| August 13, 2010 | ||
| By EDGAR | ||
| Securities and Exchange Commission | ||
| Division of Corporation Finance | ||
| 100 F Street, N.E. | ||
| Washington D.C. 20549 | ||
| Attention: | Mr. Jim Rosenberg, | |
| Senior Assistant Chief Accountant | ||
| Re: Principal Financial Group, Inc. | ||
| Form 10-K for the Fiscal Year Ended December 31, 2009 | ||
| Form 10-Q for the Quarterly Period Ended March 31, 2010 | ||
| File No. 001-16725 | ||
| Dear Mr. Rosenberg: | ||
| On behalf of Principal Financial Group, Inc., this letter responds to the comments of the | ||
| Division of Corporation Finance of the Securities and Exchange Commission contained in your | ||
| letter dated June 29, 2010, concerning the company’s annual report on Form 10-K and quarterly | ||
| report on Form 10-Q, both referenced above. In order to facilitate your review of our | ||
| responses, we have repeated your comments in bold in numerical order, immediately followed | ||
| by our responses in plain text. | ||
| Form 10-K for the Fiscal Year Ended December 31, 2009 | ||
| Notes to the Consolidated Financial Statements | ||
| 5. Investments, page 106 | ||
| 1. | Your disclosure does not appear to comply fully with note 6 to Article 7-03.1 of | |
| Regulation S-X. Please revise to disclose the name and aggregate amount invested in | ||
| each person and its affiliates that exceeds 10% of your total stockholders’ equity. | ||
| RESPONSE: | ||
| As of March 31, 2010, and December 31, 2009, our aggregate amount invested in a single | ||
| person and its affiliates did not exceed 10% of our total stockholders’ equity. | ||
| Commercial Mortgage Loans, page 112 | ||
| 2. | Please disclose, preferably in a table, loans in your commercial loan portfolio | |
| grouped by current loan-to-value ratio, as appropriate, to provide informative | ||
| disclosure about the risks in your portfolio. For example, groupings could include | ||
| loans classified as low, medium or high loan-to-value ratio with a note explaining the | ||
| definition of low, medium and high. | ||
| Page 2 | |
| RESPONSE: | |
| We respectfully submit that we will address your request for additional disclosures regarding | |
| the credit quality of our commercial mortgage loan portfolio through the implementation of | |
| ASU 2010-20,Disclosures about the Credit Quality of Financing Receivables and the | |
| Allowance for Credit Losses, which was issued in July 2010 and will be effective for our year- | |
| end 2010 reporting. The guidance requires interim and annual credit quality disclosures about a | |
| portfolio by class of financing receivable, including quantitative and qualitative information | |
| about the credit quality of financing receivables. We are in the process of evaluating alternative | |
| ways to meet these disclosure requirements for year-end 2010 reporting. | |
| In the interim periods we intend to continue to provide information regarding the risks in our | |
| portfolio as we have done heretofore. Following is the disclosure included in our first quarter | |
| 2010 Form 10-Q: | |
| Page 84 of the MD&A - 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. The weighted average loan-to-value ratio at origination for new brick and | |
| mortar commercial mortgages, excluding Global Asset Management segment | |
| mortgages, in our portfolio was 55% and 52% as of March 31, 2010 and December 31, | |
| 2009, respectively. The debt service coverage ratio at loan inception for new brick and | |
| mortar commercial mortgages, excluding Global Asset Management segment | |
| mortgages, in our portfolio was 1.9 and 2.0 times as of March 31, 2010 and | |
| December 31, 2009, respectively. The weighted average loan-to-value ratio for loans | |
| held in our brick and mortar commercial mortgage portfolio, excluding Global Asset | |
| Management segment mortgages, was 69% as of both March 31, 2010 and December | |
| 31, 2009. The debt service coverage ratio for loans held in our brick and mortar | |
| commercial mortgage portfolio, excluding Global Asset Management segment | |
| mortgages, was 1.8 times as of both March 31, 2010 and December 31, 2009. | |
| Form 10-Q for the quarterly period ended March 31, 2010 | |
| Notes to the Consolidated Financial Statements | |
| 9. Fair Value Measurements, page 34 | |
| 3. | Please revise your disclosures for assets and liabilities classified as Level 2 and |
| Level 3 to quantify the inputs used in determining the fair value of each class of | |
| assets or liabilities as required by ASC 820-10-50-2e as amended by ASU 2010- | |
| 06. Please see ASC 820-10-55-22A for examples of the inputs to be disclosed. | |
| RESPONSE: | |
| First Quarter 2010 | |
| In response to your request to revise our disclosure to include quantitative information about the | |
| inputs used to fair value assets and liabilities, we would first like to describe our approach for | |
| the first quarter of 2010 when we implemented the new guidance. As we worked through the | |
| implementation of ASU 2010-06, it was unclear to us whether providing quantitative | |
| Page 3 |
| information about the inputs used in determining Level 2 and Level 3 measurements was |
| required or was an alternative offered as one example to meet the requirement to describe the |
| inputs used. As amended by ASU 2010-06, paragraph 820-10-50-2(e) requires that companies |
| provide “a description” of the valuation techniques and of the inputs used to determine fair |
| value. While ASC 820-10-55-22a and 22b discuss the disclosures of quantitative information |
| on the inputs used, we did not interpret these examples as disclosure requirements, but rather as |
| illustrations of ways that companies may comply with the requirements. The uncertainty |
| around whether specific disclosures of quantitative inputs were required was shared by our |
