3 million of net realized capital gains for the year ended
December 31, 2000. The decrease was primarily due to an increase in net realized
74
capital losses for the year ended December 31, 2001, on sales of equity
securities and real estate. The decrease included $10.5 million of net realized
capital losses related to our investment in Enron and related entities.
As a result of the foregoing factors and the inclusion of non-recurring items,
net loss increased $122.6 million to a net loss of $75.6 million for the year
ended December 31, 2001, from $47.0 million of net income for the year ended
December 31, 2000. For the year ended December 31, 2001, net income included the
effect of non-recurring items totaling $20.4 million, net of tax, related to:
(1) the negative effects of (a) expenses of our demutualization ($18.6 million)
and (b) an increase in our loss contingency reserve for sales practices
litigation ($5.9 million) and (2) the positive effect of investment income
generated from the proceeds of our IPO ($4.1 million). For the year ended
December 31, 2000, net income included the negative effect of non-recurring
items totaling $101.0 million, net of tax, related to: (1) a loss contingency
reserve established for sales practices litigation ($93.8 million) and (2)
expenses of our demutualization ($7.2 million).
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Total operating revenues increased $35.2 million, or 57%, to $97.1 million for
the year ended December 31, 2000, from $61.9 million for the year ended December
31, 1999. Net investment income increased $71.0 million, as a result of improved
investment yields for the segment. The increase was partially offset by an $11.5
million decrease in net investment income, reflecting a reduction in average
invested assets, primarily due to the sale of invested assets in 1999 to
partially fund the acquisition of BT Financial Group. The increase in total
revenues was also partially offset by a $9.0 million decrease related to a
change in inter-segment eliminations included in this segment, which was offset
by a corresponding change in total expenses. In addition, the increase was also
partially offset by an $8.5 million decrease in fees and other revenues,
primarily related to the termination of a reinsurance and participation
agreement under which we continued to receive fee revenues in 1999, but not in
2000. Net investment income also decreased $5.0 million related to our pro rata
share of net loss of HealthExtras, Inc., a company in which we hold a minority
interest.
Total expenses decreased $39.7 million, or 73%, to $14.4 million for the year
ended December 31, 2000, from $54.1 million for the year ended December 31,
1999. Interest expense related to IRS tax audit matters decreased $40.8 million,
primarily due to a net recovery of previously paid interest related to a
successful tax audit appeal. Expenses also decreased $33.2 million due to the
cessation of interim service agreements with Coventry at the end of 1999. A $9.0
million decrease in operating expenses was related to a change in inter-segment
eliminations included in this segment. The decreases were partially offset by
$31.2 million of additional interest expense for the year ended December 31,
2000, on private debt securities and commercial paper issued in connection with
the acquisition of BT Financial Group in August 1999. In addition, a $10.0
million increase was related primarily to corporate initiatives funded by this
segment.
Income tax expense (benefits) increased $16.7 million to $15.0 million of income
tax expense for the year ended December 31, 2000, from a $1.7 million income tax
benefit for the year ended December 31, 1999. The increase was primarily a
result of an increase in pre-tax operating earnings, which included tax-exempt
income. The effective income tax rate for this segment was lower than the
corporate income tax rate of 35% for the years ended December 31, 2000 and 1999
because of tax-exempt income.
As a result of the foregoing factors, operating earnings increased $58.2 million
to $67.7 million for the year ended December 31, 2000, from $9.5 million for the
year ended December 31, 1999.
Net realized capital gains, as adjusted, decreased $204.2 million, or 72%, to
$80.3 million for the year ended December 31, 2000, from $284.5 million for the
year ended December 31, 1999. The decrease was primarily due to decreased sales
of invested assets, primarily equity securities, for the year ended December 31,
2000. We sold a significant portion of our equity securities portfolio in 1999
and 1998 to reduce our exposure to common stock and to realize appreciation.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2000, net income decreased $247.0 million, or
84%, to $47.0 million for the year ended December 31, 2000, from $294.0 million
for the year ended December 31, 1999. For the year ended December 31, 2000, net
income included the negative effect of non-recurring items totaling $101.0
million, net of tax, related to: (1) a loss contingency reserve established for
sales practices litigation ($93.8 million) and (2) expenses of our
demutualization ($7.2 million).
75
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. The primary source of our
liquidity is dividends we receive from Principal Life. We could also receive
dividends from our other subsidiaries, including Princor Financial Services
Corporation, Principal Financial Services (Australia) Inc., Principal
International de Chile, S.A. and PFG do Brasil Ltda; however, given the
historical cash flows of the operations and financial results of these
subsidiaries, it is unlikely we may rely upon them for significant cash flow in
the next year. The payment of dividends by Principal Life to us is limited by
Iowa laws. Under Iowa laws, Principal Life may pay dividends only from the
earned surplus arising from its business and must receive the prior approval of
the Insurance Commissioner of the State of Iowa ("the Commissioner") to pay a
stockholder dividend if such a stockholder dividend would exceed certain
statutory limitations. The current statutory limitation is the greater of:
o 10% of Principal Life's policyholder surplus as of the previous year-end; or
o the net gain from operations from the previous calendar year.
Iowa law gives the Commissioner discretion to disapprove requests for dividends
in excess of these limits. Based on this limitation and 2001 statutory results,
Principal Life could pay approximately $640.3 million in stockholder dividends
in 2002 without exceeding the statutory limitation. Principal Life was able to
pay approximately $760.9 million in statutory dividends in 2001 based on its
2000 statutory financial results without being subject to the restrictions on
payment of extraordinary stockholder dividends.
Total stockholder dividends paid by Principal Life to its parent company in 2001
and 2000 were $734.7 million and $538.8 million, respectively. On February 26,
2002, Principal Life declared an ordinary dividend of $390.0 million payable to
its parent on or about April 5, 2002.
Another source of liquidity is issuance of our common stock. In 2001, net
proceeds from our IPO totaled $1,753.9 million, of which we retained $64.2
million for working capital, payment of dividends, and other general corporate
purposes. The remaining $1,689.7 million was contributed to Principal Life
Insurance Company principally to fund demutualization compensation to
policyholders in the form of policy credits and cash, and to cover certain
expenses related to our demutualization. In addition, net proceeds from the
issuance of additional shares for the exercise of the over-allotment options
granted to the underwriters in the IPO, totaled $265.4 million, all of which we
retained for repurchase of shares issued in the exercise of the over-allotment
options. The repurchase of these shares was approved by the board of directors.
Through December 31, 2001, we purchased the full amount of shares approved by
the board.
In addition to the sources of cash flows previously mentioned, we have various
sources of short-term funding, consisting primarily of commercial paper and
outstanding balances on revolving credit facilities with various financial
institutions. As of December 31, 2001, we have credit facilities with various
financial institutions in an aggregate amount of $1.4 billion. Committed lines
of credit totaling $600.0 million, of which there were no outstanding balances
as of December 31, 2001, also support cash flow requirements. These lines of
credit are available to provide backup of the commercial paper programs. In
addition, we have $780.0 million in credit facilities to finance a commercial
mortgage-backed securities pipeline ("CMBS") and $45.0 million of unused lines
of credit for short-term debt used for general corporate purposes.
Our primary uses of liquidity could include payment of dividends on our common
stock, interest payments and any other payments related to debt servicing,
payment of benefits, claims and settlement expenses and dividends to
policyholders, payment of general operating expenses, contributions to
subsidiaries, acquisitions and the repurchase of our common stock. Any such
repurchases would occur after due consideration and approval by our board of
directors. On February 26, 2002, the company's board of directors authorized
the repurchase of up to $450.0 million of the company's common stock. The
repurchases will be made in the open market or through privately negotiated
transactions from time to time, depending upon market conditions.
Our fundamental business approach is to avoid guarantees or other commitments to
or on behalf of affiliated companies of Principal Financial Group, Inc.
Affiliates are encouraged to operate as autonomously as possible; however, there
are instances where a rated entity within Principal Financial Group, Inc.
provides a guarantee to or on behalf of an affiliate. The guarantees typically
supplement a partially secured transaction, but require the additional
enhancement provided by the guarantee to make the transaction more economical
for our organization.
76
Various businesses throughout our organization have a range of standard
guarantees and commitments to or on behalf of affiliated entities within the
organization in connection with managing the risks of these businesses. We
continually manage liabilities that have any acceleration, additional collateral
support, changes in terms, or creation of additional financial obligations in
our regular liquidity analysis. We have found all of these obligations to be
manageable and do not believe they materially impact our liquidity or capital
resources.
Sources and Uses of Cash of Consolidated Operations
Net cash provided by operating activities was $3,944.8 million and $2,637.3
million for the years ended December 31, 2001 and 2000, respectively. The
increase in net cash provided was due, in part, to: (1) a decrease in cash paid
for operating expenses due to improved expense management and a decrease in
commissions, a result of our decision to reinsure 100% of our group Medicare
supplement insurance business effective July 1, 2000; (2) a decrease in cash
paid for income taxes due to the change in pre-tax operating earnings; and (3) a
decrease in cash paid for benefits, claims, and settlement expenses. The
following also contributed to the increase: (1) an increase in fees and other
revenues, reflecting the increase in mortgage loan production volume; (2) an
increase in net investment income due to an increase in average invested assets
and cash as well as investment yields; and (3) an increase in premiums and other
considerations received primarily due to an increase in premiums from single
premium group annuities with life contingencies. Continuation of the low
interest rate environment and poor performance in the equity markets, could
reduce customer demand for pension, individual annuity, variable investment or
mutual fund products, resulting in reduced cash flows from our subsidiaries'
operations. However, should interest rates rise, we may experience a decrease in
cash flows from residential mortgage loan production.
Net cash used in investing activities was $3,698.4 million and $1,273.3 million
for the years ended December 31, 2001 and 2000, respectively. The decrease in
cash from investing activities was primarily due to a significant increase
during 2001 in the volume of net mortgage loans purchased and sold. Also
contributing to the decrease in cash was an increase in net mortgage loan
servicing rights purchased, also a result of increased mortgage loan production
volume in 2001 and an increase in net cash invested in available-for-sale
securities during 2001 compared to 2000.
Net cash used in financing activities was $549.2 million and $1,006.9 million
for the years ended December 31, 2001 and 2000, respectively. The decrease in
net cash used in financing activities was primarily due to the receipt of net
proceeds from issuance of common stock in conjunction with our IPO and exercise
of the underwriters' over-allotment options, and, to a lesser extent, due to net
proceeds received from short-term borrowings. Partially offsetting the
decreases, were payments made to eligible policyholders as part of our
demutualization, the repurchase of shares of our common stock as approved by our
board of directors, and, to a lesser extent, the repayment of long-term debt in
2001 compared to the issuance of long-term debt in 2000.
Given the historical cash flow of our subsidiaries and the financial results of
these subsidiaries, we believe the cash flow from our consolidated operating
activities over the next year will provide sufficient liquidity for our
operations, as well as satisfy interest payments and any payments related to
debt servicing.
Principal Life
Historically, the principal cash flow sources for Principal Life have been
premiums from life and health insurance products, pension and annuity deposits,
asset management fee revenues, administrative services fee revenues, income from
investments, proceeds from the sales or maturity of investments, long-term debt
and short-term borrowings. Cash outflows consist primarily of payment of
benefits to policyholders and beneficiaries, income and other taxes, current
operating expenses, payment of dividends to policyholders, payments in
connection with investments acquired, payments made to acquire subsidiaries,
payment of dividends to parent, and payments relating to policy and contract
surrenders, withdrawals, policy loans, interest expense and repayment of
short-term borrowings and long-term debt.
Principal Life maintains investment strategies generally intended to provide
adequate funds to pay benefits without forced sales of investments. Products
having liabilities with longer lives, such as life insurance and full-service
payout pension products, are matched with assets having similar estimated lives
such as mortgage loans, long-term bonds and private placement bonds.
Shorter-term liabilities are matched with investments such as short and
medium-term fixed maturities. In addition, highly liquid, high quality
short-term U.S. Treasury securities and other liquid investment grade fixed
maturities are held to fund anticipated operating expenses, surrenders,
withdrawals and development and maintenance expenses associated with new
77
products and technologies. See Item 7A, "Quantitative and Qualitative
Disclosures about Market Risk-Interest Rate Risk" for a discussion of duration
matching.
Our privately placed fixed maturity securities, commercial mortgage loans and
real estate investments are generally less liquid than our publicly traded fixed
maturity securities. As of December 31, 2001 and 2000, these asset classes
represented approximately 49% and 57%, respectively, of the value of our
consolidated invested assets.
Life insurance companies generally produce a positive cash flow from operations,
as measured by the amount by which cash inflows are adequate to meet benefit
obligations to policyholders and normal operating expenses as they are incurred.
The remaining cash flow is generally used to increase the asset base to provide
funds to meet the need for future policy benefit payments and for writing and
acquiring new business. It is important to match the investment portfolio
maturities to the cash flow demands of the type of annuity, investment or
insurance product being provided. Principal Life continuously monitors benefits,
surrenders and maturities to provide projections of future cash requirements. As
part of this monitoring process, Principal Life performs cash flow testing of
many of its assets and liabilities under various scenarios to evaluate the
adequacy of reserves. In developing its investment strategy, Principal Life
establishes a level of cash and securities which, combined with expected net
cash inflows from operations, maturities of fixed maturity investments and
principal payments on mortgage-backed securities and commercial mortgage loans,
are believed adequate to meet anticipated short-term and long-term benefit and
expense payment obligations. There can be no assurance that future experience
regarding benefits and surrenders will be similar to historic experience since
withdrawal and surrender levels are influenced by such factors as the interest
rate environment and the claims paying ability and financial strength ratings of
Principal Life.
Principal Life takes into account asset-liability management considerations in
the product development and design process. Contract terms of 96% and 97% of
Principal Life's interest-sensitive products as of December 31, 2001 and 2000,
respectively, include surrender and withdrawal provisions which mitigate the
risk of losses due to early withdrawals. These provisions generally do one or
more of the following: limit the amount of penalty-free withdrawals; limit the
circumstances under which withdrawals are permitted; or assess a surrender
charge or market value adjustment relating to the underlying assets. The market
value adjustment feature in Principal Life's fixed annuity products adjusts the
surrender value of a contract in the event of surrender prior to the end of the
contract period to protect Principal Life against losses due to higher interest
rates at the time of surrender.
Our guaranteed investment contracts and funding agreements contain provisions
limiting early surrenders, including penalties for early surrenders and minimum
notice requirements. Put provisions give customers the option to terminate a
contract prior to maturity, provided they give a minimum notice period.
The following table presents U.S. GAAP reserves for guaranteed investment
contracts and funding agreements by withdrawal provisions as of December 31,
2001 and 2000:
78
As of December 31,
-------------------------
2001 2000
----------- -----------
(in millions)
Book Value Out(1)
Puttable:
Less than 30 days' put...................... $ - $ -
30 to 89 days' put.......................... - 100.6
90 to 180 days' put......................... - 379.9
More than 180 days' put..................... 55.1 150.9
No active put provision(2).................. - -
----------- -----------
Total puttable........................... 55.1 631.4
Surrenderable:
Book value out without surrender charge..... 22.9 45.2
Book value out with surrender charge........ 396.3 128.0
----------- -----------
Total surrenderable...................... 419.2 173.2
----------- -----------
Total book value out................. 474.3 804.6
Market Value Out(3)
Less than 30 days' notice..................... 26.9 42.9
30 to 89 days' notice......................... 281.9 284.6
90 to 180 days' notice........................ 1,133.6 992.6
More than 180 days' notice.................... 4,795.6 5,004.4
No active surrender provision................. 238.5 297.9
----------- -----------
Total market value out................... 6,476.5 6,622.4
Not puttable or surrenderable................. 11,502.1 10,521.3
----------- -----------
Total GICs and funding agreements........ $ 18,452.9 $ 17,948.3
=========== ===========
- --------------------
(1) Book Value Out: The amount equal to the sum of deposits less withdrawals
with interest accrued at the contractual interest rate.
(2) Contracts currently in initial lock-out period but which will become
puttable with 90 days' notice at some time in the future.
(3) Market Value Out: The amount equal to the book value out plus a market
value adjustment to adjust for changes in interest rates.
International Operations
BT Financial Group required infusions of capital of $1.7 million, $59.3 million
and $1.6 million for the years ended December 31, 2001, 2000 and 1999,
respectively. The 2001 infusion was provided to further develop our operations
in the UK, the 2000 infusion was to service acquisition related debt funding
expenses, and the 1999 infusion represented initial capital amounts for Europe
and Ireland. Primary sources of cash inflows for BT Financial Group are fee
revenues and interest spread earned on margin lending operations. Cash outflows
consist primarily of operating expenses.
Principal International is in a development or entry stage in several countries.
Historically, principal cash flow sources for Principal International have been
pension and annuity deposits, asset management fee revenues, administrative
services fee revenues, insurance premiums, income from investments, proceeds
from the sales or maturity of investments and short-term borrowings. Cash
outflows consist primarily of payment of benefits to policyholders and
beneficiaries, income and other taxes, current operating expenses, payments in
connection with investments acquired, and payments relating to policy and
contract surrenders, withdrawals, policy loans, interest expense and repayment
of short-term borrowings.
79
Principal International maintains investment strategies generally intended to
provide adequate funds to pay benefits without forced sales of investments.
Highly liquid, high quality short-term government securities and other liquid
investment grade fixed maturities are held to fund anticipated operating cash
outflows and development and maintenance expenses associated with new products
and technologies.
Principal International's operating companies monitor benefits, surrenders and
maturities to provide projections of future cash requirements. There can be no
assurance that future experience regarding benefits and surrenders will be
similar to historic experience since withdrawal and surrender levels are
influenced by factors such as the interest rate environment and local economic
conditions in each country.
Our Brazilian and Chilean operations produced positive cash flow from operations
in 2001 and in 2000. These cash flows have been historically maintained at the
local country level for strategic expansion purposes. Our other international
operations have required infusions of capital of $44.7 million, $75.8 million
and $126.8 million for the years ended December 31, 2001, 2000 and 1999,
respectively, to meet the cash outflow requirements of those operations or to
fund acquisitions. These other operations are primarily in the start-up stage or
are expanding in the short term. Our capital funding of these operations is
consistent with our long-term strategy to establish viable companies that can
sustain future growth from internally generated sources.
Contractual Obligations and Commercial Commitments
The following tables present payments due by period for contractual obligations
as of December 31, 2001 and 2000:
As of December 31, 2001
-----------------------------------------------------------------------
Less
than 1 4 - 5 After 5
Contractual Obligations Total year 1-3 years years years
- ------------------------------------ ----------- ----------- ----------- ----------- -----------
(in millions)
Long-term debt(1)............... $1,378.4 $ 165.1 $ 288.8 $ 5.4 $ 919.1
Operating leases(2)............. 213.8 60.3 83.6 44.5 25.4
Non-recourse medium-term
notes(3)...................... 3,298.4 160.2 496.1 470.2 2,171.9
----------- ----------- ----------- ----------- -----------
Total contractual cash
obligations................ $4,890.6 $ 385.6 $ 868.5 $ 520.1 $3,116.4
=========== =========== =========== =========== ===========
As of December 31, 2000
-----------------------------------------------------------------------
Less
than 1 4 - 5 After 5
Contractual Obligations Total year 1-3 years years years
- ------------------------------------ ----------- ----------- ----------- ----------- -----------
(in millions)
Long-term debt(1)............... $1,336.5 $ 118.9 $ 103.2 $ 205.2 $ 909.2
Operating leases(2)............. 174.5 49.1 72.8 41.6 11.0
Non-recourse medium-term
notes(3)...................... 2,475.3 164.3 476.6 424.9 1,409.5
----------- ----------- ----------- ----------- -----------
Total contractual cash
obligations................ $3,986.3 $ 332.3 $ 652.6 $ 671.7 $2,329.7
=========== =========== =========== =========== ===========
- ----------------------
(1) The following are included in long-term debt:
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty
Limited, our wholly-owned indirect subsidiary, issued $665.0 million of
unsecured redeemable long-term debt ($200.0 million of 7.95% notes due
August 15, 2004, and $465.0 million in 8.2% notes due August 15, 2009).
Interest on the notes is payable semiannually on February 15 and August 15
of each year, commencing February 15, 2000. Principal Financial Group
(Australia) Holdings Pty Limited used the net proceeds from the notes to
partially fund the purchase of the outstanding stock of several companies
affiliated with Bankers Trust Australia Group. On December 28, 2001, all of
the long-term debt obligations of Principal Financial Group (Australia)
Holdings Pty Limited were assumed by its parent, PFSI.
80
On March 10, 1994, Principal Life issued $300.0 million of surplus notes,
including $200.0 million due March 1, 2024, at a 7.875% annual interest
rate and the remaining $100.0 million due March 1, 2044, at an 8% annual
interest rate. No affiliates of ours hold any portion of the notes. Each
payment of interest and principal on the notes, however, may be made only
with the prior approval of the Commissioner and only to the extent that
Principal Life has sufficient surplus earnings to make such payments. For
each of the years ended December 31, 2001, 2000 and 1999, interest of $23.8
million was approved by the Commissioner, paid and charged to expense.
The mortgages and other notes payable are financings for real estate
developments. We have obtained loans with various lenders to finance these
developments. Outstanding principal balances as of December 31, 2001, range
from $0.1 million to $101.9 million per development with interest rates
generally ranging from 7.2% to 8.6%. Outstanding principal balances as of
December 31, 2000, range from $0.5 million to $102.8 million per
development with interest rates generally ranging from 6.9% to 8.6%.
(2) As a lessee, we lease office space, data processing equipment, corporate
aircraft and office furniture and equipment under various operating leases.
(3) Non-recourse medium term notes represent claims for principal and interest
under international funding agreements issued to non-qualified institutional
investors. These international funding agreements are afforded equal
priority to claims of life insurance and annuity policyholders under
insolvency provisions of Iowa Insurance Laws and, accordingly, are reported
as contractholder funds liabilities.
The components of short-term debt as of December 31, 2001 and 2000, are as
follows:
As of December 31,
----------------------------
2001 2000
------------ ------------
(in millions)
Commercial paper..................... $ 199.9 $ 29.9
Other recourse short-term debt....... 22.0 16.6
Non-recourse short-term debt......... 289.7 413.0
------------ ------------
Total short-term debt............. $ 511.6 $ 459.5
============ ============
Short-term debt consists primarily of commercial paper and outstanding balances
on revolving credit facilities with various financial institutions. As of
December 31, 2001, we had credit facilities with various financial institutions
in an aggregate amount of $1.4 billion. We may borrow up to $600.0 million on a
back-stop facility to support our $1.0 billion commercial paper program. In
addition, as of December 31, 2001, we have $780.0 million in credit facilities
to finance a CMBS pipeline and $45.0 million of unused lines of credit for
short-term debt used for general corporate purposes.
The weighted-average interest rates on short-term borrowings as of December 31,
2001 and 2000, were 2.30% and 7.17%, respectively.
Off-Balance Sheet Arrangements
We have entered into certain contracts to: 1) fund residential mortgage loan
production, 2) sell qualifying delinquent residential mortgage loans, and 3)
securitize margin loans. As appropriate under U.S. GAAP, the contracts involve
special purpose entities ("SPEs") or trusts that are not reported on our
consolidated statement of financial position.
Residential Mortgage Loan Production. In June 2000, our mortgage banking segment
created a special purpose bankruptcy remote entity, Principal Residential
Mortgage Capital Resources, LLC ("PRMCR"), to provide an off-balance sheet
source of funding for our residential mortgage loan production. We sell eligible
residential mortgage loans to PRMCR, where they are warehoused until sold to the
final investor. We sold approximately $38.0 billion and $5.3 billion in mortgage
loans to PRMCR in 2001 and 2000, respectively. The maximum amount of mortgage
loans, which can be warehoused in PRMCR, has increased from $1.0 billion at
inception to $4.0 billion as of December 31, 2001. PRMCR held $3.0 billion in
mortgage loans held for sale as of December 31, 2001. The portfolio of loans
81
held for sale by PRMCR must meet portfolio criteria, eligibility
representations, and portfolio aging limitations. Based on these eligibility
representations, we are required to repurchase ineligible loans from PRMCR.
PRMCR is capitalized by equity certificates owned by third party investors not
affiliated with us or our affiliates, directors, or officers and thus, is not
consolidated. The equity holders bear the risk of loss on defaulted mortgages.
At December 31, 2001, PRMCR had outstanding equity certificates of $193.0
million. PRMCR also issues short-term secured liquidity notes as well as medium
term notes to provide funds for its purchase of mortgage loans from us. At
December 31, 2001, PRMCR had outstanding secured liquidity notes of $1.3
billion, three-year fixed term notes of $800.0 million and five-year variable
term notes of $800.0 million. All borrowings are collateralized by the assets of
PRMCR.
We paid a commitment fee to PRMCR based on the overall warehouse limit. PRMCR
used a portion of the fee to fund a cash collateral account maintained at PRMCR.
These funds are available as additional collateral to cover credit related
losses on defaulted loans. The balance in the account was $24.0 million at
December 31, 2001. Any remaining amounts in the cash collateral account will be
returned to us upon the termination of PRMCR. This right to the return of the
cash collateral amount is reflected in other assets on our consolidated
statements of financial position.
We maintain a right to the servicing of the mortgage loans held by PRMCR and
upon the sale of the majority of the mortgage loans to the final investors. In
addition, we perform certain secondary marketing, accounting and various
administrative functions on behalf of PRMCR. As servicer, we receive a monthly
servicing fee, and may receive an excess servicing fee if funds are available
within PRMCR. Additionally, as servicer we are required to advance to PRMCR
those payments due from borrowers, but not received, as of specified cut-off
dates. We received $12.6 million and $2.2 million in servicing fees from PRMCR
in 2001 and 2000, respectively.
In order to hedge interest rate risk and non-credit related market value risk
associated with its inventory of mortgage loans held for sale, PRMCR entered
into swaps with counterparties not affiliated with us or PRMCR. The swap
counterparties are required to maintain certain minimum ratings as approved by
the rating agencies. Through separate swap agreements with the swap
counterparties that mirror the original swaps with PRMCR, the interest rate risk
and non-credit related market value components are swapped back to us.
Delinquent Residential Mortgage Loan Funding. In October 2000, our mortgage
banking segment created a wholly-owned, unconsolidated qualifying special
purpose entity, Principal Residential Mortgage Funding, LLC ("PRMF"), to provide
an off-balance sheet source of funding for up to $250.0 million of qualifying
delinquent mortgage loans. The limit was increased to $357.0 million in December
2001. We sell qualifying delinquent loans to PRMF which then transfers the loans
to Principal Residential Mortgage EBO Trust ("Trust"), an unaffiliated Delaware
business trust. The Trust funds its acquisitions of mortgage loans by selling
participation certificates, representing an undivided interest in the Trust, to
commercial paper conduit purchasers, who are not affiliated with us or any of
our affiliates, directors or officers. At December 31, 2001, PRMF held $273.5
million in mortgage loans and had outstanding participation certificates of
$256.9 million.
Mortgage loans typically remain in the Trust until they are processed through
the foreclosure claim process, are paid-off or reinstate. Loans that reinstate
are no longer eligible to remain in the Trust and are required to be removed by
us at fair market value at the monthly settlement date following reinstatement.
We are retained as the servicer of the mortgage loans and also perform
accounting and various administrative functions on behalf of PRMF, in its
capacity as the managing member of PRMF. As the servicer, we receive a servicing
fee pursuant to the pooling and servicing agreement. We may also receive a
successful servicing fee only after all other conditions in the monthly cash
flow distribution are met. At December 31, 2001, our residual interest in such
cash flows was $21.5 million and was recorded in other investments on the
consolidated statements of financial position. The value of the residual
interest was based on the net present value of expected cash flows from PRMF, as
well as estimates of foreclosure losses associated with the related loans. We
are required to advance funds for payment of interest on the participation
certificates and other carrying costs, if sufficient cash is not available in
the collection account to meet this obligation.
We and the Trust are parties to a cost of funds hedge agreement. We pay the
weighted average cost of funds on the participation certificates plus fees and
expenses and receive the indicated swap bid rate, subject to a cap.
82
Margin Loan Securitizations. We sell loans under a margin loan securitization
program and retain primary servicing responsibilities and subordinated
interests. We receive servicing distributions approximating 0.3 percent of the
outstanding balance and rights to future cash flows through an excess
distribution from the trust, representing the balance remaining after all
interest and fees of the trust have been accounted for. Our retained interests
are subordinated to investors' interests. Retained interests equate to 7% of the
outstanding loan balances, of which we earn a return of 2.0% over the Australian
30 day Bank Bill swap rate. The investors and the securitization trusts have no
recourse to our other assets for failure of debtors to pay when due. The value
of our retained interests is subject to market risk and all positions are
primarily hedged. No gains or losses on the transaction have been realized to
date.
The fair values of the retained interests, $37.8 million at December 31, 2001,
are based upon our relative ownership percentage of the outstanding loan
balances. At December 31, 2001, we utilized the present value of expected future
cash flows as a valuation technique to assess the sensitivity of the fair values
of retained interests. Key economic assumptions used in measuring the retained
interests included interest margin, credit losses, terminations and discount
rates, and the resulting changes to the fair values were not significant.
Proceeds from advances on margin loans previously securitized were $86.4 million
and $16.1 million for the years ended December 31, 2001 and 2000, respectively.
Investments
We had total consolidated assets as of December 31, 2001, of $88.4 billion, of
which $44.8 billion were invested assets. The rest of our total consolidated
assets are comprised primarily of separate account assets for which we do not
bear investment risk. Because we generally do not bear any investment risk on
assets held in separate accounts, the discussion and financial information below
does not include such assets. Of our invested assets, $43.4 billion were held by
our U.S. operations and the remaining $1.4 billion were held by our
International Asset Management and Accumulation segment.
U.S Investment Operations
Our U.S. invested assets are managed by Principal Capital Management, a
subsidiary of Principal Life. Our primary investment objective is to maximize
after-tax returns consistent with acceptable risk parameters. We seek to protect
policyholders' benefits by optimizing the risk/return relationship on an ongoing
basis, through asset/liability matching, reducing the credit risk, avoiding high
levels of investments that may be redeemed by the issuer, maintaining
sufficiently liquid investments and avoiding undue asset concentrations through
diversification. We are exposed to three primary sources of investment risk:
o credit risk, relating to the uncertainty associated with the continued
ability of a given obligor to make timely payments of principal and
interest;
o interest rate risk, relating to the market price and/or cash flow variability
associated with changes in market yield curves; and
o equity risk, relating to adverse fluctuations in a particular common stock.
Our ability to manage credit risk is essential to our business and our
profitability. We devote considerable resources to the credit analysis of each
new investment. We manage credit risk through industry, issuer and asset class
diversification. Our Investment Committee, appointed by our board of directors,
establishes all investment policies and reviews and approves all investments. As
of December 31, 2001, there are ten members on the Investment Committee, two of
whom are members of our board of directors. The remaining eight members are
senior management members representing various areas of our company.
Our Fixed Income Securities Committee, consisting of fixed income securities
senior management members, approves the credit rating for the fixed maturity
securities we purchase. Teams of security analysts organized by industry focus
either on the public or private markets and analyze and monitor these
investments. In addition, we have teams who specialize in residential
mortgage-backed securities, commercial mortgage-backed securities and public
below investment grade securities. We establish a credit reviewed list of
approved public issuers to provide an efficient way for our portfolio managers
to purchase liquid bonds for which credit review has already been completed.
Issuers remain on the list for six months unless removed by our analyst. Our
analysts monitor issuers on the list on a continuous basis with a formal review
83
documented every six months or more frequently if material events affect the
issuer. The analysis includes both fundamental and technical factors. The
fundamental analysis encompasses both quantitative and qualitative analysis of
the issuer.
The qualitative analysis includes an assessment of both accounting and
management aggressiveness. In addition, technical indicators such as stock price
volatility and credit default swap levels are monitored.
Our Fixed Income Securities Committee also reviews private transactions on a
continuous basis to assess the quality ratings of our privately placed
investments. We regularly review our investments to determine whether we should
re-rate them, employing the following criteria:
o material declines in the issuer's revenues or margins;
o significant management or organizational changes;
o significant uncertainty regarding the issuer's industry;
o debt service coverage or cash flow ratios that fall below industry-specific
thresholds;
o violation of financial covenants; and
o other business factors that relate to the issuer.
A dedicated risk management team is responsible for centralized monitoring of
the commercial mortgage portfolio. We apply a variety of strategies to minimize
credit risk in our commercial mortgage loan portfolio. When considering the
origination of new commercial mortgage loans, we review the cash flow
fundamentals of the property, make a physical assessment of the underlying
security, conduct a comprehensive market analysis and compare against industry
lending practices. We use a proprietary risk rating model to evaluate all new
and a majority of existing loans within the portfolio. The proprietary risk
model is designed to stress projected cash flows under simulated economic and
market downturns. Our lending guidelines are designed to encourage 75% or less
loan-to-value ratios and a debt service coverage ratio of at least 1.2 times. We
analyze investments outside of these guidelines based on cash flow quality,
tenancy and other factors. From 1998 through December 31, 2001, the weighted
average loan-to-value ratio at origination for brick and mortar commercial
mortgages in our portfolio was in the 65%-68% range and debt service coverage
ratios at loan inception in the 1.6-1.7 times range.
We have limited exposure to equity risk in our common stock portfolio. Equity
securities accounted for only 2% of our U.S. invested assets as of December 31,
2001.
Our investment decisions and objectives are a function of the underlying risks
and product profiles of each primary business operation. In addition, we
diversify our product portfolio offerings to include products that contain
features that will protect us against fluctuations in interest rates. Those
features include adjustable crediting rates, policy surrender charges and market
value adjustments on liquidations. For further information on our management of
interest rate risk, see Item 7A, "Quantitative and Qualitative Disclosures about
Market Risk".
Overall Composition of U.S. Invested Assets
U.S. invested assets as of December 31, 2001, were predominantly of high quality
and broadly diversified across asset class, individual credit, industry and
geographic location. As shown in the following table, the major categories of
U.S. invested assets are fixed maturity securities and commercial mortgages. The
remainder is invested in real estate, equity securities and other assets. In
addition, policy loans are included in our invested assets. We combined our
invested assets in the Closed Block with invested assets outside the Closed
Block in view of the similar asset quality characteristics of the two
portfolios. The following discussion analyzes the composition of U.S. invested
assets, which includes $4,169.1 million in invested assets of the Closed Block
as of December 31, 2001, but excludes invested assets of the participating
separate accounts.
84
U.S. Invested Assets
As of December 31,
------------------------------------------------
2001 2000
---------------------- ----------------------
Carrying % of Carrying % of
Amount Total Amount Total
----------- ------- ----------- -------
($ in millions)
Fixed maturity securities
Public......................................... $ 18,227.6 42% $ 14,263.6 35%
Private........................................ 10,800.2 25 11,611.4 28
Equity securities, available-for-sale............. 808.7 2 666.0 2
Mortgage loans
Commercial .................................... 9,740.4 22 10,775.3 26
Residential.................................... 1,144.2 3 550.5 1
Real estate held for sale ........................ 390.7 1 695.4 2
Real estate held for investment................... 783.4 2 696.4 2
Policy loans...................................... 831.9 2 803.6 2
Other investments ................................ 678.4 1 681.2 2
----------- ------- ----------- -------
Total invested assets.......................... $ 43,405.5 100% $ 40,743.4 100%
======= =======
Cash and cash equivalents......................... 495.8 750.1
----------- -----------
Total invested assets and cash ................ $ 43,901.3 $ 41,493.5
=========== ===========
We actively manage public fixed maturity securities, including our portfolio of
residential mortgage-backed securities, in order to provide liquidity and
enhance yield and total return. Our residential mortgage-backed securities are
managed to ensure that the securities we hold trade close to or below par in
order to manage prepayment risk. This active management has resulted in the
realization of capital gains and losses with respect to such investments.
U.S. Investment Results
The yield on U.S. invested assets and on cash and cash equivalents, excluding
net realized gains and losses, was 7.6%, 7.5% and 7.4% for the years ended
December 31, 2001, 2000 and 1999, respectively.
The following table illustrates the yields on average assets for each of the
components of our investment portfolio for the years ended December 31, 2001,
2000 and 1999:
85
U.S. Invested Assets
Yields by Asset Type
As of or for the year ended December 31,
----------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- --------------------
Yield Amount Yield Amount Yield Amount
------ ---------- ------ ---------- ------ ----------
($ in millions)
Fixed maturity securities
Gross investment income(1)............... 7.7% $ 2,117.7 7.5% $ 1,813.3 7.4% $ 1,651.4
Net realized capital losses.............. (1.1) (310.2) (0.5) (129.6) (0.5) (104.3)
---------- ---------- ----------
Total.................................. $ 1,807.5 $ 1,683.7 $ 1,547.1
========== ========== ==========
Ending assets (at carrying value)........ $29,027.8 $25,875.0 $22,584.3
Equity securities, available-for-sale
Gross investment income(1)............... 3.7% $ 27.5 10.1% $ 72.1 4.4% $ 39.2
Net realized capital gains (losses)...... (9.6) (70.8) 11.2 80.3 43.2 381.4
---------- ---------- ----------
Total.................................. $ (43.3) $ 152.4 $ 420.6
========== ========== ==========
Ending assets (at carrying value)........ $ 808.7 $ 666.0 $ 768.1
Mortgage loans - Commercial
Gross investment income(1)............... 7.8% $ 797.3 8.2% $ 955.6 8.1% $ 1,005.8
Net realized capital gains (losses)...... 0.1 10.7 0.1 8.6 (0.1) (8.4)
---------- ---------- ----------
Total.................................. $ 808.0 $ 964.2 $ 997.4
========== ========== ==========
Ending assets (at carrying value)........ $ 9,740.4 $10,775.3 $12,588.9
Mortgage loans - Residential
Gross investment income(1)............... 8.1% $ 68.8 9.3% $ 56.1 11.9% $ 98.3
Net realized capital gains (losses)...... - - - - - -
---------- ---------- ----------
Total.................................. $ 68.8 $ 56.1 $ 98.3
========== ========== ==========
Ending assets (at carrying value)........ $ 1,144.2 $ 550.5 $ 651.0
Real estate
Gross investment income(1)............... 13.8% $ 177.6 9.5% $ 170.8 7.8% $ 187.1
Net realized capital gains (losses)...... (1.5) (19.0) 4.6 82.3 2.4 56.4
---------- ---------- ----------
Total.................................. $ 158.6 $ 253.1 $ 243.5
========== ========== ==========
Ending assets (at carrying value)........ $ 1,174.1 $ 1,391.8 $ 2,201.2
Policy loans
Gross investment income(1)............... 7.0% $ 57.5 7.0% $ 55.1 6.5% $ 50.2
Net realized capital gains (losses)...... - - - - - -
---------- ---------- ----------
Total.................................. $ 57.5 $ 55.1 $ 50.2
========== ========== ==========
Ending assets (at carrying value)........ $ 831.9 $ 803.6 $ 780.5
Cash and cash equivalents
Gross investment income(1)............... 4.5% $ 28.3 4.3% $ 24.0 5.1% $ 20.0
Net realized capital losses.............. - (0.1) (0.5) (2.7) - (0.1)
---------- ---------- ----------
Total $ 28.2 $ 21.3 $ 19.9
========== ========== ==========
Ending assets (at carrying value)........ $ 495.8 $ 750.1 $ 368.4
Other investments
Gross investment income(1)............... 13.8% $ 93.6 9.5% $ 57.0 9.2% $ 39.4
Net realized capital gains (losses)...... (9.5) (64.6) 16.4 98.2 16.6 70.8
---------- ---------- ----------
Total.................................. $ 29.0 $ 155.2 $ 110.2
========== ========== ==========
Ending assets (at carrying value)........ $ 678.4 $ 681.2 $ 514.0
Total before investment expenses
Gross investment income(1)............... 7.9% $ 3,368.3 7.8% $ 3,204.0 7.7% $ 3,091.4
Net realized capital gains (losses)...... (1.1) (454.0) 0.3 137.1 1.0 395.8
---------- ---------- ----------
Total.................................. $ 2,914.3 $ 3,341.1 $ 3,487.2
========== ========== ==========
Investment expenses........................... 0.2% $ 102.8 0.3% $ 136.7 0.3% $ 113.5
Net investment income......................... 7.6% $ 3,265.5 7.5% $ 3,067.3 7.4% $ 2,977.9
- --------------------
(1) Yields are based on annual average asset carrying values for the years ended
December 31, 2001, 2000, and 1999.
