SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-Q
__________________
|X|QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
|_|TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
__________________
Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 42-1520346
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
__________________
711 High Street, Des Moines, Iowa 50392
(Address of principal executive offices)
(515) 247-5111
(Registrant's telephone number, including area code)
__________________
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding as of May 1, 2003 was 327,302,908.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
Page
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at March 31, 2003
(Unaudited)and December 31, 2002..................................3
Unaudited Consolidated Statements of Operations for the three
months ended March 31, 2003 and 2002..............................4
Unaudited Consolidated Statements of Stockholders' Equity for the
three months ended March 31, 2003 and 2002........................5
Unaudited Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and 2002..............................6
Notes to Unaudited Consolidated Financial Statements - March 31,
2003..............................................................8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................16
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......49
Item 4. Controls and Procedures..........................................56
Part II - OTHER INFORMATION
Item 1. Legal Proceedings................................................57
Item 6. Exhibits and Reports on Form 8-K.................................58
Signature and Certifications.............................................59
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
MARCH 31, DECEMBER 31,
2003 2002
------------------ ------------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale....................................... $35,690.4 $34,185.7
Fixed maturities, trading.................................................. 101.1 101.7
Equity securities, available-for-sale...................................... 388.4 378.7
Mortgage loans............................................................. 11,236.0 11,081.9
Real estate................................................................ 1,329.1 1,229.0
Policy loans............................................................... 810.9 818.5
Other investments.......................................................... 1,083.7 1,200.1
------------------ ------------------
Total investments....................................................... 50,639.6 48,995.6
Cash and cash equivalents.................................................. 966.9 1,038.6
Accrued investment income.................................................. 620.3 646.3
Premiums due and other receivables......................................... 543.7 459.7
Deferred policy acquisition costs.......................................... 1,400.4 1,414.4
Property and equipment..................................................... 470.5 482.5
Goodwill................................................................... 121.7 106.5
Other intangibles.......................................................... 110.9 88.8
Mortgage loan servicing rights............................................. 1,606.8 1,518.6
Separate account assets.................................................... 33,906.7 33,501.4
Other assets............................................................... 1,453.0 1,608.9
------------------ ------------------
Total assets............................................................ $91,840.5 $89,861.3
================== ==================
LIABILITIES
Contractholder funds....................................................... $27,366.8 $26,315.0
Future policy benefits and claims.......................................... 14,838.6 14,736.4
Other policyholder funds................................................... 671.1 642.9
Short-term debt............................................................ 758.6 564.8
Long-term debt............................................................. 1,335.6 1,332.5
Deferred income taxes...................................................... 1,390.7 1,177.7
Separate account liabilities............................................... 33,906.7 33,501.4
Other liabilities.......................................................... 4,735.6 4,933.4
------------------ ------------------
Total liabilities....................................................... 85,003.7 83,204.1
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500.0 million shares authorized,
376.8 million and 376.7 million shares issued, and 328.0 million and
334.4 million shares outstanding in 2003 and 2002, respectively......... 3.8 3.8
Additional paid-in capital................................................. 7,108.6 7,106.3
Retained earnings.......................................................... 185.1 29.4
Accumulated other comprehensive income..................................... 841.5 635.8
Treasury stock, at cost (48.8 million and 42.3 million shares in 2003 and
2002, respectively)..................................................... (1,302.2) (1,118.1)
------------------ ------------------
Total stockholders' equity.............................................. 6,836.8 6,657.2
------------------ ------------------
Total liabilities and stockholders' equity.............................. $91,840.5 $89,861.3
================== ==================
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2003 2002
----------------- ---------------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
REVENUES
Premiums and other considerations...................... $ 905.5 $ 885.7
Fees and other revenues................................ 632.0 432.9
Net investment income.................................. 836.0 811.1
Net realized/unrealized capital gains (losses)......... (76.7) 98.1
----------------- ---------------
Total revenues....................................... 2,296.8 2,227.8
EXPENSES
Benefits, claims and settlement expenses............... 1,195.2 1,203.2
Dividends to policyholders............................. 80.1 82.4
Operating expenses..................................... 799.3 592.2
----------------- ---------------
Total expenses....................................... 2,074.6 1,877.8
----------------- ---------------
Income from continuing operations before
income taxes......................................... 222.2 350.0
Income taxes........................................... 65.8 106.3
----------------- ---------------
Income from continuing operations, net of related 156.4 243.7
income taxes.........................................
Income (loss) from discontinued operations, net of
related income taxes................................. (0.7) 2.3
----------------- ---------------
Income before cumulative effect of accounting change... 155.7 246.0
Cumulative effect of accounting change, net of related
income taxes......................................... - (280.9)
----------------- ---------------
Net income (loss)...................................... $ 155.7 $ (34.9)
================= ===============
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2003 2002
----------------- ---------------
EARNINGS PER COMMON SHARE
Basic and diluted earnings per common share:
Income from continuing operations, net of related
income taxes....................................... $0.47 $0.68
Income (loss) from discontinued operations, net of
related income taxes............................... - -
----------------- ---------------
Income before cumulative effect of accounting change. 0.47 0.68
Cumulative effect of accounting change, net of
related income taxes............................... - (0.78)
----------------- ---------------
Net income (loss).................................... $0.47 $(0.10)
================= ===============
SEE ACCOMPANYING NOTES.
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
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, 2002..... $3.8 $7,072.5 $ (29.1) $147.5 $ (374.4) $6,820.3 360,142.2
Shares issued, net of put
options....................... - 9.7 - - - 9.7 320.4
Treasury stock acquired and
sold, net..................... - 1.3 - - (23.3) (22.0) (801.4)
Comprehensive loss:
Net loss...................... - - (34.9) - - (34.9)
Net unrealized losses......... - - - (288.9) - (288.9)
Provision for deferred
income tax benefit.......... - - - 102.3 - 102.3
Foreign currency
translation adjustment...... - - - 11.5 - 11.5
-------------
Comprehensive loss.............. (210.0)
---------- ---------- ---------- --------------- ---------- ------------- --------------
BALANCES AT MARCH 31, 2002...... $3.8 $7,083.5 $ (64.0) $(27.6) $ (397.7) $6,598.0 359,661.2
========== ========== ========== =============== ========== ============= ==============
BALANCES AT JANUARY 1, 2003..... $3.8 $7,106.3 $ 29.4 $635.8 $(1,118.1) $6,657.2 334,419.3
Shares issued, net of call
options....................... - (3.0) - - - (3.0) 156.8
Stock-based compensation........ - 5.3 - - 5.3
Treasury stock acquired......... - - - - (184.1) (184.1) (6,533.0)
Comprehensive income:
Net income.................... - - 155.7 - - 155.7
Net unrealized gains.......... - - - 331.9 - 331.9
Provision for deferred
income taxes................ - - - (117.0) - (117.0)
Foreign currency
translation adjustment...... - - - (9.2) - (9.2)
-------------
Comprehensive income............ 361.4
---------- ---------- ---------- --------------- ---------- ------------- --------------
BALANCES AT MARCH 31, 2003...... $3.8 $7,108.6 $ 185.1 $841.5 $(1,302.2) $6,836.8 328,043.1
========== ========== ========== =============== ========== ============= ==============
SEE ACCOMPANYING NOTES.
5
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2003 2002
----------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income (loss)..................................... $ 155.7 $ (34.9)
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Loss (income) from discontinued operations, net
of related income taxes............................ 0.7 (2.3)
Cumulative effect of accounting change,
net of related income taxes....................... - 280.9
Amortization of deferred policy acquisition
costs.............................................. 51.4 23.0
Additions to deferred policy acquisition costs...... (85.8) (81.9)
Accrued investment income........................... 26.0 10.0
Premiums due and other receivables.................. 30.9 51.2
Contractholder and policyholder liabilities
and dividends..................................... 481.2 349.6
Current and deferred income taxes................... 63.3 100.8
Net realized/unrealized capital (gains) losses...... 76.7 (98.1)
Depreciation and amortization expense............... 24.6 25.0
Amortization of mortgage servicing rights........... 111.2 67.9
Stock-based compensation............................ 3.5 -
Mortgage servicing rights valuation adjustments..... 159.3 1.4
Other............................................... (142.9) (198.1)
----------------- ----------------
Net adjustments....................................... 800.1 529.4
----------------- ----------------
Net cash provided by operating activities............. 955.8 494.5
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases........................................... (2,911.7) (3,841.2)
Sales............................................... 690.6 1,627.4
Maturities.......................................... 1,065.9 1,140.1
Net cash flows from trading securities................ - (14.1)
Mortgage loans acquired or originated................. (16,253.6) (10,615.0)
Mortgage loans sold or repaid......................... 16,191.3 10,777.0
Purchase of mortgage servicing rights................. (310.6) (252.7)
Proceeds from sale of mortgage servicing rights....... 0.5 1.6
Real estate acquired.................................. (98.9) (108.5)
Real estate sold...................................... 25.6 25.2
Net change in property and equipment.................. (3.1) (14.1)
Net proceeds from sales of subsidiaries............... 2.1 -
Purchases of interest in subsidiaries, net of cash
acquired............................................ (60.3) -
Net change in other investments....................... 0.5 370.1
----------------- ----------------
Net cash used in investing activities................. $ (1,661.7) $ (904.2)
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2003 2002
----------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock, net of call and put
options............................................ $ (3.0) $ 11.0
Acquisition and sales of treasury stock, net......... (184.1) (23.3)
Issuance of long-term debt........................... 7.5 7.9
Principal repayments of long-term debt............... (4.4) (42.8)
Net proceeds of short-term borrowings................ 192.8 181.6
Investment contract deposits......................... 2,937.8 1,913.2
Investment contract withdrawals...................... (2,312.4) (1,710.1)
----------------- ----------------
Net cash provided by financing activities............ 634.2 337.5
----------------- ----------------
Net decrease in cash and cash equivalents............ (71.7) (72.2)
Cash and cash equivalents at beginning of period..... 1,038.6 561.2
----------------- ----------------
Cash and cash equivalents at end of period........... $ 966.9 $ 489.0
================= ================
SEE ACCOMPANYING NOTES.
7
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Principal
Financial Group, Inc. and its majority-owned subsidiaries have been prepared in
conformity with accounting principles generally accepted in the U.S. ("U.S.
GAAP") for interim financial statements and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three months ended
March 31, 2003, are not necessarily indicative of the results that may be
expected for the year ended December 31, 2003. These interim unaudited
consolidated financial statements should be read in conjunction with our annual
audited financial statements as of December 31, 2002, included in our Form 10-K
for the year ended December 31, 2002, filed with the United States Securities
and Exchange Commission. The accompanying consolidated statement of financial
position at December 31, 2002, has been derived from the audited consolidated
statement of financial position but does not include all of the information and
footnotes required by U.S. GAAP for complete financial statements.
Reclassifications have been made to the December 31, 2002 and March 31, 2002,
financial statements to conform to the March 31, 2003, presentation.
SEPARATE ACCOUNTS
At March 31, 2003, the separate accounts included a separate account valued at
$838.0 million, which primarily includes shares of our stock that were allocated
and issued to eligible participants of qualified employee benefit plans
administered by us as part of the policy credits issued under the
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 our results of operations.
STOCK-BASED COMPENSATION
At March 31, 2003, we have four stock-based compensation plans. We applied the
fair value method to all stock-based awards granted subsequent to January 1,
2002. For stock-based awards granted prior to this date, we used the intrinsic
value method.
8
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Awards under our plans vest over periods ranging from three months to three
years. Therefore, the cost related to stock-based compensation included in the
determination of net income for the three months ended March 31, 2003, is less
than that which would have been recognized if the fair value based method had
been applied to all awards since the inception of our stock-based compensation
plans. Had compensation expense for our 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 Statement of Financial Accounting
Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, our net
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.
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2003 2002
----------------- ----------------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
Net income (loss), as reported.................................. $155.7 $(34.9)
Add: Stock-based compensation expense included in reported
net income, net of related tax effects........................ 3.0 2.3
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of
related tax effects........................................... 3.9 3.9
----------------- ----------------
Pro forma net income (loss)..................................... $154.8 $(36.5)
================= ================
Basic and diluted earnings per share:
As reported................................................... $ 0.47 $ (0.10)
Pro forma..................................................... 0.47 (0.10)
2. FEDERAL INCOME TAXES
The effective income tax rate on net income for the three months ended March 31,
2003 and 2002, is lower than the prevailing corporate federal income tax rate
primarily due to income tax deductions allowed for corporate dividends received
and interest exclusion from taxable income, partially offset by state income
taxes.
9
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
3. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------
2003 2002
-------------- --------------
(IN MILLIONS)
COMPREHENSIVE INCOME (LOSS):
Net income (loss)................................................ $ 155.7 $ (34.9)
Net change in unrealized gains and losses on fixed maturities,
available-for-sale............................................. 406.8 (359.6)
Net change in unrealized gains and losses on equity securities,
available-for-sale, including seed money in separate accounts.. (5.1) 19.4
Adjustments for assumed changes in amortization patterns:
Deferred policy acquisition costs.............................. (48.1) 41.5
Unearned revenue reserves...................................... 2.1 (2.8)
Net change in unrealized gains and losses on derivative
instruments.................................................... 14.4 12.6
Adjustments to unrealized gains for Closed Block policyholder
dividend obligation............................................ (38.2) -
Provision for deferred income tax benefit (expense).............. (117.0) 102.3
Change in net foreign currency translation adjustment............ (9.2) 11.5
-------------- --------------
Comprehensive income (loss)...................................... $ 361.4 $ (210.0)
============== ==============
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS
LITIGATION
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 asset management and
accumulation products and services, life, health and disability insurance, and
mortgage banking. Some of the lawsuits are class actions, or purport to be, and
some include claims for punitive damages. 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.
