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, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 42-1520346
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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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)
------------------
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 |_|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding as of May 6, 2002, was 358,607,981.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at March 31, 2002
(Unaudited) and December 31, 2001............................... 3
Unaudited Consolidated Statements of Operations for the three
months ended March 31, 2002 and 2001............................ 4
Unaudited Consolidated Statements of Stockholders' Equity for
the three months ended March 31, 2002 and 2001.................. 5
Unaudited Consolidated Statements of Cash Flows for the three
months ended March 31, 2002 and 2001............................ 6
Notes to Unaudited Consolidated Financial Statements -
March 31, 2002.................................................. 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk.... 63
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................. 68
Item 6. Exhibits and Reports on Form 8-K.............................. 69
Signature............................................................. 70
2
PART I - FINANCIAL INFORMATION
ITEM . FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
MARCH 31, DECEMBER 31,
2002 2001
------------------ ------------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale................................ $30,841.9 $30,012.3
Fixed maturities, trading........................................... 30.8 17.8
Equity securities, available-for-sale............................... 899.7 833.6
Mortgage loans...................................................... 10,899.3 11,065.7
Real estate......................................................... 1,264.0 1,181.8
Policy loans........................................................ 823.2 831.9
Other investments................................................... 692.2 829.8
------------------ ------------------
Total investments............................................... 45,451.1 44,772.9
Cash and cash equivalents........................................... 557.5 623.8
Accrued investment income........................................... 584.3 594.3
Premiums due and other receivables.................................. 494.7 531.3
Deferred policy acquisition costs................................... 1,463.2 1,372.5
Property and equipment.............................................. 515.6 518.2
Goodwill............................................................ 151.7 439.2
Other intangibles................................................... 700.5 789.2
Mortgage loan servicing rights...................................... 1,984.6 1,779.2
Separate account assets............................................. 35,876.8 35,864.8
Other assets........................................................ 978.7 1,065.1
------------------ ------------------
Total assets..................................................... $88,758.7 $88,350.5
================== ==================
LIABILITIES
Contractholder funds................................................ $25,115.6 $24,684.4
Future policy benefits and claims................................... 14,116.6 14,034.6
Other policyholder funds............................................ 603.7 589.1
Short-term debt..................................................... 693.2 511.6
Long-term debt...................................................... 1,343.5 1,378.4
Income taxes currently payable...................................... 0.4 0.5
Deferred income taxes............................................... 757.2 894.6
Separate account liabilities........................................ 35,876.8 35,864.8
Other liabilities................................................... 3,653.7 3,572.2
------------------ ------------------
Total liabilities................................................ 82,160.7 81,530.2
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500 million shares
authorized, 376.2 million shares issued, 359.7 million
shares outstanding............................................... 3.8 3.8
Additional paid-in capital.......................................... 7,083.5 7,072.5
Retained-earnings deficit........................................... (64.0) (29.1)
Accumulated other comprehensive income (loss)....................... (27.6) 147.5
Treasury stock, at cost (16.5 million shares)....................... (397.7) (374.4)
------------------ ------------------
Total stockholders' equity...................................... 6,598.0 6,820.3
------------------ ------------------
Total liabilities and stockholders' equity...................... $88,758.7 $88,350.5
================== ==================
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------------------
2002 2001
------------------ -----------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
REVENUES
Premiums and other considerations.............. $885.7 $1,064.2
Fees and other revenues........................ 476.0 413.0
Net investment income.......................... 813.2 839.7
Net realized capital gains (losses)............ 98.1 (80.9)
------------------ ------------------
Total revenues............................. 2,273.0 2,236.0
EXPENSES
Benefits, claims, and settlement expenses...... 1,203.2 1,391.9
Dividends to policyholders..................... 82.4 81.0
Operating expenses............................. 630.8 622.7
------------------ ------------------
Total expenses............................. 1,916.4 2,095.6
------------------ ------------------
Income before income taxes and cumulative
effect of accounting changes .............. 356.6 140.4
Income taxes................................... 110.6 24.4
------------------ ------------------
Income before cumulative effect of accounting 246.0 116.0
changes ...................................
Cumulative effect of accounting changes, net
of related income taxes.................... (280.9) (10.7)
------------------ ------------------
Net income (loss).............................. $(34.9) $ 105.3
================== ==================
FOR THE THREE MONTHS
ENDED MARCH 31, 2002
---------------------
EARNINGS PER COMMON SHARE
Basic earnings per common share:
Income before cumulative effect of accounting
change..................................... $0.68
Cumulative effect of accounting change,
net of related income taxes................ (0.78)
---------------------
Net loss..................................... $(0.10)
=====================
Diluted earnings per common share:
Income before cumulative effect of accounting
change..................................... $0.68
Cumulative effect of accounting change,
net of related income taxes................ (0.78)
---------------------
Net loss..................................... $(0.10)
=====================
SEE ACCOMPANYING NOTES.
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
ADDITIONAL RETAINED OTHER TOTAL
COMMON PAID-IN EARNINGS COMPREHENSIVE TREASURY STOCKHOLDERS' OUTSTANDING
STOCK CAPITAL (DEFICIT) INCOME (LOSS) STOCK EQUITY SHARES
------ ---------- --------- ------------- -------- ------------- --------------
(IN MILLIONS) (IN THOUSANDS)
BALANCES AT JANUARY 1, 2001............ $ - $ - $6,312.5 $ (60.0) $ - $ 6,252.5 -
Comprehensive income:
Net income.......................... - - 105.3 - - 105.3 -
Net unrealized gains................ - - - 301.3 - 301.3 -
Provision for deferred income taxes. - - - (108.2) - (108.2) -
Foreign currency translation
adjustment........................ - - - (95.9) - (95.9) -
Cumulative effect of
accounting change, net of
related income taxes.............. - - - (14.2) - (14.2) -
-------------
Comprehensive income................... 188.3
------ ---------- --------- ------------- -------- ------------- --------------
BALANCES AT MARCH 31, 2001............. $ - $ - $6,417.8 $ 23.0 $ - $ 6,440.8 -
====== ========== ========= ============= ======== ============= ==============
BALANCES AT JANUARY 1, 2002............ $3.8 $7,072.5 $ (29.1) $ 147.5 $(374.4) $ 6,820.3 360,142.2
Stock issued........................... - 9.7 - - - 9.7 320.4
Treasury stock acquired and
reissued, net....................... - 1.3 - - (23.3) (22.0) (801.4)
Comprehensive loss:
Net loss............................ - - (34.9) - - (34.9) -
Net unrealized losses............... - - - (288.9) - (288.9) -
Provision for deferred income
tax benefit....................... - - - 102.3 - 102.3 -
Foreign currency translation
adjustment........................ - - - 11.5 - 11.5 -
-------------
Comprehensive loss..................... (210.0)
------ ---------- --------- ------------- -------- ------------- --------------
BALANCES AT MARCH 31, 2002............. $3.8 $7,083.5 $ (64.0) $ (27.6) $(397.7) $ 6,598.0 359,661.2
====== ========== ========= ============= ======== ============= ==============
SEE ACCOMPANYING NOTES.
5
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
----------------------------------
2002 2001
----------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income (loss)..................................... $ (34.9) $ 105.3
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Cumulative effect of accounting changes,
net of related income taxes.................... 280.9 10.7
Amortization of deferred policy acquisition
costs.......................................... 23.0 68.3
Additions to deferred policy acquisition costs... (81.9) (70.9)
Accrued investment income........................ 10.0 11.6
Premiums due and other receivables............... 58.1 2.8
Contractholder and policyholder liabilities
and dividends.................................. 322.0 238.7
Current and deferred income taxes................ 96.5 36.3
Net realized capital (gains) losses.............. (98.1) 80.9
Depreciation and amortization expense............ 27.1 38.3
Amortization and impairment/recovery of
mortgage servicing rights..................... 83.4 52.9
Other............................................ (201.1) 107.4
----------------- ----------------
Net adjustments....................................... 519.9 577.0
----------------- ----------------
Net cash provided by operating activities............. 485.0 682.3
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases.......................................... (3,841.2) (4,470.0)
Sales............................................. 1,627.4 1,809.6
Maturities........................................ 1,140.1 710.0
Net cash flows from trading securities................ (14.1) -
Mortgage loans acquired or originated................. (10,615.0) (5,592.2)
Mortgage loans sold or repaid......................... 10,777.0 5,715.6
Purchase of mortgage servicing rights................. (252.7) (117.8)
Proceeds from sale of mortgage servicing rights....... 1.6 23.3
Real estate acquired.................................. (108.5) (99.1)
Real estate sold...................................... 25.2 329.4
Net change in property and equipment.................. (15.9) (11.5)
Net disbursements from sales of subsidiaries.......... - (13.5)
Purchases of interest in subsidiaries, net of cash
acquired........................................... - (4.2)
Net change in other investments....................... 387.3 (44.0)
----------------- ----------------
Net cash used in investing activities................. (888.8) (1,764.4)
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------
2002 2001
----------- ----------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock............................ $ 11.0 $ -
Acquisition and reissuance of treasury stock, net... (23.3) -
Issuance of long-term debt.......................... 7.9 27.8
Principal repayments of long-term debt.............. (42.8) (70.1)
Proceeds of short-term borrowings................... 1,556.6 2,005.6
Repayment of short-term borrowings.................. (1,375.0) (1,914.9)
Investment contract deposits........................ 1,913.2 1,844.2
Investment contract withdrawals..................... (1,710.1) (1,211.5)
----------- ----------
Net cash provided by financing activities........... 337.5 681.1
----------- ----------
Net decrease in cash and cash equivalents........... (66.3) (401.0)
Cash and cash equivalents at beginning of year...... 623.8 926.6
----------- ----------
Cash and cash equivalents at end of year............ $ 557.5 $ 525.6
=========== ==========
SEE ACCOMPANYING NOTES.
7
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Principal
Financial Group, Inc. and its majority-owned subsidiaries ("the Company") 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 month
period ended March 31, 2002, are not necessarily indicative of the results that
may be expected for the year ended December 31, 2002. These interim unaudited
consolidated financial statements should be read in conjunction with the
Company's annual audited financial statements as of December 31, 2001, included
in the Company's Form 10-K for the year ended December 31, 2001, filed with the
United States Securities and Exchange Commission. The accompanying consolidated
statement of financial position at December 31, 2001, has been derived from the
audited consolidated statement of financial position but does not include all of
the information and footnotes required by U.S. GAAP for complete financial
statements.
Reclassifications have been made to the December 31, 2001, and March 31, 2001,
financial statements to conform to the March 31, 2002, presentation.
SEPARATE ACCOUNTS
At March 31, 2002, the Separate Accounts included a separate account valued at
$1.1 billion which primarily included shares of the Company's stock that were
allocated and issued to eligible participants of qualified employee benefit
plans administered by the Company as part of the policy credits issued under the
Company's demutualization. These shares are included in both basic and diluted
earnings per share calculations. The separate account shares are recorded at
fair value and are reported as separate account assets and separate account
liabilities in the consolidated statement of financial position. Activity of the
separate account shares is reflected in both the separate account assets and
separate account liabilities and does not impact the Company's results of
operations.
ACCOUNTING CHANGES
In June 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, BUSINESS
COMBINATIONS ("SFAS 141"), and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE
ASSETS ("SFAS 142"). SFAS 141 requires that the purchase method of accounting be
used for all business combinations initiated after June 30, 2001. SFAS 141 also
includes guidance on the initial recognition and measurement of goodwill and
other intangible assets arising from business combinations completed after June
30, 2001. SFAS 142, effective January 1, 2002, prohibits the amortization of
goodwill and intangible assets with indefinite useful lives. Intangible assets
with finite useful lives will continue to be amortized over their estimated
useful lives. Additionally, SFAS 142 requires that goodwill and indefinite-lived
intangible assets be reviewed for impairment at least annually. This includes a
more stringent impairment test methodology for measuring and recognizing
impairment losses.
During the fourth quarter of 2001, each operating segment of the Company
completed initial valuations of goodwill and intangible assets, as set forth in
the guidelines of SFAS 142. The valuation was performed using discounted cash
flow methodologies and applying a series of variable parameters and assumptions
to deliver operating cash flow projections. Due to changes in funds under
management, business conditions and economic outlook, the Company recognized an
after-tax impairment amount of $280.9 million upon the adoption of SFAS 142 on
January 1, 2002.
8
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
This impairment, which has been recognized in the Company's first quarter 2002
consolidated financial statements as a cumulative effect of a change in
accounting principle, was reported in the Company's operating segments as
follows (in millions):
INTERNATIONAL
ASSET
MANAGEMENT
AND LIFE
ACCUMULATION AND HEALTH
SEGMENT SEGMENT CONSOLIDATED
------------- ---------- ------------
Goodwill................................ $298.9 $4.6 $303.5
Other intangibles....................... 112.1 - 112.1
Income tax impact....................... (134.7) - (134.7)
------------- ---------- ------------
Total impairment, net of income taxes... $276.3 $4.6 $280.9
============= ========== ============
Net income (loss) and earnings per share (basic and diluted) for the three
months ended March 31, 2002 and 2001, adjusted for the effects of SFAS 142
related to non-amortization of goodwill and indefinite-lived intangibles as if
adoption had occurred on January 1, 2001, is as follows (in millions, except per
share data):
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------
2002 2001(1)
----------- -------------
Net income (loss).......................... $(34.9) $105.3
Adjust for amortization expense:
Goodwill................................ - 9.8
Brand name and management rights........ - 4.5
Assembled workforce .................... - 1.0
----------- --------------
Total amortization expense ................ - 15.3
Tax impacts of amortization expense ....... - (3.4)
----------- --------------
Adjusted net income (loss)................. $(34.9) $117.2
=========== ==============
Basic earnings per share:
Net income (loss).......................... $ (0.10) $ 0.29
Adjust for amortization expense:
Goodwill ................................ - 0.03
Brand name and management rights ........ - 0.01
Assembled workforce ..................... - -
----------- -------------
Total amortization expense ................ - 0.04
Tax impacts of amortization expense ....... - (0.01)
----------- -------------
Adjusted net income (loss)................. $ (0.10) $ 0.32
=========== =============
Diluted earnings per share:
Net income (loss).......................... $ (0.10) $ 0.29
Adjust for amortization expense:
Goodwill ................................ - 0.03
Brand name and management rights ........ - 0.01
Assembled workforce ..................... - -
----------- -------------
Total amortization expense ................ - 0.04
Tax impacts of amortization expense ....... - (0.01)
----------- -------------
Adjusted net income (loss)................. $ (0.10) $ 0.32
=========== =============
- ------
9
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(1) For purposes of the Company's unaudited basic and diluted pro-forma earnings
per share calculations, the weighted average number of shares outstanding during
the three months ended March 31, 2001, was assumed to be 360.8 million shares.
These shares represent 260.8 million shares issued to policyholders entitled to
receive compensation in the demutualization and 100.0 million shares sold to
investors in the initial public offering ("IPO"), effective October 26, 2001.
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS ("SFAS 144"). This Statement supersedes SFAS No.
121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF, and amends Accounting Principles Board ("APB") Opinion
No. 30, REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL
OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY
OCCURRING EVENTS AND TRANSACTIONS ("Opinion 30"), establishing a single
accounting model for the disposal of long-lived assets. SFAS 144 generally
retains the basic provisions of existing guidance, but broadens the presentation
of any discontinued operations to include a component of an entity (rather than
a segment of a business as defined in Opinion 30). The Company adopted SFAS 144
on January 1, 2002, which did not have a significant impact on the Company's
consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"). In June 1999, SFAS No. 137,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - DEFERRAL OF THE
EFFECTIVE DATE OF FASB STATEMENT NO. 133 was issued deferring the effective date
of SFAS 133 by one year, to fiscal years beginning after June 15, 2000. In June
2000, the FASB issued SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE
INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES - AN AMENDMENT OF FASB STATEMENT NO.
133, which amended the accounting and reporting standards of SFAS 133 for
certain derivative instruments and certain hedging activities.
As amended, SFAS 133 requires, among other things, that all derivatives be
recognized in the consolidated statement of financial position as either assets
or liabilities that are measured at fair value. SFAS 133 also established
special accounting for qualifying hedges, which allows for matching the timing
of gain or loss recognition on the hedging instrument with the recognition of
the corresponding changes in value of the hedged item. Changes in the fair value
of a derivative qualifying as a hedge are recognized in earnings or directly in
stockholders' equity depending on the instrument's intended use. For derivatives
that are not designated as hedges or that do not meet the hedge accounting
criteria in SFAS 133, changes in fair value are required to be recognized in
earnings in the period of change.
At January 1, 2001, the Company's consolidated financial statements were
adjusted to record a cumulative effect of adopting SFAS 133, as follows (in
millions):
ACCUMULATED OTHER
NET LOSS COMPREHENSIVE LOSS
-------- ------------------
Adjustment to fair value of derivative
contracts (1)............................ $(16.4) $(15.8)
Income tax impact.......................... 5.7 1.6
-------- ------------------
Total ..................................... $(10.7) $(14.2)
======== ==================
- ------------------
(1) Amount presented is net of adjustment to hedged item.
10
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
2. GOODWILL AND OTHER INTANGIBLE ASSETS
Other intangible assets are as follows (in millions):
AS OF AS OF
MARCH 31, 2002 DECEMBER 31, 2001
---------------------- ----------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
Amortized intangible assets:
Value of insurance in force acquired... $83.8 $10.2 $83.7 $10.2
======== ============ ======== ============
AS OF MARCH 31, AS OF DECEMBER 31,
2002 2001
--------------- -------------------
NET CARRYING NET CARRYING
AMOUNT AMOUNT
--------------- -------------------
Unamortized intangible assets:
Brand name and management rights .... $613.3 $679.0
Assembled work force ................ - 22.3
Other ............................... 13.6 14.4
--------------- --------------------
Total ............................... $626.9 $715.7
=============== ====================
The amortization expense for the value of insurance in force acquired for the
three months ended March 31, 2002 and 2001, is $0.9 million and $1.0 million,
respectively. At December 31, 2001, the estimated amortization expense for the
next five years is as follows (in millions):
Estimated
Amortization Expense
----------------------
2002............... $4.2
2003................ 3.7
2004................ 3.6
2005................ 3.6
2006................ 3.6
The changes in the carrying amount of goodwill for the three months ended March
31, 2002, are as follows (in millions):
INTERNATIONAL
U.S. ASSET ASSET LIFE
MANAGEMENT MANAGEMENT AND
AND AND HEALTH MORTGAGE CORPORATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
------------ ------------- ----------- ---------- ------------- ------------
Balance at January 1, 2002 $16.1 $380.1 $49.3 $8.4 $(14.8) $439.1
Goodwill disposed of
during the period...... - - - - 14.8 14.8
Cumulative effect of
accounting change....... - (298.9) (4.6) - - (303.5)
Foreign currency
translation............ - 1.3 - - - 1.3
------------ ------------- ----------- ---------- ------------- ------------
Balance at March 31, 2002 $16.1 $ 82.5 $44.7 $8.4 $ - $151.7
============ ============= =========== ========== ============= ============
11
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
3. MERGERS, ACQUISITIONS, AND DIVESTITURES
DIVESTITURES
On February 1, 2002, the Company sold its remaining stake of 15.1 million shares
in Coventry Health Care, Inc. ("Coventry") common stock and a warrant,
exercisable for 3.1 million shares of Coventry common stock. Total proceeds from
the completion of this transaction were $325.2 million and the Company
recognized a net realized capital gain of $182.8 million.
4. CLOSED BLOCK
In connection with its 1998 mutual insurance holding company formation,
Principal Life Insurance Company ("Principal Life") formed and began operating a
closed block ("Closed Block") for the benefit of individual participating
dividend-paying policies in force on that date. As of March 31, 2002, cumulative
actual earnings, including consideration of net unrealized gains, has been less
than cumulative expected earnings. Therefore, no policyholder dividend
obligation has been recognized.
Closed Block liabilities and assets designated to the Closed Block are as
follows:
AS OF MARCH 31, AS OF DECEMBER 31,
2002 2001
--------------- ------------------
(IN MILLIONS)
CLOSED BLOCK LIABILITIES
Future policy benefits and claims................. $5,240.9 $5,248.7
Other policyholder funds.......................... 22.6 20.3
Policyholder dividends payable.................... 389.4 376.6
Other liabilities................................. 56.0 11.8
--------------- ------------------
Total Closed Block liabilities.................. 5,708.9 5,657.4
ASSETS DESIGNATED TO THE CLOSED BLOCK
Fixed maturities, available-for-sale.............. 2,533.6 2,466.3
Equity securities, available-for-sale............. 23.4 23.4
Mortgage loans.................................... 887.1 880.0
Real estate....................................... - -
Policy loans...................................... 782.6 792.5
Other investments................................. 10.6 6.9
--------------- ------------------
Total investments............................... 4,237.3 4,169.1
Cash and cash equivalents (deficit)............... (29.0) (8.0)
Accrued investment income......................... 75.9 77.2
Deferred tax asset................................ 86.3 80.8
Premiums due and other receivables................ 34.5 33.3
--------------- ------------------
Total assets designated to the Closed Block..... 4,405.0 4,352.4
--------------- ------------------
Excess of Closed Block liabilities over assets
designated to the Closed Block.................. 1,303.9 1,305.0
Amounts included in other comprehensive
income.......................................... 28.9 43.6
--------------- ------------------
Maximum future earnings to be recognized from
Closed Block assets and liabilities............. $1,332.8 $1,348.6
=============== ==================
12
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
4. CLOSED BLOCK (CONTINUED)
Closed Block revenues and expenses were as follows:
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------
2002 2001
----------- -----------
(IN MILLIONS)
REVENUES
Premiums and other considerations................... $178.8 $187.2
Net investment income............................... 79.4 76.9
Net realized capital gains (losses) ................ (6.7) 0.7
----------- -----------
Total revenues.................................... 251.5 264.8
EXPENSES
Benefits, claims, and settlement expenses........... 145.0 157.7
Dividends to policyholders.......................... 77.7 78.0
Operating expenses.................................. 3.0 3.1
----------- -----------
Total expenses.................................... 225.7 238.8
----------- -----------
Closed Block revenue, net of Closed Block expenses,
before income taxes............................... 25.8 26.0
Income taxes........................................ 8.5 8.5
----------- -----------
Closed Block revenue, net of Closed Block expenses
and income taxes.................................. 17.3 17.5
Funding adjustment charges.......................... (1.5) (1.8)
----------- -----------
Closed Block revenue, net of Closed Block expenses,
income taxes and funding adjustment charges....... $ 15.8 $ 15.7
=========== ===========
The change in maximum future earnings of the Closed Block was as follows:
AS OF OR FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------------------
2002 2001
------------- -------------
(IN MILLIONS)
Beginning of year..................... $1,348.6 $1,408.8
End of period......................... 1,332.8 1,393.1
------------- -------------
Change in maximum future earnings.... $ (15.8) $ (15.7)
============= =============
Principal Life charges the Closed Block with federal income taxes, payroll
taxes, state and local premium taxes and other state or local taxes, licenses
and fees as provided in the plan of reorganization.
13
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
5. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
FOR THE THREE
MONTHS ENDED
MARCH 31,
------------------
2002 2001
-------- --------
(IN MILLIONS)
COMPREHENSIVE INCOME (LOSS):
Net income (loss).......................................... $ (34.9) $105.3
Net change in unrealized gains and losses on fixed
maturities, available-for-sale.......................... (359.6) 387.1
Net change in unrealized gains and losses on equity
securities, available-for-sale, including seed money
in separate accounts.................................... 19.4 (13.3)
Adjustments for assumed changes in amortization patterns:
Deferred policy acquisition costs....................... 41.5 (67.1)
Unearned revenue reserves............................... (2.8) 5.2
Net change in unrealized gains and losses on derivative
instruments............................................. 12.6 (10.6)
Provision for deferred income taxes (benefits)............. 102.3 (108.2)
Change in net foreign currency translation adjustment...... 11.5 (95.9)
Cumulative effect of accounting change, net of related
income taxes............................................ - (14.2)
-------- --------
Comprehensive income (loss)................................ $(210.0) $188.3
======== ========
6. SEGMENT INFORMATION
The Company provides financial products and services through the following
segments: U.S. Asset Management and Accumulation, International Asset Management
and Accumulation, Life and Health Insurance and Mortgage Banking. In addition,
there is a Corporate and Other segment. The segments are managed and reported
separately because they provide different products and services, have different
strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and
related financial products and services primarily to businesses, their employees
and other individuals and provides asset management services to the Company's
asset accumulation business, the life and health insurance operations and
third-party clients.