| peers. |
| Our investment portfolio is very large and diverse, covering multiple asset classes. One third- |
| party pricing service with whom we work to determine the fair valuation of our Level 2 |
| securities is International Data Corporation (IDC), a global provider of market data. During our |
| first quarter evaluation of the guidance, we had discussions with IDC regarding the availability |
| of quantitative valuation information, and at that time we understood that no other clients were |
| requesting that level of information. At that time, IDC had no plans to expand the information it |
| already provided. Through conversations with peer companies and other pricing vendors, we |
| found no companies in our sample that were planning to include quantitative information in |
| their disclosures, both because of the lack of clarity around the requirement and the lack of |
| available information. |
| In response to the ASU, we enhanced our disclosure by providing expanded qualitative |
| discussion of the inputs by asset class (Attachment A illustrates, via highlighting, all instances |
| where qualitative discussion of inputs are discussed). Because of the size and diversification of |
| our portfolio, we did not believe that it would be practical to provide aggregated quantitative |
| information that would be meaningful to the users of the financial statements. We reviewed |
| peer company first quarter reports, found that our disclosures were comparable, and that no one |
| had provided quantitative information on the specific inputs used. Upon receipt of your letter, |
| we again reached out to IDC. It still has no plans to expand upon the information it provides in |
| order to address this issue. The pricing service informed us that no other companies requested |
| such information. IDC’s inability to provide the data does not reflect an unwillingness to do so, |
| but rather the same challenge we face - to find a way to provide the information in a way that is |
| meaningful and useful. |
| Validation of Fair Values |
| As financial statement preparers, it is our responsibility to understand the inputs into the fair |
| value determination so that we are able to make the proper determination of the fair value level |
| and are able to validate the period-end values for inclusion in our financial statements. |
| Although we do not obtain detailed input on the multiple assumptions the pricing vendors use |
| to value each security, we do have an understanding of the methodologies and types of inputs |
| used by asset class and have a formal process to validate fair value prices provided by external |
| sources. The review process includes investment analyst validation of all stale prices and a |
| sample of externally sourced prices considered to have utilized observable inputs in order to |
| validate the reasonableness of the prices. In addition, all externally sourced prices considered |
| to have utilized unobservable inputs are validated. The validation process for both of these may |
| include comparison of the price to a second external source, review of recent trade activity, use |
| of internal models and direct interaction with external sources such as pricing vendors, brokers |
| or other traders. Additionally, at the macro level, we perform analysis of our portfolio |
| Page 4 | ||||
| compared to the current market environment based on interest rates and credit spreads by | ||||
| sector, duration and credit quality to confirm reasonableness of overall prices. | ||||
| Looking Forward | ||||
| We appreciate and support the desire to provide financial statement users with information that | ||||
| assists in their assessment of the quality of the fair values of a company’s investment holdings. | ||||
| Furthermore, we acknowledge that we can continue to improve upon the qualitative disclosures | ||||
| regarding valuation techniques and inputs. Specifically, we are evaluating how to improve the | ||||
| qualitative discussion of the valuation and inputs of our Level 3 securities, excluding separate | ||||
| account assets. Because these securities are valued using unobservable inputs, we believe that | ||||
| disclosing more information for those securities could be useful to investors. | ||||
| We have real concerns with our ability, as a single financial statement preparer, to find an | ||||
| effective solution with regard to disclosing quantitative inputs that is satisfactory to all | ||||
| interested parties. Our observation is that the majority of preparers did not provide disclosure | ||||
| that quantifies their fair value inputs. We can only conclude that there is a lack of clarity with | ||||
| the required disclosure, challenges with compliance, or both. To that end, we respectfully | ||||
| request the Commission (perhaps through the Office of Chief Accountant) to consider whether | ||||
| this situation warrants a working group consisting of financial statement preparers, pricing | ||||
| services, auditors, standard setters and financial statement users to obtain a broader perspective | ||||
| on the issues with the goal of finding a workable solution for all, and to facilitate consistent | ||||
| interpretation and application of the solution. | ||||
| We are willing to discuss in more detail the challenges we have identified in meeting your | ||||
| request as well as share our perspective on how changes in the requirement could be modified | ||||
| to find the right balance between providing meaningful information and doing so in an effective | ||||
| manner. | ||||
| * * * * * | ||||
| After you have completed your review of our response, please call me if you have any questions | ||||
| or comments. | ||||
| Sincerely, | ||||
| /s/ Terrance J. Lillis | ||||
| Terrance J. Lillis | ||||