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. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs filed an appeal on May 15, 2002, with the 7th
Circuit Court of Appeals. On November 22, 2002, the 7th Circuit Court of Appeals
affirmed the District Court's decision. The Plaintiffs filed a Petition for a
Writ of Certiorari on April 21, 2003, requesting the United States Supreme Court
to review the decision of the 7th Circuit Court of Appeals.
10
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
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 our business, financial position or results of operations. The
outcome of litigation is always uncertain, and unforeseen results can occur. It
is possible that such outcomes could materially affect our results of operations
in a particular quarter or annual period.
GUARANTEES AND INDEMNIFICATIONS
In the normal course of business, we have provided guarantees to third parties
primarily related to a former subsidiary, joint ventures and industrial revenue
bonds. These agreements generally expire from 2003 through 2019. The estimated
maximum exposure under these agreements as of March 31, 2003, was $183.0
million; however, we believe the likelihood is remote that material payments
will be required and therefore have not accrued for a liability on our
consolidated statements of financial position. Should we be required to perform
under these guarantees, we generally could recover a portion of the loss from
third parties through recourse provisions included in agreements with such
parties, the sale of assets held as collateral that can be liquidated in the
event that performance is required under the guarantees or other recourse
generally available to us, minimizing the impact to our results of operations.
In connection with the 2002 sale of BT Financial Group, we agreed to indemnify
the purchaser, Westpac Banking Corporation ("Westpac") for, among other things,
the costs associated with potential late filings made by BT Financial Group in
New Zealand prior to Westpac's ownership, up to a maximum of A$250 million
Australian dollars (approximately U.S. $150 million). New Zealand securities
regulations allow Australian issuers to issue their securities in New Zealand
provided that certain documents are appropriately filed with the New Zealand
Registrar of Companies. Specifically, the regulations require that any
amendments to constitutions and compliance plans be filed in New Zealand. In
April 2003, the New Zealand Securities Commission ("the Commission") opined that
such late filings would result in certain New Zealand investors having a right
to return of their investment plus interest at 10% per annum from the date of
investment. Consequently, the Commission has advised that it has initiated an
inquiry into the matter, both with regard to BT Financial Group and other
similar issuers. We view these potential late filings as a technical matter as
we believe investors received the information that is required to be provided
directly to them. In addition, we believe this technical issue may affect many
in the industry and result in a favorable legislative or judicial solution.
Finally, we are reviewing the applicability of the indemnification regarding
this matter. Although we cannot predict the outcome of this matter or reasonably
estimate losses, we do not believe that it would result in a material adverse
effect on our business or financial position. It is possible, however, that it
could have a material adverse effect on our results of operations in a
particular quarter or annual period.
In the normal course of business, we are subject to indemnification obligations
related to the sale of residential mortgage loans. Under these indemnifications,
we are required to repurchase certain mortgage loans that fail to meet the
standard representations and warranties included in the sales contracts. The
amount of our exposure is based on the potential loss that may be incurred if
the repurchased mortgage loans are processed through the foreclosure process.
Based on historical experience, total mortgage loans repurchased pursuant to
these indemnification obligations are estimated to be approximately 0.04% of
annual mortgage loan production levels. Total losses on the mortgage loans
repurchased are estimated to approximate 25% of the unpaid principal balance of
the related mortgage loans. As of March 31, 2003, $1.6 million has been accrued
for representing the fair value of such indemnifications issued after January 1,
2003, in accordance with Financial Accounting Standards Board Interpretation
Number 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS.
11
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
We are also subject to various other indemnification obligations issued in
conjunction with certain transactions, primarily the sale of BT Financial Group
and other divestitures, the sale of servicing rights in our mortgage banking
business, acquisitions, and financing transactions whose terms range in duration
and often are not explicitly defined. Certain portions of these indemnifications
may be capped, while other portions are not subject to such limitations.
Generally, a maximum obligation is not explicitly stated; therefore, the overall
maximum amount of the obligation under the indemnifications cannot be reasonably
estimated. While we are unable to estimate with certainty the ultimate legal and
financial liability with respect to these indemnifications, we believe the
likelihood is remote that material payments would be required under such
indemnifications and therefore such indemnifications would not result in a
material adverse effect on our business, financial position or results of
operations.
5. SEGMENT INFORMATION
We provide 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 our asset
accumulation business, the life and health insurance operations and third-party
clients.
The International Asset Management and Accumulation segment offers retirement
products and services, annuities, long-term mutual funds and life insurance
through subsidiaries in Argentina, Chile, Mexico and Hong Kong and joint
ventures in Brazil, Japan, India and Malaysia. Prior to October 31, 2002, the
operating segment included BT Financial Group, an Australia based asset manager.
We sold substantially all of BT Financial Group, effective October 31, 2002. As
a result, the results of operations (excluding corporate overhead) for BT
Financial Group are reported as other after-tax adjustments for all periods
presented.
The Life and Health insurance segment provides individual and group life
insurance, group health insurance and individual and group disability insurance
throughout the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers 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 our financing activities, income on capital not
allocated to other segments, intersegment eliminations and certain income,
expenses and other after-tax adjustments not allocated to the segments based on
review of the nature of such items.
12
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
5. SEGMENT INFORMATION (CONTINUED)
We evaluate segment performance on segment operating earnings, which is
determined by adjusting U.S. GAAP net income for net realized/unrealized capital
gains and losses, as adjusted, and other after-tax adjustments which management
believes are not indicative of overall operating trends. Net realized/unrealized
capital gains and losses, as adjusted, are net of income taxes, 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 and losses distributed, minority interest capital gains
and certain market value adjustments to fee revenues. Segment operating revenues
exclude net realized/unrealized capital gains and their impact on recognition of
front-end fee revenues and certain market value adjustments to fee revenues.
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 our results of
operations by highlighting earnings attributable to the normal, ongoing
operations of the business. However, segment operating earnings are not a
substitute for net income determined in accordance with U.S. GAAP.
For the three months ended March 31, 2003, other after-tax adjustments of ($0.7)
million included the negative effects of a change in the estimated loss on
disposal of BT Financial Group.
For the three months ended March 31, 2002, other after-tax adjustments of
($280.6) million included the negative effects of: (1) a cumulative effect of
accounting change related to the implementation of SFAS 142, GOODWILL AND OTHER
INTANGIBLE ASSETS, ($280.9 million) and (2) expenses related to the
demutualization ($2.0 million); and the positive effect of the income from
discontinued operations of BT Financial Group ($2.3 million).
The accounting policies of the segments are consistent with the accounting
policies for the consolidated financial statements, with the exception of
capital allocation. We allocate capital to our segments based upon an internal
capital model that allows management to more effectively manage our capital.
13
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
5. SEGMENT INFORMATION (CONTINUED)
The following tables summarize selected financial information on a continuing
basis by segment and reconcile segment totals to those reported in the
consolidated financial statements:
FOR THE THREE MONTHS ENDED MARCH 31,
-------------------------------------
2003 2002
----------------- ---------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation.................... $ 886.0 $ 862.1
International Asset Management and Accumulation........... 76.8 75.9
Life and Health Insurance................................. 1,012.3 978.5
Mortgage Banking.......................................... 404.5 208.7
Corporate and Other....................................... (0.7) 10.5
---------------- ---------------
Total segment operating revenues........................ 2,378.9 2,135.7
Net realized/unrealized capital gains (losses), including
recognition of front-end fee revenues and certain market
value adjustments to fee revenues....................... (82.1) 92.1
----------------- ---------------
Total revenue per consolidated statements of operations. $ 2,296.8 $ 2,227.8
================= ===============
REVENUES FROM EXTERNAL CUSTOMERS:
U.S. Asset Management and Accumulation.................... $ 821.8 $ 768.3
International Asset Management and Accumulation........... 71.2 83.2
Life and Health Insurance................................. 998.5 963.2
Mortgage Banking.......................................... 402.2 208.7
Corporate and Other....................................... 3.1 204.4
----------------- ---------------
Total external revenues................................. $ 2,296.8 $ 2,227.8
================= ===============
INTERSEGMENT REVENUES:
U.S. Asset Management and Accumulation.................... $ 13.3 $ 14.6
International Asset Management and Accumulation........... - -
Life and Health Insurance................................. (1.3) (1.5)
Mortgage Banking.......................................... 2.3 -
Corporate and Other....................................... (14.3) (13.1)
----------------- ---------------
Total................................................... $ - $ -
================= ===============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ................... $ 97.5 $ 100.2
International Asset Management and Accumulation........... 6.6 1.2
Life and Health Insurance................................. 59.1 54.3
Mortgage Banking.......................................... 52.3 26.5
Corporate and Other ...................................... (5.0) 0.3
----------------- ---------------
Total segment operating earnings...................... 210.5 182.5
Net realized/unrealized capital gains (losses), as (54.1) 63.2
adjusted................................................
Other after-tax adjustments............................... (0.7) (280.6)
----------------- ---------------
Net income (loss) per consolidated statements of
operations............................................ $ 155.7 $ (34.9)
================= ===============
14
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
6. EARNINGS PER SHARE
Reconciliations of weighted-average shares outstanding and income from
continuing operations for basic and diluted earnings per share are presented
below:
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
---------------------------------------- ----------------------------------------
WEIGHTED- WEIGHTED-
AVERAGE PER SHARE AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
----------- ------------- ------------- ------------ -------------- ------------
(IN MILLIONS) (IN MILLIONS)
Basic earnings per share:
Income from continuing
operations................ $156.4 331.4 $0.47 $243.7 360.4 $0.68
Dilutive effects:
Stock options............. 0.3 0.3
Restricted stock
units (1)............... - -
Put options (1)........... - -
----------- ------------- ------------- ------------ -------------- ------------
Diluted earnings per share.. $156.4 331.7 $0.47 $243.7 360.7 $0.68
=========== ============= ============= ============ ============== ============
- -----------------
(1) The dilutive effect was less than 0.1 million shares.
The calculation of diluted earnings per share for the three months ended March
31, 2003 excludes the incremental effect related to call options to purchase our
stock and certain outstanding stock-based compensation grants due to their
anti-dilutive effect.
The calculation of diluted earnings per share for the three months ended March
31, 2002, excludes the incremental effect related to a put option contract. This
contract's strike price was lower than the average market price of our stock
during the period the contract was outstanding, resulting in an anti-dilutive
effect.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis discusses our financial condition as of March 31, 2003,
compared with December 31, 2002, and our consolidated results of operations for
the three months ended March 31, 2003 and 2002, prepared in conformity with
accounting principles generally accepted in the U.S. ("U.S. GAAP"). The
discussion and analysis includes, where appropriate, factors that may affect our
future financial performance. The discussion should be read in conjunction with
our Form 10-K, for the year ended December 31, 2002, filed with the United
States Securities and Exchange Commission and the unaudited consolidated
financial statements and the related notes to the financial statements and the
other financial information included elsewhere in this Form 10-Q.
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) 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; (2) 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; (3)
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; (4) 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 and
cause some of our existing liabilities to be subject to acceleration, additional
collateral support, changes in terms, or creation of additional financial
obligations; (5) our efforts to reduce the impact of interest rate changes on
our profitability and surplus may not be effective; (6) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (7) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (8) our reserves established for future
policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (9) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends Iowa insurance
laws impose on Principal Life; (10) we may need to fund deficiencies in our
closed block ("Closed Block") assets which benefit only the holders of Closed
Block policies; (11) changes in regulations or accounting standards may reduce
our profitability; (12) litigation and regulatory investigations may harm our
financial strength and reduce our profitability; (13) fluctuations in foreign
currency exchange rates could 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) 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; and
(16) a downgrade in our debt ratings may adversely affect our ability to secure
funds and cause some of our existing liabilities to be subject to acceleration,
additional collateral support, changes in terms, or creation of additional
financial obligations.
16
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
asset management operations conducted through Principal Global Investors.
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
Principal International, offers retirement products and services,
annuities, long-term mutual funds and life insurance through subsidiaries
in Argentina, Chile, Mexico and Hong Kong and joint ventures in Brazil,
Japan, India and Malaysia. Prior to October 31, 2002, the operating segment
included BT Financial Group, an Australia based asset manager. We sold
substantially all of BT Financial Group, effective October 31, 2002. See
"Transactions Affecting Comparability of Results of Operations."
o Life and Health Insurance, which provides life insurance, health insurance
as well as disability insurance throughout the U.S. Our life insurance
products include universal and variable universal life, traditional life,
and group life. Our health insurance products include medical insurance,
dental and vision insurance, and administrative services. Our disability
insurance products include individual and group disability insurance.
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.
