SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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1-16725
(Commission file number)
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)
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711 HIGH STREET, DES MOINES, IOWA 50392
(Address of principal executive offices)
(515) 247-5111
(Registrant's telephone number, including area code)
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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 April 28, 2004 was 319,201,574.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at March 31, 2004
(Unaudited)and December 31, 2003............................3
Unaudited Consolidated Statements of Operations for the three
months ended March 31, 2004 and 2003........................4
Unaudited Consolidated Statements of Stockholders' Equity for
the three months ended March 31, 2004 and 2003..............5
Unaudited Consolidated Statements of Cash Flows for the three
months ended March 31, 2004 and 2003........................6
Notes to Unaudited Consolidated Financial Statements -
March 31, 2004..............................................8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...........................................35
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......77
Item 4. Controls and Procedures..........................................84
PART II - OTHER INFORMATION
Item 1. Legal proceedings................................................84
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities................................................85
Item 6. Exhibits and Reports on Form 8-K.................................85
Signature................................................................86
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
MARCH 31, DECEMBER 31,
2004 2003
------------------ ------------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale........................................ $ 38,641.7 $ 37,449.7
Fixed maturities, trading................................................... 103.4 102.9
Equity securities, available-for-sale....................................... 749.2 712.5
Mortgage loans.............................................................. 12,888.1 13,508.1
Real estate................................................................. 1,473.9 1,537.5
Policy loans................................................................ 804.5 804.1
Other investments........................................................... 1,331.7 1,463.0
------------------ ------------------
Total investments........................................................ 55,992.5 55,577.8
Cash and cash equivalents................................................... 1,608.6 1,692.9
Accrued investment income................................................... 625.8 650.7
Premiums due and other receivables.......................................... 543.7 719.8
Deferred policy acquisition costs........................................... 1,552.4 1,571.7
Property and equipment...................................................... 443.3 447.8
Goodwill.................................................................... 250.1 184.2
Other intangibles........................................................... 156.4 121.4
Mortgage loan servicing rights.............................................. 1,748.1 1,953.1
Separate account assets..................................................... 46,186.6 43,407.8
Other assets................................................................ 1,705.3 1,427.2
------------------ ------------------
Total assets............................................................. $ 110,812.8 $ 107,754.4
================== ==================
LIABILITIES
Contractholder funds........................................................ $ 28,913.7 $ 28,902.5
Future policy benefits and claims........................................... 15,525.8 15,474.7
Other policyholder funds.................................................... 769.2 710.2
Short-term debt............................................................. 986.3 1,617.8
Long-term debt.............................................................. 2,555.1 2,767.3
Income taxes payable........................................................ 146.0 90.0
Deferred income taxes....................................................... 1,849.8 1,644.0
Separate account liabilities................................................ 46,186.6 43,407.8
Other liabilities........................................................... 5,893.3 5,740.5
------------------ ------------------
Total liabilities........................................................ 102,825.8 100,354.8
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500.0 million shares
authorized, 377.6 million and 377.4 million shares issued, and 320.8
million and 320.7 million shares outstanding in 2004 and 2003,
respectively............................................................. 3.8 3.8
Additional paid-in capital.................................................. 7,179.1 7,153.2
Retained earnings........................................................... 824.0 630.4
Accumulated other comprehensive income...................................... 1,539.6 1,171.3
Treasury stock, at cost (56.8 million and 56.7 million shares in 2004 and
2003, respectively)...................................................... (1,559.5) (1,559.1)
------------------ ------------------
Total stockholders' equity............................................... 7,987.0 7,399.6
------------------ ------------------
Total liabilities and stockholders' equity............................... $ 110,812.8 $ 107,754.4
================== ==================
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2004 2003
---------------- ----------------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
REVENUES
Premiums and other considerations..................... $ 921.8 $ 905.5
Fees and other revenues............................... 561.1 632.0
Net investment income................................. 817.0 836.0
Net realized/unrealized capital losses................ (42.8) (76.7)
---------------- ----------------
Total revenues..................................... 2,257.1 2,296.8
EXPENSES
Benefits, claims and settlement expenses.............. 1,187.5 1,195.2
Dividends to policyholders............................ 73.3 80.1
Operating expenses.................................... 730.9 799.3
---------------- ----------------
Total expenses..................................... 1,991.7 2,074.6
---------------- ----------------
Income from continuing operations before income
taxes.............................................. 265.4 222.2
Income taxes.......................................... 66.1 65.8
---------------- ----------------
Income from continuing operations, net of related
income taxes....................................... 199.3 156.4
Loss from discontinued operations, net of related
income taxes....................................... - (0.7)
---------------- ----------------
Income before cumulative effect of
accounting change.................................. 199.3 155.7
Cumulative effect of accounting change, net of
related income taxes............................... (5.7) -
---------------- ----------------
Net income............................................ $ 193.6 $ 155.7
================ ================
EARNINGS PER COMMON SHARE
Basic and diluted earnings per common share:
Income from continuing operations, net of
related income taxes............................. $ 0.62 $ 0.47
Loss from discontinued operations, net of
related income taxes............................. - -
---------------- ----------------
Income before cumulative effect of
accounting change................................ 0.62 0.47
Cumulative effect of accounting change, net of
related income taxes............................. (0.02) -
---------------- ----------------
Net income......................................... $ 0.60 $ 0.47
================ ================
SEE ACCOMPANYING NOTES.
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS' OUTSTANDING
STOCK CAPITAL EARNINGS INCOME STOCK EQUITY SHARES
------------- ------------ -------------- --------------- ----------- --------------- -----------
(IN MILLIONS) (IN THOUSANDS)
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)
Net 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
============= ============ ============== =============== =========== =============== ===========
BALANCES AT JANUARY 1, 2004........ $3.8 $7,153.2 $ 630.4 $1,171.3 $(1,559.1) $7,399.6 320,667.5
Shares issued...................... - 16.0 - - - 16.0 160.5
Stock-based compensation........... - 9.9 - - - 9.9
Treasury stock acquired............ - - - - (0.4) (0.4) (10.2)
Comprehensive income:
Net income....................... - - 193.6 - - 193.6
Net unrealized gains............. - - - 537.1 - 537.1
Provision for deferred income
taxes.......................... - - - (172.7) - (172.7)
Net foreign currency translation
adjustment....................... - - - 3.9 - 3.9
---------------
Comprehensive income............... 561.9
------------- ------------ -------------- --------------- ----------- --------------- -----------
BALANCES AT MARCH 31, 2004......... $3.8 $7,179.1 $ 824.0 $1,539.6 $(1,559.5) $7,987.0 320,817.8
============= ============ ============== =============== =========== =============== ===========
SEE ACCOMPANYING NOTES.
5
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2004 2003
----------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income............................................ $ 193.6 $ 155.7
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss from discontinued operations, net of related
income taxes................................... - 0.7
Cumulative effect of accounting change,
net of related income taxes.................... 5.7 -
Amortization of deferred policy acquisition costs. 36.2 51.4
Additions to deferred policy acquisition costs.... (97.3) (85.8)
Accrued investment income......................... 24.9 26.0
Premiums due and other receivables................ 47.5 30.9
Contractholder and policyholder liabilities
and dividends.................................. 366.6 481.2
Current and deferred income taxes................. 75.5 63.3
Net realized/unrealized capital losses............ 42.8 76.7
Depreciation and amortization expense............. 27.2 24.6
Mortgage loans held for sale, acquired or
originated..................................... (7,647.2) (16,153.1)
Mortgage loans held for sale, sold or repaid, net
of gain........................................ 8,143.8 15,924.1
Real estate acquired through operating activities. (1.4) (6.3)
Real estate sold through operating activities..... 33.4 1.2
Amortization of mortgage servicing rights......... 95.6 111.2
Stock-based compensation.......................... 8.2 3.5
Mortgage servicing rights valuation adjustments... 271.6 159.3
Other............................................. (46.1) (117.5)
----------------- ----------------
Net adjustments....................................... 1,387.0 591.4
----------------- ----------------
Net cash provided by operating activities............. 1,580.6 747.1
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases......................................... (2,317.3) (2,911.7)
Sales............................................ 606.9 690.6
Maturities....................................... 1,245.1 1,065.9
Mortgage loans acquired or originated................. (390.7) (215.6)
Mortgage loans sold or repaid......................... 417.0 313.9
Purchase of mortgage servicing rights................. (102.7) (310.6)
Proceeds from sale of mortgage servicing rights....... - 0.5
Real estate acquired.................................. (10.2) (92.6)
Real estate sold...................................... 46.2 23.6
Net change in property and equipment.................. (9.6) (3.1)
Net proceeds from sales of subsidiaries............... - 2.1
Purchases of interest in subsidiaries, net of
cash acquired..................................... (106.2) (60.3)
Net change in other investments....................... 20.2 (0.4)
----------------- ----------------
Net cash used in investing activities................. $ (601.3) $ (1,497.7)
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2004 2003
----------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock, net of call options........ $ 3.5 $ (3.0)
Acquisition of treasury stock........................ (0.4) (184.1)
Proceeds from financing element derivatives.......... 55.3 -
Payments for financing element derivatives........... (22.0) -
Issuance of long-term debt........................... 5.2 7.5
Principal repayments of long-term debt............... (220.3) (4.4)
Net proceeds (repayments) of short-term borrowings... (632.7) 192.8
Investment contract deposits......................... 1,356.5 2,937.8
Investment contract withdrawals...................... (1,602.1) (2,312.4)
Net increase (decrease) in banking operation
deposits.......................................... (6.6) 44.7
----------------- ----------------
Net cash provided by (used in) financing activities.. (1,063.6) 678.9
----------------- ----------------
Net decrease in cash and cash equivalents............ (84.3) (71.7)
Cash and cash equivalents at beginning of period..... 1,692.9 1,038.6
----------------- ----------------
Cash and cash equivalents at end of period........... $ 1,608.6 $ 966.9
================= ================
SEE ACCOMPANYING NOTES.
7
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Principal
Financial Group, Inc. ("PFG"), its majority-owned subsidiaries and, subsequent
to June 30, 2003, its consolidated variable interest entities ("VIE"), 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, 2004, are not necessarily indicative of the results that may be
expected for the year ended December 31, 2004. These interim unaudited
consolidated financial statements should be read in conjunction with our annual
audited financial statements as of December 31, 2003, included in our Form 10-K
for the year ended December 31, 2003, filed with the United States Securities
and Exchange Commission ("SEC"). The accompanying consolidated statement of
financial position at December 31, 2003, 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 March 31, 2003 financial statements to
conform to the March 31, 2004 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
On December 24, 2003, the Financial Accounting Standards Board (the "FASB")
issued FASB Interpretation No. 46 (Revised 2003): CONSOLIDATION OF VARIABLE
INTEREST ENTITIES ("FIN 46R"), to clarify some of the provisions of FIN 46 and
to exempt certain entities from its requirements. We adopted FIN 46R effective
January 1, 2004, which did not have a material impact on our consolidated
financial statements.
On July 7, 2003, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 03-1, ACCOUNTING AND REPORTING BY INSURANCE
ENTERPRISES FOR CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE
ACCOUNTS ("SOP 03-1"). This SOP addresses an insurance enterprise's accounting
for certain fixed and variable contract features not covered by other
authoritative accounting guidance. We adopted SOP 03-1 effective January 1,
2004, and recorded a cumulative effect of accounting change of $(5.7) million,
which is net of income tax benefits of $3.0 million.
A provision of SOP 03-1 relates to the classification of contracts and
calculation of an additional liability for contracts that contain significant
insurance features. The adoption of the guidance requires the recognition of a
liability in addition to the contract account value in cases where the insurance
benefit feature results in gains in early years followed by losses in later
years. The accrual and release of the additional liability also impacts the
amortization of deferred policy acquisition costs ("DPAC"). As of January 1,
2004, we increased future policyholder benefits due to our no lapse guarantee
feature of our universal life and variable universal life products within our
Life and Health Insurance segment and for variable annuities with guaranteed
minimum death benefits in our U.S. Asset Management and Accumulation segment.
This resulted in an after-tax cumulative effect of $(0.9) million in the Life
and Health Insurance segment and $(1.5) million in the U.S. Asset Management and
Accumulation segment.
8
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
We also decreased an equity method investment within our International Asset
Management and Accumulation segment by $3.3 million, net of income taxes, as of
January 1, 2004, for select deferred annuity products, which include guaranteed
annuitization purchase rates. The guidance requires contracts which provide for
potential benefits in addition to the account balance that are payable only upon
annuitization to establish an additional liability if the present value of the
annuitized benefits exceed the expected account balance at the expected
annuitization date.
In addition, the guidance clarifies the accounting and classification for sales
inducements. Although the valuation impacts were immaterial, we reclassified
$37.6 million of sales inducements from DPAC to other assets effective January
1, 2004.
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin ("SAB") 105,
APPLICATION OF ACCOUNTING PRINCIPLES TO LOAN COMMITMENTS ("SAB 105"), in which
the SEC Staff expressed their view that the fair value of recorded loan
commitments, including interest rate lock commitments ("IRLCs"), that are
required to follow derivative accounting under Statement of Financial Accounting
Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, should not consider the expected future cash flows related to the
associated servicing of the loan. Accordingly, effective April 1, 2004, we
intend to record IRLCs at zero value at date of issuance with subsequent gains
or losses measured by changes in market interest rates. We do not expect this
SAB to have a material impact on our consolidated financial statements.
SEPARATE ACCOUNTS
At March 31, 2004 and December 31, 2003, the separate accounts included a
separate account valued at $814.9 million and $833.9 million, respectively,
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. Changes in fair value of the separate account shares are
reflected in both the separate account assets and separate account liabilities.
STOCK-BASED COMPENSATION
At March 31, 2004, 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.
9
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Awards under our plans vest over periods ranging from one year 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, 2004, 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 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,
--------------------------------
2004 2003
--------------- ---------------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
Net income, as reported.......................................... $ 193.6 $155.7
Add: Stock-based compensation expense included in reported
net income, net of related tax effects......................... 3.4 3.0
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of related
tax effects.................................................... 4.2 3.9
--------------- ---------------
Pro forma net income............................................. $ 192.8 $154.8
=============== ===============
Basic and diluted earnings per share:
As reported.................................................... $ 0.60 $ 0.47
Pro forma...................................................... 0.60 0.47
2. FEDERAL INCOME TAXES
The effective income tax rate on income from continuing operations for the three
months ended March 31, 2004 and 2003, is lower than the prevailing corporate
federal income tax rate primarily due to income tax deductions allowed for
corporate dividends received, a tax benefit associated with prior year
accumulated losses on a foreign investment and interest exclusion from taxable
income, partially offset by state income taxes.
10
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
3. EMPLOYEE AND AGENT BENEFITS
COMPONENTS OF NET PERIODIC BENEFIT COST (INCOME):
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------------------- ----------------------------
FOR THE THREE MONTHS FOR THE THREE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
---------------------------- ----------------------------
2004 2003 2004 2003
------------- -------------- ------------- --------------
(IN MILLIONS)
Service cost.......................... $ 12.8 $ 12.3 $ 2.3 $ 3.1
Interest cost......................... 18.3 16.7 3.9 4.5
Expected return on plan assets........ (21.5) (18.7) (6.8) (6.4)
Amortization of prior service
cost (benefit)...................... 0.4 0.4 (0.7) (0.8)
Amortization of transition asset...... - (0.1) - -
Recognized net actuarial loss......... 4.1 4.4 0.1 0.6
------------- -------------- ------------- --------------
Net periodic benefit cost (income).... $ 14.1 $ 15.0 $(1.2) $ 1.0
============= ============== ============= ==============
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 ("the Act") was signed into law. This Act introduces a
prescription drug benefit under Medicare (Medicare Part D), as well as a federal
subsidy to sponsors of retiree health benefits. The benefit obligations and net
periodic postretirement benefit costs do not reflect any amount associated with
the subsidy as we have not determined that the benefits provided by the plan are
actuarially equivalent to Medicare. The Centers of Medicare and Medicaid
Services ("CMS") are expected to issue guidance on the definition of actuarially
equivalent retiree health coverage later this year. This specific authoritative
guidance, when issued, could require us to change previously reported
information. The new Act will be reflected once the plan is amended or FASB
issues finalized guidance on the accounting impact of the Act.
CONTRIBUTIONS
We anticipate contributing $1.4 million in 2004 to fund our other postretirement
benefit plans. We contributed an immaterial portion of this amount during the
three months ended March 31, 2004. Our funding policy for the qualified pension
plan is to fund the plan annually in an amount at least equal to the minimum
annual contribution required under ERISA and, generally, not greater than the
maximum amount that can be deducted for federal income tax purposes. We don't
anticipate that we will be required to fund a minimum annual contribution under
ERISA for the qualified pension plan. At this time, it is too early to estimate
the amount that may be contributed, but it is possible that we may fund the
plans in 2004 in the range of $10 million to $50 million for both the qualified
and nonqualified plans. No contributions were made to the plans during the three
months ended March 31, 2004.
11
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
4. COMPREHENSIVE INCOME
Comprehensive income is as follows (in millions):
FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------------------
2004 2003
---------------- ----------------
COMPREHENSIVE INCOME:
Net income.................................. $ 193.6 $ 155.7
Net change in unrealized gains and losses
on fixed maturities, available-for-sale... 638.3 406.8
Net change in unrealized gains and losses
on equity securities, available-for-sale.. 9.2 (2.6)
Adjustments for assumed changes in
amortization patterns:
Deferred policy acquisition costs......... (42.6) (48.1)
Sales inducements......................... (3.1) -
Unearned revenue reserves................. 1.3 2.1
Net change in unrealized gains and losses
on derivative instruments................. 2.6 14.4
Adjustments to unrealized gains for
Closed Block policyholder dividend
obligation................................ (54.9) (38.2)
Provision for deferred income tax expense... (172.7) (117.0)
Net change in unrealized gains and losses
on equity method subsidiaries and
minority interest adjustments............. (13.7) (2.5)
Change in net foreign currency translation
adjustment................................ 3.9 (9.2)
---------------- ----------------
Comprehensive income........................ $ 561.9 $ 361.4
================ ================
5. DEBT
SHORT-TERM DEBT
Effective February 28, 2004, Principal Residential Mortgage, Inc. renewed a
short-term borrowing arrangement with an unaffiliated entity providing up to
$700.00 million related to the activities of its Principal Residential Mortgage
Servicing subsidiary. At March 31, 2004, we had a $300.0 million note payable
outstanding pursuant to this borrowing arrangement. The scheduled maturity of
this note payable is February 28, 2005. We were not in compliance with one of
the covenants under this agreement at March 31, 2004. We obtained a waiver from
the unaffiliated entity.
LONG-TERM DEBT
The components of long-term debt as of March 31, 2004 and December 31, 2003,
were as follows (in millions):
12
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
5. DEBT (CONTINUED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2004 2003
------------------- -------------------
7.95% notes payable, due 2004....................................... $ 200.0 $ 200.0
8.2% notes payable, due 2009........................................ 464.0 464.0
7.875% surplus notes payable, due 2024.............................. - 199.0
8% surplus notes payable, due 2044.................................. 99.2 99.2
PRMCR medium term notes............................................. 1,200.0 1,200.0
PRMCR equity certificates........................................... 193.0 193.0
Nonrecourse mortgages and notes payable............................. 341.7 340.7
Other mortgages and notes payable................................... 57.2 71.4
------------------- -------------------
Total long-term debt................................................ $ 2,555.1 $ 2,767.3
=================== ===================
The amounts included above are net of the discount and direct costs associated
with issuing these notes, which are being amortized to expense over their
respective terms using the interest method.
On March 10, 1994, our subsidiary, Principal Life Insurance Company ("Principal
Life") issued $300.0 million of surplus notes, including $200.0 million due
March 1, 2024, at a 7.875% annual interest rate and the remaining $100.0 million
due March 1, 2044, at an 8% annual interest rate. Subject to the Commissioner of
Insurance of the State of Iowa (the "Commissioner") approval, the surplus notes
due March 1, 2024, were optionally redeemable at Principal Life's election on or
after March 1, 2004, in whole or in part at a redemption price of approximately
103.6% of par. We elected, with the Commissioner's approval, to redeem on March
1, 2004, the entire outstanding $200.0 million principal amount of surplus notes
due March 1, 2024, at a redemption price of 103.6%. Total cash paid for the
surplus note redemption on March 1, 2004, was $207.2 million.
6. 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.
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 net income. The outcome of
litigation is always uncertain, and unforeseen results can occur. It is possible
that such outcomes could materially affect net income in a particular quarter or
annual period.
13
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
6. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
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 2004 through 2019. The maximum
exposure under these agreements as of March 31, 2004, was approximately $192.0
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 net income. The fair value
of such guarantees issued after January 1, 2003, was insignificant.
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$250.0 million
Australian dollars (approximately U.S. $190.0 million as of March 31, 2004). 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
required that any amendments to constitutions and compliance plans be filed in
New Zealand. In April 2003, the New Zealand Securities 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. 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. This technical issue affected many in the industry. On April
15, 2004, the New Zealand government enacted legislation that will provide
issuers, including BT Financial Group, the opportunity for retroactive relief
from such late filing violations. The law allows issuers to apply for judicial
validation of non-compliant issuances resulting from late filings. The law
further provides that judicial relief is mandatory and unconditional unless an
investor was materially prejudiced by the late filing. A related judicial action
is pending. 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 net income in a particular quarter or
annual period.
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 residential mortgage loans and 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 net income. The fair value of such indemnifications issued
after January 1, 2003, was insignificant.
14
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
7. 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, the Corporate
and Other segment 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, Hong Kong and India and joint
ventures in Brazil, Japan and Malaysia.
The Life and Health insurance segment provides individual life insurance, group
health insurance and specialty benefits, which consists of group dental and
vision insurance, individual and group disability insurance, and group life
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 (including interest
expense), income on capital not allocated to other segments, intersegment
eliminations, income tax risks and certain income, expenses and other after-tax
adjustments not allocated to the segments based on the nature of such items.
Management uses segment operating earnings for goal setting, determining
employee compensation, and evaluating performance on a basis comparable to that
used by securities analysts. We determine segment operating earnings 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 and sales inducement 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 losses 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.
The accounting policies of the segments are consistent with the accounting
policies for the consolidated financial statements, with the exception of income
tax allocation. The Corporate and Other segment functions to absorb the risk
inherent in interpreting and applying tax law. The segments are allocated tax
adjustments consistent with the positions we took on our tax returns. The
Corporate and Other segment results reflect any differences between the tax
returns and the estimated resolution of any disputes.
15
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
7. 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:
AS OF MARCH 31, AS OF DECEMBER 31,
2004 2003
---------------------- --------------------
(IN MILLIONS)
ASSETS:
U.S. Asset Management and Accumulation ............... $ 87,221.9 $83,904.8
International Asset Management and Accumulation....... 3,143.3 3,011.4
Life and Health Insurance............................. 12,514.5 12,171.8
Mortgage Banking...................................... 5,434.0 5,558.8
Corporate and Other .................................. 2,499.1 3,107.6
---------------------- --------------------
Total consolidated assets........................... $ 110,812.8 $107,754.4
====================== ====================
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------------
2004 2003
-------------- --------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation................ $ 897.2 $ 886.0
International Asset Management and Accumulation....... 115.5 76.8
Life and Health Insurance............................. 1,035.3 1,012.3
Mortgage Banking...................................... 255.6 404.5
Corporate and Other................................... 0.3 (0.7)
-------------- --------------
Total segment operating revenues.................... 2,303.9 2,378.9
Net realized/unrealized capital losses, including
recognition of front-end fee revenues and certain
market value adjustments to fee revenues............ (46.8) (82.1)
-------------- --------------
Total revenue per consolidated statements
of operations..................................... $ 2,257.1 $2,296.8
============== ==============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ............... $ 122.0 $ 97.5
International Asset Management and Accumulation....... 8.7 6.6
Life and Health Insurance............................. 74.8 59.1
Mortgage Banking...................................... 28.6 52.3
Corporate and Other .................................. (11.5) (5.0)
-------------- --------------
Total segment operating earnings.................... 222.6 210.5
Net realized/unrealized capital losses, as adjusted... (23.3) (54.1)
Other after-tax adjustments (1)....................... (5.7) (0.7)
-------------- --------------
Net income per consolidated statements
of operations..................................... $ 193.6 $ 155.7
============== ==============
- ------------------------
(1) For the three months ended March 31, 2004, other after-tax adjustments of
$(5.7) million included the negative effect of a cumulative effect of
accounting change related to the implementation of SOP 03-1. 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.
16
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
8. EARNINGS PER SHARE
The computations of the basic and diluted per share amounts for our continuing
operations were as follows:
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2004 2003
---------------- -----------------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
Income from continuing operations........ $199.3 $156.4
================ =================
Weighted-average shares outstanding:
Basic.................................. 320.8 331.4
Dilutive effect:
Stock options........................ 1.1 0.3
Restricted stock units............... 0.1 -
---------------- -----------------
Diluted................................ 322.0 331.7
================ =================
Income from continuing operations
per share:
Basic.................................. $ 0.62 $ 0.47
================ =================
Diluted................................ $ 0.62 $ 0.47
================ =================
The calculation of diluted earnings per share for the three months ended March
31, 2004 and 2003, excludes the incremental effect related to certain
stock-based compensation grants due to their anti-dilutive effect.
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
Principal Life has established special purpose entities to issue secured
medium-term notes. Under the program, the payment obligations of principal and
interest on the notes are secured by funding agreements issued by Principal
Life. Principal Life's payment obligations on the funding agreements are fully
and unconditionally guaranteed by PFG. All of the outstanding stock of Principal
Life is indirectly owned by PFG and PFG is the only guarantor of the payment
obligations of the funding agreements.
The following tables set forth condensed consolidating financial information of
Principal Life and PFG as of March 31, 2004 and December 31, 2003, and for the
three months ended March 31, 2004 and 2003.