| Senior Vice President and | ||||
| Chief Financial Officer | ||||
| (515) 247-4885 | ||||
| cc: | Vanessa Robertson (Securities and Exchange Commission) | |||
| Mary Mast (Securities and Exchange Commission) | ||||
| Page 5 | |
| Attachment A |
| From 3/31/2010 Principal Financial Group 10-Q Note 9 – Fair Value Measurements: Determination of fair value The following discussion describes the valuation methodologies used for assets and liabilities measured at fair value on a recurring basis or disclosed at fair value. The techniques utilized in estimating the fair values of financial instruments are reliant on the assumptions used. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below. Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument. We validate prices through an investment analyst review process, which includes validation through direct interaction with external sources, review of recent trade activity or use of internal models. In circumstances where broker quotes are used to value an instrument, we generally receive one non-binding quote. Broker quotes are validated through an investment analyst review process, which includes validation through direct interaction with external sources and use of internal models or other relevant information. We did not make any significant changes to our valuation processes during the first quarter of 2010. Fixed Maturities Fixed maturities include bonds, asset-backed securities, redeemable preferred stock and certain nonredeemable preferred stock. When available, the fair value of fixed maturities is based on quoted prices of identical assets in active markets. These are reflected in Level 1 and primarily include U.S. Treasury bonds and actively traded redeemable corporate preferred securities. When quoted prices are not available, our first priority is to obtain prices from third party pricing vendors. We have regular interaction with these vendors to ensure we understand their pricing methodologies and to confirm they are utilizing observable market information. Their methodologies vary by asset class and include inputs such as estimated cash flows, benchmark yields, reported trades, broker quotes, credit quality, industry events and economic events. Fixed maturities with validated prices from pricing services, which includes the majority of our public fixed maturities in all asset classes, are generally reflected in Level 2. Also included in Level 2 are corporate bonds where quoted market prices are not available, for which a matrix pricing valuation approach is used. Inthis approach, securities are grouped into pricing categories that vary by sector, rating and average life. Each pricing category is assigned a risk spread based on studies of observable public market data from the investment professionals assigned to specific security classes. The expected cash flows of the security are then discounted back at the current Treasury curve plus the appropriate risk spread. Although the matrix valuation approach provides a fair valuation of each pricing category, the valuation of an individual security within each pricing category may actually be impacted by company specific factors. |
| Page 6 If we are unable to price a fixed maturity security using prices from third party pricing vendors or other sources specific to the asset class, we may obtain a broker quote or utilize an internal pricing model specific to the asset utilizing relevant market information, to the extent available, which are reflected in Level 3 and can include fixed maturities across all asset classes.These models primarily use projected cash flows discounted using a rate derived from market interest rate curves and relevant risk spreads.As of March 31, 2010, less than 1% of our fixed maturity securities, which were classified as Level 3 assets, were valued using internal pricing models. Equity Securities Equity securities include mutual funds, common stock and nonredeemable preferred stock. Fair values of equity securities are determined using quoted prices in active markets for identical assets when available, which are reflected in Level 1. When quoted prices are not available, we may utilize internal valuation methodologies appropriate for the specific asset that use observable inputs such as underlying share prices,which are reflected in Level 2.Fair values might also be determined using broker quotes or through the use of internal models or analysisthat incorporate significant assumptions deemed appropriate given the circumstances and consistent with what other market participants would use when pricing such securities, which are reflected in Level 3. Mortgage Loans Mortgage loans are not measured at fair value on a recurring basis. Fair values of commercial and residential mortgage loans are primarily determined by discounting the expected cash flows atcurrent treasury rates plus an applicable risk spread, which reflects credit quality and maturity of the loans. The risk spread is based on market clearing levels for loans with comparable credit quality, maturities and risk. The fair value of mortgage loans may also be based on the fair value of the underlying real estate collateral, which is estimated using appraised values. Policy Loans Policy loans are not measured at fair value on a recurring basis. Fair values of policy loans are estimated bydiscounting expected cash flows using a risk-free rate based on the U.S. Treasury curve. Derivatives The fair values of exchange-traded derivatives are determined through quoted market prices, which are reflected in Level 1. Exchange-traded derivatives include interest rate and equity futures that are settled daily such that their fair value is not reflected in the consolidated statements of financial position. The fair values of over-the-counter derivative instruments are determined using either pricing valuation models that utilize market observable inputs or broker quotes. The majority of our over-the-counter derivatives are valued with models that use market observable inputs, which are reflected in Level 2.Significant inputs include contractual terms, interest rates, currency exchange rates, credit spread curves, equity prices, and volatilities. |