Fixed Maturity Securities
We have classified the majority of our fixed maturity securities as
available-for-sale. Accordingly, we mark such securities to market, with
unrealized gains and losses excluded from earnings and reported as a separate
component of other comprehensive income, net of deferred income taxes and an
adjustment for the effect on deferred policy acquisition costs that would have
occurred had such gains and losses been realized. We write down to fair value
securities whose value is deemed other than temporarily impaired. We record
writedowns as realized losses included in earnings and adjust the cost basis of
such securities to fair value. The new cost basis is not changed for subsequent
recoveries in value.
86
Fixed maturity securities consist of short-term investments, publicly traded
debt securities, privately placed debt securities and small amounts of
redeemable preferred stock, and represented 67% of total U.S. invested assets as
of December 31, 2001, and 63% as of December 31, 2000. The fixed maturity
securities portfolio was comprised, based on carrying amount, of 63% in publicly
traded fixed maturity securities and 37% in privately placed fixed maturity
securities as of December 31, 2001, and 55% in publicly traded fixed maturity
securities and 45% in privately placed fixed maturity securities as of December
31, 2000. Included in the privately placed category as of December 31, 2001,
were $3.5 billion of securities eligible for resale to qualified institutional
buyers under Rule 144A under the Securities Act of 1933. Fixed maturity
securities were diversified by category of issuer as of December 31, 2001, and
December 31, 2000, as shown in the following table:
U.S. Invested Assets
Fixed Maturity Securities by Type of Issuer
As of December 31,
--------------------------------------------
2001 2000
-------------------- --------------------
Carrying % of Carrying % of
Amount Total Amount Total
---------- ------ ---------- ------
($ in millions)
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies.............. $ 15.1 -% $ 21.3 -%
States and political subdivisions.................... 317.5 1 295.7 1
Foreign governments.................................. 603.5 2 604.3 2
Corporate - public................................... 13,038.8 45 8,740.8 34
Corporate - private.................................. 9,171.1 32 9,796.6 38
Mortgage-backed securities and other asset-
backed securities................................. 5,881.8 20 6,416.3 25
---------- ------ ---------- ------
Total fixed maturities............................ $ 29,027.8 100% $ 25,875.0 100%
========== ====== ========== ======
The international exposure in our U.S. invested assets totaled $3,877.4 million,
or 13%, of total fixed maturity securities, as of December 31, 2001, comprised
of corporate and foreign government fixed maturity securities. Of the $3,877.4
million as of December 31, 2001, investments totaled $1,177.6 million in the
United Kingdom, $653.8 million in the continental European Union, $511.0 million
in Asia, $383.2 million in South America, $336.8 million in Australia and $25.7
million in Japan. The remaining $789.3 million was invested in 14 other
countries. All international fixed maturity securities held by our U.S.
operations are either denominated in U.S. dollars or have been swapped into U.S.
dollar equivalents. Our international investments are analyzed internally by
country and industry credit investment professionals. We control concentrations
using issuer and country level exposure benchmarks, which are based on the
credit quality of the issuer and the country. Our investment policy limits total
international fixed maturity securities investments to 15% of total statutory
general account assets with a 4% limit in emerging markets. Exposure to Canada
is not included in our international exposure due to its treatment by the NAIC.
As of December 31, 2001, our investments in Canada totaled $852.1 million.
The Securities Valuation Office of the NAIC evaluates most of the fixed maturity
securities that we and other U.S. insurance companies hold. The Securities
Valuation Office evaluates the bond investments of insurers for regulatory
reporting purposes and assigns securities to one of six investment categories.
The NAIC Designations closely mirror the nationally recognized securities rating
organizations' credit ratings for marketable bonds. NAIC Designations 1 and 2
include bonds considered investment grade by such rating organizations. Bonds
are considered investment grade when rated "Baa3" or higher by Moody's, or
"BBB-" or higher by Standard & Poor's. NAIC Designations 3 through 6 are
referred to as below investment grade. Bonds are considered below investment
grade when rated "Ba1" or lower by Moody's, or "BB+" or lower by Standard &
Poor's.
The following tables present our publicly traded, privately placed and total
fixed maturity securities by NAIC Designation and the equivalent ratings of the
nationally recognized securities rating organizations as of December 31, 2001,
and December 31, 2000, as well as the percentage, based on estimated fair value,
that each designation comprises:
87
U.S. Invested Assets
Publicly Traded Fixed Maturity Securities by Credit Quality
As of December 31, 2001 As of December 31, 2000
-------------------------------- ---------------------------------
% of % of
Rating Total Total
NAIC Agency Amortized Carrying Carrying Amortized Carrying Carrying
Rating Equivalent Cost Amount Amount Cost Amount Amount
- ------ ---------------------- --------- --------- -------- --------- --------- ---------
($ in millions)
1 Aaa/Aa/A.............. $ 9,955.3 $10,406.5 57% $ 9,029.4 $ 9,283.0 65%
2 Baa................... 6,939.5 7,112.8 39 4,432.3 4,492.8 32
3 Ba.................... 496.3 474.5 3 451.7 434.1 3
4 B..................... 165.3 148.4 1 44.4 21.9 -
5 Caa and lower......... 28.4 26.5 - 27.7 27.3 -
6 In or near
default............... 60.6 58.9 - 14.9 4.5 -
--------- --------- -------- --------- --------- ---------
Total public
fixed maturities.. $17,645.4 $18,227.6 100% $14,000.4 $14,263.6 100%
========= ========= ======== ========= ========= =========
U.S. Invested Assets
Privately Placed Fixed Maturity Securities by Credit Quality
As of December 31, 2001 As of December 31, 2000
-------------------------------- ---------------------------------
% of % of
Rating Total Total
NAIC Agency Amortized Carrying Carrying Amortized Carrying Carrying
Rating Equivalent Cost Amount Amount Cost Amount Amount
- ------ ---------------------- --------- --------- -------- --------- --------- ---------
($ in millions)
1 Aaa/Aa/A.............. $ 4,184.6 $ 4,349.7 40% $ 5,155.9 $ 5,213.9 45%
2 Baa................... 4,780.5 4,921.8 46 4,749.2 4,822.0 42
3 Ba.................... 1,105.7 1,085.9 10 1,151.3 1,126.5 10
4 B..................... 236.4 223.7 2 349.5 335.4 3
5 Caa and lower......... 64.0 64.3 1 73.3 40.7 -
6 In or near
default............... 180.3 154.8 1 111.0 72.9 -
--------- --------- -------- --------- --------- ---------
Total private
fixed maturities.. $10,551.5 $10,800.2 100% $11,590.2 $11,611.4 100%
========= ========= ======== ========= ========= =========
88
U.S. Invested Assets
Total Fixed Maturity Securities by Credit Quality
As of December 31, 2001 As of December 31, 2000
-------------------------------- ---------------------------------
% of % of
Rating Total Total
NAIC Agency Amortized Carrying Carrying Amortized Carrying Carrying
Rating Equivalent Cost Amount Amount Cost Amount Amount
- ------ ---------------------- --------- --------- -------- --------- --------- ---------
($ in millions)
1 Aaa/Aa/A.............. $14,139.9 $14,756.2 51% $14,185.3 $14,496.9 56%
2 Baa................... 11,720.0 12,034.6 42 9,181.5 9,314.8 36
3 Ba.................... 1,602.0 1,560.4 5 1,603.0 1,560.6 6
4 B..................... 401.7 372.1 1 393.9 357.3 2
5 Caa and lower......... 92.4 90.8 - 101.0 68.0 -
6 In or near
default............... 240.9 213.7 1 125.9 77.4 -
--------- --------- ------ --------- --------- ---------
Total fixed
Maturities........ $28,196.9 $29,027.8 100% $25,590.6 $25,875.0 100%
========= ========= ====== ========= ========= =========
We believe that our long-term fixed maturity securities portfolio is well
diversified among industry types and between publicly traded and privately
placed securities. Each year we direct the majority of our net cash inflows into
investment grade fixed maturity securities. We typically invest up to 7% of
general account cash flow in below investment grade assets. While the general
account investment returns have improved due to the below investment grade asset
class, we manage its growth strategically by limiting it to 10% of the total
fixed maturity securities portfolio.
We invest in privately placed fixed maturity securities to enhance the overall
value of the portfolio, increase diversification and obtain higher yields than
are possible with comparable quality public market securities. Generally,
private placements provide broader access to management information,
strengthened negotiated protective covenants, call protection features and,
where applicable, a higher level of collateral. They are, however, generally not
freely tradable because of restrictions imposed by federal and state securities
laws and illiquid trading markets. As of December 31, 2001, the percentage,
based on estimated fair value, of total publicly traded and privately placed
fixed maturity securities that were investment grade with an NAIC Designation 1
or 2 was 93%.
The following tables show the carrying amount of our corporate fixed maturity
securities by industry category, as well as the percentage of the total
corporate portfolio that each industry category comprises as of December 31,
2001, and December 31, 2000. The tables also show by industry category the
relative amounts of publicly traded and privately placed securities.
U.S. Invested Assets
Corporate Fixed Maturity Securities Portfolio by Industry
as of December 31, 2001
Publicly Traded Privately Placed Total
------------------ ------------------- --------------------
Carrying % of Carrying % of Carrying % of
Amount Total Amount Total Amount Total
---------- ----- ---------- ----- ---------- ------
($ in millions)
Industry Class
Transportation and Public Utilities..... $ 5,119.9 39% $ 2,120.7 23% $ 7,240.6 33%
Finance, Insurance and Real Estate...... 3,296.0 25 2,107.7 23 5,403.7 24
Manufacturing........................... 2,765.9 21 2,461.9 27 5,227.8 23
Mining.................................. 891.5 7 865.0 9 1,756.5 8
Retail.................................. 484.4 4 738.6 8 1,223.0 5
Services................................ 384.2 3 593.9 7 978.1 4
Public Administration................... 31.8 - 122.6 1 154.4 1
Construction............................ 1.8 - 112.5 1 114.3 1
Agriculture, Forestry and Fishing....... 63.3 1 48.2 1 111.5 1
---------- ----- ---------- ----- ---------- ------
Total............................... $ 13,038.8 100% $ 9,171.1 100% $ 22,209.9 100%
========== ===== ========== ===== ========== ======
89
U.S. Invested Assets
Corporate Fixed Maturity Securities Portfolio by Industry as of December 31, 2000
Publicly Traded Privately Placed Total
------------------ ------------------- --------------------
Carrying % of Carrying % of Carrying % of
Amount Total Amount Total Amount Total
---------- ----- ---------- ----- ---------- ------
($ in millions)
Industry Class
Transportation and Public Utilities..... $ 3,197.1 37% $ 1,957.9 20% $ 5,155.0 28%
Finance, Insurance and Real Estate...... 2,657.1 30 2,300.9 24 4,958.0 27
Manufacturing........................... 1,678.9 19 2,845.9 29 4,524.8 24
Mining.................................. 496.1 6 936.8 10 1,432.9 8
Retail.................................. 295.2 3 795.9 8 1,091.1 6
Services................................ 351.5 4 686.3 7 1,037.8 5
Public Administration................... 20.3 - 111.4 1 131.7 1
Construction............................ 9.9 - 120.3 1 130.2 1
Agriculture, Forestry and Fishing....... 34.7 1 41.2 - 75.9 -
---------- ----- ---------- ----- ---------- ------
Total............................... $ 8,740.8 100% $ 9,796.6 100% $ 18,537.4 100%
========== ===== ========== ===== ========== ======
As of December 31, 2001, our largest unaffiliated single concentration of fixed
maturity securities consisted of $315.3 million of corporate bonds by Ford Motor
Company and its affiliates. This represented approximately 1% of our total U.S.
invested assets as of December 31, 2001. No other individual non-government
issuer represented more than 1% of U.S. invested assets.
We held $5,881.8 million of mortgage-backed and asset-backed securities as of
December 31, 2001, and $6,416.3 million as of December 31, 2000. The following
table presents the types of mortgage-backed securities ("MBSs"), as well as
other asset-backed securities, held for the years indicated:
U.S. Invested Assets
Mortgage and Asset-Backed Securities
Carrying Amount
As of December 31,
------------------------
2001 2000
---------- ----------
(in millions)
Residential pass-through securities......... $ 2,855.5 $ 3,426.5
Commercial MBS.............................. 1,874.1 1,403.4
Asset-backed securities..................... 1,152.2 1,586.4
---------- ----------
Total MBSs and asset-backed securities... $ 5,881.8 $ 6,416.3
========== ==========
We believe that it is desirable to hold residential mortgage-backed securities
due to their credit quality and liquidity as well as portfolio diversification
characteristics. Our portfolio is comprised of GNMA, FNMA and FHLMC pass-through
securities and is actively managed to ensure that the securities held are
trading close to or below par, in order to reduce risk of prepayments. As of
December 31, 2001, we held no collateralized mortgage obligations in our U.S.
invested asset portfolio.
Commercial mortgage-backed securities provide high levels of credit protection,
diversification, reduced event risk and enhanced liquidity. Commercial
mortgage-backed securities are predominantly comprised of rated large pool
securitizations that are individually and collectively diverse by property type,
borrower and geographic dispersion.
We purchase asset-backed securities, ("ABS"), to diversify the overall credit
risks of the fixed maturity securities portfolio and to provide attractive
returns. The principal risks in holding asset-backed securities are structural
and credit risks. Structural risks include the security's priority in the
issuer's capital structure, the adequacy of and ability to realize proceeds from
the collateral and the potential for prepayments. Credit risks involve
issuer/servicer risk where collateral values can become impaired in the event of
servicer credit deterioration.
90
Our ABS portfolio is diversified both by type of asset and by issuer. We
actively monitor holdings of asset-backed securities to ensure that the risk
profile of each security improves or remains consistent. If we are not receiving
an adequate yield for the risk, relative to other investment opportunities, we
will attempt to sell the security. Prepayments in the ABS portfolio are, in
general, insensitive to changes in interest rates or are insulated to such
changes by call protection features. In the event that we are subject to
prepayment risk, we monitor the factors that impact the level of prepayment and
prepayment speed for those asset-backed securities. To the extent we believe
that prepayment risk increases, we may attempt to sell the security and reinvest
in another security that offers better yield relative to the risk. In addition,
we diversify the risks of asset-backed securities by holding a diverse class of
securities, which limits our exposure to any one security.
U.S. Invested Assets
Asset-Backed Securities by Type
Carrying Amount
As of December 31,
------------------------
2001 2000
---------- ----------
(in millions)
Credit cards................................ $ 131.2 $ 220.0
Automobile receivables...................... 49.7 72.2
Collateralized debt obligations............. 468.6 579.1
Lease receivables........................... 101.5 198.9
Consumer loans.............................. 126.5 145.0
Other....................................... 274.7 371.2
---------- ----------
Total asset-backed securities............ $ 1,152.2 $ 1,586.4
========== ==========
In accordance with our asset liability risk management techniques, we manage the
expected lives of U.S. invested assets to be similar to the lives of our
liabilities. Significant amounts of our liabilities have an expected life of six
years or less. Therefore, comparable amounts of assets have a similar expected
life. The amortized cost and estimated fair value of fixed maturity securities,
by contractual maturity dates, excluding scheduled sinking funds, as of December
31, 2001, and December 31, 2000, as follows:
U.S. Invested Assets
Fixed Maturity Securities by Contractual Maturity Dates
As of December 31,
------------------------------------------------
2001 2000
---------------------- ----------------------
Amortized Carrying Amortized Carrying
Cost Amount Cost Amount
--------- --------- --------- ---------
(in millions)
Due in one year or less.............................. $ 1,358.2 $ 1,367.3 $ 1,093.6 $ 1,083.8
Due after one year through five years................ 10,484.3 10,815.0 9,691.0 9,687.7
Due after five years through ten years............... 5,535.6 5,722.0 5,058.0 5,135.6
Due after ten years.................................. 5,159.3 5,241.7 3,505.4 3,551.6
--------- --------- --------- ---------
Subtotal.......................................... 22,537.4 23,146.0 19,348.0 19,458.7
Mortgage-backed and other securities without a
single maturity date.............................. 5,659.5 5,881.8 6,242.6 6,416.3
--------- --------- --------- ---------
Total........................................... $28,196.9 $29,027.8 $25,590.6 $25,875.0
========= ========= ========= =========
We monitor any decline in the credit quality of fixed maturity securities
through the designation of "problem securities", "potential problem securities"
and "restructured securities". We define problem securities in our fixed
maturity portfolio as securities: (i) as to which principal and/or interest
payments are in default or (ii) issued by a company that went into bankruptcy
subsequent to the acquisition of such securities. We define potential problem
securities in our fixed maturity portfolio as securities included on an internal
"watch list" for which management has concerns as to the ability of the issuer
to comply with the present debt payment terms and which may result in the
security becoming a problem or being restructured. The decision whether to
classify a performing fixed maturity security as a potential problem involves
significant subjective judgments by our management as to the likely future
industry conditions and developments with respect to the issuer. We define
91
restructured securities in our fixed maturity portfolio as securities where a
concession has been granted to the borrower related to the borrower's financial
difficulties that would not have otherwise been considered. We determine that
restructures should occur in those instances where greater economic value will
be realized under the new terms than through liquidation or other disposition
and may involve a change in contractual cash flows.
In December 2001, Enron Corp., along with certain of its subsidiaries, filed
voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy
Court. We recognized realized losses in 2001 for other than temporary
impairments and have classified our remaining investment in Enron Corp. and
Enron related entities of $45.5 million in our problem fixed maturity
securities.
The following table presents the total carrying amount of our fixed maturity
portfolio, as well as its problem, potential problem and restructured fixed
maturities for the years indicated:
U.S. Invested Assets
Problem, Potential Problem and Restructured Fixed Maturities at Carrying Amount
As of December 31,
----------------------------
2001 2000
------------ ------------
($ in millions)
Total fixed maturity securities (public and private)......... $ 29,027.8 $ 25,875.0
============ ============
Problem fixed maturity securities............................ $ 198.8 $ 79.0
Potential problem fixed maturity securities.................. 365.1 132.5
Restructured fixed maturity securities....................... 110.8 48.6
------------ ------------
Total problem, potential problem and restructured fixed
maturity securities..................................... $ 674.7 $ 260.1
============ ============
Total problem, potential problem and restructured fixed
maturity securities as a percent of total fixed maturity
securities.............................................. 2% 1%
Equity Securities
Our equity securities consist primarily of investments in common stocks. We
classify our investment in common stocks as available for sale and report them
at fair value. We report unrealized gains and losses on common stocks as a
separate component of other comprehensive income, net of deferred income taxes
and an adjustment for the effect on deferred acquisition costs that would have
occurred if such gains and losses had been realized.
Investments in equity securities, totaled $808.7 million and $666.0 million,
which represented 2% of U.S. invested assets as of December 31, 2001, and
December 31, 2000, respectively. Investments in company-sponsored funds totaled
$463.3 million, or 57%, of our U.S. equity securities as of December 31, 2001.
These sponsored funds are intended to be marketed to our asset management
clients. Of company-sponsored funds, $313.6 million represented underlying
investments in publicly-traded equities, $144.0 million represented investments
in publicly-traded fixed income securities and $5.7 million in balanced funds
which represented investments in both publicly-traded equities and fixed income
securities as of December 31, 2001. The remaining balance of equity securities
is a mixture of public and private securities acquired for investment purposes
or which were acquired through equity participation features of below investment
grade bonds or through recoveries of defaulted securities.
Mortgage Loans
Mortgage loans comprised 25% of total U.S. invested assets as of December 31,
2001, and 27% as of December 31, 2000. Mortgage loans consist of commercial and
residential loans. Commercial mortgage loans comprised $9,740.4 million as of
December 31, 2001, and $10,775.3 million as of December 31, 2000, or 89% and
95%, of total mortgage loan investments, respectively. Residential mortgages
comprised $1,144.2 million and $550.5 million, or 11% and 5%, of total mortgage
loan investments as of December 31, 2001, and December 31, 2000, respectively.
Principal Residential Mortgage, Inc. and Principal Bank hold the majority of
92
residential loans. Principal Residential Mortgage, Inc. holds residential loans
as part of its securitization inventory and Principal Bank holds residential
loans to comply with federal thrift charter requirements.
Commercial Mortgage Loans. Commercial mortgages play an important role in our
investment strategy by:
o providing strong risk adjusted relative value in comparison to other
investment alternatives;
o enhancing total returns; and
o providing strategic portfolio diversification.
As a result, we have focused on constructing a solid, high quality portfolio of
mortgages. Our portfolio is generally comprised of mortgages with conservative
loan-to-value ratios, high debt service coverages and general purpose property
types with a strong credit tenancy.
Our commercial loan portfolio consists of primarily non-recourse, fixed rate
mortgages on fully or near fully leased properties. The mortgage portfolio is
comprised of general-purpose industrial properties, manufacturing office
properties and credit oriented retail properties.
California accounted for 21% of our commercial mortgage loan portfolio as of
December 31, 2001. We are, therefore, exposed to potential losses resulting from
the risk of catastrophes, such as earthquakes, that may affect the region. Like
other lenders, we generally do not require earthquake insurance for properties
on which we make commercial mortgage loans. With respect to California
properties, however, we obtain an engineering report specific to each property.
The report assesses the building's design specifications, whether it has been
upgraded to meet seismic building codes and the maximum loss that is likely to
result from a variety of different seismic events. We also obtain a report that
assesses by building and geographic fault lines the amount of loss our
commercial mortgage loan portfolio might suffer under a variety of seismic
events.
The following is a summary of our commercial mortgage loans by property type and
region as of December 31, 2001, and December 31, 2000:
U.S. Invested Assets
Commercial Mortgage Loan Distribution by Type
As of December 31,
------------------------------------------
2001 2000
------------------- -------------------
Carrying % of Carrying % of
Amount Total Amount Total
---------- ----- ---------- -----
($ in millions)
Office........................ $ 3,252.5 33% $ 3,273.5 30%
Retail........................ 3,106.5 32 3,612.7 34
Industrial.................... 2,948.9 30 3,381.6 31
Apartments.................... 349.8 4 419.7 4
Mixed use/other............... 111.8 1 130.2 1
Hotel......................... 61.6 1 65.6 1
Valuation allowance........... (90.7) (1) (108.0) (1)
---------- ----- ---------- -----
Total...................... $ 9,740.4 100% $10,775.3 100%
========== ===== ========== =====
93
U.S. Invested Assets
Commercial Mortgage Loan Distribution by Region
As of December 31,
------------------------------------------
2001 2000
------------------- -------------------
Carrying % of Carrying % of
Amount Total Amount Total
---------- ----- ---------- -----
($ in millions)
Pacific................. $ 2,421.3 25% $ 2,774.8 26%
South Atlantic.......... 2,403.0 25 2,630.5 24
Middle Atlantic......... 1,606.3 16 1,664.9 15
East North Central...... 930.1 10 1,006.2 9
West South Central...... 769.0 8 886.4 8
Mountain................ 637.7 7 600.2 6
West North Central...... 397.8 4 439.9 4
East South Central...... 338.5 3 384.5 4
New England............. 327.4 3 495.9 5
Valuation allowance..... (90.7) (1) (108.0) (1)
---------- ----- ---------- -----
Total................ $ 9,740.4 100% $10,775.3 100%
========== ===== ========== =====
Our commercial loan portfolio is highly diversified by borrower. As of December
31, 2001, 43% of the U.S. commercial mortgage loan portfolio was comprised of
mortgage loans with principal balances of less than $10.0 million. The following
table shows our U.S. commercial mortgage loan portfolio by loan size, for the
years indicated:
U.S. Invested Assets
Commercial Mortgage Loan Portfolio - By Loan Size
As of December 31, 2001 As of December 31, 2000
------------------------------- -------------------------------
Number Principal % of Number Principal % of
of Loans Balance Total of Loans Balance Total
-------- ---------- ----- -------- ---------- -----
($ in millions)
Under $5 million........................ 1,102 $ 2,306.7 23% 1,236 $ 2,553.5 24%
$5 million but less than $10 million.... 275 1,925.5 20 304 2,116.5 19
$10 million but less than $20 million... 168 2,267.2 23 187 2,515.2 23
$20 million but less than $30 million... 59 1,410.6 14 63 1,495.3 14
$30 million and over.................... 42 1,925.0 20 48 2,204.5 20
-------- ---------- ----- -------- ----------- -----
Total............................. 1,646 $ 9,835.0 100% 1,838 $ 10,885.0 100%
======== ========== ===== ======== =========== =====
The total number of commercial mortgage loans outstanding as of December 31,
2001 and December 31, 2000 was 1,646 and 1,838, respectively. The average loan
size of our commercial mortgage portfolio was $6.0 million as of December 31,
2001. The largest loan on any single property at such dates aggregated $100.0
million for December 31, 2001 and 2000, respectively, and represented 0.2% of
U.S. invested assets on these dates. Total mortgage loans to the 10 largest
borrowers accounted in the aggregate for approximately 7.1% of the total
carrying amount of the commercial mortgage loan portfolio as of December 31,
2001, and 7.0% as of December 31, 2000, and 2% of total U.S. invested assets as
of December 31, 2001 and 2000, respectively. As of such dates, all such loans
were performing.
The following table presents the disposition of maturities as of December 31,
2001, and December 31, 2000:
94
U.S. Invested Assets
Dispositions of Scheduled Maturities of Commercial Mortgage Loans
Amortized Cost
As of December 31,
-------------------
2001 2000
------- -------
(in millions)
Paid as scheduled........... $ 434.7 $ 395.0
Extended.................... 138.1 174.8
Refinanced.................. 75.7 82.7
Foreclosed.................. 5.4 -
Expired maturities.......... 10.6 59.1
------- -------
Total.................... $ 664.5 $ 711.6
======= =======
The amortized cost of commercial mortgage loans by contractual maturity dates,
excluding scheduled sinking funds as of December 31, 2001, and December 31,
2000, are as follows:
U.S. Invested Assets
Commercial Mortgage Loan Portfolio Maturity Profile
As of December 31,
-------------------------------------
2001 2000
----------------- ----------------
Amortized % of Amortized % of
Cost Total Cost Total
---------- ----- ---------- -----
($ in millions)
Due in one year or less................ $ 732.6 8% $ 675.8 6%
Due after one year through five years.. 3,180.8 32 3,033.4 28
Due after five years through ten years. 2,890.8 29 3,900.7 36
Due after ten years.................... 3,026.9 31 3,273.4 30
---------- ----- ---------- -----
Total............................... $ 9,831.1 100% $10,883.3 100%
========== ===== ========== =====
We actively monitor and manage our commercial mortgage loan portfolio.
Substantially all loans within the portfolio are analyzed regularly, based on a
proprietary risk rating cash flow model, in order to monitor the financial
quality of these assets and are internally rated. Based on ongoing monitoring,
mortgage loans with a likelihood of becoming delinquent are identified and
placed on an internal "watch list". Among criteria which would indicate a
potential problem are: imbalances in ratios of loan to value or contract rents
to debt service, major tenant vacancies or bankruptcies, borrower sponsorship
problems, late payments, delinquent taxes and loan relief/restructuring
requests.
We state commercial mortgage loans at their unpaid principal balances, net of
discount accrual and premium amortization, valuation allowances and writedowns
for impairment. We provide a valuation allowance for commercial mortgage loans
based on past loan loss experience and for specific loans considered to be
impaired. Mortgage loans are considered impaired when, based on current
information and events, it is probable that all amounts due according to the
contractual terms of the loan agreement may not be collected. When we determine
that a loan is impaired, we establish a valuation allowance for loss for the
excess of the carrying value of the mortgage loan over its estimated fair value.
Estimated fair value is based on either the present value of expected future
cash flows discounted at the loan's original effective interest rate, the loan's
observable market price or the fair value of the collateral. We record increases
in such valuation allowances as realized investment losses and, accordingly, we
reflect such losses in our consolidated results of operations. Such increases
(decreases) in valuation allowances aggregated $(17.3) million for the year
ended December 31, 2001, and $(9.8) million for the year ended December 31,
2000.
We review our mortgage loan portfolio and analyze the need for a valuation
allowance for any loan which is delinquent for 60 days or more, in process of
foreclosure, restructured, on the "watch list", or which currently has a
valuation allowance. We categorize loans which are delinquent, loans in process
of foreclosure and loans to borrowers in bankruptcy as "problem" loans.
Potential problem loans are loans placed on an internal "watch list" for which
95
management has concerns as to the ability of the borrower to comply with the
present loan payment terms and which may result in the loan becoming a problem
or being restructured. The decision whether to classify a performing loan as a
potential problem involves significant subjective judgments by management as to
the likely future economic conditions and developments with respect to the
borrower. We categorize loans for which the original terms of the mortgages have
been modified or for which interest or principal payments have been deferred as
"restructured" loans. We also consider matured loans that are refinanced at
below market rates as restructured.
We charge mortgage loans deemed to be uncollectible against the allowance for
losses and credit subsequent recoveries to the allowance for losses. We maintain
the allowance for losses at a level management believes to be adequate to absorb
estimated probable credit losses. Management bases its periodic evaluation of
the adequacy of the allowance for losses on our past loan loss experience, known
and inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of the underlying collateral,
composition of the loan portfolio, current economic conditions and other
relevant factors. The evaluation is inherently subjective as it requires
estimating the amounts and timing of future cash flows expected to be received
on impaired loans that may change.
The following table represents our commercial mortgage valuation allowance for
the years indicated:
U.S. Invested Assets
Commercial Mortgage Valuation Allowance
As of December 31,
--------------------------
2001 2000
----------- -----------
($ in millions)
Beginning balance.......................................... $ 108.0 $ 117.8
Provision.................................................. 12.0 3.0
Release due to writedowns, sales and foreclosures.......... (29.3) (12.8)
----------- -----------
Ending balance............................................. $ 90.7 $ 108.0
=========== ===========
Valuation allowance as % of carrying value before reserves. 1% 1%
The following table presents the carrying amounts of problem, potential problem
and restructured commercial mortgages relative to the carrying amount of all
commercial mortgages for the years indicated:
U.S. Invested Assets
Problem, Potential Problem and Restructured Commercial Mortgages at Carrying Amount
As of December 31,
-------------------------
2001 2000
----------- ----------
($ in millions)
Total commercial mortgages ................................ $ 9,740.4 $10,775.3
=========== ==========
Problem commercial mortgages(1)............................ $ 47.1 $ 8.9
Potential problem commercial mortgages .................... 98.9 58.9
Restructured commercial mortgages ......................... 42.4 92.6
----------- ----------
Total problem, potential problem and
restructured commercial mortgages .................... $ 188.4 $ 160.4
=========== ==========
Total problem, potential problem and restructured
commercial mortgages as a percent of total commercial
mortgages............................................. 2% 1%
- --------------------
(1) Problem commercial mortgages included mortgage loans in foreclosure of $6.0
million as of December 31, 2000. There were no mortgage loans in foreclosure
as of December 31, 2001.
96
Equity Real Estate
We hold commercial equity real estate as part of our investment portfolio. As of
December 31, 2001, and December 31, 2000, the carrying amount of equity real
estate investment was $1,174.1 million and $1,391.8 million, or 3% and 4% of
U.S. invested assets, respectively. We own real estate, real estate acquired
upon foreclosure of commercial mortgage loans and interests, both majority owned
and non-majority owned, in real estate joint ventures. We continue to focus on a
long-term strategy of reducing our real estate equity portfolio.
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale". Real estate held for investment totaled $783.4
million as of December 31, 2001, and $696.4 million as of December 31, 2000. The
carrying value of real estate held for investment is generally adjusted for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. Such impairment adjustments
are recorded as realized investment losses and accordingly, are reflected in our
consolidated results of operations. For the years ended December 31, 2001 and
December 31, 2000, there were no such impairment adjustments.
The carrying amount of real estate held for sale as of December 31, 2001, and
December 31, 2000, was $390.7 million and $695.4 million, net of valuation
allowances of $19.8 million and $40.8 million, respectively. Once we identify a
real estate property to be sold and commence a plan for marketing the property,
we classify the property as held for sale. We establish a valuation allowance
subject to periodical revisions, if necessary, to adjust the carrying value of
the property to reflect the lower of its current carrying value or the fair
value, less associated selling costs.
We use research, both internal and external, to recommend appropriate product
and geographic allocations and changes to the equity real estate portfolio. We
monitor product, geographic and industry diversification separately and together
to determine the most appropriate mix.
Equity real estate is distributed across geographic regions of the country with
larger concentrations in the South Atlantic, Pacific, and West South Central
regions of the United States as of December 31, 2001. By property type, there is
a concentration in office buildings that represented approximately 36% of the
equity real estate portfolio as of December 31, 2001. Our largest equity real
estate holding as of December 31, 2001 consisted of an office/industrial park
located in Durham, North Carolina with an aggregate carrying value of
approximately $148.3 million and represented approximately 13% of total U.S.
equity real estate assets and 0.3% of U.S. invested assets. The ten largest real
estate properties as of December 31, 2001 comprised 47% of total U.S. equity
real estate assets and 1% of total U.S. invested assets. In addition, our equity
real estate includes our investment in BT Hotels. As of December 31, 2001, BT
Hotels was fully consolidated into our financial statements and is reflected in
the International region and Hotel/Motel property type in the following
investment schedules:
97
U.S. Invested Assets
Equity Real Estate by Region(1)
As of December 31,
------------------------------------------
2001 2000
------------------- -------------------
Carrying % of Carrying % of
Amount Total Amount Total
---------- ----- ---------- -----
($ in millions)
South Atlantic............. $ 376.4 32% $ 431.7 31%
West South Central......... 236.4 20 362.2 26
International.............. 223.6 19 - -
Pacific.................... 183.8 16 384.6 28
East North Central......... 62.3 5 120.7 9
East South Central......... 32.3 3 21.5 1
West North Central......... 28.0 2 19.0 1
New England................ 14.3 1 14.5 1
Mountain................... 8.8 1 8.9 1
Middle Atlantic............ 8.2 1 28.7 2
---------- ----- ---------- -----
Total................... $ 1,174.1 100% $ 1,391.8 100%
========== ===== ========== =====
- --------------------
(1) Regions are defined by the American Council of Life Insurers.
U.S. Invested Assets
Equity Real Estate by Property Type
As of December 31,
------------------------------------------
2001 2000
------------------- -------------------
Carrying % of Carrying % of
Amount Total Amount Total
---------- ----- ---------- -----
($ in millions)
Office..................... $ 422.9 36% $ 615.5 44%
Hotel/Motel................ 223.6 19 - -
Industrial................. 221.6 19 413.6 30
Retail..................... 138.9 12 152.7 11
Service Center............. 63.1 5 120.1 9
Land....................... 53.3 5 89.9 6
Apartments................. 50.7 4 - -
---------- ----- ---------- -----
Total................... $ 1,174.1 100% $ 1,391.8 100%
========== ===== ========== =====
Derivatives
We use various derivative financial instruments to manage our exposure to
fluctuations in interest rates, including interest rate futures and interest
rate swaps and swaptions. We use interest rate futures contracts to hedge
changes in interest rates subsequent to the issuance of an insurance liability,
such as a guaranteed investment contract, but prior to the purchase of a
supporting asset, or during periods of holding assets in anticipation of near
term liability sales. We use interest rate swaps primarily to more closely match
the interest rate characteristics of assets and liabilities. They can be used to
change the interest rate characteristics of specific assets and liabilities as
well as an entire portfolio. Occasionally, we will sell a callable liability or
a liability with attributes similar to a call option. In these cases, we will
use interest rate swaptions or similar products to hedge the risk of early
liability payment, thereby transforming the callable liability into a fixed term
liability.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. An example of an investment we limit
because of the option risk is residential mortgage-backed securities. We assess
option risk in all investments we make and, when we take that risk, we price for
it accordingly.
98
Foreign currency risk is the risk that we will incur economic losses due to
adverse fluctuations in foreign currency exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional amount of our currency swap agreements associated with
foreign-denominated liabilities as of December 31, 2001, was $3,130.9 million.
We also have fixed maturity securities that are denominated in foreign
currencies. However, we use derivatives to hedge the foreign currency risk of
these funding agreements and securities. As of December 31, 2001, the fair value
of our foreign currency denominated fixed maturity securities was $304.6
million. We use currency swap agreements of the same currency to hedge the
foreign currency exchange risk related to these investments. The notional amount
of our currency swap agreements associated with foreign-denominated fixed
maturity securities as of December 31, 2001, was $296.0 million.
In conjunction with the interest rate swaps, interest rate swaptions and other
derivatives, we are exposed to counterparty risk, or the risk that counterparty
fails to perform the terms of the derivative contract. We actively manage this
risk by:
o establishing exposure limits which take into account non-derivative
exposure we have with the counterparty as well as derivative exposure;
o performing similar credit analysis prior to approval on each derivatives
counterparty that we do when lending money on a long-term basis;
o limiting exposure to AA- credit or better;
o conducting stress-test analysis to determine the maximum exposure created
during the life of a prospective transaction; and
o daily monitoring of counterparty credit ratings.
All new derivative counterparties are approved by the investment committee. We
believe the risk of incurring losses due to nonperformance by our counterparties
is remote and that such losses, if any, would not be material. Futures contracts
trade on organized exchanges and, therefore, effectively have no credit risk.