17
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF FINANCIAL POSITION
MARCH 31, 2004
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
-------------- ---------------- ---------------------- --------------- ---------------
(IN MILLIONS)
ASSETS
Investments, excluding
investment in
unconsolidated entities....... $ - $ 49,153.3 $ 8,038.3 $ (1,384.1) $ 55,807.5
Investment in unconsolidated
entities...................... 7,819.1 876.2 6,078.0 (14,588.2) 185.1
Cash and cash equivalents....... 175.7 171.5 1,748.5 (487.1) 1,608.6
Other intangibles............... - 4.4 152.0 - 156.4
Mortgage loan servicing rights.. - - 1,748.1 - 1,748.1
Separate account assets......... - 45,504.8 670.8 11.0 46,186.6
All other assets................ 1.2 3,735.9 1,578.5 (195.1) 5,120.5
-------------- ---------------- ---------------------- --------------- ---------------
Total assets.................. $ 7,996.0 $ 99,446.1 $ 20,014.2 $(16,643.5) $ 110,812.8
============== ================ ====================== =============== ===============
LIABILITIES
Contractholder funds............ $ - $ 29,051.7 $ 12.0 $ (150.0) $ 28,913.7
Future policy benefits and
claims........................ - 14,065.0 1,460.8 - 15,525.8
Other policyholder funds........ - 764.7 4.5 - 769.2
Short-term debt................. - - 1,429.2 (442.9) 986.3
Long-term debt.................. - 227.0 2,590.5 (262.4) 2,555.1
Income taxes currently
payable....................... - 200.0 33.0 (87.0) 146.0
Deferred income taxes........... 8.3 1,154.9 690.5 (3.9) 1,849.8
Separate account liabilities.... - 45,504.8 670.8 11.0 46,186.6
Other liabilities............... 0.7 1,096.5 5,303.8 (507.7) 5,893.3
-------------- ---------------- ---------------------- --------------- ---------------
Total liabilities............. 9.0 92,064.6 12,195.1 (1,442.9) 102,825.8
STOCKHOLDERS' EQUITY
Common stock.................... 3.8 2.5 - (2.5) 3.8
Additional paid-in capital...... 7,179.1 5,073.7 6,818.9 (11,892.6) 7,179.1
Retained earnings (deficit)..... 824.0 774.8 (539.4) (235.4) 824.0
Accumulated other
comprehensive income.......... 1,539.6 1,530.5 1,539.6 (3,070.1) 1,539.6
Treasury stock, at cost......... (1,559.5) - - - (1,559.5)
-------------- ---------------- ---------------------- --------------- ---------------
Total stockholders' equity.... 7,987.0 7,381.5 7,819.1 (15,200.6) 7,987.0
-------------- ---------------- ---------------------- --------------- ---------------
Total liabilities and
stockholders' equity.......... $ 7,996.0 $ 99,446.1 $ 20,014.2 $(16,643.5) $ 100,812.8
============== ================ ====================== ============== ===============
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
18
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 2003
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
-------------- ---------------- --------------------- -------------- ---------------
(IN MILLIONS)
ASSETS
Investments, excluding
investment in
unconsolidated entities....... $ - $48,156.9 $ 8,610.9 $ (1,357.2) $ 55,410.6
Investment in unconsolidated
entities...................... 7,234.0 793.8 5,693.3 (13,553.9) 167.2
Cash and cash equivalents....... 173.8 640.5 1,360.5 (481.9) 1,692.9
Other intangibles............... - 4.5 116.9 - 121.4
Mortgage loan servicing rights.. - - 1,953.1 - 1,953.1
Separate account assets......... - 42,753.4 632.2 22.2 43,407.8
All other assets................ 1.7 3,825.7 1,374.4 (200.4) 5,001.4
-------------- ---------------- --------------------- -------------- ---------------
Total assets.................. $7,409.5 $96,174.8 $ 19,741.3 $(15,571.2) $ 107,754.4
============== ================ ===================== ============== ===============
LIABILITIES
Contractholder funds............ $ - $29,040.4 $ 11.9 $ (149.8) $ 28,902.5
Future policy benefits and
claims........................ - 14,025.3 1,449.4 - 15,474.7
Other policyholder funds........ - 706.2 4.0 - 710.2
Short-term debt................. - - 2,053.8 (436.0) 1,617.8
Long-term debt.................. - 423.3 2,630.7 (286.7) 2,767.3
Income taxes currently
payable....................... - 160.0 4.3 (74.3) 90.0
Deferred income taxes........... 8.2 974.0 666.9 (5.1) 1,644.0
Separate account liabilities.... - 42,753.4 632.2 22.2 43,407.8
Other liabilities............... 1.7 1,226.1 5,054.2 (541.5) 5,740.5
-------------- ---------------- --------------------- -------------- ---------------
Total liabilities............. 9.9 89,308.7 12,507.4 (1,471.2) 100,354.8
STOCKHOLDERS' EQUITY
Common stock.................... 3.8 2.5 - (2.5) 3.8
Additional paid-in capital...... 7,153.2 5,052.1 6,796.9 (11,849.0) 7,153.2
Retained earnings (deficit)..... 630.4 594.6 (734.4) 139.8 630.4
Accumulated other
comprehensive income.......... 1,171.3 1,216.9 1,171.4 (2,388.3) 1,171.3
Treasury stock, at cost......... (1,559.1) - - - (1,559.1)
-------------- ---------------- --------------------- -------------- ---------------
Total stockholders' equity.... 7,399.6 6,866.1 7,233.9 (14,100.0) 7,399.6
-------------- -------------------------------------- -------------- ---------------
Total liabilities and
stockholders' equity.......... $7,409.5 $96,174.8 $ 19,741.3 $(15,571.2) $ 107,754.4
============== ================ ===================== ============== ===============
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
19
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
-------------- --------------- ---------------------- -------------- -----------------
(IN MILLIONS)
REVENUES
Premiums and other
considerations.................... $ - $ 857.7 $ 64.1 $ - $ 921.8
Fees and other revenues............. - 233.9 385.0 (57.8) 561.1
Net investment income............... 0.6 702.2 104.9 9.3 817.0
Net realized/unrealized
capital losses.................... - (41.5) (6.9) 5.6 (42.8)
-------------- --------------- ---------------------- -------------- -----------------
Total revenues.................... 0.6 1,752.3 547.1 (42.9) 2,257.1
EXPENSES
Benefits, claims, and settlement
expenses.......................... - 1,111.8 78.1 (2.4) 1,187.5
Dividends to policyholders.......... - 73.3 - - 73.3
Operating expenses.................. 2.7 395.2 383.4 (50.4) 730.9
-------------- --------------- ---------------------- -------------- -----------------
Total expenses.................... 2.7 1,580.3 461.5 (52.8) 1,991.7
-------------- --------------- ---------------------- -------------- -----------------
Income (loss) before income
taxes and cumulative effect of
accounting change................. (2.1) 172.0 85.6 9.9 265.4
Income taxes (benefits)............. (0.7) 41.3 23.1 2.4 66.1
Equity in the net income of
subsidiaries, excluding
cumulative effect of
accounting change................. 200.7 51.9 138.2 (390.8) -
-------------- --------------- ---------------------- -------------- -----------------
Income before cumulative
effect of accounting change....... 199.3 182.6 200.7 (383.3) 199.3
Cumulative effect of accounting
change, net of related income
taxes............................. (5.7) (2.5) (5.7) 8.2 (5.7)
-------------- --------------- ---------------------- -------------- -----------------
Net income.......................... $ 193.6 $ 180.1 $ 195.0 $ (375.1) $ 193.6
============== =============== ====================== ============== =================
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
20
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
-------------- ----------------- --------------------- --------------- ---------------
(IN MILLIONS)
REVENUES
Premiums and other considerations.. $ - $ 870.9 $ 34.6 $ - $ 905.5
Fees and other revenues............ - 196.2 483.3 (47.5) 632.0
Net investment income.............. 0.9 733.7 103.6 (2.2) 836.0
Net realized/unrealized capital
gains (losses)................... - (79.3) 11.6 (9.0) (76.7)
-------------- ----------------- --------------------- --------------- ---------------
Total revenues................... 0.9 1,721.5 633.1 (58.7) 2,296.8
EXPENSES
Benefits, claims, and settlement
expenses......................... - 1,147.0 50.0 (1.8) 1,195.2
Dividends to policyholders......... - 80.1 - - 80.1
Operating expenses................. 2.2 384.4 453.6 (40.9) 799.3
-------------- ----------------- --------------------- --------------- ---------------
Total expenses................... 2.2 1,611.5 503.6 (42.7) 2,074.6
-------------- ----------------- --------------------- --------------- --------------
Income (loss) from continuing
operations before income taxes... (1.3) 110.0 129.5 (16.0) 222.2
Income taxes (benefits)............ (0.5) 20.2 49.2 (3.1) 65.8
Equity in the net income of
subsidiaries, excluding
discontinued operations.......... 157.2 49.8 76.9 (283.9) -
-------------- ----------------- --------------------- --------------- ---------------
Income from continuing
operations, net of related
income taxes..................... 156.4 139.6 157.2 (296.8) 156.4
Loss from discontinued operations,
net of related income taxes...... (0.7) - (0.7) 0.7 (0.7)
-------------- ----------------- --------------------- --------------- ---------------
Net income......................... $ 155.7 $ 139.6 $ 156.5 $ (296.1) $ 155.7
============== ================= ===================== =============== ===============
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
21
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
------------- ---------------- -------------------- --------------- ------------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net cash provided by (used in)
operating activities............ $ (1.2) $ 354.1 $ 1,207.5 $ 20.2 $ 1,580.6
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases....................... - (1,880.7) (436.2) (0.4) (2,317.3)
Sales........................... - 488.4 118.5 - 606.9
Maturities...................... - 985.0 260.1 - 1,245.1
Mortgage loans acquired or
originated...................... - (323.3) (74.3) 6.9 (390.7)
Mortgage loans sold or repaid..... - 369.3 79.1 (31.4) 417.0
Purchase of mortgage servicing
rights.......................... - - (102.7) - (102.7)
Real estate acquired.............. - (1.5) (8.7) - (10.2)
Real estate sold.................. - 20.5 25.7 - 46.2
Net change in property and
equipment....................... - (7.2) (2.4) - (9.6)
Purchases of interest in
subsidiaries, net of cash
acquired........................ - - (106.2) - (106.2)
Dividends received from
unconsolidated entities......... - 11.2 94.4 (105.6) -
Net change in other investments... - (75.3) 18.9 76.6 20.2
------------- ---------------- -------------------- --------------- ------------------
Net cash used in investing
activities...................... $ - $ (413.6) $ (133.8) $ (53.9) $ (601.3)
22
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
-------------- --------------- ---------------------- --------------- ---------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock........ $ 3.5 $ - $ - $ - $ 3.5
Acquisition of treasury stock... (0.4) - - - (0.4)
Issuance of long-term debt...... - 12.3 0.4 (7.5) 5.2
Principal repayments of long-
term debt..................... - (209.5) (42.7) 31.9 (220.3)
Net repayments of short-term
borrowings.................... - - (625.8) (6.9) (632.7)
Dividends paid to parent........ - - (11.0) 11.0 -
Investment contract deposits.... - 1,356.5 - - 1,356.5
Investment contract
withdrawals................... - (1,602.1) - - (1,602.1)
Net decrease in banking
operation deposits............ - - (6.6) - (6.6)
Proceeds from financing
element derivatives........... - 55.3 - - 55.3
Payments for financing element
derivatives................... - (22.0) - - (22.0)
-------------- --------------- ---------------------- --------------- ---------------
Net cash provided by (used in)
financing activities.......... 3.1 (409.5) (685.7) 28.5 (1,063.6)
-------------- --------------- ---------------------- --------------- ---------------
Net increase (decrease) in cash
and cash equivalents.......... 1.9 (469.0) 388.0 (5.2) (84.3)
Cash and cash equivalents at
beginning of year............. 173.8 640.5 1,360.5 (481.9) 1,692.9
-------------- --------------- ---------------------- --------------- ---------------
Cash and cash equivalents at
end of year................... $ 175.7 $ 171.5 $ 1,748.5 $(487.1) $ 1,608.6
============== =============== ====================== =============== ===============
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
23
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
------------- ----------------- -------------------- --------------- -----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net cash provided by (used in)
operating activities.......... $ (0.8) $ 456.5 $ 404.1 $ (112.7) $ 747.1
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases..................... - (2,418.1) (500.5) 6.9 (2,911.7)
Sales......................... - 602.4 88.2 - 690.6
Maturities.................... - 869.4 196.5 - 1,065.9
Net cash flows from trading
securities.................... - - 2.0 (2.0) -
Mortgage loans acquired or
originated.................... - (227.2) 11.6 - (215.6)
Mortgage loans sold or repaid... - 226.1 89.6 (1.8) 313.9
Purchase of mortgage
servicing rights.............. - - (310.6) - (310.6)
Proceeds from sale of mortgage
servicing rights.............. - - 0.5 - 0.5
Real estate acquired............ - (84.1) (8.5) - (92.6)
Real estate sold................ - 5.9 17.7 - 23.6
Net change in property and
equipment..................... - (2.9) (0.2) - (3.1)
Net proceeds from sales of
subsidiaries.................. - - 2.1 - 2.1
Purchases of interest in
subsidiaries, net of cash
acquired...................... - (18.5) (41.8) - (60.3)
Dividends received from
(contributions to)
unconsolidated entities....... - 22.9 (18.7) (4.2) -
Net change in other investments. - (24.4) (68.6) 92.6 (0.4)
------------- ----------------- -------------------- --------------- -----------------
Net cash used in investing
activities.................... $ - $ (1,048.5) $ (540.7) $ 91.5 $ (1,497.7)
24
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL PRINCIPAL LIFE PRINCIPAL FINANCIAL PRINCIPAL
FINANCIAL INSURANCE SERVICES, INC. AND FINANCIAL
GROUP, INC. COMPANY OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED (1) ELIMINATIONS CONSOLIDATED
------------- ---------------- --------------------- --------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock........ $ (3.0) $ - $ - $ - $ (3.0)
Acquisition of treasury stock... (184.1) - - - (184.1)
Issuance of long-term debt...... - - 7.5 - 7.5
Principal repayments of long-
term debt..................... - (4.4) (1.8) 1.8 (4.4)
Net proceeds of short-term
borrowings.................... - - 191.7 1.1 192.8
Investment contract deposits.... - 2,937.8 - - 2,937.8
Investment contract
withdrawals................... - (2,312.4) - - (2,312.4)
Net increase in banking
operation deposits............ - - 44.7 - 44.7
------------- ---------------- --------------------- --------------- ----------------
Net cash provided by (used in)
financing activities.......... (187.1) 621.0 242.1 2.9 678.9
------------- ---------------- --------------------- --------------- ----------------
Net increase (decrease) in cash
and cash equivalents.......... (187.9) 29.0 105.5 (18.3) (71.7)
Cash and cash equivalents at
beginning of year............. 332.1 585.7 809.7 (688.9) 1,038.6
------------- ---------------- --------------------- --------------- ----------------
Cash and cash equivalents at
end of year................... $ 144.2 $ 614.7 $ 915.2 $(707.2) $ 966.9
============= ================ ===================== =============== ================
- -----------------------
(1) Principal Financial Services, Inc. consolidated, except Principal Life,
which is reported on the equity method.
25
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
In December 2003, we filed a shelf registration statement with the Securities
and Exchange Commission. The shelf registration totals $3.0 billion, with the
ability to issue debt securities, preferred stock, common stock, warrants, stock
purchase contracts and stock purchase units of PFG and trust preferred
securities of three subsidiary trusts. If we issue securities, we intend to use
the proceeds from the sale of the securities offered by this prospectus,
including the corresponding junior subordinated debentures issued to the trusts
in connection with their investment of all the proceeds from the sale of
preferred securities, for general corporate purposes, including working capital,
capital expenditures, investments in subsidiaries, acquisitions and refinancing
of debt, including commercial paper and other short-term indebtedness. Principal
Financial Services, Inc. unconditionally guarantees our obligations with respect
to one or more series of debt securities described in the shelf registration
statement.
The following tables set forth condensed consolidating financial information of
Principal Financial Services, Inc. and Principal Financial Group, Inc. as of
March 31, 2004 and December 31, 2003, and for the three months ended March 31,
2004 and 2003.
CONDENSED CONSOLIDATING STATEMENTS OF FINANCIAL POSITION
MARCH 31, 2004
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL LIFE INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
------------- ---------------- --------------------- --------------- ----------------
(IN MILLIONS)
ASSETS
Investments, excluding
investment in
unconsolidated entities....... $ - $ 151.5 $ 55,656.0 $ - $ 55,807.5
Investment in unconsolidated
entities...................... 7,819.1 8,375.8 185.1 (16,194.9) 185.1
Cash and cash equivalents....... 175.7 580.8 1,065.3 (213.2) 1,608.6
Other intangibles............... - - 156.4 - 156.4
Mortgage loan servicing rights.. - - 1,748.1 - 1,748.1
Separate account assets......... - - 46,186.6 - 46,186.6
All other assets................ 1.2 99.6 5,043.0 (23.3) 5,120.5
------------- ---------------- --------------------- --------------- ----------------
Total assets.................. $ 7,996.0 $ 9,207.7 $ 110,040.5 $(16,431.4) $110,812.8
============= ================ ===================== =============== ================
LIABILITIES
Contractholder funds............ $ - $ - $ 28,913.7 $ - $ 28,913.7
Future policy benefits and
claims........................ - - 15,525.8 - 15,525.8
Other policyholder funds........ - - 769.2 - 769.2
Short-term debt................. - 239.9 757.1 (10.7) 986.3
Long-term debt.................. - 664.1 1,891.0 - 2,555.1
Income taxes currently
payable....................... - 13.6 139.1 (6.7) 146.0
Deferred income taxes........... 8.3 19.5 1,822.2 (0.2) 1,849.8
Separate account liabilities.... - - 46,186.6 - 46,186.6
Other liabilities............... 0.7 451.5 5,660.0 (218.9) 5,893.3
------------- ---------------- --------------------- --------------- ----------------
Total liabilities............. $ 9.0 $ 1,388.6 $ 101,664.7 $ (236.5) $102,825.8
26
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF FINANCIAL POSITION (CONTINUED)
MARCH 31, 2004
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
STOCKHOLDERS' EQUITY
Common stock................... $ 3.8 $ - $ 64.4 $ (64.4) $ 3.8
Additional paid-in capital..... 7,179.1 6,818.9 5,906.1 (12,725.0) 7,179.1
Retained earnings (deficit).... 824.0 (539.4) 867.2 (327.8) 824.0
Accumulated other
comprehensive income......... 1,539.6 1,539.6 1,538.1 (3,077.7) 1,539.6
Treasury stock, at cost........ (1,559.5) - - - (1,559.5)
-------------- ------------------ -------------------- --------------- ----------------
Total stockholders' equity... 7,987.0 7,819.1 8,375.8 (16,194.9) 7,987.0
-------------- ------------------ -------------------- --------------- ----------------
Total liabilities and
stockholders' equity......... $ 7,996.0 $ 9,207.7 $ 110,040.5 $ (16,431.4) $ 110,812.8
============== ================== ==================== =============== ================
27
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF FINANCIAL POSITION
DECEMBER 31, 2003
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
ASSETS
Investments, excluding
investment in
unconsolidated entities...... $ - $ 150.5 $ 55,260.1 $ - $ 55,410.6
Investment in unconsolidated
entities..................... 7,234.0 7,771.7 167.2 (15,005.7) 167.2
Cash and cash equivalents...... 173.8 872.7 870.1 (223.7) 1,692.9
Other intangibles.............. - - 121.4 - 121.4
Mortgage loan servicing
rights....................... - - 1,953.1 - 1,953.1
Separate account assets........ - - 43,407.8 - 43,407.8
All other assets............... 1.7 186.1 4,831.1 (17.5) 5,001.4
-------------- ------------------ -------------------- --------------- ----------------
Total assets................. $ 7,409.5 $8,981.0 $ 106,610.8 $(15,246.9) $ 107,754.4
============== ================== ==================== =============== ================
LIABILITIES
Contractholder funds........... $ - $ - $ 28,902.5 $ - $ 28,902.5
Future policy benefits and
claims....................... - - 15,474.7 - 15,474.7
Other policyholder funds....... - - 710.2 - 710.2
Short-term debt................ - 399.9 1,228.6 (10.7) 1,617.8
Long-term debt................. - 664.0 2,103.3 - 2,767.3
Income taxes currently
payable...................... - 14.1 76.6 (0.7) 90.0
Deferred income taxes.......... 8.2 20.7 1,615.1 - 1,644.0
Separate account liabilities... - - 43,407.8 - 43,407.8
Other liabilities.............. 1.7 648.3 5,320.3 (229.8) 5,740.5
-------------- ------------------ -------------------- --------------- ----------------
Total liabilities............ 9.9 1,747.0 98,839.1 (241.2) 100,354.8
STOCKHOLDERS' EQUITY
Common stock................... 3.8 - 64.4 (64.4) 3.8
Additional paid-in capital..... 7,153.2 6,796.9 5,851.8 (12,648.7) 7,153.2
Retained earnings (deficit).... 630.4 (734.3) 685.6 48.7 630.4
Accumulated other
comprehensive income......... 1,171.3 1,171.4 1,169.9 (2,341.3) 1,171.3
Treasury stock, at cost........ (1,559.1) - - - (1,559.1)
-------------- ------------------ -------------------- --------------- ----------------
Total stockholders' equity... 7,399.6 7,234.0 7,771.7 (15,005.7) 7,399.6
-------------- ------------------ -------------------- -------------- ----------------
Total liabilities and
stockholders' equity......... $ 7,409.5 $8,981.0 $ 106,610.8 $(15,246.9) $ 107,754.4
============== ================== ==================== =============== ================
28
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
REVENUES
Premiums and other
considerations................. $ - $ - $ 921.8 $ - $ 921.8
Fees and other revenues.......... - - 561.3 (0.2) 561.1
Net investment income............ 0.6 12.8 803.5 0.1 817.0
Net realized/unrealized
capital losses................. - (1.8) (41.0) - (42.8)
-------------- ------------------ -------------------- --------------- ----------------
Total revenues................. 0.6 11.0 2,245.6 (0.1) 2,257.1
EXPENSES
Benefits, claims, and settlement
expenses....................... - - 1,187.5 - 1,187.5
Dividends to policyholders....... - - 73.3 - 73.3
Operating expenses............... 2.7 14.8 713.5 (0.1) 730.9
-------------- ------------------ -------------------- --------------- ----------------
Total expenses................. 2.7 14.8 1,974.3 (0.1) 1,991.7
-------------- ------------------ -------------------- --------------- ----------------
Income (loss) before income
taxes and cumulative effect
of accounting change........... (2.1) (3.8) 271.3 - 265.4
Income taxes (benefits).......... (0.7) (1.4) 68.2 - 66.1
Equity in the net income of
subsidiaries, excluding
cumulative effect of
accounting change.............. 200.7 203.1 - (403.8) -
-------------- ------------------ -------------------- --------------- ----------------
Income before cumulative
effect of accounting change.... 199.3 200.7 203.1 (403.8) 199.3
Cumulative effect of accounting
change, net of related income
taxes.......................... (5.7) (5.7) (5.7) 11.4 (5.7)
-------------- ------------------ -------------------- --------------- ----------------
Net income....................... $ 193.6 $195.0 $ 197.4 $(392.4) $ 193.6
============== ================== ==================== =============== ================
29
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
REVENUES
Premiums and other
considerations................. $ - $ - $ 905.5 $ - $ 905.5
Fees and other revenues.......... - - 632.2 (0.2) 632.0
Net investment income............ 0.9 32.9 802.0 0.2 836.0
Net realized/unrealized capital
gains (losses)................. - 7.5 (84.2) - (76.7)
-------------- ------------------ -------------------- --------------- ----------------
Total revenues................. 0.9 40.4 2,255.5 - 2,296.8
EXPENSES
Benefits, claims, and settlement
expenses....................... - - 1,195.2 - 1,195.2
Dividends to policyholders....... - - 80.1 - 80.1
Operating expenses............... 2.2 15.4 781.7 - 799.3
-------------- ------------------ -------------------- --------------- ----------------
Total expenses................. 2.2 15.4 2,057.0 - 2,074.6
-------------- ------------------ -------------------- --------------- ----------------
Income (loss) from continuing
operations before income taxes. (1.3) 25.0 198.5 - 222.2
Income taxes (benefits).......... (0.5) 9.3 57.0 - 65.8
Equity in the net income of
subsidiaries, excluding
discontinued operations........ 157.2 141.5 - (298.7) -
-------------- ------------------ -------------------- --------------- ----------------
Income from continuing
operations, net of related
income taxes................... 156.4 157.2 141.5 (298.7) 156.4
Loss from discontinued
operations, net of related
income taxes................... (0.7) (0.7) (0.7) 1.4 (0.7)
-------------- ------------------ -------------------- --------------- ----------------
Net income....................... $ 155.7 $ 156.5 $ 140.8 $ (297.3) $ 155.7
============== ================== ==================== =============== ================
30
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net cash provided by (used in)
operating activities.......... $(1.2) $ ( 61.6) $ 1,640.9 $ 2.5 $1,580.6
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases..................... - (150.4) (2,166.9) - (2,317.3)
Sales......................... - 102.4 504.5 - 606.9
Maturities.................... - - 1,245.1 - 1,245.1
Mortgage loans acquired or
originated.................... - - (390.7) - (390.7)
Mortgage loans sold or repaid... - - 417.0 - 417.0
Purchase of mortgage servicing
rights........................ - - (102.7) - (102.7)
Real estate acquired............ - - (10.2) - (10.2)
Real estate sold................ - - 46.2 - 46.2
Net change in property and
equipment..................... - - (9.6) - (9.6)
Purchases of interest in
subsidiaries, net of cash
acquired...................... - (25.7) (80.5) - (106.2)
Dividends received from
unconsolidated entities....... - 35.3 5.4 (40.7) -
Net change in other investments. - (32.0) 19.7 32.5 20.2
---------------- ------------------ -------------------- --------------- ----------------
Net cash used in investing
activities.................... $ - $ (70.4) $ (522.7) $ (8.2) $ (601.3)
31
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2004
PRINCIPAL LIFE
PRINCIPAL PRINCIPAL INSURANCE PRINCIPAL
FINANCIAL FINANCIAL COMPANY AND FINANCIAL
GROUP, INC. SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
PARENT ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock.......... $ 3.5 $ - $ - $ - $ 3.5
Acquisition of treasury stock..... (0.4) - - - (0.4)
Issuance of long-term debt........ - - 5.2 - 5.2
Principal repayments of
long-term debt.................. - - (220.3) - (220.3)
Net repayments of short-term
borrowings...................... - (159.9) (472.7) (0.1) (632.7)
Dividends paid to parent.......... - - (16.3) 16.3 -
Investment contract deposits...... - - 1,356.5 - 1,356.5
Investment contract withdrawals... - - (1,602.1) - (1,602.1)
Net increase (decrease) in
banking operation deposits...... - - (6.6) - (6.6)
Proceeds from financing element
derivatives..................... - - 55.3 - 55.3
Payments for financing element
derivatives..................... - - (22.0) - (22.0)
-------------- ------------------ -------------------- --------------- ----------------
Net cash provided by (used in)
financing activities............ 3.1 (159.9) (923.0) 16.2 (1,063.6)
-------------- ------------------ -------------------- --------------- ----------------
Net increase (decrease) in cash
and cash equivalents............ 1.9 (291.9) 195.2 10.5 (84.3)
Cash and cash equivalents at
beginning of year............... 173.8 872.7 870.1 (223.7) 1,692.9
-------------- ------------------ -------------------- --------------- ----------------
Cash and cash equivalents at end
of year......................... $ 175.7 $ 580.8 $ 1,065.3 $(213.2) $ 1,608.6
============== ================== ==================== =============== ================
32
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL PRINCIPAL LIFE
FINANCIAL PRINCIPAL INSURANCE PRINCIPAL
GROUP, INC. FINANCIAL COMPANY AND FINANCIAL
PARENT SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net cash provided by (used in)
operating activities........... $ (0.8) $ 30.5 $ 740.0 $ (22.6) $ 747.1
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases...................... - (1.2) (2,910.5) - (2,911.7)
Sales.......................... - 2.7 687.9 - 690.6
Maturities..................... - - 1,065.9 - 1,065.9
Mortgage loans acquired or
originated..................... - - (215.6) - (215.6)
Mortgage loans sold or repaid.... - - 313.9 - 313.9
Purchase of mortgage servicing
rights......................... - - (310.6) - (310.6)
Proceeds from sale of mortgage
servicing rights............... - - 0.5 - 0.5
Real estate acquired............. - - (92.6) - (92.6)
Real estate sold................. - - 23.6 - 23.6
Net change in property and
equipment...................... - - (3.1) - (3.1)
Net proceeds from sales of
subsidiaries................... - - 2.1 - 2.1
Purchases of interest in
subsidiaries, net of cash
acquired....................... - - (60.3) - (60.3)
Dividends received from
unconsolidated entities........ - 9.5 29.7 (39.2) -
Net change in other investments.. - (26.1) (0.6) 26.3 (0.4)
-------------- ------------------ -------------------- --------------- ----------------
Net cash used in investing
activities..................... $ - $ (15.1) $ (1,469.7) $ (12.9) $ (1,497.7)
33
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2004
(UNAUDITED)
9. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 2003
PRINCIPAL PRINCIPAL LIFE
FINANCIAL PRINCIPAL INSURANCE PRINCIPAL
GROUP, INC. FINANCIAL COMPANY AND FINANCIAL
PARENT SERVICES, INC. OTHER SUBSIDIARIES GROUP, INC.
ONLY ONLY COMBINED ELIMINATIONS CONSOLIDATED
-------------- ------------------ -------------------- --------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock.......... $ (3.0) $ - $ - $ - $ (3.0)
Acquisition of treasury stock..... (184.1) - - - (184.1)
Issuance of long-term debt........ - - 7.5 - 7.5
Principal repayments of
long-term debt.................. - - (4.4) - (4.4)
Net proceeds of short-term
borrowings...................... - 117.4 75.4 - 192.8
Dividends paid to parent.......... - - (4.0) 4.0 -
Investment contract deposits...... - - 2,937.8 - 2,937.8
Investment contract withdrawals... - - (2,312.4) - (2,312.4)
Net increase in banking
operation deposits.............. - - 44.7 - 44.7
-------------- ------------------ -------------------- --------------- ----------------
Net cash provided by (used in)
financing activities............ (187.1) 117.4 744.6 4.0 678.9
-------------- ------------------ -------------------- --------------- ----------------
Net increase (decrease) in cash
and cash equivalents............ (187.9) 132.8 14.9 (31.5) (71.7)
Cash and cash equivalents at
beginning of year............... 332.1 977.7 301.4 (572.6) 1,038.6
-------------- ------------------ -------------------- --------------- ----------------
Cash and cash equivalents at end
of year......................... $ 144.2 $1,110.5 $ 316.3 $ (604.1) $ 966.9
============== ================== ==================== =============== ================
34
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, 2004,
compared with December 31, 2003, and our consolidated results of operations for
the three months ended March 31, 2004 and 2003, 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, 2003, 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 laws, 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) 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 (15) 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.
35
OVERVIEW
We provide financial products and services through the following 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, Hong Kong and India and joint ventures in
Brazil, Japan, and Malaysia. Prior to October 31, 2002, the 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 individual life insurance, health
insurance as well as specialty benefits throughout the U.S. Our individual
life insurance products include universal and variable universal life and
traditional life. Our health insurance products include group medical
insurance and fee-for-service. Our specialty benefit products include group
dental and vision insurance, individual and group disability insurance, and
group life insurance.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
o Corporate and Other, which 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, income
tax risk assumptions and certain income, expenses and other after-tax
adjustments not allocated to the segments based on the nature of such
items.
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during 2004 and 2003:
DAO HENG FUND MANAGEMENT. On January 31, 2004, our wholly owned subsidiary,
Principal Asset Management Company (Asia) Limited, purchased a 100% ownership of
Dao Heng Fund Management ("DHFM") in Hong Kong from Guoco Group Limited
("Guoco"). The acquisition of DHFM increases our presence in the Hong Kong
defined contribution pension market and increases the potential of our long-term
mutual fund operations. Effective January 31, 2004, the operations of DHFM are
reported in our International Asset Management and Accumulation segment.
MOLLOY COMPANIES. On December 17, 2003, we signed an agreement to acquire the
Molloy Companies. The Molloy Companies consist of J.F. Molloy & Associates,
Inc., Molloy Medical Management, Inc., Molloy Actuarial and Consulting
Corporation and Molloy Wellness Company. The Molloy Companies offer companies
and organizations consultative, administrative and claims services for insured
36
and self-funded health plans through top benefit brokers and consultants.
Effective January 2, 2004, the operations of the Molloy Companies are reported
in our Life and Health segment.
POST ADVISORY GROUP. On August 21, 2003, we agreed to purchase approximately 68%
of Post Advisory Group ("Post Advisory") for approximately $101.6 million.
Effective October 15, 2003, we owned 23% of Post Advisory and purchased an
additional 45% on, January 5, 2004. Our assets under management increased
approximately $5.0 billion as a result of the acquisition. Effective October 15,
2003, the operations of Post Advisory are reported in our U.S. Asset Management
and Accumulation segment.
PRINCIPAL ASSET MANAGEMENT COMPANY. On August 31, 2003, we announced that our
wholly owned subsidiary, Principal Financial Group (Mauritius) Ltd., had entered
into a joint venture agreement with Punjab National Bank ("PNB") and Vijaya
Bank, two large Indian commercial banks, to sell long-term mutual funds and
related financial services in India. The new company will be called Principal
PNB Asset Management Company. As part of this transaction, we will roll our
existing fund management company, Principal Asset Management Company, into the
joint venture. We will retain 65% of the new company, selling 30% to PNB, who
will merge its own PNB funds into the new company, and 5% to Vijaya Bank. We
expect to close the transaction in the second quarter of 2004.
On June 24, 2003, Principal Financial Group (Mauritius) Ltd. finalized an
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. $20.3 million). This
transaction gave Principal Financial Group (Mauritius) Ltd. 100% ownership of
IDBI - Principal Asset Management Company. Upon completion of the transaction,
IDBI - Principal Asset Management Company was renamed to Principal Asset
Management Company.
As part of our International Asset Management and Accumulation segment, we
account for Principal Asset Management Company's statements of financial
position using the full consolidation method of accounting. Activity that
affected our statements of operations before our acquisition of majority
ownership of the subsidiary is accounted for using the equity method of
accounting. Activity that will affect our statements of operations in future
periods will be accounted for using the full consolidation method of accounting.
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.
DISPOSITIONS
BT FINANCIAL GROUP. On October 31, 2002, we sold substantially all of BT
Financial Group to Westpac Banking Corporation ("Westpac"). As of March 31,
2004, we have received proceeds of A$958.9 million Australian dollars ("A$")
(U.S. $537.4 million) from Westpac, with future contingent proceeds in 2004 of
up to A$150.0 million (approximately U.S. $115.0 million). The contingent
proceeds will be based on Westpac's future success in growing retail funds under
management. We do not anticipate receiving the contingent proceeds.
Excluding contingent proceeds, our total after-tax proceeds from the sale were
approximately U.S. $890.0 million. This amount includes cash proceeds from
Westpac, 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.
37
During the three months ended March 31, 2004, we did not incur any after-tax
gain or loss associated with the loss on disposal of BT Financial Group.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations and cash flows have been removed from our results of
continuing operations for all periods presented.