| Page 7 These valuation models consider projected discounted cash flows, relevant swap curves, and appropriate implied volatilities.Certain over-the-counter derivatives utilize unobservable market data, primarily independent broker quotes that are nonbinding quotes based on models that do not reflect the result of market transactions, which are reflected in Level 3. Our derivative contracts are generally documented under ISDA Master Agreements, which provide for legally enforceable set-off and close-out netting of exposures to specific counterparties. Collateral arrangements are bilateral and based on current ratings of each entity. We utilize the LIBOR interest rate curve to value our positions, which includes a credit spread. This credit spread incorporates an appropriate level of nonperformance risk into our valuations given the current ratings of our counterparties, as well as the collateral agreements in place. Counterparty credit risk is routinely monitored to ensure our adjustment for non-performance risk is appropriate. Interest rate contracts.We use discounted cash flow valuation techniques to determine the fair value of interest rate swaps using observable swap curves as the inputs.These are reflected in Level 2. In addition, we have a limited number of complex inflation-linked interest rate swaps and interest rate collars that are valued using broker quotes. These are reflected in Level 3.We use option pricing models to determine the fair value of swaptions using observable swap interest rate curves and observable implied volatilities as inputs.These are reflected in Level 2. Foreign exchange contracts.We use discounted cash flow valuation techniques that utilize observable swap curves and exchange rates as the inputs to determine the fair value of foreign currency swaps.These are reflected in Level 2. In addition, we have a limited number of non-standard currency swaps that are valued using broker quotes. These are reflected within Level 3.Currency forwards are valued using observable market inputs, including forward currency exchange rates. These are reflected in Level 2. Equity contracts.We use an option pricing model using observable implied volatilities, dividend yields, index prices and swap curves as the inputs to determine the fair value of equity options.These are reflected in Level 2. Credit contracts.We use either the ISDA Credit Default Swap Standard discounted cash flow model that utilizes observable default probabilities and recovery rates as inputs or broker prices to determine the fair value of credit default swaps.These are reflected in Level 3. Other contracts.We use broker prices to determine the fair value of commodity swaps. These are reflected in Level 3. Other Investments Other investments reported at fair value primarily include seed money investments, for which the fair value is determined using the net asset value of the fund. The net asset value of the fund represents the price at which we feel we would be able to initiate a transaction. Seed money investments in mutual funds for which the net asset value is published are reflected in Level 1. Seed money investments in mutual funds or other investment funds in markets that do not have a published net asset value are reflected in Level 2. |
| Page 8 Other investments reported at fair value also include commercial mortgage loans of consolidated VIEs for which the fair value option was elected, which are reflected in Level 3. Fair value of these commercial mortgage loans is computed utilizing a discount rate based on the current market. The market discount rate is then adjusted based on various factors that differentiate it from our pool of loans. The carrying amounts of other assets classified as other investments in the accompanying consolidated statements of financial position, which are not measured at fair value on a recurring basis, approximate their fair values. Cash and Cash Equivalents Certain cash equivalents are reported at fair value on a recurring basis and include money market instruments and other short-term investments with maturities of less than three months. Fair values of these cash equivalents may be determined using public quotations, when available, which are reflected in Level 1. When public quotations are not available, because of the highly liquid nature of these assets, carrying amounts may be used to approximate fair values, which are reflected in Level 2. The carrying amounts of cash and cash equivalents that are not reported at fair value on a recurring basis approximate their fair value. Separate Account Assets Separate account assets include equity securities, debt securities and derivative instruments, for which fair values are determined as previously described, and are reflected in Level 1, Level 2 and Level 3. Separate account assets also include commercial mortgage loans, for which the fair value is estimated bydiscounting the expected total cash flows using market rates that are applicable to the yield, credit quality and maturity of the loans. The market clearing spreads vary based on mortgage type, weighted average life, rating and liquidity. These are reflected in Level 3. Finally, separate account assets include real estate, for which the fair value is estimatedusing discounted cash flow valuation models that utilize public real estate market data inputs such as transaction prices, market rents, vacancy levels, leasing absorption, market cap rates and discount rates.In addition, each property is appraised annually by an independent appraiser. The real estate within the separate accounts is reflected in Level 3. Cash Collateral and Cash Collateral Payable Cash collateral is not measured at fair value on a recurring basis. The carrying amounts of cash collateral received and posted under derivative credit support annex (collateral) agreements and the carrying amount of the payable associated with our obligation to return the cash collateral received approximate their fair value. Investment-Type Insurance Contracts Investment-type insurance contracts are not measured at fair value on a recurring basis. The fair values of our reserves and liabilities for investment-type insurance contracts are |