The notional amounts used to express the extent of our involvement in swap
transactions represent a standard measurement of the volume of our swap
business. Notional amount is not a quantification of market risk or credit risk
and it may not necessarily be recorded on the balance sheet. Notional amounts
represent those amounts used to calculate contractual flows to be exchanged and
are not paid or received, except for contracts such as currency swaps. Actual
credit exposure represents the amount owed to us under derivative contracts as
of the valuation date. The following tables present our position in, and credit
exposure to, derivative financial instruments as of December 31, 2001, and
December 31, 2000:
99
U.S. Invested Assets
Derivative Financial Instruments
As of December 31,
------------------------------------------
2001 2000
------------------- -------------------
Notional % of Notional % of
Amount Total Amount Total
---------- ----- ---------- -----
($ in millions)
Mortgage-backed forwards and options....... $ 9,250.7 34% $ 1,898.3 18%
Foreign currency swaps..................... 4,091.9 15 2,745.0 26
Swaptions ................................. 3,570.0 13 697.7 7
Interest rate floors....................... 3,400.0 13 2,450.0 23
Interest rate swaps........................ 3,272.5 12 2,241.5 22
Interest rate lock commitments............. 2,565.9 9 - -
Currency forwards.......................... 380.0 1 39.4 -
Bond forwards.............................. 357.4 1 - -
Principal Only swaps....................... 250.0 1 150.0 1
U.S. treasury futures...................... 186.6 1 183.2 2
Treasury rate guarantees................... 88.0 - 60.0 1
Call options............................... 30.0 - 30.0 -
Other...................................... 25.0 - - -
---------- ----- ---------- -----
Total................................... $ 27,468.0 100% $ 10,495.1 100%
========== ===== ========== =====
U.S. Invested Assets
Derivative Financial Instruments
As of December 31,
--------------------------------------
2001 2000
----------------- -----------------
Credit % of Credit % of
Exposure Total Exposure Total
-------- ----- -------- -----
($ in millions)
Foreign currency swaps................. $ 101.1 33% $ 45.3 42%
Interest rate swaps.................... 78.4 25 14.1 13
Currency forwards...................... 55.3 18 5.5 5
Mortgage-backed forwards and options... 41.7 14 - -
Interest rate floors................... 13.2 4 20.0 18
Call options........................... 8.9 3 12.3 11
Swaptions ............................. 8.7 3 11.8 11
Other.................................. 0.1 - - -
-------- ----- -------- -----
Total............................... $ 307.4 100% $ 109.0 100%
======== ===== ======== =====
Other Investments
Our other investments totaled $678.4 million as of December 31, 2001, compared
to $681.2 million as of December 31, 2000. Our investment in Coventry is
included in other investments as we accounted for it using the equity method. As
of December 31, 2001, our carrying value in Coventry was $146.0 million. With
the adoption of SFAS 133 on January 1, 2001, derivatives were reflected on our
balance sheet and accounted for $116.5 million in other investments as of
December 31, 2001. The remaining invested assets include leases and other
private equity investments.
Securities Lending
The terms of our securities lending program, approved in 1999, allow us to lend
our securities to major brokerage firms. Our policy requires an initial minimum
of 102% of the fair value of the loaned securities as collateral. Our securities
on loan as of December 31, 2001, had a fair value of $0.5 million.
100
International Investment Operations
As of December 31, 2001, our international investment operations consist of the
investments of Principal International and BT Financial Group and comprise $1.4
billion in invested assets, which primarily represent the assets of Principal
International. Principal Capital Management works with each Principal
International affiliate to develop investment policies and strategies that are
consistent with the products they offer. Due to the regulatory constraints in
each country, each company maintains its own investment policies which are
approved by Principal Capital Management. Each international affiliate is
required to submit a compliance report relative to its strategy to Principal
Capital Management. A credit committee comprised of Principal Capital Management
employees and international affiliate company chief investment officers review
each corporate credit annually. In addition, employees from our U.S. operations
who serve on the credit committee currently hold investment positions in two of
our international affiliates. Principal Capital Management provides credit
analysis training to Principal International personnel.
Overall Composition of International Invested Assets
As shown in the following table, the major categories of international invested
assets as of December 31, 2001, and December 31, 2000, were fixed maturity
securities and residential mortgage loans:
International Invested Assets
As of December 31,
--------------------------------------
2001 2000
----------------- -----------------
Carrying % of Carrying % of
Amount Total Amount Total
-------- ----- -------- -----
($ in millions)
Fixed maturity securities
Public.................................. $ 941.3 69% $ 948.6 70%
Private................................. 61.0 4 16.3 1
Equity securities, available-for-sale...... 24.9 2 76.9 6
Mortgage loans
Residential............................. 181.1 13 166.9 12
Real estate held for investment............ 7.7 1 8.7 1
Other investments ......................... 151.4 11 129.8 10
-------- ----- -------- -----
Total invested assets................... $1,367.4 100% $1,347.2 100%
===== =====
Cash and cash equivalents.................. 128.0 176.5
-------- --------
Total invested assets and cash ......... $1,495.4 $1,523.7
======== ========
International Investment Results
The yield on international invested assets and on cash and cash equivalents,
excluding net realized gains and losses, was 8.5%, 7.1% and 7.5% for the years
ended December 31, 2001, 2000 and 1999, respectively.
The following table illustrates the yields on average assets for each of the
components of our investment portfolio for the years ended December 31, 2001,
2000 and 1999:
101
International Invested Assets
Yields by Asset Type
As of or for the year ended December 31,
-------------------------------------------------------------
2001 2000 1999
------------------- ----------------- ------------------
Yield Amount Yield Amount Yield Amount
----- ---------- ----- ---------- ----- ----------
($ in millions)
Fixed maturity securities
Gross investment income(1)............ 9.1% $ 89.3 7.4% $ 67.4 6.9% $ 61.0
Net realized capital gains (losses)... (2.2) (22.0) 0.4 3.7 0.8 7.4
---------- ---------- ----------
Total............................... $ 67.3 $ 71.1 $ 68.4
========== ========== ==========
Ending assets (at carrying value)..... $ 1,002.3 $ 964.9 $ 859.6
Equity securities, available-for-sale
Gross investment income(1)............ 0.4% $ 0.2 0.6% $ 0.5 6.9% $ 7.0
Net realized capital gains (losses)... 6.5 3.3 (1.3) (1.1) 1.6 1.6
---------- ---------- ----------
Total............................... $ 3.5 $ (0.6) $ 8.6
========== ========== ==========
Ending assets (at carrying value)..... $ 24.9 $ 76.9 $ 96.1
Mortgage loans - Residential
Gross investment income(1)............ 10.4% $ 18.1 8.6% $ 11.2 15.2% $ 7.0
Net realized capital gains (losses)... - - - - - -
---------- ---------- ----------
Total............................... $ 18.1 $ 11.2 $ 7.0
========== ========== ==========
Ending assets (at carrying value)..... $ 181.1 $ 166.9 $ 92.3
Real estate
Gross investment income(1)............ 7.3% $ 0.6 5.1% $ 0.5 8.6% $ 0.4
Net realized capital gains (losses)... - - - - - -
---------- ---------- ----------
Total............................... $ 0.6 $ 0.5 $ 0.4
========== ========== ==========
Ending assets (at carrying value)..... $ 7.7 $ 8.7 $ 10.8
Cash and cash equivalents
Gross investment income(1)............ 2.9% $ 4.4 4.4% $ 8.3 4.8% $ 5.9
Net realized capital gains (losses)... - - - - - -
---------- ---------- ----------
Total............................... $ 4.4 $ 8.3 $ 5.9
========== ========== ==========
Ending assets (at carrying value)..... $ 128.0 $ 176.5 $ 201.1
Other investments
Gross investment income(1)............ 12.2% $ 17.1 11.7% $ 19.1 15.4% $ 15.9
Net realized capital gains (losses)... (29.4) (41.3) 0.1 0.2 (0.3) (0.3)
---------- ---------- ----------
Total............................... $ (24.2) $ 19.3 $ 15.6
========== ========== ==========
Ending assets (at carrying value)..... $ 151.4 $ 129.8 $ 196.4
Total before investment expenses
Gross investment income(1)............ 8.6% $ 129.7 7.2% $ 107.0 7.7% $ 97.2
Net realized capital gains (losses)... (4.0) (60.0) 0.2 2.8 0.7 8.7
---------- ---------- ----------
Total............................... $ 69.7 $ 109.8 $ 105.9
========== ========== ==========
Investment expenses........................ -% $ 0.7 0.1% $ 2.0 0.2% $ 3.1
Net investment income...................... 8.5% $ 129.0 7.1% $ 105.0 7.5% $ 94.1
- --------------------
(1) Yields are based on annual average asset carrying values for the years ended
December 31, 2001, 2000, and 1999.
Fixed Maturity Securities
Fixed maturity securities consist primarily of publicly traded debt securities
and represented 73% of total international invested assets as of December 31,
2001, and 71% as of December 31, 2000. Fixed maturity securities were
diversified by type of issuer as of December 31, 2001, and for the year ended
December 31, 2000, as shown in the following table:
102
International Invested Assets
Fixed Maturity Securities by Type of Issuer
As of December 31,
---------------------------------------------
2001 2000
-------------------- -------------------
Carrying % of Carrying % of
Amount Total Amount Total
-------- ----- -------- -----
($ in millions)
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies................ $ 0.3 -% $ 1.8 -%
Foreign governments.................................... 322.8 32 313.6 32
Corporate - public..................................... 363.6 37 376.5 39
Corporate - private.................................... 61.0 6 16.3 2
Mortgage-backed securities and other asset-
Backed securities................................... 254.6 25 256.7 27
-------- ----- -------- -----
Total fixed maturities.............................. $1,002.3 100% $ 964.9 100%
======== ===== ======== =====
The fixed maturity securities held by the international operations have not been
rated by external agencies and cannot be presented in a comparable rating agency
equivalent.
The issuers of the majority of our fixed maturity corporate securities are
mainly banks and are categorized in the finance, insurance and real estate
category as shown in the following tables:
International Invested Assets
Corporate Fixed Maturity Securities Portfolio by Industry as of December 31, 2001
Publicly Traded Privately Placed Total
----------------- ----------------- -----------------
Carrying % of Carrying % of Carrying % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
($ in millions)
Industry Class
Finance, Insurance and Real Estate.... $ 180.2 50% $ 17.5 29% $ 197.7 47%
Services.............................. 50.3 14 9.8 16 60.1 14
Construction.......................... 47.6 13 6.0 10 53.6 12
Transportation and Public Utilities... 49.7 14 - - 49.7 12
Retail................................ 35.6 9 1.2 2 36.8 9
Manufacturing......................... 0.1 - 26.5 43 26.6 6
Public Administration................. 0.1 - - - 0.1 -
-------- ----- -------- ----- -------- -----
Total.............................. $ 363.6 100% $ 61.0 100% $ 424.6 100%
======== ===== ======== ===== ======== =====
International Invested Assets
Corporate Fixed Maturity Securities Portfolio by Industry
as of December 31, 2000
Publicly Traded Privately Placed Total
------------------ ----------------- -----------------
Carrying % of Carrying % of Carrying % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
($ in millions)
Industry Class
Finance, Insurance and Real Estate.... $ 240.3 64% $ - -% $ 240.3 61%
Transportation and Public Utilities... 100.6 27 - - 100.6 26
Retail................................ 26.2 7 - - 26.2 7
Manufacturing......................... 0.3 - 13.3 82 13.6 3
Services.............................. 9.1 2 2.7 17 11.8 3
Construction.......................... - - 0.3 1 0.3 -
-------- ----- -------- ----- -------- -----
Total.............................. $ 376.5 100% $ 16.3 100% $ 392.8 100%
======== ===== ======== ===== ======== =====
103
The international operations held $254.6 million of residential pass-through
securities as of December 31, 2001, and $256.7 million as of December 31, 2000.
The amortized cost and estimated fair value of fixed maturity securities, by
contractual maturity dates excluding scheduled sinking funds, as of December 31,
2001, and December 31, 2000, were as follows:
International Invested Assets
Fixed Maturity Securities by Contractual Maturity Dates
As of December 31,
-----------------------------------------------
2001 2000
---------------------- ---------------------
Amortized Carrying Amortized Carrying
Cost Amount Cost Amount
--------- --------- --------- --------
(in millions)
Due in one year or less.............................. $ 35.5 $ 36.0 $ 31.6 $ 29.2
Due after one year through five years................ 161.7 162.3 91.8 95.3
Due after five years through ten years............... 212.8 211.8 215.6 217.2
Due after ten years.................................. 326.6 337.6 356.4 366.5
--------- --------- --------- --------
Subtotal.......................................... 736.6 747.7 695.4 708.2
Mortgage-backed and other securities without a
single maturity date.............................. 248.8 254.6 253.5 256.7
--------- --------- --------- --------
Total............................................. $ 985.4 $ 1,002.3 $ 948.9 $ 964.9
========= ========= ========= ========
The international operations held $20.1 million of restructured government bonds
in Argentina, which represented 2% of international fixed maturity securities as
of December 31, 2001.
Equity Securities
Our equity securities represented 2% of international invested assets as of
December 31, 2001, and 6% as of December 31, 2000. Our equity securities
consisted of $8.2 million in mutual funds and $16.7 million in common stock as
of December 31, 2001.
Residential Mortgage Loans
Our Chilean operations originate and purchase residential mortgage loans.
Residential mortgage loans comprised $181.1 million, or 13%, of international
invested assets as of December 31, 2001, and $166.9 million, or 12%, as of
December 31, 2000.
Derivatives
The derivative contracts outstanding as of December 31, 2000 related to the 144A
debt issued to purchase BT Financial Group in 1999. On December 28, 2001, all
obligations of the long-term debt were assumed by Principal Financial Services,
Inc., and as of that date Principal Financial Group (Australia) Holdings Pty
Limited's obligations ceased. In conjunction with the move of the debt, the
outstanding derivative contracts were assigned to PFSI. The following tables
present our position in, and credit exposure to, derivative financial
instruments as of December 31, 2001, and December 31, 2000.
104
International Invested Assets
Derivative Financial Instruments
As of December 31,
--------------------------------------
2001 2000
----------------- -----------------
Notional % of Notional % of
Amount Total Amount Total
-------- ----- -------- -----
($ in millions)
Foreign currency swaps....... $ 13.4 100% $ 665.0 39%
Interest rate swaps.......... - - 665.0 39
Currency forwards............ - - 380.0 22
-------- ----- -------- -----
Total..................... $ 13.4 100% $1,710.0 100%
======== ===== ======== =====
International Invested Assets
Derivative Financial Instruments
As of December 31,
--------------------------------------
2001 2000
----------------- -----------------
Credit % of Credit % of
Exposure Total Exposure Total
-------- ----- -------- -----
($ in millions)
Interest rate swaps.......... $ - -% $ 39.1 42%
Foreign currency swaps....... - - 28.4 30
Currency forwards............ - - 26.2 28
-------- ----- -------- -----
Total..................... - -% $ 93.7 100%
======== ===== ======== =====
Other Investments
Our other investments totaled $151.4 million as of December 31, 2001, compared
to $129.8 million as of December 31, 2000. Of the $151.4 million, $37.8 million
is related to subordinated notes in BT Financial Group's margin lending program,
$68.2 million represents our investments in unconsolidated subsidiaries in
Brazil, Japan, India and Mexico, $25.5 million represents BT Financial Group's
investment in unit trusts, $19.5 million represents other invested assets from
our Chilean operations and $0.4 million represents other invested assets from
our Mexican operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Exposures and Risk Management
Market risk is the risk that we will incur losses due to adverse fluctuations in
market rates and prices. Our primary market risk exposure is to changes in
interest rates, although we also have exposures to changes in equity prices and
foreign currency exchange rates.
The active management of market risk is an integral part of our operations. We
manage our overall market risk exposure within established risk tolerance ranges
by using the following approaches:
o rebalance our existing asset or liability portfolios;
o control the risk structure of newly acquired assets and liabilities; or
o use derivative instruments to modify the market risk characteristics of
existing assets or liabilities or assets expected to be purchased.
105
Interest Rate Risk
Interest rate risk is the risk that we will incur economic losses due to adverse
changes in interest rates. Our exposure to interest rate risk stems largely from
our substantial holdings of guaranteed fixed rate liabilities in our U.S. Asset
Management and Accumulation segment.
We seek to earn returns on investments that enhance our ability to offer
competitive rates and prices to customers while contributing to attractive and
stable profits and long-term capital growth. Accordingly, our investment
decisions and objectives are a function of the underlying risks and product
profiles of each primary business operation. In addition, we diversify our
product portfolio offerings to include products that contain features that will
protect us against fluctuations in interest rates. Those features include
adjustable crediting rates, policy surrender charges and market value
adjustments on liquidations.
We manage the interest rate risk inherent in our assets relative to the interest
rate risk inherent in our liabilities. One of the measures we use to quantify
this exposure is duration. Duration measures the change in the fair value of
assets and liabilities for given changes in interest rates. For example, if
interest rates increase by a hypothetical 100 basis points, the fair value of an
asset with a duration of 5 years is expected to decrease in value by
approximately 5%.
To calculate duration, we project asset and liability cashflows. These cashflows
are discounted to a net present value basis using a spot yield curve, which is a
blend of the spot yield curves for each of the asset types in the portfolio.
Duration is calculated by re-calculating these cashflows and redetermining the
net present value based upon an alternative level of interest rates, and
determining the percentage change in fair value.
As of December 31, 2001, the difference between the asset and liability
durations on our primary duration managed portfolio was .02 years. This duration
gap indicates that as of this date the sensitivity of the fair value of our
assets to interest rate movements is greater than that of the fair value of our
liabilities. Our goal is to minimize the duration gap. Currently, our guidelines
dictate that total duration gaps between the asset and liability portfolios must
be within 0.25 years. The value of the assets in this portfolio was $23,735.5
million as of December 31, 2001.
We also manage interest rate risk by employing a partial duration analysis. With
this technique, the yield curve is dissected into various term components and a
partial duration is calculated for each. Each partial duration represents the
potential change in fair value of the asset or liability to interest rate shift
in rates in the applicable component of the yield curve. We minimize potential
volatility in the fair value of surplus of Principal Life as a result of changes
in the yield curve by managing each partial duration gap between the assets and
liabilities within established guidelines.
With respect to our primary duration managed portfolio, we use several methods
to correct any potential total or partial duration gaps that are outside of our
established risk tolerance ranges. We can rebalance the existing asset or
liability portfolios or we can redirect new asset purchases until the asset
portfolio is better aligned with the liabilities and our duration gaps are back
within their limits. If a more expedient correction is desired, another method
we use is forward interest rate swaps. These swaps are designed to move duration
exposure from one specific point on the yield curve to another, and are an
efficient way to quickly shift the partial and total duration profile of the
asset portfolio so that duration gaps and hence interest rate risk is minimized.
For products such as whole life insurance, term life insurance and single
premium deferred annuities, the liability cashflow is less predictable, and a
duration-matching strategy is less reliable and manageable. We do, however, try
to manage the duration of these portfolios. For these products, we manage
interest rate risk based on a modeling process that considers the target average
life, maturities, crediting rates and assumptions of policyholder behavior. As
of December 31, 2001, the weighted-average difference between the asset and
liability durations on these portfolios was 1.2 years. This duration gap
indicates that as of this date the sensitivity of the fair value of our assets
to interest rate movements is greater than that of the fair value of our
liabilities. We attempt to monitor this duration gap consistent with our overall
risk/reward tolerances. The value of the assets in these portfolios was
$10,225.7 million as of December 31, 2001.
We also have a block of participating general account pension business that
passes the actual investment performance of the assets to the customer. The
investment strategy of this block is to maximize investment return to the
customer on a "best efforts" basis, and there is little or no attempt to manage
106
the duration of this portfolio since there is little or no interest rate risk.
The value of the assets in these portfolios was $4,886.3 million as of December
31, 2001.
Using the assumptions and data in effect as of December 31, 2001, we estimate
that a 100 basis point immediate, parallel increase in interest rates decreases
the net fair value of our portfolio by $127.5 million. The following table
details the estimated changes by risk management strategy:
As of
Risk Management December 31, 2001 Net Fair Value
Strategy Value of Total Assets Change
- ------------------------------ --------------------- --------------
(in millions)
Primary duration-managed...... $ 23,735.5 $ (4.7)
Duration-monitored............ 10,225.7 (122.8)
Non duration-managed.......... 4,886.3 -
--------------------- --------------
Total...................... $ 38,847.5 $(127.5)
===================== ==============
Our selection of a 100 basis point immediate, parallel increase or decrease in
interest rates is a hypothetical rate scenario we use to demonstrate potential
risk. While a 100 basis point immediate, parallel increase does not represent
our view of future market changes, it is a near term reasonably possible
hypothetical change that illustrates the potential impact of such events. While
these fair value measurements provide a representation of interest rate
sensitivity, they are based on our portfolio exposures at a point in time and
may not be representative of future market results. These exposures will change
as a result of ongoing portfolio transactions in response to new business,
management's assessment of changing market conditions and available investment
opportunities.
We are also exposed to interest rate risk in our Mortgage Banking segment. We
manage this risk by striving to balance our loan origination and loan servicing
operations, the two of which are generally counter-cyclical. In addition, we use
various financial instruments, including derivatives contracts, to manage the
interest rate risk specifically related to committed loans in the pipeline and
mortgage servicing rights. The overall objective of our interest rate risk
management policies is to offset changes in the values of these items resulting
from changes in interest rates. We do not speculate on the direction of interest
rates in our management of interest rate risk.
We manage interest rate risk on our mortgage loan pipeline by buying and selling
mortgage-backed securities in the forward markets, over-the-counter options on
mortgage-backed securities, U.S. Treasury and Eurodollar futures contracts and
options on futures contracts. We also use interest rate floors, futures
contracts, options on futures contracts, swaps and swaptions, mortgage-backed
securities and principal-only strips in hedging a portion of our portfolio of
mortgage servicing rights from prepayment risk associated with changes in
interest rates.
We measure pipeline interest rate risk exposure by adjusting the at-risk
pipeline in light of the theoretical optionality of each applicant's rate/price
commitment. The at-risk pipeline, which consists of closed loans and rate locks,
is then refined at the product type level to express each product's sensitivity
to changes in market interest rates in terms of a single current coupon MBS
duration. Suitable hedges are selected and a similar methodology applied to this
hedge position. The variety of hedging instruments allows us to match the
behavior of the financial instrument with that of the different types of loans
originated. We limit our risk exposure by requiring that the net position value
not change by more than $10.0 million given an instantaneous change in the
benchmark MBS price of +/- 2.5%. This price sensitivity analysis is performed at
least once daily. The value of the loans in the pipeline as of December 31,
2001, was $7.0 billion. Due to the impact of our hedging activities, we estimate
that a 100 basis point immediate parallel increase in the interest rates
decreases the December 31, 2001, net position value by $12.5 million.
The financial risk associated with our mortgage servicing operations is the risk
that the market value of the servicing asset falls below its U.S. GAAP book
value. To measure this risk, we analyze each servicing risk tranche's U.S. GAAP
book value in relation to the then current market value for similar servicing
rights. We perform this valuation using option-adjusted spread valuation
techniques applied to each risk tranche. We produce tranche market values at
least monthly.
The market value of the servicing asset declines as interest rates decrease due
to possible mortgage loan servicing rights impairment that may result from
increased current and projected future prepayment activity. The change in value
of the servicing asset due to interest rate movements is reduced by the use of
107
financial instruments, including derivative contracts, that increase in
aggregate value when interest rates decline. Based on values as of December 31,
2001, a 100 basis point parallel decrease in interest rates produces a $191.4
million decline in value of the servicing asset of our Mortgage Banking segment,
net of the impact of these hedging vehicles, due to the differences between
market values and U.S. GAAP book values.
Derivatives. We use various derivative financial instruments to manage our
exposure to fluctuations in interest rates, including interest rate swaps,
Principal Only swaps, interest rate floors, swaptions, U.S. Treasury futures,
Treasury rate guarantees, interest rate lock commitments and mortgage-backed
forwards and options. We use interest rate futures contracts and mortgage-backed
forwards to hedge changes in interest rates subsequent to the issuance of an
insurance liability, such as a guaranteed investment contract, but prior to the
purchase of a supporting asset, or during periods of holding assets in
anticipation of near term liability sales. We use interest rate swaps and
Principal Only swaps primarily to more closely match the interest rate
characteristics of assets and liabilities. They can be used to change the
interest rate characteristics of specific assets and liabilities as well as an
entire portfolio. Occasionally, we will sell a callable liability or a liability
with attributes similar to a call option. In these cases, we will use interest
rate swaptions or similar products to hedge the risk of early liability payment
thereby transforming the callable liability into a fixed term liability.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. An example of an investment we limit
because of the option risk is residential mortgage-backed securities. We assess
option risk in all investments we make and, when we assume such risk, we seek to
price for it accordingly to achieve an appropriate return on our investments.
In conjunction with the interest rate swaps, interest rate swaptions and other
derivatives, we are exposed to counterparty risk, or the risk that counterparty
fails to perform the terms of the derivative contract. We actively manage this
risk by:
o establishing exposure limits which take into account non-derivative
exposure we have with the counterparty as well as derivative exposure;
o performing similar credit analysis prior to approval on each derivatives
counterparty that we do when lending money on a long-term basis;
o limiting exposure to AA- credit or better;
o conducting stress-test analysis to determine the maximum exposure created
during the life of a prospective transaction; and
o daily monitoring of counterparty credit ratings.
All new derivative counterparties are approved by the investment committee. We
believe the risk of incurring losses due to nonperformance by our counterparties
is remote and that such losses, if any, would not be material. Futures contracts
trade on organized exchanges and, therefore, effectively have no credit risk.
The following table shows the interest rate sensitivity of our derivatives
measured in terms of fair value. These exposures will change as a result of
ongoing portfolio and risk management activities.
108
As of December 31, 2001
----------------------------------------------------------------------
Fair Value (no accrued interest)
-----------------------------------------
Weighted
Notional Average Term -100 Basis +100 Basis
Amount (Years) Point Change No Change Point Change
--------- ------------ ------------ --------- ------------
($ in millions)
Interest rate swaps.................. $ 3,272.5 5.60(1) $ (51.9) $ 1.8 $ 50.7
Principal Only swaps................. 250.0 2.32(1) 21.6 (5.7) (17.9)
Other................................ 25.0 0.30(1) 0.7 0.1 (0.5)
Interest rate floors................. 3,400.0 4.50(2) 55.6 49.0 (23.2)
U.S. Treasury futures................ 186.6 0.25(3) 3.4 0.9 (1.6)
Swaptions............................ 3,570.0 1.61(4) 89.8 51.1 (40.3)
Treasury rate guarantees............. 88.0 0.32(5) (6.1) 0.2 6.6
Bond forwards........................ 357.4 1.69(5) 12.0 (9.6) (30.5)
Mortgage-backed forwards and options. 9,250.7 0.24(5) (205.6) 36.6 254.4
Interest rate lock commitments....... 2,565.9 0.12(6) 64.1 (11.5) (130.0)
--------- ------------ --------- ------------
Total............................. $22,966.1 $ (16.4) $ 112.9 $ 67.7
========= ============ ========= ============
- --------------------
(1) Based on maturity date of swap.
(2) Based on maturity date of floor.
(3) Based on maturity date.
(4) Based on option date of swaption.
(5) Based on settlement date.
(6) Based on expiration date.
We use U.S. treasury futures to manage our over/under commitment position, and
our position in these contracts changes daily.
Debt Issued and Outstanding. As of December 31, 2001, the aggregate fair value
of debt was $1,447.3 million. A 100 basis point, immediate, parallel decrease in
interest rates would increase the fair value of debt by approximately $81.4
million.
As of December 31, 2001
Fair Value (no accrued interest)
-100 Basis +100 Basis
Point Change No Change Point Change
------------ --------- ------------
(in millions)
7.95% notes payable, due 2004............... $ 222.2 $ 216.9 $ 211.8
8.2% notes payable, due 2009................ 542.1 511.2 482.5
7.875% surplus notes payable, due 2024...... 215.7 193.9 175.4
8% surplus notes payable, due 2044.......... 108.0 95.7 85.7
Non-recourse mortgages and notes payable.... 271.6 260.4 249.9
Other mortgages and notes payable........... 169.1 169.2 169.2
------------ --------- ------------
Total long-term debt..................... $ 1,528.7 $ 1,447.3 $ 1,374.5
============ ========= ============
Equity Risk
Equity risk is the risk that we will incur economic losses due to adverse
fluctuations in a particular common stock. As of December 31, 2001, the fair
value of our equity securities was $833.6 million. A 10% decline in the value of
the equity securities would result in an unrealized loss of $83.4 million.
We also have indirect equity risk exposure with respect to BT Financial Group
margin lending operations. Under the terms of this financing arrangement, BT
Financial Group margin lending operations allow retail clients and independent
financial advisors on behalf of clients, within limits approved by senior
management, to borrow funds from BT Financial Group to invest in an approved
list of securities and mutual fund investments which serve as security for the
loan. The risk of loan default increases as the value of the underlying
securities declines. This risk is actively managed through the use of margin
calls on loans when the underlying securities fall below established levels.
Overall, the margin lending portfolio is limited to a ratio of borrowed funds to
market value of securities of an average of 60%. On November 30, 1999, BT
109
Financial Group margin lending operations securitized its margin lending
portfolio with Westpac Banking Corporation, an Australian bank. Under the terms
of this financing, BT Financial Group margin lending operations are required to
allocate capital equal to approximately 7% of the outstanding borrowed amount,
as a cushion for loan defaults. As of December 31, 2001, the margin lending
portfolio was $539.5 million, or A$1,054.0 million, while the ratio of borrowed
funds to market value of securities was 43%, below that of the maximum allowed.
Foreign Currency Risk
Foreign currency risk is the risk that we will incur economic losses due to
adverse fluctuations in foreign currency exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional amount of our currency swap agreements associated with
foreign-denominated liabilities as of December 31, 2001, was $3,130.9 million.
We also have fixed maturity securities that are denominated in foreign
currencies. However, we use derivatives to hedge the foreign currency risk, both
interest payments and the final maturity payment, of these funding agreements
and securities. As of December 31, 2001, the fair value of our foreign currency
denominated fixed maturity securities was $304.6 million. We use currency swap
agreements of the same currency to hedge the foreign currency exchange risk
related to these investments. The notional amount of our currency swap
agreements associated with foreign-denominated fixed maturity securities as of
December 31, 2001, was $296.0 million. With regard to our international
operations, we attempt to do as much of our business as possible in the
functional currency of the country of operation. At times, however, we are
unable to do so, and in these cases, we use foreign exchange derivatives to
hedge the resulting risks.
Additionally, we utilize foreign currency swaps related to $665.0 million of
private notes issued in connection with our acquisition of BT Financial Group.
The interest payments related to these notes were serviced through operating
cash flows of our Australian operations. By utilizing the foreign currency and
interest rate swaps, the impact of Australian and U.S. dollar exchange rate
fluctuations had a minimal effect on our ability to rely on the cash flows of
our Australian operations to service the interest and principal payments related
to the notes. On December 28, 2001, all of the long-term debt obligations of
Principal Financial Group (Australia) Holdings Pty Limited were ceased and were
assumed by its parent, PFSI.
We estimate that as of December 31, 2001, a 10% immediate unfavorable change in
each of the foreign currency exchange rates to which we are exposed would result
in no change to the net fair value of our foreign currency denominated
instruments identified above, including the currency swap agreements. The
selection of a 10% immediate unfavorable change in all currency exchange rates
should not be construed as a prediction by us of future market events, but
rather as an illustration of the potential impact of such an event. Our largest
individual currency exposure is to fluctuations between the Australian dollar
and the U.S. dollar.
Effects of Inflation
We do not believe that inflation, in the United States or in the other countries
in which we operate, has had a material effect on our consolidated operations
over the past five years. In the future, however, we may be affected by
inflation to the extent it causes interest rates to rise.
110
Item 8. Financial Statements and Supplementary Data
Report of Management...................................... 111
Report of Independent Auditors............................ 112
Audited Consolidated Financial Statements
Consolidated Statements of Financial Position.......... 113
Consolidated Statements of Operations.................. 114
Consolidated Statements of Stockholders' Equity........ 115
Consolidated Statements of Cash Flows.................. 116
Notes to Consolidated Financial Statements............ 118
Report of Management
The management of Principal Financial Group, Inc. is responsible for the
preparation and integrity of the consolidated financial statements and related
financial information included in the annual report. The financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States and include amounts based on management's best estimates
and informed judgements. Management believes the statements fairly present
Principal Financial Group, Inc.'s financial position and results of operation,
and that other information contained in this Form 10-K is consistent with the
financial statements.
Management is responsible for maintaining systems of internal accounting
controls designed to provide reasonable assurance as to the integrity of the
financial records and the protection of corporate assets. Principal Financial
Group, Inc. supports and manages an active program designed to monitor
compliance with policies and procedures and evaluate internal control.
Ernst & Young LLP, independent auditors, has audited the consolidated financial
statements of Principal Financial Group, Inc. The audit was conducted in
accordance with auditing standards generally accepted in the United States.
Those standards require that the independent auditor plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
from material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. The independent auditors have discussed with the audit
committee accounting principles, estimates and judgments used by management in
the preparation of the consolidated financial statements.
The board of directors is responsible for engaging the independent auditors,
evaluating the independent auditors' independence, overseeing the independent
audit, and assuring management fulfills its responsibilities in the preparation
of the financial statements and for maintaining the system of internal controls.
The audit committee of the board meets quarterly with management, the internal
auditors and the independent auditors to enable the board to fulfill these
responsibilities.
By: /s/ Michael H. Gersie
-----------------------------------
Michael H. Gersie
Executive Vice President and Chief
Financial Officer
By: /s/ Douglas C. Cunningham
-----------------------------------
Douglas C. Cunningham
Vice President and Corporate Controller
111
Report of Independent Auditors
The Board of Directors and Stockholders
Principal Financial Group, Inc.
We have audited the accompanying consolidated statements of financial position
of Principal Financial Group, Inc. (the Company), successor to Principal Mutual
Holding Company, as of December 31, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Principal
Financial Group, Inc. at December 31, 2001 and 2000, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for derivative instruments and hedging
activities in response to a new accounting standard that became effective
January 1, 2001.
/s/ Ernst & Young LLP
Des Moines, Iowa
February 1, 2002
112
Principal Financial Group, Inc.
Consolidated Statements of Financial Position
December 31,
2001 2000
---------- ----------
(in millions,
except per share data)
Assets
Fixed maturities, available-for-sale........... $30,012.3 $26,839.9
Fixed maturities, trading...................... 17.8 -
Equity securities, available-for-sale.......... 833.6 742.9
Mortgage loans................................. 11,065.7 11,492.7
Real estate.................................... 1,181.8 1,400.5
Policy loans................................... 831.9 803.6
Other investments.............................. 829.8 811.0
---------- ----------
Total investments........................... 44,772.9 42,090.6
Cash and cash equivalents...................... 623.8 926.6
Accrued investment income...................... 594.3 530.8
Premiums due and other receivables............. 531.3 505.7
Deferred policy acquisition costs.............. 1,372.5 1,333.3
Property and equipment......................... 518.2 507.0
Goodwill and other intangibles................. 1,228.4 1,375.9
Mortgage loan servicing rights................. 1,779.2 1,084.4
Separate account assets........................ 35,864.8 34,916.2
Other assets................................... 1,065.1 1,134.4
---------- ----------
Total assets................................ $88,350.5 $84,404.9
========== ==========
Liabilities
Contractholder funds........................... $24,684.4 $24,300.2
Future policy benefits and claims.............. 14,034.6 13,346.0
Other policyholder funds....................... 589.1 597.4
Short-term debt................................ 511.6 459.5
Long-term debt................................. 1,378.4 1,336.5
Income taxes currently payable................. 0.5 108.4
Deferred income taxes.......................... 894.6 487.4
Separate account liabilities................... 35,864.8 34,916.2
Other liabilities.............................. 3,572.2 2,600.8
---------- ----------
Total liabilities........................... 81,530.2 78,152.4
Stockholders' equity
Common stock, par value $.01 per share -
2,500 million shares authorized, 375.8
million shares issued, 360.1 million
shares outstanding.......................... 3.8 -
Additional paid-in capital..................... 7,072.5 -
Retained earnings (deficit).................... (29.1) 6,312.5
Accumulated other comprehensive income (loss).. 147.5 (60.0)
Treasury stock, at cost (15.7 million shares).. (374.4) -
---------- ----------
Total stockholders' equity.................. 6,820.3 6,252.5
---------- ----------
Total liabilities and stockholders' equity.. $88,350.5 $84,404.9
========== ==========
See accompanying notes.
113
Principal Financial Group, Inc.
Consolidated Statements of Operations
For the year ended December 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Revenues
Premiums and other considerations............... $4,122.3 $3,996.4 $3,937.6
Fees and other revenues......................... 1,814.7 1,576.3 1,287.3
Net investment income........................... 3,394.5 3,172.3 3,072.0
Net realized capital gains (losses)............. (514.0) 139.9 404.5
---------- ---------- ----------
Total revenues.................................. 8,817.5 8,884.9 8,701.4
Expenses
Benefits, claims, and settlement expenses....... 5,482.1 5,232.3 5,260.9
Dividends to policyholders...................... 313.7 312.7 304.6
Operating expenses.............................. 2,573.2 2,479.4 2,070.3
---------- ---------- ----------
Total expenses.................................. 8,369.0 8,024.4 7,635.8
---------- ---------- ----------
Income before income taxes and cumulative
effect of accounting change.................. 448.5 860.5 1,065.6
Income taxes.................................... 79.0 240.3 323.5
---------- ---------- ----------
Income before cumulative effect of accounting 369.5 620.2 742.1
change.......................................
Cumulative effect of accounting change, net
of related income taxes...................... (10.7) - -
---------- ---------- ----------
Net income...................................... $ 358.8 $ 620.2 $ 742.1
========== ========== ==========
For the period Pro forma (unaudited) for
October 26, 2001 through the year ended
December 31, 2001 December 31, 2001
--------------------------- ---------------------------
Pro forma earnings per common share
Basic earnings per common share:
Income (loss) before cumulative effect of
accounting change.......................... $(0.08) $ 1.02
Cumulative effect of accounting change,
net of related income taxes................ - (0.03)
--------------------------- ---------------------------
Net income (loss)............................ $(0.08) $ 0.99
=========================== ===========================
Diluted earnings per common share:
Income (loss) before cumulative effect of
accounting change.......................... $(0.08) $ 1.02
Cumulative effect of accounting change,
net of related income taxes................ - (0.03)
--------------------------- ---------------------------
Net income (loss)............................ $(0.08) $ 0.99
=========================== ===========================
The unaudited pro forma earnings per common share information above gives effect
to the Demutualization and Initial Public Offering completed on October 26, 2001
(see Note 18 to the consolidated financial statements).
See accompanying notes.
114
Principal Financial Group, Inc.
Consolidated Statements of Stockholders' Equity
Accumulated
Additional Retained other Total
Common paid-in earnings comprehensive Treasury stockholders' Outstanding
stock capital (deficit) income (loss) stock equity shares
------ ---------- --------- ------------- -------- ------------- -----------
(in millions) (in thousands)
Balances at January 1, 1999............. $- $ - $4,950.2 $ 717.0 $ - $ 5,667.2
Comprehensive loss:
Net income........................... - - 742.1 - - 742.1
Net unrealized gains (losses)........ - - - (1,300.9) - (1,300.9)
Provision for deferred
income tax benefit................. - - - 453.0 - 453.0
Foreign currency translation
adjustment......................... - - - (8.5) - (8.5)
-------------
Comprehensive loss...................... (114.3)
------ ---------- --------- ------------- -------- ------------- -----------
Balances at December 31, 1999........... - - 5,692.3 (139.4) - 5,552.9
Comprehensive income:
Net income........................... - - 620.2 - - 620.2
Net unrealized gains (losses)........ - - - 351.9 - 351.9
Provision for deferred income-taxes.. - - - (120.0) - (120.0)
Foreign currency translation
adjustment......................... - - - (152.5) - (152.5)
-------------
Comprehensive income.................... 699.6
------ ---------- --------- ------------- -------- ------------- -----------
Balances at December 31, 2000........... - - 6,312.5 (60.0) - 6,252.5
Demutualization transaction............. 2.6 5,047.7 (6,700.4) - - (1,650.1) 260,805.9
Stock issued and held in rabbi
trusts............................... - 6.7 - - (6.7) - (363.7)
Initial public offering................. 1.0 1,752.9 - - - 1,753.9 100,000.0
Shares issued........................... 0.2 265.2 - - - 265.4 15,000.0
Treasury stock acquired................. - - - - (367.7) (367.7) (15,300.0)
Comprehensive income:
Net income before demutualization.... - - 387.9 - - 387.9
Net loss after demutualization....... - - (29.1) - - (29.1)
--------- -------------
Net income for the year.............. - - 358.8 - - 358.8
Net unrealized gains (losses)........ - - - 451.6 - 451.6
Provision for deferred income-taxes.. - - - (158.1) - (158.1)
Foreign currency translation
adjustment......................... - - - (71.8) - (71.8)
Cumulative effect of accounting
change, net of related income
taxes.............................. - - - (14.2) - (14.2)
-------------
Comprehensive income.................... 566.3
------ ---------- --------- ------------- -------- ------------- -----------
Balances at December 31, 2001........... $3.8 $7,072.5 $ (29.1) $ 147.5 $(374.4) $ 6,820.3 360,142.2
====== ========== ========= ============= ======== ============= ===========
See accompanying notes.