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$250.0 million Australian dollars
(approximately U.S. $190.0 million as of March 31, 2004). 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 required that any
amendments to constitutions and compliance plans be filed in New Zealand. In
April 2003, the New Zealand Securities 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. 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. This
technical issue affected many in the industry. On April 15, 2004, the New
Zealand government enacted legislation that will provide issuers, including BT
Financial Group, the opportunity for retroactive relief from such late filing
violations. The law allows issuers to apply for judicial validation of
non-compliant issuances resulting from late filings. The law further provides
that judicial relief is mandatory and unconditional unless an investor was
materially prejudiced by the late filing. A related judicial action is pending.
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 net income in a particular quarter or annual
period.
OTHER TRANSACTIONS
SALE OF RETAIL FIELD MORTGAGE LENDING BRANCH OFFICES. On February 4, 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.
PRINCIPAL RESIDENTIAL MORTGAGE CAPITAL RESOURCES, LLC. As a result of the
implementation of Financial Accounting Standards Board (the "FASB")
Interpretation No. 46: CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("FIN 46"),
effective July 1, 2003, Mortgage Banking assets and liabilities include the full
consolidation of Principal Residential Mortgage Capital Resources, LLC
("PRMCR"), which provides a source of funding for our residential mortgage loan
production.
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.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
income from continuing operations. Our consolidated income from continuing
operations was positively impacted $0.5 million for the three months ended March
31, 2004 and negatively impacted $2.1 million for the three months ended March
31, 2003, respectively, as a result of fluctuations in foreign currency to U.S.
dollar exchange rates. For a discussion of our approaches to foreign currency
38
exchange rate risk, see Item 3. "Quantitative and Qualitative Disclosures about
Market Risk."
PENSION AND OTHER POST-RETIREMENT BENEFIT EXPENSE
The 2004 annual pension benefit expense for substantially all of our employees
and certain agents is approximately $56.4 million pre-tax, which is a $3.8
million decrease over the 2003 pre-tax pension expense of $60.2 million.
Approximately $14.1 million of pre-tax pension expense was reflected in the
determination of first quarter, 2004 net income. In addition, approximately
$14.1 million of pre-tax pension expense will be reflected in each of the
following three quarters for 2004. This decrease in expense over 2003 is
primarily due to the plan's liability experience, an increase in the plan's
turnover assumption, and the plan's asset performance. The discount rate used to
determine the 2004 expense was 6.25%, which is down from the 6.5% discount rate
used to calculate the 2003 expense. The expected long-term return on assets
assumption used for the 2004 pension expense remained at 8.5%.
PERMANENT IMPAIRMENT OF MORTGAGE SERVICING RIGHTS
During the second quarter of 2003, we established a policy of evaluating
permanent impairment of our mortgage servicing rights. Each quarter we will
evaluate permanent impairment of our mortgage servicing rights and will
recognize a direct write-down when the gross carrying value is not expected to
be recovered in the foreseeable future. We estimate the amount of permanent
impairment based on an analysis of the mortgage servicing rights valuation
allowance related to loans that have prepaid. During the twelve months ended
December 31, 2003, we recorded a permanent impairment of our mortgage servicing
rights of approximately $666.4 million, which reduced the gross carrying value
and the valuation allowance of the mortgage servicing rights, thereby precluding
subsequent reversals. During the three months ending March 31, 2004, we recorded
a permanent impairment of our mortgage servicing rights of approximately $60.8
million. These write-downs had no immediate impact on our net income or
financial position in 2003 or the current quarter. However, these write-downs
have resulted in a reduction of amortization expense in the current quarter and
may reduce amortization expense in future periods.
RECENT ACCOUNTING PRONOUNCEMENTS
On December 24, 2003, the FASB issued FASB Interpretation No. 46 (Revised 2003):
CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("FIN 46R"), to clarify some of the
provisions of FIN 46 and to exempt certain entities from its requirements. We
adopted FIN 46R effective January 1, 2004, which did not have a material impact
on our consolidated financial statements.
On July 7, 2003, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 03-1, ACCOUNTING AND REPORTING BY INSURANCE
ENTERPRISES FOR CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE
ACCOUNTS ("SOP 03-1"). This SOP addresses an insurance enterprise's accounting
for certain fixed and variable contract features not covered by other
authoritative accounting guidance. We adopted SOP 03-1 effective January 1,
2004, and recorded a cumulative effect of accounting change of $(5.7) million,
which is net of income tax benefits of $3.0 million.
A provision of SOP 03-1 relates to the classification of contracts and
calculation of an additional liability for contracts that contain significant
insurance features. The adoption of the guidance requires the recognition of a
liability in addition to the contract account value in cases where the insurance
benefit feature results in gains in early years followed by losses in later
years. The accrual and release of the additional liability also impacts the
amortization of deferred policy acquisition costs ("DPAC"). As of January 1,
2004, we increased future policyholder benefits due to our no lapse guarantee
feature of our universal life and variable universal life products within our
Life and Health Insurance segment and for variable annuities with guaranteed
minimum death benefits in our U.S. Asset Management and Accumulation segment.
This resulted in an after-tax cumulative effect of $(0.9) million in the Life
and Health Insurance segment and $(1.5) million in the U.S. Asset Management and
Accumulation segment.
39
We also decreased an equity method investment within our International Asset
Management and Accumulation segment by $3.3 million, net of income taxes, as of
January 1, 2004, for select deferred annuity products, which include guaranteed
annuitization purchase rates. The guidance requires contracts which provide for
potential benefits in addition to the account balance that are payable only upon
annuitization to establish an additional liability if the present value of the
annuitized benefits exceed the expected account balance at the expected
annuitization date.
In addition, the guidance clarifies the accounting and classification for sales
inducements. Although the valuation impacts were immaterial, we reclassified
$37.6 million of sales inducements from DPAC to other assets effective January
1, 2004.
On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin ("SAB") 105,
APPLICATION OF ACCOUNTING PRINCIPLES TO LOAN COMMITMENTS ("SAB 105"), in which
the SEC Staff expressed their view that the fair value of recorded loan
commitments, including interest rate lock commitments ("IRLCs"), that are
required to follow derivative accounting under Statement of Financial Accounting
Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES,
should not consider the expected future cash flows related to the associated
servicing of the loan. SAB 105 requires IRLCs issued after April 1, 2004, to be
accounted for as written options that would be reported as a liability until
expiration or termination of the commitment. We do not expect this SAB to have a
material impact on our consolidated financial statements.
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
periods indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------------
2004 2003
------------------ -----------------
INCOME STATEMENT DATA:
Revenues:
Premiums and other considerations...................................... $ 921.8 $ 905.5
Fees and other revenues................................................ 561.1 632.0
Net investment income.................................................. 817.0 836.0
Net realized/unrealized capital losses................................. (42.8) (76.7)
------------------ -----------------
Total revenues....................................................... 2,257.1 2,296.8
Expenses:
Benefits, claims and settlement expenses............................... 1,187.5 1,195.2
Dividends to policyholders............................................. 73.3 80.1
Operating expenses..................................................... 730.9 799.3
------------------ -----------------
Total expenses....................................................... 1,991.7 2,074.6
------------------ -----------------
Income from continuing operations before income taxes.................... 265.4 222.2
Income taxes............................................................. 66.1 65.8
------------------ -----------------
Income from continuing operations, net of related income taxes....... 199.3 156.4
Loss from discontinued operations, net of related income taxes........... - (0.7)
------------------ -----------------
Income before cumulative effect of accounting changes.................... 199.3 155.7
Cumulative effect of accounting change, net of related income taxes...... (5.7) -
------------------ -----------------
Net income........................................................... $ 193.6 $ 155.7
================== =================
40
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Premiums and other considerations increased $16.3 million, or 2%, to $921.8
million for the three months ended March 31, 2004, from $905.5 million for the
three months ended March 31, 2003. The increase reflected a $29.5 million
increase from the International Asset Management and Accumulation segment,
primarily related to record sales of single premium annuities with life
contingencies in Chile in 2004 following a year of decreased sales due to market
contraction and the strengthening of the Chilean peso versus the U.S. dollar. In
addition, Life and Health segment premiums increased $11.7 million primarily due
to increased sales and stable persistency in our specialty benefits business.
The increases were partially offset by a $24.9 million decrease from the U.S.
Asset Management and Accumulation segment, primarily a result of a 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 decreased $70.9 million, or 11%, to $561.1 million for
the three months ended March 31, 2004, from $632.0 million for the three months
ended March 31, 2003. The decrease was largely due to a $139.0 million decrease
from the Mortgage Banking segment resulting from a decrease in mortgage loan
production. The decrease was partially offset by a $46.4 million increase from
the U.S. Asset Management and Accumulation segment primarily related to
improvements in the equity markets and net cash flow, which have led to higher
account values, and increases in management fee income. In addition, Life and
Health fees and other revenues increased $13.2 million primarily due to the
acquisition of the Molloy Companies effective January 2, 2004 and due to growth
in the universal life and variable universal life insurance business.
Net investment income decreased $19.0 million, or 2%, to $817.0 million for the
three months ended March 31, 2004, from $836.0 million for the three months
ended March 31, 2003. The decrease was primarily related to a decrease in
annualized investment yields. The annualized yield on average invested assets
and cash was 5.7% for the three months ended March 31, 2004, compared to 6.6%
for the three months ended March 31, 2003. This reflects lower yields on
invested assets due in part to a lower interest rate environment. Partially
offsetting the decrease was a $4,648.5 million, or 9%, increase in average
invested assets and cash, excluding the impact of the implementation of FIN 46.
Net realized/unrealized capital losses decreased $33.9 million, or 44%, to $42.8
million for the three months ended March 31, 2004, from $76.7 million for the
three months ended March 31, 2003. The decrease includes a reduction in write
downs of other than temporary declines in the value of certain fixed maturity
securities and less losses on credit impaired fixed maturity securities sales
partially offset by higher losses related to hedging activities.
41
The following table highlights the contributors to net realized/unrealized
capital gains and losses for the three months ended March 31, 2004.
FOR THE THREE MONTHS ENDED MARCH 31, 2004
-----------------------------------------------------------------------
NET REALIZED NET REALIZED/
GAINS UNREALIZED
(LOSSES) ON HEDGING CAPITAL GAINS
IMPAIRMENTS DISPOSAL ADJUSTMENTS (LOSSES)
---------------- ---------------- ----------------- -------------------
(IN MILLIONS)
Fixed maturity securities (1)... $ (21.8) $ 5.1 $ 27.9 $ 11.2
Equity securities (2)........... (3.9) 3.9 - -
Mortgage loans on real
estate (3).................... (11.7) - - (11.7)
Real estate..................... (3.3) 3.9 - 0.6
Derivatives..................... - - (72.9) (72.9)
Other (4)....................... - 25.3 4.7 30.0
---------------- ---------------- ----------------- -------------------
Total......................... $ (40.7) $ 38.2 $ (40.3) $ (42.8)
================ ================ ================= ===================
- -----------------------
(1) Impairments include $2.4 million in recoveries on the sale of previously
impaired assets and $24.2 million of impairment losses. Net realized gains
(losses) on disposal includes gross realized gains of $14.2 million and
gross realized losses of $9.1 million.
(2) Impairments include $3.9 million of impairment losses. Net realized gains
(losses) on disposal includes gross realized gains of $5.5 million and gross
realized losses of $1.6 million.
(3) Includes $5.6 million in realized losses due to sale, foreclosure, or
impairment write-down of commercial mortgage loans and a $6.1 million
increase in commercial mortgage valuation allowance.
(4) Net realized gains (losses) on disposal includes $10.6 million in realized
gains on seed money, $6.8 million for mark to market gains on seed money,
and $1.9 million related to foreign currency gains.
Benefits, claims and settlement expenses decreased $7.7 million, or 1%, to
$1,187.5 million for the three months ended March 31, 2004, from $1,195.2
million for the three months ended March 31, 2003. The decrease was primarily
due to a $33.7 million decrease from the U.S. Asset Management and Accumulation
segment, reflecting a decrease in pension full-service payout sales of single
premium group annuities with life contingencies. Partially offsetting the
decrease was a $28.2 million increase in the International Asset Management and
Accumulation segment primarily a result of higher reserve expenses due to record
sales of single premium annuities with life contingencies in Chile in 2004
following a year of decreased sales due to market contraction and the
strengthening of the Chilean peso versus the U.S. dollar.
Dividends to policyholders decreased $6.8 million, or 8%, to $73.3 million for
the three months ended March 31, 2004, from $80.1 million for the three months
ended March 31, 2003. The decrease was attributable to a $3.5 million decrease
from the Life and Health Insurance segment, resulting from changes in the
individual life insurance dividend crediting rates. In addition, U.S. Management
and Accumulation dividends to policyholders decreased $3.3 million resulting
from a decrease in dividends for our participating pension full-service
accumulation products.
Operating expenses decreased $68.4 million, or 9%, to $730.9 million for the
three months ended March 31, 2004, from $799.3 million for the three months
ended March 31, 2003. The decrease was largely due to a $110.8 million decrease
from the Mortgage Banking segment primarily resulting from a decrease in the
impairment of capitalized mortgage servicing rights net of servicing hedge
activity and amortization of mortgage servicing rights. Partially offsetting the
decrease was an $18.0 million increase in the Corporate and Other segment partly
related to a prepayment penalty recognized on redemption of our surplus notes
due 2024. In addition, U.S Asset Management and Accumulation segment operating
42
expenses increased $14.6 million due to our acquisition of Post Advisory in the
third quarter of 2003 and increases in professional and investment management
fees.
Income taxes increased $0.3 million to $66.1 million for the three months ended
March 31, 2004 from $65.8 million for the three months ended March 31, 2003. The
effective income tax rate was 25% for the three months ended March 31, 2004 and
30% for the three months ended March 31, 2003. The effective income tax rate for
the three months ended March 31, 2004 was lower than the corporate income tax
rate of 35% primarily due to income tax deductions allowed for corporate
dividends received, a tax benefit associated with prior year accumulated losses
on a foreign investment and interest exclusion from taxable income, partially
offset by state income taxes. The effective income tax rate for the three months
ended March 31, 2003 was 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. The decrease in the effective tax rate to 25% for the three months ended
March 31, 2004, from 30% for the three months ended March 31, 2003, was
primarily due to a tax benefit associated with prior year accumulated losses on
a foreign investment.
As a result of the foregoing factors and the inclusion of a loss from
discontinued operations and the cumulative effect of accounting change, net of
related income taxes, net income increased $37.9 million, or 24%, to $193.6
million for the three months ended March 31, 2004, from $155.7 million for the
three months ended March 31, 2003. 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 SOP 03-1.
RESULTS OF OPERATIONS BY SEGMENT
We use operating earnings, which excludes the effect of net realized/unrealized
capital gains and losses, as adjusted, and other after-tax adjustments, for goal
setting, determining employee compensation, and evaluating performance on a
basis comparable to that used by securities analysts. 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 we
believe are not indicative of overall operating trends. Note that after-tax
adjustments have occurred in the past and could recur in future reporting
periods. 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:
43
AS OF OR FOR THREE MONTHS ENDED
MARCH 31,
-----------------------------------
2004 2003
--------------- ---------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation................................. $ 897.2 $ 886.0
International Asset Management and Accumulation........................ 115.5 76.8
Life and Health Insurance.............................................. 1,035.3 1,012.3
Mortgage Banking....................................................... 255.6 404.5
Corporate and Other(1)................................................. 0.3 (0.7)
--------------- ---------------
Total segment operating revenues..................................... 2,303.9 2,378.9
Net realized/unrealized capital losses, including recognition of
front-end fee revenues and certain market value adjustments to fee
revenues(2).......................................................... (46.8) (82.1)
--------------- ---------------
Total revenue per consolidated statements of operations.............. $ 2,257.1 $ 2,296.8
=============== ===============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ................................ $ 122.0 $ 97.5
International Asset Management and Accumulation........................ 8.7 6.6
Life and Health Insurance.............................................. 74.8 59.1
Mortgage Banking....................................................... 28.6 52.3
Corporate and Other ................................................... (11.5) (5.0)
--------------- ---------------
Total segment operating earnings..................................... 222.6 210.5
Net realized/unrealized capital losses, as adjusted(2)................. (23.3) (54.1)
Other after-tax adjustments(3)......................................... (5.7) (0.7)
--------------- ---------------
Net income (loss) per consolidated statements of operations.......... $ 193.6 $ 155.7
=============== ===============
TOTAL ASSETS BY SEGMENT:
U.S. Asset Management and Accumulation(4).............................. $ 87,221.9 $ 72,396.8
International Asset Management and Accumulation........................ 3,143.3 2,269.6
Life and Health Insurance.............................................. 12,514.5 11,477.0
Mortgage Banking(5).................................................... 5,434.0 3,651.5
Corporate and Other(6)................................................. 2,499.1 2,045.6
--------------- ---------------
Total assets......................................................... $110,812.8 $ 91,840.5
=============== ===============
- -----------------------
(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 and losses, related
changes in the amortization pattern of deferred policy acquisition and
sales inducement costs, recognition of front-end fee revenues for sales
charges on pension products and services and certain market value
adjustments to fee revenues.
44
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------
2004 2003
-------------- --------------
(IN MILLIONS)
Net realized/unrealized capital losses.......................................... $ (42.8) $ (76.7)
Certain market value adjustments to fee revenues................................ (2.9) (9.8)
Recognition of front-end fee revenues........................................... (1.1) 4.4
-------------- --------------
Net realized/unrealized capital losses, including recognition of front-end
fee revenues and certain market value adjustments to fee revenues........... (46.8) (82.1)
Amortization of deferred policy acquisition and sales inducement costs
related to net realized capital gains (losses)................................ 2.1 3.7
Capital (gains) losses distributed.............................................. (2.0) 1.6
Minority interest capital gains................................................. (0.1) (0.1)
-------------- --------------
Net realized/unrealized capital losses, including recognition of
front-end fee revenues and certain market value adjustments to fee
revenues, net of related amortization of deferred policy
acquisition and sales inducement costs, capital losses distributed and
minority interest capital gains............................................. (46.8) (76.9)
Income tax effect............................................................... 23.5 22.8
-------------- --------------
Net realized/unrealized capital losses, as adjusted........................... $ (23.3) $ (54.1)
============== ==============
(3) For the three months ended March 31, 2004, other after-tax adjustments of
$5.7 million included the negative effect of a cumulative effect of an
accounting change, a result of our implementation of SOP 03-1. 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.
(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
$814.9 million at March 31, 2004, and $838.0 million at March 31, 2003.
Changes in fair value of the separate account are reflected in both
separate account assets and separate account liabilities.
(5) As a result of our implementation of FIN 46, effective July 1, 2003,
Mortgage Banking assets include the full consolidation of PRMCR, which
provides a source of funding for our residential mortgage loan production.
PRMCR held $1.2 billion in mortgage loans held for sale as of March 31,
2004.
(6) Includes inter-segment elimination amounts related to an internal line of
credit, intercompany short-term investments, internally generated mortgage
loans, and long-term borrowings. The Corporate and Other segment managed a
revolving line of credit used by other segments. The Mortgage Banking
segment and the Life and Health Insurance segment have cash deposited with
the U.S. Asset Management and Accumulation segment. The U.S. Asset
Management and Accumulation segment and the 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. The U.S. Asset Management and Accumulation
segment provides a source of funding for the Mortgage Banking segment's
mortgage servicing rights.
45
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 periods indicated:
FOR THE THREE MONTHS ENDED MARCH 31,
-------------------------------------
2004 2003
---------------- ----------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other considerations............ $ 88.9 $ 113.8
Fees and other revenues...................... 229.8 184.8
Net investment income........................ 578.5 587.4
---------------- ----------------
Total operating revenues................... 897.2 886.0
Expenses:
Benefits, claims and settlement expenses,
including dividends to policyholders......... 498.6 535.6
Operating expenses............................ 238.4 225.4
---------------- ----------------
Total expenses............................. 737.0 761.0
---------------- ----------------
Pre-tax operating earnings.................... 160.2 125.0
Income taxes.................................. 38.2 27.5
---------------- ----------------
Operating earnings............................ 122.0 97.5
Net realized/unrealized capital losses, as
adjusted..................................... (37.2) (31.1)
Other after-tax adjustments................... (1.5) -
---------------- ----------------
U.S. GAAP REPORTED:
Net income.................................... $ 83.3 $ 66.4
================ ================
- -------------------------
(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, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Premiums and other considerations decreased $24.9 million, or 22%, to $88.9
million for the three months ended March 31, 2004, from $113.8 million for the
three months ended March 31, 2003. The decrease primarily resulted from a $19.8
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. Also contributing to the overall decline was a $5.1 million decrease in
individual payout annuity sales, primarily related to increased competitive
pricing pressures.
Fees and other revenues increased $45.0 million, or 24%, to $229.8 million for
the three months ended March 31, 2004, from $184.8 million for the three months
ended March 31, 2003. Pension full-service accumulation fees and other revenue
increased $21.1 million primarily due to an increase in revenue from
improvements in the equity markets and net cash flow, which have led to higher
account values. In addition, Principal Global Investors fees and other revenues
increased $14.6 million primarily due to increased management fees stemming from
our acquisition of Post Advisory in third quarter of 2003 and an increase in
assets under management. Furthermore, mutual fund fees and other revenue
increased $17.0 million due to an increase in commission and management fee
46
income, which resulted from higher sales and account values. Of this increase,
$8.7 million relates to sales within the segment and is eliminated at an
operating segment level.
Net investment income decreased $8.9 million, or 2%, to $578.5 million for the
three months ended March 31, 2004, from $587.4 million for the three months
ended March 31, 2003. The decrease primarily resulted from a decrease in the
average annualized yield on invested assets and cash, which was 5.7% for the
three months ended March 31, 2004, compared to 6.3% for the three months ended
March 31, 2003. This reflects lower yields on fixed maturity securities and
commercial mortgages due in part to a lower interest rate environment. The
decrease was offset by a $3,123.7 million, or 8%, increase in average invested
assets and cash.
Benefits, claims and settlement expenses, including dividends to policyholders,
decreased $37.0 million, or 7%, to $498.6 million for the three months ended
March 31, 2004, from $535.6 million for the three months ended March 31, 2003.
The decrease primarily resulted from a $20.8 million decrease in our pension
full-service payout business as a result of decreased sales of single premium
group annuities with life contingencies. In addition, pension full-service
accumulation products decreased $9.2 million primarily due to lower interest
credited on our non-participating deposit type business and due to decreases in
cost of interest credited on declining business from our participating block.
Operating expenses increased $13.0 million, or 6%, to $238.4 million for the
three months ended March 31, 2004, from $225.4 million for the three months
ended March 31, 2003. The increase primarily resulted from an $8.8 million
increase in Principal Global Investors due to our acquisition of Post Advisory
in the third quarter of 2003 and to a lesser extent an increase in consulting
and professional fees. In addition, pension full-service accumulation expenses
increased $6.4 million primarily due to a decrease in the capitalization of
deferred policy acquisition costs and due to higher investment management fees
and compensation costs.
Income taxes increased $10.7 million, or 39%, to $38.2 million for the three
months ended March 31, 2004, from $27.5 million for the three months ended March
31, 2003. The effective income tax rate for this segment was 24% for the three
months ended March 31, 2004, and 22% for the three months ended March 31, 2003.
The effective income tax rates for the three months ended March 31, 2004 and
2003, were lower than the corporate income tax rate of 35% primarily due to
income tax deductions allowed for the corporate dividends received and other
tax-exempt income. The increase in the effective tax rate was primarily due to a
greater increase in pre-tax operating earnings relative to the increase in
permanent tax differences.
As a result of the foregoing factors, operating earnings increased $24.5
million, or 25%, to $122.0 million for the three months ended March 31, 2004
from $97.5 million for the three months ended March 31, 2003.
Net realized/unrealized capital losses, as adjusted, increased $6.1 million, or
20%, to $37.2 million for the three months ended March 31, 2004, from $31.1
million for the three months ended March 31, 2003. The increase is primarily due
to higher capital losses related to hedging activities and increased commercial
mortgage loan losses, which were offset by lower other than temporary declines
in the value of certain fixed maturity securities.
As a result of the foregoing factors and the inclusion of other after-tax
adjustments, net income increased $16.9 million, or 25%, to $83.3 million for
the three months ended March 31, 2004, from $66.4 million for the three months
ended March 31, 2003. For the three months ended March 31, 2004, net income
included the negative effect of other after-tax adjustments totaling $1.5
million, related to a cumulative effect of accounting change due to our
implementation of SOP 03-1.
47
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 periods
indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------------
2004 2003
------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues (1):
Premiums and other considerations........................ $ 60.2 $ 30.7
Fees and other revenues.................................. 21.5 14.8
Net investment income.................................... 33.8 31.3
------------- ---------------
Total operating revenues............................... 115.5 76.8
Expenses:
Benefits, claims and settlement expenses................. 75.7 48.1
Operating expenses....................................... 26.5 20.6
------------- ---------------
Total expenses......................................... 102.2 68.7
------------- ---------------
Pre-tax operating earnings................................. 13.3 8.1
Income taxes .............................................. 4.6 1.5
------------- ---------------
Operating earnings......................................... 8.7 6.6
Net realized/unrealized capital gains (losses), as
adjusted................................................. 3.6 (4.4)
Other after-tax adjustments................................ (3.3) (0.7)
------------- ---------------
U.S. GAAP REPORTED:
Net income................................................. $ 9.0 $ 1.5
============= ===============
OTHER DATA:
Operating earnings:
Principal International.................................. $ 8.7 $ 6.6
BT Financial Group....................................... - -
Net income (loss):
Principal International.................................. $ 9.0 $ 2.2
BT Financial Group....................................... - (0.7)
- -------------------------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Premiums and other considerations increased $29.5 million, or 96%, to $60.2
million for the three months ended March 31, 2004, from $30.7 million for the
three months ended March 31, 2003. An increase of $30.1 million in Chile was
primarily a result of record sales of single premium annuities with life
contingencies in 2004 following a year of decreased sales due to market
contraction and the strengthening of the Chilean peso versus the U.S. dollar.
Fees and other revenues increased $6.7 million, or 45%, to $21.5 million for the
three months ended March 31, 2004, from $14.8 million for the three months ended
March 31, 2003. An increase of $2.2 million in Hong Kong was primarily a result
of an increase in assets under management due to the acquisition of Dao Heng
48
Fund Management in 2004. An increase of $2.1 million in Mexico was primarily a
result of an increase in the number of retirement plan participants due to the
acquisition of AFORE Tepeyac in February 2003. In addition, an increase of $1.0
million in India was primarily a result of accounting for Principal Asset
Management Company using the full consolidation method of accounting due to our
100% ownership beginning third quarter 2003. Prior to third quarter 2003,
results were reported using equity method of accounting.
Net investment income increased $2.5 million, or 8%, to $33.8 million for the
three months ended March 31, 2004, from $31.3 million for the three months ended
March 31, 2003. The increase was primarily due to a $498.1 million increase, or
33%, increase in average invested assets and cash, excluding our equity
investment in subsidiaries. The increase was partially offset by a significant
decrease in investment yields. The annualized yield on average invested assets
and cash, excluding our equity investment in subsidiaries, was 5.7% for the
three months ended March 31, 2004, compared to 7.9% for the three months ended
March 31, 2003.
Benefits, claims and settlement expenses increased $27.6 million, or 57%, to
$75.7 million for the three months ended March 31, 2004, from $48.1 million for
the three months ended March 31, 2003. An increase of $25.5 million in Chile was
primarily a result of higher reserve expenses due to record sales of single
premium annuities with life contingencies in 2004 following a year of decreased
sales due to market contraction and the strengthening of the Chilean peso versus
the U.S. dollar.
Operating expenses increased $5.9 million, or 29%, to $26.5 million for the
three months ended March 31, 2004, from $20.6 million for the three months ended
March 31, 2003. An increase of $2.6 million in Chile was primarily due to
non-deferrable commissions on record sales of single premium annuities with life
contingencies and the strengthening of the Chilean peso versus the U.S. dollar.
In addition, an increase of $2.4 million in Mexico was primarily due to the
acquisition of Principal Genera, S.A. de C.V., Operadora de Fondos de Inversion
in 2003 coupled with a refinement in amortization methodology of the value of
business acquired ("VOBA").
Income taxes increased $3.1 million to $4.6 million for the three months ended
March 31, 2004, from $1.5 million for the three months ended March 31, 2003. The
increase was primarily a result of an increase in deferred taxes related to our
Brazilian equity method investment.
As a result of the foregoing factors, operating earnings increased $2.1 million,
or 32%, to $8.7 million for the three months ended March 31, 2004, from $6.6
million for the three months ended March 31, 2003.
Net realized/unrealized capital gains, as adjusted, increased $8.0 million to
$3.6 million of net realized/unrealized capital gains for the three months ended
March 31, 2004, from $4.4 million of net realized/unrealized capital losses for
the three months ended March 31, 2003. An increase of $4.6 million in Hong Kong
was primarily due to a change in the fair value of embedded derivatives. In
addition, an increase of $2.3 million in India was primarily a result of
accounting for Principal Asset Management Company using the full consolidation
method of accounting due to our 100% ownership that occurred in third quarter
2003.
As a result of the foregoing factors and the inclusion of other after-tax
adjustments, net income increased $7.5 million to $9.0 million for the three
months ended March 31, 2004, from $1.5 million for the three months ended March
31, 2003. For the three months ended March 31, 2004, net income included the
negative effect of other after-tax adjustments totaling $3.3 million, due to the
cumulative effect of an accounting change related to the implementation of SOP
03-1. For the three months ended March 31, 2003, net income included the
negative effect of other after-tax adjustments totaling $0.7 million, related to
the change in the estimated loss on disposal of BT Financial Group.
49
LIFE AND HEALTH INSURANCE SEGMENT
Beginning January 1, 2004, we strategically realigned products and services of
the Life and Health segment to better reflect how we manage our business. The
new divisions of the Life and Health segment are individual life insurance,
health insurance and specialty benefits. Our individual life insurance products
include universal and variable universal life insurance and traditional life
insurance. Our health insurance products include group medical insurance and
fee-for-service. Our specialty benefit products include group dental and vision
insurance, individual and group disability insurance, and group life insurance.
The following table presents certain summary financial data relating to the Life
and Health Insurance segment for the periods indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------------
2004 2003
---------------- ----------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues (1):
Premiums and other considerations............ $ 772.7 $ 761.0
Fees and other revenues...................... 97.6 84.4
Net investment income........................ 165.0 166.9
---------------- ----------------
Total operating revenues.................... 1,035.3 1,012.3
Expenses:
Benefits, claims and settlement expenses..... 616.1 617.8
Dividends to policyholders................... 72.0 75.5
Operating expenses........................... 233.6 230.1
---------------- ----------------
Total expenses.............................. 921.7 923.4
---------------- ----------------
Pre-tax operating earnings..................... 113.6 88.9
Income taxes................................... 38.8 29.8
---------------- ----------------
Operating earnings............................. 74.8 59.1
Net realized/unrealized capital losses, as
adjusted..................................... (1.9) (9.3)
Other after-tax adjustments.................... (0.9) -
---------------- ----------------
U.S. GAAP REPORTED:
Net income..................................... $ 72.0 $ 49.8
================ ================
- -----------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Premiums and other considerations increased $11.7 million, or 2%, to $772.7
million for the three months ended March 31, 2004, from $761.0 million for the
three months ended March 31, 2003. Specialty benefits insurance premiums
increased $20.2 million primarily due to increased sales and stable persistency.