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during 2003 and 2002:
IDBI - PRINCIPAL ASSET MANAGEMENT COMPANY. On March 28, 2003, our wholly-owned
subsidiary, Principal Financial Group (Mauritius) Ltd. signed a buy-sale
agreement to purchase an additional 50% ownership of IDBI - Principal Asset
Management Company in India from Industrial Development Bank of India ("IDBI")
for 940 million Indian Rupees ("INR") (approximately U.S. $19.8 million). This
transaction will give Principal Financial Group (Mauritius) Ltd. 100% ownership
of IDBI - Principal Asset Management Company. We expect this transaction to be
completed in the second quarter of 2003.
Principal Financial Group (Mauritius) Ltd. is also in negotiations to sell
minority ownership of IDBI - Principal Asset Management Company to Punjab
National Bank and Vijaya Bank, two large Indian commercial banks. Subsequent to
the close of these transactions, Principal Financial Group (Mauritius) Ltd. will
retain majority ownership of IDBI - Principal Asset Management Company. We
expect to close negotiations in the second half of 2003.
17
We currently account for IDBI - Principal Asset Management Company using the
equity method of accounting. We plan to fully consolidate the subsidiary when we
become majority owners.
AFORE TEPEYAC S.A. DE C.V. On February 28, 2003, we purchased a 100% ownership
of AFORE Tepeyac S.A. de C.V. ("AFORE Tepeyac") in Mexico from Mapfre American
Vida, Caja Madrid and Mapfre Tepeyac for MX$590.0 million Mexican Pesos ("MX$")
(approximately U.S. $53.5 million). The operations of AFORE Tepeyac have been
integrated into Principal International, Inc., as a part of our International
Asset Management and Accumulation segment.
BENEFIT CONSULTANTS, INC. On January 1, 2003, we acquired Benefit Consultants,
Inc. ("BCI Group") headquartered in Appleton, Wisconsin. BCI Group is a
full-service consulting, actuarial and administration firm that specializes in
administering qualified and nonqualified retirement benefit plans with a primary
focus on employee stock ownership plans. Effective, January 1, 2003, the
operations of BCI Group are reported in our U.S. Asset Management and
Accumulation segment.
ZURICH AFORE S.A. DE C.V. On May 31, 2002, we purchased a 100% ownership of
Zurich AFORE S.A. de C.V. ("Zurich AFORE") in Mexico from Zurich Financial
Services for MX$480.5 million (approximately U.S. $49.0 million). The operations
of Zurich AFORE have been integrated into Principal International, Inc., as a
part of our International Asset Management and Accumulation segment.
DISPOSITIONS
We entered into disposition agreements or disposed of the following businesses,
among others, during 2003 and 2002:
BT FINANCIAL GROUP. On October 31, 2002, we sold substantially all of BT
Financial Group to Westpac Banking Corporation ("Westpac") for proceeds of
A$900.0 million Australian dollars ("A$") (U.S. $499.4 million), and future
contingent proceeds in 2004 of up to A$150.0 million (approximately U.S. $80.0
million). The contingent proceeds will be based on Westpac's future success in
growing retail funds under management.
Excluding contingent proceeds, our estimated after-tax proceeds from the sale
are expected to be approximately U.S. $875.0 million. This amount includes cash
proceeds, expected tax benefits, and gain from unwinding the hedged asset
associated with our investment in BT Financial Group. As of December 31, 2002,
we accrued for an estimated after-tax loss on disposal of $208.7 million. During
the three months ended March 31, 2003, we incurred an additional after-tax loss
of $0.7 million. These losses are recorded in the loss from discontinued
operations in the consolidated statements of operations. Future adjustments to
the estimated loss are expected to be recorded through the first half of 2003,
as the proceeds from the sale are finalized.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, and therefore is still included in
our results of continuing operations. The results of operations (excluding
corporate overhead) for BT Financial Group are reported as other after-tax
adjustments in our International Asset Management and Accumulation segment.
Selected financial information for the discontinued operations is as follows:
18
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------------
2003 2002
----------------- ---------------
(IN MILLIONS, EXCEPT AS INDICATED)
Total assets under management ($ in
billions)................................. $ - $ 20.7
================= ===============
Total revenues. ............................ $ - $ 44.8
================= ===============
Loss from continuing operations (corporate
overhead)................................. $ - $ (0.8)
Income (loss) from discontinued operations:
Income (loss) before income taxes........... - 6.6
Income taxes (benefits)..................... - 4.3
----------------- ---------------
Income (loss) from discontinued operations.. - 2.3
Loss on disposal, net of related income
taxes..................................... (0.7) -
----------------- ---------------
Income (loss) from discontinued operations,
net of related income taxes............... (0.7) 2.3
Cumulative effect of accounting change, net
of related income taxes................... - (255.4)
----------------- ---------------
Net loss.................................... $ (0.7) $(253.9)
================= ===============
In connection with the 2002 sale of BT Financial Group, we agreed to indemnify
the purchaser, Westpac Banking Corporation ("Westpac") for, among other things,
the costs associated with potential late filings made by BT Financial Group in
New Zealand prior to Westpac's ownership, up to a maximum of A$250 million
Australian dollars (approximately U.S. $150 million). New Zealand securities
regulations allow Australian issuers to issue their securities in New Zealand
provided that certain documents are appropriately filed with the New Zealand
Registrar of Companies. Specifically, the regulations require that any
amendments to constitutions and compliance plans be filed in New Zealand. In
April 2003, the New Zealand Securities Commission ("the Commission") opined that
such late filings would result in certain New Zealand investors having a right
to return of their investment plus interest at 10% per annum from the date of
investment. Consequently, the Commission has advised that it has initiated an
inquiry into the matter, both with regard to BT Financial Group and other
similar issuers. We view these potential late filings as a technical matter as
we believe investors received the information that is required to be provided
directly to them. In addition, we believe this technical issue may affect many
in the industry and result in a favorable legislative or judicial solution.
Finally, we are reviewing the applicability of the indemnification regarding
this matter. Although we cannot predict the outcome of this matter or reasonably
estimate losses, we do not believe that it would result in a material adverse
effect on our business or financial position. It is possible, however, that it
could have a material adverse effect on our results of operations in a
particular quarter or annual period.
COVENTRY HEALTH CARE. On February 1, 2002, we sold our remaining stake of 15.1
million shares of Coventry Health Care, Inc. ("Coventry") common stock and a
warrant, exercisable for 3.1 million shares of Coventry common stock. We
received proceeds of $325.4 million, resulting in a net realized capital gain of
$183.0 million, or $114.5 million net of income taxes.
We reported our investment in Coventry in our Corporate and Other segment and
accounted for it using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million for the three months ended March 31,
2002.
19
OTHER TRANSACTIONS
SALE OF RETAIL FIELD MORTGAGE LENDING BRANCH OFFICES. On February 5, 2003,
Principal Residential Mortgage signed a definitive agreement to sell the retail
field mortgage lending branches to American Home Mortgage, Inc. ("American Home
Mortgage"), an independent retail mortgage banking company. American Home
Mortgage has paid Principal Residential Mortgage a guaranteed profit margin on
its application pipeline that existed as of February 4, 2003 and has purchased
the assets of the branch network and assumed related liabilities.
REINSURANCE TRANSACTION. Effective January 1, 2002, we entered into a
reinsurance agreement to reinsure group medical insurance contracts. We have
amended the contract. Effective January 1, 2003, the reinsurance contract will
be reported under the deposit method of accounting. This will reduce ceded
premiums and claims prospectively.
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 2002. The devaluation did not 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 net income was negatively
impacted $1.8 million for the three months ended March 31, 2003 and positively
impacted $1.3 million for the three months ended March 31, 2002, 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 Item 3.
"Quantitative and Qualitative Disclosures about Market Risk."
PENSION AND OTHER POST-RETIREMENT BENEFIT EXPENSE
The 2003 annual pension benefit expense for substantially all of our employees
and certain agents is approximately $60.2 million pre-tax, $39.1 million
after-tax. This is an annual pre-tax increase of $53.7 million over the 2002
pre-tax pension expense of $6.5 million. Approximately $15.0 million of pre-tax
pension expense was reflected in the determination of first quarter, 2003 net
income. In addition, approximately $15.0 million of pre-tax pension expense will
be reflected in each of the following three quarters of 2003. This increase in
expense over 2002 is primarily due to the impact of low interest rates and the
equity market downturn. The discount rate used to value the liabilities was
lowered to 6.5% from the 2002 discount rate of 7.5% and the return on assets
assumption was lowered to 8.5% from the 2002 return on assets assumption of
9.0%. To a lesser extent, the expense for other post-retirement benefits expense
increased as well.
20
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
years indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
------------- -------------
INCOME STATEMENT DATA: (IN MILLIONS)
Revenues:
Premiums and other considerations......................... $ 905.5 $ 885.7
Fees and other revenues................................... 632.0 432.9
Net investment income..................................... 836.0 811.1
Net realized/unrealized capital gains (losses)............ (76.7) 98.1
------------- --------------
Total revenues.......................................... 2,296.8 2,227.8
Expenses:
Benefits, claims and settlement expenses.................. 1,195.2 1,203.2
Dividends to policyholders................................ 80.1 82.4
Operating expenses........................................ 799.3 592.2
------------- --------------
Total expenses.......................................... 2,074.6 1,877.8
------------- --------------
Income from continuing operations before income taxes....... 222.2 350.0
Income taxes................................................ 65.8 106.3
------------- --------------
Income from continuing operations, net of related
income taxes............................................ 156.4 243.7
Income (loss) from discontinued operations, net of related
income taxes.............................................. (0.7) 2.3
------------- --------------
Income before cumulative effect of accounting changes..... 155.7 246.0
Cumulative effect of accounting change, net of related
income taxes.............................................. - (280.9)
------------- --------------
Net income (loss)......................................... $ 155.7 $ (34.9)
============= ==============
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premiums and other considerations increased $19.8 million, or 2%, to $905.5
million for the three months ended March 31, 2003, from $885.7 million for the
three months ended March 31, 2002. The increase reflected a $26.1 million
increase from the Life and Health Insurance segment, primarily related to health
premium rate increases, a reduction in ceded premiums resulting from a change in
the accounting treatment of a group medical reinsurance contract, and increased
group disability sales. The increase also reflected a $4.2 million increase from
the U.S. Asset Management and Accumulation segment, primarily a result of an
increase in individual payout annuity sales due to an expanding distribution
presence that was partially offset by a decrease in pension full-service payout
sales of single premium group annuities with life contingencies. These increases
were partially offset by a $10.5 million decrease from the International Asset
Management and Accumulation segment due to a decrease in Chile primarily a
result of decreased sales of single premium annuities with life contingencies
related to market contraction, the weakening of the Chilean peso versus the U.S.
dollar, and a decrease in Mexico primarily a result of prolonged government
retention of potential annuitants.
Fees and other revenues increased $199.1 million, or 46%, to $632.0 million for
the three months ended March 31, 2003, from $432.9 million for the three months
ended March 31, 2002. The increase was primarily due to a $178.9 million
increase from the Mortgage Banking segment resulting from an increase in
mortgage loan production fee revenues, reflecting the increase in mortgage loan
production volume. The increase also related to an $11.7 million increase from
the U.S. Asset Management and Accumulation segment primarily related to the
acquisition of BCI Group and an increase in the fee scale of selected funds. In
addition, the increase was also due to a $7.4 million increase from the Life and
Health Insurance segment, primarily related to growth and fee increases in the
fee-for-service business and growth in our individual universal and variable
universal life insurance business.
21
Net investment income increased $24.9 million, or 3%, to $836.0 million for the
three months ended March 31, 2003, from $811.1 million for the three months
ended March 31, 2002. The increase was primarily a result of a $5,180.3 million,
or 11%, increase in average invested assets and cash. Partially offsetting the
increase was a decrease in annualized investment yields. The annualized yield on
average invested assets and cash was 6.6% for the three months ended March 31,
2003, compared to 7.1% for the three months ended March 31, 2002. This reflects
lower yields on fixed maturity securities due in part to a lower interest rate
environment.
Net realized/unrealized capital losses increased $174.8 million to $76.7 million
of net realized/unrealized capital losses for the three months ended March 31,
2003, from $98.1 million of net realized/unrealized capital gains for the three
months ended March 31, 2002. The increase was primarily due to the capital gain
realized as the result of the sale of our remaining investment in Coventry in
February 2002 with no corresponding activity in 2003. There was also an increase
in other than temporary impairments of fixed maturity securities partially
offset by lower losses on the sales of fixed maturity securities and equity
securities.
Benefits, claims and settlement expenses decreased $8.0 million, or 1%, to
$1,195.2 million for the three months ended March 31, 2003, from $1,203.2
million for the three months ended March 31, 2002. The decrease was due to a
$12.2 million decrease from the U.S. Asset Management and Accumulation segment,
primarily reflecting a decrease in interest credited to customers. The decrease
also reflected a $5.2 million decrease from the International Asset Management
and Accumulation segment primarily a result of prolonged government retention of
potential annuitants in Mexico. These decreases were partially offset by an $8.3
million increase from the Life and Health Insurance segment, primarily due to a
reduction in ceded claims for group medical reinsurance, which was a result of a
change in the accounting treatment of the contract.
Dividends to policyholders decreased $2.3 million, or 3%, to $80.1 million for
the three months ended March 31, 2003, from $82.4 million for the three months
ended March 31, 2002. The decrease was primarily attributable to a $2.5 million
decrease from the Life and Health Insurance segment, resulting from changes in
the individual life dividend scale.