The International Asset Management and Accumulation segment provides asset
management products and services to retail clients in Australia and
institutional clients throughout the world and provides life insurance and
retirement and related financial products and services primarily to businesses,
their employees and other individuals principally in Australia, Chile, Brazil,
New Zealand, Mexico, India, Japan, Argentina and Hong Kong.
The Life and Health insurance segment provides individual life and disability
insurance to the owners and employees of businesses and other individuals in the
U.S. and provides group life and health insurance to businesses in the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers primarily in the U.S.
14
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
6. SEGMENT INFORMATION (CONTINUED)
The Corporate and Other segment manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate and
Other segment primarily reflect financing activities for the Company, income on
capital not allocated to other segments, intersegment eliminations and
non-recurring or other income or expenses not allocated to the segments based on
review of the nature of such items.
The Corporate and Other segment includes an equity ownership interest in
Coventry. The ownership interest was sold on February 1, 2002, described further
in Note 3. The Corporate and Other segment's equity in earnings of Coventry,
which was included in net investment income, was $2.1 million and $4.9 million
for the three months ended March 31, 2002 and 2001, respectively.
The Company evaluates segment performance on segment operating earnings, which
is determined by adjusting U.S. GAAP net income for net realized capital gains
and losses, as adjusted, and non-recurring items which management believes are
not indicative of overall operating trends. Net realized capital gains, as
adjusted, are net of tax, related changes in the amortization pattern of
deferred policy acquisition costs, recognition of front-end fee revenues for
sales charges on pension products and services, net realized capital gains
credited to customers and certain market value adjustments to fee revenues.
Segment operating revenues exclude net realized capital gains and their impact
on recognition of front-end fee revenues. While these items may be significant
components in understanding and assessing the consolidated financial
performance, management believes the presentation of segment operating earnings
enhances the understanding of the Company's results of operations by
highlighting earnings attributable to the normal, recurring operations of the
business. However, segment operating earnings are not a substitute for net
income determined in accordance with U.S. GAAP.
For the three months ended March 31, 2002, the Company excluded $282.9 million
of non-recurring items, net of income taxes, including the negative effects of:
(1) a cumulative effect of accounting change related to the implementation of
SFAS 142 ($280.9 million); and (2) expenses related to the demutualization ($2.0
million).
For the three months ended March 31, 2001, the Company excluded $20.5 million of
non-recurring items, net of income taxes, including the negative effects of: (1)
a cumulative effect of accounting change related to the implementation of SFAS
133 ($10.7 million); (2) an increase in the loss contingency reserve established
for sales practices litigation ($5.9 million); and (3) expenses related to
demutualization ($3.9 million).
The accounting policies of the segments are similar to those of the Company,
with the exception of capital allocation. The Company allocates capital to its
segments based upon an internal capital model that allows management to more
effectively manage the Company's capital.
15
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
6. SEGMENT INFORMATION (CONTINUED)
The following table summarizes selected financial information by segment as of,
or for the three months ended, March 31, 2002 and 2001, and reconciles segment
totals to those reported in the consolidated financial statements (in millions):
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
------------ ------------- ---------- ---------- ------------- ------------
2002
Revenues:
Operating revenues..... $ 862.1 $ 121.1 $ 978.5 $ 208.7 $ 10.5 $ 2,180.9
Net realized capital
gains (losses)....... (73.2) 7.3 (16.8) - 180.8 98.1
Plus recognition of
front-end fee
revenues............. 2.6 - - - - 2.6
Less capital gains
distributed as
market value
adjustment........... (8.6) - - - - (8.6)
------------ ------------- ---------- ---------- ------------- ------------
Revenues................. $ 782.9 $ 128.4 $ 961.7 $ 208.7 $ 191.3 $ 2,273.0
============ ============= ========== ========== ============= ============
Net income:
Operating earnings..... $ 100.2 $ 5.2 $ 54.3 $ 26.5 $ 0.3 $ 186.5
Net realized capital
gains (losses), as
adjusted............. (44.8) 3.8 (10.5) - 113.0 61.5
Non-recurring items.... - (276.3) (4.6) - (2.0) (282.9)
------------ ------------- ---------- ---------- ------------- ------------
Net income (loss)........ $ 55.4 $ (267.3) $ 39.2 $ 26.5 $ 111.3 $ (34.9)
============ ============= ========== ========== ============= ============
Assets................... $68,738.6 $ 4,677.7 $10,939.1 $2,897.3 $1,506.0 $ 88,758.7
============ ============= ========== ========== ============= ============
Other segment data:
Revenues from external
customers............ $ 768.3 $ 128.0 $ 963.2 $ 208.7 $ 204.8 $ 2,273.0
Intersegment revenues.. 14.6 0.4 (1.5) - (13.5) -
Interest expense....... 1.3 0.2 0.2 - 20.8 22.5
Income tax expense..... 2.7 5.3 22.6 15.6 64.4 110.6
Amortization of
intangibles.......... - 0.9 - - - 0.9
16
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
6. SEGMENT INFORMATION (CONTINUED)
INTERNATIONAL
U.S. ASSET ASSET
MANAGEMENT MANAGEMENT LIFE AND
AND AND HEALTH MORTGAGE CORPORATE AND
ACCUMULATION ACCUMULATION INSURANCE BANKING OTHER CONSOLIDATED
------------ ------------- ---------- ---------- ------------- ------------
2001
Revenues:
Operating revenues...... $ 1,015.7 $ 144.4 $ 1,002.4 $ 119.6 $ 35.0 $ 2,317.1
Net realized capital
losses................ (11.9) (37.7) (1.3) - (30.0) (80.9)
Less recognition of
front-end fee
revenues.............. (0.2) - - - - (0.2)
------------ ------------- ---------- ---------- ------------- ------------
Revenues.................. $ 1,003.6 $ 106.7 $ 1,001.1 $ 119.6 $ 5.0 $ 2,236.0
============ ============= ========== ========== ============= ============
Net income:
Operating earnings
(loss)................ $ 88.8 $ (5.3) $ 42.5 $ 23.9 $ 23.8 $ 173.7
Net realized capital
losses, as adjusted... (7.4) (20.3) (0.6) - (19.6) (47.9)
Non-recurring items..... (10.8) - 0.1 - (9.8) (20.5)
------------ ------------- ---------- ---------- ------------- ------------
Net income (loss)......... $ 70.6 $ (25.6) $ 42.0 $ 23.9 $ (5.6) $ 105.3
============ ============= ========== ========== ============= ============
Assets.................... $64,144.6 $4,928.1 $10,566.0 $1,915.2 $1,017.9 $82,571.8
============ ============= ========== ========== ============= ============
Other segment data:
Revenues from external
customers............. $ 978.2 $ 106.4 $ 1,001.7 $ 117.8 $ 31.9 $ 2,236.0
Intersegment revenues... 25.4 0.3 (0.6) 1.8 (26.9) -
Interest expense........ 1.3 - 2.2 - 17.2 20.7
Income tax expense
(benefit)............. 16.4 (18.8) 21.2 12.8 (7.2) 24.4
Amortization of
goodwill and other
intangibles........... 0.3 15.2 0.9 0.2 (0.3) 16.3
The Company operates in the U.S. and in selected markets internationally
(including Australia, Chile, Brazil, New Zealand, Mexico, India, Japan,
Argentina and Hong Kong). The following table summarizes selected financial
information by geographic location as of or for the three months ended March 31,
2002 and 2001 (in millions):
LONG-LIVED NET INCOME
REVENUES ASSETS ASSETS (LOSS)
---------- ------------ ---------- ----------
2002
U.S.............. $2,144.6 $ 562.4 $84,081.0 $232.4
International.... 128.4 805.4 4,677.7 (267.3)
---------- ------------ ---------- ----------
Total............ $2,273.0 $1,367.8 $88,758.7 $(34.9)
========== ============ ========== ==========
2001
U.S.............. $2,129.3 $ 520.1 $77,643.7 $130.9
International.... 106.7 1,206.3 4,928.1 (25.6)
---------- ------------ ---------- ----------
Total............ $2,236.0 $1,726.4 $82,571.8 $105.3
========== ============ ========== ==========
Long-lived assets include property and equipment and goodwill and other
intangibles.
The Company's operations are not materially dependent on one or a few customers,
brokers or agents, and revenues, assets and operating earnings are attributed to
geographic location based on the country of domicile the sales originate from.
17
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
7. STOCKHOLDERS' EQUITY
COMMON STOCK
On February 26, 2002, the Company's board of directors authorized the repurchase
of up to $450.0 million of the Company's common stock. The repurchases will be
made in the open market or through privately negotiated transactions from time
to time, depending on market conditions. As part of the repurchase program, the
Company sold "put options" for a premium of $3.6 million, which obligates the
Company to repurchase a total of 3.0 million shares at an aggregate cost of
$76.9 million three months after the issuance of the contracts, if the fixed
price is higher than the market price. If the fixed price is lower than the
market price on those dates, then the options expire and there is no obligation
for the Company to repurchase its common stock. The proceeds from the put
transactions were reported as additional paid-in capital. During the three
months ended March 31, 2002, the Company purchased 1.2 million shares in the
open market at an aggregate cost of $29.6 million.
In addition, the Company reissued treasury stock held in the rabbi trust during
the three months ended March 31, 2002. The reissuance generated proceeds of $8.0
million, with a cost of $6.7 million.
8. EARNINGS PER SHARE
After the Company's IPO, effective October 26, 2001, SFAS No. 128, EARNINGS PER
SHARE, was adopted, which requires disclosure of basic and diluted earnings per
share.
Reconciliations of weighted-average shares outstanding and net income for basic
and diluted net income per share for the three months ended March 31, 2002, are
presented below:
FOR THE THREE MONTHS ENDED
MARCH 31, 2002
-------------------------------
WEIGHTED
AVERAGE PER SHARE
INCOME SHARES AMOUNT
-------- ---------- -----------
(IN MILLIONS)
Basic earnings per share:
Income before cumulative effect
of accounting change............ $246.0 360.4 $0.68
Dilutive effects:
Stock options .................. - 0.3 -
Put options (1).............. - - -
======== ========= ===========
Diluted earnings per share.......... $246.0 360.7 $0.68
======== ========= ===========
- -------------------
(1) Of the three put option contracts, the dilutive effect of two of the
contracts did not meet specified reporting thresholds. The calculation of
diluted earnings per share for the three months ended March 31, 2002, excludes
the incremental effect related to the third put option contract. This contract's
strike price is lower than the average market price of the Company's stock
during the period the contract has been outstanding, resulting in an
anti-dilutive effect.
18
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, 2002,
compared with December 31, 2001, and our consolidated results of operations for
the three months ended March 31, 2002 and 2001, 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, 2001, 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. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) competition from companies that may have greater financial
resources, broader arrays of products, higher ratings and stronger financial
performance may impair our ability to retain existing customers, attract new
customers and maintain our profitability; (2) a decline or increased volatility
in the securities markets could result in investors withdrawing from the markets
or decreasing their rates of investment, either of which could reduce our net
income, revenues and assets under management; (3) a downgrade in Principal Life
Insurance Company's ("Principal Life") financial strength ratings may increase
policy surrenders and withdrawals, reduce new sales and terminate relationships
with distributors; (4) our efforts to reduce the impact of interest rate changes
on our profitability and surplus may not be effective; (5) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (6) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (7) fluctuations in foreign currency
exchange rates could reduce our profitability; (8) a decline in Australian
equity values may reduce the profitability of BT Financial Group; (9) our
reserves established for future policy benefits and claims may prove inadequate,
requiring us to increase liabilities; (10) our investment portfolio is subject
to several risks which may diminish the value of our invested assets and affect
our sales, profitability and the investment returns credited to our customers;
(11) our ability to pay stockholder dividends and meet our obligations may be
constrained by the limitations on dividends Iowa insurance laws impose on
Principal Life; (12) we may need to fund deficiencies in our closed block
("Closed Block") assets allocated to the Closed Block which benefit only the
holders of Closed Block policies; (13) changes in regulations or accounting
standards may reduce our profitability; (14) litigation and regulatory
investigations may harm our financial strength and reduce our profitability;
(15) a challenge to the Insurance Commissioner of the State of Iowa's approval
of the plan of conversion could put the terms of our demutualization in question
and reduce the market price of our common stock; (16) 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 (17) a downgrade in our debt ratings may adversely
affect our ability to secure funds.
OVERVIEW
We are a leading provider of retirement savings, investment and insurance
products and services. We have four operating segments:
o U.S. Asset Management and Accumulation, which consists of our asset
accumulation operations providing retirement savings and related investment
products and services, and our asset management operations which are
conducted through Principal Capital Management, our U.S.-based asset
manager. We provide a comprehensive portfolio of asset accumulation
products and services to businesses and individuals in the U.S., with a
concentration on small and medium-sized businesses, which we define as
businesses with fewer than 1,000 employees. We offer to businesses products
and services for defined contribution pension plans, including 401(k) and
403(b) plans, defined benefit pension plans and non-qualified executive
benefit plans. We also offer annuities, mutual funds and bank products and
services to the employees of our business customers and other individuals.
19
o International Asset Management and Accumulation, which consists of BT
Financial Group, our Australia-based asset manager, and Principal
International, which offers retirement products and services, annuities,
mutual funds and life insurance through subsidiaries in Argentina, Chile,
Mexico and Hong Kong and joint ventures in Brazil, Japan and India.
o Life and Health Insurance, which provides individual life and disability
insurance as well as group life and health insurance throughout the U.S.
Our individual insurance products include interest-sensitive life,
traditional life and disability insurance. Our group insurance products
include life, disability, medical, dental and vision insurance, and
administrative services.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following business, among others, during 2001:
SPECTRUM ASSET MANAGEMENT. On October 1, 2001, Spectrum Asset Management became
an affiliate of Principal Capital Management, LLC. The acquisition was accounted
for using the purchase method and the results of operations of the acquired
business have been included in our financial statements from the date of
acquisition. We included revenues of $0.8 million for the three months ended
March 31, 2002, in our consolidated results of operations.
DISPOSITIONS
We entered into dispositions or disposed of the following businesses, among
others, during 2002 and 2001:
COVENTRY HEALTH CARE. On February 1, 2002, we sold our remaining stake of 15.1
million shares of Coventry Health Care, Inc. ("Coventry") common stock and a
warrant, exercisable for 3.1 million shares of Coventry common stock. We
received proceeds of $325.2 million, resulting in a net realized capital gain of
$182.8 million, or $114.4 million net of income taxes.
We reported our investment in Coventry in our Corporate and Other segment and
accounted for it using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million and $4.9 million for the three months
ended March 31, 2002 and 2001, respectively.
PT ASURANSI JIWA PRINCIPAL INDONESIA. On September 25, 2001, we disposed of all
the stock of PT Asuransi Jiwa Principal Indonesia, our subsidiary in Indonesia.
We currently have no business operations in Indonesia. We received nominal
proceeds, which resulted in a realized capital loss of $6.7 million. We included
nominal revenues and net loss from our operations in Indonesia in our
consolidated results of operations for the three months ended March 31, 2001.
PRINCIPAL INTERNATIONAL ESPANA, S.A. DE SEGUROS DE VIDA. On February 15, 2001,
we disposed of all of the stock of Principal International Espana, S.A. de
Seguros de Vida, our subsidiary in Spain, for nominal proceeds, resulting in a
realized capital loss of $38.4 million, or $21.0 million net of income taxes,
ceasing our business operations in Spain.
We did not include revenues or net income from our operations in Spain in our
consolidated results of operations for the three months ended March 31, 2002 and
2001.
20
REINSURANCE TRANSACTIONS
Effective January 1, 2002, we entered into a reinsurance agreement to reinsure
group medical insurance contracts, which should result in reduced volatility of
our group medical insurance earnings. The reinsurance agreement resulted in
$11.1 million of ceded premiums and $9.6 million of ceded claims for the three
months ended March 31, 2002.
FLUCTUATIONS IN FOREIGN CURRENCY TO U.S. DOLLAR EXCHANGE RATES
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
In January 2002, the Argentine government ended its tie of the Argentine peso to
the U.S. dollar, creating a dual currency system with an official fixed exchange
rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and
free-floating exchange rate for other transactions, subsequently floating the
Argentine peso in February. The devaluation did not materially impact our
consolidated results of operations.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
operating earnings and net income (loss). Our consolidated operating earnings
were positively impacted $0.2 million and negatively impacted $0.2 million for
the three months ended March 31, 2002, and 2001, respectively, as a result of
fluctuations in foreign currency to U.S. dollar exchange rates. For a discussion
of our approaches to foreign currency exchange rate risk, see Item 3,
"Quantitative and Qualitative Disclosures about Market Risk."
CHANGES TO OUR CRITICAL ACCOUNTING POLICIES
Changes in the business environment and applicable authoritative accounting
guidance require us to closely monitor our accounting policies. During the three
months ended March 31, 2002, we adopted newly issued guidance from the Financial
Accounting Standards Board ("FASB") and changed our critical accounting policy
for business combinations.
ACCOUNTING FOR BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, FASB issued Statement of Financial Accounting Standards ("SFAS")
No. 141, BUSINESS COMBINATIONS ("SFAS 141"), and SFAS No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS ("SFAS 142"). SFAS 141 requires that the purchase method
of accounting be used for all business combinations initiated after June 30,
2001. SFAS 141 also includes guidance on the initial recognition and measurement
of goodwill and other intangible assets arising from business combinations
completed after June 30, 2001. SFAS 142, effective January 1, 2002, prohibits
the amortization of goodwill and intangible assets with indefinite useful lives.
Intangible assets with finite useful lives will continue to be amortized over
their estimated useful lives. Additionally, SFAS 142 requires that goodwill and
indefinite-lived intangible assets be reviewed for impairment at least annually.
This includes a more stringent impairment test methodology for measuring and
recognizing impairment losses.
During the fourth quarter of 2001, each of our operating segments completed
initial valuations of goodwill and intangible assets, as set forth in the
guidelines of SFAS 142. The valuation was performed using discounted cash flow
methodologies and applying a series of variable parameters and assumptions to
deliver operating cash flow projections. Due to changes in funds under
management, business conditions and economic outlook, we recognized an after-tax
impairment amount of $280.9 million upon the adoption of SFAS 142 on January 1,
2002.
21
This impairment, which has been recognized in our first quarter 2002
consolidated financial statements as a cumulative effect of a change in
accounting principle, was reported in our operating segments as follows (in
millions):
INTERNATIONAL ASSET LIFE
MANAGEMENT AND AND HEALTH
ACCUMULATION SEGMENT SEGMENT CONSOLIDATED
-------------------- ------------ ------------
Goodwill................................. $298.9 $4.6 $303.5
Other intangibles........................ 112.1 - 112.1
Income tax impact........................ (134.7) - (134.7)
-------------------- ------------ ------------
Total impairment, net of income taxes.... $276.3 $4.6 $280.9
==================== ============ ============
Net income (loss) for the three months ended March 31, 2002 and 2001, adjusted
for the effects of SFAS 142 related to non-amortization of goodwill and
indefinite-lived intangibles as if adoption had occurred on January 1, 2001, is
as follows (in millions):
FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------
2002 2001
---------- -----------
Net income (loss)...................... $(34.9) $105.3
Adjust for amortization expense:
Goodwill............................ - 9.8
Brand name and management rights.... - 4.5
Assembled workforce ................ - 1.0
---------- -----------
Total amortization expense .... - 15.3
Tax impacts of amortization expense ... - (3.4)
---------- -----------
Adjusted net income (loss)..... $(34.9) $117.2
========== ===========
22
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
periods indicated:
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------
2002 2001
---------- ----------
(IN MILLIONS)
INCOME STATEMENT DATA:
Revenues:
Premiums and other considerations.......................... $ 885.7 $ 1,064.2
Fees and other revenues.................................... 476.0 413.0
Net investment income...................................... 813.2 839.7
Net realized capital gains (losses)........................ 98.1 (80.9)
---------- ----------
Total revenues.......................................... 2,273.0 2,236.0
Expenses:
Benefits, claims and settlement expenses................. 1,203.2 1,391.9
Dividends to policyholders............................... 82.4 81.0
Operating expenses....................................... 630.8 622.7
---------- ----------
Total expenses.......................................... 1,916.4 2,095.6
---------- ----------
Income before income taxes and cumulative effect of
accounting changes......................................... 356.6 140.4
Income taxes................................................ 110.6 24.4
---------- ----------
Income before cumulative effect of accounting changes.. 246.0 116.0
Cumulative effect of accounting changes, net of related
income taxes............................................... (280.9) (10.7)
---------- ----------
Net income (loss)....................................... $ (34.9) $ 105.3
========== ==========
OTHER DATA:
Net income (loss)........................................... $ (34.9) $ 105.3
Less:
Net realized capital gains (losses), as adjusted........... 61.5 (47.9)
Non-recurring items........................................ (282.9) (20.5)
---------- ----------
Operating earnings.......................................... $ 186.5 $ 173.7
========== ==========
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Premiums and other considerations decreased $178.5 million, or 17%, to $885.7
million for the three months ended March 31, 2002, from $1,064.2 million for the
three months ended March 31, 2001. The decrease reflected a $139.9 million, or
56%, decrease from the U.S. Asset Management and Accumulation segment, primarily
a result of a decrease in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. The premium income we receive from these contracts fluctuates due
to the variability in the number and size of pension plan terminations in the
market, the interest rate environment and our ability to attract new sales. In
addition, a $33.4 million, or 4%, decrease from the Life and Health Insurance
segment premiums was primarily due to the ceding of medical premiums related to
a new group medical reinsurance agreement effective January 1, 2002, and due to
a reclassification of revenues from our group universal life insurance product
from premiums to fee revenues and the loss of a large customer in 2000.
International Asset Management and Accumulation segment premiums decreased $5.2
million, or 11%, primarily resulting from reduced sales of single premium
annuities with life contingencies in Mexico.
Fees and other revenues increased $63.0 million, or 15%, to $476.0 million for
the three months ended March 31, 2002, from $413.0 million for the three months
ended March 31, 2001. The increase was primarily due to a $66.3 million, or 54%,
increase from the Mortgage Banking segment primarily resulting from residential
mortgage loan production fee revenues, reflecting the increase in residential
mortgage loan production volume and, to a lesser extent, resulting from growth
in residential mortgage loan servicing fee revenues. The increase was also due
23
to a $12.1 million, or 19%, increase from the Life and Health Insurance segment,
primarily related to growth in our individual interest-sensitive life insurance
business and a reclassification of revenues from our group universal life
insurance product to fee revenues from premiums. The increases were partially
offset by a $16.5 million, or 23%, decrease from the International Asset
Management and Accumulation segment primarily a result of declining assets under
management in Australia for the three months ended March 31, 2002, divestiture
of a non-core business in Australia during the latter part of 2001 and the
weakening of the Australian dollar versus the U.S. dollar.
Net investment income decreased $26.5 million, or 3%, to $813.2 million for the
three months ended March 31, 2002, from $839.7 million for the three months
ended March 31, 2001. The decrease was primarily a result of a decrease in
investment yields. The yield on average invested assets and cash was 7.1% for
the three months ended March 31, 2002, compared to 7.7% for the three months
ended March 31, 2001. This reflects a decrease in investment gains on real
estate due to lower sales of certain real estate held-for-sale, compared to an
unusually high volume of sales during 2001. In addition, the decrease reflects
lower yields on fixed maturity securities due in part to a lower interest rate
environment. The decrease in investment yields was partially offset by a
$1,930.0 million, or 4%, increase in average invested assets and cash.
Net realized capital gains (losses) increased $179.0 million to $98.1 million of
net realized capital gains for the three months ended March 31, 2002, from $80.9
million of net realized capital losses for the three months ended March 31,
2001. Net realized capital gains increased during the three months ended March
31, 2002, primarily due to the sale of our remaining stake in Coventry. The
increase in realized capital gains was partially offset by realized capital
losses on the sales of fixed maturity securities and write downs of other than
temporary declines in value of certain fixed maturity securities. During the
three months ended March 31, 2001, we realized capital losses on the sales of
equity securities, a result of the decline in the equity markets, the sale of
our operations in Spain, and other than temporary declines in value of certain
fixed maturity securities.
Benefits, claims and settlement expenses decreased $188.7 million, or 14%, to
$1,203.2 million for the three months ended March 31, 2002, from $1,391.9
million for the three months ended March 31, 2001. The decrease was primarily
due to a $146.2 million, or 21%, decrease from the U.S. Asset Management and
Accumulation segment, primarily reflecting a decrease in reserves resulting from
a decrease in sales of single premium group annuities with life contingencies.