Individual life insurance premiums decreased $9.8 million, primarily a result of
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 $13.2 million, or 16%, to $97.6 million for
the three months ended March 31, 2004, from $84.4 million for the three months
ended March 31, 2003. Fee revenues from our health insurance business increased
$8.0 million, primarily a result of the acquisition of the Molloy Companies
50
effective January 2, 2004. Fee revenues from our individual life insurance
business increased $4.6 million, primarily due to the continued shift in
customer preference to fee-based universal and variable universal life insurance
products.
Net investment income decreased $1.9 million, or 1%, to $165.0 million for the
three months ended March 31, 2004, from $166.9 million for the three months
ended March 31, 2003. The decrease primarily relates to a decrease in the
average annualized yield on invested assets and cash, which was 6.5% for the
three months ended March 31, 2004, compared to 7.0% for the three months ended
March 31, 2003. This reflects lower yields on invested assets due in part to a
lower interest rate environment. The decrease was partially offset by a $530.4
million, or 6%, increase in average invested assets and cash for the segment.
Benefits, claims and settlement expenses decreased $1.7 million to $616.1
million for the three months ended March 31, 2004, from $617.8 million for the
three months ended March 31, 2003. Individual life insurance benefits, claims
and settlement expenses decreased $9.0 million, primarily due to the impact of
decreased premium and lower death claims. In addition, health insurance
benefits, claims and settlement expenses decreased $2.5 million, primarily due
to a reduction in members and reserve refinements, partially offset by increased
claim costs per member. Specialty benefit insurance benefits, claims and
settlement expenses increased $9.8 million, primarily due to growth in the
business.
Dividends to policyholders decreased $3.5 million, or 5%, to $72.0 million for
the three months ended March 31, 2004, from $75.5 million for the three months
ended March 31, 2003. The decrease is primarily related to a decrease in the
individual life insurance dividend crediting rates.
Operating expenses increased $3.5 million, or 2%, to $233.6 million for the
three months ended March 31, 2004, from $230.1 million for the three months
ended March 31, 2003. Specialty benefits operating expenses increased $4.6
million primarily due to increases in non-deferrable commissions related to
higher premium, incentive compensation for employees, and loss adjustment
expenses. Health insurance operating expenses increased $4.4 million, primarily
a result of the acquisition of the Molloy Companies, increased non-deferrable
commissions, and increased loss adjustment expenses partially offset by a
decrease in tax related expenses. Individual life insurance operating expenses
decreased $5.5 million primarily due to lower DPAC amortization resulting from
the impact of updating the mortality assumptions in the DPAC models for
universal life and variable universal life insurance products.
Income taxes increased $9.0 million, or 30%, to $38.8 million for the three
months ended March 31, 2004, from $29.8 million for the three months ended March
31, 2003. The effective income tax rate for the segment was 34% for the three
months ended March 31, 2004 and 2003. The effective income tax rates for the
three months ended March 31, 2004 and 2003 were lower than the corporate income
tax rate of 35% primarily due to tax-exempt income.
As a result of the foregoing factors, operating earnings increased $15.7
million, or 27%, to $74.8 million for the three months ended March 31, 2004,
from $59.1 million for the three months ended March 31, 2003.
Net realized/unrealized capital losses, as adjusted, decreased $7.4 million, or
80%, to $1.9 million for the three months ended March 31, 2004, from $9.3
million for the three months ended March 31, 2003. The decrease is primarily the
result of lower capital losses on other than temporary declines in the value of
certain fixed maturity securities.
As a result of the foregoing factors and the inclusion of other after-tax
adjustments, net income increased $22.2 million, or 45%, to $72.0 million for
the three months ended March 31, 2004, from $49.8 million for the three months
ended March 31, 2003. For the three months ended March 31, 2004, net income
included the negative effect of other after-tax adjustments totaling $0.9
million, due to a cumulative effect of accounting change, a result of our
implementation of SOP 03-1.
51
MORTGAGE BANKING SEGMENT
The following table presents certain summary financial data relating to the
Mortgage Banking segment for the periods indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------------
2004 2003
----------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues:
Loan servicing.................................... $ 181.1 $ 164.1
Loan production................................... 74.5 240.4
----------------- ---------------
Total operating revenues........................ 255.6 404.5
Expenses:
Loan servicing.................................... 173.3 256.9
Loan production................................... 36.3 63.5
----------------- ---------------
Total expenses.................................. 209.6 320.4
----------------- ---------------
Pre-tax operating earnings.......................... 46.0 84.1
Income taxes........................................ 17.4 31.8
----------------- ---------------
Operating earnings.................................. 28.6 52.3
Net realized/unrealized capital losses, as adjusted. - -
Other after-tax adjustments......................... - -
----------------- ---------------
U.S. GAAP REPORTED:
Net income.......................................... $ 28.6 $ 52.3
================= ===============
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Total operating revenues decreased $148.9 million, or 37%, to $255.6 million for
the three months ended March 31, 2004, from $404.5 million for the three months
ended March 31, 2003. Residential mortgage loan production revenues decreased
$165.9 million due to a decrease in mortgage loan production to $6.8 billion for
the three months ended March 31, 2004, compared to $15.5 billion for the same
period a year ago. Residential mortgage loan servicing revenues increased $17.0
million primarily due to the sale of approximately $169.2 million of delinquent
GNMA loans in the first quarter of 2004 with no corresponding activity for the
same period a year ago. Also contributing to the increase was an increase in the
average balance of the servicing portfolio to $118.7 billion for the three
months ended March 31, 2004, compared to $111.0 billion for the same period a
year ago.
Total expenses decreased $110.8 million, or 35%, to $209.6 million for the three
months ended March 31, 2004, from $320.4 million for the three months ended
March 31, 2003. Residential mortgage loan servicing expenses decreased $83.6
million primarily due to a $56.0 million decrease in the impairment of
capitalized mortgage servicing rights net of servicing hedge activity. This
decrease primarily related to valuation model adjustments that were made in the
first quarter of 2003, which resulted in a $90.5 million impairment. There were
no model adjustments required in the first quarter of 2004. In addition,
amortization of capitalized mortgage servicing rights and interest differential,
which is the interest we are required to pass through to the investor in excess
of what we collect when loans pay off, decreased due to the decrease in actual
and expected prepayments. Amortization also decreased as a result of the
recognition of $666.4 million in direct write-downs of the capitalized basis in
2003. This write-down had no impact on our net income or financial position in
2003, but resulted in a reduction of amortization expense in 2004 and may result
in a reduction of amortization expense in future periods. Residential mortgage
52
loan production expenses decreased $27.2 million reflecting the decrease in
residential mortgage loan production volume.
Income taxes decreased $14.4 million, or 45%, to $17.4 million for the three
months ended March 31, 2004, from $31.8 million for the three months ended March
31, 2003. The decrease in income taxes primarily resulted from a decrease in
pre-tax operating earnings. The effective income tax rate for this segment was
38% for the three months ended March 31, 2004 and 2003. The effective income tax
rates for the three months ended March 31, 2004 and 2003, were higher than the
corporate income tax rate of 35% due to state income taxes.
As a result of the foregoing factors, operating earnings and net income
decreased $23.7 million, or 45%, to $28.6 million for the three months ended
March 31, 2004, from $52.3 million for the three months ended March 31, 2003.
CORPORATE AND OTHER SEGMENT
The following table presents certain summary financial data relating to the
Corporate and Other segment for the periods indicated:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------------
2004 2003
----------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues (1):
Total operating revenues.......................... $ 0.3 $ (0.7)
Expenses:
Total expenses.................................... 21.2 6.3
----------------- ---------------
Pre-tax operating loss................................ (20.9) (7.0)
Income tax benefits................................... (9.4) (2.0)
----------------- ---------------
Operating loss........................................ (11.5) (5.0)
Net realized/unrealized capital gains (losses), as
adjusted............................................ 12.2 (9.3)
Other after-tax adjustments........................... - -
----------------- ---------------
U.S. GAAP REPORTED:
Net income (loss)..................................... $ 0.7 $ (14.3)
================= ===============
- ------------
(1) Excludes net realized/unrealized capital gains (losses).
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Total operating revenues increased $1.0 million to $0.3 million for the three
months ended March 31, 2004, from a negative $0.7 million for the three months
ended March 31, 2003. The increase was partially due to a $3.3 million decrease
in inter-segment eliminations included in this segment, which was offset by a
corresponding change in total expenses. The increase in total revenues was
partially offset by a $2.0 million decrease in net investment income, primarily
due to a decrease in average annualized investment yields for the segment.
Total expenses increased $14.9 million to $21.2 million for the three months
ended March 31, 2004, from $6.3 million for the three months ended March 31,
2003. An increase of $7.2 million related to a prepayment penalty recognized on
53
redemption of our surplus notes due 2024. Inter-segment eliminations included in
this segment decreased $3.3 million, resulting in an increase in total expenses.
Income tax benefits increased $7.4 million to $9.4 million for the three months
ended March 31, 2004, from $2.0 million for the three months ended March 31,
2003. The increase was primarily a result of an increase in pre-tax operating
loss as well as a tax benefit associated with prior year accumulated losses on a
foreign investment.
As a result of the foregoing factors, operating loss increased $6.5 million to
$11.5 million for the three months ended March 31, 2004, from $5.0 million for
the three months ended March 31, 2003.
Net realized/unrealized capital gains, as adjusted, increased $21.5 million to
$12.2 million of net realized/unrealized capital gains for the three months
ended March 31, 2004, from $9.3 million of net realized/unrealized capital
losses for the three months ended March 31, 2003. The increase was primarily due
to realized capital gains on sales of invested assets.
As a result of the foregoing factors, net income increased $15.0 million to $0.7
million of net income for the three months ended March 31, 2004, from $14.3
million of net loss for the three months ended March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
Our legal entity organizational structure has an impact on our ability to meet
cash flow needs as an organization. Following is a simplified organizational
structure.
Principal Financial Group, Inc.
|
Principal Financial Services, Inc.
| | |
Principal Life Principal International Other
Insurance Company Entities Subsidiaries
| |
Principal Other
Residential Subsidiaries
Mortgage, Inc.
SOURCES AND USES OF CASH OF CONSOLIDATED OPERATIONS
Net cash provided by operating activities was $1,580.6 million and $747.1
million for the three months ended March 31, 2004 and 2003, respectively. The
increase in cash provided by our operations between periods primarily related to
increases in net funds collected through servicing on behalf of investors
related to mortgage banking services as well as an increase in the net cash
provided by the mortgage loans held for sale activity.
Net cash used in investing activities was $601.3 million and $1,497.7 million
for the three months ended March 31, 2004 and 2003, respectively. The decrease
in cash used in investing activities between periods was primarily related to an
increase in the net sales and maturities of available-for-sale securities in
addition to a decline in net purchases of mortgage servicing rights.
Net cash used in financing activities was $1,063.6 million for the three months
ended March 31, 2004, compared to net cash provided by financing activities of
$678.9 million for the three months ended March 31, 2003. The increase in net
cash used in financing activities was primarily due to net withdrawals of
investment contracts compared to net deposits in the prior year. The redemption
54
of a surplus note, as well as an increase in the payment of short-term debt,
primarily related to PRMCR, also contributed to the increase in cash used in
financing activities. These items were slightly offset by a decline in treasury
stock acquired.
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 2003 statutory results,
Principal Life could pay approximately $701.2 million in stockholder dividends
in 2004 without exceeding the statutory limitation.
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, 2004, we did not repurchase shares of
our outstanding common stock on the open market.
INTERNATIONAL ASSET MANAGEMENT AND ACCUMULATION OPERATIONS
We have received approximately U.S. $890.0 million of total proceeds from our
sale of substantially all of BT Financial Group to Westpac. This amount includes
cash proceeds from Westpac, 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 approximately U.S. $115.0 million may be received
in 2004, if Westpac experiences growth in their retail assets under management.
We do not anticipate receiving the contingent proceeds.
Our Brazilian, Chilean and Mexican operations produced positive cash flow from
operations for the three months ended March 31, 2004 and 2003. These cash flows
have been historically maintained at the local country level for strategic
expansion purposes and local capital requirements. In March 2004, our Brazilian
operations returned $8.2 million in the form of dividends to our subsidiary,
Principal Financial Services, Inc. Our international operations have required
infusions of capital of $4.2 million for the three months ended March 31, 2004,
and $29.5 million for the three months ended March 31, 2003, primarily to fund
acquisitions and to a lesser extent, to meet the cash outflow and capital
requirements of certain operations. These 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.
55
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of March 31, 2004, we had $2,555.1 million of long-term debt outstanding
compared to $2,767.3 million at December 31, 2003. On March 10, 1994, our
subsidiary, Principal Life issued $300.0 million of surplus notes, including
$200.0 million due March 1, 2024, at a 7.875% annual interest rate and the
remaining $100.0 million due March 1, 2044, at an 8% annual interest rate.
Subject to the Commissioner of Insurance of the State of Iowa (the
"Commissioner") approval, the surplus notes due March 1, 2024, were optionally
redeemable at Principal Life's election on or after March 1, 2004, in whole or
in part at a redemption price of approximately 103.6% of par. We elected, with
the Commissioner's approval, to redeem on March 1, 2004, the entire outstanding
$200.0 million principal amount of surplus notes due March 1, 2024, at a
redemption price of 103.6%. Total cash paid for the surplus note redemption on
March 1, 2004, was $207.2 million.
There have been no other significant changes to the long-term contractual
obligations since December 31, 2003.
SHORT-TERM DEBT
As of March 31, 2004, we had $986.3 million of short-term debt outstanding
compared to $1,617.8 million at December 31, 2003. As of March 31, 2004, we had
credit facilities with various financial institutions in an aggregate amount of
$4.9 billion, which consisted of a $2.5 billion PRMCR credit facility and $2.4
billion in other credit facilities. We consolidated PRMCR in July 2003 as a
result of adopting FIN 46. PRMCR can use the $2.5 billion credit facility to
issue short-term debt. As of March 31, 2004, PRMCR had no outstanding balances
under this facility. Of our other remaining credit facilities, as of March 31,
2004, we had $886.1 million of outstanding borrowings from these credit
facilities. Our credit facilities include a $600.0 million back-stop facility to
provide 100% support for our commercial paper program, of which there were no
outstanding balances as of March 31, 2004. Also included in our credit
facilities is a short-term borrowing arrangement with an unaffiliated entity
renewed by Principal Residential Mortgage, Inc. on February 28, 2004, to provide
up to $700.0 million related to the activities of its Principal Residential
Mortgage Servicing subsidiary. At March 31, 2004, we had a $300.0 million note
payable outstanding pursuant to this borrowing arrangement. The scheduled
maturity of this note payable is February 28, 2005. We were not in compliance
with one of the covenants under this agreement at March 31, 2004. We obtained a
waiver from the unaffiliated entity.
PRMCR also has $100.0 million outstanding short-term debt in fixed term notes as
of March 31, 2004, which was originally issued under a separate credit facility
for long-term borrowings. Due to the maturity date of less than twelve months at
the time of consolidation in July 2003, the fixed term notes were classified as
short-term debt.
OFF-BALANCE SHEET ARRANGEMENTS
DELINQUENT RESIDENTIAL MORTGAGE LOAN FUNDING. Principal Residential Mortgage
Funding, LLC ("PRMF"), provides an off-balance sheet source of funding for
qualifying delinquent mortgage loans. We sell qualifying delinquent FHA and VA
mortgage loans to PRMF which then transfers the loans to Principal Residential
Mortgage EBO Trust ("Trust"), an unaffiliated Delaware business trust and a
qualifying special purpose entity. At March 31, 2004 and 2003, the Trust held
$652.5 million and $507.0 million in mortgage loans, respectively, and had
outstanding participation certificates of $617.6 million and $479.3 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 $11.0 million and $7.0 million in
servicing and successful servicing fees from PRMF in the first quarter of 2004
56
and 2003, respectively. At March 31, 2004 and 2003, our residual interest in
such cash flows was $54.4 million and $39.9 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 2004 through 2019. The maximum
exposure under these agreements as of March 31, 2004, was approximately $192.0
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 net income. The fair value
of such guarantees issued after January 1, 2003, was insignificant.
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$250.0 million Australian dollars
(approximately U.S. $190.0 million as of March 31, 2004). 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 required that any
amendments to constitutions and compliance plans be filed in New Zealand. In
April 2003, the New Zealand Securities 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. 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. This
technical issue affected many in the industry. On April 15, 2004, the New
Zealand government enacted legislation that will provide issuers, including BT
Financial Group, the opportunity for retroactive relief from such late filing
violations. The law allows issuers to apply for judicial validation of
non-compliant issuances resulting from late filings. The law further provides
that judicial relief is mandatory and unconditional unless an investor was
materially prejudiced by the late filing. A related judicial action is pending.
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 net income in a particular quarter or annual
period.
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 residential mortgage loans and 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 net income. The fair value of such indemnifications issued
after January 1, 2003, was insignificant.
INVESTMENTS
We had total consolidated assets as of March 31, 2004, of $110.8 billion, of
which $56.0 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
57
assets held in separate accounts, the discussion and financial information below
does not include such assets. Of our invested assets, $53.9 billion were held by
our U.S. operations and the remaining $2.1 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,
is responsible for establishing all investment policies, reviewing and approving
all investments. As of March 31, 2004, there are ten members on the Investment
Committee, one of 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 one year unless removed by our analysts. Our
analysts monitor issuers on the list on a continuous basis with a formal review
documented annually 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;
58
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 65%
and the debt service coverage ratio at loan inception was 2.4 times as of March
31, 2004.
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,
2004.
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, 2004, were predominantly of high quality
and broadly diversified across asset class, individual credit, industry and
geographic location. Asset allocation is determined based on cash flow and the
risk/return requirements of our products. 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.
59
U.S. INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
------------------------ -------------------------
2004 2003
------------------------ -------------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
------------ ----------- ------------- ----------
($ IN MILLIONS)
Fixed maturity securities
Public........................................... $ 25,517.4 47% $ 24,785.0 46%
Private.......................................... 11,722.8 22 11,343.0 21
Equity securities.................................. 697.3 1 670.7 1
Mortgage loans
Commercial ...................................... 9,703.7 18 9,630.4 18
Residential (1).................................. 2,852.0 5 3,544.6 7
Real estate held for sale ......................... 502.3 1 524.4 1
Real estate held for investment.................... 962.3 2 1,003.6 2
Policy loans....................................... 804.5 2 804.1 2
Other investments ................................. 1,117.1 2 1,249.7 2
------------- ----------- ------------- ----------
Total invested assets.......................... 53,879.4 100% 53,555.5 100%
=========== ==========
Cash and cash equivalents.......................... 1,537.8 1,619.8
------------- -------------
Total invested assets and cash ................ $ 55,417.2 $ 55,175.3
============= =============
- -----------------------
(1) As a result of our implementation of FIN 46, effective July 1, 2003,
residential mortgage loans include the full consolidation of PRMCR, which
provides a source of funding for our residential mortgage loan production.
PRMCR held $1.2 billion in mortgage loans held for sale as of March 31, 2004
and $2.0 billion as of December 31, 2003.
We actively manage public fixed maturity securities, including our portfolio of
residential mortgage-backed securities, in order to provide liquidity and
enhance yield and total return. Our residential mortgage-backed securities are
managed to reduce the risk of prepayment. This active management has resulted in
the realization of capital gains and losses with respect to such investments.
U.S. INVESTMENT RESULTS
The following tables present the yield and investment income, excluding net
realized/unrealized gains and losses for our U.S. invested assets. The
annualized yield on U.S. invested assets and on cash and cash equivalents was
5.7% for the three months ended March 31, 2004, compared to 6.5% for the three
months ended March 31, 2003. We calculate annualized yields using a simple
average of asset classes at the beginning and end of the reporting period.
Effective July 1, 2003, residential mortgage loans increased significantly due
to the full consolidation of PRMCR under the implementation of FIN 46. The yield
on other invested assets for the first quarter of 2003 was high due to
derivatives associated with the increase in mortgage loan production.
60
U.S. INVESTED ASSETS
INVESTMENT INCOME YIELDS BY ASSET TYPE
FOR THE THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------
2004 2003
--------------------------- -----------------------
YIELD AMOUNT YIELD AMOUNT
----------- ------------- ---------- -----------
($ IN MILLIONS)
Fixed maturity securities............. 5.9% $ 540.1 6.5% $548.3
Equity securities..................... 6.8 11.6 7.5 6.8
Mortgage loans - Commercial........... 7.0 169.7 7.4 174.4
Mortgage loans - Residential.......... 5.8 46.5 4.4 16.4
Real Estate........................... 9.2 34.3 6.8 21.5
Policy loans.......................... 6.4 12.8 6.9 14.0
Cash and cash equivalents............. 0.7 2.9 1.4 3.2
Other investments..................... 4.5 13.2 18.3 46.4
------------- -----------
Total before investment expenses.... 6.0 831.1 6.7 831.0
Investment expenses................... 0.3 47.9 0.2 26.3
------------- -----------
Net investment income............... 5.7% $ 783.2 6.5% $804.7
============= ===========
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 69% of total U.S. invested assets as of March 31, 2004
and 67% as of December 31, 2003. 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,
2004 and December 31, 2003, respectively. Included in the privately placed
category as of March 31, 2004, were $4.7 billion of securities eligible for
resale to qualified institutional buyers under Rule 144A under the Securities
Act of 1933. Fixed maturity securities were diversified by category of issuer as
of March 31, 2004, and December 31, 2003, as shown in the following table:
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY TYPE OF ISSUER
AS OF MARCH 31, AS OF DECEMBER 31,
------------------------ ------------------------
2004 2003
------------------------ -------------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
--------------- ------- ------------- -----------
($ IN MILLIONS)
U.S. Government and agencies........................... $ 620.5 2% $ 610.9 2%
States and political subdivisions...................... 525.1 1 537.0 1
Non-U.S. governments................................... 464.5 1 422.4 1
Corporate - public..................................... 18,539.0 50 18,033.4 50
Corporate - private.................................... 9,824.9 26 9,693.1 27
Residential pass-through securities.................... 2,027.1 6 2,070.3 6
Commercial MBS......................................... 3,157.3 9 2,917.4 8
Collateral mortgage obligations........................ 511.1 1 294.6 1
Asset-backed securities................................ 1,570.7 4 1,548.9 4
--------------- ------- ------------- -----------
Total fixed maturities............................. $ 37,240.2 100% $ 36,128.0 100%
=============== ======= ============= ===========
61
We held $7,266.2 million of mortgage-backed and asset-backed securities as of
March 31, 2004, and $6,831.2 million as of December 31, 2003.
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,
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. fixed maturity securities totaled
$5,299.8 million, or 14% of total fixed maturity securities, as of March 31,
2004, comprised of corporate and foreign government fixed maturity securities.
Of the $5,299.8 million as of March 31, 2004, investments totaled $1,498.7
million in the United Kingdom, $1,268.0 million in the continental European
Union, $607.5 million in Asia, $440.5 million in South America, $423.3 million
in Australia and $16.0 million in Japan. The remaining $1,045.8 million is
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 18% 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, 2004, our investments in Canada totaled $1,364.8
million.
As of March 31, 2004, our top ten corporate bond exposures were rated an "A"
equivalent or better by the rating agencies and represented $2,940.9 million, or
8% of our fixed maturity securities portfolio and 5% of total U.S. invested
assets. As of March 31, 2004, no individual non-government issuer represented
more than 1% of U.S. invested assets.
Valuation techniques for the fixed maturity securities portfolio vary by
security type and the availability of market data. Pricing models and their
underlying assumptions impact the amount and timing of unrealized gains and
losses recognized, and the use of different pricing models or assumptions could
produce different financial results. Interactive Data Corporation ("IDC") or
direct broker quotes are our sources for external prices for our public bonds
and those private placement securities that are actively traded in the secondary
62
market. In cases where quoted market prices are not available, a matrix pricing
valuation approach is used. Securities are grouped into pricing categories that
vary by asset class, sector, rating, and average life. Each pricing category is
assigned a risk spread based on studies of observable public market data or
market clearing data from the investment professionals assigned to specific
security classes. The expected cash flows of the security are then discounted
back at the current Treasury curve plus the appropriate risk spread. Although
the matrix valuation approach provides a fair valuation of each pricing
category, the valuation of an individual security within each pricing category
may actually be impacted by company specific factors. Certain market events that
could impact the valuation of securities include issuer credit ratings, business
climate, management changes, litigation, and government actions among others.
The resulting prices are then reviewed by pricing analysts. All loans placed on
the "watch list" are valued individually by the investment analysts or the
analysts that focus on troubled securities ("Workout group"). Although we
believe our estimates reasonably reflect the fair value of those securities, the
key assumptions about risk premiums, performance of underlying collateral (if
any) and other factors involve significant assumptions and may not reflect those
of an active market. To the extent that bonds have longer maturity dates,
management's estimate of fair value may involve greater subjectivity since they
involve judgment about events well into the future. Every month, there is a
comprehensive review of all impaired securities and problem loans by a group
consisting of the Chief Investment Officer, the Portfolio Managers, and the
Workout Group. The valuation of impaired bonds for which there is no quoted
price is typically based on the present value of the future cash flows expected
to be received. If the company is likely to continue operations, the estimate of
future cash flows is typically based on the expected operating cash flows of the
company that are available to make payments of the bonds. If the company is
likely to liquidate, the estimate of future cash flows is based on an estimate
of the liquidation value of its net assets.
The Securities Valuation Office ("SVO") of the NAIC evaluates most of the fixed
maturity securities that we and other U.S. insurance companies hold. The SVO
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. As of March 31, 2004, the
percentage, based on estimated fair value, of total publicly traded and
privately placed fixed maturity securities that were investment grade with an
NAIC Designation 1 or 2 was 93%.
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 2.18 times compared to the
Standard & Poor's drift ratio of 2.47 times, as of December 31, 2003.
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, 2004, and December 31, 2003, as well as the
percentage, based on estimated fair value, that each designation comprises:
63
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF MARCH 31, 2004 AS OF DECEMBER 31, 2003
------------------------------------------ --------------------------------------------
% OF % OF
RATING TOTAL TOTAL
NAIC AGENCY AMORTIZED CARRYING CARRYING AMORTIZED CARRYING CARRYING
RATING (1) EQUIVALENT COST AMOUNT AMOUNT COST AMOUNT AMOUNT
- ------------ ---------------------- ------------ ---------- -------------- ------------ ------------ ---------------
($ IN MILLIONS)
1 Aaa/Aa/A............. $ 17,686.3 $19,085.8 51% $ 17,299.2 $ 18,415.1 51%
2 Baa.................. 14,269.2 15,641.5 42 13,579.3 14,657.1 41
3 Ba................... 1,540.3 1,677.5 5 1,998.0 2,123.1 6
4 B.................... 545.1 546.7 1 517.4 514.5 1
5 Caa and lower........ 101.3 98.8 - 230.9 225.4 1
6 In or near default... 182.0 189.9 1 220.7 192.8 -
------------ ---------- -------------- ----------- ------------ ---------------
Total fixed
maturities....... $ 34,324.2 $37,240.2 100% $ 33,845.5 $ 36,128.0 100%
============ ========== ============== =========== ============ ===============
- -----------------------
(1) Includes 137 securities with an amortized cost of $1,336.4 million, gross
gains of $55.8 million, gross losses of $2.3 million and a carrying amount
of $1,389.9 million as of March 31, 2004, that are still pending a review
and assignment of a rating by the SVO. Due to the timing of when fixed
maturity securities are purchased, legal documents are filed, and the
review by the SVO, there will always be securities in our portfolio that
are unrated over a reporting period. In these instances, an equivalent
rating is assigned based on our fixed income analyst's assessment.
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, 2004, we had invested 3% 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.
The following table shows 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, 2004, and December 31, 2003.
64
U.S. INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES BY SALOMON INDUSTRY
AS OF MARCH 31, AS OF DECEMBER 31,
-------------------------- --------------------------
2004 2003
-------------------------- --------------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
------------- ----------- -------------- ----------
($ IN MILLIONS)
INDUSTRY CLASS
Finance - Bank.......................... $ 3,076.0 11% $ 3,041.9 11%
Finance - Insurance..................... 1,987.2 7 1,718.1 6
Finance - Other......................... 3,454.4 12 3,337.5 12
Industrial - Consumer................... 989.3 3 879.4 3
Industrial - Energy..................... 2,799.3 10 2,779.5 10
Industrial - Manufacturing.............. 5,669.1 20 5,729.6 21
Industrial - Other...................... 161.7 1 158.7 1
Industrial - Service.................... 4,469.9 16 4,503.0 16
Industrial - Transport.................. 1,003.3 3 967.8 4
Utility - Electric...................... 2,826.8 10 2,751.2 10
Utility - Other......................... 61.4 - 67.4 -
Utility - Telecom....................... 1,865.5 7 1,792.4 6
------------- ----------- -------------- ----------
Total............................... $ 28,363.9 100% $ 27,726.5 100%
============= =========== ============== ==========
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 where default is perceived to be imminent in the near
term, 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. If at the time of restructure, the present value of the
new future cash flows is less than the current cost of the asset being
restructured, a realized capital loss is recorded in net income and a new cost
basis is established.
We have a process in place to identify securities that could potentially have an
impairment that is other than temporary. This process involves monitoring market
events that could impact issuers' credit ratings, business climate, management
changes, litigation and government actions, and other similar factors. This
process also involves monitoring late payments, pricing levels, downgrades by
rating agencies, key financial ratios, financial statements, revenue forecasts
and cash flow projections as indicators of credit issues
Every month, a group of individuals including the Chief Investment Officer, our
Portfolio Managers, members of our Workout Group, and representatives from
Investment Accounting review all securities where market value is less than
seventy-five percent of amortized cost to determine whether impairments need to
be taken. The analysis focuses on each issuer's ability to service its debts in
65
a timely fashion and the length of time the security has been trading below
cost. Formal documentation of the analysis and the company's decision is
prepared and approved by management.
We consider relevant facts and circumstances in evaluating whether the
impairment of a security is other than temporary. Relevant facts and
circumstances considered include: (1) the length of time the fair value has been
below cost; (2) the financial position and access to capital of the issuer,
including the current and future impact of any specific events; and (3) our
ability and intent to hold the security to maturity or until it recovers in
value. To the extent we determine that a security is deemed to be other than
temporarily impaired, the difference between amortized cost and fair value would
be charged to earnings.