Operating expenses increased $207.1 million, or 35%, to $799.3 million for the
three months ended March 31, 2003, from $592.2 million for the three months
ended March 31, 2002. The increase was largely due to a $153.8 million increase
from the Mortgage Banking segment primarily resulting from growth in the
mortgage loan servicing portfolio, an increase in impairment of capitalized
mortgage servicing rights net of servicing hedge activity and an increase in the
mortgage loan production volume. The increase was also due to a $45.3 million
increase in the U.S Asset Management and Accumulation segment due to higher
incentive compensation accruals, the expansion of our asset management offshore
operations and deferred policy acquisition cost ("DPAC") unlocking. In addition,
Life and Health Insurance segment operating expenses increased $21.5 million
related to increased employee benefit costs, a decrease in DPAC capitalization
due to the decrease in sales, and growth in the fee-for-service business. These
increases were partially offset by a $10.9 million decrease from the Corporate
and Other segment, primarily due to decreased corporate initiatives funded by
this segment.
Income taxes decreased $40.5 million, or 38%, to $65.8 million for the three
months ended March 31, 2003 from $106.3 million for the three months ended March
31, 2002. The effective income tax rate was 30% for the three months ended March
31, 2003 and 2002. The effective income tax rates for the three months ended
March 31, 2003 and 2002 were lower than the corporate income tax rate of 35%
primarily due to income tax deductions allowed for corporate dividends received
and interest exclusion from taxable income, partially offset by state income
taxes.
As a result of the foregoing factors and the inclusion of loss from discontinued
operations and the cumulative effect of accounting change, net of related income
taxes, net income increased $190.6 million to $155.7 million of net income for
22
the three months ended March 31, 2003, from $34.9 million of net loss for the
three months ended March 31, 2002. The loss from discontinued operations was
related to our sale of BT Financial Group. The cumulative effect of accounting
change was related to our implementation of SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS ("SFAS 142") in 2002.
RESULTS OF OPERATIONS BY SEGMENT
We evaluate segment performance by segment operating earnings, which excludes
the effect of net realized/unrealized capital gains and losses, as adjusted, and
other after-tax adjustments. Segment operating earnings are determined by
adjusting U.S. GAAP net income for net realized/unrealized capital gains and
losses, as adjusted, and other after-tax adjustments that we believe are not
indicative of overall operating trends. However, it is possible that these
adjusting items have occurred in the past and could recur in the future. 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, ongoing operations of our
businesses.
The following table presents segment information as of or for the periods
indicated:
23
AS OF OR FOR THREE MONTHS
ENDED MARCH 31,
-----------------------------------
2003 2002
--------------- ---------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation.......................... $ 886.0 $ 862.1
International Asset Management and Accumulation................. 76.8 75.9
Life and Health Insurance....................................... 1,012.3 978.5
Mortgage Banking................................................ 404.5 208.7
Corporate and Other(1).......................................... (0.7) 10.5
--------------- ---------------
Total segment operating revenues.............................. 2,378.9 2,135.7
Net realized/unrealized capital gains (losses), including
recognition of front-end fee revenues and certain market value
adjustments to fee revenues(2)................................ (82.1) 92.1
--------------- ---------------
Total revenue per consolidated statements of operations....... $ 2,296.8 $ 2,227.8
=============== ===============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ......................... $ 97.5 $ 100.2
International Asset Management and Accumulation................. 6.6 1.2
Life and Health Insurance....................................... 59.1 54.3
Mortgage Banking................................................ 52.3 26.5
Corporate and Other ............................................ (5.0) 0.3
--------------- ---------------
Total segment operating earnings.............................. 210.5 182.5
Net realized/unrealized capital gains (losses), as adjusted(2).. (54.1) 63.2
Other after-tax adjustments(3).................................. (0.7) (280.6)
--------------- ---------------
Net income (loss) per consolidated statements of operations... $ 155.7 $ (34.9)
=============== ===============
TOTAL ASSETS BY SEGMENT:
U.S. Asset Management and Accumulation(4)....................... $72,396.8 $ 68,738.6
International Asset Management and Accumulation................. 2,269.6 4,677.7
Life and Health Insurance....................................... 11,477.0 10,939.1
Mortgage Banking................................................ 3,651.5 2,897.3
Corporate and Other(5).......................................... 2,045.6 1,506.0
--------------- ---------------
Total assets.................................................. $91,840.5 $ 88,758.7
=============== ===============
- -----------------------
(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, internal interest paid to our Mortgage Banking
segment for escrow accounts deposited with our U.S. Asset Management and
Accumulation segment.
(2)In addition to sales activity and other than temporary impairments, net
realized/unrealized capital gains (losses) include unrealized gains (losses)
on mark to market changes of certain seed money investments and investments
classified as trading securities, as well as unrealized gains (losses) on
certain derivatives. Net realized/unrealized capital gains (losses), as
adjusted, are net of income taxes, net realized capital gains and losses
distributed, minority interest capital gains, 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.
24
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------
2003 2002
-------------- --------------
(IN MILLIONS)
Net realized/unrealized capital gains (losses)................ $ (76.7) $ 98.1
Certain market value adjustments to fee revenues.............. (9.8) (8.6)
Recognition of front-end fee revenues......................... 4.4 2.6
-------------- --------------
Net realized/unrealized capital gains (losses),
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues............................... (82.1) 92.1
Amortization of deferred policy acquisition costs
related to net realized capital gains (losses).............. 3.7 10.9
Capital losses distributed.................................... 1.6 -
Minority interest capital gains............................... (0.1) -
-------------- --------------
Net realized/unrealized 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, capital losses distributed and minority interest
capital gains............................................. (76.9) 103.0
Income tax effect............................................. 22.8 (39.8)
-------------- --------------
Net realized/unrealized capital gains (losses), as
as adjusted............................................... $ (54.1) $ 63.2
============== ==============
(3)For the three months ended March 31, 2003, other after-tax adjustments of
$0.7 million included the negative effect of a change in the estimated loss
on disposal of BT Financial Group. For the three months ended March 31, 2002,
other after-tax adjustments of $280.6 million included (1) the negative
effects of: (a) a cumulative effect of accounting change related to our
implementation of SFAS 142 ($280.9 million) and (b) expenses related to our
demutualization ($2.0 million) and (2) the positive effect of the income on
discontinued operations of BT Financial Group ($2.3 million).
(4)U.S. Asset Management and Accumulation separate account assets include
shares of Principal Financial Group stock allocated to a separate account, a
result of our demutualization. The value of the separate account was $838.0
million at March 31, 2003, and $1.1 billion at March 31, 2002. Activity of
the separate account was reflected in both separate account assets and
separate account liabilities and did not impact our results of operations.
(5)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.
25
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:
FOR THE THREE MONTHS ENDED MARCH 31,
-------------------------------------
2003 2002
---------------- ----------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other considerations........... $ 113.8 $ 109.6
Fees and other revenues..................... 184.8 173.7
Net investment income....................... 587.4 578.8
---------------- ----------------
Total operating revenues.................. 886.0 862.1
Expenses:
Benefits, claims and settlement expenses,
including dividends to policyholders........ 535.6 547.6
Operating expenses.......................... 225.4 187.5
---------------- ----------------
Total expenses............................ 761.0 735.1
---------------- ----------------
Pre-tax operating earnings.................... 125.0 127.0
Income taxes.................................. 27.5 26.8
---------------- ----------------
Operating earnings............................ $ 97.5 $ 100.2
================ ================
- -----------------------------
(1) Excludes net realized/unrealized capital losses and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premiums and other considerations increased $4.2 million, or 4%, to $113.8
million for the three months ended March 31, 2003, from $109.6 million for the
three months ended March 31, 2002. The increase primarily resulted from a $15.4
million increase in individual payout annuity sales due to an expanding
distribution presence. This increase was offset by an $11.2 million decrease in
pension full-service payout sales of single premium group annuities with life
contingencies, which are typically used to fund defined benefit plan
terminations. The premium income received from these contracts fluctuates due to
the variability in the number and size of pension plan terminations, the
interest rate environment, and the ability to attract new sales.
Fees and other revenues increased $11.1 million, or 6%, to $184.8 million for
the three months ended March 31, 2003, from $173.7 million for the three months
ended March 31, 2002. Pension full-service accumulation fees and other revenue
increased $7.0 million primarily due to the acquisition of BCI Group and an
increase in the fee scale of selected funds. In addition, Principal Global
Investors fees and other revenues increased $5.3 million primarily due to
increased revenues from Spectrum and the expansion of our asset management
offshore operations.
Net investment income increased $8.6 million, or 1%, to $587.4 million for the
three months ended March 31, 2003, from $578.8 million for the three months
ended March 31, 2002. The increase primarily resulted from a $3,375.5 million,
or 10%, increase in average invested assets and cash. The increase was offset by
a decrease in the average annualized yield on invested assets and cash, which
was 6.3% for the three months ended March 31, 2003, compared to 6.8% for the
three months ended March 31, 2002.
Benefits, claims and settlement expenses, including dividends to policyholders,
decreased $12.0 million, or 2%, to $535.6 million for the three months ended
26
March 31, 2003, from $547.6 million for the three months ended March 31, 2002.
The decrease primarily resulted from a $25.8 million decrease in our pension
full-service accumulation business. This decrease was largely due a decrease in
interest credited to customers and a decrease in our participating block of
business. Partially offsetting this decrease was a $14.8 million increase, which
primarily related to an increase in reserves resulting from higher individual
payout annuity sales.
Operating expenses increased $37.9 million, or 20%, to $225.4 million for the
three months ended March 31, 2003, from $187.5 million for the three months
ended March 31, 2002. The increase largely resulted from a $15.1 million
increase in Principal Global Investors operating expenses due to higher
incentive compensation accruals and the expansion of our asset management
offshore operations. In addition, pension full-service accumulation operating
expenses increased $12.0 million primarily due to favorable unlocking of DPAC in
2002, resulting from a change in the compensation structure for Employee Benefit
Sales and Service. Furthermore, individual deferred annuity operating expenses
increased $7.4 million primarily due to DPAC unlocking caused by adverse
separate account performance and higher lapse rates associated with the variable
deferred annuity product line.
Income taxes increased $0.7 million, or 3%, to $27.5 million for the three
months ended March 31, 2003, from $26.8 million for the three months ended March
31, 2002. The effective income tax rate for this segment was 22% for the three
months ended March 31, 2003, and 21% for the three months ended March 31, 2002.
The effective income tax rates for the three months ended March 31, 2003 and
2002, 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.
Operating earnings decreased $2.7 million, or 3%, to $97.5 million for the three
months ended March 31, 2003 from $100.2 million for the three months ended March
31, 2002 primarily reflecting higher incentive compensation accruals, the
expansion of the asset management offshore operations and favorable DPAC
unlocking in 2002.
27
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 THREE MONTHS ENDED
MARCH 31,
--------------------------------
2003 2002
------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues (1):
Premiums and other considerations...................... $ 30.7 $ 41.2
Fees and other revenues................................ 14.8 12.1
Net investment income.................................. 31.3 22.6
------------- ---------------
Total operating revenues............................. 76.8 75.9
Expenses:
Benefits, claims and settlement expenses............... 48.1 52.7
Operating expenses..................................... 20.6 22.8
------------- ---------------
Total expenses....................................... 68.7 75.5
------------- ---------------
Pre-tax operating earnings............................... 8.1 0.4
Income taxes (benefits).................................. 1.5 (0.8)
------------- ---------------
Operating earnings....................................... $ 6.6 $ 1.2
============= ===============
OTHER DATA:
Operating earnings (loss):
Principal International................................ $ 6.6 $ 2.0
BT Financial Group..................................... - (0.8)
- ---------------------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premiums and other considerations decreased $10.5 million, or 25%, to $30.7
million for the three months ended March 31, 2003, from $41.2 million for the
three months ended March 31, 2002. A decrease of $5.1 million in Chile was
primarily a result of decreased sales of single premium annuities with life
contingencies due to market contraction and the weakening of the Chilean peso
versus the U.S. dollar. In addition, a decrease of $4.2 million in Mexico was
primarily a result of prolonged government retention of potential annuitants.
Fees and other revenues increased $2.7 million, or 22%, to $14.8 million for the
three months ended March 31, 2003, from $12.1 million for the three months ended
March 31, 2002. An increase of $3.3 million in Mexico was primarily a result of
an increase in the number of retirement plan participants due to the acquisition
of Zurich AFORE in 2002 and AFORE Tepeyac in 2003. The increase was partially
offset by a decrease of $0.3 million in Argentina, primarily related to the
weakening of the Argentine peso versus the U.S. dollar and of the general
economic environment.
Net investment income increased $8.7 million, or 38%, to $31.3 million for the
three months ended March 31, 2003, from $22.6 million for the three months ended
March 31, 2002. The increase was primarily related to an increase in the
annualized yield on average invested assets and cash, excluding our equity
investment in subsidiaries, which was 7.9% for the three months ended March 31,
2003, compared to 6.2% for the three months ended March 31, 2002. To a lesser
extent, the increase was due to a $155.4 million, or 12%, increase in average
invested assets and cash, excluding our equity investment in subsidiaries.