The decrease was also due to a $35.5 million, or 6%, decrease from the Life and
Health Insurance segment, due to ceded claims under a new group medical
reinsurance agreement; a reduction in group medical insurance business; and
improved claim experience partially offset by a reserve established due to the
withdrawal of medical products from the Florida small employer market. In
addition, a $4.8 million, or 8% decrease from the International Asset Management
and Accumulation segment was primarily the result of a decrease in reserve
changes to reflect the impact of deflation adjustments in Chile and was a result
of the weakening of the Chilean peso versus the U.S. dollar.
Dividends to policyholders increased $1.4 million, or 2%, to $82.4 million for
the three months ended March 31, 2002, from $81.0 million for the three months
ended March 31, 2001. The increase was attributable to a $1.6 million, or 57%,
increase from the U.S. Asset Management and Accumulation segment, resulting from
an increase in dividends for our pension full-service accumulation products. The
increase was offset by a $0.2 million decrease from the Life and Health
Insurance segment due to a change in the dividend scale.
Operating expenses increased $8.1 million, or 1%, to $630.8 million for the
three months ended March 31, 2002, from $622.7 million for the three months
ended March 31, 2001. The increase was primarily due to an $83.7 million, or
101%, increase from the Mortgage Banking segment resulting from a net loss from
servicing hedge activity in 2002 compared to a net gain in 2001 and due to
growth in the residential mortgage loan servicing portfolio. The increase was
partially offset by a $36.4 million, or 17%, decrease from the U.S. Asset
Management and Accumulation segment, primarily reflecting a decrease in
amortization of deferred policy acquisition costs of our pension products due to
unlocking. The increase was also partially offset by a $32.2 million, or 34%,
decrease from the International Asset Management and Accumulation segment, in
part related to the discontinuation of amortization expense in 2002 as a result
of the adoption of SFAS 142. In addition, staff restructuring efforts undertaken
to reduce ongoing operating expenses resulted in a 30% decrease of staff levels,
resulting in a decrease in salary and incentive costs within this segment. In
addition, the increase was partially offset by a $7.0 million, or 3%, decrease
from the Life and Health Insurance segment primarily due to higher expenses in
2001, a result of certain expenses not expected to recur.
Income taxes increased $86.2 million to $110.6 million for the three months
ended March 31, 2002, from $24.4 million for the three months ended March 31,
2001. The effective income tax rate was 31% for the three months ended
24
March 31, 2002, and 17% for the three months ended March 31, 2001. The
effective income tax rates for the three months ended March 31, 2002 and 2001,
were lower than the corporate income tax rate of 35% primarily due to income tax
deductions allowed for corporate dividends received. The increase in the
effective tax rate to 31% for the three months ended March 31,2002, from 17% for
the three months ended March 31, 2001, was primarily due to the greater increase
in net income before taxes relative to the increase in our permanent tax
differences. In addition, our effective income tax rate was further reduced for
the three months ended March 31, 2001, due to additional tax benefits related to
excess tax over book capital losses realized from the sale of our operations in
Spain.
As a result of the foregoing factors and the inclusion of the cumulative effect
of accounting changes, net of related income taxes, net income decreased $140.2
million to $34.9 million of net loss for the three months ended March 31, 2002,
from $105.3 million of net income for the three months ended March 31, 2001. The
cumulative effect of accounting changes, net of related income taxes, were
related to our implementation of SFAS 142 in 2002 and Statement of Financial
Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES ("SFAS 133") in 2001.
For the three months ended March 31, 2002, non-recurring items of $282.9
million, net of income taxes, included the negative effects of: (1) a cumulative
effect of accounting change related to our implementation of SFAS 142 ($280.9
million); and (2) expenses related to our demutualization ($2.0 million). For
the three months ended March 31, 2001, non-recurring items of $20.5 million, net
of income taxes, included the negative effects of: (1) a cumulative effect of
accounting change related to our implementation of SFAS 133 ($10.7 million); (2)
an increase in our loss contingency reserve established for sales practices
litigation ($5.9 million); and (3) expenses related to our demutualization ($3.9
million).
As a result of the foregoing factors and the exclusion of net realized capital
gains (losses), as adjusted and nonrecurring items, operating earnings increased
$12.8 million, or 7%, to $186.5 million for the three months ended March 31,
2002, from $173.7 million for the three months ended March 31, 2001. The
increase resulted from an $11.8 million, or 28%, increase from the Life and
Health Insurance segment, primarily a result of improved medical and dental loss
ratios and the absence of several one-time expense items that depressed 2001
earnings. In addition, the increase resulted from an $11.4 million, or 13%,
increase from the U.S. Asset Management and Accumulation segment, primarily
related to a decrease in amortization of deferred policy acquisition costs of
our pension products due to unlocking. An increase of $10.5 million from the
International Asset Management and Accumulation segment resulted mostly from
improved earnings of BT Financial Group primarily as a result of reduced
operating expenses. The Mortgage Banking segment also increased $2.6 million, or
11%, primarily due to growth in earnings from residential mortgage loan
production. The increases were partially offset by a $23.5 million, or 99%,
decrease from the Corporate and Other segment, primarily related to a decrease
in investment gains on real estate due to lower sales of certain real estate
held-for-sale, compared to an unusually high volume of sales experienced in
2001.
RESULTS OF OPERATIONS BY SEGMENT
We evaluate segment performance by segment operating earnings, which excludes
the effect of net realized capital gains and losses, as adjusted, and
non-recurring events and transactions. Segment operating earnings are determined
by adjusting U.S. GAAP net income for net realized capital gains and losses, as
adjusted, and non-recurring items that we believe are not indicative of overall
operating trends. While these items may be significant components in
understanding and assessing our consolidated financial performance, we believe
the presentation of segment operating earnings enhances the understanding of our
results of operations by highlighting earnings attributable to the normal,
recurring operations of our businesses. However, segment operating earnings are
not a substitute for net income determined in accordance with U.S. GAAP.
The following table presents segment information as of or for the periods
indicated:
25
AS OF OR FOR THE THREE
MONTHS ENDED MARCH 31,
----------------------------
2002 2001
------------ ------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation................ $ 862.1 $ 1,015.7
International Asset Management and Accumulation....... 121.1 144.4
Life and Health Insurance............................. 978.5 1,002.4
Mortgage Banking...................................... 208.7 119.6
Corporate and Other(1)................................ 10.5 35.0
------------ ------------
Total operating revenues.............................. 2,180.9 2,317.1
Net realized capital gains (losses), including
recognition of front-end fee revenues and certain
market value adjustments to fee revenues............ 92.1 (81.1)
------------ ------------
U.S. GAAP REPORTED:
Total consolidated revenues......................... $ 2,273.0 $ 2,236.0
============ ============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ............... $ 100.2 $ 88.8
International Asset Management and Accumulation....... 5.2 (5.3)
Life and Health Insurance............................. 54.3 42.5
Mortgage Banking...................................... 26.5 23.9
Corporate and Other .................................. 0.3 23.8
------------ ------------
Total operating earnings............................ 186.5 173.7
Net realized capital gains (losses), as adjusted(2)... 61.5 (47.9)
Non-recurring items(3)................................ (282.9) (20.5)
------------ ------------
U.S. GAAP REPORTED:
Net income (loss)................................... $ (34.9) $ 105.3
============ ============
U.S. GAAP REPORTED NET INCOME (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ............... $ 55.4 $ 70.6
International Asset Management and Accumulation....... (267.3) (25.6)
Life and Health Insurance............................. 39.2 42.0
Mortgage Banking...................................... 26.5 23.9
Corporate and Other .................................. 111.3 (5.6)
------------ ------------
Total net income (loss)............................. $ (34.9) $ 105.3
============ ============
TOTAL ASSETS BY SEGMENT:
U.S. Asset Management and Accumulation(4)............. $ 68,738.6 $ 64,144.6
International Asset Management and Accumulation....... 4,677.7 4,928.1
Life and Health Insurance............................. 10,939.1 10,566.0
Mortgage Banking...................................... 2,897.3 1,915.2
Corporate and Other(5)................................ 1,506.0 1,017.9
------------ ------------
Total assets........................................ $ 88,758.7 $ 82,571.8
============ ============
- --------------------
(1) Includes inter-segment eliminations primarily related to internal
investment management fee revenues, commission fee revenues paid to U.S.
Asset Management and Accumulation agents for selling Life and Health
Insurance segment insurance products, and real estate joint venture
rental income. The Corporate and Other segment reported rental income
from real estate joint ventures for office space used by other segments.
(2) Net realized capital gains (losses), as adjusted, are net of income
taxes, related changes in the amortization pattern of deferred policy
acquisition costs, recognition of front-end fee revenues for sales
charges on pension products and services and certain market value
adjustments to fee revenues, as follows:
26
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
------------- -------------
(IN MILLIONS)
Net realized capital gains (losses)..................... $ 98.1 $ (80.9)
Certain market value adjustments to fee
revenues................................................ (8.6) -
Recognition of front-end fee revenues................... 2.6 (0.2)
------------- -------------
Net realized capital gains (losses), including
recognition of front-end fee revenues and
certain market value adjustments to fee
revenues............................................ 92.1 (81.1)
Amortization of deferred policy acquisition
costs related to net realized capital gains (losses).. 10.9 1.0
------------- -------------
Net realized capital gains (losses),
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues, net of related
amortization of deferred policy acquisition
costs............................................... 103.0 (80.1)
Income tax effect ...................................... (41.5) 32.2
------------- -------------
Net realized capital gains (losses), as
adjusted............................................ $ 61.5 $ (47.9)
============= =============
(3) For the three months ended March 31, 2002, non-recurring items of $282.9
million, net of income taxes, included the negative effects of: (1) a
cumulative effect of change in accounting principle related to our
implementation of SFAS 142 ($280.9 million) and (2) expenses related to
our demutualization ($2.0 million). For the three months ended March 31,
2001, non-recurring items of $20.5 million, net of income taxes,
included the negative effects of: (1) a cumulative effect of change in
accounting principle related to our implementation of SFAS 133 ($10.7
million); (2) an increase in our loss contingency reserve established
for sales practices litigation ($5.9 million) and (3) expenses related
to our demutualization ($3.9 million).
(4) U.S. Asset Management and Accumulation separate account assets include
shares of Principal Financial Group, Inc. stock allocated to a separate
account, a result of the demutualization. The value of the separate
account was $1.1 billion at March 31, 2002, and $1.3 billion at December
31, 2001. Activity of the separate account was reflected in both
separate account assets and separate account liabilities and did not
impact our results of operations.
(5) Includes inter-segment elimination amounts related to internally
generated mortgage loans and an internal line of credit. The U.S. Asset
Management and Accumulation segment and Life and Health Insurance
segment reported mortgage loan assets issued for real estate joint
ventures. These mortgage loans were reported as liabilities in the
Corporate and Other segment. In addition, the Corporate and Other
segment managed a revolving line of credit used by other segments.
27
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,
-----------------------
2002 2001
---------- ----------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other considerations............ $ 109.6 $ 249.5
Fees and other revenues...................... 173.7 168.5
Net investment income........................ 578.8 597.7
---------- ----------
Total operating revenues................... 862.1 1,015.7
Expenses:
Benefits, claims and settlement expenses,
including dividends to policyholders........ 547.6 692.2
Operating expenses............................ 187.5 214.2
---------- ----------
Total expenses............................. 735.1 906.4
---------- ----------
Pre-tax operating earnings.................... 127.0 109.3
Income taxes.................................. 26.8 20.5
---------- ----------
Operating earnings............................ 100.2 88.8
Net realized capital losses, as adjusted...... (44.8) (7.4)
Non-recurring items.......................... - (10.8)
---------- ----------
U.S. GAAP REPORTED:
Net income.................................... $ 55.4 $ 70.6
========== ==========
- --------------
(1) Excludes net realized 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, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Premiums and other considerations decreased $139.9 million, or 56%, to $109.6
million for the three months ended March 31, 2002, from $249.5 million for the
three months ended March 31, 2001. The decrease primarily resulted from a $150.5
million decrease in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. The premium income we receive from these contracts fluctuates due
to the variability in the number and size of pension plan terminations in the
market, the interest rate environment and our ability to attract new sales. The
decrease was partially offset by a $10.6 million increase in individual annuity
premiums due to an increase in sales.
Fees and other revenues increased $5.2 million, or 3%, to $173.7 million for the
three months ended March 31, 2002, from $168.5 million for the three months
ended March 31, 2001. An increase of $4.3 million was primarily related to an
increase in gains from commercial mortgage-backed securitizations initiated by
Principal Capital Management.
Net investment income decreased $18.9 million, or 3%, to $578.8 million for the
three months ended March 31, 2002, from $597.7 million for the three months
ended March 31, 2001. The yield on average invested assets and cash was 6.8% for
the three months ended March 31, 2002, compared to 7.3% for the three months
ended March 31, 2001. The decrease reflects lower yields due in part to a lower
interest rate environment. The decrease was partially offset by a $986.5
million, or 3%, increase in average invested assets and cash.
Benefits, claims and settlement expenses, including dividends to policyholders,
decreased $144.6 million, or 21%, to $547.6 million for the three months ended
28
March 31, 2002, from $692.2 million for the three months ended March 31, 2001. A
decrease of $156.7 million in our pension business primarily reflected the
decrease in sales of single premium group annuities with life contingencies.
Partially offsetting the decrease was a $10.5 million increase in reserves
resulting from increased individual annuity sales.
Operating expenses decreased $26.7 million, or 12%, to $187.5 million for the
three months ended March 31, 2002, from $214.2 million for the three months
ended March 31, 2001. A decrease of $31.2 million from our pension products was
due to a decrease in the amortization of deferred policy acquisition costs from
unlocking to reflect changes in assumptions for equity market performance and
lapse rates in 2001, and changes in acquisition compensation in 2002. A decrease
of $1.6 million from our individual annuity business reflects decreases in
non-deferrable expenses and amortization of deferred policy acquisition costs.
The decreases were partially offset by a $2.4 million increase from Principal
Bank due primarily to growth in bank operations.
Income taxes increased $6.3 million, or 31%, to $26.8 million for the three
months ended March 31, 2002, from $20.5 million for the three months ended March
31, 2001. The effective income tax rate for this segment was 21% for the three
months ended March 31, 2002, and 19% for the three months ended March 31, 2001.
The effective income tax rates for the three months ended March 31, 2002 and
2001, were lower than the corporate income tax rate of 35%, primarily due to
income tax deductions allowed for corporate dividends received and other
tax-exempt income.
As a result of the foregoing factors, operating earnings increased $11.4
million, or 13%, to $100.2 million for the three months ended March 31, 2002,
from $88.8 million for the three months ended March 31, 2001.
Net realized capital losses, as adjusted, increased $37.4 million to $44.8
million for the three months ended March 31, 2002, from $7.4 million for the
three months ended March 31, 2001. The increase includes realized capital losses
related to the sales of fixed maturity securities and other than temporary
declines in the value of certain fixed maturity securities for the three months
ended March 31, 2002.
As a result of the foregoing factors and the inclusion of non-recurring items
for the three months ended March 31, 2001, net income decreased $15.2 million,
or 22%, to $55.4 million for the three months ended March 31, 2002, from $70.6
million for the three months ended March 31, 2001. Non-recurring items for the
three months ended March 31, 2001, had a negative impact on net income of $10.8
million, net of income taxes, due to the cumulative effect of accounting change,
a result of our implementation of SFAS 133.
29
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,
------------------------------
2002 2001
------------- -------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other considerations.................. $ 41.2 $ 46.4
Fees and other revenues............................ 55.4 71.9
Net investment income.............................. 24.5 26.1
------------- -------------
Total operating revenues........................ 121.1 144.4
Expenses:
Benefits, claims and settlement expenses........... 52.7 57.5
Operating expenses................................ 61.4 93.6
------------- -------------
Total expenses................................ 114.1 151.1
------------- -------------
Pre-tax operating earnings (loss).................... 7.0 (6.7)
Income taxes (benefits).............................. 1.8 (1.4)
------------- -------------
Operating earnings (loss)............................ 5.2 (5.3)
Net realized capital gains (losses), as adjusted..... 3.8 (20.3)
Non-recurring items.................................. (276.3) -
------------- -------------
U.S. GAAP REPORTED:
Net loss............................................. $ (267.3) $ (25.6)
============= =============
OTHER DATA:
Operating earnings (loss):
Principal International........................... $ 2.0 $ 0.3
BT Financial Group............................... 3.2 (5.6)
Operating earnings before amortization
of goodwill and other intangibles:
Principal International.......................... $ 2.9 $ 2.7
BT Financial Group............................... 3.2 4.1
- --------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Premiums and other considerations decreased $5.2 million, or 11%, to $41.2
million for the three months ended March 31, 2002, from $46.4 million for the
three months ended March 31, 2001. Decreases of $3.4 million in Mexico and $0.8
million in Argentina were primarily a result of reduced sales of single premium
annuities with life contingencies. In addition, higher sales of single premium
annuities with life contingencies in Chile were more than offset by the
weakening of the Chilean peso versus the U.S. dollar, resulting in a $0.7
million decrease. The premium income we receive from these contracts fluctuates
due to the variability in the number of people exiting the mandatory defined
contribution system as a result of disability, death, or retirement; economic
activity; pricing conditions; and our ability to attract new sales.
Fees and other revenues decreased $16.5 million, or 23%, to $55.4 million for
the three months ended March 31, 2002, from $71.9 million for the three months
ended March 31, 2001. A decrease of $17.9 million of fee revenues generated by
BT Financial Group resulted from declining assets under management and a
30
changing product mix for the three months ended March 31, 2002, divestiture of a
non-core business in the latter part of 2001 and, to a lesser extent, the
weakening of the Australian dollar versus the U.S. dollar.
Net investment income decreased $1.6 million, or 6%, to $24.5 million for the
three months ended March 31, 2002, from $26.1 million for the three months ended
March 31, 2001. A decrease of $1.3 million from Principal International
primarily related to a decrease in average investment yields. The yield on
average invested assets and cash was 6.2% for the three months ended March 31,
2002, compared to 8.2% for the three months ended March 31, 2001. The decrease
in investment yields was partially due to the impact of deflation on nominal
yields in Chile, which, as discussed in the next paragraph, was offset by a
corresponding decrease in reserve changes.
Benefits, claims and settlement expenses decreased $4.8 million, or 8%, to $52.7
million for the three months ended March 31, 2002, from $57.5 million for the
three months ended March 31, 2001. A $5.5 million decrease in Chile was a result
of a decrease in reserve changes to reflect the impact of deflation adjustments
and a result of the weakening of the Chilean peso versus the U.S. dollar. The
decreases were partially offset by an increase in reserve changes, the result of
increased sales of annuity products in Chile.
Operating expenses decreased $32.2 million, or 34%, to $61.4 million for the
three months ended March 31, 2002, from $93.6 million for the three months ended
March 31, 2001. Operating expenses incurred by BT Financial Group decreased
$30.8 million, in part related to the discontinuation of amortization expense in
2002 as a result of the adoption of SFAS 142. In addition, staff restructuring
efforts undertaken to reduce ongoing operating expenses resulted in a 30%
decrease of staff levels, resulting in a decrease in salary and incentive costs.
Income taxes increased $3.2 million to $1.8 million of income tax expense for
the three months ended March 31, 2002, from a $1.4 million income tax benefit
for the three months ended March 31, 2001. A $3.3 million increase was primarily
due to an increase in pre-tax operating earnings from BT Financial Group.
As a result of the foregoing factors, operating earnings increased $10.5 million
to $5.2 million of operating earnings for the three months ended March 31, 2002,
from a $5.3 million operating loss for the three months ended March 31, 2001.
Net realized capital gains (losses), as adjusted, increased $24.1 million to
$3.8 million of net realized capital gains for the three months ended March 31,
2002, from $20.3 million of net realized capital losses for the three months
ended March 31, 2001. The increase was primarily due to a $21.0 million
after-tax net realized capital loss on the February 2001 sale of our operations
in Spain. In addition, a $3.0 million increase resulted primarily from gains
realized on the sale of fixed maturity securities in Chile for the three months
ended March 31, 2002.
As a result of the foregoing factors and the inclusion of non-recurring items
for the three months ended March 31, 2002, net loss increased $241.7 million to
$267.3 million for the three months ended March 31, 2002, from $25.6 million for
the three months ended March 31, 2001. For the three months ended March 31,
2002, net loss included the effect of non-recurring items totaling $276.3
million, net of income taxes, related to the negative impact of the cumulative
effect of accounting change, a result of our implementation of SFAS 142.
31
LIFE AND HEALTH INSURANCE SEGMENT
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,
---------------------------------
2002 2001
-------------- --------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues(1):
Premiums and other considerations................ $ 734.9 $ 768.3
Fees and other revenues.......................... 77.0 64.9
Net investment income............................ 166.6 169.2
-------------- --------------
Total operating revenues....................... 978.5 1,002.4
Expenses:
Benefits, claims and settlement expenses......... 609.5 645.0
Dividends to policyholders....................... 78.0 78.2
Operating expenses............................... 208.4 215.2
-------------- --------------
Total expenses................................. 895.9 938.4
-------------- --------------
Pre-tax operating earnings......................... 82.6 64.0
Income taxes....................................... 28.3 21.5
-------------- --------------
Operating earnings................................. 54.3 42.5
Net realized capital losses, as adjusted........... (10.5) (0.6)
Non-recurring items................................ (4.6) 0.1
-------------- --------------
U.S. GAAP REPORTED:
Net income......................................... $ 39.2 $ 42.0
============== ==============
- ------------
(1) Excludes net realized 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, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Premiums and other considerations decreased $33.4 million, or 4%, to $734.9
million for the three months ended March 31, 2002, from $768.3 million for the
three months ended March 31, 2001. Group life insurance premiums decreased $12.5
million, due to a reclassification of revenues from our group universal life
insurance product from premium to fee revenues and the loss of a large customer
in late 2000, resulting in a loss of premium after March 31, 2001. Group medical
premiums declined primarily due to a reinsurance agreement effective January 1,
2002, which resulted in $11.1 million of ceded premiums to the reinsurer. In
addition, group medical had a reduction in business which was offset by an
increase in premium rates. Individual traditional life insurance premiums
decreased $8.5 million, reflecting a continued shift in customer preference from
traditional life insurance products to universal life and variable universal
life insurance products.
Fees and other revenues increased $12.1 million, or 19%, to $77.0 million for
the three months ended March 31, 2002, from $64.9 million for the three months
ended March 31, 2001. Fee revenues from individual interest-sensitive life
insurance products increased $7.4 million, a result of the continued shift in
customer preference, as previously discussed. Group life insurance fee revenues
increased $7.0 million due to a reclassification of revenues from our group
universal life insurance product to fee revenues from premiums. Fee revenues
from our group fee-for-service business increased $3.6 million, primarily due to
additional services provided to our customers and price increases. The increases
were partially offset by a $4.7 million decrease in individual traditional life
insurance fee revenues, primarily related to classifying fees received from
reinsurance ceded for traditional life insurance as an offset to operating
expenses. The fees from reinsurance were previously reported as fee revenues.
32
Net investment income decreased $2.6 million, or 2%, to $166.6 million for the
three months ended March 31, 2002, from $169.2 million for the three months
ended March 31, 2001. The decrease reflects lower average investment yields due
in part to an overall lower interest rate environment. The yield on average
invested assets and cash was 7.4% for the three months ended March 31, 2002,
compared to 7.7% for the three months ended March 31, 2001. The decrease was
partially offset by a $166.0 million, or 2%, increase in average invested assets
and cash.
Benefits, claims and settlement expenses decreased $35.5 million, or 6%, to
$609.5 million for the three months ended March 31, 2002, from $645.0 million
for the three months ended March 31, 2001. Group medical insurance benefits,
claims and settlement expenses decreased $23.3 million, due to ceded claims
under a new reinsurance agreement; a reduction in group medical insurance
business; and improved claim experience, partially offset by a reserve
established due to the withdrawal of medical products from the Florida small
employer market. Individual traditional life insurance benefits, claims, and
settlement expenses decreased $8.2 million primarily due to lower death claims.
Group dental insurance benefits, claims and settlement expenses decreased $6.4
million due to improved claim experience and a decline in business.
Dividends to policyholders decreased $0.2 million to $78.0 million for the three
months ended March 31, 2002, from $78.2 million for the three months ended March
31, 2001. The decrease was due to a change in the dividend scale.
Operating expenses decreased $6.8 million, or 3%, to $208.4 million for the
three months ended March 31, 2002, from $215.2 million for the three months
ended March 31, 2001. Group life and health insurance operating expenses
decreased $8.7 million, primarily due to higher expenses in 2001, a result of
certain expenses not expected to recur. The decrease was partially offset by a
$1.9 million increase in individual life and disability insurance operating
expenses primarily due to increased employee benefit costs.