115
Principal Financial Group, Inc.
Consolidated Statements of Cash Flows
For the year ended December 31,
----------------------------------------------------
2001 2000 1999
----------------- ---------------- -----------------
(in millions)
Operating activities
Net income............................................ $ 358.8 $ 620.2 $ 742.1
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change,
net of related income taxes.................... 10.7 - -
Amortization of deferred policy acquisition
costs.......................................... 159.9 238.6 173.8
Additions to deferred policy acquisition costs... (261.7) (263.9) (253.9)
Accrued investment income........................ (66.1) (58.8) (41.2)
Premiums due and other receivables............... (25.6) (38.3) 34.4
Contractholder and policyholder liabilities
and dividends.................................. 1,869.2 1,478.5 1,650.6
Current and deferred income taxes................ 54.5 75.0 155.6
Net realized capital (gains) losses.............. 514.0 (139.9) (404.5)
Depreciation and amortization expense............ 154.9 153.6 117.1
Amortization and impairment/recovery of
mortgage servicing rights..................... 408.7 157.3 94.4
Other............................................ 767.5 415.0 (162.4)
----------------- ---------------- -----------------
Net adjustments....................................... 3,586.0 2,017.1 1,363.9
----------------- ---------------- -----------------
Net cash provided by operating activities............. 3,944.8 2,637.3 2,106.0
Investing activities Available-for-sale securities:
Purchases.......................................... (14,868.2) (13,051.0) (11,510.2)
Sales.............................................. 6,707.7 7,366.0 7,031.0
Maturities......................................... 4,729.5 2,675.3 2,599.2
Net cash flows from trading securities................ (17.0) - -
Mortgage loans acquired or originated................. (40,456.9) (10,507.5) (16,594.6)
Mortgage loans sold or repaid......................... 40,908.6 12,026.8 16,361.5
Purchase of mortgage servicing rights................. (968.4) (235.9) (336.7)
Proceeds from sale of mortgage servicing rights....... 31.5 53.0 29.2
Real estate acquired.................................. (290.0) (324.4) (449.7)
Real estate sold...................................... 803.8 796.9 869.8
Net change in property and equipment.................. (89.9) (67.1) (61.2)
Net proceeds (disbursements) from sales of
subsidiaries....................................... (7.9) - 41.7
Purchases of interest in subsidiaries, net of cash
acquired........................................... (11.1) (27.4) (1,154.6)
Net change in other investments....................... (170.1) 22.0 (166.6)
----------------- ---------------- -----------------
Net cash used in investing activities................. (3,698.4) (1,273.3) (3,341.2)
116
Principal Financial Group, Inc.
Consolidated Statements of Cash Flows (continued)
For the year ended December 31,
--------------------------------------------------
2001 2000 1999
---------------- ---------------- ----------------
(in millions)
Financing activities
Issuance of common stock............................. $ 2,019.3 $ - $ -
Payments to eligible policyholders under plan
of conversion..................................... (1,177.5) - -
Acquisition of treasury stock........................ (367.7) - -
Issuance of long-term debt........................... 149.2 230.4 885.2
Principal repayments of long-term debt............... (204.4) (120.7) (40.2)
Proceeds of short-term borrowings.................... 7,290.8 2,417.5 5,150.9
Repayment of short-term borrowings................... (7,238.7) (2,505.4) (4,895.7)
Investment contract deposits......................... 5,054.9 3,982.6 5,325.4
Investment contract withdrawals...................... (6,075.1) (5,011.3) (5,081.7)
---------------- --------------- ----------------
Net cash provided by (used in) financing activities.. (549.2) (1,006.9) 1,343.9
---------------- --------------- ----------------
Net increase (decrease) in cash and cash
equivalents....................................... (302.8) 357.1 108.7
Cash and cash equivalents at beginning of year....... 926.6 569.5 460.8
---------------- ---------------- ----------------
Cash and cash equivalents at end of year............. $ 623.8 $ 926.6 $ 569.5
================ ================ ================
Schedule of noncash transactions
Policy credits to eligible policyholders under plan
of conversion..................................... $ 472.6
================
Stock issued in exchange for membership interest..... $ 5,050.3
================
Net transfer of noncash assets and liabilities to an
unconsolidated entity in exchange for a minority
interest.......................................... $ (255.0)
================
See accompanying notes.
117
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements
December 31, 2001
1. Nature of Operations and Significant Accounting Policies
Description of Business
Principal Financial Group, Inc. and its consolidated subsidiaries ("the
Company"), the successor to Principal Mutual Holding Company, is a diversified
financial services organization engaged in promoting retirement savings and
investment and insurance products and services in the U.S. and selected
international markets. In addition, the Company offers residential mortgage loan
origination and servicing in the U.S.
Demutualization and Initial Public Offering
Under the terms of Principal Mutual Holding Company's Plan of Conversion,
effective October 26, 2001 (the "Date of Demutualization"), Principal Mutual
Holding Company converted from a mutual insurance holding company ("MIHC") to a
stock company, Principal Financial Group, Inc., a Delaware business corporation.
All policyholder membership interests in Principal Mutual Holding Company were
extinguished on that date and eligible policyholders of the MIHC received, in
aggregate, 260.8 million shares of common stock, $1,177.5 million of cash and
$472.6 million of policy credits as compensation.
On the Date of Demutualization, Principal Mutual Holding Company and two of its
subsidiaries, Principal Financial Group, Inc., an Iowa corporation, and
Principal Financial Services, Inc., an Iowa corporation, merged with and into
Principal Iowa Newco, Inc., an Iowa corporation, which changed its name to
Principal Financial Services, Inc. ("PFSI"). PFSI is a wholly-owned subsidiary
of Principal Financial Group, Inc., a Delaware corporation.
In addition, on October 26, 2001, the Company completed its initial public
offering ("IPO") in which the Company issued 100.0 million shares of common
stock at a price of $18.50 per share. Net proceeds from the IPO were $1,753.9
million, of which $64.2 million was retained by Principal Financial Group, Inc.,
and $1,689.7 million was contributed to Principal Life Insurance Company.
Proceeds were net of offering costs of $96.5 million and a related tax benefit
of $0.4 million.
Costs relating to the demutualization, excluding costs relating to the IPO, were
$18.6 million and $7.2 million, net of income taxes, in 2001 and 2000,
respectively. Demutualization expenses consist primarily of printing and mailing
costs and the aggregate cost of engaging independent accounting, actuarial,
financial, investment banking, legal and other consultants to advise the Company
on the demutualization. In addition, these costs include the costs of the
advisors of the Insurance Commissioner of the State of Iowa and the New York
State Insurance Department, other regulatory authorities and internal allocated
costs for staff and related costs associated with the demutualization.
Basis of Presentation
The accompanying consolidated financial statements of the Company and its
majority-owned subsidiaries have been prepared in conformity with accounting
principles generally accepted in the U.S. ("U.S. GAAP"). Less than
majority-owned entities in which the Company has at least a 20% interest are
reported on the equity basis in the consolidated statements of financial
position as other investments. All significant intercompany accounts and
transactions have been eliminated.
Total assets of the unconsolidated entities amounted to $4,768.8 million at
December 31, 2001, and $3,098.5 million at December 31, 2000. Total revenues of
the unconsolidated entities were $2,855.2 million, $2,226.3 million and $1,978.9
million in 2001, 2000 and 1999, respectively. During 2001, 2000 and 1999, the
Company included $53.2 million, $39.1 million and $107.7 million, respectively,
in net investment income representing the Company's share of current year net
income of the unconsolidated entities. The unconsolidated entities primarily
include the Company's 23% interest in Coventry Health Care, Inc. and minority
interests in domestic and international (Brazil, India and Japan) joint ventures
and partnerships. The Company's net investment in these Companies at December
31, 2001 and 2000, was $165.3 million and $145.0 million, respectively.
118
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Closed Block
At the time the MIHC structure was created in 1998, Principal Life Insurance
Company ("Principal Life") formed and began operating a closed block ("Closed
Block") for the benefit of individual participating dividend-paying policies in
force on that date. See Note 6 for further details regarding the Closed Block.
Use of Estimates in the Preparation of Financial Statements
The preparation of the Company's consolidated financial statements and
accompanying notes requires management to make estimates and assumptions that
affect the amounts reported and disclosed. These estimates and assumptions could
change in the future as more information becomes known, which could impact the
amounts reported and disclosed in the consolidated financial statements and
accompanying notes.
Accounting Changes
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"). In June 1999, SFAS
No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral
of the Effective Date of FASB Statement No. 133 was issued deferring the
effective date of SFAS 133 by one year, to fiscal years beginning after June 15,
2000. In June 2000, the FASB issued SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities - an amendment of FASB
Statement No. 133, which amended the accounting and reporting standards of SFAS
133 for certain derivative instruments and certain hedging activities.
As amended, SFAS 133 requires, among other things, that all derivatives be
recognized in the consolidated statement of financial position as either assets
or liabilities that are measured at fair value. SFAS 133 also establishes
special accounting for qualifying hedges, which allows for matching the timing
of gain or loss recognition on the hedging instrument with the recognition of
the corresponding changes in value of the hedged item. Changes in the fair value
of a derivative qualifying as a hedge are recognized in earnings or directly in
stockholders' equity depending on the instrument's intended use. For derivatives
that are not designated as hedges or that do not meet the hedge accounting
criteria in SFAS 133, changes in fair value are required to be recognized in
earnings in the period of change.
At January 1, 2001, the Company's consolidated financial statements were
adjusted to record a cumulative effect of adopting SFAS 133, as follows (in
millions):
Accumulated other
comprehensive
Net income income (loss)
---------- --------------------
Adjustment to fair value of derivative contracts (1)......... $(16.4) $(15.8)
Income tax impact............................................ 5.7 1.6
---------- --------------------
Total........................................................ $(10.7) $(14.2)
========== ====================
- --------------------
(1) Amount presented is net of adjustment to hedged item.
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("SFAS 140") was issued in September 2000 and was
effective for transfers, servicings and extinguishments occurring after March
31, 2001. SFAS 140 replaced SFAS No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities ("SFAS 125"). Although
SFAS 140 clarified or amended various aspects of SFAS 125, most of the
fundamental concepts from SFAS 125 were brought forward without
119
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
modification. The Company adopted SFAS 140 on April 1, 2001, and modified its
securitization trust agreements to meet the new requirements to enable it to
continue recognizing transfers of certain financial instruments as sales. As a
result, the adoption of SFAS 140 did not have a significant impact on the
Company's consolidated financial statements.
In July 2000, the Emerging Issues Task Force ("EITF") reached consensus on Issue
99-20, Recognition of Interest Income and Impairment on Certain Investments
("EITF 99-20"). This Issue requires an enterprise that invests in certain
mortgage-backed and asset-backed securities to record changes in their estimated
yield on a prospective basis and provides additional guidance in assessing these
securities for other than temporary declines in value. The Company adopted EITF
99-20 on April 1, 2001. Since adoption, the Company recognized $28.7 million of
realized capital losses related to other than temporary impairments on its
asset-backed securities.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market instruments and
other debt issues with a maturity date of three months or less when purchased.
Investments
In accordance with the provisions of SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities, the Company is required to classify
its investments into one of three categories: held-to-maturity,
available-for-sale or trading. The Company determines the appropriate
classification of fixed maturity securities at the time of purchase. Fixed
maturity securities include bonds, mortgage-backed securities, and redeemable
preferred stock. The Company classifies its fixed maturity securities as either
available-for-sale or trading and, accordingly, carries them at fair value. (See
Note 14 for policies related to the determination of fair value.) Unrealized
gains and losses related to available-for-sale securities are reflected in
stockholders' equity net of related deferred policy acquisition costs and
applicable taxes. Unrealized gains and losses related to trading securities are
reflected in net realized capital gains and losses.
The cost of fixed maturity securities is adjusted for amortization of premiums
and accrual of discounts, both computed using the interest method. The cost of
fixed maturity securities is adjusted for declines in value that are other than
temporary. Impairments in value deemed to be other than temporary are reported
as a component of net realized capital gains and losses. For loan-backed and
structured securities, the Company recognizes income using a constant effective
yield based on currently anticipated prepayments as determined by broker-dealer
surveys or internal estimates and the estimated lives of the securities.
Equity securities include common stock and non-redeemable preferred stock. The
cost of equity securities is adjusted for declines in value that are other than
temporary. Impairments in value deemed to be other than temporary are reported
as a component of net realized capital gains and losses. Equity securities are
classified as available-for-sale and, accordingly, are carried at fair value.
(See Note 14 for policies related to the determination of fair value.)
Unrealized gains and losses related to available-for-sale securities are
reflected in stockholders' equity net of related deferred policy acquisition
costs and applicable taxes.
Real estate investments are reported at cost less accumulated depreciation. The
initial cost bases of properties acquired through loan foreclosures is the lower
of the fair market values of the properties at the time of foreclosure or the
outstanding loan balance. Buildings and land improvements are generally
depreciated on the straight-line method over the estimated useful life of
improvements, and tenant improvement costs are depreciated on the straight-line
method over the term of the related lease. The Company recognizes impairment
losses for its properties when indicators of impairment are present and a
property's expected undiscounted cash flows are not sufficient to recover the
property's carrying value. In such cases, the cost bases of the properties are
120
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
reduced to fair value. Real estate expected to be disposed is carried at the
lower of cost or fair value, less cost to sell, with valuation allowances
established accordingly and depreciation no longer recognized. Any impairment
losses and any changes in valuation allowances are reported as net realized
capital losses.
Commercial and residential mortgage loans are generally reported at cost
adjusted for amortization of premiums and accrual of discounts, computed using
the interest method, and net of valuation allowances. Any changes in the
valuation allowances are reported as net realized capital gains (losses). The
Company measures impairment based upon the present value of expected cash flows
discounted at the loan's effective interest rate or the loan's observable market
price. If foreclosure is probable, the measurement of any valuation allowance is
based upon the fair value of the collateral. The Company has residential
mortgage loans held for sale in the amount of $476.1 million and $251.7 million
and commercial mortgage loans held for sale in the amount of $493.5 million and
$520.9 million at December 31, 2001 and 2000, respectively, which are carried at
lower of cost or fair value, less cost to sell, and reported as mortgage loans
in the statements of financial position.
Net realized capital gains and losses on sales of investments are determined on
the basis of specific identification. In general, in addition to realized
capital gains and losses on investment sales, unrealized gains and losses
related to other than temporary impairments, trading securities, fair value
hedge ineffectiveness, derivatives not designated as hedges and changes in the
mortgage loan allowance are reported as net realized capital gains and losses.
Unrealized gains and losses on derivatives within the Company's mortgage banking
segment are reported as either operating expenses or fees and other revenues
depending on the nature of the hedge and are excluded from net realized capital
gains and losses. Investment gains and losses on sales of certain real estate
held-for-sale are reported as net investment income and are also excluded from
net realized capital gains and losses.
Policy loans and other investments, excluding investments in unconsolidated
entities, are primarily reported at cost.
Securitizations
The Company sells commercial mortgage loans to an unconsolidated trust which
then issues mortgage-backed securities. The Company may retain interests in the
loans by purchasing portions of the securities from the issuance. Gain or loss
on the sales of the mortgages depends in part on the previous carrying amounts
of the financial assets involved in the transfer, which is allocated between the
assets sold and the retained interests based on their relative fair value at the
date of transfer. Fair values are determined by quoted market prices of external
buyers of each class of security purchased. The retained interests are
thereafter carried at fair value with other fixed maturity investments.
The Company also sells residential mortgage loans and retains servicing rights
which are retained interests in the sold loans. Gain or loss on the sales of the
loans depends in part on the previous carrying amounts of the financial assets
sold and the retained interests based on their relative fair values at the date
of the transfer. To obtain fair values, quoted market prices are used if
available. However, quotes are generally not available for retained interests,
so the Company estimates fair value based on the present value of the future
expected cash flows using management's best estimates of the key assumptions -
prepayment speeds and option adjusted spreads commensurate with the risks
involved.
The Company has developed a margin lending securitization program whereby the
Company sells receivables to an unconsolidated trust that packages and sells
interests to investors. The Company retains interest bearing subordinated
tranches. The receivables are sold at face value, which approximates cost and
fair value, to an unconsolidated trust, with no gain or loss recognized on the
sale. Retained interests are initially carried at cost based on their relative
fair values at the date of transfer, then carried at fair value thereafter.
121
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Derivatives
As a result of SFAS 133, all derivatives are recognized as either assets or
liabilities in the statement of financial position and measured at fair value.
If certain conditions are met, a derivative may be specifically designated as
one of the following:
(a) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment;
(b) a hedge of the exposure to variable cash flows of a forecasted transaction;
or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security
or a foreign-currency-denominated forecasted transaction.
The Company's accounting for the ongoing changes in fair value of a derivative
depends on the intended use of the derivative and the designation as described
above and is determined when the derivative contract is entered into. Hedge
accounting is used for derivatives that are specifically designated in advance
as hedges and that reduce the Company's exposure to an indicated risk by having
a high correlation between changes in the value of the derivatives and the items
being hedged at both the inception of the hedge and throughout the hedge period.
For derivatives hedging the exposure to changes in fair value of a recognized
asset or liability, the change in fair value of the derivative is recognized in
earnings in the period of change together with the offsetting change in fair
value on the hedged item attributable to the risk being hedged. The effect of
such accounting is to reflect in earnings the extent to which the hedge is not
effective in achieving offsetting changes in fair value.
For derivatives hedging the exposure to variable cash flows, the effective
portion of the derivative's change in fair value is initially deferred and
reported as a component of other comprehensive income and subsequently
reclassified into earnings when the forecasted transaction occurs and is
recognized in earnings. The ineffective portion of the change in fair value is
reported in earnings in the period of change. In addition, if the hedged items
are sold, terminated or matured, the changes in value of the derivatives are
also included in net income.
The Company's risk management policy regarding net investment hedges is to hedge
currency fluctuations between foreign currencies and the U.S. dollar. At
December 31, 2001, the Company was hedging a portion ($665.0 million) of its net
investment in Australia.
For derivatives hedging the foreign currency exposure of an unrecognized firm
commitment or an available-for-sale security, the change in fair value of the
derivative is recognized in earnings in the period of change together with the
offsetting change in fair value on the hedged item attributable to the risk
being hedged. The effect of such accounting is to reflect in earnings the extent
to which the hedge is not effective in achieving offsetting changes in fair
value.
For derivatives hedging the foreign currency exposure of a
foreign-currency-denominated forecasted transaction, the change in fair value is
initially deferred and reported as a component of other comprehensive income and
subsequently reclassified into earnings when the forecasted transaction occurs
and is recognized in earnings. The ineffective portion of the change in fair
value is reported in earnings in the period of change.
For derivatives not designated as a hedging instrument, the change in fair value
is recognized in earnings in the period of change.
122
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Prior to the January 1, 2001, adoption of FAS 133, the Company used futures
contracts, mortgage-backed securities forwards, interest rate and principal only
swap and floor agreements, options on futures contracts and currency rate swap
agreements to hedge and manage its exposure to changes in interest rate levels
and foreign exchange rate fluctuations, and to manage duration mismatch of
assets and liabilities. Futures contracts were marked-to-market and settled
daily with the net gain or loss at expiration or termination of the contracts
recorded in realized capital gains and losses. Outstanding mortgage-backed
forwards were reported as commitments and upon settlement, the net gain or loss
was reported in realized capital gains and losses. For interest rate and
currency swaps held by Principal Life, the net amounts paid or received and net
amounts accrued through the end of the accounting period were included in net
investment income. Any discounts or premiums related to these instruments were
amortized to net investment income over the life of the contract. Gains or
losses on contracts terminated early were recognized immediately in realized
capital gains and losses. Unrealized gains or losses on interest rate swap
contracts and currency swaps were not recognized in income. The Company
primarily utilized interest rate floors, futures and options on futures
contracts, and interest rate and principal only swaps in hedging its portfolio
of mortgage servicing rights. The realized and unrealized gains and losses on
servicing derivatives accounted for as effective hedges were considered in the
periodic assessment of mortgage servicing rights impairment. The realized and
unrealized gains and losses on servicing derivatives not considered effective
hedges were recorded in the Company's results of operations. The Company managed
interest rate risk on its mortgage loan pipeline by buying and selling
mortgage-backed securities in the forward markets, over the counter options on
mortgage-backed securities, futures contracts and options on treasury futures
contracts. The unrealized gains and losses on these derivatives were included in
the lower of cost or market calculation of mortgage loans held for sale.
Contractholder and Policyholder Liabilities
Contractholder and policyholder liabilities (contractholder funds, future policy
benefits and claims and other policyholder funds) include reserves for
investment contracts and reserves for universal life, limited payment,
participating and traditional life insurance policies. Investment contracts are
contractholders' funds on deposit with the Company and generally include
reserves for pension and annuity contracts. Reserves on investment contracts are
equal to the cumulative deposits less any applicable charges plus credited
interest.
Reserves for universal life insurance contracts are equal to cumulative premiums
less charges plus credited interest which represents the account balances that
accrue to the benefit of the policyholders. Reserves for non-participating term
life insurance contracts are computed on a basis of assumed investment yield,
mortality, morbidity and expenses, including a provision for adverse deviation,
which generally varies by plan, year of issue and policy duration. Investment
yield is based on the Company's experience. Mortality, morbidity and withdrawal
rate assumptions are based on experience of the Company and are periodically
reviewed against both industry standards and experience.
Reserves for participating life insurance contracts are based on the net level
premium reserve for death and endowment policy benefits. This net level premium
reserve is calculated based on dividend fund interest rate and mortality rates
guaranteed in calculating the cash surrender values described in the contract.
Participating business represented approximately 35%, 34% and 34% of the
Company's life insurance in force and 76%, 79% and 78% of the number of life
insurance policies in force at December 31, 2001, 2000 and 1999, respectively.
Participating business represented approximately 57%, 61% and 63% of life
insurance premiums for the years ended December 31, 2001, 2000 and 1999,
respectively.
The amount of dividends to policyholders is approved annually by Principal
Life's board of directors. The amount of dividends to be paid to policyholders
is determined after consideration of several factors including interest,
mortality, morbidity and other expense experience for the year and judgment as
to the appropriate level of statutory surplus to be retained by Principal Life.
At the end of the reporting period, Principal Life establishes a dividend
liability for the pro-rata portion of the dividends expected to be paid on or
before the next policy anniversary date.
123
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Some of the Company's policies and contracts require payment of fees in advance
for services that will be rendered over the estimated lives of the policies and
contracts. These payments are established as unearned revenue reserves upon
receipt and included in other policyholder funds in the consolidated statements
of financial position. These unearned revenue reserves are amortized to
operations over the estimated lives of these policies and contracts in relation
to the emergence of estimated gross profit margins.
The liability for unpaid accident and health claims is an estimate of the
ultimate net cost of reported and unreported losses not yet settled. This
liability is estimated using actuarial analyses and case basis evaluations.
Although considerable variability is inherent in such estimates, the Company
believes that the liability for unpaid claims is adequate. These estimates are
continually reviewed and, as adjustments to this liability become necessary,
such adjustments are reflected in current operations.
Recognition of Premiums and Other Considerations, Fees and Other Revenues
and Benefits
Traditional individual life and health insurance products include those products
with fixed and guaranteed premiums and benefits, and consist principally of
whole life and term life insurance policies. Premiums from these products are
recognized as premium revenue when due.
Immediate annuities with life contingencies include products with fixed and
guaranteed annuity considerations and benefits, and consist principally of group
and individual single premium annuities with life contingencies. Annuity
considerations from these products are recognized as revenue when due.
Group life and health insurance premiums are generally recorded as premium
revenue over the term of the coverage. Some group contracts allow for premiums
to be adjusted to reflect emerging experience. Such adjusted premiums are
recognized in the period that the related experience emerges. Fees for contracts
providing claim processing or other administrative services are recorded over
the period the service is provided.
Related policy benefits and expenses for individual and group life, annuity and
health insurance products are associated with earned premiums and result in the
recognition of profits over the expected lives of the policies and contracts.
Universal life-type policies are insurance contracts with terms that are not
fixed and guaranteed. Amounts received as payments for such contracts are not
reported as premium revenues. Revenues for universal life-type insurance
contracts consist of policy charges for the cost of insurance, policy initiation
and administration, surrender charges and other fees that have been assessed
against policy account values. Policy benefits and claims that are charged to
expense include interest credited to contracts and benefit claims incurred in
the period in excess of related policy account balances.
Investment contracts do not subject the Company to risks arising from
policyholder mortality or morbidity, and consist primarily of Guaranteed
Investment Contracts ("GICs"), funding agreements and certain deferred
annuities. Amounts received as payments for investment contracts are established
as investment contract liability balances and are not reported as premium
revenues. Revenues for investment contracts consist of investment income and
policy administration charges. Investment contract benefits that are charged to
expense include benefit claims incurred in the period in excess of related
investment contract liability balances and interest credited to investment
contract liability balances.
Fees and other revenues are earned for asset management services provided to
retail and institutional clients based largely upon contractual rates applied to
the market value of the client's portfolio. Additionally, fees and other
revenues are earned for administrative services performed including
124
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
recordkeeping and reporting services for retirement savings plans. Fees and
other revenues received for performance of asset management and administrative
services are recognized as revenue when the service is performed.
Fees and other revenues arising from the residential mortgage banking operations
consist of revenues earned for servicing and originating residential mortgage
loans as well as marketing other products to servicing portfolio customers. Net
revenues are also recognized upon the sale of residential mortgage loans and
residential mortgage loan servicing rights and are recorded in fees and other
revenues and determined using the specific identification basis. Servicing
revenues are recognized as the mortgage loan is serviced over the life of the
mortgage loan. Mortgage loans originated are sold in the secondary mortgage
markets, shortly after origination. As a result, mortgage loan origination fee
revenues are recognized when the mortgage loans are sold. Fee revenues received
for marketing other products to servicing portfolio customers are recognized
when the service is performed.
Deferred Policy Acquisition Costs
Commissions and other costs (underwriting, issuance and agency expenses and
first-year bonus interest) that vary with and are primarily related to the
acquisition of new and renewal insurance policies and investment contract
business are capitalized to the extent recoverable. Maintenance costs and
acquisition costs that are not deferrable are charged to operations as incurred.
Deferred policy acquisition costs for universal life-type insurance contracts
and participating life insurance policies and investment contracts are being
amortized over the lives of the policies and contracts in relation to the
emergence of estimated gross profit margins. This amortization is adjusted
retrospectively when estimates of current or future gross profits and margins to
be realized from a group of products and contracts are revised. The deferred
policy acquisition costs of non-participating term life insurance policies are
being amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policyholder liabilities.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs would be written off to the extent
that it is determined that future policy premiums and investment income or gross
profit margins would not be adequate to cover related losses and expenses.
Reinsurance
The Company enters into reinsurance agreements with other companies in the
normal course of business. The Company may assume reinsurance from or cede
reinsurance to other companies. Assets and liabilities related to reinsurance
ceded are reported on a gross basis. Premiums and expenses are reported net of
reinsurance ceded. The Company is contingently liable with respect to
reinsurance ceded to other companies in the event the reinsurer is unable to
meet the obligations it has assumed. At December 31, 2001, 2000 and 1999,
respectively, the Company had reinsured $15.6 billion, $13.2 billion, and $10.2
billion of life insurance in force, representing 12%, 9% and 7% of total net
life insurance in force through a single third-party reinsurer. To minimize the
possibility of losses, the Company evaluates the financial condition of its
reinsurers and continually monitors concentrations of credit risk.
The effect of reinsurance on premiums and other considerations and policy and
contract benefits and changes in reserves is as follows (in millions):
125
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
For the year ended December 31,
--------------------------------------------------------
2001 2000 1999
------------------ ------------------ ------------------
Premiums and other considerations:
Direct...................................... $4,329.9 $4,142.1 $3,990.0
Assumed..................................... 56.0 24.6 4.1
Ceded....................................... (263.6) (170.3) (56.5)
------------------ ------------------ ------------------
Net premiums and other considerations......... $4,122.3 $3,996.4 $3,937.6
================== ================== ==================
Benefits, claims and settlement expenses:
Direct...................................... $5,700.3 $5,387.8 $5,296.1
Assumed..................................... 7.4 1.9 (1.3)
Ceded....................................... (225.6) (157.4) (33.9)
------------------ ------------------ ------------------
Net benefits, claims and settlement expenses.. $5,482.1 $5,232.3 $5,260.9
================== ================== ==================
Guaranty-Fund Assessments
Guaranty-fund assessments are accrued for anticipated assessments, which are
estimated using data available from various industry sources that monitor the
current status of open and closed insolvencies. The Company has also established
an other asset for assessments expected to be recovered through future premium
tax offsets.
Separate Accounts
The separate account assets and liabilities presented in the consolidated
financial statements represent the fair market value of funds that are
separately administered by the Company for contracts with equity, real estate
and fixed-income investments. Generally, the separate account contract owner,
rather than the Company, bears the investment risk of these funds. The separate
account assets are legally segregated and are not subject to claims that arise
out of any other business of the Company. The Company receives a fee for
administrative, maintenance and investment advisory services that is included in
the consolidated statements of operations. Net deposits, net investment income
and realized and unrealized capital gains and losses on the Separate Accounts
are not reflected in the consolidated statements of operations.
At December 31, 2001, the Separate Accounts included a separate account valued
at $1.3 billion which primarily included shares of the Company's stock that were
allocated and issued to eligible participants of qualified employee benefit
plans administered by the Company as part of the policy credits issued under the
Company's demutualization. These shares are included in both basic and diluted
earnings per share calculations. The separate account shares are recorded at
fair value and are reported as separate account assets and separate account
liabilities in the consolidated statement of financial position. Activity of the
separate account shares is reflected in both the separate account assets and
separate account liabilities and does not impact the Company's results of
operations.
Income Taxes
The Company files a U.S. consolidated income tax return that includes all of its
qualifying subsidiaries and has a policy of allocating income tax expenses and
benefits to companies in the group generally based upon pro rata contribution of
taxable income or operating losses. The Company is taxed at corporate rates on
taxable income based on existing tax laws. Current income taxes are charged or
credited to operations based upon amounts estimated to be payable or recoverable
as a result of taxable operations for the current year. Deferred income taxes
are provided for the tax effect of temporary differences in the financial
reporting and income tax bases of assets and liabilities and net operating
losses using enacted income tax rates and laws. The effect on deferred tax
assets and deferred tax liabilities of a change in tax rates is recognized in
operations in the period in which the change is enacted.
126
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Foreign Exchange
Assets and liabilities of the Company's foreign subsidiaries and affiliates
denominated in non-U.S. dollars are translated into U.S. dollar equivalents at
the year-end spot foreign exchange rates. Resulting translation adjustments are
reported as a component of stockholders' equity, along with any related hedge
effects. Revenues and expenses for these entities are translated at the weighted
average exchange rates for the year. Revenue, expense and other translation
adjustments for foreign subsidiaries and affiliates with the U.S. dollar as the
functional currency and foreign currency transactions that affect cash flows are
reported in current operations, along with related hedge effects.
Pension and Postretirement Benefits
The Company accounts for its pension benefits and postretirement benefits other
than pension (medical, life insurance and long-term care) using the full accrual
method.
Property and Equipment
Property and equipment includes home office properties, related leasehold
improvements, purchased and internally developed software and other fixed
assets. Property and equipment use is shown in the consolidated statements of
financial position at cost less allowances for accumulated depreciation.
Provisions for depreciation of property and equipment are computed principally
on the straight-line method over the estimated useful lives of the assets.
Property and equipment and related accumulated depreciation are as follows (in
millions):
December 31,
2001 2000
--------- ----------
Property and equipment................ $932.0 $924.6
Accumulated depreciation.............. (413.8) (417.6)
--------- ----------
Property and equipment, net........... $518.2 $507.0
========= ==========
Goodwill and Other Intangibles
Goodwill and other intangibles include the cost of acquired subsidiaries in
excess of the fair value of the tangible net assets recorded in connection with
acquisitions. These assets are amortized on a straight-line basis generally over
8 to 40 years. At December 31, 2001, the weighted-average amortization period
for goodwill and other intangibles was 22.4 years and 36.8 years, respectively.
The carrying amounts of goodwill and other intangibles are reviewed periodically
for indicators of impairment in value, which in the view of management are other
than temporary, including unexpected or adverse changes in the economic or
competitive environments in which the Company operates and profitability
analyses on the relevant subsidiary. If facts and circumstances suggest that a
subsidiary's goodwill and other intangibles are impaired, the Company determines
whether the sum of the estimated undiscounted future cash flows of the
subsidiary are less than the carrying value. If the undiscounted future cash
flows are less than the carrying value, an impairment loss is recognized for the
excess of the carrying amount of assets over their fair value.
Goodwill and other intangibles, and related accumulated amortization, are as
follows (in millions):
127
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
December 31,
2001 2000
----------- -----------
Goodwill..................................... $ 516.2 $ 648.2
Other intangibles............................ 852.7 818.8
----------- -----------
1,368.9 1,467.0
Accumulated amortization..................... (140.5) (91.1)
----------- -----------
Total goodwill and other intangibles, net.... $ 1,228.4 $ 1,375.9
=========== ===========
Effective January 1, 2002, the Company will adopt a non-amortization,
impairment-only approach for goodwill and indefinite-lived intangible assets
based on new accounting guidance issued in 2001 described later in Note 1.
Premiums Due and Other Receivables
Premiums due and other receivables include life and health insurance premiums
due, reinsurance recoveries, guaranty funds receivable or on deposit,
receivables from the sale of securities and other receivables.
Mortgage Loan Servicing Rights
Mortgage loan servicing rights represent the cost of purchasing or originating
the right to service mortgage loans. These costs are capitalized and amortized
to operations over the estimated remaining lives of the underlying loans using
the interest method and taking into account appropriate prepayment assumptions.
Capitalized mortgage loan servicing rights are periodically assessed for
impairment, which is recognized in the consolidated statements of operations
during the period in which impairment occurs by establishing a corresponding
valuation allowance. For purposes of performing its impairment evaluation, the
Company stratifies the servicing portfolio on the basis of specified predominant
risk characteristics, including loan type and note rate. A valuation model is
used to determine the fair value of each stratum. Cash flows are calculated
using an internal prepayment model and discounted at a spread to London
Inter-Bank Offer Rates. External valuations are obtained for comparison
purposes.
Activity in the valuation allowance for mortgage loan servicing rights is
summarized as follows (in millions):
For the year ended December 31,
2001 2000 1999
---------- ---------- ----------
Balance at beginning of year... $ 2.3 $ 2.9 $ 56.1
Impairments.................... 196.0 1.1 1.7
Recoveries..................... (0.2) (1.7) (54.9)
---------- ---------- ----------
Balance at end of year......... $ 198.1 $ 2.3 $ 2.9
========== ========== ==========
During 2001, impairments reflect the results of increased mortgage loan
prepayments due to the continued reduction in market interest rates during the
year.
Other Assets
Included in other assets are certain assets pending transfer or novation that
are carried at fair value (see Note 2). The remainder of other assets are
reported primarily at cost.
128
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations and Significant Accounting Policies (continued)
Earnings Per Share
Basic earnings per share is calculated by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period and excludes the dilutive effect of stock options. The calculation of
diluted earnings per share reflects the dilution that would have occurred had
the stock options been exercised, resulting in the issuance of common stock.
Reclassifications
Reclassifications have been made to the 1999 and 2000 consolidated financial
statements to conform to the 2001 presentation.
Accounting Pronouncements Pending Adoption
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets ("SFAS 144"). This Statement supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, and amends Accounting Principles Board ("APB") Opinion
No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions ("Opinion 30"), establishing a single
accounting model for the disposal of long-lived assets. SFAS 144 generally
retains the basic provisions of existing guidance, but broadens the presentation
of any discontinued operations to include a component of an entity (rather than
a segment of a business as defined in Opinion 30). The provisions of SFAS 144
are effective for fiscal years beginning after December 15, 2001, and are not
expected to have a significant impact on the Company's consolidated financial
statements.
In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS 141"),
and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS 141 also includes guidance on
the initial recognition and measurement of goodwill and other intangible assets
arising from business combinations completed after June 30, 2001. SFAS 142,
effective January 1, 2002, prohibits the amortization of goodwill and intangible
assets with indefinite useful lives. Intangible assets with finite useful lives
will continue to be amortized over their estimated useful lives. In 2001, the
Company's amortization expense for goodwill and intangible assets was $54.7
million, of which $48.5 million will not continue after January 1, 2002.
Additionally, SFAS 142 requires that goodwill and indefinite-lived intangible
assets be reviewed for impairment at least annually. This includes a more
stringent impairment test methodology (fair value based on discounted cash
flows) for measuring and recognizing impairment losses. The Company has
estimated the impairment amount that will result from the adoption of SFAS 142
on January 1, 2002, and expects an after-tax impairment of approximately $300
million. The impairment will be recognized in the Company's first quarter 2002
consolidated financial statements as a cumulative effect of a change in
accounting principle.
2. Mergers, Acquisitions, and Divestitures
Mergers and Acquisitions
During the past three years, the Company has acquired a number of businesses,
all of which were recorded using the purchase method of accounting. Accordingly,
the results of operations of the acquired companies have been included in the
consolidated results from their respective acquisition dates.
The Company made various acquisitions during 2001 at purchase prices aggregating
$12.0 million. Such acquired companies had total assets at December 31, 2001,
and total 2001 revenue of $13.3 million and $3.9 million, respectively.
129
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
2. Mergers, Acquisitions, and Divestitures (continued)
During 2000, various acquisitions of joint ventures were made by the Company at
purchase prices aggregating $27.4 million. During 2000, the Company included
$(2.0) million in net investment income representing the Company's share of
current year net losses of the acquired joint ventures. These joint ventures are
part of the unconsolidated entities described in Note 1.
On August 31, 1999, the Company acquired the outstanding stock of several
companies affiliated with Bankers Trust Australia Group ("Acquired Companies")
from Deutsche Bank AG at a purchase price of $1,445.6 million. In connection
with the acquisition, the Company and Deutsche Bank AG agreed to the sale of the
investment banking operations of the Acquired Companies to Macquarie Bank
Limited, with net proceeds of $63.7 million from this transaction being included
in the acquired assets.