28
Benefits, claims and settlement expenses decreased $4.6 million, or 9%, to $48.1
million for the three months ended March 31, 2003, from $52.7 million for the
three months ended March 31, 2002. A $3.7 million decrease in Mexico was
primarily a result of prolonged government retention of potential annuitants. In
addition, a decrease of $1.2 million in Argentina was primarily related to the
weakening of the Argentine peso versus the U.S. dollar and of the general
economic environment.
Operating expenses decreased $2.2 million, or 10%, to $20.6 million for the
three months ended March 31, 2003, from $22.8 million for the three months ended
March 31, 2002. A decrease of $2.7 million was due to weakening currencies in
Latin American countries. Partially offsetting this decrease was an increase of
$2.2 million in Mexico primarily due to the acquisition of Zurich AFORE in 2002
and AFORE Tepeyac in 2003. Operating expenses incurred by BT Financial Group
were $1.3 million for the three months ended March 31, 2002. These expenses
represent corporate overhead allocated to BT Financial Group and do not qualify
for discontinued operations treatment.
Income tax expense increased $2.3 million to $1.5 million of income tax expense
for the three months ended March 31, 2003, from a $0.8 million income tax
benefit for the three months ended March 31, 2002. The increase was primarily a
result of an increase in pre-tax operating earnings.
Operating earnings increased $5.4 million to $6.6 million for the three months
ended March 31, 2003, from $1.2 million for the three months ended March 31,
2002 primarily due to increased earnings from the acquisition of Zurich AFORE in
2002 and higher nominal yields on invested assets in Chile.
29
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:
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------
2003 2002
--------------- ------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues(1):
Premiums and other considerations.................. $ 761.0 $ 734.9
Fees and other revenues............................ 84.4 77.0
Net investment income.............................. 166.9 166.6
-------------- ------------
Total operating revenues......................... 1,012.3 978.5
Expenses:
Benefits, claims and settlement expenses........... 617.8 609.5
Dividends to policyholders......................... 75.5 78.0
Operating expenses................................. 230.1 208.4
-------------- ------------
Total expenses................................... 923.4 895.9
-------------- ------------
Pre-tax operating earnings........................... 88.9 82.6
Income taxes......................................... 29.8 28.3
-------------- ------------
Operating earnings................................... $ 59.1 $ 54.3
============== ============
- ------------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premiums and other considerations increased $26.1 million, or 4%, to $761.0
million for the three months ended March 31, 2003, from $734.9 million for the
three months ended March 31, 2002. Health insurance premiums increased $22.7
million, primarily due to rate increases and a reduction in ceded premium for
group medical reinsurance, which was a result a change in the accounting
treatment of the contract. Disability insurance premiums increased $9.7 million
primarily due to increased sales and favorable retention. Partially offsetting
the increase was a $6.3 million decrease in life insurance premiums, primarily
resulting from the continued shift of customer preference from traditional life
insurance products to fee-based universal and variable universal life insurance
products.
Fees and other revenues increased $7.4 million, or 10%, to $84.4 million for the
three months ended March 31, 2003, from $77.0 million for the three months ended
March 31, 2002. Fee revenues from our health insurance business increased $4.7
million, primarily a result of growth and fee increases. Fee revenues from our
life insurance business increased $2.7 million, primarily due to the continued
shift in customer preference, as previously mentioned.
Net investment income increased $0.3 million to $166.9 million for the three
months ended March 31, 2003, from $166.6 million for the three months ended
March 31, 2002. The increase primarily reflects a $578.6 million, or 6%,
increase in average invested assets and cash for the segment. Partially
offsetting the increase was a lower annualized average investment yield due in
part to an overall lower interest rate environment. The annualized yield on
average invested assets and cash was 7.0% for the three months ended March 31,
2003, compared to 7.4% for the three months ended March 31, 2002.
Benefits, claims and settlement expenses increased $8.3 million, or 1%, to
$617.8 million for the three months ended March 31, 2003, from $609.5 million
for the three months ended March 31, 2002. Health insurance benefits, claims and
30
settlement expenses increased $8.6 million, primarily due to a reduction in
ceded claims for group medical reinsurance, which was related to a change in the
accounting treatment of the contract. Increased claim costs per member were more
than offset by decreases in insured members and improved loss ratios. Disability
insurance benefits, claims and settlement expenses increased $3.9 million,
primarily a result of growth in the business. Partially offsetting these
increases was a $4.2 million decrease in life insurance benefits, claims and
settlement expenses primarily due to lower reserve increases related to the
decrease in premium.
Dividends to policyholders decreased $2.5 million, or 3%, to $75.5 million for
the three months ended March 31, 2003, from $78.0 million for the three months
ended March 31, 2002. The decrease is primarily related to changes in the
individual life dividend scale.
Operating expenses increased $21.7 million, or 10%, to $230.1 million for the
three months ended March 31, 2003, from $208.4 million for the three months
ended March 31, 2002. Health insurance operating expenses increased $14.0
million, primarily a result of prior period premium tax related adjustments in
2003, growth in the fee-for-service business, increased employee benefit costs,
and increased commissions related to higher premiums. Disability insurance
operating expenses increased $5.9 million primarily due to increases in
compensation costs, non-deferrable commissions related to higher premium,
non-deferrable distribution expenses associated with higher sales, and
amortization of DPAC on a growing block of disability insurance business.
Income taxes increased $1.5 million, or 5%, to $29.8 million for the three
months ended March 31, 2003, from $28.3 million for the three months ended March
31, 2002. The effective income tax rate for the segment was 34% for the three
months ended March 31, 2003 and 2002. The effective income tax rates for the
three months ended March 31, 2003 and 2002 were lower than the corporate income
tax rate of 35% primarily due to tax-exempt income.
Operating earnings increased $4.8 million, or 9%, to $59.1 million for the three
months ended March 31, 2003, from $54.3 million for the three months ended March
31, 2002 primarily due to improved health insurance loss ratios and favorable
one-time reserve and expense adjustments in the life insurance business.
31
MORTGAGE BANKING SEGMENT
The following table presents certain summary financial data relating to the
Mortgage Banking segment for the years indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------------
2003 2002
----------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues:
Loan servicing.................................. $ 164.1 $ 127.6
Loan production................................. 240.4 81.1
----------------- ---------------
Total operating revenues...................... 404.5 208.7
Expenses:
Loan servicing.................................. 256.9 127.9
Loan production................................. 63.5 38.7
----------------- ---------------
Total expenses................................ 320.4 166.6
----------------- ---------------
Pre-tax operating earnings........................ 84.1 42.1
Income taxes...................................... 31.8 15.6
----------------- ---------------
Operating earnings................................ $ 52.3 $ 26.5
================= ===============
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Total operating revenues increased $195.8 million, or 94%, to $404.5 million for
the three months ended March 31, 2003, from $208.7 million for the three months
ended March 31, 2002. Residential mortgage loan production revenues increased
$159.3 million primarily due to an increase in mortgage loan production, which
increased to $15.5 billion for the three months ended March 31, 2003, compared
to $10.0 billion for the same period a year ago. A $36.5 million increase in
residential mortgage loan servicing revenues reflects an increase in the
residential mortgage loan servicing portfolio. The average balance of the
servicing portfolio was $111.0 billion for the three months ended March 31,
2003, compared to $85.2 billion for the same period a year ago.
Total expenses increased $153.8 million, or 92%, to $320.4 million for the three
months ended March 31, 2003, from $166.6 million for the three months ended
March 31, 2002. A $129.0 million increase in residential mortgage loan servicing
expenses resulted from increased expenses related to growth in the servicing
portfolio and a $69.0 million increase in impairment of capitalized mortgage
servicing rights net of servicing hedge activity. Residential mortgage loan
production expenses increased $24.8 million reflecting the increase in
residential mortgage loan production volume.
Income taxes increased $16.2 million to $31.8 million for the three months ended
March 31, 2003, from $15.6 million for the three months ended March 31, 2002.
The increase in income taxes primarily resulted from an increase in pre-tax
operating earnings. The effective income tax rate for this segment was 38% for
the three months ended March 31, 2003, and 37% for the three months ended March
31, 2002. The effective income tax rates for the three months ended March 31,
2003 and 2002, were higher than the corporate income tax rate of 35% due to
state income taxes.
Operating earnings increased $25.8 million, or 97%, to $52.3 million for the
three months ended March 31, 2003, from $26.5 million for the three months ended
March 31, 2002 primarily due to an increase in mortgage loan production volume
and improved margins during this period of high production volume.
32
CORPORATE AND OTHER SEGMENT
The following table presents certain summary financial data relating to the
Corporate and Other segment for the years indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------------
2003 2002
----------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues (1):
Total operating revenues........................... $ (0.7) $10.5
Expenses:
Total expenses..................................... 6.3 12.5
----------------- ---------------
Pre-tax operating loss............................... (7.0) (2.0)
Income tax benefits.................................. (2.0) (2.3)
----------------- ---------------
Operating earnings (loss)............................ $ (5.0) $ 0.3
================= ===============
- ------------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Total operating revenues decreased $11.2 million to a negative $0.7 million for
the three months ended March 31, 2003, from a positive $10.5 million for the
three months ended March 31, 2002. Net investment income decreased $9.2 million,
primarily due to a decrease in average annualized investment yields for the
segment. The decrease in total revenues was also partially due to a $3.2 million
increase in inter-segment eliminations included in this segment, which was
offset by a corresponding change in total expenses.
Total expenses decreased $6.2 million, or 50%, to $6.3 million for the three
months ended March 31, 2003, from $12.5 million for the three months ended March
31, 2002. A decrease of $6.2 million related to corporate initiatives funded by
this segment. In addition, inter-segment eliminations included in this segment
increased $3.2 million, resulting in a decrease in total expenses. These
decreases were partially offset by a $3.8 million increase in interest expense
on the 144a debt, largely due to the termination of the hedges that were in
place in 2002.
Income tax benefits decreased $0.3 million, or 13%, to $2.0 million for the
three months ended March 31, 2003, from $2.3 million for the three months ended
March 31, 2002.
Operating loss increased $5.3 million to $5.0 million of operating loss for the
three months ended March 31, 2003, from $0.3 million of operating earnings for
the three months ended March 31, 2002 primarily due to a decrease of average
annualized investment yields.
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES OF CASH OF CONSOLIDATED OPERATIONS
Net cash provided by operating activities was $955.8 million and $494.5 million
for the three months ended March 31, 2003 and 2002, respectively. The increase
in 2003 compared to 2002 is primarily related to an increase in mortgage banking
servicing and production fees, an increase in funds collected on behalf of
investors related to mortgage banking services, as well as decreases in income
tax payments and cash paid for benefits, claims and settlement expenses.
33
Net cash used in investing activities was $1,661.7 million and $904.2 million
for the three months ended March 31, 2003 and 2002, respectively. The increase
in cash used in investing activities between periods is primarily related to the
sale of our shares of Coventry stock in 2002, with no corresponding sale
occurring in 2003. Also contributing to the increase in cash used was an
increase in the volume of net mortgage loans purchased and sold in 2003,
compared to the prior year.
Net cash provided by financing activities was $634.2 million and $337.5 million
for the three months ended March 31, 2003 and 2002, respectively. The increase
in net cash provided by financing activities in 2003 compared to 2002 is
primarily due to an increase in investment contract deposits, net of
withdrawals. Partially offsetting this increase was an increase in cash used for
the repurchase of shares of our common stock.
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.
DIVIDENDS FROM PRINCIPAL LIFE
The payment of stockholder dividends by Principal Life to its parent company 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 statutory policyholder surplus as of the previous
year-end; or
o the statutory 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 2002 statutory results,
Principal Life could pay approximately $746.6 million in stockholder dividends
in 2003 without exceeding the statutory limitation.
As of March 31, 2003, Principal Life has accrued a dividend in the amount of
$200.0 million. In February 2003, Principal Life's board of directors declared
an ordinary dividend of up to $490.0 million, however, we do not plan to
transfer cash in addition to the amount accrued by Principal Life in 2003.
COMMON STOCK ISSUED AND TREASURY STOCK ACQUIRED
In the last two years, our board of directors has authorized various repurchase
programs under which we are allowed to purchase shares of our outstanding common
stock. Shares repurchased under these programs are accounted for as treasury
stock, carried at cost and reflected as a reduction to stockholders' equity.
During the three months ended March 31, 2003, we repurchased 6.5 million shares
of our outstanding common stock on the open market at an aggregated cost of
$184.1 million, relating to a stock repurchase program authorized on November
26, 2002. Under this authorization, our board of directors approved a repurchase
of up to $300.0 million.
INTERNATIONAL OPERATIONS
We expect to receive approximately $875.0 million of proceeds from our sale of
substantially all of BT Financial Group to Westpac. This amount includes cash
proceeds, expected tax benefits, and a gain from unwinding the hedged asset
associated with our investment in BT Financial Group. An additional future
contingent receipt of $80.0 million may be received in 2004, if Westpac
experiences growth in their retail assets under management. As of March 31,
2003, we have received $667.5 million of the expected proceeds.