Income taxes increased $6.8 million, or 32%, to $28.3 million for the three
months ended March 31, 2002, from $21.5 million for the three months ended March
31, 2001. The effective income tax rate for the segment was 34% for the three
months ended March 31, 2002 and 2001. The effective income tax rates for the
three months ended March 31, 2002 and 2001, 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 $11.8
million, or 28%, to $54.3 million for the three months ended March 31, 2002,
from $42.5 million for the three months ended March 31, 2001.
Net realized capital losses, as adjusted, increased $9.9 million to $10.5
million for the three months ended March 31, 2002, from $0.6 million for the
three months ended March 31, 2001. The increase includes realized capital losses
related to sales of fixed maturity securities and other than temporary declines
in the value of certain fixed maturity securities for the three months ended
March 31, 2002.
As a result of the foregoing factors and the inclusion of non-recurring items,
net income decreased $2.8 million, or 7%, to $39.2 million for the three months
ended March 31, 2002, from $42.0 million for the three months ended March 31,
2001. Non-recurring items for the three months ended March 31, 2002, had a
negative impact on net income of $4.6 million, net of income taxes, due to the
cumulative effect of accounting change, a result of our implementation of SFAS
142. Non-recurring items for the three months ended March 31, 2001, had a
positive impact on net income of $0.1 million, net of income taxes, due to the
cumulative effect of accounting change, a result of our implementation of SFAS
133.
33
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,
--------------------------------
2002 2001
-------------- --------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues(1):
Loan servicing...................... $ 127.6 $ 88.9
Loan production..................... 81.1 30.7
-------------- --------------
Total operating revenues........ 208.7 119.6
Expenses:
Loan servicing...................... 127.9 59.6
Loan production..................... 38.7 23.3
-------------- --------------
Total expenses.................. 166.6 82.9
-------------- --------------
Pre-tax operating earnings............... 42.1 36.7
Income taxes............................. 15.6 12.8
-------------- --------------
Operating earnings....................... 26.5 23.9
Net realized capital gains (losses), as
adjusted.............................. - -
Non-recurring items...................... - -
-------------- --------------
U.S. GAAP REPORTED:
Net income............................... $ 26.5 $ 23.9
============== ==============
- ------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Total operating revenues increased $89.1 million, or 74%, to $208.7 million for
the three months ended March 31, 2002, from $119.6 million for the three months
ended March 31, 2001. A $50.4 million increase in residential mortgage loan
production revenues reflects the increase in residential mortgage loan
production volume during the three months ended March 31, 2002. In addition, an
increase of $38.7 million in residential mortgage loan servicing revenues
reflects the growth in the residential mortgage loan servicing portfolio. The
continued relatively low interest rates in the first quarter of 2002 resulted in
residential mortgage loan production of $10.0 billion for the three months ended
March 31, 2002, compared to $4.9 billion for the same period a year ago. The
average balance of the servicing portfolio was $85.2 billion for the three
months ended March 31, 2002, compared to $56.6 billion for the same period a
year ago.
Total expenses increased $83.7 million, or 101%, to $166.6 million for the three
months ended March 31, 2002, from $82.9 million for the three months ended March
31, 2001. A $68.3 million increase in residential mortgage loan servicing
expenses was a result of a net loss from servicing hedge activity in 2002
compared to a net gain in 2001 and due to growth in the residential mortgage
loan servicing portfolio. Residential mortgage loan production expenses
increased $15.4 million, reflecting the increase in residential mortgage loan
production volume.
Income taxes increased $2.8 million, or 22%, to $15.6 million for the three
months ended March 31, 2002, from $12.8 million for the three months ended March
31, 2001. The effective income tax rate for this segment was 37% for the three
months ended March 31, 2002, and 35% for the three months ended March 31, 2001.
The effective income tax rate for the three months ended March 31, 2002, was
higher than the corporate income tax rate of 35% due to the allocation of
deferred state taxes.
34
As a result of the foregoing factors, operating earnings and net income
increased $2.6 million, or 11%, to $26.5 million for the three months ended
March 31, 2002, from $23.9 million for the three months ended March 31, 2001.
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,
--------------------------------
2002 2001
-------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues(1):
Total operating revenues.................. $ 10.5 $ 35.0
Expenses:
Total expenses............................ 12.5 2.7
-------------- ---------------
Pre-tax operating earnings (loss).................. (2.0) 32.3
Income taxes (benefits)............................ (2.3) 8.5
-------------- ---------------
Operating earnings................................. 0.3 23.8
Net realized capital gains (losses), as adjusted... 113.0 (19.6)
Non-recurring items................................ (2.0) (9.8)
-------------- ---------------
U.S. GAAP REPORTED:
Net income (loss).................................. $ 111.3 $ (5.6)
============== ===============
- ------------
(1) Excludes net realized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Total operating revenues decreased $24.5 million, or 70%, to $10.5 million for
the three months ended March 31, 2002, from $35.0 million for the three months
ended March 31, 2001. Net investment income decreased $30.7 million, primarily
reflecting a decrease in investment gains on real estate due to lower sales of
certain real estate held-for-sale, compared to an unusually high volume of sales
experienced in 2001. The decrease was partially offset by a $5.7 million
increase in net investment income, resulting from an increase in average
invested assets and cash.
Total expenses increased $9.8 million to $12.5 million for the three months
ended March 31, 2002, from $2.7 million for the three months ended March 31,
2001. Interest expense increased $4.6 million, primarily due to a change in
interest related to federal income tax audit activities. An increase of $2.0
million related to costs associated with operating as a public company. In
addition, a $1.8 million increase was related to corporate initiatives funded by
this segment.
Income tax benefits decreased $10.8 million to a $2.3 million income tax benefit
for the three months ended March 31 2002, from $8.5 million of income tax
expense for the three months ended March 31, 2001. The decrease was primarily a
result of a decrease in pre-tax operating earnings.
As a result of the foregoing factors, operating earnings decreased $23.5
million, or 99%, to $0.3 million for the three months ended March 31, 2002, from
$23.8 million for the three months ended March 31, 2001.
Net realized capital gains (losses), as adjusted, increased $132.6 million to
$113.0 million of net realized capital gains for the three months ended March
31, 2002, from $19.6 million of net realized capital losses for the three months
ended March 31, 2001. The increase was primarily due to a realized capital gain
related to the sale of our investment in Coventry in February 2002.
35
As a result of the foregoing factors and the inclusion of non-recurring items,
net income increased $116.9 million to $111.3 million of net income for the
three months ended March 31, 2002, from $5.6 million of net loss for the three
months ended March 31, 2001. For the three months ended March 31, 2002, net
income included the negative effect of non-recurring items totaling $2.0
million, net of income taxes, related to expenses of our demutualization. For
the three months ended March 31, 2001, net income included the negative effect
of non-recurring items totaling $9.8 million, net of income taxes, related to:
(1) an increase in our loss contingency reserve established for sales practices
litigation ($5.9 million) and (2) expenses related to our demutualization ($3.9
million).
LIQUIDITY AND CAPITAL RESOURCES
SOURCES AND USES OF CASH OF CONSOLIDATED OPERATIONS
Net cash provided by operating activities was $485.0 million and $682.3 million
for the three months ended March 31, 2002 and 2001, respectively. The decrease
in net cash provided was due, in part, to: (1) a decrease in premiums and other
considerations received primarily due to a decrease in premiums from single
premium group annuities with life contingencies and (2) an increase in separate
account withdrawals funded by Principal Life, for which the funds have not yet
been transferred from the separate accounts. The decrease in net cash provided
was partially offset by: (1) a decrease in cash paid for benefits, claims, and
settlement expenses; and (2) an increase in fees and other revenues resulting
from an increase in mortgage loan production volume. Continuation of the low
interest rate environment and poor performance in the equity markets, could
reduce customer demand for pension, individual annuity, variable investment or
mutual fund products, resulting in reduced cash flows from our operations.
However, should interest rates rise, we may experience a decrease in cash flows
from residential mortgage loan production.
Net cash used in investing activities was $888.8 million and $1,764.4 million
for the three months ended March 31, 2002 and 2001, respectively. The decrease
in cash used in investing activities was primarily due to proceeds from the sale
of our shares of Coventry stock. In addition, we experienced a decrease in net
cash invested in available-for-sale securities during 2002 compared to 2001.
Partially offsetting these decreases in cash used was a decrease in net cash
proceeds from real estate.
Net cash provided by financing activities was $337.5 million and $681.1 million
for the three months ended March 31, 2002 and 2001, respectively. The decrease
in net cash provided by financing activities was primarily due to an increase in
investment contract withdrawals. Partially offsetting the decrease were an
increase in net proceeds received from short-term borrowings and a reduction in
the repayment of long-term debt in 2002 compared to the issuance of long-term
debt in 2002.
Given the historical cash flow, 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 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 policyholder surplus as of the previous year-end; or
o the net gain from operations from the previous calendar year.
Iowa law gives the Commissioner discretion to disapprove requests for dividends
in excess of these limits. Based on this limitation and 2001 statutory results,
Principal Life could pay approximately $640.3 million in stockholder dividends
in 2002 without exceeding the statutory limitation.
Total stockholder dividends paid by Principal Life to its parent company in 2002
was $390.0 million. On February 26, 2002, Principal Life declared an ordinary
dividend of $390.0 million which was paid to its parent on April 5, 2002.
36
COMMON STOCK ISSUED AND TREASURY STOCK ACQUIRED
During the three months ended March 31, 2002, another source of liquidity was
the issuance of our common stock which resulted in $11.0 million of proceeds due
to common stock issued to employees participating in our Employee Stock Purchase
Plan, premium from the sale of "put options," and a gain from the reissuance of
treasury stock.
On February 26, 2002, our board of directors authorized the repurchase of up to
$450.0 million of our common stock. The repurchase will be made in the open
market or through privately negotiated transactions from time to time, depending
upon market conditions. During the three months ended March 31, 2002, we
purchased 1.2 million shares in the open market at an aggregate cost of $29.6
million.
INTERNATIONAL OPERATIONS
Primary sources of cash inflows for BT Financial Group are fee revenues and
interest spread earned on margin lending operations. Cash outflows consist
primarily of operating expenses. BT did not require any infusions of capital for
the three months ended March 31, 2002 or 2001.
Our Brazilian and Chilean operations, along with one of our Mexican companies,
produced positive cash flow from operations for the three months ended March 31,
2002 and 2001. These cash flows have been historically maintained at the local
country level for strategic expansion purposes. Our international operations
have required infusions of capital of $5.1 million for the three months ended
March 31, 2002 and $7.5 million for the three months ended March 31, 2001,
respectively, to meet the cash outflow requirements of those operations or to
fund acquisitions. These other operations are primarily in the start-up stage or
are expanding in the short term. Our capital funding of these operations is
consistent with our long-term strategy to establish viable companies that can
sustain future growth from internally generated sources.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following tables present payments due as of March 31, 2002 and due by period
for contractual obligations as of December 31, 2001:
AS OF
MARCH 31,
2002 AS OF DECEMBER 31, 2001
---------- --------------------------------------------------
LESS
THAN 1 4 - 5 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL TOTAL YEAR 1-3 YEARS YEARS YEARS
- -------------------------- ---------- --------- --------- --------- --------- ----------
(IN MILLIONS)
Long-term debt(1)......... $1,343.5 $1,378.4 $ 165.1 $ 288.8 $ 5.4 $ 919.1
Operating leases(2)....... 213.8 213.8 60.3 83.6 44.5 25.4
Non-recourse medium-term
notes(3)................ 3,231.6 3,298.4 160.2 496.1 470.2 2,171.9
---------- --------- --------- --------- --------- ----------
Total contractual
cash obligations...... $4,788.9 $4,890.6 $ 385.6 $ 868.5 $ 520.1 $ 3,116.4
========== ========= ========= ========= ========= ==========
- ---------------
(1) The following are included in long-term debt:
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty
Limited, our wholly-owned indirect subsidiary, issued $665.0 million of
unsecured redeemable long-term debt ($200.0 million of 7.95% notes due
August 15, 2004, and $465.0 million in 8.2% notes due August 15, 2009).
Interest on the notes is payable semiannually on February 15 and August 15
of each year, commencing February 15, 2000. Principal Financial Group
(Australia) Holdings Pty Limited used the net proceeds from the notes to
partially fund the purchase of the outstanding stock of several companies
affiliated with Bankers Trust Australia Group. On December 28, 2001, all of
the long-term debt obligations of Principal Financial Group (Australia)
Holdings Pty Limited were assumed by its parent, PFSI.
37
On March 10, 1994, Principal Life issued $300.0 million of surplus notes,
including $200.0 million due March 1, 2024, at a 7.875% annual interest
rate and the remaining $100.0 million due March 1, 2044, at an 8% annual
interest rate. No affiliates of ours hold any portion of the notes. Each
payment of interest and principal on the notes, however, may be made only
with the prior approval of the Commissioner and only to the extent that
Principal Life has sufficient surplus earnings to make such payments.
Long-term debt includes mortgages and other notes payable for real estate
developments. We have obtained loans with various lenders to finance these
developments. Outstanding principal balances as of December 31, 2001, range
from $0.1 million to $101.9 million per development with interest rates
generally ranging from 7.2% to 8.6%.
(2) As a lessee, we lease office space, data processing equipment, corporate
aircraft and office furniture and equipment under various operating leases.
Operating leases as of March 31, 2002, represents December 31, 2001
information as the leases have not changed significantly since December 31,
2001.
(3) Non-recourse medium term notes represent claims for principal and interest
under international funding agreements issued to non-qualified
institutional investors. These international funding agreements are
afforded equal priority to claims of life insurance and annuity
policyholders under insolvency provisions of Iowa Insurance Laws and,
accordingly, are reported as contractholder funds liabilities.
The components of short-term debt as of March 31, 2002 and December 31, 2001,
are as follows:
AS OF AS OF
MARCH 31, DECEMBER 31,
------------ ----------------
2002 2001
------------ ----------------
(IN MILLIONS)
Commercial paper....................... $ 474.9 $ 199.9
Other recourse short-term debt......... 18.3 22.0
Non-recourse short-term debt........... 200.0 289.7
------------ ----------------
Total short-term debt............... $ 693.2 $ 511.6
============ ================
Short-term debt consists primarily of commercial paper and outstanding balances
on revolving credit facilities with various financial institutions. As of March
31, 2002, we had credit facilities with various financial institutions in an
aggregate amount of $1.4 billion. We may borrow up to $600.0 million on a
back-stop facility to support our $1.0 billion commercial paper program. In
addition, as of March 31, 2002, we have $780.0 million in credit facilities to
finance a CMBS pipeline and $45.0 million of unused lines of credit for
short-term debt used for general corporate purposes.
OFF-BALANCE SHEET ARRANGEMENTS
We have entered into certain contracts to: 1) fund residential mortgage loan
production, 2) sell qualifying delinquent residential mortgage loans, and 3)
securitize margin loans. As appropriate under U.S. GAAP, the contracts involve
special purpose entities ("SPEs") or trusts that are not reported on our
consolidated statement of financial position.
RESIDENTIAL MORTGAGE LOAN PRODUCTION. In June 2000, our mortgage banking segment
created a special purpose bankruptcy remote entity, Principal Residential
Mortgage Capital Resources, LLC ("PRMCR"), to provide an off-balance sheet
source of funding for our residential mortgage loan production. We sell eligible
residential mortgage loans to PRMCR, where they are warehoused until sold to the
final investor. We sold approximately $10.1 billion in residential mortgage
loans to PRMCR in 2002. The maximum amount of residential mortgage loans, which
can be warehoused in PRMCR, has increased from $1.0 billion at inception to $4.0
billion as of March 31, 2002. PRMCR held $2.7 billion in residential mortgage
loans held for sale as of March 31, 2002. The portfolio of loans held for sale
by PRMCR must meet portfolio criteria, eligibility representations, and
portfolio aging limitations. Based on these eligibility representations, we are
required to repurchase ineligible loans from PRMCR.
PRMCR is capitalized by equity certificates owned by third party investors not
affiliated with us or our affiliates, directors, or officers and thus, is not
38
consolidated. The equity holders bear the risk of loss on defaulted mortgages.
At March 31, 2002, PRMCR had outstanding equity certificates of $193.0 million.
PRMCR also issues short-term secured liquidity notes as well as medium term
notes to provide funds for its purchase of residential mortgage loans from us.
At March 31, 2002, PRMCR had outstanding secured liquidity notes of $1.0
billion, three-year fixed term notes of $800.0 million and five-year variable
term notes of $800.0 million. All borrowings are collateralized by the assets of
PRMCR.
We paid a commitment fee to PRMCR based on the overall warehouse limit. PRMCR
used a portion of the fee to fund a cash collateral account maintained at PRMCR.
These funds are available as additional collateral to cover credit related
losses on defaulted loans. The balance in the account was $24.0 million at March
31, 2002. Any remaining amounts in the cash collateral account will be returned
to us upon the termination of PRMCR. This right to the return of the cash
collateral amount is reflected in other assets on our consolidated statements of
financial position.
We maintain a right to the servicing of the residential mortgage loans held by
PRMCR and upon the sale of the majority of the residential mortgage loans to the
final investors. In addition, we perform certain secondary marketing, accounting
and various administrative functions on behalf of PRMCR. As servicer, we receive
a monthly servicing fee, and may receive an excess servicing fee if funds are
available within PRMCR. Additionally, as servicer we are required to advance to
PRMCR those payments due from borrowers, but not received, as of specified
cut-off dates. We received $5.6 million in servicing fees from PRMCR in 2002.
In order to hedge interest rate risk and non-credit related market value risk
associated with its inventory of residential mortgage loans held for sale, PRMCR
entered into swaps with counterparties not affiliated with us or PRMCR. The swap
counterparties are required to maintain certain minimum ratings as approved by
the rating agencies. Through separate swap agreements with the swap
counterparties that mirror the original swaps with PRMCR, the interest rate risk
and non-credit related market value components are swapped back to us.
DELINQUENT RESIDENTIAL MORTGAGE LOAN FUNDING. In October 2000, our mortgage
banking segment created a wholly-owned, unconsolidated qualifying special
purpose entity, Principal Residential Mortgage Funding, LLC ("PRMF"), to provide
an off-balance sheet source of funding for up to $250.0 million of qualifying
delinquent residential mortgage loans. The limit was increased to $357.0 million
in December 2001. We sell qualifying delinquent loans to PRMF which then
transfers the loans to Principal Residential Mortgage EBO Trust ("Trust"), an
unaffiliated Delaware business trust. The Trust funds its acquisitions of
residential mortgage loans by selling participation certificates, representing
an undivided interest in the Trust, to commercial paper conduit purchasers, who
are not affiliated with us or any of our affiliates, directors or officers. At
March 31, 2002, PRMF held $293.5 million in residential mortgage loans and had
outstanding participation certificates of $275.4 million.
Residential mortgage loans typically remain in the Trust until they are
processed through the foreclosure claim process, are paid-off or reinstate.
Loans that reinstate are no longer eligible to remain in the Trust and are
required to be removed by us at fair market value at the monthly settlement date
following reinstatement.
We are retained as the servicer of the residential mortgage loans and also
perform accounting and various administrative functions on behalf of PRMF, in
its capacity as the managing member of PRMF. As the servicer, we receive a
servicing fee pursuant to the pooling and servicing agreement. We may also
receive a successful servicing fee only after all other conditions in the
monthly cash flow distribution are met. At March 31, 2002, our residual interest
in such cash flows was $22.8 million and was recorded in other investments on
the consolidated statements of financial position. The value of the residual
interest was based on the net present value of expected cash flows from PRMF, as
well as estimates of foreclosure losses associated with the related loans. We
are required to advance funds for payment of interest on the participation
certificates and other carrying costs, if sufficient cash is not available in
the collection account to meet this obligation.
We and the Trust are parties to a cost of funds hedge agreement. We pay the
weighted average cost of funds on the participation certificates plus fees and
expenses and receive the indicated swap bid rate, subject to a cap.
MARGIN LOAN SECURITIZATIONS. We sell loans under a margin loan securitization
program and retain primary servicing responsibilities and subordinated
interests. We receive servicing distributions approximating 0.3 percent of the
outstanding balance and rights to future cash flows through an excess
distribution from the trust, representing the balance remaining after all
interest and fees of the trust have been accounted for. Our retained interests
are subordinated to investors' interests. Retained interests equate to 7% of the
outstanding loan balances, of which we earn a return of 2.0% over the Australian
30 day Bank Bill swap rate. The investors and the securitization trusts have no
39
recourse to our other assets for failure of debtors to pay when due. The value
of our retained interests is subject to market risk and all positions are
primarily hedged. No gains or losses on the transaction have been realized to
date.
The estimated fair values of the retained interests, $40.4 million at March 31,
2002, are based upon our relative ownership percentage of the book value of the
outstanding loan balances.
Proceeds from advances on margin loans previously securitized were $5.3 million
for the three months ended March 31, 2002.
INVESTMENTS
We had total consolidated assets as of March 31, 2002, of $88.8 billion, of
which $45.4 billion were invested assets. The rest of our total consolidated
assets are comprised primarily of separate account assets for which we do not
bear investment risk. Because we generally do not bear any investment risk on
assets held in separate accounts, the discussion and financial information below
does not include such assets. Of our invested assets, $44.0 billion were held by
our U.S. operations and the remaining $1.4 billion were held by our
International Asset Management and Accumulation segment.
U.S. INVESTMENT OPERATIONS
Our U.S. invested assets are managed by Principal Capital Management, a
subsidiary of Principal Life. Our primary investment objective is to maximize
after-tax returns consistent with acceptable risk parameters. We seek to protect
policyholders' benefits by optimizing the risk/return relationship on an ongoing
basis, through asset/liability matching, reducing the credit risk, avoiding high
levels of investments that may be redeemed by the issuer, maintaining
sufficiently liquid investments and avoiding undue asset concentrations through
diversification. We are exposed to three primary sources of investment risk:
o credit risk, relating to the uncertainty associated with the continued
ability of a given obligor to make timely payments of principal and
interest;
o interest rate risk, relating to the market price and/or cash flow
variability associated with changes in market yield curves; and
o equity risk, relating to adverse fluctuations in a particular common stock.
Our ability to manage credit risk is essential to our business and our
profitability. We devote considerable resources to the credit analysis of each
new investment. We manage credit risk through industry, issuer and asset class
diversification. Our Investment Committee, appointed by our board of directors,
establishes all investment policies and reviews and approves all investments. As
of March 31, 2002, there are nine members on the Investment Committee, one of
whom is a member of our board of directors. The remaining eight members are
senior management members representing various areas of our company.
Our Fixed Income Securities Committee, consisting of fixed income securities
senior management members, approves the credit rating for the fixed maturity
securities we purchase. Teams of security analysts organized by industry focus
either on the public or private markets and analyze and monitor these
investments. In addition, we have teams who specialize in residential
mortgage-backed securities, commercial mortgage-backed securities and public
below investment grade securities. We establish a credit reviewed list of
approved public issuers to provide an efficient way for our portfolio managers
to purchase liquid bonds for which credit review has already been completed.
Issuers remain on the list for six months unless removed by our analyst. Our
analysts monitor issuers on the list on a continuous basis with a formal review
documented every six months or more frequently if material events affect the
issuer. The analysis includes both fundamental and technical factors. The
fundamental analysis encompasses both quantitative and qualitative analysis of
the issuer.
The qualitative analysis includes an assessment of both accounting and
management aggressiveness. In addition, technical indicators such as stock price
volatility and credit default swap levels are monitored.
40
Our Fixed Income Securities Committee also reviews private transactions on a
continuous basis to assess the quality ratings of our privately placed
investments. We regularly review our investments to determine whether we should
re-rate them, employing the following criteria:
o material declines in the issuer's revenues or margins;
o significant management or organizational changes;
o significant uncertainty regarding the issuer's industry;
o debt service coverage or cash flow ratios that fall below industry-specific
thresholds;
o violation of financial covenants; and
o other business factors that relate to the issuer.
A dedicated risk management team is responsible for centralized monitoring of
the commercial mortgage portfolio. We apply a variety of strategies to minimize
credit risk in our commercial mortgage loan portfolio. When considering the
origination of new commercial mortgage loans, we review the cash flow
fundamentals of the property, make a physical assessment of the underlying
security, conduct a comprehensive market analysis and compare against industry
lending practices. We use a proprietary risk rating model to evaluate all new
and a majority of existing loans within the portfolio. The proprietary risk
model is designed to stress projected cash flows under simulated economic and
market downturns. Our lending guidelines are designed to encourage 75% or less
loan-to-value ratios and a debt service coverage ratio of at least 1.2 times. We
analyze investments outside of these guidelines based on cash flow quality,
tenancy and other factors. The weighted average loan-to-value ratio at
origination for brick and mortar commercial mortgages in our portfolio was 70%
and the debt service coverage ratio at loan inception was 2.2 times as of March
31, 2002.