The purchase price and $9.4 million of direct acquisition costs have been
allocated to the assets acquired and liabilities assumed based on their
respective fair market values at the acquisition date. The allocation included
identifiable intangibles represented by management rights for the funds
management business and the brand name of $897.4 million and $38.5 million of
workforce intangibles, with $408.6 million of resulting goodwill, which are
being amortized on a straight-line basis over 40, 8 and 25 years, respectively.
Refinements in the allocation were made in 2000 as accounting completion and
valuation studies were finalized.
Completion of the sale of the investment banking operations required the
transfer or novation to Macquarie Bank Limited of the investment banking assets
and liabilities of the Acquired Companies. The bulk of these were statutorily
transferred on August 3, 1999, pursuant to the procedures laid down in the
Financial Sector (Transfers of Business) Act ("the Act") of the Commonwealth of
Australia. Certain assets and liabilities which are governed by a law other than
that of Australia, or which the Act does not address, were excluded from the
statutory transfer. For these assets and liabilities it has been necessary to
effect individual transfers or novations, in some cases with the agreement of
the relevant customers or counterparties. Pending such transfers or novations,
the Company agreed, as part of the sale of the investment banking operations,
that these assets and liabilities will remain in the name of one of the Acquired
Companies, but all economic risks and benefits associated with them will be
assumed and a related indemnification provided by Macquarie Bank Limited. In
addition, the Company may rely upon Deutsche Bank AG to ensure that the Company
does not suffer any claim or loss related to the investment banking operations
sold, including the assets and liabilities, respectively, that will remain in
the name of the Acquired Companies pending transfer or novation. These assets
and liabilities which remain in the name of one of the Acquired Companies and
aggregated $148.3 million and $53.8 million, respectively, at December 31, 2001,
are reported at fair value and included in other assets and other liabilities in
the Company's consolidated statement of financial position, with a net payable
to Deutsche Bank AG of $94.5 million. At December 31, 2000, these assets and
liabilities aggregated $424.1 million and $122.8 million, respectively, with a
net payable to Macquarie Bank Limited of $204.5 million and a net payable to
Deutsche Bank AG of $96.8 million.
On November 24, 1999, the Company purchased all of the outstanding units of BT
Hotels in response to a hostile buyout offer. At that time, the intent of the
Company's management was to immediately resyndicate the trust or resell the
trust properties, therefore, the Company recorded 100% ownership of BT Hotels
under the cost method. As of December 31, 2001, all due diligence and active
bids to sell were ceased and BT Hotels was fully consolidated into the Company's
financial statements, which did not have a material impact on total assets and
revenue.
During 1999, various other acquisitions were made by the Company at purchase
prices aggregating $121.5 million. Such acquired companies had total assets of
$126.9 million at December 31, 1999, and total revenue of $11.2 million during
1999.
130
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
2. Mergers, Acquisitions, and Divestitures (continued)
Divestitures
On November 30, 2001, the Company announced it had entered into an agreement to
sell its remaining stake of approximately 15.0 million shares of Coventry Health
Care, Inc. common stock. The transaction was completed in the first quarter of
2002 (see Note 19 for details of the transaction). Effective April 1, 1998, the
Company transferred substantially all of its managed care operations to Coventry
Corporation in exchange for a non-majority ownership position in the resulting
entity, Coventry Health Care, Inc. In September 2000, the Company sold a portion
of its equity ownership position, which reduced its ownership to approximately
25% and resulted in a realized capital gain of $13.9 million, net of tax. The
investment in Coventry Health Care, Inc. was $146.0 million and $122.9 million
at December 31, 2001 and 2000, respectively.
On September 25, 2001, the Company disposed of all the stock of PT Asuransi Jiwa
Principal Indonesia, a subsidiary in Indonesia. The Company currently has no
business operations in Indonesia. Total assets of the Company's operations in
Indonesia as of June 30, 2001, were $3.4 million. The Company included nominal
revenues and net loss from operations in Indonesia in the consolidated results
of operations for the years ended December 31, 2000 and 1999.
On February 15, 2001, the Company disposed of all the stock of Principal
International Espana, S.A. de Seguros de Vida, a subsidiary in Spain, for
nominal proceeds, resulting in a net realized capital loss of $38.4 million,
ceasing the business operations in Spain. Total assets of the operations in
Spain as of December 31, 2000, were $222.7 million. The Company included
revenues of $49.4 million and $51.7 million in the results of operations for the
years ended December 31, 2000 and 1999, respectively. The Company included a net
loss of $1.2 million and net income of $0.9 million in the results of operations
for the years ended December 31, 2000 and 1999, respectively.
Beginning January 1, 2000, the Company ceased new sales of Medicare supplement
insurance and effective July 1, 2000, the Company entered into a reinsurance
agreement to reinsure 100% of the Medicare supplement insurance block of
business. Medicare supplement insurance premiums were $98.4 million for the six
months ended June 30, 2000, and $164.6 million for the year ended December 31,
1999.
3. Investments
Fixed Maturities and Equity Securities
The cost, gross unrealized gains and losses and fair value of fixed maturities
and equity securities available-for-sale as of December 31, 2001 and 2000, are
summarized as follows (in millions):
131
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
Gross Gross
unrealized unrealized
Cost gains losses Fair value
---------------- ---------------- ---------------- ----------------
December 31, 2001
Fixed maturities:
U.S. Government and agencies...... $ 15.4 $ 0.1 $ 0.1 $ 15.4
Foreign governments............... 876.5 53.0 3.2 926.3
States and political subdivisions. 302.1 20.1 4.7 317.5
Corporate - public................ 13,049.2 513.6 160.4 13,402.4
Corporate - private............... 9,030.8 325.6 124.3 9,232.1
Mortgage-backed and other
asset-backed securities......... 5,891.3 253.5 26.2 6,118.6
---------------- ---------------- ---------------- ----------------
Total fixed maturities.............. $ 29,165.3 $ 1,165.9 $ 318.9 $ 30,012.3
================ ================ ================ ================
Total equity securities............. $ 899.1 $ 15.7 $ 81.2 $ 833.6
================ ================ ================ ================
December 31, 2000
Fixed maturities:
U.S. Government and agencies...... $ 23.2 $ 0.1 $ 0.2 $ 23.1
Foreign governments............... 895.7 27.5 5.3 917.9
States and political subdivisions. 287.4 12.5 4.2 295.7
Corporate - public................ 9,027.2 219.5 129.4 9,117.3
Corporate - private............... 9,809.9 209.0 206.0 9,812.9
Mortgage-backed and other
asset-backed securities......... 6,496.1 211.2 34.3 6,673.0
---------------- ---------------- ---------------- ----------------
Total fixed maturities.............. $ 26,539.5 $ 679.8 $ 379.4 $ 26,839.9
================ ================ ================ ================
Total equity securities............. $ 805.9 $ 191.2 $ 254.2 $ 742.9
================ ================ ================ ================
The cost and fair value of fixed maturities available-for-sale at December 31,
2001, by expected maturity, were as follows (in millions):
Cost Fair value
---------- -----------
Due in one year or less............................ $ 1,393.7 $ 1,403.3
Due after one year through five years.............. 10,646.0 10,977.3
Due after five years through ten years............. 5,748.4 5,933.8
Due after ten years................................ 5,485.9 5,579.3
---------- -----------
23,274.0 23,893.7
Mortgage-backed and other asset-backed securities.. 5,891.3 6,118.6
---------- -----------
Total.............................................. $29,165.3 $ 30,012.3
========== ===========
The above summarized activity is based on expected maturities. Actual maturities
may differ because borrowers may have the right to call or pre-pay obligations.
Corporate private placement bonds represent a primary area of credit risk
exposure. The corporate private placement bond portfolio is diversified by
issuer and industry. The Company monitors the restrictive bond covenants which
are intended to regulate the activities of issuers and control their leveraging
capabilities.
132
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
Net Investment Income
Major categories of net investment income are summarized as follows (in
millions):
For the year ended December 31,
2001 2000 1999
--------- --------- ---------
Fixed maturities, available-for-sale.... $2,207.0 $1,880.7 $1,712.4
Equity securities, available-for-sale... 27.7 72.6 46.2
Mortgage loans.......................... 884.2 1,022.9 1,111.1
Real estate............................. 178.2 171.3 187.5
Policy loans............................ 57.5 55.1 50.2
Cash and cash equivalents............... 32.7 32.3 25.9
Other................................... 110.7 76.1 55.3
--------- --------- ---------
3,498.0 3,311.0 3,188.6
Less investment expenses................ (103.5) (138.7) (116.6)
--------- --------- ---------
Net investment income................... $3,394.5 $3,172.3 $3,072.0
========= ========= =========
Net Realized Capital Gains and Losses
The major components of net realized capital gains (losses) on investments are
summarized as follows (in millions):
For the year ended December 31,
2001 2000 1999
-------- -------- --------
Fixed maturities, available-for-sale:
Gross gains........................... $ 75.8 $ 29.1 $ 31.2
Gross losses.......................... (408.8) (155.0) (128.1)
Fixed maturities, trading:
Gross gains........................... 0.9 - -
Gross losses.......................... (0.1) - -
Equity securities, available-for-sale:
Gross gains........................... 9.4 84.2 408.7
Gross losses.......................... (76.9) (5.0) (25.7)
Mortgage loans.......................... 10.7 8.6 (8.4)
Real estate............................. (19.0) 82.3 56.4
Other, including unrealized derivative
gains (losses)........................ (106.0) 95.7 70.4
-------- -------- --------
Net realized capital gains (losses)..... $(514.0) $ 139.9 $ 404.5
======== ======== ========
Proceeds from sales of investments (excluding call and maturity proceeds) in
fixed maturities were $5.7 billion, $5.7 billion and $5.5 billion in 2001, 2000
and 1999, respectively. Of the 2001, 2000 and 1999 proceeds, $1.6 billion, $2.6
billion and $3.8 billion, respectively, relates to sales of mortgage-backed
securities. The Company actively manages its mortgage-backed securities
portfolio to control prepayment risk. Gross gains of $22.5 million, $2.0 million
and $2.1 million and gross losses of $5.0 million, $40.1 million and $60.3
million in 2001, 2000 and 1999, respectively, were realized on sales of
mortgage-backed securities.
133
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
The Company recognizes impairment losses for fixed maturities and equity
securities when declines in value are other than temporary. Realized losses
related to other than temporary impairments were $227.4 million and $6.1 million
in 2001 and 2000, respectively. There were no other than temporary impairments
in 1999.
In December 2001, Enron Corp., along with certain of its subsidiaries, filed
voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy
Court. Included in the $227.4 million of realized losses in 2001 for other than
temporary impairments, $71.9 million related to the Company's exposure to Enron
Corp. and Enron related entities. Also included in net realized capital gains
and losses in 2001 was $65.8 million related to the sale of Enron investments.
As of December 31, 2001, the remaining carrying amount of the Company's
investment in Enron Corp. and Enron related entities was $45.5 million.
On September 11, 2001, terrorist attacks in the U.S. resulted in significant
loss of life and property, as well as interruption of business activities and an
overall disruption of the world economy. Some of the assets in the Company's
investment portfolio may be adversely affected by further declines in the
securities markets and economic activity caused by the terrorist attacks and
heightened security measures.
On December 31, 2001, the Company held corporate fixed maturity securities in
the following sectors impacted most significantly by the September 11, 2001
terrorist attacks (carrying amounts noted in parenthesis): airlines ($245.9
million in public debt and $208.3 million in private debt), comprised mostly of
equipment trust certificate transactions secured by aircraft; airline
manufacturers and equipment providers ($239.0 million), comprised of public and
private unsecured debt; property and casualty insurance companies ($28.9
million), comprised of public unsecured debt; and hotels and gaming companies
($168.9 million), comprised of public and private debt secured by hotel
properties. As of December 31, 2001, the Company has not recognized any related
other-than-temporary impairment of these assets.
Net Unrealized Gains and Losses
The net unrealized gains and losses on investments in fixed maturities and
equity securities available-for-sale are reported as a separate component of
equity, reduced by adjustments to deferred policy acquisition costs and unearned
revenue reserves that would have been required as a charge or credit to
operations had such amounts been realized and a provision for deferred income
taxes.
The cumulative amount of net unrealized gains and losses on available-for-sale
securities is as follows (in millions):
December 31,
2001 2000
---------- ----------
Net unrealized gains on fixed maturities, available-for-sale (1).... $827.0 $283.9
Net unrealized losses on equity securities, available-for-sale,
including seed money in separate accounts......................... (42.4) (48.9)
Adjustments for assumed changes in amortization patterns:
Deferred policy acquisition costs................................. (104.6) (43.2)
Unearned revenue reserves......................................... 7.2 2.8
Net unrealized losses on derivative instruments..................... (52.5) (6.7)
Provision for deferred income taxes................................. (214.4) (58.0)
--------- ---------
Net unrealized gains on available-for-sale securities............... $420.3 $129.9
========= =========
- ------------------
(1) Excludes net unrealized gains (losses) on fixed maturities,
available-for-sale included in fair value hedging relationships.
134
3. Investments (continued)
Commercial Mortgage Loans
Commercial mortgage loans represent a primary area of credit risk exposure. At
December 31, 2001 and 2000, the commercial mortgage portfolio is diversified by
geographic region and specific collateral property type as follows (dollars in
millions):
December 31,
2001 2000
--------------------- ----------------------
Carrying Percent Carrying Percent
amount of total amount of total
---------- --------- ---------- ---------
Geographic distribution
New England........................ $ 327.4 3.4% $ 495.9 4.6%
Middle Atlantic.................... 1,606.3 16.5 1,664.9 15.5
East North Central................. 930.1 9.5 1,006.2 9.3
West North Central................. 397.8 4.1 439.9 4.1
South Atlantic..................... 2,403.0 24.7 2,630.5 24.4
East South Central................. 338.5 3.5 384.5 3.6
West South Central................. 769.0 7.9 886.4 8.2
Mountain........................... 637.7 6.5 600.2 5.6
Pacific............................ 2,421.3 24.8 2,774.8 25.7
Valuation allowance................ (90.7) (0.9) (108.0) (1.0)
---------- --------- ---------- ---------
Total.............................. $9,740.4 100.0% $10,775.3 100.0%
========== ========= ========== =========
Property type distribution
Office............................. $3,252.5 33.4% $ 3,273.5 30.4%
Retail............................. 3,106.5 31.9 3,612.7 33.5
Industrial......................... 2,948.9 30.3 3,381.6 31.4
Apartments......................... 349.8 3.6 419.7 3.9
Hotel.............................. 61.6 0.6 65.6 0.6
Mixed use/other.................... 111.8 1.1 130.2 1.2
Valuation allowance................ (90.7) (0.9) (108.0) (1.0)
---------- --------- ---------- ---------
Total.............................. $9,740.4 100.0% $10,775.3 100.0%
========== ========= ========== =========
Mortgage loans on real estate are considered impaired when, based on current
information and events, it is probable that the Company will be unable to
collect all amounts due according to contractual terms of the loan agreement.
When the Company determines that a loan is impaired, a provision for loss is
established for the difference between the carrying amount of the mortgage loan
and the estimated value. Estimated value is based on either the present value of
the expected future cash flows discounted at the loan's effective interest rate,
the loan's observable market price or fair value of the collateral. The
provision for losses is reported as a net realized capital loss.
Mortgage loans deemed to be uncollectible are charged against the allowance for
losses, and subsequent recoveries are credited to the allowance for losses. The
allowance for losses is maintained at a level believed adequate by management to
absorb estimated probable credit losses. Management's periodic evaluation of the
adequacy of the allowance for losses is based on the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of the
underlying collateral, composition of the loan portfolio, current economic
conditions and other relevant factors. The evaluation is inherently subjective
as it requires estimating the amounts and timing of future cash flows expected
to be received on impaired loans that may change.
135
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
A summary of the changes in the commercial and residential mortgage loan
allowance for losses is as follows (in millions):
December 31,
2001 2000 1999
--------- --------- ---------
Balance at beginning of year............ $110.4 $117.8 $113.0
Provision for losses.................... 11.2 5.4 9.2
Releases due to write-downs, sales and
foreclosures.......................... (29.3) (12.8) (4.4)
--------- --------- ---------
Balance at end of year.................. $ 92.3 $110.4 $117.8
========= ========= =========
Residential Mortgage Banking Activities
The Company was servicing approximately 741,000 and 582,000 residential mortgage
loans with aggregate principal balances of approximately $80,530.5 million and
$55,987.4 million at December 31, 2001 and 2000, respectively. In connection
with these mortgage servicing activities, the Company held funds in trust for
others totaling approximately $508.9 million and $343.8 million at December 31,
2001 and 2000, respectively. As of December 31, 2001, $457.1 million of the
funds held in trust were held in the Company's banking subsidiary. In connection
with its loan administration activities, the Company advances payments of
property taxes and insurance premiums and also advances principal and interest
payments to investors in advance of collecting funds from specific mortgagors.
In addition, the Company makes certain payments of attorney fees and other costs
related to loans in foreclosure. These amounts receivable are recorded, at cost,
as advances on serviced loans. Amounts advanced are considered in management's
evaluation of the adequacy of the mortgage loan allowance for losses.
In June 2000, the Company, through its mortgage banking segment, created a
special purpose bankruptcy remote entity, Principal Residential Mortgage Capital
Resources, LLC ("PRMCR"), to provide an off-balance sheet source of funding for
the Company's residential mortgage loan production. The Company sells eligible
residential mortgage loans to PRMCR, where they are warehoused until sold to the
final investor. The Company sold $38.0 billion and $5.3 billion in mortgage
loans to PRMCR in 2001 and 2000, respectively. The maximum amount of mortgage
loans, which can be warehoused in PRMCR, has increased from $1.0 billion at
inception to $4.0 billion as of December 31, 2001. PRMCR held $3.0 billion in
mortgage loans held for sale as of December 31, 2001. The portfolio of loans
held for sale by PRMCR must meet portfolio criteria, eligibility
representations, and portfolio aging limitations. Based on these eligibility
representations, the Company is required to repurchase ineligible loans from
PRMCR.
PRMCR is capitalized by equity certificates owned by third party investors not
affiliated with the Company or its affiliates, directors or officers and thus,
is not consolidated with the Company. The equity holders bear the risk of loss
on defaulted mortgages. At December 31, 2001, PRMCR had outstanding equity
certificates of $193.0 million. PRMCR also issues short-term secured liquidity
notes as well as medium term notes to provide funds for its purchase of mortgage
loans from the Company. At December 31, 2001, PRMCR had outstanding secured
liquidity notes of $1.3 billion, three-year fixed term notes of $800.0 million
and five-year variable term notes of $800.0 million. All borrowings are
collateralized by the assets of PRMCR.
The Company paid a commitment fee to PRMCR based on the overall warehouse limit.
PRMCR used a portion of the fee to fund a cash collateral account maintained at
PRMCR. These funds are available as additional collateral to cover credit
related losses on defaulted loans. The balance in the account was $24.0 million
at December 31, 2001. Any remaining amounts in the cash collateral account will
be returned to the Company upon the termination of PRMCR. This right to the
return of the cash collateral amount is reflected in other assets on the
Company's consolidated statements of financial position.
136
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
The Company maintains a right to the servicing of the mortgage loans held by
PRMCR and upon the sale of the majority of the mortgage loans to the final
investors. In addition, the Company performs certain secondary marketing,
accounting and various administrative functions on behalf of PRMCR. As servicer,
the Company receives a monthly servicing fee, and may receive an excess
servicing fee if funds are available within PRMCR. Additionally, as servicer the
Company is required to advance to PRMCR those payments due from borrowers, but
not received, as of specified cut-off dates. The Company received $12.6 million
and $2.2 million in servicing fees from PRMCR in 2001 and 2000, respectively.
In order to hedge interest rate risk and non-credit related market value risk
associated with its inventory of mortgage loans held for sale, PRMCR entered
into swaps with counterparties not affiliated with the Company or PRMCR. The
swap counterparties are required to maintain certain minimum ratings as approved
by the rating agencies. Through separate swap agreements with the swap
counterparties that mirror the original swaps with PRMCR, the interest rate risk
and non-credit related market value components are swapped back to the Company.
In October 2000, the Company, through its mortgage banking segment, created a
wholly-owned, unconsolidated qualifying special purpose entity, Principal
Residential Mortgage Funding, LLC ("PRMF"), to provide an off-balance sheet
source of funding for up to $250.0 million of qualifying delinquent mortgage
loans. The limit was increased to $357.0 million in December 2001. The Company
sells qualifying delinquent loans to PRMF which then transfers the loans to
Principal Residential Mortgage EBO Trust ("Trust"), an unaffiliated Delaware
business trust. The Trust funds its acquisitions of the mortgage loans by
selling participation certificates, representing an undivided interest in the
Trust, to commercial paper conduit purchasers, who are not affiliated with the
Company or any of its affiliates, directors or officers. At December 31, 2001,
PRMF held $273.5 million in mortgage loans and had outstanding participation
certificates of $256.9 million.
Mortgage loans typically remain in the Trust until they are processed through
the foreclosure claim process, are paid-off or reinstate. Loans that reinstate
are no longer eligible to remain in the Trust and are required to be removed by
the Company at fair market value at the monthly settlement date following
reinstatement.
The Company is retained as the servicer of the mortgage loans and also performs
accounting and various administrative functions on behalf of PRMF, in its
capacity as the managing member of PRMF. As the servicer, the Company receives a
servicing fee pursuant to the pooling and servicing agreement. The Company may
also receive a successful servicing fee only after all other conditions in the
monthly cash flow distribution are met. At December 31, 2001, the Company's
residual interest in such cash flows was $21.5 million and was recorded in other
investments on the Company's consolidated statements of financial position. The
value of the residual interest was based on the net present value of expected
cash flows from PRMF, as well as estimates of foreclosure losses associated with
the related loans. The Company is required to advance funds for payment of
interest on the participation certificates and other carrying costs, if
sufficient cash is not available in the collection account to meet this
obligation.
The Company and the Trust are parties to a cost of funds hedge agreement. The
Company pays the weighted average cost of funds on the participation
certificates plus fees and expenses and receives the indicated swap bid rate,
subject to a cap.
137
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
3. Investments (continued)
Real Estate
Real estate holdings and related accumulated depreciation are as follows (in
millions):
December 31,
2001 2000
------------------- ------------------
Investment real estate....... $ 905.1 $ 822.2
Accumulated depreciation..... (114.1) (117.1)
------------------- ------------------
791.0 705.1
Properties held for sale..... 390.8 695.4
------------------- ------------------
Real estate, net............. $1,181.8 $1,400.5
=================== ==================
Other Investments
Other investments include minority interests in unconsolidated entities and
properties owned jointly with venture partners and operated by the partners.
Joint ventures in which the Company has an interest have mortgage loans with the
Company of $347.7 million and $612.1 million at December 31, 2001 and 2000,
respectively. The Company is committed to providing additional mortgage
financing for such joint ventures aggregating $171.8 million and $71.5 million
at December 31, 2001 and 2000, respectively.
4. Securitization Transactions
Commercial Mortgage Loans
The Company sells commercial mortgage loans in securitization transactions and
retains primary servicing responsibilities and other interests. The Company
receives annual servicing fees approximating 0.01 percent, which approximates
cost. The investors and the securitization trusts have no recourse to the
Company's other assets for failure of debtors to pay when due. The value of the
Company's retained interests is subject primarily to credit risk.
In 2001 and 2000, the Company recognized gains of $18.3 million and $0.7
million, respectively, on the securitization of commercial mortgage loans.
Key economic assumptions used in measuring the retained interests at the date of
securitization resulting from transactions completed included a cumulative
default rate between four and eight percent during 2001 and between five and
eight percent during 2000. The assumed range of the loss severity, as a
percentage of defaulted loans, was between 12 and 25 percent during 2001 and
between 13 and 25 percent during 2000. The low end of the loss severity range
relates to a portfolio of seasoned loans. The high end of the loss severity
range relates to a portfolio of newly issued loans.
At December 31, 2001, the fair values of retained interests related to the
securitizations of commercial mortgage loans were $170.5 million. Key economic
assumptions and the sensitivity of the current fair values of residual cash
flows were tested to one and two standard deviations from the expected rates.
The changes in the fair values at December 31, 2001, as a result of these
assumptions were not significant.
Residential Mortgage Loans
The Company sells residential mortgage loans and retains servicing
responsibilities pursuant to the terms of the applicable agreements. The Company
receives annual servicing fees approximating 0.4 percent of the outstanding
principal balances on the underlying loans. These sales are generally transacted
138
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. Securitization Transactions (continued)
on a non-recourse basis. The value of the servicing rights is subject to
prepayment and interest rate risks on the transferred assets.
In 2001 and 2000, the Company recognized gains of $218.8 million and $9.4
million, respectively, on the sales of residential mortgage loans.
The key economic assumptions used in determining the fair value of mortgage
servicing rights at the date of loan sale for sales completed in 2001 and 2000
were as follows:
2001 2000
------------------------------------
Weighted average life (years)........ 7.84 6.87
Weighted average prepayment speed.... 9.48% 11.81%
Yield to maturity discount rate...... 7.45% 10.74%
Prepayment speed is the constant prepayment rate that results in the weighted
average life disclosed above.
At December 31, 2001, key economic assumptions and the sensitivity of the
current fair value of the mortgage servicing rights to immediate 10 and 20
percent adverse changes in those assumptions are as follows (dollars in
millions):
Fair value of mortgage servicing rights.................. $1,811.0
Expected weighted average life (in years)................ 6.8
Prepayment speed......................................... 11.10%
Decrease in fair value of 10% adverse change............. $ 67.3
Decrease in fair value of 20% adverse change............. $ 128.9
Yield to maturity discount rate.......................... 8.86%
Decrease in fair value of 10% adverse change............. $ 130.0
Decrease in fair value of 20% adverse change............. $ 260.1
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10% variation in assumptions
generally cannot be extrapolated because the relationship of the change in the
assumption to the change in fair value may not be linear. Also, in the above
table, the effect of a variation in a particular assumption on the fair value of
the servicing rights is calculated independently without changing any other
assumption. In reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities. For example, changes in
prepayment speed estimates could result in changes in the discount rate.
Margin Lending
The Company sells loans under its margin loan securitization program and retains
primary servicing responsibilities and subordinated interests. The Company
receives servicing distributions approximating 0.3 percent of the outstanding
balance and rights to future cash flows through an excess distribution from the
trust, representing the balance remaining after all interest and fees of the
trust have been accounted for. The Company's retained interests are subordinated
to investors' interests. Retained interests equate to 7% of the outstanding loan
balances, of which the Company earns a return of 2.0% over the Australian 30 day
Bank Bill swap rate. The investors and the securitization trusts have no
recourse to the Company's other assets for failure of debtors to pay when due.
The value of the Company's retained interests is subject to market risk and all
positions are primarily hedged. No gains or losses on the transaction have been
realized to date.
The fair values of the retained interests, $37.8 million at December 31, 2001,
are based upon the Company's relative ownership percentage of the outstanding
loan balances. At December 31, 2001, the Company utilized the present
139
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
4. Securitization Transactions (continued)
value of expected future cash flows as a valuation technique to assess the
sensitivity of the fair values of retained interests. Key economic assumptions
used in measuring the retained interests included interest margin, credit
losses, terminations and discount rates, and the resulting changes to the fair
values were not significant.
Securitization Transactions Cash Flow
The table below summarizes cash flows for securitization transactions and cash
flows received from and paid to securitization trusts (in millions):
For the year ended
December 31,
2001 2000
--------- ---------
Proceeds from new securitizations..................... $39,252.1 $ 9,658.2
Proceeds from advances on margin loans previously
securitized......................................... 86.4 16.1
Servicing fees received............................... 309.5 239.3
Other cash flows received on retained interests....... 61.4 42.8
5. Derivatives Held or Issued for Purposes Other Than Trading
Derivatives are generally held for purposes other than trading and are primarily
used to hedge or reduce exposure to interest rate and foreign currency risks
associated with assets held or expected to be purchased or sold, and liabilities
incurred or expected to be incurred. Additionally, derivatives are used to
change the characteristics of the Company's asset/liability mix consistent with
the Company's risk management activities.
The Company's risk of loss is typically limited to the fair value of its
derivative instruments and not to the notional or contractual amounts of these
derivatives. Risk arises from changes in the fair value of the underlying
instruments. The Company is also exposed to credit losses in the event of
nonperformance of the counterparties. The Company's current credit exposure is
limited to the value of derivatives that have become favorable to the Company.
This credit risk is minimized by purchasing such agreements from financial
institutions with high credit ratings and by establishing and monitoring
exposure limits.
The Company's derivative transactions are generally documented under
International Swaps and Derivatives Association, Inc. Master Agreements.
Management believes that such agreements provide for legally enforceable set-off
and close out netting of exposures to specific counterparties. Under such
agreements, in connection with an early termination of a transaction, the
Company is permitted to set off its receivable from a counterparty against its
payables to the same counterparty arising out of all included transactions.
140
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Derivatives Held or Issued for Purposes Other Than Trading (continued)
The notional amounts and credit exposure of the Company's derivative financial
instruments by type are as follows (in millions):
December 31,
2001 2000
---------- ----------
Notional amounts of derivative instruments with
regard to U.S. operations
Foreign currency swaps............................ $ 4,091.9 $ 2,745.0
Interest rate floors.............................. 3,400.0 2,450.0
Interest rate swaps............................... 3,522.5 2,391.5
Mortgage-backed forwards and options.............. 9,250.7 1,898.3
Swaptions......................................... 3,570.0 697.7
Bond forwards..................................... 357.4 -
Interest rate lock commitments.................... 2,565.9 -
Call options...................................... 30.0 30.0
U.S. Treasury futures............................. 186.6 183.2
Currency forwards................................. 380.0 39.4
Treasury rate guarantees.......................... 88.0 60.0
Other............................................. 25.0 -
---------- ---------
27,468.0 10,495.1
Notional amounts of derivative instruments with
regard to international operations
Foreign currency swaps............................ 13.4 665.0
Interest rate swaps............................... - 665.0
Currency forwards................................. - 380.0
---------- ---------
13.4 1,710.0
---------- ---------
Total notional amounts at end of year............. $ 27,481.4 $ 12,205.1
========== ==========
Credit exposure of derivative instruments with
regard to U.S. operations
Foreign currency swaps............................ $ 101.1 $ 45.3
Interest rate floors.............................. 13.2 20.0
Interest rate swaps............................... 78.4 14.1
Mortgage-backed forwards and options.............. 41.7 -
Swaptions......................................... 8.7 11.8
Call options...................................... 8.9 12.3
Currency forwards................................. 55.3 5.5
Other............................................. 0.1 -
---------- ----------
307.4 109.0
Credit exposure of derivative instruments with
regard to international operations
Foreign currency swaps............................ - 28.4
Interest rate swaps............................... - 39.1
Currency forwards................................. - 26.2
---------- ----------
- 93.7
---------- ----------
Total credit exposure at end of year............. $ 307.4 $ 202.7
========== ==========
141
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Derivatives Held or Issued for Purposes Other Than Trading (continued)
The net interest effect of interest rate and currency swap transactions is
recorded as an adjustment to net investment income or interest expense, as
appropriate, over the periods covered by the agreements. The cost of derivative
instruments related to residential mortgage loan servicing rights is included in
the basis of the derivatives. These derivatives are marked-to-market with the
changes in market value reported in operating expenses on the consolidated
statements of operations.
The fair value of the Company's derivative instruments, identified as hedges and
classified as assets at December 31, 2001, was $409.9 million. Of this amount,
the fair value of derivatives related to investment hedges was $100.8 million
and was reported with other invested assets on the consolidated statement of
financial position. The fair value of derivatives related to residential
mortgage loan servicing rights and residential mortgage loans was $182.3 million
and the fair value of derivatives related to debt serviced by Australian dollars
was $126.8 million. Both are reported with other assets on the consolidated
statement of financial position. The fair value of derivative instruments
classified as liabilities at December 31, 2001, was $449.7 million and was
reported with other liabilities on the consolidated statement of financial
position.
Fair Value Hedges
The Company uses fixed-to-floating rate interest rate swaps to more closely
align the interest rate characteristics of certain assets and liabilities. In
general, these swaps are used in asset and liability management to modify
duration.
The Company also enters into currency exchange swap agreements to convert
certain foreign denominated assets and liabilities into U.S. dollar
floating-rate denominated instruments to eliminate the exposure to future
currency volatility on those items.
In 2001, the Company recognized a pre-tax net gain of $95.5 million relating to
its fair value hedges. This includes a net gain of $151.7 million related to the
ineffective portion of its fair value hedges of residential mortgage loan
servicing rights and a net loss of $43.6 million related to the change in the
value of the servicing hedges that was excluded from the assessment of hedge
effectiveness. The net gain on servicing hedges was reported with operating
expenses on the consolidated statement of operations. The net gain of $95.5
million also includes a net loss of $12.6 million related to the ineffective
portion of the Company's investment hedges, which was reported with net realized
capital gains (losses) on the consolidated statement of operations.
Cash Flow Hedges
The Company also utilizes floating-to-fixed rate interest rate swaps to match
cash flows.
The Company enters into currency exchange swap agreements to convert both
principal and interest payments of certain foreign denominated assets and
liabilities into U.S. dollar denominated fixed-rate instruments to eliminate the
exposure to future currency volatility on those items.
In 2001, the Company recognized a $5.8 million after-tax decrease in value
related to cash flow hedges in accumulated other comprehensive income. During
this time period, none of the Company's cash flow hedges have been discontinued
because it was probable that the original forecasted transaction would not occur
by the end of the originally specified time period. The Company has not
reclassified amounts from accumulated comprehensive income into earnings in the
past twelve months, and it does not expect to reclassify any amounts in the next
twelve months.
142
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
5. Derivatives Held or Issued for Purposes Other Than Trading (continued)
In most cases, zero hedge ineffectiveness for cash flow hedges is assumed
because the derivative instrument was constructed such that all terms of the
derivative match the hedged risk in the hedged item. As a result, the Company
has recognized an immaterial amount in earnings due to cash flow hedge
ineffectiveness.
The transition adjustment for the adoption of SFAS 133 resulted in a decrease to
other comprehensive income of $36.9 million ($24.0 million after tax)
representing the accumulation in other comprehensive income of the effective
portion of the Company's cash flow hedges as of January 1, 2001. In 2001, $8.9
million ($5.8 million after tax) of loss representing the effective portion of
the change in fair value of derivative instruments designated as cash flow
hedges decreased accumulated other comprehensive income resulting in an ending
balance of $(45.8) million ($(29.7) million after tax) at December 31, 2001.
Derivatives Not Designated as Hedging Instruments
The Company attempts to match the timing of when interest rates are committed on
insurance products, residential mortgage loans and other new investments.
However, timing differences may occur and can expose the Company to fluctuating
interest rates. To offset this risk, the Company uses mortgage-backed forwards,
over-the-counter options on mortgage-backed securities, U.S. Treasury futures
contracts, options on Treasury futures, Treasury rate guarantees and interest
rate floors to economically hedge anticipated transactions and to manage
interest rate risk. Futures contracts are marked-to-market and settled daily,
which minimizes the counterparty risk. Forward contracts are marked-to-market no
less than quarterly. The Company's interest rate lock commitments on residential
mortgage loans are also accounted for as derivatives.
Occasionally, the Company will sell a callable investment-type contract and may
use interest rate swaptions or similar instruments to transform the callable
liability into a fixed term liability. In addition, the Company may sell an
investment-type contract with attributes tied to market indices in which case
the Company writes an equity call option to convert the overall contract into a
fixed rate liability, essentially eliminating the equity component altogether.
Although the above-mentioned derivatives are effective hedges from an economic
standpoint, they do not meet the requirements for hedge accounting treatment
under SFAS 133. As such, periodic changes in the market value of these
instruments flow directly into net income. In 2001, gains of $68.3 million were
recognized in income from market value changes of derivatives not receiving
hedge accounting treatment.
6. Closed Block
In connection with its 1998 MIHC formation, Principal Life formed a Closed Block
to provide reasonable assurance to policyholders included therein that, after
the formation of the MIHC, assets would be available to maintain dividends in
aggregate in accordance with the 1997 policy dividend scales, if the experience
underlying such scales continued. Assets of Principal Life were allocated to the
Closed Block in an amount that produces cash flows which, together with
anticipated revenue from policies and contracts included in the Closed Block,
were expected to be sufficient to support the Closed Block policies, including
but not limited to, provisions for payment of claims, certain expenses, charges
and taxes, and to provide for continuation of policy and contract dividends in
aggregate in accordance with the 1997 dividend scales, if the experience
underlying such scales continues, and to allow for appropriate adjustments in
such scales, if such experience changes. Due to adjustable life policies being
included in the Closed Block, the Closed Block is charged with amounts necessary
to properly fund for certain adjustments, such as face amount and premium
increases, that are made to these policies after the Closed Block inception
date. These amounts are referred to as Funding Adjustment Charges and are
treated as capital transfers from the Closed Block.
143
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. Closed Block (continued)
Assets allocated to the Closed Block inure solely to the benefit of the holders
of policies included in the Closed Block. Closed Block assets and liabilities
are carried on the same basis as similar assets and liabilities held by the
Company. Principal Life will continue to pay guaranteed benefits under all
policies, including the policies within the Closed Block, in accordance with
their terms. If the assets allocated to the Closed Block, the investment cash
flows from those assets and the revenues from the policies included in the
Closed Block, including investment income thereon, prove to be insufficient to
pay the benefits guaranteed under the policies included in the Closed Block,
Principal Life will be required to make such payments from its general funds. No
additional policies were added to the Closed Block, nor was the Closed Block
affected in any other way, as a result of the demutualization.
A policyholder dividend obligation is required to be established for earnings in
the Closed Block that are not available to shareholders. A model of the Closed
Block was established to produce the pattern of expected earnings in the Closed
Block (adjusted to eliminate the impact of related amounts in accumulated other
comprehensive income). If actual cumulative earnings of the Closed Block are
greater than the expected cumulative earnings of the Closed Block, only the
expected cumulative earnings will be recognized in income with the excess
recorded as a policyholder dividend obligation. This policyholder dividend
obligation represents undistributed accumulated earnings that will be paid to
Closed Block policyholders as additional policyholder dividends unless offset by
future performance of the Closed Block that is less favorable than originally
expected. If actual cumulative performance is less favorable than expected, only
actual earnings will be recognized in income. At December 31, 2001, cumulative
actual earnings, including consideration of net unrealized gains, has been less
than cumulative expected earnings. Therefore, no policyholder dividend
obligation has been recognized.