| Page 9 estimatedusing discounted cash flow analyses based on current interest rates,including non- performance risk, being offered for similar contracts with maturities consistent with those remaining for the investment-type contracts being valued. Investment-type insurance contracts include insurance, annuity and other policy contracts that do not involve significant mortality or morbidity risk and are only a portion of the policyholder liabilities appearing in the consolidated statements of financial position. Insurance contracts include insurance, annuity and other policy contracts that do involve significant mortality or morbidity risk. The fair values for our insurance contracts, other than investment-type contracts, are not required to be disclosed. Certain annuity contracts and other investment-type insurance contracts include embedded derivatives that have been bifurcated from the host contract and that are measured at fair value on a recurring basis, which are reflected in Level 3.The key assumptions for calculating the fair value of the embedded derivative liabilities are market assumptions (such as equity market returns, interest rate levels, market volatility, correlations, among other things) and policyholder behavior assumptions (such as lapse, mortality, utilization, withdrawal patterns, among other things).They are valued using a combination of historical data and actuarial judgment. Stochastic models are used to value the embedded derivatives that incorporate a spread reflecting our own creditworthiness and risk margins. The assumption for our own non-performance risk for investment-type insurance contracts and any embedded derivatives bifurcated from certain annuity and investment-type insurance contractsis based on the current market credit spreads for debt-like instruments that we have issued and are available in the market. Short-Term Debt Short-term debt is not measured at fair value on a recurring basis. The carrying amount of short-term debt approximates its fair value because of the relatively short time between origination of the debt instrument and its maturity. Long-Term Debt Long-term debt is not measured at fair value on a recurring basis.Fair values for debt issues are estimated using discounted cash flow analysis based on our incremental borrowing rate for similar borrowing arrangements. Separate Account Liabilities Separate account liabilities are not measured at fair value on a recurring basis. Fair values of separate account liabilities, excluding insurance-related elements, are estimated based on market assumptions around what a potential acquirer would pay for the associated block of business, including both the separate account assets and liabilities. As the applicable separate account assets are already reflected at fair value, any adjustment to the fair value of the block is an assumed adjustment to the separate account liabilities. To compute fair value, the separate account liabilities are originally set to equal separate account assets because these are pass- through contracts. The separate account liabilities arereduced by the amount of future fees expected to be collected that are intended to offset upfront acquisition costs already incurred |
| Page 10 that a potential acquirer would not have to pay. The estimated future fees are adjusted by an adverse deviation discount and the amount is then discounted at a risk-free rate as measured by the yield on U.S. Treasury securities at maturities aligned with the estimated timing of fee collection. Bank Deposits Bank deposits are not measured at fair value on a recurring basis. The fair value of deposits of our Principal Bank subsidiary with no stated maturity, such as demand deposits, savings, and interest-bearing demand accounts, is equal to the amount payable on demand (i.e., their carrying amounts). The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount is estimatedusing the rates currently offered for deposits of similar remaining maturities.The fair value estimates do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. Other Liabilities Certain obligations reported in other liabilities include embedded derivatives to deliver underlying securities of structured investments to third parties. The fair value of the embedded derivatives is calculated based on the value of the underlying securities. We have had an embedded derivative in which the fair value of the underlying securities was obtained from a third party pricing vendor and was reflected in Level 2.We also have an embedded derivative in which the fair value of the underlying securities is calculated utilizing the yield, credit quality and average maturity of each security,which is reflected in Level 3. Additionally, obligations of consolidated VIEs for which the fair value option was elected are included in other liabilities. These obligations are valued either based on prices obtained from third party pricing vendors as utilized and described in our discussion of how fair value is determined for fixed maturities, which are reflected in Level 2, or broker quotes, which are reflected in Level 3. |