34
Our Brazilian, Chilean and Mexican operations produced positive cash flow from
operations for the three months ended March 31, 2003 and 2002. These cash flows
have been historically maintained at the local country level for strategic
expansion purposes. Our international operations have required an infusion of
capital of $29.5 million for the three months ended March 31, 2003, primarily to
fund our acquisition of AFORE Tepeyac in Mexico. We also required an infusion of
capital of $5.1 million for the three months ended March 31, 2002, to meet the
cash outflow requirements of our other operations or to fund acquisitions. These
other international 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
As of March 31, 2003, we had $1,335.6 million of long-term debt outstanding
compared to $1,332.5 million at December 31, 2002. Non-recourse medium-term
notes outstanding as of March 31, 2003, were $3,643.6 million compared to
$3,583.5 million at December 31, 2002. Non-recourse medium-term notes represent
claims for principal and interest under international funding agreements issued
to non-qualified institutional investors.
As of March 31, 2003, we had $758.6 million of short-term debt outstanding
compared to $564.8 million at December 31, 2002. Short-term debt consists
primarily of commercial paper and outstanding balances on revolving credit
facilities with various financial institutions. As of March 31, 2003, we had
credit facilities with various financial institutions in an aggregate amount of
$1.7 billion. These credit facilities include $700.0 million in credit
facilities to finance a commercial mortgage-backed securities ("CMBS") pipeline,
$300.0 million in credit facilities to purchase mortgage servicing rights, and
$100.0 million in credit facilities to purchase certain CMBS securities for
investment purposes. In addition, we may borrow up to $600.0 million on a
back-stop facility to support our $1.0 billion commercial paper program, of
which there were no outstanding balances as of March 31, 2003.
There have been no significant changes to the contractual obligations and
commitments since December 31, 2002.
OFF-BALANCE SHEET ARRANGEMENTS
RESIDENTIAL MORTGAGE LOAN PRODUCTION. Principal Residential Mortgage Capital
Resources, LLC ("PRMCR") provides an off-balance sheet source of funding for our
residential mortgage loan production. We sold approximately $15.6 billion and
$10.1 billion in mortgage loans to PRMCR in the first quarter of 2003 and 2002,
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 March
31, 2003. PRMCR held $3.6 billion and $2.7 billion in mortgage loans held for
sale as of March 31, 2003 and 2002, respectively. The portfolio of loans 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. During the first quarter of
2003, we repurchased $32.3 million of ineligible loans from PRMCR.
At March 31, 2003, PRMCR had outstanding equity certificates of $193.0 million,
secured liquidity notes of $1.8 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. These funds are available as additional
collateral to cover credit related losses on defaulted mortgage loans. The
balance in the account was $24.0 million at March 31, 2003 and 2002, and is
reflected in other assets on our consolidated statements of financial position.
35
We maintain a right to the servicing of the mortgage loans held by PRMCR and
retain servicing upon the sale of the majority of the mortgage loans to the
final investors. As the servicer, we receive a monthly servicing fee and may
earn additional incentive servicing fees upon successful completion of our
servicing responsibilities. We received $6.8 million and $5.6 million in
servicing and incentive servicing fees from PRMCR in the first quarter of 2003
and 2002, respectively. Any unpaid and earned incentive fees as well as any
remaining amounts in the cash collateral account will be returned to us upon the
termination of PRMCR.
DELINQUENT RESIDENTIAL MORTGAGE LOAN FUNDING. Principal Residential Mortgage
Funding, LLC ("PRMF"), provides an off-balance sheet source of funding for
qualifying delinquent mortgage loans. At March 31, 2003 and 2002, the Trust held
$507.0 million and $293.5 million in mortgage loans, respectively, and had
outstanding participation certificates of $479.3 million and $275.4 million,
respectively.
We are retained as the servicer of the mortgage loans and also perform
accounting and various administrative functions on behalf of PRMF, in our
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. We received $7.0 million and $4.8 million in
servicing and successful servicing fees from PRMF in the first quarter of 2003
and 2002, respectively. At March 31, 2003 and 2002, our residual interest in
such cash flows was $39.9 million and $22.8 million, respectively, and was
recorded in other assets on the consolidated statements of financial position.
GUARANTEES AND INDEMNIFICATIONS
In the normal course of business, we have provided guarantees to third parties
primarily related to a former subsidiary, joint ventures and industrial revenue
bonds. These agreements generally expire from 2003 through 2019. The estimated
maximum exposure under these agreements as of March 31, 2003, was $183.0
million; however, we believe the likelihood is remote that material payments
will be required and therefore have not accrued for a liability on our
consolidated statements of financial position. Should we be required to perform
under these guarantees, we generally could recover a portion of the loss from
third parties through recourse provisions included in agreements with such
parties, the sale of assets held as collateral that can be liquidated in the
event that performance is required under the guarantees or other recourse
generally available to us, minimizing the impact to our results of operations.
In connection with the 2002 sale of BT Financial Group, we agreed to indemnify
the purchaser, Westpac for, among other things, the costs associated with
potential late filings made by BT Financial Group in New Zealand prior to
Westpac's ownership, up to a maximum of A$250 million Australian dollars
(approximately U.S. $150 million). New Zealand securities regulations allow
Australian issuers to issue their securities in New Zealand provided that
certain documents are appropriately filed with the New Zealand Registrar of
Companies. Specifically, the regulations require that any amendments to
constitutions and compliance plans be filed in New Zealand. In April 2003, the
New Zealand Securities Commission ("the Commission") opined that such late
filings would result in certain New Zealand investors having a right to return
of their investment plus interest at 10% per annum from the date of investment.
Consequently, the Commission has advised that it has initiated an inquiry into
the matter, both with regard to BT Financial Group and other similar issuers. We
view these potential late filings as a technical matter as we believe investors
received the information that is required to be provided directly to them. In
addition, we believe this technical issue may affect many in the industry and
result in a favorable legislative or judicial solution. Finally, we are
reviewing the applicability of the indemnification regarding this matter.
Although we cannot predict the outcome of this matter or reasonably estimate
losses, we do not believe that it would result in a material adverse effect on
our business or financial position. It is possible, however, that it could have
a material adverse effect on our results of operations in a particular quarter
or annual period.
36
In the normal course of business, we are subject to indemnification obligations
related to the sale of residential mortgage loans. Under these indemnifications,
we are required to repurchase certain mortgage loans that fail to meet the
standard representations and warranties included in the sales contracts. The
amount of our exposure is based on the potential loss that may be incurred if
the repurchased mortgage loans are processed through the foreclosure process.
Based on historical experience, total mortgage loans repurchased pursuant to
these indemnification obligations are estimated to be approximately 0.04% of
annual mortgage loan production levels. Total losses on the mortgage loans
repurchased are estimated to approximate 25% of the unpaid principal balance of
the related mortgage loans. As of March 31, 2003, $1.6 million has been accrued
for representing the fair value of such indemnifications issued after January 1,
2003, in accordance with Financial Accounting Standards Board Interpretation
Number 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS.
We are also subject to various other indemnification obligations issued in
conjunction with certain transactions, primarily the sale of BT Financial Group
and other divestitures, the sale of servicing rights in our mortgage banking
business, acquisitions, and financing transactions whose terms range in duration
and often are not explicitly defined. Certain portions of these indemnifications
may be capped, while other portions are not subject to such limitations.
Generally, a maximum obligation is not explicitly stated; therefore, the overall
maximum amount of the obligation under the indemnifications cannot be reasonably
estimated. While we are unable to estimate with certainty the ultimate legal and
financial liability with respect to these indemnifications, we believe the
likelihood is remote that material payments would be required under such
indemnifications and therefore such indemnifications would not result in a
material adverse effect on our business, financial position or results of
operations.
INVESTMENTS
We had total consolidated assets as of March 31, 2003, of $91.8 billion, of
which $50.6 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, $49.1 billion were held by
our U.S. operations and the remaining $1.5 billion were held by our
International Asset Management and Accumulation segment.
U.S. INVESTMENT OPERATIONS
Our U.S. invested assets are managed by Principal Global Investors, 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 March 31, 2003, there are ten members on the Investment Committee, one of
37
whom is a member of our board of directors. The remaining members are senior
management members representing various areas of our company.
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. We assess option risk in all investments
we make and, when we take that risk, we price for it accordingly.
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 analysts. Our
analysts monitor issuers on the list on a continuous basis with a formal review
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. The weighted average loan-to-value ratio at
origination for brick and mortar commercial mortgages in our portfolio was 69%
and the debt service coverage ratio at loan inception was 2.4 times as of March
31, 2003.
38
We have limited exposure to equity risk in our common stock portfolio. Equity
securities accounted for only 1% of our U.S. invested assets as of March 31,
2003.
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 3, "Quantitative and Qualitative Disclosures about
Market Risk".
OVERALL COMPOSITION OF U.S. INVESTED ASSETS
U.S. invested assets as of March 31, 2003, 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. The following
discussion analyzes the composition of U.S. invested assets, but excludes
invested assets of the participating separate accounts.
U.S. INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
------------------- ----------------------
2003 2002
------------------- ----------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
----------- ------- -------------- ------
($ IN MILLIONS)
Fixed maturity securities
Public.......................................... $ 24,099.9 49% $ 22,766.8 48%
Private......................................... 10,617.9 22 10,440.3 22
Equity securities................................. 368.2 1 358.1 1
Mortgage loans
Commercial...................................... 9,453.6 19 9,365.8 20
Residential..................................... 1,523.1 3 1,463.6 3
Real estate held for sale ........................ 176.2 - 179.5 -
Real estate held for investment................... 1,145.8 2 1,042.1 2
Policy loans...................................... 810.9 2 818.5 2
Other investments ................................ 952.9 2 1,075.5 2
----------- ------- -------------- ------
Total invested assets........................... $ 49,148.5 100% $ 47,510.2 100%
====== ======
Cash and cash equivalents......................... 875.4 941.5
----------- --------------
Total invested assets and cash.................. $ 50,023.9 $ 48,451.7
=========== ==============
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 reduce the risk of prepayment. This active management has resulted in
the realization of capital gains and losses with respect to such investments.
FIXED MATURITY SECURITIES
Fixed maturity securities consist of short-term investments, publicly traded
debt securities, privately placed debt securities and redeemable preferred
stock, and represented 71% of total U.S. invested assets as of March 31, 2003
and 70% as of December 31, 2002. The fixed maturity securities portfolio was
comprised, based on carrying amount, of 69% in publicly traded fixed maturity
securities and 31% in privately placed fixed maturity securities as of March 31,
39
2003, and December 31, 2002, respectively. Included in the privately placed
category as of March 31, 2003, were $4.0 billion of securities eligible for
resale to qualified institutional buyers under Rule 144A under the Securities
Act of 1933. Fixed maturity securities were diversified by category of issuer as
of March 31, 2003, and December 31, 2002, as shown in the following table:
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY TYPE OF ISSUER
AS OF MARCH 31, AS OF DECEMBER 31,
--------------------- ----------------------
2003 2002
--------------------- ----------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
----------- ------- -------------- ------
($ IN MILLIONS)
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies................. $ 482.4 1% $ 518.6 2%
States and political subdivisions...................... 439.3 1 426.3 1
Non-U.S. governments................................... 406.9 1 380.5 1
Corporate - public..................................... 17,912.5 52 17,061.2 52
Corporate - private.................................... 8,864.3 26 8,777.5 26
Residential pass-through securities.................... 2,599.2 7 2,327.0 7
Commercial MBS......................................... 2,655.3 8 2,476.4 7
Collateral mortgage obligations........................ 84.2 - - -
Asset-backed securities................................ 1,273.7 4 1,239.6 4
----------- ------- -------------- ------
Total fixed maturities............................... $34,717.8 100% $33,207.1 100%
=========== ======= ============== ======
We held $6,612.4 million of mortgage-backed and asset-backed securities as of
March 31, 2003, and $6,043.0 million as of December 31, 2002.
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 reduce the risk of prepayment.
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.
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,
40
we diversify the risks of asset-backed securities by holding a diverse class of
securities, which limits our exposure to any one security.
The international exposure in our U.S. invested assets totaled $4,612.9 million,
or 13%, of total fixed maturity securities, as of March 31, 2003, comprised of
corporate and foreign government fixed maturity securities. Of the $4,612.9
million as of March 31, 2003, investments totaled $1,369.3 million in the United
Kingdom, $888.2 million in the continental European Union, $611.3 million in
Asia, $383.3 million in Australia, $374.4 million in South America and $21.4
million in Japan. The remaining $965.0 million was invested in 12 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 March 31, 2003, our investments in Canada totaled $1,255.3 million.
As of March 31, 2003, no individual non-government issuer represented more than
1% of U.S. invested assets.
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.
We also monitor the credit drift of our corporate fixed maturity securities
portfolio. Credit drift is defined as the ratio of the percentage of rating
downgrades, including defaults, divided by the percentage of rating upgrades. We
measure credit drift once each fiscal year, assessing the changes in our
internally developed credit ratings that have occurred during the year. Standard
& Poor's annual credit ratings drift ratio measures the credit rating change,
within a specific year, of companies that have been assigned ratings by Standard
& Poor's. The annual internal credit drift ratio on corporate fixed maturity
securities we held in our general account was 3.48 times compared to the
Standard & Poor's drift ratio of 4.14 times, as of December 31, 2002.