There are a number of significant risks and uncertainties inherent in the
process of monitoring impairments and determining if an impairment is other than
temporary. These risks and uncertainties include: (1) the risk that our
assessment of an issuer's ability to meet all of its contractual obligations
will change based on changes in the credit characteristics of that issuer, (2)
the risk that the economic outlook will be worse than expected or have more of
an impact on the issuer than anticipated, (3) the risk that our investment
professionals are making decisions based on fraudulent or misstated information
in the financial statements provided by issuers and (4) the risk that new
information obtained by us or changes in other facts and circumstances lead us
to change our intent to hold the security to maturity or until it recovers in
value. Any of these situations could result in a charge to earnings in a future
period.
The realized losses relating to other than temporary impairments were $21.8
million for the three months ended March 31, 2004. Following is a summary of our
material impairments taken for the three months ended March 31, 2004:
o $8.8 million on private fixed maturity securities of a Chilean
conglomerate. The company is in payment default, with lenders currently
exercising legal remedies for enforcement in Chile. These impairments are
based on estimated recovery values for the private securities.
o $7.1 million on private fixed maturity securities relating to an Italian
dairy and bakery goods producer. The company filed the equivalent of
Chapter 11 bankruptcy protection after disclosing massive fraud during
December 2003. After additional information has become available as part of
the bankruptcy process it was determined that a further impairment was
warranted. These impairments are based on estimated recovery values for the
private securities.
o $7.5 million on private fixed maturity securities of a U.S. prime and
sub-prime auto lending company. The company filed Chapter 11 bankruptcy
protection during late 2002 and emerged from bankruptcy during September
2003. As operating data on the restructured entity has become available it
was determined that a further impairment was warranted. These impairments
are based on estimated recovery values for the private securities.
For the three months ended March 31, 2004, we realized $9.1 of losses upon
disposal of bonds excluding hedging adjustments. Included in this $9.1 million
is $4.1 million related to sales of seven credit impaired names. These losses
were incurred as part of our general portfolio repositioning activities. We
generally intend to hold securities in unrealized loss positions until they
mature or recover. However, we do sell bonds under certain circumstances such as
when new information causes us to change our assessment of whether a bond will
recover or perform according to its contractual terms, in response to external
events (such as a merger or a downgrade) that result in investment guideline
violations (such as single issuer or overall portfolio credit quality limits),
in response to extreme catastrophic events (such as September 11, 2001) that
result in industry or market wide disruption, or to take advantage of tender
offers. Sales generate both gains and losses.
The following tables present our fixed maturity securities available-for-sale by
industry category and the associated gross unrealized gains and losses as of
March 31, 2004, and December 31, 2003.
66
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY INDUSTRY CATEGORY
AS OF MARCH 31, 2004
--------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED CARRYING
COST GAINS LOSSES (1) AMOUNT
-------------- -------------- --------------- ---------------
(IN MILLIONS)
Finance - Bank.......................... $ 2,862.5 $ 221.6 $ 8.1 $ 3,076.0
Finance - Insurance..................... 1,847.5 142.4 2.7 1,987.2
Finance - Other......................... 3,206.2 255.0 6.8 3,454.4
Industrial - Consumer................... 913.8 76.0 0.5 989.3
Industrial - Energy..................... 2,509.2 300.9 10.8 2,799.3
Industrial - Manufacturing.............. 5,210.1 464.0 5.0 5,669.1
Industrial - Other...................... 148.1 13.6 - 161.7
Industrial - Service.................... 4,059.9 413.4 3.4 4,469.9
Industrial - Transport.................. 920.3 97.0 14.0 1,003.3
Utility - Electric...................... 2,612.4 217.8 3.4 2,826.8
Utility - Other......................... 53.7 8.5 0.8 61.4
Utility - Telecom....................... 1,666.3 200.5 1.3 1,865.5
-------------- -------------- --------------- ---------------
Total corporate securities........... 26,010.0 2,410.7 56.8 28,363.9
U.S. Government and agencies............ 604.4 16.1 - 620.5
States and political subdivisions....... 479.2 46.4 0.5 525.1
Non-U.S. governments.................... 394.9 69.6 - 464.5
Mortgage-backed and other
asset-backed securities............... 6,741.3 433.3 11.8 7,162.8
-------------- -------------- --------------- ---------------
Total fixed maturity securities,
available-for-sale................ $ 34,229.8 $ 2,976.1 $ 69.1 $37,136.8
============== ============== =============== ===============
- -----------------------
(1) Included in the $69.1 million in unrealized losses is $0.2 million that
relates to fixed maturity securities that are part of fair value hedging
relationships and which have been recognized in net income versus other
comprehensive income.
67
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY INDUSTRY CATEGORY
AS OF DECEMBER 31, 2003
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED CARRYING
COST GAINS LOSSES(1) AMOUNT
------------- ------------- -------------- -------------
(IN MILLIONS)
Finance - Bank.......................... $ 2,870.2 $ 183.3 $ 11.6 $ 3,041.9
Finance - Insurance..................... 1,635.1 95.3 12.3 1,718.1
Finance - Other......................... 3,142.7 205.2 10.4 3,337.5
Industrial - Consumer................... 848.5 56.8 25.9 879.4
Industrial - Energy..................... 2,546.0 245.2 11.7 2,779.5
Industrial - Manufacturing.............. 5,363.5 382.0 15.9 5,729.6
Industrial - Other...................... 147.9 11.1 0.3 158.7
Industrial - Service.................... 4,153.6 355.2 5.8 4,503.0
Industrial - Transport.................. 914.2 74.6 21.0 967.8
Utility - Electric...................... 2,581.4 179.1 9.3 2,751.2
Utility - Other......................... 61.4 6.8 0.8 67.4
Utility - Telecom....................... 1,623.2 170.5 1.3 1,792.4
------------- ------------- -------------- -------------
Total corporate securities.......... 25,887.7 1,965.1 126.3 27,726.5
U.S. Government and agencies............ 599.0 12.9 1.0 610.9
States and political subdivisions....... 498.7 40.5 2.2 537.0
Non-U.S. governments.................... 358.2 64.2 - 422.4
Mortgage-backed and other
asset-backed securities............... 6,406.9 343.5 22.1 6,728.3
------------- ------------- -------------- -------------
Total fixed maturity securities,
available-for-sale................ $ 33,750.5 $ 2,426.2 $ 151.6 $ 36,025.1
============= ============= ============== =============
- -----------------------
(1) Included in the $151.6 million in unrealized losses is $24.8 million that
relates to fixed maturity securities that are part of fair value hedging
relationships and which have been recognized in net income versus other
comprehensive income.
The total unrealized losses on our fixed maturity securities available-for-sale
were $69.1 million and $151.6 million as of March 31, 2004 and December 31,
2003, respectively. Of the $69.1 million in gross unrealized losses as of March
31, 2004, there were $3.5 million in losses attributed to securities scheduled
to mature in one year or less, $6.9 million is attributed to securities
scheduled to mature between one to five years, $16.3 million is attributed to
securities scheduled to mature between five to ten years, $30.6 million is
attributed to securities scheduled to mature after ten years, and $11.8 million
is related to mortgage-backed and other asset-back securities. The gross
unrealized losses as of March 31, 2004 were concentrated primarily in the
Industrial-Transportation, Mortgage-backed and other asset-backed security, and
Industrial-Energy sectors. The gross unrealized losses as of December 31, 2003
were concentrated primarily in the Industrial-Consumer, Mortgage-backed and
other asset-backed security, Industrial-Transportation, and
Industrial-Manufacturing sectors.
The following tables present our fixed maturity securities available-for-sale by
investment grade and below investment grade and the associated gross unrealized
gains and losses as of March 31, 2004, and December 31, 2003.
68
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY QUALITY
AS OF MARCH 31, 2004
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED CARRYING
COST GAINS LOSSES AMOUNT
-------------- ------------- ------------- --------------
(IN MILLIONS)
Investment Grade:
Public..................................... $ 22,299.3 $ 1,958.3 $ 17.4 $ 24,240.2
Private.................................... 9,561.8 841.5 19.6 10,383.7
Below Investment Grade:
Public..................................... 1,185.8 96.7 5.2 1,277.3
Private.................................... 1,182.9 79.6 26.9 1,235.6
-------------- ------------- ------------- --------------
Total fixed maturity securities, available-
for-sale................................... $ 34,229.8 $ 2,976.1 $ 69.1 $ 37,136.8
============== ============= ============= ==============
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY QUALITY
AS OF DECEMBER 31, 2003
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED CARRYING
COST GAINS LOSSES AMOUNT
-------------- ------------- ------------- --------------
(IN MILLIONS)
Investment Grade:
Public................................... $ 21,733.3 $ 1,590.6 $ 36.1 $ 23,287.8
Private.................................. 9,050.2 671.7 40.3 9,681.6
Below Investment Grade:
Public................................... 1,407.6 102.1 12.4 1,497.3
Private.................................. 1,559.4 61.8 62.8 1,558.4
-------------- ------------- ------------- --------------
Total fixed maturity securities,
available-for-sale....................... $ 33,750.5 $ 2,426.2 $ 151.6 $ 36,025.1
============== ============= ============= ==============
69
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON INVESTMENT GRADE FIXED MATURITY SECURITIES
AVAILABLE-FOR-SALE BY AGING CATEGORY
AS OF MARCH 31, 2004
------------------------------------------------------------------------------------
PUBLIC PRIVATE TOTAL
--------------------------- --------------------------- -------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
------------- ------------- ---------- -------------- ---------- -------------
(IN MILLIONS)
Three months or less.................. $ 344.0 $ 3.3 $ 200.7 $ 2.0 $ 544.7 $ 5.3
Greater than three to six months...... 69.1 0.8 110.0 1.7 179.1 2.5
Greater than six to nine months....... 99.1 0.9 319.8 12.8 418.9 13.7
Greater than nine to twelve months.... 266.7 4.6 117.1 1.3 383.8 5.9
Greater than twelve to twenty-four
months.............................. 29.7 0.7 20.9 1.5 50.6 2.2
Greater than twenty-four to thirty-
six months.......................... 65.8 6.5 - - 65.8 6.5
Greater than thirty-six months........ 20.6 0.6 24.9 0.3 45.5 0.9
------------- ------------- ----------- -------------- ---------- -------------
Total fixed maturities, available-
for-sale.......................... $ 895.0 $ 17.4 $ 793.4 $ 19.6 $ 1,688.4 $ 37.0
============= ============= =========== ============== ========== =============
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON INVESTMENT GRADE FIXED MATURITY SECURITIES
AVAILABLE-FOR-SALE BY AGING CATEGORY
AS OF DECEMBER 31, 2003
--------------------------------------------------------------------------------------
PUBLIC PRIVATE TOTAL
--------------------------- --------------------------- ---------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
------------- ------------- ---------- -------------- ------------ -------------
(IN MILLIONS)
Three months or less.................. $ 1,157.2 $ 7.2 $ 574.6 $ 14.2 $ 1,731.8 $ 21.4
Greater than three to six months...... 794.3 10.6 464.4 14.9 1,258.7 25.5
Greater than six to nine months....... 417.7 13.4 209.2 8.5 626.9 21.9
Greater than nine to twelve months.... 50.8 1.5 5.1 0.3 55.9 1.8
Greater than twelve to twenty-four
months.............................. - - 19.1 2.1 19.1 2.1
Greater than twenty-four to thirty-
six months.......................... 21.0 2.4 - - 21.0 2.4
Greater than thirty-six months........ 25.1 1.0 27.3 0.3 52.4 1.3
------------- ------------- ---------- -------------- ----------- -------------
Total fixed maturities, available-
for-sale.......................... $ 2,466.1 $ 36.1 $1,299.7 $ 40.3 $ 3,765.8 $ 76.4
============= ============= ========== ============== =========== =============
70
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON BELOW INVESTMENT GRADE FIXED MATURITY SECURITIES
AVAILABLE-FOR-SALE BY AGING CATEGORY
AS OF MARCH 31, 2004
--------------------------------------------------------------------------------------
PUBLIC PRIVATE TOTAL
--------------------------- ------------------------------ ---------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
------------- ------------- --------------- -------------- ----------- --------------
(IN MILLIONS)
Three months or less.................. $ 73.3 $ 1.6 $ 16.7 $ 0.4 $ 90.0 $ 2.0
Greater than three to six months...... 6.0 0.1 28.1 1.4 34.1 1.5
Greater than six to nine months....... 5.2 0.1 16.4 1.3 21.6 1.4
Greater than nine to twelve months.... 3.4 0.1 - - 3.4 0.1
Greater than twelve to twenty-four
months.............................. 12.5 0.9 79.6 9.7 92.1 10.6
Greater than twenty-four to thirty-
six months.......................... 8.5 2.4 16.3 2.9 24.8 5.3
Greater than thirty-six months........ - - 60.1 11.2 60.1 11.2
------------- ------------- --------------- -------------- ----------- --------------
Total fixed maturities, available-
for-sale.......................... $108.9 $ 5.2 $217.2 $ 26.9 $ 326.1 $ 32.1
============= ============= =============== ============== =========== ==============
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON BELOW INVESTMENT GRADE FIXED MATURITY SECURITIES
AVAILABLE-FOR-SALE BY AGING CATEGORY
AS OF DECEMBER 31, 2003
--------------------------------------------------------------------------------------
PUBLIC PRIVATE TOTAL
--------------------------- ----------------------------- ----------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
------------ -------------- ------------ --------------- ---------- ----------------
(IN MILLIONS)
Three months or less.................. $ 41.1 $ 0.6 $ 67.9 $ 28.8 $ 109.0 $ 29.4
Greater than three to six months...... 5.3 0.8 40.4 6.0 45.7 6.8
Greater than six to nine months....... 3.5 0.1 24.1 0.1 27.6 0.2
Greater than nine to twelve months.... - - 0.8 0.1 0.8 0.1
Greater than twelve to twenty-four
months.............................. 26.9 0.8 68.6 9.1 95.5 9.9
Greater than twenty-four to thirty-
six months.......................... 64.2 8.8 62.6 8.2 126.8 17.0
Greater than thirty-six months........ 9.1 1.3 78.6 10.5 87.7 11.8
------------ -------------- ------------ --------------- ---------- ----------------
Total fixed maturities, available-
for-sale.......................... $150.1 $ 12.4 $ 343.0 $ 62.8 $ 493.1 $ 75.2
============ ============== ============ =============== ========== ================
Of total gross unrealized losses as of March 31, 2004 and December 31, 2003,
$37.0 million and $76.4 million were related to investment grade securities,
respectively. Gross unrealized losses related to below investment grade
securities were $32.1 million and $75.2 million as of March 31, 2004 and
December 31, 2003, respectively.
71
The following tables present the carrying amount and gross unrealized losses on
fixed maturity securities available-for-sale, where the estimated fair value has
declined and remained below amortized cost by 20% or more as of March 31, 2004,
and December 31, 2003.
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY
AGING CATEGORY
AS OF MARCH 31, 2004
-------------------------------------------------------------------------------------
PROBLEM, POTENTIAL
PROBLEM, AND ALL OTHER FIXED MATURITY
RESTRUCTURED SECURITIES TOTAL
-------------------------- --------------------------- ----------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
----------- ------------- ----------- -------------- ---------- ----------------
(IN MILLIONS)
Three months or less.................. $ - $ - $ 36.6 $ 10.1 $ 36.6 $ 10.1
Greater than three to six months...... - - 12.3 3.5 12.3 3.5
Greater than six to nine months....... - - - - - -
Greater than nine to twelve months.... - - - - - -
Greater than twelve months............ 10.1 2.8 - - 10.1 2.8
----------- ------------- ----------- -------------- ---------- ----------------
Total fixed maturity securities,
available-for-sale................ $ 10.1 $ 2.8 $ 48.9 $ 13.6 $ 59.0 $ 16.4
=========== ============= =========== ============== ========== ================
U.S. INVESTED ASSETS
UNREALIZED LOSSES ON FIXED MATURITY SECURITIES AVAILABLE-FOR-SALE BY
AGING CATEGORY
AS OF DECEMBER 31, 2003
-------------------------------------------------------------------------------------
PROBLEM, POTENTIAL
PROBLEM, AND ALL OTHER FIXED MATURITY
RESTRUCTURED SECURITIES TOTAL
-------------------------- --------------------------- ----------------------------
GROSS GROSS GROSS
CARRYING UNREALIZED CARRYING UNREALIZED CARRYING UNREALIZED
AMOUNT LOSSES AMOUNT LOSSES AMOUNT LOSSES
----------- ------------- ----------- -------------- ----------- ---------------
(IN MILLIONS)
Three months or less.................. $ 30.9 $ 34.6 $ - $ - $ 30.9 $ 34.6
Greater than three to six months...... - - - - - -
Greater than six to nine months....... - - - - - -
Greater than nine to twelve months.... 0.5 0.1 - - 0.5 0.1
Greater than twelve months............ 3.6 1.5 7.7 2.2 11.3 3.7
----------- ------------ ----------- -------------- ----------- ---------------
Total fixed maturity securities,
available-for-sale................ $ 35.0 $ 36.2 $ 7.7 $ 2.2 $ 42.7 $ 38.4
=========== ============ =========== ============== =========== ===============
Gross unrealized losses on fixed maturity securities where the estimated fair
value has been 20% or more below amortized cost were $16.4 million as of March
31, 2004 and $38.4 million as of December 31, 2003. The gross unrealized losses
attributed to those securities considered to be "problem", "potential problem"
or "restructured" were $2.8 million and $36.2 million as of March 31, 2004, and
December 31, 2003, respectively.
The following table presents the total carrying amount of our fixed maturity
portfolio, as well as its problem, potential problem and restructured fixed
maturities for the periods indicated:
72
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED FIXED MATURITIES AT CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
-------------------- ----------------------
2004 2003
-------------------- ----------------------
($ IN MILLIONS)
Total fixed maturity securities (public and private)............ $ 37,240.2 $ 36,128.0
==================== ======================
Problem fixed maturity securities............................... $ 126.6 $ 152.5
Potential problem fixed maturity securities..................... 135.9 230.1
Restructured fixed maturity securities.......................... 26.7 39.9
-------------------- ----------------------
Total problem, potential problem and restructured fixed
maturity securities......................................... $ 289.2 $ 422.5
==================== ======================
Total problem, potential problem and restructured fixed
maturity securities as a percent of total fixed maturity
securities.................................................. 1% 1%
MORTGAGE LOANS
Mortgage loans comprised 23% and 25% of total U.S. invested assets as of March
31, 2004, and December 31, 2003, respectively. Mortgage loans consist of
commercial and residential loans. Commercial mortgage loans comprised $9,703.7
million as of March 31, 2004, and $9,630.4 million as of December 31, 2003, or
77% and 73% of total mortgage loan investments, respectively. Residential
mortgages comprised $2,852.0 million as of March 31, 2004 and $3,544.6 million
as of December 31, 2003, or 23% and 27% 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. As a
result of our implementation of FIN 46, effective July 1, 2003, residential
mortgage loans include the full consolidation of PRMCR, which provides a source
of funding for our residential mortgage loan production. PRMCR held $1.2 billion
in mortgage loans held for sale as of March 31, 2004 and $2.0 billion as of
December 31, 2003.
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 20% of our commercial mortgage loan portfolio as of
March 31, 2004. We are, therefore, exposed to potential losses resulting from
the risk of catastrophes, such as earthquakes, that may affect the region. Like
73
other lenders, we generally do not require earthquake insurance for properties
on which we make commercial mortgage loans. With respect to California
properties, however, we obtain an engineering report specific to each property.
The report assesses the building's design specifications, whether it has been
upgraded to meet seismic building codes and the maximum loss that is likely to
result from a variety of different seismic events. We also obtain a report that
assesses by building and geographic fault lines the amount of loss our
commercial mortgage loan portfolio might suffer under a variety of seismic
events.
Our commercial loan portfolio is highly diversified by borrower. As of March 31,
2004, 39% 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, 2004 and
December 31, 2003 was 1,424 and 1,447, respectively. The average loan size of
our commercial mortgage portfolio was $6.9 million as of March 31, 2004.
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 either establish a valuation allowance or adjust the
cost basis of that loan and record a 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 the losses
in our consolidated results of operations. Such increases (decreases) in
valuation allowances aggregated $6.1 million for the three months ended March
31, 2004 and $(34.0) million for the year ended December 31, 2003.
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 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
74
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. As a result of a change in estimates, we evaluated the adequacy of our
commercial mortgage loan allowance at December 31, 2003 and released $23.9
million from the allowance.
The following table represents our commercial mortgage valuation allowance for
the periods indicated:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE VALUATION ALLOWANCE
AS OF MARCH 31, AS OF DECEMBER 31,
---------------------- ------------------------
2004 2003
---------------------- ------------------------
($ IN MILLIONS)
Beginning balance.......................................... $ 49.6 $ 83.6
Provision.................................................. 11.9 1.3
Release.................................................... (5.8) (35.3)
---------------------- ------------------------
Ending balance............................................. $ 55.7 $ 49.6
====================== ========================
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,
---------------------- ------------------------
2004 2003
---------------------- ------------------------
($ IN MILLIONS)
Total commercial mortgages .................................... $ 9,703.7 $ 9,630.4
====================== ========================
Problem commercial mortgages(1)................................ $ 45.8 $ 45.9
Potential problem commercial mortgages ........................ 134.0 99.3
Restructured commercial mortgages ............................. 62.9 65.3
---------------------- ------------------------
Total problem, potential problem and
restructured commercial mortgages ......................... $ 242.7 $ 210.5
====================== ========================
Total problem, potential problem and restructured
commerical mortgages as a percent of total commercial
mortgages.................................................. 2% 2%
- --------------------
(1) Problem commercial mortgages include no mortgage loans in foreclosure as of
March 31, 2004 and December 31, 2003.
EQUITY REAL ESTATE
We hold commercial equity real estate as part of our investment portfolio. As of
March 31, 2004, and December 31, 2003, the carrying amount of equity real estate
investment was $1,464.6 million and $1,528.0 million, or 3% 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.
75
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale". Real estate held for investment totaled $962.3
million as of March 31, 2004, and $1,003.6 million as of December 31, 2003. 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, 2004 and
December 31, 2003, there were no such impairment adjustments.
The carrying amount of real estate held for sale as of March 31, 2004, and
December 31, 2003, was $502.3 million and $524.4 million, net of valuation
allowances of $25.4 million and $21.5 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, 2004. By property type, there is a
concentration in office buildings that represented approximately 30% of the
equity real estate portfolio as of March 31, 2004.
OTHER INVESTMENTS
Our other investments totaled $1,117.1 million as of March 31, 2004, compared to
$1,249.7 million as of December 31, 2003. Derivatives accounted for $625.3
million in other investments as of March 31, 2004. The remaining invested assets
include minority interests in unconsolidated entities and properties owned
jointly with venture partners and operated by the partners.
INTERNATIONAL INVESTMENT OPERATIONS
As of March 31, 2004, our international investment operations consist of the
investments of Principal International comprised of $2.1 billion in invested
assets. Principal Global Investors works with each Principal International
affiliate to develop investment policies and strategies that are consistent with
the products they offer. Due to the regulatory constraints in each country, each
company maintains its own investment policies, which are approved by Principal
Global Investors. Each international affiliate is required to submit a
compliance report relative to its strategy to Principal Global Investors.
Principal Global Investors employees and international affiliate company credit
analysts jointly review each corporate credit annually.
OVERALL COMPOSITION OF INTERNATIONAL INVESTED ASSETS
As shown in the following table, the major categories of international invested
assets as of March 31, 2004, and December 31, 2003, were fixed maturity
securities and residential mortgage loans:
76
INTERNATIONAL INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
---------------------- -------------------------
2004 2003
---------------------- -------------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
------------ -------- ----------- -----------
($ IN MILLIONS)
Fixed maturity securities
Public.......................................... $ 1,499.6 72% $ 1,334.8 66%
Private......................................... 5.3 - 89.8 5
Equity securities................................. 51.9 2 41.8 2
Mortgage loans
Residential..................................... 332.4 16 333.1 16
Real estate held for investment................... 9.3 - 9.5 -
Other investments ................................ 214.6 10 213.3 11
------------ -------- ----------- -----------
Total invested assets........................... 2,113.1 100% 2,022.3 100%
======== ===========
Cash and cash equivalents......................... 70.8 73.1
------------ -----------
Total invested assets and cash ................. $ 2,183.9 $ 2,095.4
============ ===========
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.
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, 2004, the difference between the asset and liability durations
on our primary duration managed portfolio was 0.01. This duration gap indicates
that as of this date the sensitivity of the fair value of our assets to interest
77
rate movements is greater than that of the fair value of our liabilities. Our
goal is to minimize the duration gap. Currently, our guidelines indicate that
total duration gaps between the asset and liability portfolios should be within
+/-0.25. The value of the assets in this portfolio was $30,190.3 million as of
March 31, 2004.
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, 2004, the
weighted-average difference between the asset and liability durations on these
portfolios was 0.38. This duration gap indicates that as of this date the
sensitivity of the fair value of our assets to interest rate movements is
greater than that of the fair value of our liabilities. We attempt to monitor
this duration gap consistent with our overall risk/reward tolerances. The value
of the assets in these portfolios was $13,625.8 million as of March 31, 2004.
We also have a block of participating general account pension business that
passes the 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. Along with the
participating pension product line, the assets in the corporate segment used to
back surplus are also not subject to duration monitoring since there are no
liabilities associated with the assets. As of March 31, 2004, the total assets
in these two portfolios was $4,798.0 million.
Using the assumptions and data in effect as of March 31, 2004, we estimate that
a 100 basis point immediate, parallel increase in interest rates decreases the
net fair value of our portfolio by $54.4 million. The following table details
the estimated changes by risk management strategy:
CHANGE IN FAIR
AS OF VALUE OF ASSETS LESS
RISK MANAGEMENT MARCH 31, 2004 FAIR VALUE OF
STRATEGY VALUE OF TOTAL ASSETS LIABILITIES
- --------------------------------------------------------- -------------------------- -----------------------
(IN MILLIONS)
Primary duration-managed.............................. $ 30,190.3 $ (3.0)
Duration-monitored.................................... 13,625.8 (51.4)
Non duration-managed.................................. 4,798.0 -
-------------------------- -----------------------
Total............................................... $ 48,614.1 $ (54.4)
========================== =======================
Our selection of a 100 basis point immediate, parallel increase or decrease in
interest rates is a hypothetical rate scenario we use to demonstrate potential
risk. While a 100 basis point immediate, parallel increase does not represent
our view of future market changes, it is a near term reasonably possible
hypothetical change that illustrates the potential impact of such events. While
these fair value measurements provide a representation of interest rate
sensitivity, they are based on our portfolio exposures at a point in time and
may not be representative of future market results. These exposures will change
as a result of ongoing portfolio transactions in response to new business,
management's assessment of changing market conditions and available investment
opportunities.
We are also exposed to interest rate risk in our Mortgage Banking segment. We
manage this risk by striving to balance our loan origination and loan servicing
operations, the two of which are generally counter-cyclical. In addition, we use
various financial instruments, including derivatives contracts, to manage the
interest rate risk specifically related to committed loans in the pipeline and
mortgage servicing rights. The overall objective of our interest rate risk
management policies is to offset changes in the values of these items resulting
from changes in interest rates. We do not speculate on the direction of interest
rates in our management of interest rate risk.
78
We manage interest rate risk on our mortgage loan pipeline by using cash forward
sale commitments, mortgage-backed securities in the forward markets,
over-the-counter options on mortgage-backed securities, U.S. Treasury and
Eurodollar futures contracts, options on futures contracts, interest rate swaps,
options on interest rate swaps, private investor contracts to buy or sell
residential mortgage loans, and servicing-released loans sales programs. 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. Financial risk is limited by requiring that
the net position value will not change in excess of an amount established by
Senior Management of the Mortgage Banking segment given an instantaneous
pre-determined price change in the benchmark security. Price sensitivity
analysis is performed at least once daily. The pre-determined risk limits will
be reviewed periodically and updated as needed. The face amount of the loans in
the pipeline as of March 31, 2004, was $8.7 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, 2004, net
position value by $40.4 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. Financial risk is
limited by requiring that the net position value will not change in excess of an
amount established by Senior Management of the Mortgage Banking segment given an
instantaneous pre-determined change in the level of interest rates. Price
sensitivity analysis is performed at least once weekly. The pre-determined risk
limits will be reviewed periodically and updated as needed. Based on values as
of March 31, 2004, a 100 basis point immediate parallel and sustained decrease
in interest rates produces a $94.6 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.
79
DERIVATIVES
We use various derivative financial instruments to manage our exposure to
fluctuations in interest rates, including interest rate swaps, principal-only
swaps, interest rate floors, swaptions, U.S. Treasury futures, Treasury rate
guarantees, interest rate lock commitments and mortgage-backed forwards and
options. We use interest rate futures contracts and mortgage-backed forwards to
hedge changes in interest rates subsequent to the issuance of an insurance
liability, such as a guaranteed investment contract, but prior to the purchase
of a supporting asset, or during periods of holding assets in anticipation of
near term liability sales. We use interest rate swaps and principal-only swaps
primarily to more closely match the interest rate characteristics of assets and
liabilities. They can be used to change the 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, 2004 was $500.0 million and the mark
to market value was $11.4 million. We also invested in credit default swaps
creating replicated assets with a notional of $343.3 million and mark to market
value of $6.6 million as of March 31, 2004.
We also offer a guaranteed fund as an investment option in our defined
contribution plans in Hong Kong. This fund contains an embedded option that has
been bifurcated and accounted for separately in realized gains (losses). We
recognized a $0.1 million pre-tax gain for the three months ended March 31,
2004.
The obligation to deliver the underlying securities of certain consolidated
grantor trusts to various unrelated trust certificate holders contains an
embedded derivative of the forecasted transaction to deliver the underlying
securities.