144
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. Closed Block (continued)
Closed Block liabilities and assets designated to the Closed Block are as
follows:
December 31,
2001 2000
-------- --------
(in millions)
Closed Block liabilities
Future policy benefits and claims................. $5,248.7 $5,051.5
Other policyholder funds.......................... 20.3 4.8
Policyholder dividends payable.................... 376.6 402.2
Other liabilities................................. 11.8 22.6
-------- --------
Total Closed Block liabilities.................. 5,657.4 5,481.1
Assets designated to the Closed Block
Fixed maturities, available-for-sale.............. 2,466.3 2,182.2
Equity securities, available-for-sale............. 23.4 -
Mortgage loans.................................... 880.0 919.4
Real estate....................................... - 0.2
Policy loans...................................... 792.5 770.0
Other investments................................. 6.9 1.1
-------- --------
Total investments............................... 4,169.1 3,872.9
Cash and cash equivalents (deficit)............... (8.0) 22.7
Accrued investment income......................... 77.2 72.3
Deferred tax asset................................ 80.8 97.8
Premiums due and other receivables................ 33.3 33.8
-------- --------
Total assets designated to the Closed Block..... 4,352.4 4,099.5
-------- --------
Excess of Closed Block liabilities over assets
designated to the Closed Block.................. 1,305.0 1,381.6
Amounts included in other comprehensive
income.......................................... 43.6 27.2
-------- --------
Maximum future earnings to be recognized from
Closed Block assets and liabilities............. $1,348.6 $1,408.8
======== ========
145
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
6. Closed Block (continued)
Closed Block revenues and expenses were as follows:
For the year ended December 31,
2001 2000 1999
---------- ---------- ----------
(in millions)
Revenues
Premiums and other considerations....... $ 742.1 $ 752.4 $ 764.4
Net investment income................... 311.8 289.9 269.2
Net realized capital losses............. (19.7) (4.9) (2.0)
---------- ---------- ----------
Total revenues........................ 1,034.2 1,037.4 1,031.6
Expenses
Benefits, claims, and settlement
expenses.............................. 614.4 601.2 614.6
Dividends to policyholders.............. 305.8 307.7 295.9
Operating expenses...................... 12.7 13.6 13.2
---------- ---------- ----------
Total expenses 932.9 922.5 923.7
---------- ---------- ----------
Closed Block revenue, net of Closed
Block expenses, before income taxes.. 101.3 114.9 107.9
Income taxes............................ 33.5 38.4 37.0
---------- ---------- ----------
Closed Block revenue, net of Closed
Block expenses and income taxes....... 67.8 76.5 70.9
Funding adjustment charges.............. (7.6) (12.0) (12.2)
---------- ---------- ----------
Closed Block revenue, net of Closed
Block expenses, income tax and
funding adjustment charges............ $ 60.2 $ 64.5 $ 58.7
========== ========== ==========
The change in maximum future earnings of the Closed Block was as follows:
December 31,
2001 2000
---------- ----------
(in millions)
Beginning of year.................. $1,408.8 $1,473.3
End of year........................ 1,348.6 1,408.8
---------- ----------
Change in maximum future earnings.. $ (60.2) $ (64.5)
========== ==========
Principal Life charges the Closed Block with federal income taxes, payroll
taxes, state and local premium taxes and other state or local taxes, licenses
and fees as provided in the plan of reorganization.
146
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
7. Deferred Policy Acquisition Costs
Policy acquisition costs deferred and amortized in 2001, 2000 and 1999 are as
follows (in millions):
December 31,
2001 2000 1999
---------- ---------- ----------
Balance at beginning of year.......... $1,333.3 $1,430.9 $1,104.7
Cost deferred during the year......... 261.7 263.9 253.9
Amortized to expense during the year.. (159.9) (238.6) (173.8)
Effect of unrealized (gains) losses... (62.6) (122.9) 246.1
---------- ---------- ----------
Balance at end of year................ $1,372.5 $1,333.3 $1,430.9
========== ========== ==========
8. Insurance Liabilities
Contractholder Funds
Major components of contractholder funds in the consolidated statements of
financial position, are summarized as follows (in millions):
December 31,
2001 2000
----------- -----------
Liabilities for investment-type contracts:
Guaranteed investment contracts................................... $14,123.5 $14,779.6
U.S. funding agreements........................................... 307.1 772.1
International funding agreements backing medium-term notes........ 3,298.4 2,475.3
International funding agreements.................................. 723.9 -
Other investment-type contracts................................... 2,276.3 2,537.0
----------- -----------
Total liabilities for investment-type contracts..................... 20,729.2 20,564.0
Liabilities for individual annuities................................ 2,557.6 2,442.7
Universal life and other reserves................................... 1,397.6 1,293.5
----------- -----------
Total contractholder funds.......................................... $24,684.4 $24,300.2
=========== ===========
The Company's guaranteed investment contracts and funding agreements contain
provisions limiting early surrenders, including penalties for early surrenders
and minimum notice requirements. Put provisions give customers the option to
terminate a contract prior to maturity, provided they give a minimum notice
period.
147
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
8. Insurance Liabilities (continued)
The following table presents U.S. GAAP reserves for guaranteed investment
contracts and funding agreements by withdrawal provisions (in millions):
December 31, 2001
-----------------
Book Value Out(1)
Puttable:
Less than 30 days' put......................... $ -
30 to 89 days' put............................. -
90 to 180 days' put............................ -
More than 180 days' put........................ 55.1
No active put provision(2)..................... -
-----------------
Total puttable................................... 55.1
Surrenderable:
Book value out without surrender charge........ 22.9
Book value out with surrender charge........... 396.3
-----------------
Total surrenderable.............................. 419.2
-----------------
Total book value out............................. 474.3
Market Value Out(3)
Less than 30 days' notice........................ 26.9
30 to 89 days' notice............................ 281.9
90 to 180 days' notice........................... 1,133.6
More than 180 days' notice....................... 4,795.6
No active surrender provision.................... 238.5
-----------------
Total market value out........................... 6,476.5
Not puttable or surrenderable.................... 11,502.1
-----------------
Total GICs and funding agreements................ $18,452.9
=================
- ------------------
(1) Book Value Out: The amount equal to the sum of deposits less withdrawals
with interest accrued at the contractual interest rate.
(2) Contracts currently in initial lock-out period but which will become
puttable with 90 days' notice at some time in the future.
(3) Market Value Out: The amount equal to the book value out plus a market
value adjustment to adjust for changes in interest rates.
Funding agreements are issued to non-qualified institutional investors both in
domestic and international markets. The Company has a $4.0 billion international
program, under which a consolidated offshore special purpose entity was created
to issue nonrecourse medium-term notes. Under the program, the proceeds of each
note series issuance are used to purchase a funding agreement from the Company,
which is used to secure that particular series of notes. The payment terms of
any particular series of notes match the payment terms of the funding agreement
that secures that series. Claims for principal and interest under those
international funding agreements are afforded equal priority to claims of life
insurance and annuity policyholders under insolvency provisions of Iowa
Insurance Laws and, accordingly, are reported as contractholder funds
liabilities in the Company's consolidated statement of financial position. In
general, the medium-term note funding agreements do not give the contractholder
the right to terminate prior to contractually stated maturity dates, absent the
148
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
8. Insurance Liabilities (continued)
existence of certain circumstances which are largely within the Company's
control. As of December 31, 2001, the contractual maturities were 2002 - $160.2
million; 2003 - $496.1 million; 2004 - $470.2 million; 2005 - $714.5 million;
2006 - $98.9 million; and thereafter - $1,358.5 million.
In February 2001, the Company agreed to issue up to $3.0 billion of funding
agreements under another program to support the prospective issuance by an
unaffiliated entity of medium-term notes in both domestic and international
markets. The unaffiliated entity is not consolidated in the Company's financial
statements. The funding agreements issued to the unaffiliated entity are
reported as contractholder funds liabilities in the Company's consolidated
statement of financial position. As of December 31, 2001, $723.9 million has
been issued under this program.
Future Policy Benefits and Claims
Activity in the liability for unpaid accident and health claims, which is
included with future policy benefits and claims in the consolidated statements
of financial position, is summarized as follows (in millions):
December 31,
2001 2000 1999
----------- ----------- -----------
Balance at beginning of year..... $ 705.0 $ 721.7 $ 641.4
Incurred:
Current year................... 1,597.1 1,788.1 1,872.2
Prior years.................... (17.5) (17.8) (6.2)
----------- ----------- -----------
Total incurred................... 1,579.6 1,770.3 1,866.0
Payments:
Current year................... 1,283.2 1,447.3 1,466.3
Prior years.................... 286.6 339.7 319.4
----------- ----------- -----------
Total payments................... 1,569.8 1,787.0 1,785.7
Balance at end of year:
Current year................... 313.9 340.8 405.9
Prior years.................... 400.9 364.2 315.8
----------- ----------- -----------
Total balance at end of year..... $ 714.8 $ 705.0 $ 721.7
=========== =========== ===========
The activity summary in the liability for unpaid accident and health claims
shows a decrease of $17.5 million, $17.8 million and $6.2 million to the
December 31, 2000, 1999 and 1998 liability for unpaid accident and health
claims, respectively, arising in prior years. Such liability adjustments, which
affected current operations during 2001, 2000 and 1999, respectively, resulted
from developed claims for prior years being different than were anticipated when
the liabilities for unpaid accident and health claims were originally estimated.
These trends have been considered in establishing the current year liability for
unpaid accident and health claims.
On September 11, 2001, terrorist attacks in the U.S. resulted in significant
loss of life and property, as well as interruption of business activities and an
overall disruption of the world economy. As of December 31, 2001, the Company
recognized $6.7 million (net of income tax and reinsurance) in losses from
individual and group life and disability insurance claims as a result of these
events.
149
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
9. Debt
Short-Term Debt
Short-term debt consists primarily of commercial paper and outstanding balances
on revolving credit facilities with various financial institutions. At December
31, 2001, the Company and certain subsidiaries had credit facilities with
various financial institutions in an aggregate amount of $1.4 billion. These
credit facilities include $600.0 million on a back-stop facility to support the
Company's $1 billion commercial paper program, $780.0 million in credit
facilities to finance a CMBS pipeline and $45.0 million of unused lines of
credit for short-term debt used for general corporate purposes.
The weighted average interest rates on short-term borrowings as of December 31,
2001 and 2000, were 2.30% and 7.17%, respectively.
The components of short-term debt as of December 31, 2001 and 2000 are as
follows (in millions):
December 31,
2001 2000
------- -------
Commercial paper.................... $ 199.9 $ 29.9
Other recourse short-term debt...... 22.0 16.6
Non-recourse short-term debt........ 289.7 413.0
------- -------
Total short-term debt............... $ 511.6 $ 459.5
======= =======
Long-Term Debt
The components of long-term debt as of December 31, 2001 and December 31, 2000
are as follows (in millions):
December 31,
2001 2000
-------- --------
7.95% notes payable, due 2004.............. $ 199.1 $ 199.3
8.2% notes payable, due 2009............... 464.6 464.9
7.875% surplus notes payable, due 2024. 199.0 198.9
8% surplus notes payable, due 2044......... 99.1 99.1
Non-recourse mortgages and notes payable... 247.5 149.8
Other mortgages and notes payable.......... 169.1 224.5
-------- --------
Total long-term debt....................... $1,378.4 $1,336.5
======== ========
The amounts included above are net of the discount and direct costs associated
with issuing these notes, which are being amortized to expense over their
respective terms using the interest method.
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty Limited,
a wholly-owned indirect subsidiary of the Company, issued $665.0 million of
unsecured redeemable long-term debt ($200.0 million of 7.95% notes due August
15, 2004, and $465.0 million in 8.2% notes due August 15, 2009). Interest on the
notes is payable semiannually on February 15 and August 15 of each year,
commencing February 15, 2000. Principal Financial Group (Australia) Holdings Pty
Limited used the net proceeds from the notes to partially fund the purchase of
the outstanding stock of several companies affiliated with Bankers Trust
Australia Group (see Note 2). On December 28, 2001, all of the long-term debt
obligations of Principal Financial Group (Australia) Holdings Pty Limited were
assumed by its parent, PFSI.
150
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
9. Debt (continued)
On March 10, 1994, Principal Life issued $300.0 million of surplus notes,
including $200.0 million due March 1, 2024, at a 7.875% annual interest rate and
the remaining $100.0 million due March 1, 2044, at an 8% annual interest rate.
No affiliates of the Company hold any portion of the notes. Each payment of
interest and principal on the notes, however, may be made only with the prior
approval of the Commissioner of Insurance of the State of Iowa (the
"Commissioner") and only to the extent that Principal Life has sufficient
surplus earnings to make such payments. For each of the years ended December 31,
2001, 2000 and 1999, interest of $23.8 million was approved by the Commissioner,
paid and charged to expense.
Subject to Commissioner approval, the surplus notes due March 1, 2024, may be
redeemed at Principal Life's election on or after March 1, 2004, in whole or in
part at a redemption price of approximately 103.6% of par. The approximate 3.6%
premium is scheduled to gradually diminish over the following ten years. These
surplus notes may then be redeemed on or after March 1, 2014, at a redemption
price of 100% of the principal amount plus interest accrued to the date of
redemption.
In addition, subject to Commissioner approval, the notes due March 1, 2044, may
be redeemed at Principal Life's election on or after March 1, 2014, in whole or
in part at a redemption price of approximately 102.3% of par. The approximate
2.3% premium is scheduled to gradually diminish over the following ten years.
These notes may be redeemed on or after March 1, 2024, at a redemption price of
100% of the principal amount plus interest accrued to the date of redemption.
The mortgages and other notes payable are financings for real estate
developments. The Company has obtained loans with various lenders to finance
these developments. Outstanding principal balances as of December 31, 2001,
range from $0.1 million to $101.9 million per development with interest rates
generally ranging from 7.2% to 8.6%. Outstanding principal balances as of
December 31, 2000, range from $0.5 million to $102.8 million per development
with interest rates generally ranging from 6.9% to 8.6%.
At December 31, 2001, future annual maturities of the long-term debt are as
follows (in millions):
2002............................................ $ 165.1
2003............................................ 5.6
2004............................................ 283.2
2005............................................ 2.6
2006............................................ 2.8
Thereafter...................................... 919.1
---------
Total future maturities of the long-term debt... $ 1,378.4
=========
Cash paid for interest for 2001, 2000 and 1999, was $98.1 million, $116.8
million and $127.7 million, respectively. These amounts include interest paid on
taxes during these years.
151
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
10. Income Taxes
The Company's income tax expense (benefit) is as follows (in millions):
For the year ended December 31,
2001 2000 1999
-------- -------- --------
Current income taxes:
Federal................................. $ 18.7 $ 167.7 $ 74.9
State and foreign....................... 36.9 37.3 23.2
Net realized capital gains (losses)..... (214.1) 29.6 162.8
-------- -------- --------
Total current income taxes (benefit)...... (158.5) 234.6 260.9
Deferred income taxes..................... 237.5 5.7 62.6
-------- -------- --------
Total income taxes........................ $ 79.0 $ 240.3 $ 323.5
======== ======== ========
The Company's provision for income taxes may not have the customary relationship
of taxes to income. Differences between the prevailing corporate income tax rate
of 35% times the pre-tax income and the Company's effective tax rate on pre-tax
income are generally due to inherent differences between income for financial
reporting purposes and income for tax purposes, and the establishment of
adequate provisions for any challenges of the tax filings and tax payments to
the various taxing jurisdictions. A reconciliation between the corporate income
tax rate and the effective tax rate is as follows:
For the year ended December 31,
2001 2000 1999
-------- -------- --------
Statutory corporate tax rate.............. 35% 35% 35%
Dividends received deduction.............. (14) (5) (3)
Interest exclusion from taxable income.... (3) (1) -
Other..................................... - (1) (2)
-------- -------- --------
Effective tax rate........................ 18% 28% 30%
======== ======== ========
Significant components of the Company's net deferred income taxes are as follows
(in millions):
December 31,
2001 2000
-------- --------
Deferred income tax assets (liabilities):
Insurance liabilities................................... $ 132.2 $ 181.1
Deferred policy acquisition costs....................... (390.7) (360.1)
Net unrealized gains on available for sale securities... (218.9) (59.1)
Mortgage loan servicing rights.......................... (355.2) (206.3)
Other................................................... (13.6) (6.6)
-------- --------
Total deferred income tax liabilities..................... $(846.2) $(451.0)
======== ========
At December 31, 2001 and 2000, respectively, the Company's net deferred tax
liability is comprised of international net deferred tax assets of $48.4 million
and $36.4 million which have been included in other assets, and $894.6 million
and $487.4 million of U.S. net deferred tax liabilities which have been included
in deferred income taxes in the consolidated statements of financial position.
The Internal Revenue Service (the "Service") has completed examination of the
U.S. consolidated federal income tax returns for 1996 and prior years. The
Service has also begun to examine returns for 1997 and 1998. The Company
believes that there are adequate defenses against or sufficient provisions for
any challenges.
152
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
10. Income Taxes (continued)
Undistributed earnings of certain foreign subsidiaries are considered
indefinitely reinvested by the Company. A tax liability will be recognized when
the Company expects distribution of earnings in the form of dividends, sale of
the investment or otherwise.
Cash paid for income taxes was $90.3 million in 2001, $279.3 million in 2000 and
$251.5 million in 1999.
11. Employee and Agent Benefits
The Company has defined benefit pension plans covering substantially all of its
employees and certain agents. Some of these plans provide supplemental pension
benefits to employees with salaries and/or pension benefits in excess of the
qualified plan limits imposed by federal tax law. The employees and agents are
generally first eligible for the pension plans when they reach age 21. For plan
participants employed prior to January 1, 2002, the pension benefits are based
on the greater of a final average pay benefit or a cash balance benefit. The
final average pay benefit is based on the years of service and generally the
employee's or agent's average annual compensation during the last five years of
employment. Partial benefit accrual of final average pay benefits is recognized
from first eligibility until retirement based on attained service divided by
potential service to age 65 with a minimum of 35 years of potential service. The
cash balance portion of the plan will start on January 1, 2002. An employee's
account will be credited with an amount based on the employee's salary, age and
service. These credits will accrue with interest. For plan participants hired on
and after January 1, 2002, only the cash balance plan applies. The Company's
policy is to fund the cost of providing pension benefits in the years that the
employees and agents are providing service to the Company. The Company's funding
policy for all plans is to deposit the U.S. GAAP-related net periodic pension
cost using long-term assumptions, unless the U.S. GAAP funded status is
positive, in which case no deposit is made. Prior to 2001, the Company's funding
policy was to deposit an amount within the range of U.S. GAAP net periodic
pension cost and the sum of the actuarial normal cost and any change in the
unfunded accrued liability over a 30-year period as a percentage of
compensation.
As a result of the Company's demutualization, the qualified defined benefit
pension plan received $56.7 million in compensation which will be amortized over
the remaining service period of plan participants.
The Company also provides certain health care, life insurance and long-term care
benefits for retired employees. Retiree health benefits are provided for
employees hired prior to January 1, 2002, while retiree long-term care benefits
are provided for employees whose retirement was effective prior to July 1, 2000.
Covered employees are first eligible for these postretirement benefits when they
reach age 57 and have completed ten years of service with the Company. Partial
benefit accrual of these health, life and long-term care benefits is recognized
from the employee's date of hire until retirement based on attained service
divided by potential service to age 65 with a minimum of 35 years of potential
service. The Company's policy is to fund the cost of providing retiree benefits
in the years that the employees are providing service to the Company. The
Company's funding policy for all plans is to deposit the U.S. GAAP-related net
periodic postretirement benefit cost using long-term assumptions unless the U.S.
GAAP funded status is positive, in which case no deposit is made. Prior to 2001,
the Company's funding policy was to deposit an amount within the range of U.S.
GAAP net periodic postretirement cost and the sum of the actuarial normal cost
and any change in the unfunded accrued liability over a 30-year period as a
percentage of compensation.
As a result of the Company's demutualization, the postretirement benefit plans
received $11.3 million in compensation, which will be used to pay benefit claims
and participant contributions, with the remainder to be amortized over the
remaining service period of plan participants.
The plans' combined funded status, reconciled to amounts recognized in the
consolidated statements of financial position and consolidated statements of
operations, is as follows (dollars in millions):
153
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
11. Employee and Agent Benefits (continued)
Other postretirement
Pension benefits benefits
---------------------- ----------------------
December 31, December 31,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Change in benefit obligation
Benefit obligation at beginning of year.... $ (797.3) $ (732.5) $ (221.8) $ (227.9)
Service cost............................... (31.2) (35.0) (8.3) (10.4)
Interest cost.............................. (59.3) (57.5) (15.6) (19.0)
Actuarial gain (loss)...................... (42.0) (2.7) (25.7) 3.7
Benefits paid.............................. 31.7 30.4 9.6 -
Other...................................... 42.1 - 30.7 31.8
---------- ---------- ---------- ----------
Benefit obligation at end of year.......... $ (856.0) $ (797.3) $ (231.1) $ (221.8)
========== ========== ========== ==========
Change in plan assets
Fair value of plan assets at beginning
of year.................................. $1,115.4 $1,059.8 $ 359.8 $ 345.5
Actual return (loss) on plan assets........ (15.7) 75.1 5.6 13.7
Employer contribution...................... 9.0 10.9 1.4 18.6
Benefits paid.............................. (31.7) (30.4) (4.4) (18.0)
Other...................................... (124.5) - - -
---------- ---------- ---------- ----------
Fair value of plan assets at end
of year.................................. $ 952.5 $1,115.4 $ 362.4 $ 359.8
========== ========== ========== ==========
Funded status.............................. $ 96.5 $ 318.1 $ 131.3 $ 138.0
Unrecognized net actuarial gain............ (65.3) (194.2) (0.6) (19.4)
Unrecognized prior service (cost) benefit.. 7.6 9.2 (28.2) (29.8)
Unamortized transition obligation (asset).. (2.7) (14.2) - 0.3
---------- ---------- ---------- ----------
Other assets - prepaid benefit cost........ $ 36.1 $ 118.9 $ 102.5 $ 89.1
========== ========== ========== ==========
Weighted-average assumptions as of
December 31
Discount rate.............................. 7.50% 8.00% 7.50% 8.00%
Components of net periodic benefit cost
Service cost............................... $ 31.2 $ 35.0 $ 8.3 $ 10.4
Interest cost.............................. 59.3 57.5 15.6 19.0
Expected return on plan assets............. (99.2) (81.3) (32.3) (25.1)
Amortization of prior service (cost)
benefit.................................. 1.7 1.7 (2.6) -
Amortization of transition (asset)
obligation............................... (11.5) (11.5) 0.3 2.3
Recognized net actuarial gain.............. (14.1) (12.5) (1.3) (1.1)
---------- ---------- ---------- ----------
Net periodic benefit cost (income)......... $ (32.6) $ (11.1) $ (12.0) $ 5.5
========== ========== ========== ==========
154
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
11. Employee and Agent Benefits (continued)
Effective January 1, 2000, the Company amended the method of determining
postretirement health benefit plan contributions and terminated long-term care
coverage for participants retiring on and subsequent to July 1, 2000. The result
of these amendments decreased the postretirement benefit obligation by $31.8
million and was partially offset by the remaining portion of the original
transition obligation. During 2001, the Company reclassified assets supporting
non-qualified pension plan liabilities through a reduction in contractholder
funds and an increase in invested assets.
For 2001 and 2000, the expected long-term rates of return on plan assets for
pension benefits were 9.0% and 8.1%, respectively, on a pre-tax basis. The
assumed rate of increase in future compensation levels varies by age for both
the qualified and non-qualified pension plans.
For 2001 and 2000, the expected long-term rates of return on plan assets for
other post-retirement benefits varied by benefit type and employee group and
ranged from 7.8% to 9.3% and 8.0% to 8.1%, respectively, on a pre-tax basis.
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligations starts at 9% in 2001 and declines to an
ultimate rate of 6% in 2011. Assumed health care cost trend rates have a
significant effect on the amounts reported for the health care plans.
A one-percentage-point change in assumed health care cost trend rates would have
the following effects (in millions):
1-percentage-point 1-percentage-point
increase decrease
------------------ ------------------
Effect on total of service and interest cost components....... $ 5.3 $ (6.0)
Effect on accumulated postretirement benefit obligation....... 50.1 (40.2)
In addition, the Company has defined contribution plans that are generally
available to all employees and agents who are age 21 or older. Eligible
participants may contribute up to 20% of their compensation. The Company matches
the participant's contribution at a 50% contribution rate up to a maximum
Company contribution of 3% of the participant's compensation in 2001 and 2000,
and 2% of the participant's compensation in 1999. The defined contribution plan
allows employees to choose among various investment options, including the
Company's common stock. The Company contributed $17.9 million in 2001, $16.0
million in 2000 and $11.0 million in 1999 to these defined contribution plans.
As a result of the Company's demutualization, the defined contribution plans
received $19.7 million in compensation, which was allocated to participant
accounts.
12. Commitments and Contingencies
Leases
The Company, as a lessor, leases industrial, office, retail and other investment
real estate properties under various operating leases. Rental income for all
operating leases totaled $178.4 million in 2001, $292.5 million in 2000 and
$356.8 million in 1999.
155
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
12. Commitments and Contingencies (continued)
At December 31, 2001, future minimum annual rental commitments under these
noncancelable operating leases are as follows (in millions):
Held for Total rental
Held for sale investment commitments
------------- ---------- ------------
2002................................. $ 51.9 $ 72.3 $124.2
2003................................. 49.5 60.0 109.5
2004................................. 46.5 49.0 95.5
2005................................. 40.3 38.5 78.8
2006................................. 36.7 25.7 62.4
Thereafter........................... 202.3 57.7 260.0
------------- ---------- ------------
Total future minimum lease receipts.. $427.2 $303.2 $730.4
============= ========== ============
The Company, as a lessee, leases office space, data processing equipment,
corporate aircraft and office furniture and equipment under various operating
leases. Rental expense for all operating leases totaled $58.8 million in 2001,
$66.3 million in 2000 and $78.5 million in 1999. At December 31, 2001, future
minimum annual rental commitments under these noncancelable operating leases are
as follows (in millions):
2002.............................................................. $ 60.3
2003.............................................................. 48.5
2004.............................................................. 35.1
2005.............................................................. 23.6
2006.............................................................. 20.9
Thereafter........................................................ 28.2
------
216.6
Less future sublease rental income on these noncancelable leases.. 2.8
------
Total future minimum lease payments............................... $213.8
======
Litigation
The Company is a plaintiff or defendant in actions arising out of its
operations. The Company is, from time to time, also involved in various
governmental and administrative proceedings. While the outcome of any pending or
future litigation cannot be predicted, management does not believe that any
pending litigation will have a material adverse effect on the Company's
business, financial condition or results of operations. However, no assurances
can be given that such litigation would not materially and adversely affect the
Company's business, financial condition or results of operations.
Other companies in the life insurance industry have historically been subject to
substantial litigation resulting from claims disputes and other matters. Most
recently, such companies have faced extensive claims, including class-action
lawsuits, alleging improper life insurance sales practices. Negotiated
settlements of such class-action lawsuits have had a material adverse effect on
the business, financial condition and results of operations of certain of these
companies. Principal Life is currently a defendant in two class-action lawsuits
which allege improper sales practices.
156
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
12. Commitments and Contingencies (continued)
In 2000, the Company reached an agreement in principle to settle these two
class-action lawsuits alleging improper sales practices. In April 2001, the
proposed settlement of the class-action lawsuits received court approval. In
agreeing to the settlement, the Company specifically denied any wrongdoing. The
Company has accrued a loss reserve for its best estimate based on information
available. As uncertainties continue to exist in resolving this matter, it is
reasonably possible that, as the actual cost of the claims subject to
alternative dispute resolution becomes available, the final cost of settlement
could exceed the Company's estimate. The range of any additional cost related to
the settlement cannot be presently estimated; however, the Company believes the
settlement will not have a material impact on its business, financial condition
or results of operations. A number of persons and entities who were eligible to
be class members have excluded themselves from the class (or "opted out"), as
the law permits them to do. The Company has been notified that some of those who
opted out from the class will file lawsuits and make claims similar to those
addressed by the settlement. Some of these lawsuits are presently on file.
Insurance Guaranty Assessments
The Company is also subject to insurance guaranty laws in the states in which it
writes business. These laws provide for assessments against life and health
insurance companies for the benefit of policyholders and claimants in the event
of insolvency of other life and health insurance companies. The assessments may
be partially recovered through a reduction in future premium taxes in some
states. The Company believes such assessments in excess of amounts accrued would
not materially affect its financial condition or results of operations.
Securities Held for Collateral
The Company held $759.9 million in mortgage-backed securities in trust at
December 31, 2001, to satisfy collateral requirements associated with the
Company's mortgage banking segment and derivatives credit support agreements.
13. Stockholders' Equity
Common Stock
As a result of the demutualization and initial public offering described in Note
1, the Company has one class of capital stock, common stock ($.01 par value,
2,500 million shares authorized).
On November 9, 2001, the Company issued 15.0 million additional shares of common
stock, at a price of $18.50 per share, as a result of the exercise of
over-allotment options granted to underwriters in the IPO. Net proceeds from the
over-allotment were $265.4 million.
On November 27, 2001, the Company announced that its board of directors
authorized a repurchase program beginning in the fourth quarter of 2001, to be
completed in the three to six months following the announcement, depending on
market conditions, under which the Company would purchase up to 15.3 million
shares of its outstanding common stock. Stock repurchased under the program is
accounted for as treasury stock, carried at cost and reflected as a reduction to
stockholders' equity. Through December 31, 2001, the Company purchased the 15.3
million shares, primarily through an accelerated share repurchase program (13.0
million shares), as well as in the open market and through privately negotiated
transactions, at an aggregate cost of $367.7 million. The 13.0 million shares
purchased under the accelerated share repurchase program are subject to a future
contingent purchase price adjustment. The adjustment will be based upon the
difference between the market price of the Company's common stock as of December
14, 2001, and its volume weighted average price over an extended trading period
as outlined in the forward stock purchase contract and, at the Company's
determination, can be settled in either cash or shares of common stock.
Settlement of this contract will occur at contract completion.
157
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
13. Stockholders' Equity (continued)
As a result of the demutualization, 363.7 thousand shares with a value of $6.7
million were issued to rabbi trusts held by the Company for certain benefit
plans. These shares were reported as treasury stock and additional paid-in
capital in the consolidated statements of stockholders' equity at December 31,
2001.
Other Comprehensive Income
Comprehensive income (loss) includes all changes in stockholders' equity during
a period except those resulting from investments by stockholders and
distributions to stockholders.
The components of accumulated other comprehensive income are as follows (in
millions):
Net unrealized Net
gains (losses) unrealized
on gains Foreign
available- (losses) on currency Accumulated other
for-sale derivative translation comprehensive
securities instruments adjustment income (loss)
-------------- ----------- ----------- -----------------
Balances at January 1, 1999........ $ 740.3 $ 5.6 $ (28.9) $ 717.0
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale............... (1,375.4) - - (1,375.4)
Net change in unrealized gains
(losses) on equity securities,
available-for-sale, including
seed money in separate accounts.. (131.1) - - (131.1)
Adjustments for assumed changes
in amortization pattern:
Deferred policy acquisition
costs........................ 246.1 - - 246.1
Unearned revenue reserves...... (29.5) - - (29.5)
Net change in unrealized gains/
(losses) on derivative
instruments...................... - (11.0) - (11.0)
Provision for deferred income tax
benefit.......................... 449.1 3.9 - 453.0
Change in net foreign currency
translation adjustment........... - - (8.5) (8.5)
-------------- ----------- ----------- -----------------
Balances at December 31, 1999...... (100.5) (1.5) (37.4) (139.4)
158
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
13. Stockholders' Equity (continued)
Net unrealized Net
gains (losses) unrealized
on gains Foreign
available- (losses) on currency Accumulated other
for-sale derivative translation comprehensive
securities instruments adjustment income (loss)
-------------- ----------- ----------- -----------------
Balances at January 1, 2000........ $ (100.5) $ (1.5) $ (37.4) $ (139.4)
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale.............. 721.8 - - 721.8
Net change in unrealized gains
(losses) on equity securities,
available-for-sale, including
seed money in separate accounts. (261.1) - - (261.1)
Adjustments for assumed changes
in amortization pattern:
Deferred policy acquisition
costs........................ (122.6) - - (122.6)
Unearned revenue reserves..... 15.1 - - 15.1
Net change in unrealized gains/
(losses) on derivative
instruments................... - (1.3) - (1.3)
Provision for deferred income tax
benefit......................... (120.5) 0.5 - (120.0)
Change in net foreign currency
translation adjustment.......... - - (152.5) (152.5)
-------------- ----------- ----------- ----------------
Balances at December 31, 2000...... 132.2 (2.3) (189.9) (60.0)
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale.............. 511.0 - - 511.0
Net change in unrealized gains
(losses) on equity securities,
available-for-sale, including
seed money in separate accounts. 6.5 - - 6.5
Adjustments for assumed changes
in amortization pattern:
Deferred policy acquisition
costs........................ (61.3) - - (61.3)
Unearned revenue reserves..... 4.3 - - 4.3
Net change in unrealized gains
(losses) on derivative
instruments..................... - (8.9) - (8.9)
Provision for deferred income tax
benefit......................... (161.2) 3.1 - (158.1)
Change in net foreign currency
translation adjustment.......... - - (71.8) (71.8)
Cumulative effect of accounting
change, net of related income
taxes........................... 33.8 (36.9) (11.1) (14.2)
-------------- ----------- ----------- ----------------
Balances at December 31, 2001...... $ 465.3 $ (45.0) $ (272.8) $ 147.5
============== =========== =========== ================
159
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
13. Stockholders' Equity (continued)
The following table sets forth the adjustments necessary to avoid duplication of
items that are included as part of net income for a year that had been part of
other comprehensive income in prior years (in millions):
December 31,
2001 2000 1999
-------- -------- ----------
Unrealized gains (losses) on available-
for-sale securities arising during
the year............................... $537.7 $261.8 $(1,036.1)
Adjustment for realized gains (losses)
on available-for-sale securities
included in net income................. (247.3) (29.9) 188.2
-------- -------- ----------
Unrealized gains (losses) on available-
for-sale securities, as adjusted....... $290.4 $231.9 $ (847.9)
======== ======== ==========
The above table is presented net of tax, related changes in the amortization
patterns of deferred policy acquisition costs and unearned revenue reserves.
Dividend Limitations
Under Iowa law, Principal Life may pay stockholder dividends only from the
earned surplus arising from its business and must receive the prior approval of
the Commissioner to pay a stockholder dividend if such a stockholder dividend
would exceed certain statutory limitations. The current statutory limitation is
the greater of 10% of Principal Life's policyholder surplus as of the preceding
year-end or the net gain from operations from the previous calendar year. Based
on this limitation and 2001 statutory results, Principal Life could pay
approximately $640.3 million in stockholder dividends in 2002 without exceeding
the statutory limitation.
In 2001 and 2000, Principal Life notified the Commissioner in advance of all
stockholder dividend payments. Total stockholder dividends paid to its parent
company in 2001 and 2000 were $734.7 million and $538.8 million, respectively.
In 1999, Principal Life notified the Commissioner in advance of all stockholder
dividend payments and received approval for an extraordinary stockholder
dividend of $250.0 million. Total stockholder dividends paid to its parent
company in 1999 were $509.0 million.
14. Fair Value of Financial Instruments
The following discussion describes the methods and assumptions utilized by the
Company in estimating its fair value disclosures for financial instruments.
Certain financial instruments, particularly policyholder liabilities other than
investment-type contracts, are excluded from these fair value disclosure
requirements. The techniques utilized in estimating the fair values of financial
instruments are affected by the assumptions used, including discount rates and
estimates of the amount and timing of future cash flows. Care should be
exercised in deriving conclusions about the Company's business, its value or
financial position based on the fair value information of financial instruments
presented below. The estimates shown are not necessarily indicative of the
amounts that would be realized in a one-time, current market exchange of all of
the Company's financial instruments.
The Company defines fair value as the quoted market prices for those instruments
that are actively traded in financial markets. In cases where quoted market
prices are not available, fair values are estimated using present value or other
valuation techniques. The fair value estimates are made at a specific point in
time, based on available market information and judgments about the financial
160
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
14. Fair Value of Financial Instruments (continued)
instrument, including estimates of timing, amount of expected future cash flows
and the credit standing of counterparties. Such estimates do not consider the
tax impact of the realization of unrealized gains or losses. In many cases, the
fair value estimates cannot be substantiated by comparison to independent
markets. In addition, the disclosed fair value may not be realized in the
immediate settlement of the financial instrument.
Fair values of public debt and equity securities have been determined by the
Company from public quotations, when available. Private placement securities and
other fixed maturities and equity securities are valued by discounting the
expected total cash flows. Market rates used are applicable to the yield, credit
quality and average maturity of each security.
Fair values of commercial mortgage loans are determined by discounting the
expected total cash flows using market rates that are applicable to the yield,
credit quality and maturity of each loan. Fair values of residential mortgage
loans are determined by a pricing and servicing model using market rates that
are applicable to the yield, rate structure, credit quality, size and maturity
of each loan.
The fair values for assets classified as policy loans, other investments
excluding equity investments in subsidiaries, cash and cash equivalents and
accrued investment income in the accompanying consolidated statements of
financial position approximate their carrying amounts.
Mortgage loan servicing rights represent the present value of estimated future
net revenues from contractually specified servicing fees. The fair value was
estimated with a valuation model using an internal prepayment model and
discounted at a spread to London Inter-Bank Offer Rates.
The fair values of the Company's reserves and liabilities for investment-type
insurance contracts (insurance, annuity and other policy contracts that do not
involve significant mortality or morbidity risk and that are only a portion of
the policyholder liabilities appearing in the consolidated statements of
financial position) are estimated using discounted cash flow analyses (based on
current interest rates being offered for similar contracts with maturities
consistent with those remaining for the investment-type contracts being valued).
The fair values for the Company's insurance contracts (insurance, annuity and
other policy contracts that do involve significant mortality or morbidity risk),
other than investment-type contracts, are not required to be disclosed. The
Company does consider, however, the various insurance and investment risks in
choosing investments for both insurance and investment-type contracts.
Fair values for debt issues are estimated using discounted cash flow analysis
based on the Company's incremental borrowing rate for similar borrowing
arrangements.
161
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
14. Fair Value of Financial Instruments (continued)
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2001 and 2000, are as follows (in millions):
2001 2000
----------------------- -----------------------
Carrying Carrying
amount Fair value amount Fair value
---------- ----------- ---------- -----------
Assets (liabilities)
Fixed maturities, available-for-
sale (see Note 3)............... $30,012.3 $30,012.3 $26,839.9 $26,839.9
Fixed maturities, trading (see
Note 3)......................... 17.8 17.8 - -
Equity securities, available-for-
sale (see Note 3)............... 833.6 833.6 742.9 742.9
Mortgage loans.................... 11,065.7 11,345.7 11,492.7 11,741.9
Policy loans...................... 831.9 831.9 803.6 803.6
Other investments................. 616.1 616.1 507.5 507.5
Cash and cash equivalents......... 623.8 623.8 926.6 926.6
Accrued investment income......... 594.3 594.3 530.8 530.8
Mortgage loan servicing rights.... 1,779.2 1,811.7 1,084.4 1,193.5
Investment-type insurance
contracts....................... (23,286.8) (23,642.4) (22,818.6) (22,688.9)
Short-term debt................... (511.6) (511.6) (459.5) (459.5)
Long-term debt.................... (1,378.4) (1,383.0) (1,336.5) (1,343.1)
15. Statutory Insurance Financial Information
Principal Life, the largest subsidiary (indirect) of Principal Financial Group,
Inc., prepares statutory financial statements in accordance with the accounting
practices prescribed or permitted by the Insurance Division of the Department of
Commerce of the State of Iowa (the "State of Iowa"). Currently "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. The impact of
any permitted accounting practices on statutory surplus is not material. The
accounting practices used to prepare statutory financial statements for
regulatory filings differ in certain instances from U.S. GAAP. Prescribed or
permitted statutory accounting practices are used by state insurance departments
to regulate Principal Life.