The following table presents our total fixed maturity securities by NAIC
Designation and the equivalent ratings of the nationally recognized securities
rating organizations as of March 31, 2003, and December 31, 2002, as well as the
percentage, based on estimated fair value, that each designation comprises:
41
U.S. INVESTED ASSETS
TOTAL FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF MARCH 31, 2003 AS OF DECEMBER 31, 2002
----------------------------------------- ------------------------------------------
% 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....... $16,181.9 $ 17,411.0 50% $15,377.5 $16,539.9 50%
2 Baa............ 13,292.1 14,214.2 41 12,921.8 13,657.4 41
3 Ba............. 2,174.8 2,149.8 6 2,168.8 2,080.8 6
4 B.............. 482.8 439.3 1 506.2 434.5 1
5 Caa and lower.. 222.7 188.3 1 215.6 162.5 1
6 In or near
default........ 316.8 315.2 1 371.0 332.0 1
------------ ------------ ----------- ------------ ------------ -----------
Total fixed
maturities... $32,671.1 $ 34,717.8 100% $31,560.9 $33,207.1 100%
============ ============ =========== ============ ============ ===========
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. Our current policy is to limit the
percentage of cash flow invested in below investment grade assets to 7% of cash
flow. As of March 31, 2003, we had invested 4% of new cash flow for the year 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
portfolios.
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 March 31, 2003, 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 91%.
The following tables show the carrying amount of our corporate fixed maturity
securities by Salomon industry category, as well as the percentage of the total
corporate portfolio that each Salomon industry category comprises as of March
31, 2003, and December 31, 2002.
42
U.S. INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY SALOMON INDUSTRY
AS OF MARCH 31, AS OF DECEMBER 31,
------------------------ -----------------------
2003 2002
------------------------ -----------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
------------ ---------- ------------- --------
($ IN MILLIONS)
INDUSTRY CLASS
Finance - Bank.......................... $ 2,563.5 10% $ 2,431.5 9%
Finance - Insurance..................... 1,155.5 4 1,006.8 4
Finance - Other......................... 3,327.0 12 3,199.0 12
Industrial - Consumer................... 931.9 4 958.2 4
Industrial - Energy..................... 3,069.6 11 2,959.5 11
Industrial - Manufacturing.............. 5,905.8 22 5,882.5 23
Industrial - Other...................... 137.1 1 133.1 1
Industrial - Service.................... 4,197.5 16 3,932.7 15
Industrial - Transport.................. 1,046.9 4 1,058.9 4
Utility - Electric...................... 2,659.6 10 2,539.4 10
Utility - Other......................... 103.5 - 161.4 1
Utility - Telecom....................... 1,678.9 6 1,575.7 6
----------- ---------- ------------- --------
Total................................. $ 26,776.8 100% $ 25,838.7 100%
========== ========== ============= ========
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
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.
We recognize permanent impairment losses for fixed maturities when declines in
value are other than temporary. Realized losses related to other than temporary
impairments were $65.9 for the three months ended March 31, 2003.
In July 2002, Worldcom Inc. filed a voluntary petition for Chapter 11
reorganization with the U.S. Bankruptcy Court. We recognized realized losses for
other than temporary impairments during the second quarter of 2002. Our
remaining investment in WorldCom Inc. is classified in our problem fixed
maturity securities portfolio in the amount of $15.2 million as of March 31,
2003.
The cost, gross unrealized gains and losses and the fair value of our fixed
maturity securities available-for-sale as of March 31, 2003 and December 31,
2002, are summarized as follows:
43
U.S. INVESTED ASSETS
FIXED MATURITIES AVAILABLE-FOR-SALE
AS OF MARCH 31, 2003
-------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ------------- ------------ -------------
( IN MILLIONS)
Fixed maturities:
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies. $ 463.8 $ 18.6 $ - $ 482.4
Non-U.S. governments........................ 347.4 59.6 0.1 406.9
States and political subdivisions........... 407.4 37.2 5.3 439.3
Corporate - public.......................... 16,808.7 1,262.0 158.2 17,912.5
Corporate - private......................... 8,438.1 599.0 172.8 8,864.3
Mortgage-backed and other
asset-backed securities................... 6,109.1 423.7 21.5 6,511.3
--------- ------------- ------------ -------------
Total fixed maturities...................... $32,574.5 $ 2,400.1 $ 357.9 $ 34,616.7
========= ============= ============ =============
Of the $357.9 million in gross unrealized losses, $74.9 million relates to
securities where the estimated fair value has declined and remained below
amortized cost by 20% or more for six months or greater.
U.S. INVESTED ASSETS
FIXED MATURITIES AVAILABLE-FOR-SALE
AS OF DECEMBER 31, 2002
-------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ------------- ------------ -------------
( IN MILLIONS)
Fixed maturities:
U.S. Treasury securities and obligations of
U.S Government corporations and agencies.. $ 499.2 $ 19.4 $ - $ 518.6
Non-U.S. governments........................ 329.9 53.7 3.1 380.5
States and political subdivisions........... 399.2 33.0 5.9 426.3
Corporate - public.......................... 16,257.2 1,085.7 281.7 17,061.2
Corporate - private......................... 8,442.5 521.0 186.0 8,777.5
Mortgage-backed and other
asset-backed securities................... 5,535.9 419.9 14.5 5,941.3
--------- ---------- ------------ -------------
Total fixed maturities...................... $31,463.9 $ 2,132.7 $ 491.2 $ 33,105.4
========= ========== ============ =============
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 periods indicated:
44
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED FIXED MATURITIES AT CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
------------------ --------------------
2003 2002
------------------ --------------------
($ IN MILLIONS)
Total fixed maturity securities (public and private)............ $ 34,717.8 $ 33,207.1
================== ====================
Problem fixed maturity securities............................... $ 326.8 $ 262.0
Potential problem fixed maturity securities..................... 432.0 508.4
Restructured fixed maturity securities.......................... 73.7 103.9
------------------ --------------------
Total problem, potential problem and restructured fixed
maturity securities......................................... $ 832.5 $ 874.3
================== ====================
Total problem, potential problem and restructured fixed
maturity securities as a percent of total fixed maturity
securities.................................................. 2% 3%
MORTGAGE LOANS
Mortgage loans comprised 22% and 23% of total U.S. invested assets as of March
31, 2003, and December 31, 2002, respectively. Mortgage loans consist of
commercial and residential loans. Commercial mortgage loans comprised $9,453.6
million as of March 31, 2003, and $9,365.8 million as of December 31, 2002, or
86% of total mortgage loan investments, respectively. Residential mortgages
comprised $1,523.1 million as of March 31, 2003 and $1,463.6 million as of
December 31, 2002, or 14% of total mortgage loan investments, respectively.
Principal Residential Mortgage, Inc. and Principal Bank hold the majority of
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
March 31, 2003. 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
45
commercial mortgage loan portfolio might suffer under a variety of seismic
events.
Our commercial loan portfolio is highly diversified by borrower. As of March 31,
2003, 43% of the U.S. commercial mortgage loan portfolio was comprised of
mortgage loans with principal balances of less than $10.0 million. The total
number of commercial mortgage loans outstanding as of March 31, 2003 and
December 31, 2002 was 1,537 and 1,529, respectively. The average loan size of
our commercial mortgage portfolio was $6.2 million as of March 31, 2003. As of
such dates, all such loans were performing.
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 write downs
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 decreases in
valuation allowances aggregated $2.3 million for the three months ended March
31, 2003 and $7.1 million for the year ended December 31, 2002.
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
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.
46
The following table represents our commercial mortgage valuation allowance for
the periods indicated:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE VALUATION ALLOWANCE
AS OF MARCH 31, AS OF DECEMBER 31,
2003 2002
--------------- -----------------------
($ IN MILLIONS)
Beginning balance.......................................... $ 83.6 $ 90.7
Provision.................................................. - 33.5
Release due to write downs, sales and foreclosures......... (2.3) (40.6)
------------------ -----------------------
Ending balance............................................. $ 81.3 $ 83.6
================== =======================
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 periods indicated:
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED COMMERCIAL MORTGAGES
AT CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
2003 2002
------------------ -----------------------
($ IN MILLIONS)
Total commercial mortgages ................................ $ 9,453.6 $ 9,365.8
================== =======================
Problem commercial mortgages(1)............................ $ 74.1 $ 77.2
Potential problem commercial mortgages .................... 71.9 50.4
Restructured commercial mortgages ......................... 46.9 46.9
------------------ -----------------------
Total problem, potential problem and
restructured commercial mortgages...................... $ 192.9 $ 174.5
================== =======================
Total problem, potential problem and restructured
commercial mortgages as a percent of total commercial
mortgages.............................................. 2% 2%
- --------------------
(1) Problem commercial mortgages included mortgage loans in foreclosure of $0.4
million as of March 31, 2003 and December 31, 2002, respectively.
47
EQUITY REAL ESTATE
We hold commercial equity real estate as part of our investment portfolio. As of
March 31, 2003, and December 31, 2002, the carrying amount of equity real estate
investment was $1,322.0 million and $1,221.6 million, or 2% 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.
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale". Real estate held for investment totaled $1,145.8
million as of March 31, 2003, and $1,042.1 million as of December 31, 2002. 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 periods ended March 31, 2003 and
December 31, 2002, there were no such impairment adjustments.
The carrying amount of real estate held for sale as of March 31, 2003, and
December 31, 2002, was $176.2 million and $179.5 million, net of valuation
allowances of $16.6 million and $19.3 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, West South Central and Pacific
regions of the United States as of March 31, 2003. By property type, there is a
concentration in office buildings that represented approximately 33% of the
equity real estate portfolio as of March 31, 2003.
OTHER INVESTMENTS
Our other investments totaled $952.9 million as of March 31, 2003, compared to
$1,075.5 million as of December 31, 2002. With the adoption of SFAS 133 on
January 1, 2001, derivatives were reflected on our balance sheet and accounted
for $443.6 million in other investments as of March 31, 2003. The remaining
invested assets include minority interests in unconsolidated entities and
properties owned jointly with venture partners and operated by the partners.
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 related to our invested assets as of March 31, 2003, had a fair value of
$685.4 million.
INTERNATIONAL INVESTMENT OPERATIONS
As of March 31, 2003, our international investment operations consist of the
investments of Principal International comprised of $1.5 billion in invested
assets. Principal Global Investors works with each Principal International
affiliate to develop investment policies and strategies that are consistent with
the products they offer. Due to the regulatory constraints in each country, each
company maintains its own investment policies, which are approved by Principal
Global Investors. Each international affiliate is required to submit a
48
compliance report relative to its strategy to Principal Global Investors.
Principal Global Investors employees and international affiliate company credit
analysts jointly review each corporate credit annually.
OVERALL COMPOSITION OF INTERNATIONAL INVESTED ASSETS
As shown in the following table, the major categories of international invested
assets as of March 31, 2003, and December 31, 2002, were fixed maturity
securities and residential mortgage loans:
INTERNATIONAL INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
--------------------- ---------------------
2003 2002
--------------------- ---------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
----------- ------- ---------- -------
($ IN MILLIONS)
Fixed maturity securities
Public....................................... $ 989.2 66% $ 998.6 67%
Private...................................... 84.5 6 81.7 6
Equity securities.............................. 20.2 1 20.6 1
Mortgage loans
Residential.................................. 259.3 17 252.5 17
Real estate held for investment................ 7.1 1 7.4 1
Other investments ............................. 130.8 9 124.6 8
----------- ------- ---------- -------
Total invested assets........................ $ 1,491.1 100% $1,485.4 100%
======= =======
Cash and cash equivalents...................... 91.5 97.1
----------- ----------
Total invested assets and cash............... $ 1,582.6 $ 1,582.5
=========== ==========
ITEM 3. 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.
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.
49
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. To calculate duration, we project asset and liability
cash flows. These cash flows 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
cash flows and re-determining the net present value based upon an alternative
level of interest rates, and determining the percentage change in fair value.
As of March 31, 2003, the difference between the asset and liability durations
on our primary duration managed portfolio was 0.07 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 $28,656.7
million as of March 31, 2003.
For products such as whole life insurance and term life insurance that are less
sensitive to interest rate risk, and for other products such as individual
single premium deferred annuities, 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 March 31, 2003, the
weighted-average difference between the asset and liability durations on these
portfolios was (0.19) years. This duration gap indicates that as of this date
the sensitivity of the fair value of our assets to interest rate movements is
less 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 $12,335.5 million as of March 31, 2003.
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
the duration of this portfolio since there is little or no interest rate risk.
The value of the assets in these portfolios was $5,312.0 million as of March 31,
2003.
Using the assumptions and data in effect as of March 31, 2003, we estimate that
a 100 basis point immediate, parallel increase in interest rates increases the
net fair value of our portfolio by $3.6 million. The following table details the
estimated changes by risk management strategy:
AS OF CHANGE IN FAIR VALUE
RISK MANAGEMENT MARCH 31, 2003 OF ASSETS LESS FAIR
STRATEGY VALUE OF TOTAL ASSETS VALUE OF LIABILITIES
- -------------------------------------------------------- -------------------------- -------------------------
(IN MILLIONS)
Primary duration-managed................................ $ 28,656.7 $ (20.1)
Duration-monitored...................................... 12,335.5 23.7
Non duration-managed.................................... 5,312.0 -
-------------------------- -------------------------
Total................................................... $ 46,304.2 $ 3.6
========================== =========================
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.
50
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 ("benchmark interest rate"). 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. Price sensitivity analysis is performed at
least once daily. The face amount of the loans in the pipeline as of March 31,
2003, was $13.9 billion. Due to the impact of our hedging activities, we
estimate that a 100 basis point immediate and sustained increase in the
benchmark interest rates decreases the March 31, 2003, net position value by
$92.2 million.