We have limited exposure to equity risk in our common stock portfolio. Equity
securities accounted for only 2% of our U.S. invested assets as of March 31,
2002.
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, 2002, were predominantly of high quality
and broadly diversified across asset class, individual credit, industry and
geographic location. As shown in the following table, the major categories of
U.S. invested assets are fixed maturity securities and commercial mortgages. The
remainder is invested in real estate, equity securities and other assets. In
addition, policy loans are included in our invested assets. We combined our
invested assets in the Closed Block with invested assets outside the Closed
Block in view of the similar asset quality characteristics of the two
portfolios. The following discussion analyzes the composition of U.S. invested
assets, which includes $4,237.3 million in invested assets of the Closed Block
as of March 31, 2002, but excludes invested assets of the participating separate
accounts.
41
U.S. INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
---------- -------- ---------- --------
($ IN MILLIONS)
Fixed maturity securities
Public................................. $ 19,273.7 44% $ 18,227.6 42%
Private................................ 10,594.2 24 10,800.2 25
Equity securities, available-for-sale..... 873.0 2 808.7 2
Mortgage loans
Commercial ............................ 9,565.2 22 9,740.4 22
Residential............................ 1,119.2 2 1,144.2 3
Real estate held for sale ................ 390.2 1 390.7 1
Real estate held for investment........... 865.5 2 783.4 2
Policy loans.............................. 823.2 2 831.9 2
Other investments ........................ 523.5 1 678.4 1
---------- -------- ---------- --------
Total invested assets.................. $ 44,027.7 100% $ 43,405.5 100%
=== ===
Cash and cash equivalents................. 429.8 495.8
---------- ----------
Total invested assets and cash ........ $ 44,457.5 $ 43,901.3
========== ==========
We actively manage public fixed maturity securities, including our portfolio of
residential mortgage-backed securities, in order to provide liquidity and
enhance yield and total return. Our residential mortgage-backed securities are
managed to ensure that the securities we hold trade close to or below par in
order to manage prepayment risk. This active management has resulted in the
realization of capital gains and losses with respect to such investments.
U.S. INVESTMENT RESULTS
The yield on U.S. invested assets and on cash and cash equivalents, excluding
net realized gains and losses, was 7.1% and 7.7% for the three months ended
March 31, 2002 and 2001, respectively.
42
The following table illustrates the yields on average assets for each of the
components of our investment portfolio for the three months ended March 31, 2002
and 2001, respectively:
U.S. INVESTED ASSETS
YIELDS BY ASSET TYPE
AS OF OR FOR THE THREE MONTHS ENDED MARCH 31,
---------------------------------------------
2002 2001
------------------ ------------------
YIELD AMOUNT YIELD AMOUNT
------ ---------- ------ ----------
($ IN MILLIONS)
Fixed maturity securities
Gross investment income(1)........... 7.0% $ 517.9 7.7% $ 523.5
Net realized capital losses.......... (1.1) (79.1) (0.4) (25.3)
---------- ----------
Total.............................. $ 438.8 $ 498.2
========== ==========
Ending assets (at carrying value).... $29,867.9 $28,302.5
Equity securities, available-for-sale
Gross investment income(1)........... 4.2% $ 8.8 2.4% $ 3.8
Net realized capital losses.......... (3.4) (7.1) (23.0) (35.8)
---------- ----------
Total.............................. $ 1.7 $ (32.0)
========== ==========
Ending assets (at carrying value).... $ 873.0 $ 580.9
Mortgage loans - Commercial
Gross investment income(1)........... 7.6% $ 182.3 7.8% $ 207.3
Net realized capital gains (losses).. (0.3) (7.0) 0.3 8.8
---------- ----------
Total.............................. $ 175.3 $ 216.1
========== ==========
Ending assets (at carrying value).... $ 9,565.2 $10,491.7
Mortgage loans - Residential
Gross investment income(1)........... 6.9% $ 19.5 7.1% $ 11.2
Net realized capital gains (losses).. - - - -
---------- ----------
Total.............................. $ 19.5 $ 11.2
========== ==========
Ending assets (at carrying value).... $ 1,119.2 $ 716.8
Real estate
Gross investment income(1)........... 7.9% $ 23.9 19.7% $ 63.2
Net realized capital gains (losses).. (0.3) (1.0) 6.5 20.9
---------- ----------
Total.............................. $ 22.9 $ 84.1
========== ==========
Ending assets (at carrying value).... $ 1,255.7 $ 1,177.8
Policy loans
Gross investment income(1)........... 7.0% $ 14.5 7.0% $ 14.3
Net realized capital gains (losses).. - - - -
---------- ----------
Total.............................. $ 14.5 $ 14.3
========== ==========
Ending assets (at carrying value).... $ 823.2 $ 819.3
Cash and cash equivalents
Gross investment income(1)........... 3.7% $ 4.3 (1.1)% $ (1.6)
Net realized capital losses.......... (0.9) (1.0) - -
---------- ----------
Total $ 3.3 $ (1.6)
========== ==========
Ending assets (at carrying value).... $ 429.8 $ 408.5
Other investments
Gross investment income(1)........... 24.3% $ 36.5 10.4% $ 18.9
Net realized capital gains (losses).. 123.8 186.0 (6.5) (11.8)
---------- ----------
Total.............................. $ 222.5 $ 7.1
========== ==========
Ending assets (at carrying value).... $ 523.5 $ 767.8
Total before investment expenses
Gross investment income(1)........... 7.3% $ 807.7 7.9% $ 840.6
Net realized capital gains (losses).. 0.8 90.8 (0.4) (43.2)
---------- ----------
Total.............................. $ 898.5 $ 797.4
========== ==========
Investment expenses.................... 0.2% $ 19.0 0.3% $ 27.0
Net investment income.................. 7.1% $ 788.7 7.7% $ 813.6
- --------------------
(1) Yields, which are annualized for interim periods, are based on quarterly
average asset carrying values for the three months ended March 31, 2002 and
2001.
43
FIXED MATURITY SECURITIES
We have classified the majority of our fixed maturity securities as
available-for-sale. Accordingly, we mark such securities to market, with
unrealized gains and losses excluded from earnings and reported as a separate
component of other comprehensive income, net of deferred income taxes and an
adjustment for the effect on deferred policy acquisition costs that would have
occurred had such gains and losses been realized. We write down to fair value
securities whose value is deemed other than temporarily impaired. We record
write downs as realized losses included in net income and adjust the cost basis
of such securities to fair value. The new cost basis is not changed for
subsequent recoveries in value.
Fixed maturity securities consist of short-term investments, publicly traded
debt securities, privately placed debt securities and small amounts of
redeemable preferred stock, and represented 68% of total U.S. invested assets as
of March 31, 2002 and 67% as of December 31, 2001. The fixed maturity securities
portfolio was comprised, based on carrying amount, of 65% in publicly traded
fixed maturity securities and 35% in privately placed fixed maturity securities
as of March 31, 2002, and 63% in publicly traded fixed maturity securities and
37% in privately placed fixed maturity securities as of December 31, 2001.
Included in the privately placed category as of March 31, 2002, were $3.5
billion of securities eligible for resale to qualified institutional buyers
under Rule 144A under the Securities Act of 1933. Fixed maturity securities were
diversified by category of issuer as of March 31, 2002, and December 31, 2001,
as shown in the following table:
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY TYPE OF ISSUER
AS OF MARCH 31, AS OF DECEMBER 31,
---------------- ------------------
2002 2001
---------------- ------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
--------- ----- --------- -----
($ IN MILLIONS)
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies.. $ 292.8 1% $ 15.1 -%
States and political subdivisions............ 316.5 1 317.5 1
Foreign governments.......................... 507.7 2 603.5 2
Corporate - public........................... 13,991.3 47 13,038.8 45
Corporate - private.......................... 9,072.2 30 9,171.1 32
Mortgage-backed securities and other asset-
backed securities.......................... 5,687.4 19 5,881.8 20
--------- ----- --------- ----
Total fixed maturities..................... $29,867.9 100% $29,027.8 100%
========= === ========= ===
The international exposure in our U.S. invested assets totaled $3,819.7 million,
or 13%, of total fixed maturity securities, as of March 31, 2002, comprised of
corporate and foreign government fixed maturity securities. Of the $3,819.7
million as of March 31, 2002, investments totaled $1,125.6 million in the United
Kingdom, $606.2 million in the continental European Union, $519.9 million in
Asia, $381.7 million in South America, $332.1 million in Australia and $25.9
million in Japan. The remaining $828.3 million was invested in 13 other
countries. All international fixed maturity securities held by our U.S.
operations are either denominated in U.S. dollars or have been swapped into U.S.
dollar equivalents. Our international investments are analyzed internally by
country and industry credit investment professionals. We control concentrations
using issuer and country level exposure benchmarks, which are based on the
credit quality of the issuer and the country. Our investment policy limits total
international fixed maturity securities investments to 15% of total statutory
general account assets with a 4% limit in emerging markets. Exposure to Canada
is not included in our international exposure due to its treatment by the NAIC.
As of March 31, 2002, our investments in Canada totaled $970.5 million.
The Securities Valuation Office of the NAIC evaluates most of the fixed maturity
securities that we and other U.S. insurance companies hold. The Securities
Valuation Office evaluates the bond investments of insurers for regulatory
reporting purposes and assigns securities to one of six investment categories.
The NAIC Designations closely mirror the nationally recognized securities rating
organizations' credit ratings for marketable bonds. NAIC Designations 1 and 2
include bonds considered investment grade by such rating organizations. Bonds
are considered investment grade when rated "Baa3" or higher by Moody's, or
"BBB-" or higher by Standard & Poor's. NAIC Designations 3 through 6 are
referred to as below investment grade. Bonds are considered below investment
grade when rated "Ba1" or lower by Moody's, or "BB+" or lower by Standard &
Poor's.
44
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 2.43 times compared to the
Standard & Poor's drift ratio of 4.27 times, as of December 31, 2001.
The following tables present our publicly traded, privately placed and total
fixed maturity securities by NAIC Designation and the equivalent ratings of the
nationally recognized securities rating organizations as of March 31, 2002, and
December 31, 2001, as well as the percentage, based on estimated fair value,
that each designation comprises:
U.S. INVESTED ASSETS
PUBLICLY TRADED FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF MARCH 31, 2002 AS OF DECEMBER 31, 2001
------------------------------ ------------------------------
% OF % OF
RATING TOTAL TOTAL
NAIC AGENCY AMORTIZED CARRYING CARRYING AMORTIZED CARRYING CARRYING
RATING EQUIVALENT COST AMOUNT AMOUNT COST AMOUNT AMOUNT
- ------ --------------------- --------- --------- -------- --------- --------- --------
($ IN MILLIONS)
1 Aaa/Aa/A............. $10,307.6 $10,596.8 55% $ 9,955.3 $10,406.5 57%
2 Baa.................. 7,977.4 8,049.6 42 6,939.5 7,112.8 39
3 Ba................... 364.5 353.6 2 496.3 474.5 3
4 B.................... 189.7 188.5 1 165.3 148.4 1
5 Caa and lower........ 44.4 37.7 - 28.4 26.5 -
6 In or near default... 61.6 47.5 - 60.6 58.9 -
--------- --------- -------- --------- --------- --------
Total public
fixed maturities... $18,945.2 $19,273.7 100% $17,645.4 $18,227.6 100%
========= ========= === ========= ========= ===
U.S. INVESTED ASSETS
PRIVATELY PLACED FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF MARCH 31, 2002 AS OF DECEMBER 31, 2001
------------------------------ ------------------------------
% OF % OF
RATING TOTAL TOTAL
NAIC AGENCY AMORTIZED CARRYING CARRYING AMORTIZED CARRYING CARRYING
RATING EQUIVALENT COST AMOUNT AMOUNT COST AMOUNT AMOUNT
- ------ --------------------- --------- --------- -------- --------- --------- --------
($ IN MILLIONS)
1 Aaa/Aa/A............. $ 4,198.0 $ 4,301.0 40% $ 4,184.6 $ 4,349.7 40%
2 Baa.................. 4,687.2 4,778.4 45 4,780.5 4,921.8 46
3 Ba................... 1,089.5 1,065.8 10 1,105.7 1,085.9 10
4 B.................... 196.3 186.2 2 236.4 223.7 2
5 Caa and lower........ 77.6 72.1 1 64.0 64.3 1
6 In or near default... 206.3 190.7 2 180.3 154.8 1
--------- --------- -------- --------- --------- --------
Total private
fixed maturities... $10,454.9 $10,594.2 100% $10,551.5 $10,800.2 100%
========= ========= === ========= ========= ===
45
U.S. INVESTED ASSETS
TOTAL FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF MARCH 31, 2002 AS OF DECEMBER 31, 2001
------------------------------ ------------------------------
% OF % OF
RATING TOTAL TOTAL
NAIC AGENCY AMORTIZED CARRYING CARRYING AMORTIZED CARRYING CARRYING
RATING EQUIVALENT COST AMOUNT AMOUNT COST AMOUNT AMOUNT
- ------ --------------------- --------- --------- -------- --------- --------- --------
($ IN MILLIONS)
1 Aaa/Aa/A............. $14,505.6 $14,897.8 50% $14,139.9 $14,756.2 51%
2 Baa.................. 12,664.6 12,828.0 43 11,720.0 12,034.6 42
3 Ba................... 1,454.0 1,419.4 5 1,602.0 1,560.4 5
4 B.................... 386.0 374.7 1 401.7 372.1 1
5 Caa and lower........ 122.0 109.8 - 92.4 90.8 -
6 In or near default... 267.9 238.2 1 240.9 213.7 1
--------- --------- -------- --------- --------- --------
Total fixed
Maturities....... $29,400.1 $29,867.9 100% $28,196.9 $29,027.8 100%
========= ========= === ========= ========= ===
We believe that our long-term fixed maturity securities portfolio is well
diversified among industry types and between publicly traded and privately
placed securities. Each year we direct the majority of our net cash inflows into
investment grade fixed maturity securities. We typically invest up to 7% of
general account cash flow in below investment grade assets. While the general
account investment returns have improved due to the below investment grade asset
class, we manage its growth strategically by limiting it to 10% of the total
fixed maturity securities portfolio.
We invest in privately placed fixed maturity securities to enhance the overall
value of the portfolio, increase diversification and obtain higher yields than
are possible with comparable quality public market securities. Generally,
private placements provide broader access to management information,
strengthened negotiated protective covenants, call protection features and,
where applicable, a higher level of collateral. They are, however, generally not
freely tradable because of restrictions imposed by federal and state securities
laws and illiquid trading markets. As of March 31, 2002, the percentage, based
on estimated fair value, of total publicly traded and privately placed fixed
maturity securities that were investment grade with an NAIC Designation 1 or 2
was 93%.
The following tables show the carrying amount of our corporate fixed maturity
securities by industry category, as well as the percentage of the total
corporate portfolio that each industry category comprises as of March 31, 2002,
and December 31, 2001. The tables also show by industry category the relative
amounts of publicly traded and privately placed securities.
U.S. INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY INDUSTRY AS OF MARCH 31, 2002
PUBLICLY TRADED PRIVATELY PLACED TOTAL
------------------- ------------------- -------------------
CARRYING % OF CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
----------- ------ ----------- ------ ----------- ------
($ IN MILLIONS)
INDUSTRY CLASS
Transportation and Public Utilities..... $ 5,249.2 38% $ 2,097.4 23% $ 7,346.6 32%
Finance, Insurance and Real Estate...... 3,436.0 25 2,105.0 23 5,541.0 24
Manufacturing........................... 3,008.4 21 2,414.1 27 5,422.5 24
Mining.................................. 1,135.3 8 881.4 10 2,016.7 9
Retail.................................. 520.4 4 730.5 8 1,250.9 5
Services................................ 384.6 3 533.3 6 917.9 4
Agriculture, Forestry and Fishing....... 191.5 1 47.1 - 238.6 1
Public Administration................... 63.1 - 157.4 2 220.5 1
Construction............................ 2.8 - 106.0 1 108.8 -
----------- ----- ----------- ------ ----------- ------
Total............................... $ 13,991.3 100% $ 9,072.2 100% $ 23,063.5 100%
=========== === =========== === =========== ===
46
U.S. INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY INDUSTRY
AS OF DECEMBER 31, 2001
PUBLICLY TRADED PRIVATELY PLACED TOTAL
------------------- ------------------- -------------------
CARRYING % OF CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
----------- ------ ----------- ------ ----------- ------
($ IN MILLIONS)
INDUSTRY CLASS
Transportation and Public Utilities..... $ 5,119.9 39% $ 2,120.7 23% $ 7,240.6 33%
Finance, Insurance and Real Estate...... 3,296.0 25 2,107.7 23 5,403.7 24
Manufacturing........................... 2,765.9 21 2,461.9 27 5,227.8 23
Mining.................................. 891.5 7 865.0 9 1,756.5 8
Retail.................................. 484.4 4 738.6 8 1,223.0 5
Services................................ 384.2 3 593.9 7 978.1 4
Public Administration................... 31.8 - 122.6 1 154.4 1
Construction............................ 1.8 - 112.5 1 114.3 1
Agriculture, Forestry and Fishing....... 63.3 1 48.2 1 111.5 1
----------- ------ ----------- ------ ----------- ------
Total............................... $ 13,038.8 100% $ 9,171.1 100% $ 22,209.9 100%
=========== === =========== === =========== ===
As of March 31, 2002, our largest unaffiliated single concentration of fixed
maturity securities consisted of $333.2 million of corporate bonds by American
International Group and its affiliates. This represented approximately 1% of our
total U.S. invested assets as of March 31, 2002. No other individual
non-government issuer represented more than 1% of U.S. invested assets.
We held $5,687.4 million of mortgage-backed and asset-backed securities as of
March 31, 2002, and $5,881.8 million as of December 31, 2001. The following
table presents the types of mortgage-backed securities ("MBSs"), as well as
other asset-backed securities, held as of the dates indicated:
U.S. INVESTED ASSETS
MORTGAGE AND ASSET-BACKED SECURITIES
CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
(IN MILLIONS)
Residential pass-through securities.......... $ 2,651.5 $ 2,855.5
Commercial MBS............................... 1,941.2 1,874.1
Asset-backed securities...................... 1,094.7 1,152.2
--------------- ------------------
Total MBSs and asset-backed securities.... $ 5,687.4 $ 5,881.8
=============== ==================
We believe that it is desirable to hold residential mortgage-backed securities
due to their credit quality and liquidity as well as portfolio diversification
characteristics. Our portfolio is comprised of GNMA, FNMA and FHLMC pass-through
securities and is actively managed to ensure that the securities held are
trading close to or below par, in order to reduce risk of prepayments. As of
March 31, 2002, we held no collateralized mortgage obligations in our U.S.
invested asset portfolio.
Commercial mortgage-backed securities provide high levels of credit protection,
diversification, reduced event risk and enhanced liquidity. Commercial
mortgage-backed securities are predominantly comprised of rated large pool
securitizations that are individually and collectively diverse by property type,
borrower and geographic dispersion.
We purchase asset-backed securities, ("ABS"), to diversify the overall credit
risks of the fixed maturity securities portfolio and to provide attractive
returns. The principal risks in holding asset-backed securities are structural
and credit risks. Structural risks include the security's priority in the
issuer's capital structure, the adequacy of and ability to realize proceeds from
the collateral and the potential for prepayments. Credit risks involve
issuer/servicer risk where collateral values can become impaired in the event of
servicer credit deterioration.
47
Our ABS portfolio is diversified both by type of asset and by issuer. We
actively monitor holdings of asset-backed securities to ensure that the risk
profile of each security improves or remains consistent. If we are not receiving
an adequate yield for the risk, relative to other investment opportunities, we
will attempt to sell the security. Prepayments in the ABS portfolio are, in
general, insensitive to changes in interest rates or are insulated to such
changes by call protection features. In the event that we are subject to
prepayment risk, we monitor the factors that impact the level of prepayment and
prepayment speed for those asset-backed securities. To the extent we believe
that prepayment risk increases, we may attempt to sell the security and reinvest
in another security that offers better yield relative to the risk. In addition,
we diversify the risks of asset-backed securities by holding a diverse class of
securities, which limits our exposure to any one security.
U.S. INVESTED ASSETS
ASSET-BACKED SECURITIES BY TYPE
CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
(IN MILLIONS)
Credit cards....................... $ 124.0 $ 131.2
Automobile receivables............. 44.1 49.7
Collateralized debt obligations.... 448.6 468.6
Lease receivables.................. 76.1 101.5
Consumer loans..................... 121.2 126.5
Other.............................. 280.7 274.7
--------------- -----------------
Total asset-backed securities... $ 1,094.7 $ 1,152.2
=============== =================
In accordance with our asset liability risk management techniques, we manage the
expected lives of U.S. invested assets to be similar to the lives of our
liabilities. Significant amounts of our liabilities have an expected life of six
years or less. Therefore, comparable amounts of assets have a similar expected
life. The amortized cost and estimated fair value of fixed maturity securities,
by contractual maturity dates, excluding scheduled sinking funds, as of March
31, 2002, and December 31, 2001, were as follows:
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY CONTRACTUAL MATURITY DATES
AS OF MARCH 31, AS OF DECEMBER 31,
---------------------------- ---------------------------
2002 2001
---------------------------- ---------------------------
AMORTIZED CARRYING AMORTIZED CARRYING
COST AMOUNT COST AMOUNT
------------ ------------ ------------ ------------
(IN MILLIONS)
Due in one year or less.............................. $ 1,406.6 $ 1,412.9 $ 1,358.2 $ 1,367.3
Due after one year through five years................ 10,506.4 10,727.3 10,484.3 10,815.0
Due after five years through ten years............... 6,302.3 6,389.1 5,535.6 5,722.0
Due after ten years.................................. 5,657.7 5,651.2 5,159.3 5,241.7
------------ ------------ ------------ ------------
Subtotal.......................................... 23,873.0 24,180.5 22,537.4 23,146.0
Mortgage-backed and other securities without a
single maturity date.............................. 5,527.1 5,687.4 5,659.5 5,881.8
------------ ------------ ------------ ------------
Total........................................... $ 29,400.1 $ 29,867.9 $ 28,196.9 $ 29,027.8
============ ============ ============ ============
We monitor any decline in the credit quality of fixed maturity securities
through the designation of "problem securities", "potential problem securities"
and "restructured securities". We define problem securities in our fixed
maturity portfolio as securities: (i) as to which principal and/or interest
payments are in default or (ii) issued by a company that went into bankruptcy
subsequent to the acquisition of such securities. We define potential problem
securities in our fixed maturity portfolio as securities included on an internal
48
"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.
In December 2001, Enron Corp., along with certain of its subsidiaries, filed
voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy
Court. We recognized realized losses in 2001 for other than temporary
impairments and have classified our remaining investment in Enron Corp. and
Enron related entities in our problem fixed maturity securities in the amount of
$49.6 million as of March 31, 2002.
The following table presents the total carrying amount of our fixed maturity
portfolio, as well as its problem, potential problem and restructured fixed
maturities for the periods indicated:
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED FIXED MATURITIES AT CARRYING AMOUNT
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
($ IN MILLIONS)
Total fixed maturity securities (public and private)........... $ 29,867.9 $ 29,027.8
=============== ==================
Problem fixed maturity securities.............................. $ 148.8 $ 198.8
Potential problem fixed maturity securities.................... 387.1 365.1
Restructured fixed maturity securities......................... 134.8 110.8
--------------- ------------------
Total problem, potential problem and restructured fixed
maturity securities....................................... $ 670.7 $ 674.7
=============== ==================
Total problem, potential problem and restructured fixed
maturity securities as a percent of total fixed maturity
securities................................................ 2% 2%
EQUITY SECURITIES
Our equity securities consist primarily of investments in common stocks. We
classify our investment in common stocks as available for sale and report them
at fair value. We report unrealized gains and losses on common stocks as a
separate component of other comprehensive income, net of deferred income taxes
and an adjustment for the effect on deferred acquisition costs that would have
occurred if such gains and losses had been realized.
Investments in equity securities, totaled $873.0 million and $808.7 million,
which represented 2% of U.S. invested assets as of March 31, 2002, and December
31, 2001, respectively. Investments in company-sponsored funds totaled $513.7
million, or 59%, of our U.S. equity securities as of March 31, 2002. These
sponsored funds are intended to be marketed to our asset management clients. Of
company-sponsored funds, $322.4 million represented underlying investments in
publicly-traded equities, $185.7 million represented investments in
publicly-traded fixed income securities and $5.6 million in balanced funds which
represented investments in both publicly-traded equities and fixed income
securities as of March 31, 2002. The remaining balance of equity securities is a
mixture of public and private securities acquired for investment purposes or
which were acquired through equity participation features of below investment
grade bonds or through recoveries of defaulted securities.