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;
o implementing credit support annex (collateral) agreements with selected
counterparties to further limit counterparty exposures; and
80
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, 2004, and December
31, 2003:
DERIVATIVE FINANCIAL INSTRUMENTS - NOTIONAL AMOUNTS
AS OF MARCH 31, AS OF DECEMBER 31,
-------------------------- ---------------------------
2004 2003
-------------------------- ---------------------------
NOTIONAL % OF NOTIONAL % OF
AMOUNT TOTAL AMOUNT TOTAL
---------------- --------- ------------ -------------
($ IN MILLIONS)
Mortgage-backed forwards and options............ $ 11,816.4 27% $ 4,892.3 16%
Swaptions....................................... 10,957.5 25 5,642.5 18
Interest rate swaps............................. 6,468.5 15 8,158.9 26
Interest rate lock commitments.................. 6,036.7 14 2,242.4 7
Foreign currency swaps.......................... 2,686.3 6 2,823.4 9
U.S. Treasury futures (LIBOR)................... 2,325.0 5 4,380.0 14
Interest rate floors............................ 1,650.0 4 1,650.0 5
Credit default swaps ........................... 843.3 2 863.3 3
Bond forwards................................... 467.2 1 467.2 1
Currency forwards............................... 425.7 1 282.0 1
Call options.................................... 30.0 - 30.0 -
U.S. Treasury futures........................... 18.9 - 27.8 -
Bond options.................................... 17.5 - 17.5 -
Other........................................... 1.5 - 1.5 -
---------------- --------- ------------ -------------
Total........................................ $ 43,744.5 100% $ 31,478.8 100%
================ ========= ============ =============
81
DERIVATIVE FINANCIAL INSTRUMENTS - CREDIT EXPOSURES
AS OF MARCH 31, AS OF DECEMBER 31,
-------------------------- ---------------------------
2004 2003
-------------------------- ---------------------------
CREDIT % OF CREDIT % OF
EXPOSURE TOTAL EXPOSURE TOTAL
---------------- --------- ------------ -------------
($ IN MILLIONS)
Foreign currency swaps.......................... $ 545.7 75% $ 637.1 75%
Interest rate swaps............................. 76.1 10 89.6 10
Bond forwards................................... 59.9 8 52.2 6
Credit default swaps............................ 18.9 3 45.9 5
Swaptions ...................................... 17.2 2 29.2 3
Call options.................................... 6.5 1 6.6 1
Currency forwards............................... 3.2 1 0.3 -
Interest rate floors............................ 0.1 - 1.9 -
---------------- --------- ------------ -------------
Total......................................... $ 727.6 100% $ 862.8 100%
================ ========= ============ =============
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.
AS OF MARCH 31, 2004
-------------------------------------------------------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
------------------------------------------------
WEIGHTED
AVERAGE -100 BASIS +100 BASIS
NOTIONAL TERM POINTS POINT
AMOUNT (YEARS) CHANGE NO CHANGE CHANGE
----------------- ----------------- ------------ ------------- ----------------
($ IN MILLIONS)
Interest rate swaps.................. $ 6,468.5 8.34(1) $ 131.9 $ 31.8 $ (34.8)
Swaptions............................ 10,957.5 1.29(4) 762.6 375.6 170.4
Mortgage-backed forwards and options. 11,816.4 0.07(5) (168.0) 5.0 199.1
U.S. Treasury futures (LIBOR)........ 2,325.0 1.51(3) (7.4) (0.9) 5.6
Interest rate lock commitments....... 6,036.7 0.09(6) 101.0 2.7 (229.5)
Interest rate floors................. 1,650.0 2.25(2) 63.1 31.5 12.7
Bond forwards........................ 467.2 2.64(5) 88.0 59.9 33.7
U.S. Treasury futures................ 18.9 0.14(3) (1.2) (0.1) 1.0
Bond options......................... 17.5 2.54(5) (2.5) (1.0) (0.4)
----------------- ------------ ------------- ----------------
Total............................. $ 39,757.7 $ 967.5 $ 504.5 $ 157.8
================= ============ ============= ================
- --------------------
(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.
82
DEBT ISSUED AND OUTSTANDING
As of March 31, 2004, the aggregate fair value of long-term debt was $2,695.6
million, which includes debt related to our implementation of FIN 46. A 100
basis point, immediate, parallel decrease in interest rates would increase the
fair value of debt by approximately $49.5 million.
AS OF MARCH 31, 2004
-------------------------------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
-------------------------------------------------------------
-100 BASIS +100 BASIS
POINT CHANGE NO CHANGE POINT CHANGE
-------------------- ---------------- ------------------
(IN MILLIONS)
4.55% notes payable, due 2004...................... $ 413.3 $ 410.2 $ 407.1
7.95% notes payable, due 2004...................... 205.0 204.2 203.5
Variable rate equity certificates, due 2005 (1).... 44.0 44.0 44.0
Variable rate notes payable, due 2006 (2).......... 800.0 800.0 800.0
Variable rate equity certificates, due 2006 (3).... 149.0 149.0 149.0
8.2% notes payable, due 2009....................... 588.3 562.1 537.4
8% surplus notes payable, due 2044................. 121.8 110.1 99.0
Non-recourse mortgages and notes payable........... 365.3 358.4 351.8
Other mortgages and notes payable.................. 58.4 57.6 56.7
-------------------- ---------------- ------------------
Total long-term debt............................ $ 2,745.1 $ 2,695.6 $ 2,648.5
==================== ================ ==================
- -----------------------
(1) Represents $44.0 million at 165 basis points over 1 month LIBOR.
(2) Represents $400.0 million at 25 basis points over 1 month LIBOR and $400.0
million at 29 basis points over 1 month LIBOR.
(3) Represents $25.2 million at 157 basis points over 1 month LIBOR, $49.3
million at 170 basis points over 1 month LIBOR and $74.5 million at 180
basis points over 1 month LIBOR.
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, 2004, the fair value
of our equity securities was $749.2 million. A 10% decline in the value of the
equity securities would result in an unrealized loss of $74.9 million. As of
March 31, 2004, a 10% immediate and sustained decline in the equity markets
would result in a decrease of asset-based fee revenues of $30.8 million over the
next nine months. The selection of a 10% unfavorable change in the equity
markets 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.
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, 2004, was $2,451.6 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, 2004, the fair value of our foreign currency
denominated fixed maturity securities was $313.9 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, 2004, was $234.7 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
83
these cases, we use foreign exchange derivatives to hedge the resulting risks.
Additionally, we may take measures to hedge our net equity investments in our
foreign subsidiaries from currency risks. As of March 31, 2004, we used currency
forwards to hedge a portion of our net equity investment in our Mexican
operations from currency fluctuations. The outstanding notional amount of the
currency forwards relating to these operations was $19.7 million (approximately
$225 million Mexican pesos) and we recognized a $0.3 million pre-tax gain in
other comprehensive income for the three months ended March 31, 2004.
We estimate that as of March 31, 2004, 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.
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 March 31,
2004, and have concluded that our disclosure controls and procedures are
effective.
There was no change in our internal control over financial reporting during our
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
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.
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 net income. The outcome of
litigation is always uncertain, and unforeseen results can occur. It is possible
that such outcomes could materially affect net income in a particular quarter or
annual period.
84
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table presents the amount of our share purchase activity for the
periods indicated:
ISSUER PURCHASES OF EQUITY SECURITIES
MAXIMUM
NUMBER (OR
APPROXIMATE
DOLLAR VALUE) OF
TOTAL NUMBER OF SHARES (OR UNITS)
TOTAL NUMBER SHARES (OR UNITS) THAT MAY YET BE
NUMBER OF AVERAGE PURCHASED AS PART OF PURCHASED UNDER
SHARES (OR PRICE PAID PUBLICLY THE PLANS OR
UNITS) PER SHARE ANNOUNCED PROGRAMS (IN
PERIOD PURCHASED (OR UNIT) PLANS OR PROGRAMS MILLIONS) (1)
- ---------------------------------------------------------------------------------------------------------------------------
January 1, 2004 - January 31, 2004...... 644 (2) $33.07 - $147.0
February 1, 2004 - February 29, 2004.... - - - $147.0
March 1, 2004 - March 31, 2004.......... 9,600 (3) $36.37 - $147.0
--------------- -----------------------
Total................................... 10,244 $36.16 - $147.0
=============== =======================
- -------------------------
(1) In May 2003, our board of directors authorized a repurchase program of up
to $300.0 million of our outstanding common stock. This program began after
the completion of the November 2002 repurchase program, which authorized
the repurchase of up to $300.0 million of our outstanding common stock.
There is no expiration date for this program.
(2) Principal Financial Services, Inc., a subsidiary of Principal Financial
Group, Inc., purchased J.F. Molloy and Associates, Inc. effective January
2, 2004. At the time of acquisition, 644 shares of the common stock of
Principal Financial Group, Inc., which were granted as part of our
demutualization, were held in the name of J.F. Molloy and Associates, Inc.
(3) This activity represents the portion of common stock issued and acquired
for a stock incentive award that was utilized to execute the award.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
10.6 The Principal Select Savings Excess Plan, restated as of January
1, 2004
10.7 The Principal Supplemental Executive Retirement Plan for
Employees, restated as of January 1, 2003
12 Statement Regarding Computation of Ratio of Earnings to Fixed
Charges
31.1 Certification of J. Barry Griswell
31.2 Certification of Michael H. Gersie
32.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18
of the United States Code - J. Barry Griswell
32.2 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
Current Report on Form 8-K dated February 2, 2004, and filed February 3,
2004.
Current Report on Form 8-K dated and filed February 3, 2004.
85
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 5, 2004 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
86
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION PAGE
10.6 The Principal Select Savings Excess Plan, restated as of January
1, 2004........................................................ 88
10.7 The Principal Supplemental Executive Retirement Plan for
Employees, restated as of January 1, 2003...................... 106
12 Statement Regarding Computation of Ratio of Earnings to Fixed
Charges........................................................ 123
31.1 Certification of J. Barry Griswell............................... 125
31.2 Certification of Michael H. Gersie............................... 125
32.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18
of the United States Code - J. Barry Griswell................. 126
32.2 Certification Pursuant to Section 1350 of Chapter 63 of Title
18 of the United States Code - Michael H. Gersie.............. 127
87
EXHIBIT 10.6
THE PRINCIPAL
SELECT SAVINGS EXCESS PLAN
Restated January 1, 2004
88
INTRODUCTION
The Company established this Plan on September 1, 1988, for a select group of
management, highly compensated employees, or field representatives who, due to
the amount of their compensation, are unable to fully participate in the
elective deferral and matching contributions available to the other eligible
participants in the Associated Plan. The Plan is designed and intended to be a
"top-hat" plan - that is, an unfunded plan maintained primarily for the purpose
of providing deferred compensation for a select group of management, highly
compensated employees, or field representatives within the meaning of ERISA ss.
201(2), 301(a)(3) and 401(a)(1), and therefore is exempt from Parts 2, 3 and 4
of Title I of ERISA, and is intended to be a nonqualified plan for purposes of
Code ss. 401.
The Company is of the opinion that the Plan should be changed. It believes that
the best means to accomplish these changes is to completely restate the Plan's
terms, provisions and conditions. The restatement, effective January 1, 2004, is
set forth in this document and is substituted in lieu of the prior document.
ARTICLE I
DEFINITIONS
SECTION 1.01 -- FORMAT.
Words and phrases defined in the DEFINITIONS SECTION of this Article will have
the defined meaning when used in this Plan, unless the context clearly indicates
otherwise. These words and phrases will have an initial capital letter to aid in
identifying them as defined terms.
Words and phrases with an initial capital letter that are not defined in the
DEFINITIONS SECTION of this Article will have the meaning assigned to such word
or phase under the Associated Plan, unless the context clearly indicates
otherwise.
SECTION 1.02 -- DEFINITIONS.
ACCOUNT means an account established for a Participant pursuant to the ACCOUNTS
SECTION of Article III.
ACTIVE PARTICIPANT means any Employee, Agent or Field Manager in the Eligible
Group.
AGENT means an individual who is not an Employee and who holds a current DD713
contract or any successor full-time contract with the Company, and including,
but not limited to, one of the following positions:
o an agent;
o a sales supervisor;
o a special marketing developer;
o a special agency assistant;
o a business specialist; or
o an executive benefits specialist.
ANNUALIZED COMPENSATION means an individual's Compensation (including bonuses,
incentive payments and other special compensation, excluding pay received from a
long term incentive pay plan) expressed on an annual basis. Solely for purposes
of determining Annualized Compensation, an individual's Compensation will be
89
deemed to include his compensation with a prior employer if it is earned within
the calendar year in which he is hired or his contract first becomes effective.
ASSOCIATED PLAN means:
(a) In the case of an Employee, The Principal Select Savings Plan for
Employees; or
(b) In the case of an Agent or Field Manager, The Principal Select Savings Plan
for Individual Field.
BENEFICIARY means the person or persons designated as such pursuant to the
BENEFICIARIES SECTION of Article VII.
CHANGE IN CONTROL means the occurrence of any of the following events: (i) the
acquisition by any Person (as defined in Section 3(a)(9) of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections
13(d) and 14(d) thereof)), entity or "group" (as defined in Section 13(d) of the
Exchange Act) of fifty percent (50%) or more of the outstanding voting power of
the Parent then outstanding voting securities; (ii) the merger, consolidation or
reorganization of the Parent, as a result of which persons who were stockholders
of the Parent immediately prior to such merger, consolidation or reorganization,
do not, immediately thereafter, own, directly or indirectly, more than fifty
percent (50%) of the combined voting power entitled to vote generally in the
election of directors of the merged, consolidated or reorganized company; (iii)
within any twelve (12) month period, the persons who were directors of the
Parent at the beginning of such period (the "Incumbent Directors") cease to
constitute at least a majority of the Board, provided that any director elected
to the Board, or nominated for election, by a majority of the Incumbent
Directors then still in office shall be deemed to be an Incumbent Director for
purposes of this clause (iii); (iv) the liquidation or dissolution of the
Parent; and (v) the sale, transfer of other disposition, in one transaction or
series of related transactions, of more than fifty percent (50%) of the fair
market value of the assets of the Parent to any Person. For purposes of this
definition, the terms "Person," "entity" and "group" shall not include (a) the
Parent or any of its subsidiaries or controlled affiliates; (b) a trustee or
other fiduciary holding securities under an employee benefit plan of the Parent
or any of its subsidiaries or affiliates; (c) an underwriter temporarily holding
securities of the Parent pursuant to an offering of such securities; or (d) a
corporation owned, directly or indirectly, by the shareholders of the Parent in
substantially the same proportions as their ownership of stock of the Parent.
CODE means the Internal Revenue Code of 1986, as amended.
COMMON STOCK means the common stock, par value $0.01 per share, of the Parent.
COMPANY means Principal Life Insurance Company.
COMPANY MATCH CREDIT means a credit to an Account made in accordance with the
COMPANY MATCH CREDITS SECTION of Article III.
COMPENSATION means Compensation as defined in the Associated Plan, but
determined without regard to the compensation limit of Code ss. 401(a)(17) and
without regard to any reduction in Compensation resulting from a salary deferral
agreement made pursuant to this Plan.
CONTROLLED GROUP MEMBER means any corporation or other business entity that is a
member of the same controlled group as, or is under common control with, the
Parent as determined under Code ss. 414(b) or (c).
DEFERRAL ELIGIBLE AMOUNT means:
(a) In the case of an Employee, his Compensation, excluding any bonuses
paid under any long term incentive pay plan, plus any other bonus or
other incentive payment the Corporate Management Committee determines
in its sole discretion to be eligible for a deferral election under the
ELECTIVE DEFERRAL CREDITS SECTION of Article III.
90
(b) In the case of an Agent or Field Manager, his Compensation.
EARLY RETIREMENT DATE means the last day of any month following Termination of
Service in which the Participant has attained age fifty-seven (57) or more and
completed ten (10) or more years of service.
ELECTIVE DEFERRAL CREDIT means a credit to an Account made in accordance with
the ELECTIVE DEFERRAL CREDIT SECTION of Article III.
ELIGIBLE GROUP means the group of Employees, Agents and Field Managers who are
eligible to participate in the Plan, as determined under the ELIGIBLE GROUP
SECTION of Article II.
EMPLOYEE means any common-law employee of the Company or a Controlled Group
Member (while it is a Controlled Group Member).
ERISA means the Employee Retirement Income Security Act of 1974, as amended.
FIELD MANAGER means an individual who is not an Employee and who holds a current
DD 713 contract or any successor full-time contract with the Company, and
including, but not limited to, one of the following full-time field management
positions:
o management assistant;
o management associate;
o manager;
o managing director;
o co-managing director;
o assistant managing director;
o associate managing director;
o regional managing director;
o co-regional managing director;
o advanced planning director;
o director - relationship management;
o regional client service director;
o advanced planning regional vice president; or
o disability income regional vice president.
LATE RETIREMENT DATE means the last day of any month following Termination of
Service which is after a Participant's Normal Retirement Date.
NORMAL RETIREMENT DATE means last day of any month following Termination of
Service on or after the date the Participant reaches age 65.
PARENT means the Principal Financial Group, Inc., a Delaware corporation, and
any successor thereto.
PARTICIPANT means any Active Participant, or any current or former Employee,
Agent or Field Manager who is not an Active Participant but who has a balance
remaining in an Account under the Plan.
PARTICIPATING CONTROLLED GROUP MEMBER means any Controlled Group Member that has
adopted the Associated Plan and that employs one or more Participants (a
Participating Controlled Group Member will automatically ceases to participate
if it ceases to be a Controlled Group Member).
PLAN means The Principal Select Savings Excess Plan.
PLAN YEAR means the calendar year.
91
RETIREMENT means his early, normal or late retirement date following his
Termination of Service.
TERMINATION OF SERVICE means:
(a) In the case of an Employee resignation, discharge, retirement, death or
the happening of any other event or circumstance that results in the
severance of the common-law employer-employee relationship with the
Company and all Controlled Group Members, unless the Employee then
becomes an Agent or Field Manager.
(b) In the case of an Agent or Field Manager, the date of termination of
his agent's contract DD713 (as such contract may be amended from time
to time, or successor contracts to it) unless the Agent or Field
Manager then becomes an Employee.
TRANSFER CREDIT means a credit to an Account made in accordance with the
TRANSFER CREDITS SECTION of Article III.
VALUATION DATE means each day on which trading occurs on the New York Stock
Exchange.
ARTICLE II
PARTICIPATION
SECTION 2.01 -- ELIGIBLE GROUP.
All Employees, Agents and Field Managers who are in the Eligible Group will be
eligible to participate in the Plan. An Employee, Agent or Field Manager is in
the Eligible Group if:
(a) he is eligible to participate in the Associated Plan; and either;
(b) his compensation for the previous year is one hundred and twenty-five
percent (125%) or more of the salary minimum used in the definition of
a highly compensated employee under Code ss. 414(q) for that year;
(c) his compensation for the current year is one hundred and twenty-five
percent (125%) or more of the salary minimum used in the definition of
a highly compensated employee under Code ss. 414(q) for the year; or
(d) he has been selected by the Corporate Management Committee to
participate in this Plan.
However, the Corporate Management Committee in its sole and absolute discretion
may determine that an Employee, Agent or Field Manager described above will not
be in the Eligible Group, or may determine that an Employee, Agent or Field
Manager not described above will be in the Eligible Group. However, as to
Employees, the Plan is intended to cover only those Employees who are in a
select group of management or highly compensated employees within the meaning of
ERISA ss.ss. 201(2), 301(a)(3) and 401(a)(1); and, accordingly, if any
interpretation is issued by the Department of Labor that would exclude any
Employee from satisfying that requirement, such Employee immediately will cease
to be in the Eligible Group.
An Agent or Field Manager will cease to be in the Eligible Group as of the
earlier of the date of termination of his agent's contract DD713 (as such
contract may be amended from time to time, or successor contracts to it), or as
of the date the Company sends written notice to him of cancellation of his
agent's contract DD713 (as such contract may be amended from time to time, or
successor contracts to it), or as of such earlier date on which he ceases to
satisfy the requirements of the first paragraph of this definition.
92
SECTION 2.02 -- NOTICE OF ELIGIBILITY.
The Company will notify each Employee, Agent and Field Manager prior to, or as
soon as administratively practicable after, his entry into the Eligible Group of
his eligibility to participate in the Plan.
SECTION 2.03 -- END OF ELIGIBILITY AND PARTICIPATION.
An Employee, Agent or Field Manager who is in the Eligible Group may continue as
an Active Participant for so long as the Plan remains in effect and he remains
in the Eligible Group. A Participant shall cease to be a Participant on the date
he has received a full distribution of all benefits payable to him under the
terms of the Plan.
ARTICLE IIL
CONTRIBUTION CREDITS
SECTION 3.01 -- ELECTIVE DEFERRAL CREDITS.
An Elective Deferral Credit will be added to the Account of an Active
Participant for a given pay date if such Participant is eligible to and has
elected to have a Deferral Eligible Amount that he would otherwise receive in
cash on such pay date reduced in order to receive an Elective Deferral Credit
under this Plan. The Elective Deferral Credit for a given pay date will be added
on or as soon as administratively practicable after the pay date in an amount
equal the amount of the reduction in the Deferral Eligible Amount.
The Plan provides for an automatic election to have Elective Deferral Credits
made. The automatic Elective Deferral Credit shall be 6% of Compensation,
excluding compensation received from an annual incentive pay plan.
An Active Participant may elect to reduce his Deferral Eligible Amount by the
following:
(a) With respect to items of Compensation, for any pay date, the
Participant may elect to reduce his Compensation for such pay date by
any whole percentage, not more than fifteen percent (15%). However, an
election to reduce Compensation for purposes of receiving Elective
Deferral Credits will be effective during a Plan Year only once the
Participant has either:
(i) Received Elective Deferral Contributions under the Associated
Plan equal to the maximum allowed under Code ss. 402(g); or
(ii) Received Compensation recognized under the Associated Plan
equal to the maximum allowed to be recognized under Code ss.
401(a)(17).
(b) With respect to bonuses paid under an annual incentive pay plan, the
Participant may elect to reduce the payment by any whole percentage,
but not more than one-hundred percent (100%).
(c) With respect to other amounts that the Corporate Management Committee
determines are Deferral Eligible Amounts, the Corporate Management
Committee will establish such minimum and maximum reduction amount as
it may determine appropriate in its sole and absolute discretion.
93
An election (or the modification or revocation of an election) must be made in
such manner and in accordance with such rules as may be prescribed for this
purpose by the Company (including by means of a voice response or other
electronic system under circumstances authorized by the Company)
An election by an Employee with respect to any item of Compensation (other than
annual incentive compensation) must be made prior to the start of the first
payroll period to which such election relates during the Plan Year. An election
by an Employee with respect to bonuses paid under an annual incentive pay plan,
or any other amounts that the Corporate Management Committee determines are
Deferral Eligible Amounts, must be made by December 31st of the year prior to
the year with respect to which the bonus or other amount is earned; except that,
for the bonus or other amount payable for the year in which an Employee is first
notified of his eligibility to participate in the Plan, an election may be made
within thirty (30) days after he is notified of his eligibility to participate
(and before the amount is made available in cash to the Employee).
An election by an Agent or Field Manager with respect to any Deferral Eligible
Amount must be made by December 31st of the year prior to the year in which the
Deferral Eligible Amount would otherwise be payable in cash to the Agent or
Field Manager; except that, for such amounts payable for the year in which an
Agent or Field Manager is first notified of his eligibility to participate in
the Plan, an election may be made within thirty (30) days after he is notified
of his eligibility to participant (and before the amount is made available in
cash to the Agent or Field Manager).
An election will automatically be carried over and applied to the next Plan
Year. Elective Deferral Credits will automatically stop during the Plan Year
upon Termination of Service or upon otherwise ceasing to be within the Eligible
Group, or upon termination of the Plan. For Agents and Field Managers, an
election will be irrevocable throughout the Plan Year (or the remaining portion
thereof); except that, when an election is made to cease Elective Deferral
Credits.
The Company may, in its sole discretion, limit the minimum or maximum amount of
Elective Deferral Credits that are allowed under the Plan by any Active
Participant or any group of Active Participants.
SECTION 3.02 -- COMPANY MATCH CREDITS.
A Company Match Credit will be added to the Account of an Active Participant for
a given pay date if such Participant receives an Elective Deferral Credit for
such pay date under the ELECTIVE DEFERRAL CREDITS SECTION of this Article as a
result of an election to reduce Compensation. The amount of the Company Match
Credit for a given pay date will equal the lesser of fifty percent (50%) of the
Participant's Elective Deferral Credit for such pay date, or three percent (3%)
of the Participant's Compensation for the payroll period.
SECTION 3.03 -- TRANSFER CREDITS.
If so elected by a Participant who is also a participant in the Nonqualified
Defined Contribution Plan for Designated Participants, a Transfer Credit will be
added to the Account of such Participant to reflect an automatic transfer of any
credit under the Nonqualified Defined Contribution Plan for Designated
Participants when the transfer credit becomes vested.
SECTION 3.04 -- ACCOUNTS.
An Account will be maintained under the Plan on behalf of each Participant.
Separate accounting records will be maintained to reflect the portion of an
Account attributable to:
94
(a) Elective Deferral Credits under the ELECTIVE DEFERRAL CREDITS SECTION of
this Article;
(b) Company Match Credits under the COMPANY MATCH CREDITS SECTION of this
Article;
(c) Transfer Credits under the TRANSFER CREDITS SECTION of this Article.
Additional Accounts may also be maintained if considered appropriate by the
Company in the administration of the Plan.
Accounts will have a cash balance expressed in United States Dollars.
Accounts are for bookkeeping purposes only and the maintenance of Accounts will
not require any segregation of assets of the Company or any Participating
Controlled Group Member. Neither the Company nor any Participating Controlled
Group Member will have any obligation whatsoever to set aside funds for the Plan
or for the benefit of any Participant or Beneficiary, and no Participant or
Beneficiary will have any rights to any amounts that may be set aside other than
the rights of an unsecured general creditor of the Company or Participating
Controlled Group Member that employs (or employed) the Participant.
ARTICLE IV
EARNINGS CREDITS
SECTION 4.01 -- ADJUSTMENT TO REFLECT EARNINGS CREDITS.
Accounts will be adjusted (increased or decreased) as of each Valuation Date to
reflect earnings credits as determined under the EARNINGS CREDITS SECTION of
this Article IV.
SECTION 4.02 -- EARNINGS CREDITS.
The Company will establish a procedure by which a Participant (or Beneficiary
following the death of a Participant) may elect to have his/her earnings credits
determined based on the performance of one or more investment options deemed to
be available under the Plan. The Company, in its sole discretion, will determine
the investment options that will be available as benchmarks for determining the
earnings credit, which may include mutual funds, common or commingled investment
funds, group annuity contracts (general account or separate account), a fund
that invests in Common Stock of the Parent or any other investment option deemed
appropriate by the Company. The Company may at any time and from time to time
add to or remove from the investment options deemed to be available under the
Plan.
A Participant (or Beneficiary following the death of the Participant) will be
allowed on a hypothetical basis to direct the investment of his/her Account
among the investment options available under the Plan. Hypothetical investment
directions may be given with such frequency as is deemed appropriate by the
Company, and must be made in such percentage or dollar increments, in such
manner and in accordance with such rules as may be prescribed for this purpose
by the Company (including by means of a voice response or other electronic
system under circumstances so authorized by the Company). If an investment
option has a loss, the earnings credit attributable to such investment option
will serve to reduce the Account; similarly, if an investment option has a gain,
the earnings credit attributable to such investment option will serve to
increase the Account. If the Participant fails to elect an investment option,
the earnings credit will be based on a money market investment option or such
other investment option as may be selected for this purpose by the Company.
An Account is subject to any minimum guarantees applicable under a group annuity
contract or other investment arrangement.
95
SECTION 4.03 -- HYPOTHETICAL INVESTMENTS.
All investment directions of a Participant or Beneficiary will be on a
"hypothetical" basis for the sole purpose of establishing the earnings credit
for his/her Account - that is, the Account will be adjusted for earnings credits
as if the Account were invested pursuant to the investment directions of the
Participant or Beneficiary, but actual investments need not be made pursuant to
such directions. However, the Company, in its sole discretion and without any
obligation, may direct that investments be made per the investment directions of
Participants and Beneficiaries in order to hedge the liability of the Company
and Participating Controlled Group Members.
If the Company directs that investments actually be made in Common Stock to
hedge liability, any transactions costs (brokerage fees and commissions) on
purchases and sales of Common Stock may be charged to the Participant's Account.
SECTION 4.04 -- STATEMENTS.
The Company may cause benefit statements to be issued from time to time advising
Participants and Beneficiaries of the balance and/or investment of their
Accounts, but it is not required to issue benefits statements.
The Company may correct errors that appear on benefit statements at any time,
and the issuance of a benefit statement (and any errors that may appear on a
statement) will not in any way alter or affect the rights of a Participant or
Beneficiary with respect to the Plan. Each Participant or Beneficiary has a duty
to promptly review each benefit statement and to notify the Company of any error
that appears on such statement within thirty (30) days of the date such
statement is provided or made available to the Participant or Beneficiary (for
example, the date the statement is sent by mail, or the date the statement is
provided or made available electronically). If a Participant or Beneficiary
fails to review a benefit statement or fails to notify the Company of any error
that appears on such statement within such period of time, he will not be able
to bring any claim seeking relief or damages based on the error.
ARTICLE V
WITHDRAWALS WHILE IN SERVICE
A Participant may withdraw any part of his account for an unforeseeable
emergency (a financial hardship due to an unanticipated emergency, as defined
under the Associated Plan).
A Participant may withdraw any part of his account, provided he pays a 10%
penalty on the amount withdrawn and Elective Deferral Credits cease for 12
months.
If a Participant becomes Totally and Permanently Disabled, a single lump sum
payment will be made as soon as administratively practicable following proof of
disability, unless a timely distribution election is on file. A Participant can
elect a 5 year or 10 year fixed period installment, if his account value exceeds
$25,000.
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ARTICLE VI
DISTRIBUTIONS AFTER TERMINATION OF SERVICE
SECTION 6.01 -- BENEFIT ON TERMINATION OF SERVICE.
A Participant will be eligible to receive a distribution of the full balance of
his Account following his/her Termination of Service in accordance with the
terms of this Article.
SECTION 6.02 -- TIME AND FORM OF DISTRIBUTION.
A distribution will be made (or commence) in cash as soon as administratively
practicable after Termination of Service in the following form:
(a) In the case of a Termination of Service that occurs for reasons other
than Retirement, the distribution will be made in the form of a single
lump-sum payment. A Participant can elect a 5-year or 10-year fixed
period installment, if his account value exceeds $25,000.
(b) For reasons of Retirement, the distribution will be made in one of the
following forms as elected by the Participant:
(i) A single lump-sum payment;
(ii) A single life annuity with a certain period of ten years;
(iii) A single life annuity with installment refund;
(iv) A survivorship life annuity with installment refund and a
survivorship percentage of fifty percent (50%);
(v) A fixed period annuity for any period of whole months which is
not less than 120 and does not exceed the life expectancy of
the Participant and the named Beneficiary.
(vi) Annual cash installments each of an amount equal to any fixed
whole percentage, not less than ten percent (10%) and not more
than thirteen percent (13%), as elected by the Participant, of
his remaining Account. Such amount shall be payable annually
until his Account is exhausted. Once elected, the amount will
not change.
To determine the amount of any annuity payments to a Participant, the balance of
his Account will be converted to an annuity using interest and mortality
assumptions deemed reasonable by the Corporate Management Committee.
In-kind distributions (including in-kind distributions of Common Stock) are not
allowed under the Plan.
SECTION 6.03 -- DISTRIBUTION ELECTION PROCEDURES.
A distribution election must be made in such manner and in accordance with such
rules as may be prescribed for this purpose by the Company (including by means
of a voice response or other electronic system under circumstances authorized by
the Company). A distribution election will be effective only if it is received
in properly completed form by the Company as part of the Participant's initial
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enrollment in the Plan, or thereafter, at least twelve (12) months prior to
Termination of Service or Totally and Permanently Disabled.