The NAIC revised the Accounting Practices and Procedures Manual in a process
referred to as Codification. The revised manual was effective January 1, 2001.
The State of Iowa adopted the provisions of the revised manual without
modification. The revised manual has changed, to some extent, prescribed
statutory accounting practices and has resulted in changes to the accounting
practices that Principal Life uses to prepare its statutory-basis financial
statements.
The net impact of these changes to Principal Life's statutory-basis capital and
surplus as of January 1, 2001, was not significant.
162
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
15. Statutory Insurance Financial Information (continued)
Statutory net income and statutory surplus of Principal Life are as follows (in
millions):
As of or for the year ended December 31,
2001 2000 1999
--------- --------- ---------
Statutory net income.... $ 415.0 $ 912.6 $ 713.7
Statutory surplus....... 3,483.8 3,356.4 3,151.9
Life and health insurance companies are subject to certain risk-based capital
("RBC") requirements as specified by the NAIC. Under those requirements, the
amount of capital and surplus maintained by a life and health insurance company
is to be determined based on the various risk factors related to it. At December
31, 2001, Principal Life meets the RBC requirements.
16. Segment Information
The Company provides financial products and services through the following
segments: U.S. Asset Management and Accumulation, International Asset Management
and Accumulation, Life and Health Insurance and Mortgage Banking. In addition,
there is a Corporate and Other segment. The segments are managed and reported
separately because they provide different products and services, have different
strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and
related financial products and services primarily to businesses, their employees
and other individuals and provides asset management services to the Company's
asset accumulation business, the life and health insurance operations and
third-party clients.
The International Asset Management and Accumulation segment provides asset
management products and services to retail clients in Australia and
institutional clients throughout the world and provides life insurance and
retirement and related financial products and services primarily to businesses,
their employees and other individuals principally in Australia, Chile, Brazil,
New Zealand, Mexico, India, Japan, Argentina and Hong Kong.
The Life and Health insurance segment provides individual life and disability
insurance to the owners and employees of businesses and other individuals in the
U.S. and provides group life and health insurance to businesses in the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers primarily in the U.S.
The Corporate and Other segment manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate and
Other segment primarily reflect financing activities for the Company, income on
capital not allocated to other segments, intersegment eliminations and
non-recurring or other income or expenses not allocated to the segments based on
review of the nature of such items.
The Corporate and Other segment includes an equity ownership interest in
Coventry Health Care, Inc. The ownership interest was initiated through a
transaction in 1998, described further in Note 2. The Corporate and Other
segment's equity in earnings of Coventry Health Care, Inc., which was included
in net investment income, was $19.8 million and $20.0 million for the years
ended December 31, 2001 and 2000, respectively.
The Company evaluates segment performance on segment operating earnings, which
excludes the effect of net realized capital gains and losses, as adjusted, and
non-recurring events and transactions. Net realized capital gains, as adjusted,
are net of tax, related changes in the amortization pattern of deferred policy
acquisition costs, recognition of front-end fee revenues for sales charges on
163
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
16. Segment Information (continued)
pension products and services, net realized capital gains credited to customers
and certain market value adjustments to fee revenues. Segment operating revenues
exclude net realized capital gains and their impact on recognition of front-end
fee revenues. Segment operating earnings is determined by adjusting U.S. GAAP
net income for net realized capital gains and losses, as adjusted, and
non-recurring items which management believes are not indicative of overall
operating trends. While these items may be significant components in
understanding and assessing the consolidated financial performance, management
believes the presentation of segment operating earnings enhances the
understanding of the Company's results of operations by highlighting earnings
attributable to the normal, recurring operations of the business. However,
segment operating earnings are not a substitute for net income determined in
accordance with U.S. GAAP.
In 2001, the Company excluded $31.1 million of non-recurring items, net of tax,
from net income for the presentation of operating earnings. The non-recurring
items included (1) the negative effects of (a) expenses related to the
demutualization; (b) a cumulative effect of change in accounting principle
related to the implementation of SFAS 133; and (c) an increase to a loss
contingency reserve for sales practices litigation; and (2) the positive effect
of investment income generated from the proceeds of the IPO.
In 2000, the Company excluded $101.0 million of non-recurring items, net of tax,
from net income for the presentation of operating earnings. The non-recurring
items included the negative effects of (a) a loss contingency reserve
established for sales practices litigation; and (b) expenses related to the
development of a plan of demutualization.
The accounting policies of the segments are similar to those as described in
Note 1, with the exception of capital allocation. The Company allocates capital
to its segments based upon an internal capital model that allows management to
more effectively manage the Company's capital.
164
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
16. Segment Information (continued)
The following table summarizes selected financial information by segment as of,
or for the year ended, December 31 and reconciles segment totals to those
reported in the consolidated financial statements (in millions):
International
Asset
U.S. Asset Management Life and
Management and and Health Mortgage Corporate and
Accumulation Accumulation Insurance Banking Other Consolidated
-------------- ------------- ---------- -------- ------------- ------------
2001
Revenues:
Operating revenues..... $ 3,800.0 $ 734.0 $ 3,946.4 $ 757.4 $ 100.8 $ 9,338.6
Net realized capital
losses............... (248.6) (60.0) (62.2) - (143.2) (514.0)
Plus recognition of
front-end fee
revenues............. 1.5 - - - - 1.5
Less capital gains
distributed as
market value
adjustment........... (14.9) - - - - (14.9)
Plus investment income
generated from IPO
proceeds............. - - - - 6.3 6.3
-------------- ------------- ---------- -------- ------------- ------------
Revenues................. $ 3,538.0 $ 674.0 $ 3,884.2 $ 757.4 $ (36.1) $ 8,817.5
============== ============= ========== ======== ============= ============
Net income:
Operating earnings
(loss)............... $ 353.8 $ (8.9) $ 201.2 $ 126.7 $ 38.1 $ 710.9
Net realized capital
losses, as adjusted.. (164.7) (29.2) (33.8) - (93.3) (321.0)
Non-recurring items.... (10.8) - 0.1 - (20.4) (31.1)
-------------- ------------- ---------- -------- ------------- ------------
Net income (loss)........ $ 178.3 $ (38.1) $ 167.5 $ 126.7 $ (75.6) $ 358.8
============== ============= ========== ======== ============= ============
Assets................... $68,543.8 $4,956.9 $10,776.2 $2,718.8 $1,354.8 $88,350.5
============== ============= ========== ======== ============= ============
Other segment data:
Revenues from external
customers............ $ 3,483.4 $ 672.8 $ 3,888.3 $ 757.4 $ 15.6 $ 8,817.5
Intersegment revenues.. 54.6 1.2 (4.1) - (51.7) -
Interest expense....... 3.3 0.6 0.8 - 71.5 76.2
Income tax expense
(benefit)............ (6.3) (37.8) 86.2 78.4 (41.5) 79.0
Amortization of
goodwill and other
intangibles.......... 3.4 47.3 4.1 0.8 (0.9) 54.7
165
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
16. Segment Information (continued)
International
Asset
U.S. Asset Management Life and
Management and and Health Mortgage Corporate and
Accumulation Accumulation Insurance Banking Other Consolidated
-------------- ------------- ---------- -------- ------------- ------------
2000
Revenues:
Operating revenues..... $ 3,533.9 $ 630.7 $ 4,122.6 $ 359.8 $ 97.1 $ 8,744.1
Net realized capital
gains (losses)....... (53.8) 2.8 70.8 - 120.1 139.9
Plus recognition of
front-end fee
revenues............. 0.9 - - - - 0.9
-------------- ------------- ---------- -------- ------------- ------------
Revenues................ $ 3,481.0 $ 633.5 $ 4,193.4 $ 359.8 $ 217.2 $ 8,884.9
============== ============= ========== ======== ============= ============
Net income:
Operating earnings
(loss)............... $ 356.6 $ (8.5) $ 162.3 $ 50.0 $ 67.7 $ 628.1
Net realized capital
gains (losses), as
adjusted............. (35.9) 1.4 47.3 - 80.3 93.1
Non-recurring items.... - - - - (101.0) (101.0)
-------------- ------------- ---------- -------- ------------- ------------
Net income (loss)....... $ 320.7 $ (7.1) $ 209.6 $ 50.0 $ 47.0 $ 620.2
============== ============= ========== ======== ============= ============
Assets.................. $65,795.9 $ 5,525.9 $10,569.0 $1,556.3 $ 957.8 $ 84,404.9
============== ============= ========== ======== ============= ============
Other segment data:
Revenues from external
customers............ $ 3,439.7 $ 632.4 $ 4,196.9 $ 359.8 $ 256.1 $ 8,884.9
Intersegment revenues.. 41.3 1.1 (3.5) - (38.9) -
Interest expense....... - - - - 78.4 78.4
Income tax expense..... 102.0 6.1 104.7 27.0 0.5 240.3
Amortization of
goodwill and other
intangibles.......... 1.0 47.9 7.7 0.8 (1.1) 56.3
166
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
16. Segment Information (continued)
International
Asset
U.S. Asset Management Life and
Management and and Health Mortgage Corporate and
Accumulation Accumulation Insurance Banking Other Consolidated
-------------- ------------- ---------- -------- ------------- ------------
1999
Revenues:
Operating revenues..... $ 3,472.6 $ 379.6 $ 3,985.5 $ 398.3 $ 61.9 $ 8,297.9
Net realized capital
gains (losses)....... (58.0) 8.7 16.0 - 437.8 404.5
Less recognition of
front-end fee
revenues............. (1.0) - - - - (1.0)
-------------- ------------- ---------- -------- ------------- ------------
Revenues.............. $ 3,413.6 $ 388.3 $ 4,001.5 $ 398.3 $ 499.7 $ 8,701.4
============== ============= ========== ======== ============= ============
Net income:
Operating earnings
(loss)............... $ 356.6 $ (38.4) $ 90.7 $ 56.8 $ 9.5 $ 475.2
Net realized capital
gains (losses), as
adjusted............. (35.4) 7.7 10.1 - 284.5 266.9
-------------- ------------- ---------- -------- ------------- ------------
Net income (loss)........ $ 321.2 $ (30.7) $ 100.8 $ 56.8 $ 294.0 $ 742.1
============== ============= ========== ======== ============= ============
Assets................... $65,096.4 $ 5,926.8 $10,070.8 $1,737.7 $1,121.5 $ 83,953.2
============== ============= ========== ======== ============= ============
Other segment data:
Revenues from external
customers............ $ 3,384.9 $ 388.3 $ 4,007.9 $ 398.3 $ 522.0 $ 8,701.4
Intersegment revenues.. 28.7 - (6.4) - (22.3) -
Interest expense....... - 0.7 - - 47.1 47.8
Income tax expense
(benefit)............ 126.4 (3.2) 18.1 30.7 151.5 323.5
Amortization of
goodwill and other
intangibles.......... 1.0 16.0 4.0 0.8 (1.6) 20.2
167
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
16. Segment Information (continued)
The Company operates in the U.S. and in selected markets internationally
(including Australia, Chile, Brazil, New Zealand, Mexico, India, Japan,
Argentina and Hong Kong). The following table summarizes selected financial
information by geographic location as of or for the year ended December 31 (in
millions):
Long-lived Net income
Revenues assets Assets (loss)
-------- ---------- --------- ----------
2001
U.S............... $8,143.5 $ 554.3 $83,393.6 $ 396.9
International..... 674.0 1,192.3 4,956.9 (38.1)
-------- ---------- --------- ----------
Total............. $8,817.5 $ 1,746.6 $88,350.5 $ 358.8
======== ========== ========= ==========
2000
U.S............... $8,251.4 $ 517.7 $78,879.0 $ 627.3
International..... 633.5 1,365.2 5,525.9 (7.1)
-------- ---------- --------- ----------
Total............. $8,884.9 $ 1,882.9 $84,404.9 $ 620.2
======== ========== ========= ==========
1999
U.S............... $8,313.1 $ 505.0 $78,026.4 $ 772.8
International..... 388.3 1,474.2 5,926.8 (30.7)
-------- ---------- --------- ----------
Total............. $8,701.4 $ 1,979.2 $83,953.2 $ 742.1
======== ========== ========= ==========
Long-lived assets include property and equipment and goodwill and other
intangibles.
The Company's operations are not materially dependent on one or a few customers,
brokers or agents, and revenues, assets and operating earnings are attributed to
geographic location based on the country of domicile the sales originate from.
17. Stock Compensation Plans
On May 21, 2001, the Company approved and adopted the Stock Incentive Plan,
Board of Directors' Stock Plan ("Directors' Stock Plan") and Employee Stock
Purchase Plan ("Stock Purchase Plan"). In addition, the Long Term Performance
Plan was amended to utilize stock as an option for payment. The Plan of
Conversion of Principal Mutual Holding Company for its demutualization restricts
the ability to use stock as a form of payment for awards under the Long Term
Performance Plan until at least six months following completion of the IPO.
Under the terms of the Stock Incentive Plan, grants may be non-qualified stock
options, incentive stock options qualifying under Section 422 of the Internal
Revenue Code, restricted stock, restricted stock units and stock appreciation
rights. On November 26, 2001, a one-time, grant of non-qualified stock options
was made under the Stock Incentive Plan to essentially all employees, including
career agents who are statutory employees.
The Stock Incentive Plan has options exercisable at November 26, 2004. Total
options granted under this plan amounted to 3.7 million options in 2001. Options
outstanding under the Stock Incentive Plan were granted at a price equal to the
market value of the Company's common stock on the date of grant, cliff-vest
after a three-year period for employees still employed or under contract and
expire ten years after the grant date.
The Directors' Stock Plan provides for the grant of nonqualified stock options,
restricted stock, or restricted stock units to the Company's non-employee
directors. The total number of shares to be issued under this plan may not
exceed 500,000 shares. Options granted under the Directors' Stock Plan have an
exercise price equal to the fair market value of the common stock on the date of
the grant and a term equal to the earlier of three years from the date the
participant ceases to provide service or the tenth anniversary of the date the
option was granted. Options vest quarterly over a one-year period unless
services to the Company cease, at which time, all vesting stops. There were no
options, shares of restricted stock, or restricted stock units granted under
this plan in 2001.
168
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
17. Stock Compensation Plans (continued)
The Company also maintains its Long Term Performance Plan, which provides the
opportunity for eligible executives to share in the success of Principal
Financial Group, Inc., if specified minimum corporate performance objectives are
achieved over a three-year period. In 2001, the Company recorded compensation
expense of $13.7 million related to the plan.
The maximum number of shares of common stock the Company may issue under the
Stock Incentive Plan, together with an excess plan (a non-qualified defined
contribution retirement plan), the Directors Stock Plan, the Long Term
Performance Plan and any new plan awarding our common stock, in the five years
following the completion of the initial public offering, is 6% of the number of
shares outstanding immediately following the completion of the IPO. As of
December 31, 2001, a total of 21,648,355 shares are available to be made
issuable by the Company for these plans.
Under the Company's Stock Purchase Plan, participating employees have the
opportunity to purchase shares of the Company's common stock on a quarterly
basis. The Stock Purchase Plan provides that eligible employees may contribute
10% of the employee's salary or a maximum of $10,000 to the plan during any
year. Employees may purchase shares of the Company's common stock at a price
equal to 85% of the share's fair market value as of the beginning or end of the
quarter, whichever is lower. During 2001, employees purchased 320,406 shares
under the Stock Purchase Plan at a price of 85% of the share's fair market value
of $22.33 per share.
The maximum number of shares of common stock that the Company may issue under
the Stock Purchase Plan is 2% of the number of shares outstanding immediately
following the completion of the IPO. As of December 31, 2001, a total of
7,216,118 shares are available to be made issuable by the Company for this plan.
Pursuant to SFAS No. 123, Accounting for Stock-Based Compensation, the Company
has elected to account for its stock option and stock purchase plans under the
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees and,
accordingly, employee options and stock purchases were excluded from
compensation expense. However, compensation expense has been recognized for
stock option awards issued to career agents using the fair value method as
prescribed in FASB Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation - An Interpretation of APB Opinion No. 25. Total
compensation expense recognized in income was $13,570 for the period ended
December 31, 2001.
169
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
17. Stock Compensation Plans (continued)
Had compensation expense for the Company's stock option awards and employees'
purchase rights been determined based upon fair values at the grant dates for
awards under the plans in accordance with SFAS No. 123, the Company's income and
earnings per share would have been reduced to the pro forma amounts indicated
below. For the purposes of pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period.
Pro forma for the Pro forma
period October 26, 2001 (unaudited) for
through the year ended
December 31, 2001 December 31, 2001(1)
----------------------- ------------------------
(in millions, except per share data)
Net income (loss):
As reported............... $(29.1) $358.8
Pro forma (unaudited)..... (30.3) 357.5
Earnings per share:
Basic:
As reported............. $(0.08) $ 0.99
Pro forma (unaudited)... (0.08) 0.99
Diluted:
As reported............. $(0.08) $ 0.99
Pro forma (unaudited)... (0.08) 0.99
- --------------------
(1) Calculation of weighted-average shares included in the December 31, 2001 pro
forma disclosures are described in Note 18.
The fair value per share of stock options granted during 2001 using the
Black-Scholes option valuation model was $6.07. The fair value of each option
was estimated on the date of grant using the Black-Scholes option pricing model
and the following assumptions:
Risk-free interest rate...................... 3.7%
Expected volatility of common stock.......... 37.5%
Dividend yield............................... 1.12%
Expected life of options..................... 3 years
The fair value of the employees' purchase rights, which represent a price equal
to 15% of the share's fair market value under the Stock Purchase Plan, was $1.6
million.
170
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
17. Stock Compensation Plans (continued)
The following is a summary of the status of all of the Company's stock option
plans as of December 31, 2001, and related changes during the year then ended:
Number Weighted-average
of shares exercise price
-------------- ----------------
(in thousands)
Options outstanding at January 1, 2001 - $ -
Granted.................................... 3,671,000 22.33
Exercised.................................. - -
Cancelled.................................. 32,800 22.33
--------------
Options outstanding at December 31, 2001..... 3,638,200 22.33
==============
Options exercisable at December 31, 2001..... 1,000 22.33
At December 31, 2001, the Company had 3.6 million stock options outstanding with
a weighted-average remaining contractual life of 9.9 years and a
weighted-average exercise price of $22.33.
18. Earnings Per Share
After the Company's IPO, SFAS No. 128, Earnings per Share, was adopted, which
requires disclosure of basic and diluted earnings per share.
For purposes of the Company's unaudited basic and diluted pro forma earnings per
share calculations for the period January 1, 2001 through October 25, 2001, the
weighted-average number of shares outstanding was assumed to be 360.8 million
shares. These shares represent 260.8 million shares issued to policyholders
entitled to receive compensation in the demutualization and 100.0 million shares
sold to investors in the IPO, prior to the underwriters' exercise of the
over-allotment option. The shares issued to the policyholders include 56.2
million shares issued as policy credits and held in one of the Company's
separate accounts.
171
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
18. Earnings Per Share (continued)
Reconciliations of weighted-average shares outstanding and net income (loss) for
basic and diluted net income per share for the year ended December 31, 2001, and
for the period October 26, 2001 through December 31, 2001, are presented below:
Pro forma (unaudited)
---------------------------
For the year ended For the period October 26, 2001
December 31, 2001 through December 31, 2001
--------------------------- ------------------------------
Weighted Weighted
average Per share average Per share
Income shares amount Loss shares amount
------ -------- --------- ------- -------- ---------
(in millions) (in millions)
Basic earnings per share:
Income (loss) before
cumulative effect
of accounting
change............... $369.5 362.4 $1.02 $(29.1) 369.5 $(0.08)
Dilutive effects:
Stock options (1).... - - - - - -
------ -------- --------- ------- -------- ---------
Diluted earnings per
share................ $369.5 362.4 $1.02 $(29.1) 369.5 $(0.08)
====== ======== ========= ======= ======== =========
- ---------------------
(1) The dilutive effect of the stock options did not meet specified reporting
thresholds.
The calculation of diluted earnings per share for the year ended December 31,
2001 and for the period October 26, 2001 through December 31, 2001, excludes the
incremental effect related to a treasury stock repurchase forward contract. This
contract's inception price is in excess of the average volume weighted average
price for purchases of the Company's stock during the period the contract has
been outstanding, resulting in an anti-dilutive effect.
19. Subsequent Event
On February 1, 2002, the Company sold its remaining stake of 15.1 million shares
in Coventry Health Care, Inc. common stock and a warrant, exercisable for
approximately 3.1 million shares of Coventry common stock. Total estimated
proceeds from the completion of this transaction are $325.2 million and the
Company will recognize an estimated net realized capital gain of $183.1 million
during the first quarter of 2002.
172
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
20. Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 2001
and 2000:
For the three months ended during 2001
March 31 June 30 September 30 December 31
--------- --------- ------------ -----------
(in millions, except per share data)
Premiums and other
considerations................. $1,064.2 $ 891.1 $1,255.0 $ 912.0
Net investment income............ 839.7 846.3 829.1 879.4
Net realized capital gains
(losses)....................... (80.9) (96.0) (80.8) (256.3)
Total revenue.................... 2,236.0 2,084.7 2,456.5 2,040.3
Benefits, claims, and settlement
expenses....................... 1,391.9 1,247.3 1,597.3 1,245.6
Income before taxes and
cumulative effect of
accounting change.............. 140.4 150.8 148.6 8.7
Cumulative effect of
accounting change.............. (10.7) - - -
Net income....................... 105.3 119.1 115.8 18.6
Income before cumulative effect
of accounting change per
common share (1):
Basic........................ N/A N/A N/A $ 0.05
Diluted...................... N/A N/A N/A 0.05
Net income per common share (1):
Basic........................ N/A N/A N/A 0.05
Diluted...................... N/A N/A N/A 0.05
Market price:
High........................... N/A N/A N/A 24.75
Low............................ N/A N/A N/A 20.40
Close.......................... N/A N/A N/A 24.00
- --------------------
(1) Fourth quarter 2001 earnings per share are on a pro forma basis as the
Company's IPO did not close until October 26, 2001. See Note 1. Actual
net income per common share for the period from October 26, 2001 through
December 31, 2001, was $(0.08) for basic and diluted computations.
173
Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
20. Quarterly Results of Operations (Unaudited) (continued)
For the three months ended during 2000
March 31 June 30 September 30 December 31
--------- --------- ------------ -----------
(in millions, except per share data)
Premiums and other
considerations................. $1,014.4 $ 978.3 $ 910.5 $ 1,093.2
Net investment income............ 789.5 768.6 777.9 836.3
Net realized capital gains
(losses)....................... 70.3 (38.8) 20.9 87.5
Total revenue.................... 2,270.6 2,094.9 2,123.8 2,395.6
Benefits, claims, and
settlement expenses............ 1,319.6 1,311.5 1,193.7 1,407.5
Income before taxes and
cumulative effect of
accounting change.............. 282.4 68.2 229.1 280.8
Cumulative effect of
accounting change.............. - - - -
Net income....................... 193.1 52.2 173.9 201.0
Income before cumulative effect
of accounting change per
common share:
Basic....................... N/A N/A N/A N/A
Diluted..................... N/A N/A N/A N/A
Net income per common share:
Basic.......................... N/A N/A N/A N/A
Diluted........................ N/A N/A N/A N/A
Market price:
High........................... N/A N/A N/A N/A
Low............................ N/A N/A N/A N/A
Close.......................... N/A N/A N/A N/A
174
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information called for by Item 10 pertaining to directors is set forth in
Principal Financial Group, Inc.'s proxy statement relating to the 2002 annual
shareholders meeting (the "Proxy Statement") which will be filed with the
Securities and Exchange Commission on or about April 15, 2002, under the
captions, "Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance." Such information is incorporated herein by reference. The
information called for by Item 10 pertaining to executive officers can be found
in Part I of this Form 10-K under the caption, "Executive Officers of the
Registrant."
Item 11. Executive Compensation
The information called for by Item 11 pertaining to executive compensation is
set forth in the Proxy Statement under the caption, "Executive Compensation,"
and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by Item 12 pertaining to security ownership of
certain beneficial owners and management is set forth in the Proxy Statement
under the caption, "Security Ownership of Certain Beneficial Owners and
Management," and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The information called for by Item 13 pertaining to certain relationships and
related transactions is set forth in the Proxy Statement and is incorporated
herein by reference.
175
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
a. Documents filed as part of this report.
1. Financial Statements (see Item 8. Financial Statements and
Supplementary Data)
Report of Independent Auditors
Audited Consolidated Financial Statements
Consolidated Statements of Financial Position
Consolidated Statements of Operations
Consolidated Statements of Stockholders` Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Report of Independent Auditors on Schedules
Schedule I - Summary of Investments - Other Than Investments in
Related Parties
Schedule II - Condensed Financial Information of Registrant
(Parent Only)
Schedule III - Supplementary Insurance Information
Schedule IV - Reinsurance
3. Exhibits
Exhibit
Number Description
2.1 Plan of Conversion**
2.2 Share Sale Deed, dated as of June 17, 1999, among BT Investments
(Australia) LLC, BT Foreign Investment Corporation, BT New
Zealand Limited, BT International (Delaware), Inc., BT Nominees
(H.K.) Limited, Deutsche Bank AG, Bankers Trust Corporation,
Principal Financial Group (Australia) Pty Limited and Principal
Financial Services, Inc.**
2.3 Deed to Amend the Share Sale Deed, dated as of August 31, 1999,
among BT Investments (Australia) LLC, BT Foreign Investment
Corporation, BT New Zealand Limited, BT International (Delaware),
Inc., BT Nominees (H.K.) Limited, Deutsche Bank AG, Bankers Trust
Corporation, Principal Financial Group (Australia) Pty Limited
and Principal Financial Services, Inc.**
2.4 Second Amendment to the Share Sale Deed, dated as of March 14,
2001, among BT Investments (Australia) LLC, BT Foreign Investment
Corporation, Deutsche New Zealand Limited (formerly called BT New
Zealand Limited), BT International (Delaware), Inc., DB Nominees
(H.K.) Limited (formerly called BT Nominees (H.K.) Limited),
Deutsche Bank AG, Bankers Trust Corporation, Principal Financial
Group (Australia) Pty Limited and Principal Financial Services,
Inc.**
3.1 Form of Amended and Restated Certificate of Incorporation of
Principal Financial Group, Inc.(included in Exhibit 2.1)**
3.2 Form of By-Laws of Principal Financial Group, Inc. (included in
Exhibit 2.1)**
4.1 Form of Certificate for the Common Stock of Principal Financial
Group, Inc., par value $0.01 per share**
4.2 Form of Stockholder Rights Agreement**
10.1 Principal Financial Group, Inc. Stock Incentive Plan**
10.2 Principal Financial Group Long-Term Performance Plan**
10.3 Principal Financial Group Incentive Pay Plan (PrinPay), amended
and restated effective January 1, 2002*
10.4 Principal Financial Group, Inc. Directors Stock Plan**
10.5 Principal Select Savings Excess Plan**
10.6 Supplemental Executive Retirement Plan for Employees**
10.7 Employment Agreement, dated as of May 19, 2000, among Principal
Mutual Holding Company, Principal Financial Group, Inc.,
Principal Financial Services, Inc., Principal Life Insurance
Company and J. Barry Griswell**
10.8 Change-of-Control Supplement and Amendment to Employment
Agreement, dated as of October 19, 2000, among Principal Mutual
Holding Company, Principal Financial Group, Inc., Principal
Financial Services, Inc., Principal Life Insurance Company
and J. Barry Griswell**
176
10.9 Form of Principal Mutual Holding Company and Principal Life
Insurance Company Change of Control Employment Agreement
(Tier One Executives) among Principal Mutual Holding Company,
Principal Financial Group, Inc., Principal Financial Services,
Inc., Principal Life Insurance Company and an Executive**
10.10 Fiscal Agency Agreement, dated as of August 25, 1999, among
Principal Financial Group (Australia) Holdings Pty Limited,
Principal Financial Services, Inc. and U.S. Bank Trust National
Association**
21 Principal Financial Group, Inc. Member Companies as of
December 31, 2001*
23 Consent of Ernst & Young LLP*
24 Power of Attorney*
* Filed herewith.
** Incorporated by reference to the exhibit with the same number filed with
Principal Financial Group, Inc.'s Registration Statement on Form S-1,
as amended (Commission File No. 333-62558).
b. Reports on Form 8-K
The Current Report on Form 8-K (Item 9), dated November 30, 2001, was
filed December 3, 2001.
c. See Item 14(a)3.
d. See Item 14(a)2.
177
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PRINCIPAL FINANCIAL GROUP, INC.
Dated: March 8, 2002 By /s/ Michael H. Gersie
----------------------------------
Michael H. Gersie
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
Dated: March 8, 2002
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- ------------------------------
J. Barry Griswell Charles S. Johnson
Chairman, President, Chief Director
Executive Officer and Director
By /s/ Michael H. Gersie By /s/ Michael H. Gersie*
------------------------------- ------------------------------
Michael H. Gersie William T. Kerr
Executive Vice President and Director
Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- -------------------------------
Betsy J. Bernard Victor H. Loewenstein
Director Director
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- ------------------------------
Jocelyn Carter-Miller Ronald D. Pearson
Director Director
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- ------------------------------
Gary E. Costley Federico F. Pena
Director Director
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- ------------------------------
David J. Drury Donald M. Stewart
Director Director
By /s/ Michael H. Gersie* By /s/ Michael H. Gersie*
------------------------------- ------------------------------
C. Daniel Gelatt, Jr. Elizabeth E. Tallett
Director Director
By /s/ Michael H. Gersie*
-------------------------------
Sandra L. Helton
Director
* Attorney-in-Fact and Agent
178
Report of Independent Auditors on Schedules
The Board of Directors and Stockholders
Principal Financial Group, Inc.
We have audited the consolidated financial statements of Principal Financial
Group, Inc. (the Company) as of December 31, 2001 and 2000, and for each of the
three years in the period ended December 31, 2001, and have issued our report
thereon dated February 1, 2002 (included elsewhere in this Form 10-K). Our
audits also included the financial statement schedules listed in the Index at
Item 14(a) of this Form 10-K. These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedules referred to above,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Des Moines, Iowa
February 1, 2002
179
Schedule I - Summary of Investments - Other Than Investments in Related Parties
As of December 31, 2001
Amount as shown
in the Statement
of Financial
Type of Investment Cost Value Position
- --------------------------------------------------------- ---------- ---------- ----------------
(in millions)
Fixed maturities, available-for-sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies............... $ 15.4 $ 15.4 $ 15.4
States, municipalities and political subdivisions..... 302.1 317.5 317.5
Foreign governments................................... 876.5 926.3 926.3
Public utilities...................................... 3,290.8 3,330.1 3,330.1
Convertibles and bonds with warrants attached......... 61.2 61.0 61.0
Redeemable preferred.................................. 373.9 374.5 374.5
All other corporate bonds............................. 18,354.1 18,868.9 18,868.9
Mortgage-backed and other asset-backed securities........ 5,891.3 6,118.6 6,118.6
---------- ---------- ----------------
Total fixed maturities, available-for-sale......... 29,165.3 30,012.3 30,012.3
Fixed maturities, trading................................ 17.0 17.8 17.8
Equity securities, available-for-sale
Common stocks:
Banks, trust and insurance companies.................. 37.0 29.0 29.0
Industrial, miscellaneous and all other............... 606.5 549.5 549.5
Non-redeemable preferred stock........................... 255.6 255.1 255.1
---------- ---------- ----------------
Total equity securities, available-for-sale........ 899.1 833.6 833.6
Mortgage loans........................................... 11,158.0 xxxx 11,065.7
Real estate, net:
Real estate acquired in satisfaction of debt(1)....... 49.8 xxxx 45.2
Other real estate(1).................................. 1,151.8 xxxx 1,136.6
Policy loans............................................. 831.9 xxxx 831.9
Other investments(2)..................................... 652.0 xxxx 829.8
---------- ----------------
Total investments.................................. $ 43,924.9 xxxx $ 44,772.9
========== ================
- --------------------
(1) The amounts shown in the Statement of Financial Position for real estate
differ from cost due to properties which were determined to be impaired.
The cost bases of these properties are reduced to fair value. Real estate
expected to be disposed is carried at the lower of cost or fair value, less
cost to sell, with valuation allowances established.
(2) The amount shown in the Statement of Financial Position for other
investments differs from cost due to accumulated earnings from minority
interests in unconsolidated entities and properties owned jointly with
venture partners and operated by the partners.
180
Schedule II - Condensed Financial Information of Registrant (Parent Only)
($ in millions, except per share data)
Statement of Financial Position
As of December 31, 2001
Assets:
Cash and cash equivalents................................ $ 37.1
Income taxes receivable.................................. 0.2
Investment in subsidiary................................. 6,783.2
---------
Total assets........................................... $ 6,820.5
=========
Liabilities and stockholders' equity:
Liabilities:
Amounts payable to subsidiary............................ $ 0.2
---------
Total liabilities...................................... 0.2
Stockholders' equity:
Common stock, par value $.01 per share - 2,500 million
shares authorized, 375.8 million shares issued,
360.1 million shares outstanding..................... 3.8
Additional paid-in capital............................... 7,072.5
Retained earnings deficit................................ (29.1)
Accumulated other comprehensive income................... 147.5
Treasury stock, at cost (15.7 million shares)............ (374.4)
---------
Total stockholders' equity............................... 6,820.3
---------
Total liabilities and stockholders' equity............. $ 6,820.5
=========
Statement of Operations
For the period October 26, 2001 through December 31, 2001
Revenues:
Net investment income..................... $ 0.7
-------
Total revenues.......................... 0.7
Expenses:
Other operating costs and expenses........ 0.3
-------
Total expenses.......................... 0.3
-------
Income before income taxes.................. 0.4
Income taxes................................ 0.2
-------
Net income after taxes...................... 0.2
Equity in the net loss of subsidiary........ (29.3)
-------
Net loss.................................... $(29.1)
=======
See accompanying notes.
181
Schedule II - Condensed Financial Information of Registrant (Parent Only)
(continued)
Statement of Cash Flows
For the period October 26, 2001 through December 31, 2001
(in millions)
Net loss............................................... $ (29.1)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Equity in the net loss of subsidiary.............. 29.3
Increase in amounts payable to subsidiary......... 0.2
Increase in income taxes.......................... (0.2)
-----------
Net cash provided by operating activities......... 0.2
Cash flows from investing activities:
Capital contributed to subsidiary.................... (1,689.7)
Dividends received from subsidiary................... 75.0
-----------
Net cash used in investing activities............. (1,614.7)
Cash flows from financing activities:
Issuance of common stock............................. 2,019.3
Acquisition of treasury stock........................ (367.7)
-----------
Net cash provided by financing activities............ 1,651.6
Net increase in cash and cash equivalents............ 37.1
Cash and cash equivalents at beginning of period..... -
-----------
Cash and cash equivalents at end of year............. $ 37.1
===========
See accompanying notes.
182
Schedule II - Condensed Financial Information of Registrant (Parent Only)
(continued)
Notes to Condensed Financial Statements
(1) Basis of Presentation
The accompanying condensed financial statements should be read in
conjunction with the consolidated financial statements and notes
thereto of Principal Financial Group, Inc.
In the parent company only financial statements, our investments in
subsidiaries are stated at cost plus equity in undistributed earnings
of subsidiaries.
The parent company only Statement of Operations and Statement of Cash
Flows reflect the results of operations from October 26, 2001, the date
of demutualization and initial public offering.
(2) Cash Dividends from Subsidiary
The parent company received cash dividends totaling $75.0 million in
2001 from its subsidiary.
183
Schedule III - Supplementary Insurance
Information As of December 31, 2001, 2000 and 1999
and for each of the years then ended
Deferred Future Contractholder
Policy Policy and Other
Acquisition Benefits Policyholder
Segment Costs and Claims Funds
----------- ----------- --------------
(in millions)
2001:
U.S. Asset Management and Accumulation.............. $ 411.6 $ 6,463.2 $ 23,421.7
International Asset Management and Accumulation..... 50.2 1,022.7 32.4
Life and Health Insurance........................... 910.7 6,544.4 1,880.2
Mortgage Banking.................................... - - -
Corporate and Other................................. - 4.3 (60.8)
----------- ----------- --------------
Total............................................. $ 1,372.5 $ 14,034.6 $ 25,273.5
=========== =========== ==============
2000:
U.S. Asset Management and Accumulation.............. $ 368.9 $ 6,065.5 $ 23,046.1
International Asset Management and Accumulation..... 37.8 971.8 52.5
Life and Health Insurance........................... 926.6 6,304.5 1,799.0
Mortgage Banking.................................... - - -
Corporate and Other................................. - 4.2 -
----------- ----------- --------------
Total............................................. $ 1,333.3 $ 13,346.0 $ 24,897.6
=========== =========== ==============
1999:
U.S. Asset Management and Accumulation.............. $ 426.2 $ 5,675.1 $ 23,515.7
International Asset Management and Accumulation..... 21.6 834.7 57.8
Life and Health Insurance........................... 983.1 6,097.1 1,623.2
Mortgage Banking.................................... - - -
Corporate and Other................................. - 5.3 -
----------- ----------- --------------
Total............................................. $ 1,430.9 $ 12,612.2 $ 25,196.7
=========== =========== ==============
184
Schedule III - Supplementary Insurance Information, (continued)
As of December 31, 2001, 2000 and 1999
and for each of the years then ended
Amortization
Benefits, of Deferred
Premiums and Net Claims and Policy Other
Other Investment Settlement Acquisition Operating
Segment Considerations Income (1) Expenses Costs Expenses(1)
- ------- -------------- ---------- ---------- ------------ -----------
(in millions)
2001:
U.S. Asset Management and Accumulation...... $ 766.3 $ 2,400.6 $ 2,583.1 $ 64.9 $ 700.5
International Asset Management
and Accumulation......................... 344.9 129.0 407.5 3.1 339.3
Life and Health Insurance................... 3,011.1 678.6 2,491.0 91.9 740.7
Mortgage Banking............................ - 31.1 - - 552.3
Corporate and Other......................... - 155.2 0.5 - 80.5
-------------- ---------- ---------- ------------ -----------
Total.................................... $ 4,122.3 $ 3,394.5 $ 5,482.1 $ 159.9 $ 2,413.3
============== ========== ========== ============ ===========
2000:
U.S. Asset Management and Accumulation...... $ 525.4 $ 2,303.9 $ 2,310.6 $ 123.7 $ 619.5
International Asset Management
and Accumulation......................... 220.5 105.0 262.2 2.0 370.3
Life and Health Insurance................... 3,250.5 642.1 2,659.4 113.0 798.6
Mortgage Banking............................ - (15.7) - - 282.7
Corporate and Other......................... - 137.0 0.1 - 169.6
-------------- ---------- ---------- ------------ -----------
Total.................................... $ 3,996.4 $ 3,172.3 $ 5,232.3 $ 238.7 $ 2,240.7
============== ========== ========== ============ ===========
1999:
U.S. Asset Management and Accumulation...... $ 566.7 $ 2,289.7 $ 2,335.3 $ 60.2 $ 561.5
International Asset Management
and Accumulation......................... 179.9 94.1 210.1 1.8 210.3
Life and Health Insurance................... 3,190.6 614.7 2,714.9 111.7 760.4
Mortgage Banking............................ - 3.3 - - 310.8
Corporate and Other......................... 0.4 70.2 0.6 0.1 53.5
-------------- ---------- ---------- ------------ -----------
Total.................................... $ 3,937.6 $ 3,072.0 $ 5,260.9 $ 173.8 $ 1,896.5
============== ========== ========== ============ ===========
(1) Allocations of net investment income and certain operating expenses are
based on a number of assumptions and estimates, and reported operating
results would change by segment if different methods were applied.