MORTGAGE LOANS
Mortgage loans comprised 24% and 25% of total U.S. invested assets as of March
31, 2002, and December 31, 2001, respectively. Mortgage loans consist of
commercial and residential loans. Commercial mortgage loans comprised $9,565.2
million as of March 31, 2002, and $9,740.4 million as of December 31, 2001, or
90% and 89%, of total mortgage loan investments, respectively. Residential
mortgages comprised $1,119.2 million and $1,144.2 million, or 10% and 11%, of
total mortgage loan investments as of March 31, 2002, and December 31, 2001,
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.
49
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 22% of our commercial mortgage loan portfolio as of
March 31, 2002. We are, therefore, exposed to potential losses resulting from
the risk of catastrophes, such as earthquakes, that may affect the region. Like
other lenders, we generally do not require earthquake insurance for properties
on which we make commercial mortgage loans. With respect to California
properties, however, we obtain an engineering report specific to each property.
The report assesses the building's design specifications, whether it has been
upgraded to meet seismic building codes and the maximum loss that is likely to
result from a variety of different seismic events. We also obtain a report that
assesses by building and geographic fault lines the amount of loss our
commercial mortgage loan portfolio might suffer under a variety of seismic
events.
The following is a summary of our commercial mortgage loans by property type and
region as of March 31, 2002, and December 31, 2001:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE LOAN DISTRIBUTION BY TYPE
AS OF MARCH 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
---------- ----- ---------- -----
($ IN MILLIONS)
Office................ $ 3,217.7 33% $ 3,252.5 33%
Retail................ 3,031.1 32 3,106.5 32
Industrial............ 2,846.1 30 2,948.9 30
Apartments............ 400.5 4 349.8 4
Mixed use/other....... 105.9 1 111.8 1
Hotel................. 61.6 1 61.6 1
Valuation allowance... (97.7) (1) (90.7) (1)
---------- ----- ---------- -----
Total.............. $ 9,565.2 100% $ 9,740.4 100%
========== === ========== ===
50
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE LOAN DISTRIBUTION BY REGION
AS OF MARCH 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
---------- ----- ---------- -----
($ IN MILLIONS)
Pacific................. $2,419.1 25% $2,421.3 25%
South Atlantic.......... 2,261.2 24 2,403.0 25
Middle Atlantic......... 1,584.5 16 1,606.3 16
East North Central...... 922.3 10 930.1 10
West South Central...... 759.2 8 769.0 8
Mountain................ 642.0 7 637.7 7
West North Central...... 405.3 4 397.8 4
New England............. 343.0 4 327.4 3
East South Central...... 326.3 3 338.5 3
Valuation allowance..... (97.7) (1) (90.7) (1)
---------- ----- ---------- -----
Total................ $9,565.2 100% $9,740.4 100%
========== === ========== ===
Our commercial loan portfolio is highly diversified by borrower. As of March 31,
2002, 41% of the U.S. commercial mortgage loan portfolio was comprised of
mortgage loans with principal balances of less than $10.0 million. The following
table shows our U.S. commercial mortgage loan portfolio by loan size, for the
periods indicated:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE LOAN PORTFOLIO - BY LOAN SIZE
AS OF MARCH 31, 2002 AS OF DECEMBER 31, 2001
---------------------------- ----------------------------
NUMBER PRINCIPAL % OF NUMBER PRINCIPAL % OF
OF LOANS BALANCE TOTAL OF LOANS BALANCE TOTAL
-------- --------- ----- -------- --------- -----
($ IN MILLIONS)
Under $5 million........................ 1,066 $ 2,251.0 23% 1,102 $ 2,306.7 23%
$5 million but less than $10 million.... 251 1,768.6 18 275 1,925.5 20
$10 million but less than $20 million... 172 2,336.0 24 168 2,267.2 23
$20 million but less than $30 million... 58 1,394.5 15 59 1,410.6 14
$30 million and over.................... 42 1,914.8 20 42 1,925.0 20
-------- --------- ----- -------- --------- -----
Total............................. 1,589 $ 9,664.9 100% 1,646 $ 9,835.0 100%
======== ========= === ======== ========= ===
The total number of commercial mortgage loans outstanding as of March 31, 2002
and December 31, 2001 was 1,589 and 1,646, respectively. The average loan size
of our commercial mortgage portfolio was $6.1 million as of March 31, 2002. The
largest loan on any single property at such dates aggregated $100.0 million for
March 31, 2002 and December 31, 2001, respectively, and represented 0.2% of U.S.
invested assets on these dates. Total mortgage loans to the 10 largest borrowers
accounted in the aggregate for approximately 7% of the total carrying amount of
the commercial mortgage loan portfolio as of March 31, 2002, and December 31,
2001, respectively and 2% of total U.S. invested assets as of March 31, 2002 and
December 31, 2001, respectively. As of such dates, all such loans were
performing.
51
The following table presents the disposition of maturities as of March 31, 2002,
and December 31, 2001:
U.S. INVESTED ASSETS
DISPOSITIONS OF SCHEDULED MATURITIES OF COMMERCIAL MORTGAGE LOANS
AMORTIZED COST
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
(IN MILLIONS)
Paid as scheduled...... $ 33.4 $ 434.7
Extended............... 92.0 138.1
Refinanced............. 35.8 75.7
Foreclosed............. - 5.4
Expired maturities..... - 10.6
--------------- ------------------
Total............... $ 161.2 $ 664.5
=============== ==================
The amortized cost of commercial mortgage loans by contractual maturity dates,
excluding scheduled sinking funds as of March 31, 2002, and December 31, 2001,
are as follows:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE LOAN PORTFOLIO MATURITY PROFILE
AS OF MARCH 31, AS OF DECEMBER 31,
----------------- ------------------
2002 2001
----------------- ------------------
AMORTIZED % OF AMORTIZED % OF
COST TOTAL COST TOTAL
--------- ------ --------- ------
($ IN MILLIONS)
Due in one year or less................ $ 745.0 8% $ 732.6 8%
Due after one year through five years.. 3,219.7 33 3,180.8 32
Due after five years through ten years. 2,709.6 28 2,890.8 29
Due after ten years.................... 2,988.6 31 3,026.9 31
--------- ------ --------- ------
Total............................... $ 9,662.9 100% $ 9,831.1 100%
========= === ========= ===
We actively monitor and manage our commercial mortgage loan portfolio.
Substantially all loans within the portfolio are analyzed regularly, based on a
proprietary risk rating cash flow model, in order to monitor the financial
quality of these assets and are internally rated. Based on ongoing monitoring,
mortgage loans with a likelihood of becoming delinquent are identified and
placed on an internal "watch list". Among criteria which would indicate a
potential problem are: imbalances in ratios of loan to value or contract rents
to debt service, major tenant vacancies or bankruptcies, borrower sponsorship
problems, late payments, delinquent taxes and loan relief/restructuring
requests.
We state commercial mortgage loans at their unpaid principal balances, net of
discount accrual and premium amortization, valuation allowances and write downs
for impairment. We provide a valuation allowance for commercial mortgage loans
based on past loan loss experience and for specific loans considered to be
impaired. Mortgage loans are considered impaired when, based on current
information and events, it is probable that all amounts due according to the
contractual terms of the loan agreement may not be collected. When we determine
that a loan is impaired, we establish a valuation allowance for loss for the
excess of the carrying value of the mortgage loan over its estimated fair value.
Estimated fair value is based on either the present value of expected future
cash flows discounted at the loan's original effective interest rate, the loan's
observable market price or the fair value of the collateral. We record increases
in such valuation allowances as realized investment losses and, accordingly, we
reflect such losses in our consolidated results of operations. Such increases
(decreases) in valuation allowances aggregated $7.0 million for the three months
ended March 31, 2002, and $(17.3) million for the year ended December 31, 2001.
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
52
valuation allowance. We categorize loans which are delinquent, loans in process
of foreclosure and loans to borrowers in bankruptcy as "problem" loans.
Potential problem loans are loans placed on an internal "watch list" for which
management has concerns as to the ability of the borrower to comply with the
present loan payment terms and which may result in the loan becoming a problem
or being restructured. The decision whether to classify a performing loan as a
potential problem involves significant subjective judgments by management as to
the likely future economic conditions and developments with respect to the
borrower. We categorize loans for which the original terms of the mortgages have
been modified or for which interest or principal payments have been deferred as
"restructured" loans. We also consider matured loans that are refinanced at
below market rates as restructured.
We charge mortgage loans deemed to be uncollectible against the allowance for
losses and credit subsequent recoveries to the allowance for losses. We maintain
the allowance for losses at a level management believes to be adequate to absorb
estimated probable credit losses. Management bases its periodic evaluation of
the adequacy of the allowance for losses on our past loan loss experience, known
and inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of the underlying collateral,
composition of the loan portfolio, current economic conditions and other
relevant factors. The evaluation is inherently subjective as it requires
estimating the amounts and timing of future cash flows expected to be received
on impaired loans that may change.
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,
--------------- ------------------
2002 2001
--------------- ------------------
($ IN MILLIONS)
Beginning balance.......................................... $ 90.7 $ 108.0
Provision.................................................. 21.7 12.0
Release due to write downs, sales and foreclosures......... (14.7) (29.3)
--------------- ------------------
Ending balance....................................... $ 97.7 $ 90.7
=============== ==================
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,
--------------- ------------------
2002 2001
--------------- ------------------
($ IN MILLIONS)
Total commercial mortgages ............................... $ 9,565.2 $ 9,740.4
=============== ==================
Problem commercial mortgages(1)........................... $ 81.6 $ 47.1
Potential problem commercial mortgages ................... 57.3 98.9
Restructured commercial mortgages ........................ 44.1 42.4
--------------- ------------------
Total problem, potential problem and
restructured commercial mortgages ................... $ 183.0 $ 188.4
=============== ==================
Total problem, potential problem and restructured
commercial mortgages as a percent of total commercial
mortgages.............................................. 2% 2%
- --------------------
(1) There were no mortgage loans in foreclosure as of March 31, 2002 and
December 31, 2001.
53
EQUITY REAL ESTATE
We hold commercial equity real estate as part of our investment portfolio. As of
March 31, 2002, and December 31, 2001, the carrying amount of equity real estate
investment was $1,255.7 million and $1,174.1 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. We continue to focus on a long-term
strategy of reducing our real estate equity portfolio.
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale". Real estate held for investment totaled $865.5
million as of March 31, 2002, and $783.4 million as of December 31, 2001. 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, 2002 and
December 31, 2001, there were no such impairment adjustments.
The carrying amount of real estate held for sale as of March 31, 2002, and
December 31, 2001, was $390.2 million and $390.7 million, net of valuation
allowances of $17.4 million and $19.8 million, respectively. Once we identify a
real estate property to be sold and commence a plan for marketing the property,
we classify the property as held for sale. We establish a valuation allowance
subject to periodical revisions, if necessary, to adjust the carrying value of
the property to reflect the lower of its current carrying value or the fair
value, less associated selling costs.
We use research, both internal and external, to recommend appropriate product
and geographic allocations and changes to the equity real estate portfolio. We
monitor product, geographic and industry diversification separately and together
to determine the most appropriate mix.
Equity real estate is distributed across geographic regions of the country with
larger concentrations in the South Atlantic, West South Central and Pacific
regions of the United States as of March 31, 2002. By property type, there is a
concentration in office buildings that represented approximately 34% of the
equity real estate portfolio as of March 31, 2002. Our largest equity real
estate holding as of March 31, 2002 consisted of an office/industrial park
located in Durham, North Carolina with an aggregate carrying value of
approximately $149.1 million and represented approximately 12% of total U.S.
equity real estate assets and 0.3% of U.S. invested assets. The ten largest real
estate properties as of March 31, 2002 comprised 45% of total U.S. equity real
estate assets and 1% of total U.S. invested assets. In addition, our equity real
estate includes our investment in BT Hotels. As of December 31, 2001, BT Hotels
was fully consolidated into our financial statements and is reflected in the
International region and Hotel/Motel property type in the following investment
schedules:
54
U.S. INVESTED ASSETS
EQUITY REAL ESTATE BY REGION(1)
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
-------- ----- -------- -----
($ IN MILLIONS)
South Atlantic........... $ 427.4 34% $ 376.4 32%
West South Central....... 258.9 21 236.4 20
International............ 233.4 18 223.6 19
Pacific.................. 183.4 15 183.8 16
East North Central....... 61.3 5 62.3 5
East South Central....... 32.4 3 32.3 3
West North Central....... 27.5 2 28.0 2
New England.............. 14.3 1 14.3 1
Mountain................. 13.6 1 8.8 1
Middle Atlantic.......... 3.5 - 8.2 1
-------- ----- -------- -----
Total................. $1,255.7 100% $1,174.1 100%
======== === ======== ===
- ------------
(1) Regions are defined by the American Council of Life Insurers.
U.S. INVESTED ASSETS
EQUITY REAL ESTATE BY PROPERTY TYPE
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
-------- ----- -------- -----
($ IN MILLIONS)
Office........................ $ 425.4 34% $ 422.9 36%
Hotel/Motel................... 233.4 19 223.6 19
Industrial.................... 228.1 18 221.6 19
Retail........................ 129.4 10 138.9 12
Apartments.................... 125.9 10 50.7 4
Service Center................ 62.7 5 63.1 5
Land.......................... 50.8 4 53.3 5
-------- ---- -------- -----
Total...................... $1,255.7 100% $1,174.1 100%
======== === ======== ===
DERIVATIVES
We use various derivative financial instruments to manage our exposure to
fluctuations in interest rates, including interest rate futures and interest
rate swaps and swaptions. We use interest rate futures contracts to hedge
changes in interest rates subsequent to the issuance of an insurance liability,
such as a guaranteed investment contract, but prior to the purchase of a
supporting asset, or during periods of holding assets in anticipation of near
term liability sales. We use interest rate swaps primarily to more closely match
the interest rate characteristics of assets and liabilities. They can be used to
change the interest rate characteristics of specific assets and liabilities as
well as an entire portfolio. Occasionally, we will sell a callable liability or
a liability with attributes similar to a call option. In these cases, we will
use interest rate swaptions or similar products to hedge the risk of early
liability payment, thereby transforming the callable liability into a fixed term
liability.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. An example of an investment we limit
because of the option risk is residential mortgage-backed securities. We assess
option risk in all investments we make and, when we take that risk, we price for
it accordingly.
55
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, 2002, was $3,025.4 million. We
also have fixed maturity securities that are denominated in foreign currencies.
However, we use derivatives to hedge the foreign currency risk of these funding
agreements and securities. As of March 31, 2002, the fair value of our foreign
currency denominated fixed maturity securities was $302.1 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, 2002, was $315.1 million.
In conjunction with the interest rate swaps, interest rate swaptions and other
derivatives, we are exposed to counterparty risk, or the risk that counterparty
fails to perform the terms of the derivative contract. We actively manage this
risk by:
o establishing exposure limits which take into account non-derivative
exposure we have with the counterparty as well as derivative exposure;
o performing similar credit analysis prior to approval on each derivatives
counterparty that we do when lending money on a long-term basis;
o limiting exposure to AA- credit or better;
o conducting stress-test analysis to determine the maximum exposure created
during the life of a prospective transaction; and
o daily monitoring of counterparty credit ratings.
All new derivative counterparties are approved by the investment committee. We
believe the risk of incurring losses due to nonperformance by our counterparties
is remote and that such losses, if any, would not be material. Futures contracts
trade on organized exchanges and, therefore, effectively have no credit risk.
The notional amounts used to express the extent of our involvement in swap
transactions represent a standard measurement of the volume of our swap
business. Notional amount is not a quantification of market risk or credit risk
and it may not necessarily be recorded on the balance sheet. Notional amounts
represent those amounts used to calculate contractual flows to be exchanged and
are not paid or received, except for contracts such as currency swaps. Actual
credit exposure represents the amount owed to us under derivative contracts as
of the valuation date. The following tables present our position in, and credit
exposure to, derivative financial instruments as of March 31, 2002, and December
31, 2001:
56
U.S. INVESTED ASSETS
DERIVATIVE FINANCIAL INSTRUMENTS
AS OF MARCH 31, AS OF DECEMBER 31,
------------------ ------------------
2002 2001
------------------ ------------------
NOTIONAL % OF NOTIONAL % OF
AMOUNT TOTAL AMOUNT TOTAL
--------- ----- --------- -----
($ IN MILLIONS)
Mortgage-backed forwards and options.... $12,443.6 38% $ 9,250.7 34%
Foreign currency swaps.................. 4,005.5 12 4,091.9 15
Interest rate lock commitments.......... 3,651.2 11 2,565.9 9
Interest rate floors.................... 3,400.0 10 3,400.0 13
Interest rate swaps..................... 3,350.6 10 3,272.5 12
U.S. Treasury futures (LIBOR)........... 3,220.0 10 - -
Swaptions .............................. 1,458.0 4 3,570.0 13
Principal Only swaps.................... 475.5 1 250.0 1
Currency forwards....................... 380.0 1 380.0 1
Bond forwards........................... 355.7 1 357.4 1
U.S. Treasury futures................... 292.4 1 186.6 1
Options on futures...................... 100.0 1 - -
Other................................... 45.0 - 25.0 -
Call options............................ 30.0 - 30.0 -
Treasury rate guarantees................ 26.5 - 88.0 -
--------- ----- --------- -----
Total................................ $33,234.0 100% $27,468.0 100%
========= === ========= ===
U.S. INVESTED ASSETS
DERIVATIVE FINANCIAL INSTRUMENTS
AS OF MARCH 31, AS OF DECEMBER 31,
---------------- ------------------
2002 2001
---------------- ------------------
CREDIT % OF CREDIT % OF
EXPOSURE TOTAL EXPOSURE TOTAL
-------- ----- -------- -----
($ IN MILLIONS)
Foreign currency swaps................... $ 96.7 32% $ 101.1 33%
Interest rate swaps...................... 78.5 26 78.4 25
Mortgage-backed forwards and options..... 50.7 17 41.7 14
Currency forwards........................ 48.5 16 55.3 18
Interest rate floors..................... 13.0 5 13.2 4
Call options............................. 8.4 3 8.9 3
Swaptions ............................... 3.4 1 8.7 3
Other.................................... - - 0.1 -
-------- ----- -------- -----
Total................................. $ 299.2 100% $ 307.4 100%
======== === ======== =====
OTHER INVESTMENTS
Our other investments totaled $523.5 million as of March 31, 2002, compared to
$678.4 million as of December 31, 2001. With the adoption of SFAS 133 on January
1, 2001, derivatives were reflected on our balance sheet and accounted for
$141.5 million in other investments as of March 31, 2002. The remaining invested
assets include leases and other private equity investments.
Our investment in Coventry is also included in other investments as we account
for it using the equity method. As of December 31, 2001, our carrying value in
Coventry was $146.0 million. On February 1, 2002, we sold our remaining
investment in Coventry for a net realized gain.
57
SECURITIES LENDING
The terms of our securities lending program, approved in 1999, allow us to lend
our securities to major brokerage firms. Our policy requires an initial minimum
of 102% of the fair value of the loaned securities as collateral. Our securities
on loan as of March 31, 2002, had a fair value of $611.5 million.
INTERNATIONAL INVESTMENT OPERATIONS
As of March 31, 2002, our international investment operations consist of the
investments of Principal International and BT Financial Group and comprise $1.4
billion in invested assets, which primarily represent the assets of Principal
International. Principal Capital Management works with each Principal
International affiliate to develop investment policies and strategies that are
consistent with the products they offer. Due to the regulatory constraints in
each country, each company maintains its own investment policies which are
approved by Principal Capital Management. Each international affiliate is
required to submit a compliance report relative to its strategy to Principal
Capital Management. A credit committee comprised of Principal Capital Management
employees and international affiliate company chief investment officers review
each corporate credit annually. In addition, employees from our U.S. operations
who serve on the credit committee currently hold investment positions in two of
our international affiliates. Principal Capital Management provides credit
analysis training to Principal International personnel.
OVERALL COMPOSITION OF INTERNATIONAL INVESTED ASSETS
As shown in the following table, the major categories of international invested
assets as of March 31, 2002, and December 31, 2001, were fixed maturity
securities and residential mortgage loans:
INTERNATIONAL INVESTED ASSETS
AS OF MARCH 31, AS OF DECEMBER 31,
---------------- ------------------
2002 2001
---------------- ------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
--------- ----- --------- -----
($ IN MILLIONS)
Fixed maturity securities
Public................................ $ 939.8 66% $ 941.3 69%
Private............................... 65.0 4 61.0 4
Equity securities, available-for-sale.... 26.7 2 24.9 2
Mortgage loans
Residential........................... 214.9 15 181.1 13
Real estate held for investment.......... 8.3 1 7.7 1
Other investments ....................... 168.7 12 151.4 11
--------- ----- --------- -----
Total invested assets................. $1,423.4 100% $ 1,367.4 100%
=== ===
Cash and cash equivalents................ 127.7 128.0
--------- ---------
Total invested assets and cash ....... $1,551.1 $ 1,495.4
========= =========
INTERNATIONAL INVESTMENT RESULTS
The yield on international invested assets and on cash and cash equivalents,
excluding net realized gains and losses, was 6.4% and 7.5% for the three months
ended March 31, 2002 and 2001, respectively.
The following table illustrates the yields on average assets for each of the
components of our investment portfolio for the three months ended March 31, 2002
and 2001, respectively:
58
INTERNATIONAL INVESTED ASSETS
YIELDS BY ASSET TYPE
AS OF OR FOR THE THREE MONTHS ENDED
MARCH 31,
---------------- ----------------
2002 2001
---------------- ----------------
YIELD AMOUNT YIELD AMOUNT
----- --------- ------ --------
($ IN MILLIONS)
Fixed maturity securities
Gross investment income(1)............ 6.6% $ 16.5 7.9% $ 17.5
Net realized capital gains............ 1.8 4.4 0.4 0.9
--------- --------
Total............................... $ 20.9 $ 18.4
========= ========
Ending assets (at carrying value)..... $ 1,004.8 $ 808.3
Equity securities, available-for-sale
Gross investment income(1)............ -% $ - -% $ -
Net realized capital gains............ 3.1 0.2 1.4 0.2
--------- --------
Total............................... $ 0.2 $ 0.2
========= ========
Ending assets (at carrying value)..... $ 26.7 $ 37.7
Mortgage loans - Residential
Gross investment income(1)............ 5.9% $ 2.9 7.6% $ 3.2
Net realized capital gains (losses)... - - - -
--------- --------
Total............................... $ 2.9 $ 3.2
========= ========
Ending assets (at carrying value)..... $ 214.9 $ 170.1
Real estate
Gross investment income(1)............ 5.0% $ 0.1 37.1% $ 0.8
Net realized capital gains (losses)... - - - -
--------- --------
Total............................... $ 0.1 $ 0.8
========= ========
Ending assets (at carrying value)..... $ 8.3 $ 8.3
Cash and cash equivalents
Gross investment income(1)............ 2.8% $ 0.9 5.2% $ 1.9
Net realized capital gains (losses)... - - - -
--------- --------
Total............................... $ 0.9 $ 1.9
========= ========
Ending assets (at carrying value)..... $ 127.7 $ 117.1
Other investments
Gross investment income(1)............ 10.5% $ 4.2 9.5% $ 3.0
Net realized capital gains (losses)... 6.7 2.7 (123.6) (38.8)
--------- --------
Total............................... $ 6.9 $ (35.8)
========= ========
Ending assets (at carrying value)..... $ 168.7 $ 121.4
Total before investment expenses
Gross investment income(1)............ 6.5% $ 24.6 7.6% $ 26.4
Net realized capital gains (losses)... 1.9 7.3 (10.8) (37.7)
--------- --------
Total............................... $ 31.9 $ (11.3)
========= ========
Investment expenses..................... -% $ 0.1 0.1% $ 0.3
Net investment income................... 6.4% $ 24.5 7.5% $ 26.1
- --------------------
(1) Yields, which are annualized for interim periods, are based on quarterly
average asset carrying values for the three months ended March 31, 2002 and
2001.
FIXED MATURITY SECURITIES
Fixed maturity securities consist primarily of publicly traded debt securities
and represented 70% of total international invested assets as of March 31, 2002,
and 73% as of December 31, 2001. Fixed maturity securities were diversified by
type of issuer as of March 31, 2002, and for the year ended December 31, 2001,
as shown in the following table:
59
INTERNATIONAL INVESTED ASSETS
FIXED MATURITY SECURITIES BY TYPE OF ISSUER
AS OF AS OF
MARCH 31, DECEMBER 31,
--------------- ----------------
2002 2001
--------------- ----------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
-------- ----- -------- ------
($ IN MILLIONS)
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies............ $ 0.2 -% $ 0.3 -%
Foreign governments............................... 275.3 27 322.8 32
Corporate - public................................ 382.9 38 363.6 37
Corporate - private............................... 65.0 7 61.0 6
Mortgage-backed securities and other asset-
Backed securities............................... 281.4 28 254.6 25
-------- ----- -------- ------
Total fixed maturities.......................... $1,004.8 100% $1,002.3 100%
======== === ======== ===
The fixed maturity securities held by the international operations have not been
rated by external agencies and cannot be presented in a comparable rating agency
equivalent.