Notwithstanding the above, if a Participant's Termination of Service occurs by
action of the Company within two (2) years following a Change in Control for any
reason other than embezzlement or engaging in any criminal act, a distribution
will be made in the form of a single lump-sum payment within ten (10) days
following Termination of Service.
SECTION 6.04 -- DEFAULT ELECTIONS.
If a Participant fails to file a timely election as to the form of distribution,
the distribution will be made in the form of a single lump-sum distribution of
the full balance of the Account.
SECTION 6.05 -- CASH-OUT OF SMALL ACCOUNTS AT OPTION OF COMMITTEE.
Notwithstanding any contrary election made by a Participant, if the balance of a
Participant's Account does not exceed $25,000 at Termination of Service or Total
and Permanent Disability, the Corporate Management Committee may in its sole and
absolute discretion direct that such full balance will be paid in a single-sum
distribution in full settlement of all obligations under the Plan. For the
annual payment distribution option at Retirement, a single-sum distribution will
be made when the balance reaches $5,000.
SECTION 6.06 -- VALUATION OF ACCOUNTS FOLLOWING TERMINATION OF SERVICE.
An Account will continue to be credited with the EARNINGS CREDITS SECTION of
Article IV until it is paid in full to the Participant or Beneficiary, or it is
converted into an annuity pursuant to the TIME AND FORM OF DISTRIBUTION SECTION
of this Article.
SECTION 6.07 -- DISTRIBUTIONS PURSUANT TO A DOMESTIC RELATIONS ORDER.
The Plan permits the benefits actually payable to a Participant to be divided
with a spouse or former spouse of a participant who meets the definition of
alternate payee under ERISA ss. 206(d) provided that the Plan Administrator
determines that the domestic relations order meets the criteria of a qualified
domestic relations order, as defined in ERISA ss. 206(d). A distribution to an
alternate payee is not allowed prior to payment (or commencement) of a benefit
to a Participant, and the Plan will not recognize a domestic relations order
that purports to create a separate interest to the alternate payee. In addition,
once a form of benefit has commenced, the form of measuring life may not be
changed
The Company will establish reasonable procedures to determine whether a domestic
relations order meets the criteria of ERISA ss. 206(d). Upon receiving a
domestic relations order, the Company promptly will notify the Participant and
an alternate payee named in the order, in writing, of the receipt of the order
and the Plan's procedures for determining the status of the order. Within a
reasonable period of time after receiving the domestic relations order, the
Company will determine the status of the order and will notify the Participant
and each alternate payee, in writing, of its determination. The Company will
provide notice under this paragraph by mailing to the individual's address
specified in the domestic relations order.
If any portion of the Participant's benefit under this Plan is payable during
the period the Company is making its determination of the status of the domestic
relations order, a separate accounting will be made of the amount payable. If
the Company determines the order is a domestic relations order within the
criteria of ERISA ss. 206(d) within 18 months of the date amounts are first
payable following receipt of the order, the payable amounts will be distributed
in accordance with the order. If the Company does not make its determination of
the status of the order within the 18 month determination period, the payable
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amounts will be distributed in the manner the Plan would distribute if the order
did not exist and the order will apply prospectively if the Company later
determines the order meets the criteria of ERISA ss. 206(d).
The plan will make payments or distributions required under this section by
separate benefit checks or other separate distribution to the alternate payee(s)
and report the payments accordingly, provided however, that the Company may
report the distributions as income to the Participant as it determines to be
consistent with the requirements of the Code.
ARTICLE VII
DISTRIBUTIONS AFTER DEATH
SECTION 7.01 -- SURVIVOR BENEFITS.
If a Participant dies prior to the full distribution of his Account, his
Beneficiary will be entitled to the following survivor benefit under the Plan:
(a) If the Participant dies while receiving installment payments, such
installments will continue to his Beneficiary over the same period such
installments would have been paid to the Participant;
(b) If the Participant dies while receiving annuity payments, such annuity
payments will continue to his Beneficiary if and as consistent with the
form of annuity payout being made under the Plan; or
(c) Otherwise, if the Participant dies prior to payment (or commencement)
of a benefit under Article VI, the survivor benefit will consist of a
single lump-sum payment in an amount equal to the total balance in the
Account.
The survivor benefit will be paid (or start to be paid) on or as soon as
administratively practicable after the Company determines that a survivor
benefit is payable under the Plan - that is, the date the Company is provided
with the documentation reasonably necessary to establish the fact of death of
the Participant and the identity and entitlement of the Beneficiary.
SECTION 7.02 -- CASH-OUT OF SURVIVOR BENEFITS AT OPTION OF COMMITTEE.
Notwithstanding the above, if periodic payments (either installments or
annuities) are due to a Beneficiary under the above rules, the Corporate
Management Committee may, in its sole discretion, elect to pay the survivor
benefit in a single lump-sum payment in an amount equal to the remaining balance
in the Account (in the case of an installment payout) or the present value of
the annuity (in the case of an annuity payout) in full satisfaction of the
survivor benefit otherwise payable under the Plan. Present value for this
purpose will be determined using interest and mortality assumptions deemed
reasonable by the Corporate Management Committee.
SECTION 7.03 -- BENEFICIARIES.
A Participant may designate any person (natural or otherwise, including a trust)
as his/her Beneficiary to receive the survivor benefit (if any) payable when he
dies, and may change or revoke a designation previously made without the consent
of any Beneficiary. If a Beneficiary designation is not on file, or if no
designated Beneficiary survives the Participant, the Beneficiary will be the
person designated by the Participant under the Associated Plan or, in the
absence of a designation, the default Beneficiary under the Associated Plan. If
the primary Beneficiary designated by a Participant dies prior to complete
distribution of the survivor benefit, the remaining benefit will be paid to any
contingent Beneficiary designated by the Participant, or if there is no
surviving contingent Beneficiary, a lump sum of the remaining benefit will be
paid to the estate of the primary Beneficiary.
A Beneficiary designation must be made on such form and in accordance with such
rules as may be prescribed for this purpose by the Company. A Beneficiary
designation will be effective (and will revoke all prior designations) if it is
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received by the Company (or if sent by mail, the post-mark of the mailing is)
prior to the date of death of the Participant
ARTICLE VIII
ADMINISTRATION OF PLAN
SECTION 8.01 -- ADMINISTRATION.
The Company is the administrator of the Plan with authority to control and
manage the operation and administration of the Plan and make all decisions and
determinations incident thereto. Action on behalf of the Company as
administrator may be taken by any of the following:
(a) CORPORATE MANAGEMENT COMMITTEE. The Corporate Management Committee of
the Company will be responsible for selecting the Employees, Agents and
Field Managers who are in the Eligible Group. This committee shall have
authority to make rules and regulations for the administration of the
Plan, and its interpretations and decisions with regard thereto shall
be final and conclusive.
(b) BENEFIT PLANS INVESTMENT COMMITTEE. The Benefit Plans Investment
Committee of the Company is responsible for all investment matters
relating to the Plan, including the investment of assets that may (but
are not required to be) set aside to hedge liabilities resulting from
the Plan, and actual investment of the rabbi trust, including the
selection and monitoring investment providers (including the Trustee)
with respect to the Plan.
The members of the Benefit Plans Investment Committee will be appointed
by the Chief Executive Officer of the Company.
Day-to-day non-discretionary administration of the Plan may be performed by the
Human Resources Department.
SECTION 8.02 -- CORRECTION OF ERRORS AND DUTY TO REVIEW INFORMATION.
Errors may occur in the operation and administration of the Plan. The Company
reserves the right to cause such equitable adjustments to be made to correct for
such errors as it considers appropriate (including adjustments to Participant or
Beneficiary Accounts), which will be final and binding on the Participant or
Beneficiary.
Each Participant and Beneficiary has the duty to promptly review any information
that is provided or made available to the Participant or Beneficiary and that
relates in any way to the operation and administration of the Plan or his
elections under the Plan (for example, to review payroll stubs to make sure a
contribution election is being implemented appropriately, to review benefit
statements to make sure investment elections are being implemented
appropriately, to review summary plan descriptions and prospectuses, etc.) and
to notify the Company of any error made in the operation or administration of
the Plan that affects the Participant or Beneficiary within thirty (30) days of
the date such information is provided or made available to the Participant or
Beneficiary (for example, the date the information is sent by mail or the date
the information is provided or made available electronically). If the
Participant or Beneficiary fails to review any information or fails to notify
100
the Company of any error within such period of time, he will not be able to
bring any claim seeking relief or damages based on the error. If the Company is
notified of an alleged error within the thirty (30) day time period, the Company
will investigate and either correct the error or notify the Participant or
Beneficiary that it believes that no error occurred. If the Participant or
Beneficiary is not satisfied with the correction (or the decision that no
correction is necessary), he will have sixty (60) days from the date of
notification of the correction (or notification of the decision that no
correction is necessary), to file a formal claim under the claims procedures
under the CLAIMS PROCEDURES SECTION of this Article.
SECTION 8.03 -- CLAIMS PROCEDURES.
If a Participant or Beneficiary does not feel as if he has received full payment
of the benefit due such person under the Plan, the Participant or Beneficiary
may file a written claim with the Company setting forth the nature of the
benefit claimed, the amount thereof, and the basis for claiming entitlement to
such benefit. The Vice President of Human Resources of the Company will
determine the validity of the claim and communicate a decision to the claimant
promptly and, in any event, not later than ninety (90) days after the date of
the claim. The claim may be deemed by the claimant to have been denied for
purposes of further review described below in the event a decision is not
furnished to the claimant within such ninety (90) day period. If additional
information is necessary to make a determination on a claim, the claimant will
be advised of the need for such additional information within forty-five (45)
days after the date of the claim. The claimant will have up to one hundred and
eighty (180) days to supplement the claim information, and the claimant will be
advised of the decision on the claim within forty-five (45) days after the
earlier of the date the supplemental information is supplied or the end of the
one hundred and eighty (180) day period.
A claim for benefits which is denied will be denied by written notice setting
forth in a manner calculated to be understood by the claimant:
(a) The specific reason or reasons for the denial, including a specific
reference to any provisions of the Plan (including any internal rules,
guidelines, protocols, criteria, etc.) on which the denial is based;
(b) A description of any additional material or information that is
necessary to process the claim; and
(c) An explanation of the procedure for further reviewing the denial of the
claim.
Within sixty (60) days after the receipt of a denial on a claim, a claimant or
his/her authorized representative may file a written request for review of such
denial. Such review will be undertaken by the Corporate Management Committee and
will be a full and fair review. The claimant will have the right to review all
pertinent documents. The Corporate Management Committee will issue a decision
not later than sixty (60) days after receipt of a request for review from a
claimant unless special circumstances, such as the need to hold a hearing,
require a longer period of time, in which case a decision will be rendered as
soon as possible but not later than one hundred and twenty (120) days after
receipt of the claimant's request for review. The decision on review will be in
writing and will include specific reasons for the decision written in a manner
calculated to be understood by the claimant with specific reference to any
provisions of the Plan on which the decision is based.
SECTION 8.04 -- INDEMNIFICATION.
The Company and the Participating Controlled Group Members jointly and severally
agree to indemnify and hold harmless, to the extent permitted by law, each
director, officer, and employee against any and all liabilities, losses, costs,
or expenses (including legal fees) of whatsoever kind and nature that may be
imposed on, incurred by, or asserted against such person at any time by reason
of such person's services in the administration of the Plan, but only if such
101
person did not act dishonestly, or in bad faith, or in willful violation of the
law or regulations under which such liability, loss, cost, or expense arises.
SECTION 8.05 -- EXERCISE OF AUTHORITY.
The Company and any person who has authority with respect to the management,
administration or investment of the Plan may exercise that authority in his full
discretion. This discretionary authority includes, but is not limited to, the
authority to make any and all factual determinations and interpret all terms and
provisions of this document (or any other document established for use in the
administration of the Plan) relevant to the issue under consideration. The
exercise of authority will be binding upon all persons; and it is intended that
the exercise of authority be given deference in all courts of law to the
greatest extent allowed under law, and that it not be overturned or set aside by
any court of law unless found to be arbitrary and capricious.
SECTION 8.06 -- TELEPHONIC OR ELECTRONIC NOTICES AND TRANSACTIONS.
Any notice that is required to be given under the Plan to a Participant or
Beneficiary, and any action that can be taken under the Plan by a Participant or
Beneficiary (including enrollments, changes in deferral percentages,
withdrawals, distributions, investment changes, consents, etc.), may be by means
of voice response or other electronic system to the extent so authorized by the
Company.
ARTICLE IX
CONTRACTUAL OBLIGATIONS AND FUNDING
SECTION 9.01 -- CONTRACTUAL OBLIGATIONS.
The Plan creates a contractual obligation on the part of the Company and each
Participating Controlled Group Member to provide benefits as set forth in the
Plan with respect to:
(a) Participants who are employed with or contract with the Company or that
Participating Controlled Group Member;
(b) Participants who were employed with or contract with the Company or
that Participating Controlled Group Member prior to Termination of
Service; and
(c) Beneficiaries of the Participants described in (a) and (b).
A Participating Controlled Group Member is not responsible for (and has no
contractual obligation with respect to) benefits payable to a Participant who is
or was employed with or contracted with the Company or another Participating
Controlled Group Member. If a Participant is employed with or contracts with two
or more employers (the Company and a Participating Controlled Group Member, or
two or more Participating Controlled Group Members, etc.), either concurrently
or at different times, each will be responsible for the benefit attributable to
Elective Deferral Credits, Company Match Credits and Transfer Credits made with
respect to the period while the Participant was employed with or contracted with
that employer, adjusted for earnings credits.
The Parent and the Company each will guarantee and assume secondary liability
for the contractual commitment of each Participating Controlled Group Member
under this Section.
102
SECTION 9.02 -- FUNDING.
The Company has established a "rabbi" trust to serve as a funding vehicle for
benefits payable under the Plan. However, neither the Company nor any
Participating Controlled Group Member is obligated to fund such trust. The rabbi
trust will be invested in the manner directed by the Company.
The establishment and funding of the rabbi trust will not affect the contractual
obligations of the Company and Participating Controlled Group Member under the
CONTRACTUAL OBLIGATIONS SECTION of this Article, except that such obligations
with respect to any Participant or Beneficiary will be offset to the extent that
payments actually are made from the trust to such Participant or Beneficiary.
The rabbi trust used to fund benefits payable under this Plan may be used to
fund benefits payable under any other non-qualified deferred compensation plan
maintained by the Company or a Participating Controlled Group.
ARTICLE X
GENERAL PROVISIONS
SECTION 10.01 -- AMENDMENT AND TERMINATION.
The Board or its delegate may amend or terminate this Plan at any time and for
any reason by resolution of its Corporate Management Committee.
An amendment or termination of the Plan may not have the effect of reducing the
balance of the Account of any Participant or Beneficiary.
After termination of the Plan, no Elective Deferral Credits, Company Match
Credits or Transfer Credits will be added to the Account of any Participant
attributable to periods after the date of termination. Distribution following
termination of the Plan will be made at the same time and in the same form as if
the termination had not occurred, and a Participant will continue to have the
same options available to him to defer distribution as otherwise provided under
the Plan. However, if so elected by a majority of the Participants who have
Accounts at termination of the Plan (including Participants or Beneficiaries who
are receiving installments or annuity payouts), the termination of the Plan will
be treated as a termination of employment and each Participant or Beneficiary
will receive a single sum payment of the full balance of his/her Account in full
satisfaction of all obligations under the Plan and without regard to any
distribution elections in place with respect to such Participant or Beneficiary.
SECTION 10.02-- EMPLOYMENT STATUS.
Nothing contained in this Plan gives an Eligible Employee the right to be
retained in the Company's employ or to interfere with the Company's right to
discharge any Eligible Employee.
SECTION 10.03 -- RIGHTS TO PLAN ASSETS.
Neither the Company nor any Participating Controlled Group Member will have any
obligation whatsoever to set aside funds for the Plan or for the benefit of any
Participant or Beneficiary, and no Participant or Beneficiary will have any
rights to any amounts that may be set aside other than the rights of an
unsecured general creditor of the Company or Participating Controlled Group
Member that employs (or employed) the Participant.
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SECTION 10.04 -- NONALIENATION OF BENEFITS.
Benefits payable under the Plan are not subject to the claims of any creditor of
any Participant or Beneficiary. A Participant or Beneficiary does not have any
rights to alienate, anticipate, Commute, pledge, encumber or assign any of such
benefits. The preceding sentences shall also apply to the creation, assignment,
or recognition of a right to any benefit payable with respect to a Participant
according to a domestic relations order, unless such order is determined by the
Company to be a domestic relations order, as defined in ERISA Act Section
206(d), or any domestic relations order entered before January 1, 1985.
SECTION 10.05-- CONSTRUCTION.
The validity of the Plan or any of its provisions is determined under and
construed according to Federal law and, to the extent permissible, according to
the laws of the state in which the Company has its principal office. In case any
provision of this Plan is held illegal or invalid for any reason, such
determination shall not affect the remaining provisions of this Plan, and the
Plan shall be construed and enforced as if the illegal or invalid provision had
never been included.
In the event of any conflict between the provisions of the Plan and the terms of
any contract or policy issued hereunder, the provisions of the Plan control the
operation and administration of the Plan.
SECTION 10.06-- WORD USAGE.
The masculine gender, where used in this Plan, shall include the feminine gender
and the singular words as used in this Plan may include the plural, unless the
context indicates otherwise.
SECTION 10.07 -- LIMITATIONS.
Notwithstanding anything to the contrary contained in the Plan, no action shall
be taken, and no award or distribution shall be made, under the Plan, which
contains any term or condition that would violate any provision of the Plan of
Conversion of Principal Mutual Holding Company. Common Stock is not allowed as a
medium of distribution under the Plan. However, if the Plan ever is amended to
allow distribution in shares of Common Stock, the number of such shares
distributed hereunder shall count against (i) the limit of six percent (6%) of
the number of shares of Common Stock outstanding immediately following the
effective date of the Plan of Conversion that may be made issuable or
distributable under all Company Stock Plans other than The Principal Select
Savings Plan for Employees, The Principal Select Savings Plan for Individual
Field and The Principal Financial Group, Inc. Employee Stock Purchase Plan, and
(ii) the guideline set forth in The Principal Financial Group, Inc. Stock
Incentive Plan limiting the maximum number of shares of Common Stock that may be
awarded or issued within eighteen (18) months of the effective date of the Plan
of Conversion of Principal Mutual Holding Company to forty percent (40%) of the
limit set forth in subclause (i).
The "Company Stock Plans" for this purpose means any stock option plan, stock
incentive plan, stock purchase plan and share ownership plans related to the
Common Stock that are customary for publicly traded companies, and shall
include, but is not limited to, the Principal Financial Group, Inc. Directors
Stock Plan, the Principal Financial Group Long-Term Performance Plan, the Plan,
the Associated Plans, the Principal Financial Group, Inc. Stock Incentive Plan
and The Principal Financial Group, Inc. Employee Stock Purchase Plan, and shall
also include, if Common Stock is allowed as a distribution, this Plan and the
Non-Qualified Defined Contribution Plan for Designated Participants.
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By executing this Plan, the Company acknowledges having counseled to
the extent necessary with selected legal and tax advisors regarding the Plan's
legal and tax implications.
Executed this 17TH day of December, 2003
PRINCIPAL LIFE INSURANCE COMPANY
By /s/ JIM DEVRIES
----------------------------------------
VICE PRESIDENT - HUMAN RESOURCES
----------------------------------------
Title
105
EXHIBIT 10.7
THE PRINCIPAL
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
FOR EMPLOYEES
Restated January 1, 2003
106
INTRODUCTION
The Company established this Plan on January 1, 1982, to provide select eligible
employees with additional benefits, including what they would have received
under the Associated Plan, but for the limit imposed on the compensation that
can be taken into account under the such plan (Code ss. 401(a)(17)), the limit
imposed on the benefits accrued and payable under such plan (Code ss. 415(b)),
or the reduction in compensation that is taken into account under such plan as a
result of an election to reduce compensation and receive Elective Deferral
Credits under The Principal Select Savings Excess Plan. The Plan is designed and
intended to be a "top-hat" plan - that is, an unfunded plan maintained primarily
for the purpose of providing retirement benefits for a select group of
management or highly compensated employees within the meaning of ERISA ss.
201(2), 301(a)(3) and 401(a)(1), and therefore is exempt from Parts 2, 3 and 4
of Title I of ERISA. The Plan also is intended to be a nonqualified plan for
purposes of Code ss. 401.
The Company is of the opinion that the Plan should be changed. It believes that
the best means to accomplish these changes is to completely restate the Plan's
terms, provisions and conditions. The restatement, effective January 1, 2003, is
set forth in this document and is substituted in lieu of the prior document.
ARTICLE I
DEFINITIONS
SECTION 1.01 -- FORMAT.
Words and phrases defined in the DEFINITIONS SECTION of this Article will have
the defined meaning when used in this Plan, unless the context clearly indicates
otherwise. These words and phrases will have an initial capital letter to aid in
identifying them as defined terms.
Words and phrases with an initial capital letter that are not defined in the
DEFINITIONS SECTION of this Article will have the meaning assigned to such word
or phase under the Associated Plan, unless the context clearly indicates
otherwise.
SECTION 1.02 -- DEFINITIONS.
ACTIVE PARTICIPANT means any Employee in the Eligible Group.
ACCRUED SUPPLEMENTAL BENEFIT means the Supplemental Pension attributable to the
formula specified in the ACCRUED SUPPLEMENTAL BENEFIT SECTION of Article III,
when expressed as a Single Life Annuity starting on the Participant's Normal
Retirement Date (or on the last day of the month that includes the date of
determination, if the date of determination is after the Participant's Normal
Retirement Date).
ASSOCIATED PLAN means The Principal Pension Plan.
BENEFICIARY means the person or persons designated as such pursuant to the
BENEFICIARIES SECTION of Article VII.
CHANGE IN CONTROL means the occurrence of any of the following events: (i) the
acquisition by any Person (as defined in Section 3(a)(9) of the Securities and
Exchange Act of 1934, as amended (the "Exchange Act") and as used in Sections
13(d) and 14(d) thereof)), entity or "group" (as defined in Section 13(d) of the
Exchange Act) of fifty percent (50%) or more of the outstanding voting power of
the Parent then outstanding voting securities; (ii) the merger, consolidation or
107
reorganization of the Parent, as a result of which persons who were stockholders
of the Parent immediately prior to such merger, consolidation or reorganization,
do not, immediately thereafter, own, directly or indirectly, more than fifty
percent (50%) of the combined voting power entitled to vote generally in the
election of directors of the merged, consolidated or reorganized company; (iii)
within any twelve (12) month period, the persons who were directors of the
Parent at the beginning of such period (the "Incumbent Directors") cease to
constitute at least a majority of the Board, provided that any director elected
to the Board, or nominated for election, by a majority of the Incumbent
Directors then still in office will be deemed to be an Incumbent Director for
purposes of this clause (iii); (iv) the liquidation or dissolution of the
Parent; and (v) the sale, transfer of other disposition, in one transaction or
series of related transactions, of more than fifty percent (50%) of the fair
market value of the assets of the Parent to any Person. For purposes of this
definition, the terms "Person," "entity" and "group" will not include (a) the
Parent or any of its subsidiaries or controlled affiliates; (b) a trustee or
other fiduciary holding securities under an employee benefit plan of the Parent
or any of its subsidiaries or affiliates; (c) an underwriter temporarily holding
securities of the Parent pursuant to an offering of such securities; or (d) a
corporation owned, directly or indirectly, by the shareholders of the Parent in
substantially the same proportions as their ownership of stock of the Parent.
CODE means the Internal Revenue Code of 1986, as amended.
COMPANY means Principal Life Insurance Company.
CONTROLLED GROUP MEMBER means any corporation or other business entity that is a
member of the same controlled group as, or is under common control with, the
Parent as determined under Code ss. 414(b) or (c).
ELIGIBLE GROUP means the group of Employees who are eligible to participate in
the Plan, as determined under the ELIGIBLE GROUP SECTION of Article II.
EMPLOYEE means any common-law employee of the Company or a Controlled Group
Member (while it is such).
ERISA means the Employee Retirement Income Security Act of 1974, as amended.
FROZEN BENEFIT means benefits accrued by Participants employed prior to January
1, 2002 and who became reemployed on or after January 1, 2002.
PARENT means the Principal Financial Group, Inc., a Delaware corporation, and
any successor thereto.
PARTICIPANT means any Active Participant, or any current or former Employee who
is not an Active Participant but who has benefits due him under the Plan.
PARTICIPATING CONTROLLED GROUP MEMBER means any Controlled Group Member that has
adopted the Associated Plan and that employs one or more Participants. A
Participating Controlled Group Member will automatically cease to participate if
it ceases to be a Controlled Group Member.
PLAN means The Principal Supplemental Executive Retirement Plan for Employees.
PLAN YEAR means the calendar year.
SOCIAL SECURITY BENEFIT means the monthly payment of primary insurance benefits
determined for a Participant by applying a salary scale, projected backwards, to
the Participant's pay as of any date of determination. The salary scale used
will be the actual change in the average wages from year to year as determined
by the Social Security Administration.
SUPPLEMENTAL PENSION means the benefit payable to a Participant in the form of
an annuity or in any other form of payment under the provisions of the Plan.
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TERMINATION OF SERVICE means resignation, discharge, retirement, death or the
happening of any other event or circumstance that results in the severance of
the common-law employer-employee relationship with the Company and all
Controlled Group Members, unless the Employee then becomes an Agent or Field
Manager.
In the event a Participant becomes Totally and Permanently Disabled and
continues to participate in the Associated Plan during the period of such
disability, his Termination of Service will be deemed to have occurred upon his
Severance Date that occurs under the Associated Plan.
In the case of an Employee working for a Controlled Group Member, a Termination
of Service will be deemed to have occurred upon the sale of the stock of the
employer (or a similar transaction) such that it is no longer a Controlled Group
Member. Similarly, a Termination of Employment will occur if an Employee resigns
or is discharged in connection with a sale of assets by the Company or a
Controlled Group Member, regardless of whether the Employee then accepts
employment with the purchaser of such assets.
VESTED means that the Participant has a termination of employment under
circumstances where he is entitled to a Pension under the Associated Plan.
ARTICLE II
PARTICIPATION
SECTION 2.01 -- ELIGIBLE GROUP.
All Employees who are in the Eligible Group will be eligible to accrue a
Supplemental Pension benefit under this Plan.
An Employee is in the Eligible Group if he is eligible to participate in the
Associated Plan, and either:
a) His compensation for the previous year is one-hundred and twenty-five
percent (125%) or more of the salary minimum used in the definition of a
"highly compensated employee" under Code ss. 414(q) for that year;
b) His compensation for the current year is one-hundred and twenty-five
percent (125%) or more of the salary minimum used in the definition of a
"highly compensated employee" under Code ss. 414(q) for the year; or
c) He has been selected by the Corporate Management Committee to participate
in this Plan.
The Corporate Management Committee in its sole and absolute discretion may
determine that an Employee described in (a) above will not be in the Eligible
Group, or may determine that an Employee not described in (a) above will be in
the Eligible Group. However, the Plan is intended to cover only those Employees
who are in a select group of management or highly compensated employees within
the meaning of ERISA ss. 201(2), 301(a)(3) and 401(a)(1); and, accordingly, if
any interpretation is issued by the Department of Labor that would exclude any
Employee from satisfying that requirement, such Employee immediately will cease
to be in the Eligible Group.
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SECTION 2.02 -- ENROLLMENT.
Enrollment is not required; rather, an Employee will automatically become an
Active Participant on the date he enters the Eligible Group.
SECTION 2.03 -- END OF ELIGIBILITY AND PARTICIPATION.
An Employee who is in the Eligible Group will continue as an Active Participant
for so long as the Plan remains in effect and he remains in the Eligible Group.
A Participant will cease to be a Participant on the date he has received a full
distribution of all benefits payable to him under the terms of the Plan.
ARTICLE IIL
SUPPLEMENTAL PENSION BENEFITS
SECTION 3.01 -- ACCRUED SUPPLEMENTAL BENEFIT.
A Participant's Accrued Supplemental Benefit as of any date of determination
will be a Single Life Annuity starting as of his Normal Retirement Date (or as
of the last day of the calendar month that next follows the date of
determination, if such date is after the Normal Retirement Date) with a monthly
amount equal to A minus B, where:
"A" = The greater of A1or A2 where:
"A1" = The Participant's Cash Balance Accrued Benefit under the
Associated Plan determined without regard to:
(i) The limit on compensation taken into account under
the Associated Plan under Code ss. 401(a)(17);
(ii) The limit on the benefit accrued and payable under
the Associated Plan under Code ss. 415(b); and
(iii) The exclusion of amounts deferred by the Participant
under The Principal Select Savings Excess Plan (or
other non-qualified deferred compensation plan
maintained or previously maintained by the Company or
Participating Controlled Group Member) from the
compensation base used in determining the benefit
accrued and payable under the Associated Plan.
"A2" = In the case of a Participant who has an Accrued Benefit
(Final Average Pay) accrued on his behalf under the Associated
Plan after January 1, 2002, A2 equals the greater of A2a or
A2b where:
A2a = The Participant's Accrued Benefit (Final Average Pay)
under the Associated Plan; or
A2b = An amount equal to 1 + 2 - 3, where:
"1" = 70.5% of the Participant's Average
Compensation multiplied by his Accrued
Benefit Adjustment (Pre-89) (Final Average
Pay).
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"2" = 65% of the Participant's Average
Compensation multiplied by his Accrued
Benefit Adjustment (Final Average Pay).
"3" = The Participant's Social Security Benefit
multiplied by the sum of his Accrued Benefit
Adjustment (Pre-89) (Final Average Pay) and
his Accrued Benefit Adjustment (Final
Average Pay).
A2a and A2b will be determined without regard to:
(i) The limit on compensation taken into account under
the Associated Plan under Code ss. 401(a)(17);
(ii) The limit on the benefit accrued and payable under
the Associated Plan under Code ss. 415(b); and
(iii) The exclusion of amounts deferred by the Participant
under The Principal Select Savings Excess Plan (or
other non-qualified deferred compensation plan
maintained or previously maintained by the Company or
Participating Controlled Group Member) from the
compensation base used in determining the benefit
accrued and payable under the Associated Plan.
"B" = The greater of B1 or B2, where:
"B1" = The Participant's Cash Balance Formula Accrued Benefit under the
Associated Plan; or "B2" = The Participant's Accrued Benefit (Final
Average Pay) under the Associated Plan.
However, if the Participant receives a distribution under the Associated Plan
prior to distribution of the Supplemental Pension benefit, the cash balance
account in B above will equal the amount that would have accrued as if no
distribution in the Associated Plan would have occurred.