185
Schedule IV - Reinsurance
As of December 31, 2001, 2000 and 1999 and for each of the years then ended
Percentage
Ceded to Assumed of Amount
Gross Other from Other Net Assumed to
Amount Companies Companies Amount Net
----------- ---------- ---------- ----------- ----------
($ in millions)
2001:
Life insurance in force............ $ 160,920.4 $ 27,049.9 $ 1,439.0 $ 135,309.5 1.1%
=========== ========== ========== ===========
Premiums:
Life insurance................... $ 2,085.4 $ 52.4 $ 56.0 $ 2,089.0 2.7%
Accident and health insurance.... 2,244.5 211.2 - 2,033.3 -%
----------- ---------- ---------- -----------
Total.......................... $ 4,329.9 $ 263.6 $ 56.0 $ 4,122.3 1.4%
=========== ========== ========== ===========
2000:
Life insurance in force............ $ 165,912.8 $ 23,094.5 $ 1,173.9 $ 143,992.2 0.8%
=========== ========== ========== ===========
Premiums:
Life insurance................... $ 1,815.7 $ 48.7 $ 24.6 $ 1,791.6 1.4%
Accident and health insurance.... 2,326.4 121.6 - 2,204.8 -%
----------- ---------- ---------- -----------
Total.......................... $ 4,142.1 $ 170.3 $ 24.6 $ 3,996.4 0.6%
=========== ========== ========== ===========
1999:
Life insurance in force............ $ 167,173.0 $ 17,529.2 $ 243.8 $ 149,887.6 0.2%
=========== ========== ========== ===========
Premiums:
Life insurance................... $ 1,829.9 $ 38.5 $ 3.8 $ 1,795.2 0.2%
Accident and health insurance.... 2,160.1 18.0 0.3 2,142.4 -%
----------- ---------- ---------- -----------
Total.......................... $ 3,990.0 $ 56.5 $ 4.1 $ 3,937.6 0.1%
=========== ========== ========== ===========
186
Exhibit Index
Exhibit
Number Description
2.1 Plan of Conversion**
2.2 Share Sale Deed, dated as of June 17, 1999, among BT Investments
(Australia) LLC, BT Foreign Investment Corporation, BT New
Zealand Limited, BT International (Delaware), Inc., BT Nominees
(H.K.) Limited, Deutsche Bank AG, Bankers Trust Corporation,
Principal Financial Group (Australia) Pty Limited and Principal
Financial Services, Inc.**
2.3 Deed to Amend the Share Sale Deed, dated as of August 31, 1999,
among BT Investments (Australia) LLC, BT Foreign Investment
Corporation, BT New Zealand Limited, BT International (Delaware),
Inc., BT Nominees (H.K.) Limited, Deutsche Bank AG, Bankers Trust
Corporation, Principal Financial Group (Australia) Pty Limited
and Principal Financial Services, Inc.**
2.4 Second Amendment to the Share Sale Deed, dated as of March 14,
2001, among BT Investments (Australia) LLC, BT Foreign Investment
Corporation, Deutsche New Zealand Limited (formerly called BT New
Zealand Limited), BT International (Delaware), Inc., DB Nominees
(H.K.) Limited (formerly called BT Nominees (H.K.) Limited),
Deutsche Bank AG, Bankers Trust Corporation, Principal Financial
Group (Australia) Pty Limited and Principal Financial Services,
Inc.**
3.1 Form of Amended and Restated Certificate of Incorporation of
Principal Financial Group, Inc.(included in Exhibit 2.1)**
3.2 Form of By-Laws of Principal Financial Group, Inc.(included in
Exhibit 2.1)**
4.1 Form of Certificate for the Common Stock of Principal Financial
Group, Inc., par value $0.01 per share**
4.2 Form of Stockholder Rights Agreement**
10.1 Principal Financial Group, Inc. Stock Incentive Plan**
10.2 Principal Financial Group Long-Term Performance Plan**
10.3 Principal Financial Group Incentive Pay Plan (PrinPay), amended and
restated effective January 1, 2002*
10.4 Principal Financial Group, Inc. Directors Stock Plan**
10.5 Principal Select Savings Excess Plan**
10.6 Supplemental Executive Retirement Plan for Employees**
10.7 Employment Agreement, dated as of May 19, 2000, among Principal
Mutual Holding Company, Principal Financial Group, Inc., Principal
Financial Services, Inc., Principal Life Insurance Company and
J. Barry Griswell**
10.8 Change-of-Control Supplement and Amendment to Employment Agreement,
dated as of October 19, 2000, among Principal Mutual Holding Company,
Principal Financial Group, Inc., Principal Financial Services, Inc.,
Principal Life Insurance Company and J. Barry Griswell**
10.9 Form of Principal Mutual Holding Company and Principal Life Insurance
Company Change of Control Employment Agreement (Tier One Executives)
among Principal Mutual Holding Company, Principal Financial Group,
Inc., Principal Financial Services, Inc., Principal Life Insurance
Company and an Executive**
10.10 Fiscal Agency Agreement, dated as of August 25, 1999, among Principal
Financial Group (Australia) Holdings Pty Limited, Principal
Financial Services, Inc. and U.S. Bank Trust National Association**
21 Principal Financial Group, Inc. Member Companies as of
December 31, 2001*
23 Consent of Ernst & Young LLP*
24 Power of Attorney*
* Filed herewith.
** Incorporated by reference to the exhibit with the same number filed with
Principal Financial Group, Inc.'s Registration Statement on Form S-1,
as amended (Commission File No. 333-62558).
187
Exhibit 10.3
Principal Financial Group Incentive Pay Plan (PrinPay)
Amended and Restated Effective January 1, 2002
Section 1. Introduction and Purpose
The Principal Financial Group Incentive Pay Plan (the "Plan") is designed to
motivate employees who work for the Principal Financial Group(R) to perform at
levels which will ensure the success of the Company. The Plan is intended to pay
financial rewards based on performance. The Plan was originally adopted by
Principal Life Insurance Company of Des Moines, Iowa on January 1, 1995 and has
since been amended from time to time. Prior to the date of this restatement, the
Plan was amended and restated on January 1, 2001. This amended and restated
version of the Plan has been adopted and assumed by the Company as of January 1,
2002. The Plan remains in effect until amended, suspended or terminated.
Section 2. Plan Year
The Plan Year is the calendar year beginning on January 1 and ending on December
31.
Section 3. Definitions
For the purposes of this Plan, the following terms shall have the meanings
indicated, unless the context clearly indicates otherwise:
"Adjusted Consolidated GAAP Equity" for any period means the ending equity of
the Company and its consolidated subsidiaries, taken as a whole, as determined
in accordance with GAAP, adjusted for accumulated other comprehensive income or
loss, as defined by GAAP, unless otherwise determined by the Committee.
"Award" means the incentive earned in a Plan Year.
"Award Component" means one of the following: corporate, business unit or
individual performance for a Participant.
"Award Opportunity" means the percentage of a Participant's Fixed Salary
earnable under the Plan if target performance for the Plan Year is met.
"Award Opportunity Scale" means the percentage of the Award Opportunity earnable
under the Plan if minimum, maximum or any other scale factors that have been
identified are met. The Award Opportunity Scale is a percentage of the Award
Opportunity. The Award Opportunity Scale for each Plan Year shall be as
determined by the Committee.
"Beneficiary" or "Beneficiaries" means the person, persons or entity entitled
under Section 7 to receive any Plan benefits payable after a Participant's
death. If a Participant dies before receiving an Award to which he or she is
entitled, the Award will be paid to the person(s) or entity designated as the
beneficiary for the Participant's life insurance benefit through The Principal
Trust for Life Insurance Benefits for Employees.
"Board" means the Board of Directors of the Company, or the successor thereto.
"Cause" shall mean any one or more of the following:
(i) a Participant's commission of a felony or other crime involving fraud,
dishonesty or moral turpitude;
(ii) a Participant's willful or reckless material misconduct in the performance
of the Participant's duties;
(iii) a Participant's habitual neglect of duties; or
188
(iv) a Participant's willful or intentional breach of obligations to an
Employer, provided that, if such breach involved an act, or failure to act,
which was done, or omitted to be done, by a Participant in good faith and
with a reasonable belief that a Participant's act, or failure to act, was
in the best interest of the Company or was required by applicable law or
administrative regulation, such breach shall not constitute Cause, if,
within 30 days after a Participant is given written notice of such breach
that specifically refers to this definition, a Participant cures such
breach to the fullest extent that it is curable;
provided, however, that Cause shall not include any one or more of the
following:
(i) a Participant's negligence, other than a Participant's habitual neglect of
duties or gross negligence; or
(ii) any act or omission believed by a Participant in good faith to have been
in or not opposed to the interest of the Company (without intent of the
Participant to gain, directly or indirectly, a profit to which the
Participant was not legally entitled).
"Committee" means the Human Resources Committee of the Board or such other
committee of the Board as the Board shall designate from time to time, which
committee shall be composed of two or more outside directors.
"Company" means Principal Financial Group, Inc. and its successors and assigns
and any company which shall acquire substantially all of its assets.
"Disability" means, with respect to any Participant, long-term disability as
defined under any long-term disability plan maintained by the Company or a
Subsidiary in which the Participant participates. In the event of any question
as to whether a Participant has a Disability, the plan administrator of the
relevant long-term disability plan shall determine whether a disability exists,
in accordance with such plan.
"Employer" means the Company and any Subsidiary whose employees are designated
as Participants under the Plan.
"Exempt" means an employee who is not subject to the minimum wage and overtime
pay provisions of the Fair Labor Standards Act. These employees include
executives, administrative employees, professional employees and those engaged
in outside sales.
"Fair Labor Standards Act" means 29 U. S. C.ss.201 et seq.
"Final Warning" means a disciplinary action designated to be a final warning.
"Fixed Salary" means the gross amount of earnings received for base salary, lump
sum merit, Personal Time Off, shift differential, on-call pay, holiday pay,
overtime and short-term disability coverage during the Plan Year. Fixed Salary
does not include the Award earned under this Plan or any other bonus, incentive
or commission paid in the current Plan Year.
"GAAP" means generally accepted accounting principles, consistently applied.
"Individual Goals" means one or more financial or non-financial measure
established for the Plan Year between the Participant and the Participant's
leader, at 100% performance, which may also have written Award Opportunity
Scales.
"Job Level" means an Employer's internal hierarchical level of a job that is
used to determine eligibility and participation in corporate programs and
amenities.
"Non-exempt" means an employee who is subject to the minimum wage and overtime
pay provisions of the Fair Labor Standards Act.
"Operating Earnings" means operating earnings of the Company and its
consolidated subsidiaries, consistent with GAAP principles, unless otherwise
determined by the Committee.
189
"Participant" means an employee who has met the eligibility requirements for the
Plan Year. For the purposes of Section 8, "Participant" shall include only an
employee who was employed by an Employer before the date of the applicable
Change of Control.
For purposes of Section 8 "Executive Participant" means an employee at the level
of vice president or equivalent and above who has met the eligibility
requirements for the Plan Year. For the purposes of Section 8, "Executive
Participant" shall include only an employee who was employed by an Employer
before the date of the applicable Change of Control.
"Performance Measures" means one or more financial or non-financial measures
established for the Plan Year. The Committee shall establish performance levels
of achievement for the Award Opportunity Scale, in order to reflect the level of
recognition to be afforded to partial achievement of, or to surpass, the level
of achievement targeted for such objectives for such Plan Year. The corporate
and business unit Performance Measures shall be selected from such measures as
the Committee or Plan Administrator shall deem appropriate, including, without
limitation, ROE, Operating Earnings, earnings before interest, taxes,
depreciation and amortization ("EBITDA"), budget, customer satisfaction and
total shareholder return.
"Plan" means the Principal Financial Group Incentive Pay Plan, as currently in
effect and as the same may be amended from time to time.
"Plan Administrator" means the committee, committees or persons in Section 9,
that have been designated by the Chief Executive Officer and approved by the
Committee.
"Retirement" means a termination of a Participant's employment for any reason
other than death, Disability or Cause and qualifying to retire under the terms
of any pension plan maintained by the Company or a Subsidiary.
"ROE" means, with respect to any calendar year, Operating Earnings divided by
the average Adjusted Consolidated GAAP Equity for the year (prior 12-month
period ending Adjusted Consolidated GAAP Equity plus end of 12-month period
Adjusted Consolidated GAAP Equity, divided by two) unless otherwise determined
by the Committee.
"Pro-Ration Factor" means the number of days as a Participant under the Plan
divided by 365 days.
"Subsidiary" means (1) any corporation in which the Company owns, directly or
indirectly, at least 50% of the outstanding equity interests and over which the
Company has effective control, or (2) any other entity or joint venture,
domestic or non-domestic, in which the Company, directly or indirectly, owns an
interest and that is designated in writing as a "Subsidiary" by the Plan
Administrator for purposes of this Plan.
"Threshold Objectives" means one or more minimal performance objectives
established hereunder that must be achieved in order for any payment to be made
for the Plan Year. Such Threshold Objectives may be any measure of performance
that the Committee shall deem appropriate, provided that, for the Plan Year
commencing in 2001 and, unless otherwise specified by the Committee by March 15
of the relevant Plan Year, the Threshold Objectives shall be:
(1) The Principal must maintain the minimum claims paying/financial strength
rating from 2 of the 3 rating agencies: e.g. Fitch AA-, Moody's Aa3 and
Standard & Poors AA-; and
(2) Adjusted Consolidated GAAP Equity for the end of the Plan Year, stated as
a percentage of the general account assets of Principal Life Insurance
Company, must be at least 6%; and
(3) Principal Life Insurance Company must have a Risk Based Capital Ratio
(as defined by the National Association of Insurance Commissioners) of at
least 150%.
Section 4. Eligibility
Exempt employees of an Employer are Participants in the Plan on their date of
hire if they are scheduled to work at least 20 hours per week on a regularly
scheduled basis. Non-exempt employees of an Employer are eligible to participate
in the Plan if they work at least 20 hours per week on a regularly scheduled
basis and become a Participant after completing six months of employment.
190
Unless pre-approved by the Plan Administrator in writing, an employee who is a
Participant in the Plan is not eligible to participate in any other Company or
Subsidiary annual incentive, bonus or commission plan. Unless pre-approved by
the Plan Administrator in writing, employees who are participants in other
annual incentives, bonus or commission plans are not eligible to be Participants
in the Plan.
Section 5. Target Award Opportunity, Performance Measures and Scales
Participants will be assigned an Award Opportunity based on their job or Job
Level with an Employer. The Award Opportunity will be paid if stated target
Performance Measures are achieved. The Plan Administrator will approve the Award
Opportunity and Award Opportunity Scale for Participants at and below the Vice
President level. The Committee will approve the Award Opportunity and Award
Opportunity Scale for Participants at the Senior Vice President level or above.
Each Participant's Award Opportunity and Award Opportunity Scale will be
segmented into one or more of the following Award Components: corporate,
business unit and/or individual, as determined by the Plan Administrator for
Participants at and below the Vice President Level, and by the Committee for
Participants at the Senior Vice President level or above. The weighting of these
components will be determined by the Plan Administrator or the Committee as the
case may be. The corporate and business unit component's performance will be
used to fund the Awards. The individual component will directly affect the
portion of the Award Opportunity earnable.
At the start of each Plan Year, Performance Measures that correspond to the
Award Opportunity Scale will be determined. Corporate Performance Measures will
be approved by the Committee. Business Unit Performance Measures will be
approved by the Plan Administrator. Individual Goals will be set jointly between
the Participant and the Participant's leader. The Individual Goals for the Chief
Executive Officer of the Principal shall be established by the Committee. The
Individual Goals can vary from year to year, from one position to another, and
from one incumbent to another. Where the development of appropriate Individual
Goals for a partial year would be impractical, eligibility for the individual
component may be delayed until the following Plan Year and payment may be based
on corporate and business unit performance level with approval by the leader.
Section 6. Award Determination
Unless otherwise determined by the Plan Administrator in writing, the
Participant's Award Opportunity for calculation of the annual Award is
determined by the Participant's job or Job Level and business unit with an
Employer held on the last day of the Plan Year and will be applied for the
entire Plan Year.
Unless otherwise determined by the Plan Administrator, Pro-Ration Factor will be
applied to a Participant's Award if the Participant transfers to or from an
ineligible position within the Plan Year.
When needed, interpolated performance levels for Corporate Performance Measures,
Business Unit Performance Measures, and where appropriate, Individual Goals will
be established on a straight-line basis in the Award Opportunity Scale. If
actual performance falls below the minimum Performance Measure set forth for the
corporate and business unit Award Component, that Award Component will be zero.
If actual performance falls below minimum performance measures set forth for the
individual Award Component the Award will be zero. If actual performance is
above the maximum Performance Measure for a particular Award Component, that
Award Component will be the maximum determined by the Committee.
Notwithstanding anything else contained in this Plan to the contrary, all
Threshold Objectives with respect to such Plan Year must be met in order for any
Award to be made under this Plan. The Committee approves corporate and business
unit Performance Measure results. Leaders approve Individual Goal results.
At the end of the Plan Year the value of the actual Awards is calculated by
completing the following steps. Step 1: Determination of the Component Score.
The Component Score is the weighted sum of the scores of the Performance
Measures for the corporate and business unit Performance Measures Step 2:
Determination of Award Score. The Award Score is the Component Score, multiplied
by the individual component score Step 3: Determination of Participant Award.
The Award paid to each Participant will be calculated by multiplying, 1) the
Participant's Fixed Salary earnings received during the Plan Year; by 2) the
Award Opportunity, by (3) Award Score, and by (4) the Pro-Ration Factor.
191
In comparing actual performance against the Performance Measures, the Committee,
by recommendation of the Chief Executive Officer may exclude from such
comparison any extraordinary gains, losses, charges, or credits which appear on
the Company's books and records as it deems appropriate. An extraordinary item
may include, without limiting the generality of the foregoing, an item in the
Company's financial statements reflecting an accounting rule, tax law, or major
legislative change not taken into consideration in the establishment of the
Performance Measures. In addition, the impact of a material disruption in the
U.S. economy or a substantive change in the Company's business plans also may be
deemed to be such an extraordinary item.
In no event will the sum of all annual Awards paid to Participants under the
Plan exceed 6% of pre-tax GAAP operating earnings of the Company for the Plan
Year. If the Awards calculated for the year would so exceed 6% of operating
earnings, all calculated Awards under the plan shall be proportionately reduced
so the Awards aggregate to no more than 6% of operating earnings.
Section 7. Distributions
No payment shall be made to any Participant who is on Final Warning any time
during the Plan Year.
Award payments shall be made following the release of audited results after the
end of the Plan Year in which they are earned, but no later than March 15.
Upon a Participant's death prior to the end of the Plan Year, the Participant's
Beneficiary (or, if none is named, the Participant's estate) shall receive an
early distribution based on the Fixed Salary received during the Plan Year,
multiplied by the Award Opportunity. Upon a Participant's death following the
close of the Plan Year, but prior to an Award payment, the Participant's
Beneficiary (or, if none is named, the Participant's estate) shall receive a
distribution at the same times as other Participants and the amount payable
shall be calculated according to Section 6.
Unless otherwise determined by the Plan Administrator in writing, upon a
Participant's Disability, Retirement, or involuntary termination due to office
closing, downsizing, outsourcing or divestiture of a business or subsidiary, the
Participant shall receive a distribution at the same time as other Participants
and the amount payable shall be calculated according to Section 6.
If a Participant terminates and is rehired during a Plan Year, the Participant's
eligibility will be restored as if they had not terminated and there will be no
Pro-Ration Factor of the Award payable to the Participant. Non-exempt employees
who have not completed the 6-month employment period to be a Participant in the
Plan will use the adjusted service date to determine when they are eligible to
be a Participant in the Plan.
If a Participant is separated from employment for Cause, as determined by the
Company, the Participant shall not be entitled to receive any further payment
under the Plan with respect to any Plan Year.
Except as provided in Section 8, if a Participant's employment is terminated for
any other reason other than those otherwise outlined above prior to any payment
in respect to any Plan Year the Participant shall forfeit their Award.
Section 8. Change of Control
Capitalized words used in this Section 8 have the meaning ascribed to them under
the Principal Severance Pay Plan for Senior Executives as amended from time to
time, unless the context clearly indicates otherwise. Notwithstanding the
foregoing, the following terms shall have the meanings ascribed to them in
Section 3 hereof: Board, Company, Disability, Employer, Executive Participant,
Participant, Plan.
Within ten (10) days following the later of a Change Date or Merger of Equals
Cessation Date ("Trigger Date"), the Company shall pay each Executive
Participant an amount equal to the Executive Participant's Target Annual Bonus
for the year in which the Trigger Date occurs multiplied by fraction, the
numerator of which is the number of days elapsed in the year up to and including
the Trigger Date, and the denominator of which is 365, in satisfaction of the
Company's obligations under the Plan for the period prior to the Trigger Date.
If, during the Post-Change Period (other than during a Post-Merger of Equals
Period) an Executive Participant's employment is terminated other than for
Cause or Disability, or an Executive Participant terminates employment for
192
Good Reason, the Company shall pay the Executive Participant the Executive
Participant's Target Annual Bonus for the year in which such termination occurs
multiplied by a fraction, the numerator of which is the number of days elapsed
in the year up to and including the Termination Date, and the denominator of
which is 365, in satisfaction of the Company's obligations under the Plan for
the period prior to the Termination Date. Any amounts payable under this
paragraph shall be reduced (but not below zero) by the amount of any annual
bonus paid to the Executive Participant with respect to the Employer's fiscal
year in which the Termination Date occurs. If an Executive Participant receives
a payment pursuant to this third paragraph of this Section 8, the Executive
Participant may not also receive payment pursuant to the fourth paragraph of
this Section 8.
If the Plan is terminated on or after the Trigger Date, within the same Plan
year as the Trigger Date, or any amendment to the Plan is adopted that adversely
affects the rights of any Participant or Beneficiary, the Company shall pay the
Participant the Participant's Target Annual Bonus for the year in which such
amendment or Plan termination occurs multiplied by a fraction, the numerator of
which is the number of days elapsed in the year up to and including the
amendment or Plan termination, and the denominator of which is 365, in
satisfaction of the Company's obligations under the Plan for the period prior to
the amendment or Plan termination. Any amounts payable under this paragraph
shall be reduced (but not below zero) by the amount of any annual bonus paid to
an Executive Participant with respect to the Employer's fiscal year in which the
Trigger Date occurs. If an Executive Participant receives a payment pursuant to
this fourth paragraph of this Section 8, the Executive Participant may not also
receive payment pursuant to the third paragraph of this Section 8.
Any amounts payable under this Section 8 shall be reduced (but not below zero)
by the amount of any annual bonus paid to an Executive Participant with respect
to the Employer's fiscal year in which the Trigger Date occurs.
Section 9. Administration
The Plan Administrator shall maintain such procedures and records as will enable
the Plan Administrator to determine the Participants and their Beneficiaries who
are entitled to receive benefits under the Plan and the amounts thereof.
The Plan Administrator shall have the exclusive right, power, and authority, in
its sole, full and absolute discretion, to interpret any and all of the
provisions of the Plan, to supervise the administration and operation of the
Plan, and to consider and decide conclusively any questions (whether fact or
otherwise) arising in connection with the administration of the Plan or any
claim for benefits arising under the Plan. Any decision or action of the Plan
Administrator shall be conclusive and binding on all parties, including the
Participants. The Plan Administrator shall also have the discretion and
authority to adopt and revise rules and procedures relating to the Plan, to
correct any defect or omission or reconcile any inconsistency in this Plan or
any payment hereunder, and to make any other determinations that it believes
necessary or advisable in the administration of the Plan.
Section 10. Amendment and Termination of Plan
The Committee shall have the authority to amend the Plan at any time and from
time to time. Any such amendments must be made by written instrument, and notice
of such amendment shall be provided to Participants as soon as practical after
adoption.
The Company reserves the right to terminate the Plan in any respect and at any
time and may do so at any time pursuant to a written resolution of the
Committee.
Notwithstanding anything else to the contrary set forth in the Plan, no
amendment or termination of the Plan may adversely affect the rights of any
Participant or Beneficiary in respect to an Award determined or earned with
respect to a Plan Year.
Section 11. Miscellaneous
No Participant or other employee shall at any time have a right to be selected
for participation in the Plan, despite having previously participated in the
Plan or any other incentive or bonus plan of the Company or any of it
affiliates.
193
The existence of this Plan, as in effect at any time or from time to time, or
participation under the Plan, shall not be deemed to constitute a contract of
employment between the Company or any Subsidiary and any employee or
Participant, nor shall it constitute a right to remain in the employ of the
Company or it's Subsidiary.
Any notice required or permitted under the Plan shall be sufficient if in
writing and hand delivered, sent by first class, registered or certified mail,
or by such other means as the Committee, in its sole discretion, may deem
appropriate. Such notice shall be deemed as given as of the date of delivery or,
if delivery is made by mail, as of the date shown on the postmark or on the
receipt for registration or certification. Mailed notice to the Committee shall
be directed to the Company's address, c/o the Plan Administrator. Mailed notice
to a Participant or Beneficiary shall be directed to the individual's last known
home address in the Participant's Employer's records.
Nothing contained in the Plan shall constitute a guaranty by any Employer or any
other person or entity that the assets of such entity will be sufficient to pay
any benefit hereunder.
Subject to the provisions of applicable law, no interest of any person or entity
in any Award, or any right to receive any distribution or other benefit under
the Plan, shall be subject in any manner to sale, transfer, assignment, pledge,
attachment, or other alienation or encumbrance of any kind; nor may such
interest in any Award, or right to receive any distribution or any benefit under
the Plan, be taken, either voluntarily or involuntarily, for the satisfaction of
the debts of, or other obligations or claims against, such person or entity,
including (but not limited to) claims for separate maintenance and claims in
bankruptcy proceedings.
The Plan shall be construed and administered under the laws of the State of
Iowa.
The Employer shall have the right to deduct, from amounts payable pursuant to
the Plan or from amounts otherwise payable to the Participant (or payable to the
beneficiary of the Participant, if the Participant is deceased), any taxes
required by law to be withheld from such Awards.
Nothing contained in this Plan shall be construed to prevent the Company, or any
Subsidiary, from taking any corporate action which is deemed by it to be
appropriate, or in its best interest, whether or not such action would have an
adverse effect on this Plan, or any Awards made under this Plan. No employee,
beneficiary, or other person shall have any claim against the Company, or a
Subsidiary, as a result of any such action.
Nothing express or implied in this Plan is intended or may be construed to give
any person other than Participants and Beneficiaries any rights or remedies
under this Plan.
A recipient of any payment under this Plan who is not a current employee of an
Employer, shall have the obligation to inform the Company of his or her current
address, or other location to which payments are to be sent. Neither the Company
nor any Subsidiary shall have any liability to such recipient, or any other
person, for any failure of such recipient, or person, to receive any payment if
it sends such payment to the address provided by such recipient by first class
mail, postage paid, or other comparable delivery method. Notwithstanding
anything else in this Plan to the contrary, if a recipient of any payment cannot
be located within 120 days following the date on which such payment is due after
reasonable efforts by the Company or a Subsidiary, such payments and all future
payments owing to such recipient shall be forfeited without notice to such
recipient. If, within two years (or such longer period as management, in its
sole discretion, may determine), after the date as of which payment was
forfeited (or, if later, is first due), the recipient, by written notice to the
Company, requests that such payment and all future payments owing to such
recipient be reinstated and provides satisfactory proof of their identity, such
payments shall be promptly reinstated. To the extent the due date of any
reinstated payment occurred prior to such reinstatement, such payment shall be
made to the recipient (without any interest from its original due date) within
90 days after such reinstatement.
On behalf of the Human Resources Committee of the Board of Directors of the
Company, this Amended and Restated Incentive Pay Plan has been executed this
5th day of February, 2002.
By:/s/ William T. Kerr
--------------------
William T. Kerr, Chair
194
Exhibit 21
===============================================================================
PROPRIETARY INFORMATION
===============================================================================
PRINCIPAL FINANCIAL GROUP, INC. - Member Companies
12/31/2001
===============================================================================
Jurisdiction of
Entity Name Incorporation
===============================================================================
ADMAR CORPORATION............................................ California
ANDUEZA & PRINCIPAL CREDITOS HIPOTECARIOS S.A............... Chile
BENEFIT FIDUCIARY CORPORATION................................ Rhode Island
BOSTON INSURANCE TRUST, INC.................................. Massachusetts
BRASILPREV PREVIDENCIA PRIVADA S.A........................... Brazil
BT (QUEENSLAND) PTY LTD...................................... Australia
BT AUSTRALIA (HOLDINGS) PTY LTD.............................. Australia
BT AUSTRALIA CORPORATE SERVICES PTY LTD...................... Australia
BT AUSTRALIA PTY LTD......................................... Australia
BT FINANCE & INVESTMENTS PTY LTD............................. Australia
BT FINANCE PTY LTD........................................... Australia
BT FINANCIAL GROUP (NZ) LTD.................................. New Zealand
BT FINANCIAL GROUP PTY LTD................................... Australia
BT FUNDS MANAGEMENT (NZ) LTD................................. New Zealand
BT FUNDS MANAGEMENT LTD...................................... Australia
BT HOTEL LTD................................................. Australia
BT INVESTMENTS (AUSTRALIA) LTD............................... Delaware
BT LIFE LTD.................................................. Australia
BT NOMINEES PTY LTD.......................................... Australia
BT PORTFOLIO SERVICES LTD.................................... Australia
BT SECURITIES LTD............................................ Australia
BT TACTICAL ASSET MANAGEMENT PTY LTD......................... Australia
CHIFLEY SERVICES PTY LTD..................................... Australia
DELAWARE CHARTER GUARANTEE & TRUST COMPANY................... Delaware
DENTAL-NET, INC.............................................. Arizona
EMPLOYERS DENTAL SERVICES, INC............................... Arizona
EQUITY FC, LTD............................................... Iowa
EXECUTIVE BENEFIT SERVICES, INC.............................. North Carolina
HEALTHRISK RESOURCE GROUP, INC............................... Iowa
IDBI-PRINCIPAL ASSET MANAGEMENT COMPANY...................... India
IDBI-PRINCIPAL TRUSTEE COMPANY LIMITED....................... India
ING/PRINCIPAL PENSIONS CO., LTD.............................. Japan
INSOURCE GROUP, LLC.......................................... Delaware
INVISTA CAPITAL MANAGEMENT, LLC.............................. Delaware
ONISTON PTY LTD.............................................. Australia
PATRICIAN ASSOCIATES, INC.................................... California
PETULA ASSOCIATES, LTD....................................... Iowa
PETULA PROLIX DEVELOPMENT COMPANY............................ Iowa
PFG DO BRASIL LTDA........................................... Brazil
PPI EMPLOYEE BENEFITS CORPORATION............................ Connecticut
PREFERRED PRODUCT NETWORK, INC............................... Delaware
PRINCIPAL AFORE, S.A., DE C.V................................ Mexico
PRINCIPAL ASSET MANAGEMENT COMPANY (ASIA) LTD................ Hong Kong
PRINCIPAL ASSET MARKETS, INC................................. Iowa
PRINCIPAL BANK............................................... Federal
PRINCIPAL CAPITAL FUTURES TRADING ADVISOR, LLC............... Delaware
195
PRINCIPAL CAPITAL GLOBAL INVESTORS LTD....................... Australia
PRINCIPAL CAPITAL INCOME INVESTORS, LLC...................... Delaware
PRINCIPAL CAPITAL MANAGEMENT (ASIA) LTD...................... Hong Kong
PRINCIPAL CAPITAL MANAGEMENT (EUROPE) LTD.................... United Kingdom
PRINCIPAL CAPITAL MANAGEMENT (IRELAND) LTD................... Ireland
PRINCIPAL CAPITAL MANAGEMENT (SINGAPORE) LTD................. Singapore
PRINCIPAL CAPITAL MANAGEMENT, LLC............................ Delaware
PRINCIPAL CAPITAL REAL ESTATE INVESTORS, LLC................. Delaware
PRINCIPAL CAPITAL TRUST...................................... Delaware
PRINCIPAL COMMERCIAL ACCEPTANCE, LLC......................... Delaware
PRINCIPAL COMMERCIAL FUNDING, LLC............................ Delaware
PRINCIPAL COMPANIA DE SEGUROS DE VIDA CHILE S.A.............. Chile
PRINCIPAL CONSULTING (INDIA) PRIVATE LIMITED................. India
PRINCIPAL DELAWARE NAME HOLDING COMPANY, INC................. Delaware
PRINCIPAL DEVELOPMENT ASSOCIATES, INC........................ California
PRINCIPAL DEVELOPMENT INVESTORS, L.L.C....................... Delaware
PRINCIPAL ENTERPRISE CAPITAL, LLC............................ Delaware
PRINCIPAL FC, LTD............................................ Iowa
PRINCIPAL FINANCIAL ADVISORS, INC............................ Iowa
PRINCIPAL FINANCIAL GROUP (AUSTRALIA) HOLDINGS PTY LTD....... Australia
PRINCIPAL FINANCIAL GROUP (MAURITIUS) LTD.................... Mauritius
PRINCIPAL FINANCIAL GROUP INVESTMENTS (AUSTRALIA) PTY LTD.... Australia
PRINCIPAL FINANCIAL GROUP, INC............................... Delaware
PRINCIPAL FINANCIAL SERVICES (AUSTRALIA), INC................ Iowa
PRINCIPAL FINANCIAL SERVICES (NZ), INC....................... Iowa
PRINCIPAL FINANCIAL SERVICES, INC............................ Iowa
PRINCIPAL GENERATION PLANT, LLC.............................. Delaware
PRINCIPAL HEALTH CARE, INC................................... Iowa
PRINCIPAL HOLDING COMPANY.................................... Iowa
PRINCIPAL HOTELS AUSTRALIA PTY LTD........................... Australia
PRINCIPAL HOTELS HOLDINGS PTY LTD............................ Australia
PRINCIPAL INSURANCE COMPANY (HONG KONG) LIMITED.............. Hong Kong
PRINCIPAL INTERNATIONAL (ASIA) LIMITED....................... Hong Kong
PRINCIPAL INTERNATIONAL ARGENTINA, S.A....................... Argentina
PRINCIPAL INTERNATIONAL DE CHILE S.A......................... Chile
PRINCIPAL INTERNATIONAL HOLDING COMPANY, LLC................. Delaware
PRINCIPAL INTERNATIONAL, INC................................. Iowa
PRINCIPAL INVESTORS CORPORATION.............................. New Jersey
PRINCIPAL LIFE COMPANIA DE SEGUROS DE VIDA, S.A.............. Argentina
PRINCIPAL LIFE INSURANCE COMPANY............................. Iowa
PRINCIPAL MANAGEMENT CORPORATION............................. Iowa
PRINCIPAL MEXICO COMPANIA DE SEGUROS, S.A. DE C.V............ Mexico
PRINCIPAL MORTGAGE REINSURANCE COMPANY....................... Vermont
PRINCIPAL NET LEASE INVESTORS, L.L.C......................... Delaware
PRINCIPAL PENSIONES, S.A. DE C.V............................. Mexico
PRINCIPAL PORTFOLIO SERVICES, INC............................ Iowa
PRINCIPAL RESIDENTIAL MORTGAGE FUNDING, LLC.................. Delaware
PRINCIPAL RESIDENTIAL MORTGAGE, INC.......................... Iowa
PRINCIPAL RETIRO COMPANIA DE SEGUROS DE RETIRO, S.A.......... Argentina
PRINCIPAL SPECTRUM ASSOCIATES, INC........................... California
PRINCIPAL TRUST COMPANY (ASIA) LIMITED....................... Hong Kong
PRINCIPAL WHOLESALE MORTGAGE, INC............................ Iowa
PRINCOR FINANCIAL SERVICES CORPORATION....................... Iowa
PROFESSIONAL PENSIONS, INC................................... Connecticut
QV1 PTY LTD.................................................. Australia
196
SIEFORE PRINCIPAL, S.A. DE C.V............................... Mexico
SPECTRUM ASSET MANAGEMENT, INC............................... Connecticut
TANNER ADMINISTRADORA DE FONDOS MUTUOS S.A................... Chile
THE ADMAR GROUP, INC......................................... Florida
ZAO PRINCIPAL INTERNATIONAL.................................. Russia
197
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-72006) pertaining to Principal Financial Group, Inc. Stock Incentive
Plan, Principal Financial Group Long-Term Performance Plan, Principal Financial
Group, Inc. Directors Stock Plan, and Principal Financial Group, Inc. Employee
Stock Purchase Plan and in the Registration Statement (Form S-8 No. 333-72002)
pertaining to The Principal Select Savings Excess Plan, Nonqualified Defined
Contribution Plan for Designated Participants, The Principal Select Savings Plan
for Individual Field, and The Principal Select Savings Plan for Employees of our
reports dated February 1, 2002, with respect to the consolidated financial
statements and schedules of Principal Financial Group, Inc. included in the
Annual Report (Form 10-K) for the year ended December 31, 2001.
/s/ Ernst & Young LLP
Des Moines, Iowa
March 6, 2002
198
Exhibit 24
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and appoints Michael
H. Gersie, Karen E. Shaff and Joyce N. Hoffman, and each of them, as such
person's true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, to sign on such person's behalf individually
and in each capacity stated below the Annual Report on Form 10-K under the
Securities Exchange Act of 1934, as amended, of Principal Financial Group, Inc.,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, and each of them, full power and authority to
do and perform each and every thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as such person could
do in person, hereby ratifying and confirming all that such attorney-in-fact or
agent may lawfully do or cause to be done by virtue hereof.
Dated February 25, 2002
/s/ J. Barry Griswell /s/ Charles S. Johnson
------------------------------ -------------------------------
J. Barry Griswell Charles S. Johnson
Chairman, President and Chief Director
Executive Officer, Director
/s/ Michael H. Gersie /s/ William T. Kerr
------------------------------ -------------------------------
Michael H. Gersie William T. Kerr
Executive Vice President and Director
Chief Financial Officer
/s/ Betsy J. Bernard /s/ Victor H. Loewenstein
------------------------------ -------------------------------
Betsy J. Bernard Victor H. Loewenstein
Director Director
/s/ Jocelyn Carter-Miller /s/ Ronald D. Pearson
------------------------------ -------------------------------
Jocelyn Carter-Miller Ronald D. Pearson
Director Director
/s/ Gary E. Costley /s/ Federico F. Pena
------------------------------ -------------------------------
Gary E. Costley Federico F. Pena
Director Director
/s/ David J. Drury /s/ Donald M. Stewart
------------------------------ -------------------------------
David J. Drury Donald M. Stewart
Director Director
/s/ C. Daniel Gelatt, Jr. /s/ Elizabeth E. Tallett
------------------------------ -------------------------------
C. Daniel Gelatt, Jr. Elizabeth E. Tallett
Director Director
/s/ Sandra L. Helton
------------------------------
Sandra L. Helton
Director
199