The issuers of the majority of our fixed maturity corporate securities are
mainly banks and are categorized in the finance, insurance and real estate
category as shown in the following tables:
INTERNATIONAL INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY INDUSTRY AS OF MARCH 31, 2002
PUBLICLY TRADED PRIVATELY PLACED TOTAL
---------------------- ------------------ --------------------
CARRYING CARRYING % OF CARRYING % OF
AMOUNT % OF TOTAL AMOUNT TOTAL AMOUNT TOTAL
-------- ----------- -------- ------ -------- ------
($ IN MILLIONS)
INDUSTRY CLASS
Finance, Insurance and Real Estate.... $ 172.7 45% $ 17.2 27% $ 189.9 43%
Services.............................. 61.7 16 20.4 31 82.1 18
Construction.......................... 38.8 10 11.5 18 50.3 11
Retail................................ 49.4 13 - - 49.4 11
Transportation and Public Utilities... 48.8 13 - - 48.8 11
Manufacturing......................... 8.0 2 15.9 24 23.9 5
Agriculture, Forestry and Fishing..... 3.3 1 - - 3.3 1
Public Administration................. 0.2 - - - 0.2 -
-------- ----------- -------- ------ -------- ------
Total.............................. $ 382.9 100% $ 65.0 100% $ 447.9 100%
======== === ======== === ======== ===
INTERNATIONAL INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY INDUSTRY AS OF DECEMBER 31, 2001
PUBLICLY TRADED PRIVATELY PLACED TOTAL
---------------------- ------------------ --------------------
CARRYING CARRYING % OF CARRYING % OF
AMOUNT % OF TOTAL AMOUNT TOTAL AMOUNT TOTAL
-------- ----------- -------- ------ -------- ------
($ IN MILLIONS)
INDUSTRY CLASS
Finance, Insurance and Real Estate.... $ 180.2 50% $ 17.5 29% $ 197.7 47%
Services.............................. 50.3 14 9.8 16 60.1 14
Construction.......................... 47.6 13 6.0 10 53.6 12
Transportation and Public Utilities... 49.7 14 - - 49.7 12
Retail................................ 35.6 9 1.2 2 36.8 9
Manufacturing......................... 0.1 - 26.5 43 26.6 6
Public Administration................. 0.1 - - - 0.1 -
-------- ----------- -------- ------ -------- ------
Total.............................. $ 363.6 100% $ 61.0 100% $ 424.6 100%
======== === ======== === ======== ===
60
The international operations held $281.4 million of residential pass-through
securities as of March 31, 2002, and $254.6 million as of December 31, 2001.
The amortized cost and estimated fair value of fixed maturity securities, by
contractual maturity dates excluding scheduled sinking funds, as of March 31,
2002, and December 31, 2001, were as follows:
INTERNATIONAL INVESTED ASSETS
FIXED MATURITY SECURITIES BY CONTRACTUAL MATURITY DATES
AS OF MARCH 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
AMORTIZED CARRYING AMORTIZED CARRYING
COST AMOUNT COST AMOUNT
--------- -------- --------- --------
(IN MILLIONS)
Due in one year or less.............................. $ 51.1 $ 52.0 $ 35.5 $ 36.0
Due after one year through five years................ 115.4 117.4 161.7 162.3
Due after five years through ten years............... 212.0 217.3 212.8 211.8
Due after ten years.................................. 328.5 336.7 326.6 337.6
--------- -------- --------- --------
Subtotal.......................................... 707.0 723.4 736.6 747.7
Mortgage-backed and other securities without a
single maturity date.............................. 276.6 281.4 248.8 254.6
--------- -------- --------- --------
Total............................................. $ 983.6 $1,004.8 $ 985.4 $1,002.3
========= ======== ========= ========
The international operations held $10.1 million of restructured government bonds
in Argentina, which represented 1% of international fixed maturity securities as
of March 31, 2002.
EQUITY SECURITIES
Our equity securities represented 2% of international invested assets as of
March 31, 2002 and December 31, 2001. Our equity securities consisted of $8.4
million in mutual funds and $18.3 million in common stock as of March 31, 2002.
RESIDENTIAL MORTGAGE LOANS
Our Chilean operations originate and purchase residential mortgage loans.
Residential mortgage loans comprised $214.9 million, or 15%, of international
invested assets as of March 31, 2002, and $181.1 million, or 13%, as of December
31, 2001.
DERIVATIVES
The following table presents our position in derivative financial instruments as
of March 31, 2002, and December 31, 2001. Our international operations did not
have credit exposure relating to derivatives as of these dates.
INTERNATIONAL INVESTED ASSETS
DERIVATIVE FINANCIAL INSTRUMENTS
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------
2002 2001
--------------- ------------------
NOTIONAL % OF NOTIONAL % OF
AMOUNT TOTAL AMOUNT TOTAL
-------- ----- -------- ------
($ IN MILLIONS)
Currency forwards.......... $ 18.6 100% $ 13.4 100%
Interest rate swaps........ - - - -
Foreign currency swaps..... - - - -
-------- ----- -------- ------
Total................... $ 18.6 100% $ 13.4 100%
======== === ======== ===
61
OTHER INVESTMENTS
Our other investments totaled $168.7 million as of March 31, 2002, compared to
$151.4 million as of December 31, 2001. Of the $168.7 million, $82.1 million
represents our international investments in unconsolidated subsidiaries, $40.4
million is related to subordinated notes in BT Financial Group's margin lending
program, $25.7 million represents BT Financial Group's investment in unit
trusts, $20.1 million represents other invested assets from our Chilean
operations and $0.4 million represents other invested assets from our Mexican
operations.
62
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
cashflows. These cashflows are discounted to a net present value basis using a
spot yield curve, which is a blend of the spot yield curves for each of the
asset types in the portfolio. Duration is calculated by re-calculating these
cashflows and redetermining the net present value based upon an alternative
level of interest rates, and determining the percentage change in fair value.
As of March 31, 2002, the difference between the asset and liability durations
on our primary duration managed portfolio was .05 years. This duration gap
indicates that as of this date the sensitivity of the fair value of our assets
to interest rate movements is greater than that of the fair value of our
liabilities. Our goal is to minimize the duration gap. Currently, our guidelines
dictate that total duration gaps between the asset and liability portfolios must
be within 0.25 years. The value of the assets in this portfolio was $23,888.2
million as of March 31, 2002.
For products such as whole life insurance, term life insurance and single
premium deferred annuities, the liability cashflow is less predictable, and a
duration-matching strategy is less reliable and manageable. We do, however, try
to manage the duration of these portfolios. For these products, we manage
interest rate risk based on a modeling process that considers the target average
life, maturities, crediting rates and assumptions of policyholder behavior. As
of March 31, 2002, the weighted-average difference between the asset and
liability durations on these portfolios was .48 years. This duration gap
indicates that as of this date the sensitivity of the fair value of our assets
to interest rate movements is less than that of the fair value of our
liabilities. We attempt to monitor this duration gap consistent with our overall
risk/reward tolerances. The value of the assets in these portfolios was $9,244.5
million as of March 31, 2002.
We also have a block of participating general account pension business that
passes the actual investment performance of the assets to the customer. The
investment strategy of this block is to maximize investment return to the
customer on a "best efforts" basis, and there is little or no attempt to manage
the duration of this portfolio since there is little or no interest rate risk.
The value of the assets in these portfolios was $5,858.2 million as of March 31,
2002.
Using the assumptions and data in effect as of March 31, 2002, we estimate that
a 100 basis point immediate, parallel increase in interest rates increases the
net fair value of our portfolio by $32.2 million. The following table details
the estimated changes by risk management strategy:
63
AS OF
RISK MANAGEMENT MARCH 31, 2002 NET FAIR VALUE
STRATEGY VALUE OF TOTAL ASSETS CHANGE
- ------------------------------- --------------------- --------------
(IN MILLIONS)
Primary duration-managed....... $ 23,888.2 $ (11.9)
Duration-monitored............. 9,244.5 44.1
Non duration-managed........... 5,858.2 -
--------------------- --------------
Total....................... $ 38,990.9 $ 32.2
===================== ==============
We are also exposed to interest rate risk in our Mortgage Banking segment. We
manage this risk by striving to balance our loan origination and loan servicing
operations, the two of which are generally counter-cyclical. In addition, we use
various financial instruments, including derivatives contracts, to manage the
interest rate risk specifically related to committed loans in the pipeline and
mortgage servicing rights. The overall objective of our interest rate risk
management policies is to offset changes in the values of these items resulting
from changes in interest rates. We do not speculate on the direction of interest
rates in our management of interest rate risk.
We manage interest rate risk on our mortgage loan pipeline by buying and selling
mortgage-backed securities in the forward markets, over-the-counter options on
mortgage-backed securities, U.S. Treasury and Eurodollar futures contracts and
options on futures contracts. We also use interest rate floors, futures
contracts, options on futures contracts, swaps and swaptions, mortgage-backed
securities and principal-only strips in hedging a portion of our portfolio of
mortgage servicing rights from prepayment risk associated with changes in
interest rates.
We measure pipeline interest rate risk exposure by adjusting the at-risk
pipeline in light of the theoretical optionality of each applicant's rate/price
commitment. The at-risk pipeline, which consists of closed loans and rate locks,
is then refined at the product type level to express each product's sensitivity
to changes in market interest rates in terms of a single current coupon MBS
duration. Suitable hedges are selected and a similar methodology applied to this
hedge position. The variety of hedging instruments allows us to match the
behavior of the financial instrument with that of the different types of loans
originated. We limit our risk exposure by requiring that the net position value
not change by more than $10.0 million given an instantaneous change in the
benchmark MBS price of +/- 2.5%. This price sensitivity analysis is performed at
least once daily. The value of the loans in the pipeline as of March 31, 2002,
was $7.3 billion. Due to the impact of our hedging activities, we estimate that
a 100 basis point immediate parallel increase in the interest rates decreases
the March 31, 2002, net position value by $23.7 million.
The financial risk associated with our mortgage servicing operations is the risk
that the market value of the servicing asset falls below its U.S. GAAP book
value. To measure this risk, we analyze each servicing risk tranche's U.S. GAAP
book value in relation to the then current market value for similar servicing
rights. We perform this valuation using option-adjusted spread valuation
techniques applied to each risk tranche. We produce tranche market values at
least monthly.
The market value of the servicing asset declines as interest rates decrease due
to possible mortgage loan servicing rights impairment that may result from
increased current and projected future prepayment activity. The change in value
of the servicing asset due to interest rate movements is reduced by the use of
financial instruments, including derivative contracts, that increase in
aggregate value when interest rates decline. Based on values as of March 31,
2002, a 100 basis point parallel decrease in interest rates produces a $241.3
million decline in value of the servicing asset of our Mortgage Banking segment,
net of the impact of these hedging vehicles, due to the differences between
market values and U.S. GAAP book values.
DERIVATIVES. We use various derivative financial instruments to manage our
exposure to fluctuations in interest rates, including interest rate swaps,
Principal Only swaps, interest rate floors, swaptions, U.S. Treasury futures,
Treasury rate guarantees, interest rate lock commitments and mortgage-backed
forwards and options. We use interest rate futures contracts and mortgage-backed
forwards to hedge changes in interest rates subsequent to the issuance of an
insurance liability, such as a guaranteed investment contract, but prior to the
purchase of a supporting asset, or during periods of holding assets in
anticipation of near term liability sales. We use interest rate swaps and
Principal Only swaps primarily to more closely match the interest rate
characteristics of assets and liabilities. They can be used to change the
interest rate characteristics of specific assets and liabilities as well as an
entire portfolio. Occasionally, we will sell a callable liability or a liability
64
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.
o In conjunction with the interest rate swaps, interest rate swaptions and
other derivatives, we are exposed to counterparty risk, or the risk that
counterparty fails to perform the terms of the derivative contract.
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, 2002
-----------------------------------------------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
-------------------------------------------
WEIGHTED
AVERAGE TERM -100 BASIS +100 BASIS
NOTIONAL AMOUNT (YEARS) POINT CHANGE NO CHANGE POINT CHANGE
--------------- ------------ ------------ --------- ------------
($ IN MILLIONS)
Interest rate swaps.................. $ 3,350.6 5.51(1) $ 43.6 $ 56.9 $ 101.1
Principal Only swaps................. 475.5 1.81(1) 59.9 (1.5) (44.7)
Other................................ 45.0 4.51(1) 1.2 (0.6) (2.3)
Interest rate floors................. 3,400.0 4.25(2) 44.1 30.6 (16.5)
U.S. Treasury futures................ 292.4 0.23(3) (1.4) (0.5) (1.0)
U.S. Treasury futures (LIBOR)........ 3,220.0 0.76(3) (8.0) 5.6 8.0
Options on futures................... 100.0 0.22(3) 1.5 - (0.1)
Swaptions............................ 1,458.0 0.56(4) 9.3 8.2 (11.5)
Treasury rate guarantees............. 26.5 0.54(5) (1.5) 0.4 2.3
Bond forwards........................ 355.7 1.36(5) 14.4 (6.9) (27.6)
Mortgage-backed forwards and options. 12,443.6 0.05(5) (222.6) 52.4 257.0
Interest rate lock commitments....... 3,651.2 0.12(6) 86.8 (15.4) (179.5)
--------------- ------------ --------- ------------
Total............................. $ 28,818.5 $ 27.3 $ 129.2 $ 85.2
=============== ============ ========= ============
- --------------------
(1) Based on maturity date of swap.
(2) Based on maturity date of floor.
(3) Based on maturity date.
(4) Based on option date of swaption.
(5) Based on settlement date.
(6) Based on expiration date.
We use U.S. Treasury futures to manage our over/under commitment position, and
our position in these contracts changes daily.
DEBT ISSUED AND OUTSTANDING. As of March 31, 2002, the aggregate fair value of
debt was $1,377.3 million. A 100 basis point, immediate, parallel decrease in
interest rates would increase the fair value of debt by approximately $68.1
million.
65
AS OF MARCH 31, 2002
-------------------------------------
FAIR VALUE (NO ACCRUED INTEREST)
-------------------------------------
-100 BASIS +100 BASIS
POINT CHANGE NO CHANGE POINT CHANGE
------------ --------- ------------
(IN MILLIONS)
7.95% notes payable, due 2004.............. $ 217.7 $ 213.0 $ 208.4
8.2% notes payable, due 2009............... 532.8 503.4 476.0
7.875% surplus notes payable, due 2024..... 202.7 187.4 172.3
8% surplus notes payable, due 2044......... 102.2 92.0 83.2
Non-recourse mortgages and notes payable... 243.4 234.9 226.8
Other mortgages and notes payable.......... 146.6 146.6 146.6
------------ --------- ------------
Total long-term debt...................... $ 1,445.4 $ 1,377.3 $ 1,313.3
============ ========= ============
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, 2002, the fair value
of our equity securities was $899.7 million. A 10% decline in the value of the
equity securities would result in an unrealized loss of $90.0 million.
We also have indirect equity risk exposure with respect to BT Financial Group
margin lending operations. Under the terms of this financing arrangement, BT
Financial Group margin lending operations allow retail clients and independent
financial advisors on behalf of clients, within limits approved by senior
management, to borrow funds from BT Financial Group to invest in an approved
list of securities and mutual fund investments which serve as security for the
loan. The risk of loan default increases as the value of the underlying
securities declines. This risk is actively managed through the use of margin
calls on loans when the underlying securities fall below established levels.
Overall, the margin lending portfolio is limited to a ratio of borrowed funds to
market value of securities of an average of 60%. On November 30, 1999, BT
Financial Group margin lending operations securitized its margin lending
portfolio with Westpac Banking Corporation, an Australian bank. Under the terms
of this financing, BT Financial Group margin lending operations are required to
allocate capital equal to approximately 7% of the outstanding borrowed amount,
as a cushion for loan defaults. As of March 31, 2002, the margin lending
portfolio was $576.5 million, or A$1,080.4 million, while the ratio of borrowed
funds to market value of securities was 44%, below that of the maximum allowed.
FOREIGN CURRENCY RISK
Foreign currency risk is the risk that we will incur economic losses due to
adverse fluctuations in foreign currency exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional amount of our currency swap agreements associated with
foreign-denominated liabilities as of March 31, 2002, was $3,025.4 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, 2002, the fair value of our foreign currency
denominated fixed maturity securities was $302.1 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, 2002, was $315.1 million. With regard to our international operations,
we attempt to do as much of our business as possible in the functional currency
of the country of operation. At times, however, we are unable to do so, and in
these cases, we use foreign exchange derivatives to hedge the resulting risks.
Additionally, we utilize foreign currency swaps related to $665.0 million of
private notes issued in connection with our acquisition of BT Financial Group.
The interest payments related to these notes were serviced through operating
cash flows of our Australian operations. By utilizing the foreign currency and
interest rate swaps, the impact of Australian and U.S. dollar exchange rate
fluctuations had a minimal effect on our ability to rely on the cash flows of
our Australian operations to service the interest and principal payments related
to the notes. On December 28, 2001, all of the long-term debt obligations of
Principal Financial Group (Australia) Holdings Pty Limited were ceased and were
assumed by its parent, PFSI.
66
We estimate that as of March 31, 2002, a 10% immediate unfavorable change in
each of the foreign currency exchange rates to which we are exposed would result
in no change to the net fair value of our foreign currency denominated
instruments identified above, including the currency swap agreements. The
selection of a 10% immediate unfavorable change in all currency exchange rates
should not be construed as a prediction by us of future market events, but
rather as an illustration of the potential impact of such an event. Our largest
individual currency exposure is to fluctuations between the Australian dollar
and the U.S. dollar.
EFFECTS OF INFLATION
We do not believe that inflation, in the United States or in the other countries
in which we operate, has had a material effect on our consolidated operations
over the past five years. In the future, however, we may be affected by
inflation to the extent it causes interest rates to rise.
67
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 medical insurance, life
insurance, annuities and residential mortgages. In addition, regulatory bodies,
such as state insurance departments, the SEC, the National Association of
Securities Dealers, Inc., the Department of Labor and other regulatory bodies
regularly make inquiries and conduct examinations or investigations concerning
our compliance with, among other things, insurance laws, securities laws, ERISA
and laws governing the activities of broker-dealers.
Recently, companies in the life insurance business have faced extensive claims,
including class-action lawsuits, alleging improper life insurance sales
practices. Principal Life is currently a defendant in two purported class-action
lawsuits alleging improper sales practices. We have reached an agreement in
principle to settle both of those lawsuits. The settlement has received court
approval. We have established reserves at a level we believe sufficient to cover
the cost of the settlement. A number of persons and entities who were eligible
to be class members have excluded themselves from the class (or "opted out"), as
the law permits them to do. Some of those class members have filed lawsuits and
we have been notified that others who opted out from the class will file
lawsuits and make claims similar to those addressed by the settlement. Similar
opt-out lawsuits have been brought against other life insurance companies as a
result of settlement of similar class-action lawsuits. Defense of these lawsuits
may cause us to incur significant costs. At this time, we are not able to
estimate the number of such lawsuits that may be filed, the costs of defending
the lawsuits or whether our defense will be successful.
A lawsuit was filed on September 27, 2001, in the United States District Court
for the Northern District of Illinois, seeking damages and other relief on
behalf of a putative class of policyholders based on allegations that the plan
of conversion of Principal Mutual Holding Company from a mutual insurance
holding company into a stock company violates the United States Constitution.
The action is captioned ESTHER L. GAYMAN V. PRINCIPAL MUTUAL HOLDING COMPANY, ET
AL. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs have 30 days to file an appeal.
While we cannot predict the outcome of any pending or future litigation,
examination or investigation, we do not believe any pending matter will have a
material adverse effect on our business, financial condition or results of
operations.
68
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
3.2 Amended and Restated By-Laws of Principal Financial Group, Inc.
10.11 Letter Agreement of Employment, dated as of March 15, 2002,
among Principal Life Insurance Company, Principal Capital
Management, LLC, and James P. McCaughan
B. REPORTS ON FORM 8-K
None
69
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 10, 2002 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
70
Exhibit Index
EXHIBIT
NUMBER DESCRIPTION PAGE
3.2 Amended and Restated By-Laws of Principal
Financial Group, Inc................................. 72
10.11 Letter Agreement of Employment, dated as of
March 15, 2002, among Principal Life Insurance
Company, Principal Capital Management, LLC, and
James P. McCaughan................................... 89
71
Exhibit 3.2
AMENDED AND RESTATED BY-LAWS
OF
PRINCIPAL FINANCIAL GROUP, INC.
Effective February 26, 2002
72
PRINCIPAL FINANCIAL GROUP, INC.
BY-LAWS
TABLE OF CONTENTS
ARTICLE I STOCKHOLDERS
SECTION 1.01. ANNUAL MEETINGS..............................................75
SECTION 1.02. SPECIAL MEETINGS.............................................75
SECTION 1.03. NOTICE OF MEETINGS; WAIVER...................................75
SECTION 1.04. QUORUM.......................................................76
SECTION 1.05. VOTING.......................................................76
SECTION 1.06. VOTING BY BALLOT.............................................76
SECTION 1.07. ADJOURNMENT..................................................76
SECTION 1.08. PROXIES......................................................76
SECTION 1.09. ORGANIZATION; PROCEDURE......................................77
SECTION 1.10. NOTICE OF STOCKHOLDER BUSINESS AND NOMINATION................77
SECTION 1.11. INSPECTORS OF ELECTIONS......................................78
SECTION 1.12. OPENING AND CLOSING OF POLLS.................................79
SECTION 1.13. NO STOCKHOLDER ACTION BY WRITTEN CONSENT.....................79
ARTICLE II BOARD OF DIRECTORS
SECTION 2.01. GENERAL POWERS...............................................79
SECTION 2.02. NUMBER OF DIRECTORS..........................................79
SECTION 2.03. CLASSIFIED BOARD OF DIRECTORS; ELECTION OF DIRECTORS.........79
SECTION 2.04. THE CHAIRMAN OF THE BOARD....................................79
SECTION 2.05. ANNUAL AND REGULAR MEETINGS..................................80
SECTION 2.06. SPECIAL MEETINGS; NOTICE.....................................80
SECTION 2.07. QUORUM; VOTIN................................................80
SECTION 2.08. ADJOURNMENT..................................................80
SECTION 2.09. ACTION WITHOUT A MEETING.....................................80
SECTION 2.10. REGULATIONS; MANNER OF ACTING................................80
SECTION 2.11. ACTION BY TELEPHONIC COMMUNICATIONS..........................80
SECTION 2.12. RESIGNATIONS.................................................81
SECTION 2.13. REMOVAL OF DIRECTORS.........................................81
SECTION 2.14. VACANCIES AND NEWLY CREATED DIRECTORSHIPS....................81
SECTION 2.15. COMPENSATION.................................................81
SECTION 2.16. RELIANCE ON ACCOUNTS AND REPORTS, ETC........................81
ARTICLE III EXECUTIVE COMMITTEE AND OTHER COMMITTEES
SECTION 3.01. EXECUTIVE COMMITTEE..........................................81
SECTION 3.02. POWERS OF EXECUTIVE COMMITTEE................................81
SECTION 3.03. OTHER COMMITTEES.............................................81
SECTION 3.04. POWERS.......................................................82
SECTION 3.05. PROCEEDINGS..................................................82
SECTION 3.06. QUORUM AND MANNER OF ACTING..................................82
SECTION 3.07. ACTION BY TELEPHONIC COMMUNICATIONS..........................82
SECTION 3.08. ABSENT OR DISQUALIFIED MEMBERS...............................82
SECTION 3.09. RESIGNATIONS.................................................82
SECTION 3.10. REMOVAL......................................................82
SECTION 3.11. VACANCIES....................................................82
ARTICLE IV OFFICERS
SECTION 4.01. CHIEF EXECUTIVE OFFICER......................................83
SECTION 4.02. SECRETARY OF THE CORPORATION.................................83
SECTION 4.03. OTHER OFFICERS ELECTED BY BOARD OF DIRECTORS.................83
SECTION 4.04. OTHER OFFICERS...............................................83
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SECTION 4.05. SALARIES.....................................................83
SECTION 4.06. REMOVAL AND RESIGNATION; VACANCIES...........................83
SECTION 4.07. AUTHORITY AND DUTIES OF OFFICERS.............................83
ARTICLE V CAPITAL STOCK
SECTION 5.01. CERTIFICATES OF STOCK, UNCERTIFICATED SHARES.................83
SECTION 5.02. SIGNATURES; FACSIMILE........................................84
SECTION 5.03. LOST, STOLEN OR DESTROYED CERTIFICATES.......................84
SECTION 5.04. TRANSFER OF STOCK............................................84
SECTION 5.05. RECORD DATE..................................................84
SECTION 5.06. REGISTERED STOCKHOLDERS......................................84
ARTICLE VI INDEMNIFICATION
SECTION 6.01. NATURE OF INDEMNITY..........................................85
SECTION 6.02. SUCCESSFUL DEFENSE...........................................85
SECTION 6.03. DETERMINATION THAT INDEMNIFICATION IS PROPER.................85
SECTION 6.04. ADVANCE PAYMENT OF EXPENSES..................................85
SECTION 6.05. PROCEDURE FOR INDEMNIFICATION OF DIRECTORS AND OFFICERS......86
SECTION 6.06. SURVIVAL; PRESERVATION OF OTHER RIGHTS.......................86
SECTION 6.07. INSURANCE....................................................86
SECTION 6.08. SEVERABILITY.................................................86
ARTICLE VII OFFICES
SECTION 7.01. INITIAL REGISTERED OFFICE....................................87
SECTION 7.02. OTHER OFFICES................................................87
ARTICLE VIII GENERAL PROVISIONS
SECTION 8.01. DIVIDENDS....................................................87
SECTION 8.02. RESERVES.....................................................87
SECTION 8.03. EXECUTION OF INSTRUMENTS.....................................87
SECTION 8.04. CORPORATE INDEBTEDNESS.......................................87
SECTION 8.05. DISPOSITION OF FUNDS.........................................87
SECTION 8.06. SALE, TRANSFER, ETC. OF SECURITIES...........................87
SECTION 8.07. VOTING AS STOCKHOLDER........................................88
SECTION 8.08. FISCAL YEAR..................................................88
SECTION 8.09. SEAL.........................................................88
SECTION 8.10. BOOKS AND RECORDS; INSPECTION................................88
ARTICLE IX AMENDMENT OF BY-LAWS
SECTION 9.01. AMENDMENT....................................................88
ARTICLE X CONSTRUCTION
SECTION 10.01. CONSTRUCTION................................................88
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PRINCIPAL FINANCIAL GROUP, INC.