The financial risk associated with our mortgage servicing operations is the risk
that the fair 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 fair value for similar servicing rights.
We perform this valuation using option-adjusted spread valuation techniques
applied to each risk tranche. We produce tranche fair values at least monthly
and model our net servicing hedge position at least daily.
The fair 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 partially offset by the
use of financial instruments, including derivative contracts that typically
increase in aggregate value when interest rates decline. Based on values as of
March 31, 2003, a 100 basis point immediate parallel and sustained decrease in
interest rates produces a $14.2 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 fair values and U.S. GAAP book values.
CASH FLOW VOLATILITY
Cash flow volatility arises as a result of several factors. One is the inherent
difficulty in perfectly matching the cash flows of new asset purchases with that
of new liabilities. Another factor is the inherent cash flow volatility of some
classes of assets and liabilities. In order to minimize cash flow volatility, we
manage differences between expected asset and liability cash flows within
pre-established guidelines.
We also seek to minimize cash flow volatility by restricting the portion of
securities with redemption features held in our invested asset portfolio. These
asset securities include redeemable corporate securities, mortgage-backed
securities or other assets with options that, if exercised, could alter the
expected future cash inflows. In addition, we limit sales liabilities with
features such as puts or other options that may change the cash flow profile of
the liability portfolio.
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
51
primarily to more closely match the interest rate characteristics of assets and
liabilities. They can be used to change the sensitivity to the interest rate 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.
We have increased our credit exposure through credit default swaps by investing
in subordinated tranches of a synthetic collateralized debt obligation. The
outstanding notional amount as of March 31, 2003 was $495.0 million and the mark
to market value was $4.1 million pre-tax. We also invested in credit swaps
creating replicated assets with a notional of $313.3 million and mark to market
value of $1.0 million as of March 31, 2003.
We also offer a guaranteed fund which contains an embedded option that has been
bifurcated and accounted for separately in realized gains (losses). We
recognized a $4.1million pre-tax loss as of March 31, 2003.
In conjunction with our use of 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 diversifying our risk across numerous approved counterparties;
o limiting exposure to A+ 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 manageable.
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 March 31, 2003, and December
31, 2002:
52
DERIVATIVE FINANCIAL INSTRUMENTS - NOTIONAL AMOUNTS
AS OF MARCH 31, AS OF DECEMBER 31,
---------------------- -------------------------
2003 2002
---------------------- -------------------------
NOTIONAL % OF NOTIONAL % OF
AMOUNT TOTAL AMOUNT TOTAL
------------- ------- ----------- ------------
($ IN MILLIONS)
Mortgage-backed forwards and options............ $15,546.2 31% $17,494.9 33%
Interest rate swaps............................. 10,667.2 21 9,719.2 18
Interest rate lock commitments.................. 9,573.9 19 8,198.1 15
Swaptions ...................................... 6,462.5 13 9,772.5 18
Foreign currency swaps.......................... 3,138.1 6 3,217.0 6
U.S. Treasury futures (LIBOR)................... 1,875.0 4 2,225.0 4
Interest rate floors............................ 1,650.0 3 1,650.0 3
Credit default swaps ........................... 808.2 1 705.2 1
Options on futures ............................. 400.0 1 - -
Bond forwards................................... 363.7 1 363.7 1
U.S. Treasury futures........................... 198.5 - 271.1 1
Principal Only swaps............................ - - 123.6 -
Treasury rate guarantees........................ 37.0 - 63.0 -
Call options.................................... 30.0 - 30.0 -
Currency forwards............................... - - 0.2 -
------------- ------- ----------- ------------
Total......................................... $50,750.3 100% $53,833.5 100%
============= ======= =========== ============
DERIVATIVE FINANCIAL INSTRUMENTS - CREDIT EXPOSURES
AS OF MARCH 31, AS OF DECEMBER 31,
----------------------- -------------------------
2003 2002
----------------------- -------------------------
CREDIT % OF CREDIT % OF
EXPOSURE TOTAL EXPOSURE TOTAL
------------- -------- ----------- ------------
($ IN MILLIONS)
Foreign currency swaps.......................... $ 387.9 82% $ 195.0 68%
Interest rate swaps............................. 47.1 10 48.4 17
Swaptions ...................................... 20.0 4 31.4 11
Credit default swaps............................ 11.1 2 8.9 3
Interest rate floors............................ 1.6 1 1.7 1
Call options.................................... 4.2 1 0.4 -
Currency forwards............................... - - - -
Total return swaps.............................. - - - -
Mortgage-backed forwards and options............ - - - -
------------- -------- ----------- ------------
Total......................................... $ 471.9 100% $ 285.8 100%
============= ======== =========== ============
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.
53
AS OF MARCH 31, 2003
-----------------------------------------------------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
-------------------------------------------------
WEIGHTED
AVERAGE TERM -100 BASIS +100 BASIS
NOTIONAL AMOUNT (YEARS) POINT CHANGE NO CHANGE POINT CHANGE
------------------ ------------- -------------- ------------ --------------
($ IN MILLIONS)
Interest rate swaps.................. $ 10,667.2 4.97(1) $ 455.1 $ 195.9 $ (35.7)
Interest rate floors................. 1,650.0 3.25(2) 76.7 41.2 20.6
Options on futures................... 400.0 0.22(3) (0.6) 0.1 5.4
U.S. Treasury futures................ 198.5 0.22(3) (4.8) (1.1) 2.7
U.S. Treasury futures (LIBOR)........ 1,875.0 1.06(3) (8.0) (3.3) 1.4
Swaptions............................ 6,462.5 1.39(4) 284.1 170.9 166.7
Treasury rate guarantees............. 37.0 0.15(5) (3.0) - 2.9
Bond forwards........................ 363.7 0.48(5) 55.0 33.0 11.2
Mortgage-backed forwards and options. 15,546.2 0.08(5) (324.2) (57.2) 102.0
Interest rate lock commitments....... 9,573.9 0.12(6) 183.5 87.6 (258.9)
------------------ -------------- ------------ --------------
Total.............................. $ 46,774.0 $ 713.8 $ 467.1 $ 18.3
================== ============== ============ ==============
- --------------------
(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 March 31, 2003, the aggregate fair value of debt was $1,472.4 million. A
100 basis point, immediate, parallel decrease in interest rates would increase
the fair value of debt by approximately $56.0 million.
AS OF MARCH 31, 2003
--------------------------------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
--------------------------------------------------------------
-100 BASIS +100 BASIS
POINT CHANGE NO CHANGE POINT CHANGE
------------------ ----------------- --------------------
(IN MILLIONS)
7.95% notes payable, due 2004...................... $ 216.9 $ 214.0 $ 211.2
8.2% notes payable, due 2009....................... 573.8 544.7 517.4
7.875% surplus notes payable, due 2024............. 218.8 213.6 202.5
8% surplus notes payable, due 2044................. 121.9 109.8 98.7
Non-recourse mortgages and notes payable........... 273.6 266.9 260.5
Other mortgages and notes payable.................. 123.4 123.4 123.4
------------ ------------ -----------------
Total long-term debt............................. $ 1,528.4 $ 1,472.4 $ 1,413.7
============ ============ =================
EQUITY RISK
Equity risk is the risk that we will incur economic losses due to adverse
fluctuations in a particular common stock. As of March 31, 2003, the fair value
of our equity securities was $388.4 million. A 10% decline in the value of the
equity securities would result in an unrealized loss of $38.8 million.
54
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 March 31, 2003, was $2,889.7 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 March 31, 2003, the fair value of our foreign currency
denominated fixed maturity securities was $296.7 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
March 31, 2003, was $248.4 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.
We estimate that as of March 31, 2003, a 10% immediate unfavorable change in
each of the foreign currency exchange rates to which we are exposed would result
in no material 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.
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.
55
ITEM 4. CONTROLS AND PROCEDURES
In order to ensure that the information that we must disclose in our filings
with the SEC is recorded, processed, summarized and reported on a timely basis,
we have adopted disclosure controls and procedures. Our Chief Executive Officer,
J. Barry Griswell, and our Chief Financial Officer, Michael H. Gersie, have
reviewed and evaluated our disclosure controls and procedures as of May 6, 2003,
and have concluded that our disclosure controls and procedures are effective.
There were no significant changes in our internal controls, or in other factors
that could significantly affect our internal controls subsequent to May 6, 2003.
56
PART II - OTHER INFORMATION
ITEM 1. 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 asset management and
accumulation products and services, life, health and disability insurance, and
mortgage banking. Some of the lawsuits are class actions, or purport to be, and
some include claims for punitive damages. 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.
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. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs filed an appeal on May 15, 2002, with the 7th
Circuit Court of Appeals. On November 22, 2002, the 7th Circuit Court of Appeals
affirmed the District Court's decision. The Plaintiffs filed a Petition for a
Writ of Certiorari on April 21, 2003, requesting the United States Supreme Court
to review the decision of the 7th Circuit Court of Appeals.
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 our business, financial position or results of operations. The
outcome of litigation is always uncertain, and unforeseen results can occur. It
is possible that such outcomes could materially affect our results of operations
in a particular quarter or annual period.
57
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
10.4 Principal Financial Group Incentive Pay Plan (PrinPay), amended and
restated effective January 1, 2003
99.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - J. Barry Griswell
99.2 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - Michael H. Gersie
B. REPORTS ON FORM 8-K
None
58
SIGNATURE
Pursuant to the requirements 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: May 7, 2003 By /S/ MICHAEL H. GERSIE
-----------------------------
Michael H. Gersie
Executive Vice President and
Chief Financial Officer
Duly Authorized Officer,
Principal Financial
Officer, and Chief
Accounting Officer
59
STATEMENT UNDER OATH OF PRINCIPAL EXECUTIVE OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO
EXCHANGE ACT FILINGS
I, J. Barry Griswell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Principal Financial
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 6, 2003
/S/ J. BARRY GRISWELL
-----------------------------
J. Barry Griswell
Chairman, President and Chief
Executive Officer
60
STATEMENT UNDER OATH OF PRINCIPAL FINANCIAL OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO
EXCHANGE ACT FILINGS
I, Michael H. Gersie, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Principal Financial
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 6, 2003
/S/ MICHAEL H. GERSIE
-----------------------------
Michael H. Gersie
Executive Vice President and
Chief Financial Officer
61
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION PAGE
10.4 Principal Financial Group Incentive Pay Plan (PrinPay),
amended and restated effective January 1, 2003......................63
99.1 Certification Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code - J. Barry Griswell...........73
99.2 Certification Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code - Michael H. Gersie...........74
62
EXHIBIT 10.4
PRINCIPAL FINANCIAL GROUP INCENTIVE PAY PLAN (PRINPAY) AMENDED AND RESTATED
EFFECTIVE JANUARY 1, 2003
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, 2002. This amended and restated
version of the Plan has been adopted and assumed by the Company as of January 1,
2003. 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.
63
"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
(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.
64
"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, shift differential, on-call 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.
"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.
65
"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.
66
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.
67
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.
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.
68
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. Earnings
received as a result of lump sum payments or PTO lump sum payments are not
included in Fixed Salary and will not be included in the award calculation.
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.
69
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 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.
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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 its
affiliates.
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 its 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.
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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
25th day of February, 2003.
By: /s/ WILLIAM T. KERR
-----------------------------------------
William Kerr, Chair
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Exhibit 99.1
CERTIFICATION PURSUANT TO SECTION 1350 OF CHAPTER 63
OF TITLE 18 OF THE UNITED STATES CODE
I, J. Barry Griswell, Chairman, President and Chief Executive Officer of
Principal Financial Group, Inc., certify that (i) the Form 10-Q for the quarter
ended March 31, 2003 fully complies with the requirements of Section 13(a) of
the Securities Exchange Act of 1934 and (ii) the information contained in the
Form 10-Q for the quarter ended March 31, 2003 fairly presents, in all material
respects, the financial condition and results of operations of Principal
Financial Group, Inc.
/S/ J. BARRY GRISWELL
-----------------------------
J. Barry Griswell
Chairman, President and Chief
Executive Officer
Date: May 6, 2003
A signed original of this written statement required by Section 906 has been
provided to Principal Financial Group, Inc. ("Principal") and will be retained
by Principal and furnished to the Securities and Exchange Commission or its
staff upon request.
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Exhibit 99.2
CERTIFICATION PURSUANT TO SECTION 1350 OF CHAPTER 63
OF TITLE 18 OF THE UNITED STATES CODE
I, Michael H. Gersie, Executive Vice President and Chief Financial Officer of
Principal Financial Group, Inc., certify that (i) the Form 10-Q for the quarter
ended March 31, 2003 fully complies with the requirements of Section 13(a) of
the Securities Exchange Act of 1934 and (ii) the information contained in the
Form 10-Q for the quarter ended March 31, 2003 fairly presents, in all material
respects, the financial condition and results of operations of Principal
Financial Group, Inc.
/S/ MICHAEL H. GERSIE
-----------------------------
Michael H. Gersie
Executive Vice President and
Chief Financial Officer
Date: May 6, 2003
A signed original of this written statement required by Section 906 has been
provided to Principal Financial Group, Inc. ("Principal") and will be retained
by Principal and furnished to the Securities and Exchange Commission or its
staff upon request.
74