If a Participant does not have an Accrued Benefit (Final Average Pay) accrued on
his behalf under the Associated Plan after January 1, 2002, then his Accrued
Supplemental Benefit will be A1 minus B1, above. Similarly, if a Participant has
an Accrued Benefit (Final Average Pay) accrued on his behalf under the
Associated Plan after January 1, 2002, his Accrued Supplemental Benefit will be
the greater of A1 or A2, minus the greater of B1 or B2, above.
SECTION 3.02 -- ENTITLEMENTS.
A Participant will have a Cash Balance Entitlement under this Plan if he is
Vested and his Supplemental Accrued Benefit (when measured as of the Benefit
Commencement Date for his/her Supplemental Pension) is determined by reference
to A1 in the ACCRUED SUPPLEMENTAL BENEFIT SECTION of this Article III.
A Participant will have a Final Average Pay Entitlement under this Plan if he is
Vested and his Supplemental Accrued Benefit (when measured as of the Benefit
Commencement Date for his/her Supplemental Pension) is determined by reference
to A2 in the ACCRUED SUPPLEMENTAL BENEFIT SECTION of this Article III.
A Participant who is not Vested will not be entitled to a Supplemental Pension
under this Plan.
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SECTION 3.03 -- SUPPLEMENTAL PENSION - CASH BALANCE ENTITLEMENT.
A Participant who has a Cash Balance Entitlement will be entitled to a
Supplemental Pension which, when expressed in the form of a Single Life Annuity
starting on the Participant's Normal Retirement Date (or on the last day of the
month that includes the date of determination, if the date of determination is
after the Participant's Normal Retirement Date), will equal A minus B, where:
"A" = The accrued benefit that would be payable to the Participant under
the Associated Plan if the Pension under the Associated Plan were
determined under the Cash Balance Formula and without regard to:
(i) The limit on compensation taken into account under the
Associated Plan under Code ss. 401(a)(17);
(ii) The limit on the benefit accrued and payable under the
Associated Plan under Code ss. 415(b); and
(iii) The exclusion of amounts deferred by the Participant under The
Principal Select Savings Excess Plan (or other non-qualified
deferred compensation plan maintained or previously maintained
by the Company or Participating Controlled Group Member) from
the compensation base used in determining the benefit accrued
and payable under the Associated Plan.
"B" = Accrued benefit that would be payable to the Participant under the
Associated Plan.
A Participant who has a Cash Balance Entitlement may receive his Supplemental
Pension upon his Termination of Service unless an election is on file, pursuant
to Section 3.06. The Participant may defer payment to any later date that is not
later than the latest date the Participant could commence payment of his Pension
under the Associated Plan.
The Supplemental Pension may be paid in any form available under the Associated
Plan for a Pension calculated under the Cash Balance Formula.
SECTION 3.04 -- SUPPLEMENTAL PENSION - FINAL AVERAGE PAY ENTITLEMENT.
A Participant who has a Final Average Pay Entitlement will be entitled to a
Supplemental Pension which, when expressed in the form of a Single Life Annuity
starting on the Participant's Normal Retirement Date (or on the last day of the
month that includes the date of determination, if the date of determination is
after the Participant's Normal Retirement Date), equals the Participant's
Accrued Supplemental Benefit.
A Participant who has a Final Average Pay Entitlement may receive his
Supplemental Pension as of the earliest date following his Termination of
Service on which he would be entitled to receive his Pension under the
Associated Plan if such Pension were determined based on his Accrued Benefit
(Final Average Pay), or the Participant may defer payment of the Supplemental
Pension to any later date that is not later than the latest date the Participant
could commence payment of his Pension under the Associated Plan.
The Supplemental Pension may be paid in any form available under the Associated
Plan for a Pension calculated under the Final Average Pay Formula.
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SECTION 3.05 - SUPPLEMENTAL PENSION - FROZEN BENEFIT ENTITLEMENT
A Participant may have a Frozen Benefit entitlement under this Plan in addition
to his Supplemental Pension. The Frozen Benefit may be paid in any form
available under the Associated Plan for a Pension calculated under the Final
Average Pay Formula.
SECTION 3.06 -- DISTRIBUTION ELECTION PROCEDURES.
A distribution election must be made in such manner and in accordance with such
rules as may be prescribed for this purpose by the Company (including by means
of a voice response or other electronic system under circumstances authorized by
the Company).
A distribution election will be effective only if it is received in properly
completed form by the Company at least twelve (12) months prior to the
Participant's Termination of Service or when the Participant first enters the
Eligible Group (even if that is within twelve (12) months of the Participant's
Termination of Service). However, in the case of a Participant in the Plan on
January 1, 2004 (which is date on which optional payment forms separate from the
Associated Plan are first allowed under the Plan), such Participant may file a
distribution election within thirty (30) days after January 1, 2004, which will
be effective immediately (even if that is within twelve (12) months of the
Participant's Termination of Service).
Notwithstanding the above, if a Participant's Termination of Service occurs by
action of the Company within two (2) years following a Change in Control for any
reason other than embezzlement or engaging in any criminal act, a distribution
will be made in the form of a single lump-sum payment within ten (10) days
following Termination of Service. Single lump-sum payments will be determined
based on the actuarial assumptions of the Associated Plan.
SECTION 3.07 -- DEFAULT ELECTION.
If a Participant fails to file a timely distribution election, his Supplemental
Pension will be paid in the form of a Single Life Annuity commencing as of his
Normal Retirement Date (or as of the last day of the month of his Termination of
Service if his Termination of Service is after his Normal Retirement Date).
SECTION 3.08 -- CASH-OUT OF SMALL BENEFITS AT OPTION OF COMMITTEE.
Notwithstanding any contrary election made by a Participant, if the present
value of the Participant's Supplemental Pension does not exceed five thousand
dollars ($5,000) at Termination of Service, the Corporate Management Committee
may in its sole and absolute discretion direct that such present value will be
paid in a single-sum distribution in full settlement of all obligations under
the Plan.
The "present value" of a Supplemental Pension for this purpose will be lump-sum
amount payable under the SUPPLEMENTAL PENSION - CASH BALANCE ENTITLEMENT SECTION
of this Article, if applicable, or the actuarial present value of the
Supplemental Pension payable under the SUPPLEMENTAL PENSION - FINAL AVERAGE PAY
ENTITLEMENT SECTION of this Article, if applicable, determined using an interest
and mortality assumption deemed reasonable by the Corporate Management
Committee.
SECTION 3.09 -- DISTRIBUTIONS PURSUANT TO A DOMESTIC RELATIONS ORDER.
The Plan permits the benefits actually payable to a Participant to be divided
with a spouse or former spouse of a participant who meets the definition of
alternate payee under ERISA ss. 206(d) provided that the Company determines that
113
the domestic relations order meets the criteria of a qualified domestic
relations order, as defined in ERISA ss. 206(d). A distribution to an alternate
payee is not allowed prior to payment (or commencement) of a benefit to a
Participant, and the Plan will not recognize a domestic relations order that
purports to create a separate interest in the alternate payee. In addition, once
a form of benefit has commenced, the form of measuring life may not be changed.
The Company will establish procedures to determine whether a domestic relations
order meets the criteria of ERISA ss. 206(d). Upon receiving a domestic
relations order, the Company promptly will notify the Participant and an
alternate payee named in the order, in writing, of the receipt of the order and
the Plan's procedures for determining the status of the order. Within a
reasonable period of time after receiving the domestic relations order, the
Company will determine the status of the order and will notify the Participant
and each alternate payee, in writing, of its determination. The Company will
provide notice under this paragraph by mailing to the individual's address
specified in the domestic relations order.
If any portion of the Participant's benefit under this Plan is payable during
the period the Company is making its determination of the status of the domestic
relations order, a separate accounting will be made of the amount payable. If
the Company determines the order is a domestic relations order within the
criteria of ERISA ss. 206(d) within eighteen (18) months of the date amounts are
first payable following receipt of the order, the payable amounts will be
distributed in accordance with the order. If the Company does not make its
determination of the status of the order within the 18 month determination
period, the payable amounts will be distributed in the manner the Plan would
distribute if the order did not exist and the order will apply prospectively if
the Company later determines the order meets the criteria of ERISA ss. 206(d).
The Plan will make payments or distributions required under this section by
separate benefit checks or other separate distribution to the alternate payee(s)
and report the payments accordingly, provided however, that the Company may
report distributions as income to the Participant for federal income tax and/or
Social Security or other withholding purposes as it determines to be consistent
with the requirements of the Code.
ARTICLE IV
VESTING
SECTION 4.01 -- VESTING.
A Participant will be entitled to a Supplemental Pension under this Plan only if
he is has a fully vested and nonforfeitable interest.
SECTION 4.02 -- FORFEITURE.
If a Participant has a Termination of Service before he is Vested, he will
forfeit his Supplemental Pension. If the Participant is subsequently rehired by
the Company or a Participating Controlled Group Member (while it is such) and he
is eligible to have his divested benefits under the Associated Plan reinstated,
his Supplemental Pension also will be reinstated under this Plan (if it then
remains in effect). Otherwise, any forfeiture will be permanent.
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ARTICLE V
DISTRIBUTIONS AFTER DEATH
SECTION 5.01 -- SURVIVOR BENEFITS PRIOR TO PENSION COMMENCEMENT - CASH BALANCE
ENTITLEMENT.
If a Vested Participant who has a Cash Balance Entitlement dies prior to payment
or commencement of his Supplemental Pension, his Beneficiary will be entitled to
a survivor benefit under the Plan in an amount equal to the lump-sum payment
that would have been payable to the Participant under the SUPPLEMENTAL PENSION -
CASH BALANCE ENTITLEMENT SECTION of Article III. This survivor benefit will be
paid as follows:
(a) If the Participant has a Spouse to whom he has been continuously
married throughout the one-year period ending on the date of his death,
and unless the Participant waives this form of payment or waives this
survivor benefit and designates a Beneficiary other than his Spouse in
accordance with the BENEFICIARIES SECTION of this Article, the survivor
benefit will be payable to the Participant's Spouse in the form of a
Single Life Annuity for the life of the Participant's Spouse that is
the Actuarial Equivalent of the lump-sum payment that would have been
payable to the Participant under the SUPPLEMENTAL PENSION - CASH
BALANCE ENTITLEMENT SECTION of Article III.
Actuarial Equivalence for this purpose will be determined using the
following actuarial assumptions: Interest - the average of the
"applicable interest rates" prescribed by the Internal Revenue Service
for purposes of Code ss. 417(e) for September, October and November
preceding the Plan Year in which the survivor benefit starts; Mortality
- the "applicable mortality table" prescribed by the Internal Revenue
Service for purposes of Code ss. 417(e) and currently set forth in
Revenue Ruling 2001-62.
(b) If the Participant does not have a Spouse to whom he has been
continuously married throughout the one-year period ending on the date
of his death , or if the Participant waives the Single Life Annuity
payment form provided under (a) or designates a Beneficiary other than
his Spouse in accordance with the BENEFICIARIES SECTION of this
Article, the survivor benefit will be a lump-sum payment equal to the
lump-sum payment that would have been payable to the Participant under
the SUPPLEMENTAL PENSION - CASH BALANCE ENTITLEMENT SECTION of Article
III.
The survivor benefit will be paid or commence as soon as administratively
practicable after the death of the Participant and the entitlement of the
Beneficiary as been determined.
SECTION 5.02 -- SURVIVOR BENEFITS PRIOR TO PENSION COMMENCEMENT - FINAL AVERAGE
PAY ENTITLEMENT.
If a Vested Participant who has a Final Average Pay Entitlement dies prior to
payment or commencement of his Supplemental Pension, and the Participant is
survived by a Spouse to whom he has been continuously married throughout the
one-year period ending on the date he dies and the Participant does not waive
this survivor benefit (as provided below), such Spouse will be entitled to a
survivor benefit under the Plan as follows:
(a) If the Spouse is entitled to a survivor benefit under the Associated
Plan based on the Participant's Accrued Benefit (Final Average Pay),
the survivor benefit under this Plan will be a monthly amount equal to
A minus B where:
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"A" = The monthly amount that would have been payable to the
Spouse as a survivor benefit under the Associated Plan if the
Participant's Accrued Benefit under the Associated Plan were
equal to his Supplemental Accrued Benefit.
"B" = The monthly amount actually payable to the Spouse as a
survivor benefit under the Associated Plan.
This survivor benefit will be payable in the same form of payment and
at the same time as the survivor benefit being paid to the Participant
under the Associated Plan
(b) If the Spouse is entitled to a survivor benefit under the Associated
Plan based on the Participant's Cash Balance Formula Accrued Benefit,
the survivor benefit under this Plan will be a monthly amount equal to
A minus B where:
"A" = The monthly amount that would have been payable to the
Spouse as a survivor benefit under the Associated Plan based
upon the Participant's Accrued Benefit (Final Average Pay) if
his Accrued Benefit (Final Average Pay) were equal to his
Supplemental Accrued Benefit.
"B" = The monthly amount actually payable to the Spouse as a
survivor benefit under the Associated Plan based upon the
Participant's Cash Balance Formula Accrued Benefit.
This survivor benefit will be payable in the form of a Qualified
Survivor Annuity commencing as of the earliest date such annuity could
commence under the Associated Plan if the survivor benefit under the
Associated Plan were based on the Accrued Benefit (Final Average Pay).
A Participant describe above may waive the survivor benefit described above and
instead elect to have the survivor benefit that is a lump -sum payment equal to
the lump-sum payment that would have been payable to the Participant under the
SUPPLEMENTAL PENSION - CASH BALANCE ENTITLEMENT SECTION of Article III
If a Vested Participant who has a Final Average Pay Entitlement dies prior to
payment or commencement of his Supplemental Pension, and the Participant is not
survived by a Spouse to whom he has been continuously married throughout the
one-year period ending on the date he dies, his Beneficiary will be entitled to
a survivor benefit under the Plan in accordance with the SURVIVOR BENEFITS PRIOR
TO PENSION COMMENCEMENT - CASH BALANCE ENTITLEMENT SECTION of this Article.
SECTION 5.03 -- SURVIVOR BENEFITS AFTER PENSION COMMENCEMENT.
If a Vested Participant elects an annuity with a survivor component as an
optional form of payment and dies after commencement of such annuity, payments
will continue consistent with the form of payment being received by the
Participant. If the annuity elected by the Participant does not have a survivor
component (e.g., a Single Life Annuity), then no survivor benefits are payable
to anyone if the Participant dies after payment or commencement of his
Supplemental Pension.
SECTION 5.04 -- CASH-OUT OF SURVIVOR BENEFITS AT OPTION OF COMMITTEE.
Notwithstanding the above, if survivor benefits are payable in annuity form to a
Beneficiary under the above rules, the Corporate Management Committee may, in
its sole discretion, elect to pay the survivor benefits in a single lump-sum
payment in an amount equal to the present value of the annuity in full
satisfaction of the survivor benefit otherwise payable under the Plan. Present
value for this purpose will be determined using interest and mortality
assumptions deemed reasonable by the Corporate Management Committee.
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SECTION 5.05 -- BENEFICIARIES.
A Participant may designate any person (natural or otherwise, including a trust)
as his Beneficiary to receive the survivor benefit (if any) payable when he
dies, and may change or revoke a designation previously made without the consent
of any Beneficiary.
In the case of a Participant who has a Spouse to whom he has been continuously
married throughout the one-year period ending on the date of his death, such
Spouse will be his Beneficiary unless he has designated a different Beneficiary.
In the case of a Participant who does not have a Spouse to whom he has been
continuously married throughout the one-year period ending on the date of his
death, if a Beneficiary designation is not on file for such Participant, or if
no designated Beneficiary survives the Participant, the Beneficiary will be the
person designated by the Participant under the Associated Plan or, in the
absence of a designation, the default Beneficiary under the Associated Plan. If
the primary Beneficiary designated by a Participant dies prior to complete
distribution of the survivor benefit, the remaining benefit will be paid to any
contingent Beneficiary designated by the Participant, or if there is no
surviving contingent Beneficiary, a lump sum of the remaining benefit will be
paid to the estate of the primary Beneficiary.
A Beneficiary designation must be made on such form and in accordance with such
rules as may be prescribed for this purpose by the Company. A Beneficiary
designation will be effective (and will revoke all prior designations) if it is
received by the Company (or if sent by mail, the post-mark of the mailing is)
prior to the date of death of the Participant
ARTICLE VI
ADMINISTRATION OF PLAN
SECTION 6.01 -- ADMINISTRATION.
The Company is the administrator of the Plan with authority to control and
manage the operation and administration of the Plan and make all decisions and
determinations incident thereto. Action on behalf of the Company as
administrator may be taken by any of the following:
(a) CORPORATE MANAGEMENT COMMITTEE. The Corporate Management Committee of
the Company will be responsible for selecting the Employees who are in
the Eligible Group. This committee shall have authority to make rules
and regulations for the administration of the Plan, and its
interpretations and decisions with regard thereto shall be final and
conclusive.
(b) BENEFIT PLANS INVESTMENT COMMITTEE. The Benefit Plans Investment
Committee of the Company is responsible for all investment matters
relating to the Plan, including the investment of assets that may (but
are not required to be) set aside to hedge liabilities resulting from
the Plan, and actual investment of the rabbi trust asset, including the
selection and monitoring investment providers (including the Trustee)
with respect to the Plan.
The members of the Benefit Plans Investment Committee will be appointed
by the Chief Executive Officer of the Company.
Day-to-day non-discretionary administration of the Plan may be performed by the
Human Resources Department.
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SECTION 6.02 -- CORRECTION OF ERRORS AND DUTY TO REVIEW INFORMATION.
Errors may occur in the operation and administration of the Plan. The Company
reserves the right to cause such equitable adjustments to be made to correct for
such errors as it considers appropriate (including adjustments to Participant or
Beneficiary benefits), which will be final and binding on the Participant or
Beneficiary.
Each Participant and Beneficiary has the duty to promptly review any information
that is provided or made available to the Participant or Beneficiary and that
relates in any way to the operation and administration of the Plan or his
elections under the Plan (for example, to review payroll stubs to make sure a
contribution election is being implemented appropriately, to review benefit
statements to make sure investment elections are being implemented
appropriately, to review summary plan descriptions and prospectuses, etc.) and
to notify the Company of any error made in the operation or administration of
the Plan that affects the Participant or Beneficiary within thirty (30) days of
the date such information is provided or made available to the Participant or
Beneficiary (for example, the date the information is sent by mail or the date
the information is provided or made available electronically). If the
Participant or Beneficiary fails to review any information or fails to notify
the Company of any error within such period of time, he will not be able to
bring any claim seeking relief or damages based on the error. If the Company is
notified of an alleged error within the thirty (30) day time period, the Company
will investigate and either correct the error or notify the Participant or
Beneficiary that it believes that no error occurred. If the Participant or
Beneficiary is not satisfied with the correction (or the decision that no
correction is necessary), he will have sixty (60) days from the date of
notification of the correction (or notification of the decision that no
correction is necessary), to file a formal claim under the claims procedures
under the CLAIMS PROCEDURES SECTION of this Article.
SECTION 6.03 -- CLAIMS PROCEDURES.
If a Participant or Beneficiary does not feel as if he has received full payment
of the benefit due such person under the Plan, the Participant or Beneficiary
may file a written claim with the Company setting forth the nature of the
benefit claimed, the amount thereof, and the basis for claiming entitlement to
such benefit. The Vice President of Human Resources of the Company will
determine the validity of the claim and communicate a decision to the claimant
promptly and, in any event, not later than ninety (90) days after the date of
the claim. The claim may be deemed by the claimant to have been denied for
purposes of further review described below in the event a decision is not
furnished to the claimant within such ninety (90) day period. If additional
information is necessary to make a determination on a claim, the claimant will
be advised of the need for such additional information within forty-five (45)
days after the date of the claim. The claimant will have up to one hundred and
eighty (180) days to supplement the claim information, and the claimant will be
advised of the decision on the claim within forty-five (45) days after the
earlier of the date the supplemental information is supplied or the end of the
one hundred and eighty (180) day period.
A claim for benefits which is denied will be denied by written notice setting
forth in a manner calculated to be understood by the claimant:
(a) The specific reason or reasons for the denial, including a specific
reference to any provisions of the Plan (including any internal rules,
guidelines, protocols, criteria, etc.) on which the denial is based;
(b) A description of any additional material or information that is
necessary to process the claim; and
(c) An explanation of the procedure for further reviewing the denial of the
claim.
118
Within sixty (60) days after the receipt of a denial on a claim, a claimant or
his authorized representative may file a written request for review of such
denial. Such review will be undertaken by the Benefit Plans Administration
Committee and will be a full and fair review. The claimant will have the right
to review all pertinent documents. The Benefit Plans Administration Committee
will issue a decision not later than sixty (60) days after receipt of a request
for review from a claimant unless special circumstances, such as the need to
hold a hearing, require a longer period of time, in which case a decision will
be rendered as soon as possible but not later than one hundred and twenty (120)
days after receipt of the claimant's request for review. The decision on review
will be in writing and will include specific reasons for the decision written in
a manner calculated to be understood by the claimant with specific reference to
any provisions of the Plan on which the decision is based.
SECTION 6.04 -- INDEMNIFICATION.
The Company and the Participating Controlled Group Members jointly and severally
agree to indemnify and hold harmless, to the extent permitted by law, each
director, officer, and employee against any and all liabilities, losses, costs,
or expenses (including legal fees) of whatsoever kind and nature that may be
imposed on, incurred by, or asserted against such person at any time by reason
of such person's services in the administration of the Plan, but only if such
person did not act dishonestly, or in bad faith, or in willful violation of the
law or regulations under which such liability, loss, cost, or expense arises.
SECTION 6.05 -- EXERCISE OF AUTHORITY.
The Company, the Corporate Management Committee, the Benefit Plans
Administration Committee, the Benefit Plans Investment Committee and any other
person or body who has authority with respect to the management, administration
or investment of the Plan may exercise that authority in its/his/her full
discretion. This discretionary authority includes, but is not limited to, the
authority to make any and all factual determinations and interpret all terms and
provisions of this document (or any other document established for use in the
administration of the Plan) relevant to the issue under consideration. The
exercise of authority will be binding upon all persons; and it is intended that
the exercise of authority be given deference in all courts of law to the
greatest extent allowed under law, and that it not be overturned or set aside by
any court of law unless found to be arbitrary and capricious.
SECTION 6.06 -- TELEPHONIC OR ELECTRONIC NOTICES AND TRANSACTIONS.
Any notice that is required to be given under the Plan to a Participant or
Beneficiary, and any action that can be taken under the Plan by a Participant or
Beneficiary, may be by means of voice response or other electronic system to the
extent so authorized by the Company.
ARTICLE VII
CONTRACTUAL OBLIGATIONS AND FUNDING
SECTION 7.01 -- CONTRACTUAL OBLIGATIONS.
The Plan creates a contractual obligation on the part of the Company and each
Participating Controlled Group Member to provide benefits as set forth in the
Plan with respect to: .
(a) Participants who are employed with the Company or a Participating
Controlled Group Member;
119
(b) Participants who were employed with the Company or a Participating
Controlled Group Member prior to Termination of Service; and
(c) Beneficiaries of the Participants described in (a) and (b).
A Participating Controlled Group Member is not responsible for (and has no
contractual obligation with respect to) benefits payable to a Participant who is
or was employed with the Company or another Participating Controlled Group
Member. If a Participant is employed with two or more employers (the Company and
a Participating Controlled Group Member, or two or more Participating Controlled
Group Members, etc.), either concurrently or at different times, each will be
responsible for the benefit attributable to the period of service with that
employer.
The Parent and the Company each will guarantee and assume secondary liability
for the contractual commitment of each Participating Controlled Group Member
under this Section.
SECTION 7.02 -- FUNDING.
The Company has established a "rabbi" trust to serve as a funding vehicle for
benefits payable under the Plan. However, neither the Company nor any
Participating Controlled Group Member is obligated to fund such trust. The rabbi
trust will be invested in the manner directed by the Benefit Plans Investment
Committee.
The establishment and funding of the rabbi trust will not affect the contractual
obligations of the Company and Participating Controlled Group Members, except
that such obligations with respect to any Participant or Beneficiary will be
offset to the extent that payments actually are made from the trust to such
Participant or Beneficiary.
The rabbi trust used to fund benefits payable under this Plan may be used to
fund benefits payable under any other non-qualified deferred compensation plan
maintained by the Company or a Participating Controlled Group Member.
ARTICLE VIII
GENERAL PROVISIONS
SECTION 8.01 -- AMENDMENT AND TERMINATION.
The Board or its delegate may amend or terminate this Plan at any time and for
any reason by resolution of its Corporate Management Committee.
An amendment or termination of the Plan may not have the effect of reducing the
overall benefit attributable to the period prior to amendment or termination and
payable to the Participant under the Associated Plan or this Plan. This will not
prohibit an amendment that reduces or eliminates the benefit accrued and payable
under this Plan and shifts the liability for such benefit to another
non-qualified retirement plan maintained by the Company or to the Associated
Plan.
After termination of the Plan, no additional benefits attributable to periods
after the date of termination will accrue under the Plan for any Participant.
The Supplemental Pension payable to any Participant after the termination of the
Plan will equal the Supplemental Pension determined as if the Participant's
Termination of Employment occurred on the date of termination of the Plan.
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Distribution following termination of the Plan will be made at the same time and
in the same form as otherwise provided for under the Plan prior to such
termination.
SECTION 8.02 -- EMPLOYMENT STATUS.
Nothing contained in this Plan gives an Eligible Employee the right to be
retained in the Company's or Controlled Group Member's employ or to interfere
with the Company's or Controlled Group Member's right to discharge any Eligible
Employee.
SECTION 8.03 -- RIGHTS TO PLAN ASSETS.
Neither the Company nor any Controlled Group Member will have any obligation
whatsoever to set aside funds for the Plan or for the benefit of any Participant
or Beneficiary, and no Participant or Beneficiary will have any rights to any
amounts that may be set aside other than the rights of an unsecured general
creditor of the Company or Controlled Group Member that employs (or employed)
the Participant.
SECTION 8.04 -- NONALIENATION OF BENEFITS.
Benefits payable under the Plan are not subject to the claims of any creditor of
any Participant or Beneficiary. A Participant or Beneficiary does not have any
rights to alienate, anticipate, commute, pledge, encumber or assign any of such
benefits. The preceding sentences will not apply to the creation, assignment, or
recognition of a right to any benefit payable with respect to a Participant
according to a domestic relations order, as defined in ERISA Act Section 206(d),
or any domestic relations order entered before January 1, 1985.
SECTION 8.05 -- CONSTRUCTION.
The validity of the Plan or any of its provisions is determined under and
construed according to Federal law and, to the extent permissible, according to
the laws of the state in which the Company has its principal office. In case any
provision of this Plan is held illegal or invalid for any reason, such
determination will not affect the remaining provisions of this Plan, and the
Plan will be construed and enforced as if the illegal or invalid provision had
never been included.
In the event of any conflict between the provisions of the Plan and the terms of
any contract or policy issued hereunder, the provisions of the Plan control the
operation and administration of the Plan.
SECTION 8.06 -- WORD USAGE.
The masculine gender, where used in this Plan, will include the feminine gender
and the singular words as used in this Plan may include the plural, unless the
context indicates otherwise.
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By executing this Plan, the Company acknowledges having counseled to
the extent necessary with selected legal and tax advisors regarding the Plan's
legal and tax implications.
Executed this 17TH day of December, 2003
PRINCIPAL LIFE INSURANCE COMPANY
By /s/ JIM DEVRIES
---------------------------------------
Vice President - Human Resources
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Exhibit 12
PRINCIPAL FINANCIAL GROUP, INC.
COMPUTATION OF EARNINGS TO FIXED CHARGES RATIO
FOR THE
THREE MONTHS
ENDED FOR THE
MARCH 31, YEAR ENDED DECEMBER 31,
------------------------ ------------------------------------------------------------
2004 2003 2003 2002 2001 2000 1999
------------ ----------- ---------- ------------ ---------- ----------- -------------
($ IN MILLIONS)
1. Income from continuing operations
before income taxes................ $ 265.4 $ 222.2 $ 953.7 $ 665.8 $ 464.1 $ 840.2 $1,066.4
2. Interest expense..................... 27.0 25.4 104.3 99.2 96.7 116.8 145.4
3. Interest factor of rental expense.... 1.3 2.2 5.0 8.9 10.3 16.1 10.5
4. Undistributed income from equity
investees.......................... - (1.1) (18.3) 4.3 (17.4) (27.1) (99.7)
------------ ----------- ---------- ------------ ---------- ----------- -------------
5. Earnings before interest credited on
investment products................ 293.7 248.7 1,044.7 778.2 553.7 946.0 1,122.6
6. Interest credited on investment
products........................... 179.7 178.8 735.7 743.4 773.1 723.5 709.5
------------ ----------- ---------- ------------ ---------- ----------- -------------
7. Earnings............................. $ 473.4 $ 427.5 $1,780.4 $ 1,521.6 $1,326.8 $1,669.5 $1,832.1
============ =========== ========== ============ ========== =========== =============
8. Interest expense..................... $ 27.0 $ 25.4 $ 104.3 $ 99.2 96.7 $ 116.8 $ 145.4
9. Interest factor of rental expense.... 1.3 2.2 5.0 8.9 10.3 16.1 10.5
10. Preferred stock dividend
requirements of majority-owned
subsidiaries (non-intercompany).... 0.2 0.7 1.2 0.4 - - -
------------ ----------- ---------- ------------ ---------- ----------- -------------
11. Fixed charges before interest
credited on investment products.... 28.5 28.3 110.5 108.5 107.0 132.9 155.9
12. Interest credited on investment
products........................... 179.7 178.8 735.7 743.4 773.1 723.5 709.5
------------ ----------- ---------- ------------ ---------- ----------- -------------
13. Fixed charges........................ $ 208.2 $ 207.1 $ 846.2 $ 851.9 $ 880.1 $ 856.4 $ 865.4
============ =========== ========== ============ ========== =========== =============
14. Ratio of earnings to fixed charges
before interest credited on
investment products
(Line item 5/Line item 11)......... 10.3 8.8 9.5 7.2 5.2 7.1 7.2
15. Ratio of earnings to fixed charges
(Line item 7/Line item 13)......... 2.3 2.1 2.1 1.8 1.5 1.9 2.1
123
Exhibit 31.1
CERTIFICATIONS
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 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 5, 2004 /S/ J. BARRY GRISWELL
-----------------------------------------
J. Barry Griswell
Chairman, President and Chief Executive
Officer
124
Exhibit 31.2
CERTIFICATIONS
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 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 5, 2004
/S/ MICHAEL H. GERSIE
-----------------------------------------
Michael H. Gersie
Executive Vice President and Chief
Financial Officer
125
Exhibit 32.1
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, 2004 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, 2004 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 5, 2004
126
Exhibit 32.2
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, 2004 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, 2004 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 5, 2004
127