AMENDED AND RESTATED BY-LAWS
Effective February 26, 2002
ARTICLE I
STOCKHOLDERS
Section 1.01. ANNUAL MEETINGS. The annual meeting of the stockholders
of the Corporation for the election of Directors and for the transaction of such
other business as properly may come before such meeting shall be held at such
place, either within or without the State of Delaware, or, within the sole
discretion of the Board of Directors, by remote electronic communication
technologies and at such date and at such time, as may be fixed from time to
time by resolution of the Board of Directors and set forth in the notice or
waiver of notice of the meeting.
Section 1.02. SPECIAL MEETINGS. Special meetings of the stockholders
may be called at any time by the Chairman of the Board, Chief Executive Officer
(or, in the event of his or her absence or disability, by the President or any
Executive Vice President), or by the Board of Directors. A special meeting shall
be called by the Chairman of the Board, Chief Executive Officer (or, in the
event of his or her absence or disability, by the President or any Executive
Vice President), or by the Secretary of the Corporation pursuant to a resolution
approved by a majority of the entire Board of Directors. Such special meetings
of the stockholders shall be held at such places, within or without the State of
Delaware, or, within the sole discretion of the Board of Directors, by remote
electronic communication technologies, as shall be specified in the respective
notices or waivers of notice thereof. Any power of the stockholders of the
Corporation to call a special meeting is specifically denied.
Section 1.03. NOTICE OF MEETINGS; WAIVER.
(a) The Secretary of the Corporation or any Assistant Secretary shall
cause written notice of the place, if any, date and hour of each meeting of the
stockholders, and, in the case of a special meeting, the purpose or purposes for
which such meeting is called, and the means of remote communications, if any, by
which stockholders and proxyholders may be deemed to be present in person and
vote at such meeting, to be given personally by mail or by electronic
transmission, not fewer than ten (10) nor more than sixty (60) days prior to the
meeting, to each stockholder of record entitled to vote at such meeting. If such
notice is mailed, it shall be deemed to have been given personally to a
stockholder when deposited in the United States mail, postage prepaid, directed
to the stockholder at his or her address as it appears on the record of
stockholders of the Corporation, or, if a stockholder shall have filed with the
Secretary of the Corporation a written request that notices to such stockholder
be mailed to some other address, then directed to such stockholder at such other
address. Such further notice shall be given as may be required by law.
(b) A written waiver of any notice of any annual or special meeting
signed by the person entitled thereto, or a waiver by electronic transmission by
the person entitled to notice, shall be deemed equivalent to notice. Neither the
business to be transacted at, nor the purpose of, any annual or special meeting
of the stockholders need be specified in a written waiver of notice. Attendance
of a stockholder at a meeting of stockholders shall constitute a waiver of
notice of such meeting, except when the stockholder attends a meeting for the
express purpose of objecting, at the beginning of the meeting, to the
transaction of any business on the ground that the meeting is not lawfully
called or convened.
(c) For notice given by electronic transmission to a stockholder to be
effective, such stockholder must consent to the Corporation's giving notice by
that particular form of electronic transmission. A stockholder may revoke
consent to receive notice by electronic transmission by written notice to the
Corporation. A stockholder's consent to notice by electronic transmission is
automatically revoked if the Corporation is unable to deliver two consecutive
electronic transmission notices and such inability becomes known to the
Secretary of the Corporation, any Assistant Secretary, the transfer agent or
other person responsible for giving notice.
(d) Notices are deemed given (i) if by facsimile, when faxed to a
number where the stockholder has consented to receive notice; (ii) if by
electronic mail, when mailed electronically to an electronic mail address at
which the stockholder has consented to receive such notice; (iii) if by posting
on an electronic network (such as a website or chatroom) together with a
separate notice to the stockholder of such specific posting, upon the later to
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occur of (A) such posting or (B) the giving of the separate notice of such
posting; or (iv) if by any other form of electronic communication, when directed
to the stockholder in the manner consented to by the stockholder.
(e) If a stockholder meeting is to be held via electronic
communications and stockholders will take action at such meeting, the notice of
such meeting must: (i) specify the means of remote communications, if any, by
which stockholders and proxy holders may be deemed to be present and vote at
such meeting; and (ii) provide the information required to access the
stockholder list. A waiver of notice may be given by electronic transmission.
Section 1.04. QUORUM. Except as otherwise required by law or by the
Certificate of Incorporation, the presence in person or by proxy of the holders
of record of one-third of the shares entitled to vote at a meeting of
stockholders shall constitute a quorum for the transaction of business at such
meeting.
Section 1.05. VOTING. If, pursuant to Section 5.05 of these By-Laws, a
record date has been fixed, every holder of record of shares entitled to vote at
a meeting of stockholders shall be entitled to one (1) vote for each share
outstanding in his or her name on the books of the Corporation at the close of
business on such record date. If no record date has been fixed, then every
holder of record of shares entitled to vote at a meeting of stockholders shall
be entitled to one (1) vote for each share of stock standing in his or her name
on the books of the Corporation at the close of business on the day next
preceding the day on which notice of the meeting is given, or, if notice is
waived, at the close of business on the day next preceding the day on which the
meeting is held. Except as otherwise required by law, the Certificate of
Incorporation or these By-Laws, directors shall be elected by a plurality of the
votes of the shares present in person or represented by proxy at a meeting and
voting for nominees in the election of directors, and in all other matters, the
affirmative vote of the majority of shares present in person or represented by
proxy at a meeting and voting on the subject matter shall be the act of the
stockholders.
Section 1.06. VOTING BY BALLOT. No vote of the stockholders on an
election of Directors need be taken by written ballot or by electronic
transmission unless otherwise required by law. Any vote not required to be taken
by ballot or by electronic transmission may be conducted in any manner approved
by the Board of Directors prior to the meeting at which such vote is taken.
Section 1.07. ADJOURNMENT. If a quorum is not present at any meeting of
the stockholders, the stockholders present in person or by proxy shall have the
power to adjourn any such meeting from time to time until a quorum is present.
Notice of any adjourned meeting of the stockholders of the Corporation need not
be given if the place, if any, date and hour thereof are announced at the
meeting at which the adjournment is taken, provided, however, that if the
adjournment is for more than thirty (30) days, or if after the adjournment a new
record date for the adjourned meeting is fixed pursuant to Section 5.05 of these
By-Laws, a notice of the adjourned meeting, conforming to the requirements of
Section 1.03 hereof, shall be given to each stockholder of record entitled to
vote at such meeting. At any adjourned meeting at which a quorum is present, any
business may be transacted that might have been transacted on the original date
of the meeting.
Section 1.08. PROXIES. Any stockholder entitled to vote at any meeting
of the stockholders may authorize another person or persons to vote at any such
meeting and express such consent or dissent for him or her by proxy. A
stockholder may authorize a valid proxy by executing a written instrument signed
by such stockholder, or by causing his or her signature to be affixed to such
writing by any reasonable means including, but not limited to, by facsimile
signature, or by transmitting or authorizing the transmission of a telegram,
cablegram or other means of electronic transmission to the person designated as
the holder of the proxy, a proxy solicitation firm or a like authorized agent.
No such proxy shall be voted or acted upon after the expiration of three years
from the date of such proxy, unless such proxy provides for a longer period.
Every proxy shall be revocable at the pleasure of the stockholder executing it,
except in those cases where applicable law provides that a proxy shall be
irrevocable. A stockholder may revoke any proxy which is not irrevocable by
attending the meeting and voting in person or by filing with the Secretary of
the Corporation either an instrument in writing revoking the proxy or another
duly executed proxy bearing a later date. Proxies by telegram, cablegram or
other electronic transmission must either set forth or be submitted with
information from which it can be determined that the telegram, cablegram or
other electronic transmission was authorized by the stockholder. Any copy,
facsimile telecommunication or other reliable reproduction of a writing or
transmission created pursuant to this section may be substituted or used in lieu
of the original writing or transmission for any and all purposes for which the
original writing or transmission could be used, provided that such copy,
facsimile telecommunication or other reproduction shall be a complete
reproduction of the entire original writing or transmission.
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Section 1.09. ORGANIZATION; PROCEDURE. At every meeting of stockholders
the presiding officer shall be the Chairman of the Board or, in the event of his
or her absence or disability, a presiding officer chosen by the Board of
Directors. The Secretary of the Corporation, or in the event of his or her
absence or disability, an Assistant Secretary, if any, or if there be no
Assistant Secretary, in the absence of the Secretary of the Corporation, an
appointee of the presiding officer, shall act as Secretary of the meeting. The
order of business and all other matters of procedure at every meeting of
stockholders may be determined by such presiding officer.
Section 1.10. NOTICE OF STOCKHOLDER BUSINESS AND NOMInATIONS.
(a) ANNUAL MEETINGS OF STOCKHOLDERS.
(i) Nominations of persons for election to the Board of
Directors of the Corporation and the proposal of business to be
considered by the stockholders may be made at an annual meeting of
stockholders (A) by or at the direction of the Board of Directors or
the Chairman of the Board, or (B) by any stockholder of the Corporation
who is entitled to vote at the meeting, who complies with the notice
procedures set forth in clauses (ii) and (iii) of this paragraph and
who was a stockholder of record at the time such notice is delivered to
the Secretary of the Corporation.
(ii) For nominations or other business to be properly brought
before an annual meeting by a stockholder, pursuant to clause (B) of
paragraph (a)(i) of this Section 1.10, the stockholder must have given
timely notice thereof in writing or by electronic transmission to the
Secretary of the Corporation. To be timely, a stockholder's notice
shall be delivered to the Secretary of the Corporation at the principal
executive offices of the Corporation not fewer than ninety (90) days
nor more than one hundred twenty (120) days prior to the first
anniversary of the preceding year's annual meeting and in any event at
least forty-five (45) days prior to the first anniversary of the date
on which the registrant first mailed its proxy materials for the prior
year's annual meeting of stockholders; PROVIDED, that if the date of
the annual meeting is advanced by more than thirty (30) days or delayed
by more than seventy (70) days from such anniversary date, notice by
the stockholder to be timely must be so delivered not earlier than one
hundred twenty (120) days prior to such annual meeting and not later
than the close of business on the later of the ninetieth day prior to
such annual meeting or the tenth day following the day on which public
announcement of the date of such meeting is first made. In no event
shall the adjournment of an annual meeting commence a new time period
for the giving of a stockholder's notice as described above. Such
stockholder's notice shall set forth (A) as to each person whom the
stockholder proposes to nominate for election or reelection as a
Director all information relating to such person that is required to be
disclosed in solicitations of proxies for election of Directors, or is
otherwise required, in each case pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), and
Rule 14a-11 thereunder, or any successor provisions, including such
person's written consent to being named in the proxy statement as a
nominee and to serving as a Director if elected; (B) as to any other
business that the stockholder proposes to bring before the meeting, a
brief description of the business desired to be brought before the
meeting, the reasons for conducting such business at the meeting and
any material interest in such business of such stockholder and of any
beneficial owner on whose behalf the proposal is made; and (C) as to
the stockholder giving the notice and any beneficial owner on whose
behalf the nomination or proposal is made (1) the name and address of
such stockholder, as they appear on the Corporation's books, and of
such beneficial owner and (2) the class and number of shares of the
Corporation which are owned beneficially and of record by such
stockholder and such beneficial owner.
(iii) Notwithstanding anything in the second sentence of
paragraph (a)(ii) of this Section 1.10 to the contrary, in the event
that the number of Directors to be elected to the Board of Directors of
the Corporation is increased and there is no public announcement naming
all of the nominees for Director or specifying the size of the
increased Board of Directors made by the Corporation at least one
hundred (100) days prior to the first anniversary of the preceding
year's annual meeting, a stockholder's notice under this paragraph
shall also be considered timely, but only with respect to nominees for
any new positions created by such increase, if it shall be delivered to
the Secretary of the Corporation at the principal executive offices of
the Corporation not later than the close of business on the tenth day
following the day on which such public announcement is first made by
the Corporation.
(b) SPECIAL MEETINGS OF STOCKHOLDERS. Only such business as shall have
been brought before the special meeting of the stockholders pursuant to the
Corporation's notice of meeting pursuant to Section 1.03 of these By-Laws shall
be conducted at such meeting. Nominations of persons for election to the Board
77
of Directors may be made at a special meeting of stockholders at which Directors
are to be elected pursuant to the Corporation's notice of meeting (1) by or at
the direction of the Board of Directors or (2) by any stockholder of the
Corporation who is entitled to vote at the meeting, who complies with the notice
procedures set forth in this Section 1.10 and who is a stockholder of record at
the time such notice is delivered to the Secretary of the Corporation.
Nominations by stockholders of persons for election to the Board of Directors
may be made at such special meeting of stockholders if the stockholder's notice
as required by paragraph (a)(ii) of this Section 1.10 shall be delivered to the
Secretary of the Corporation at the principal executive offices of the
Corporation not earlier than the one hundred and twentieth (120th) day prior to
such special meeting and not later than the close of business on the later of
the ninetieth (90th) day prior to such special meeting or the tenth (10th) day
following the day on which public announcement is first made of the date of the
special meeting and of the nominees proposed by the Board of Directors to be
elected at such meeting. In no event shall the adjournment of a special meeting
commence a new time period for the giving of a stockholder's notice as described
above.
(c) GENERAL.
(i) Only persons who are nominated in accordance with the
procedures set forth in this Section 1.10 shall be eligible to serve as
Directors and only such business shall be conducted at a meeting of
stockholders as shall have been brought before the meeting in
accordance with the procedures set forth in this Section 1.10. Except
as otherwise provided by law, the Certificate of Incorporation or these
By-Laws, the Chairman of the meeting shall have the power and duty to
determine whether a nomination or any business proposed to be brought
before the meeting was made in accordance with the procedures set forth
in this Section 1.10 and, if any proposed nomination or business is not
in compliance with this Section 1.10, to declare that such defective
proposal or nomination shall be disregarded.
(ii) For purposes of this Section 1.10, "public announcement"
shall mean disclosure in a press release reported by the Dow Jones News
Service, Associated Press or comparable national news service or in a
document publicly filed by the Corporation with the Securities and
Exchange Commission pursuant to Section 13, 14, or 15(d) of the
Exchange Act.
(iii) Notwithstanding the foregoing provisions of this Section
1.10, a stockholder shall also comply with all applicable requirements
of the Exchange Act and the rules and regulations thereunder with
respect to the matters set forth in this Section 1.10. Nothing in this
Section 1.10 shall be deemed to affect any rights (A) of stockholders
to request inclusion of proposals in the Corporation's proxy statement
pursuant to Rule 14a-8 under the Exchange Act, or (B) of the holders of
any series of Preferred Stock, if any, to elect Directors if so
provided under any applicable Preferred Stock Certificate of
Designation (as defined in the Certificate of Incorporation).
Section 1.11. INSPECTORS OF ELECTIONS. Preceding any meeting of the
stockholders, the Board of Directors shall appoint one (1) or more persons to
act as Inspectors of Elections, and may designate one (1) or more alternate
inspectors. In the event no inspector or alternate is able to act, the person
presiding at the meeting shall appoint one (1) or more inspectors to act at the
meeting. Each inspector, before entering upon the discharge of the duties of an
inspector, shall take and sign an oath faithfully to execute the duties of
inspector with strict impartiality and according to the best of his or her
ability. The inspector shall:
(a) ascertain the number of shares outstanding and the voting power
of each;
(b) determine the shares represented at a meeting and the
validity of proxies and ballots;
(c) specify the information relied upon to determine the validity of
electronic transmissions in accordance with Section 1.08 hereof;
(d) count all votes and ballots;
(e) determine and retain for a reasonable period a record of the
disposition of any challenges made to any determination by the
inspectors; and
(f) certify his or her determination of the number of shares
represented at the meeting, and his or her count of all votes
and ballots;
78
(g) appoint or retain other persons or entities to assist in the
performance of the duties of inspector; and
(h) when determining the shares represented and the validity of
proxies and ballots, be limited to an examination of the proxies,
any envelopes submitted with those proxies, any information
provided in accordance with Section 1.08 of these By-Laws, ballots
and the regular books and records of the Corporation. The
inspector may consider other reliable information for the
limited purpose of reconciling proxies and ballots submitted by
or on behalf of banks, brokers or their nominees or a similar
person which represent more votes than the holder of a proxy is
authorized by the record owner to cast or more votes than the
stockholder holds of record. If the inspector considers other
reliable information as outlined in this section, the inspector,
at the time of his or her certification pursuant to paragraph
(f) of this section, shall specify the precise information
considered, the person or persons from whom the information was
obtained, when this information was obtained, the means by which
the information was obtained, and the basis for the inspector's
belief that such information is accurate and reliable.
Section 1.12. OPENING AND CLOSING OF POLLS. The date and time for the
opening and the closing of the polls for each matter to be voted upon at a
stockholder meeting shall be announced at the meeting. The inspector shall be
prohibited from accepting any ballots, proxies or votes or any revocations
thereof or changes thereto after the closing of the polls, unless the Court of
Chancery upon application by a stockholder shall determine otherwise.
Section 1.13. NO STOCKHOLDER ACTION BY WRITTEN CONSENT. Effective as of
the time the Common Stock shall be registered pursuant to the provisions of the
Exchange Act, any action required or permitted to be taken by the stockholders
of the Corporation must be effected at a duly called annual or special meeting
of the stockholders of the Corporation, and the ability of the stockholders to
consent in writing to the taking of any action is specifically denied.
ARTICLE II
BOARD OF DIRECTORS
Section 2.01. GENERAL POWERS. Except as may otherwise be provided by
law, the Certificate of Incorporation or these By-Laws, the property, affairs
and business of the Corporation shall be managed by or under the direction of
the Board of Directors and the Board of Directors may exercise all the powers of
the Corporation.
Section 2.02. NUMBER OF DIRECTORS. Subject to the rights of the holders
of any class or series of Preferred Stock, if any, the number of Directors shall
be fixed from time to time exclusively pursuant to a resolution adopted by a
majority of the entire Board of Directors; provided, however, that the Board of
Directors shall at no time consist of fewer than three (3) Directors.
Section 2.03. CLASSIFIED BOARD OF DIRECTORS; ELECTION OF DIRECTORS. The
Directors of the Corporation, subject to the rights of the holders of shares of
any class or series of Preferred Stock, shall be classified with respect to the
time for which they severally hold office, into three (3) classes, as nearly
equal in number as possible, one class ("CLASS I") whose initial term expires at
the 2002 annual meeting of stockholders, another class ("CLASS II") whose
initial term expires at the 2003 annual meeting of stockholders, and another
class ("CLASS III") whose initial term expires at the 2004 annual meeting of
stockholders, with each class to hold office until its successors are elected
and qualified. Except as otherwise provided in Sections 2.12 and 2.13 of these
By-Laws, at each annual meeting of stockholders of the Corporation, and subject
to the rights of the holders of shares of any class or series of Preferred
Stock, the successors of the class of Directors whose term expires at that
meeting shall be elected to hold office for a term expiring at the annual
meeting of stockholders held in the third year following the year of their
election.
Section 2.04. THE CHAIRMAN OF THE BOARD. The Directors shall elect from
among the members of the Board a "Chairman of the Board". The Chairman of the
Board shall be an deemed an officer of the Corporation and shall have such
duties and powers as set forth in these By-Laws or as shall otherwise be
conferred upon the Chairman of the Board from time to time by the Board of
Directors. The Chairman of the Board shall, if present, preside over all
meetings of the Stockholders and of the Board of Directors. The Board of
Directors shall by resolution establish a procedure to provide for an acting
Chairman of the Board in the event the current Chairman of the Board is unable
to serve or act in that capacity.
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Section 2.05. ANNUAL AND REGULAR MEETINGS. The annual meeting of the
Board of Directors for the purpose of electing officers and for the transaction
of such other business as may come before the meeting shall be held as soon as
reasonably practicable following adjournment of the annual meeting of the
stockholders at the place of such annual meeting of the stockholders. Notice of
such annual meeting of the Board of Directors need not be given. The Board of
Directors from time to time may by resolution provide for the holding of regular
meetings and fix the place (which may be within or without the State of
Delaware) and the date and hour of such meetings. Notice of regular meetings
need not be given, provided, however, that if the Board of Directors shall fix
or change the time or place of any regular meeting, notice of such action shall
be mailed promptly, or sent by telephone, including a voice messaging system or
other system or technology designed to record and communicate messages,
telegraph, facsimile, electronic mail or other electronic means, to each
Director who shall not have been present at the meeting at which such action was
taken, addressed to him or her at his or her usual place of business, or shall
be delivered to him or her personally. Notice of such action need not be given
to any Director who attends the first regular meeting after such action is taken
without protesting the lack of notice to him or her, prior to or at the
commencement of such meeting, or to any Director who submits a signed waiver of
notice, whether before or after such meeting.
Section 2.06. SPECIAL MEETINGS; NOTICE. Special meetings of the Board
of Directors shall be held whenever called by the Chairman of the Board, Chief
Executive Officer (or, in the event of his or her absence or disability, by the
President or any Executive Vice President), or by the Board of Directors, at
such place (within or without the State of Delaware), date and hour as may be
specified in the respective notices or waivers of notice of such meetings.
Special meetings of the Board of Directors also may be held whenever called
pursuant to a resolution approved by a majority of the entire Board of
Directors. Special meetings of the Board of Directors may be called on
twenty-four (24) hours' notice, if notice is given to each Director personally
or by telephone, including a voice messaging system, or other system or
technology designed to record and communicate messages, telegraph, facsimile,
electronic mail or other electronic means, or on five (5) days' notice, if
notice is mailed to each Director, addressed to him or her at his or her usual
place of business or to such other address as any Director may request by notice
to the Secretary. Notice of any special meeting need not be given to any
Director who attends such meeting without protesting the lack of notice to him
or her, prior to or at the commencement of such meeting, or to any Director who
submits a signed waiver of notice, whether before or after such meeting, and any
business may be transacted thereat.
Section 2.07. QUORUM; VOTING. At all meetings of the Board of
Directors, the presence of at least a majority of the total authorized number of
Directors shall constitute a quorum for the transaction of business. Except as
otherwise required by law, the vote of at least a majority of the Directors
present at any meeting at which a quorum is present shall be the act of the
Board of Directors.
Section 2.08. ADJOURNMENT. A majority of the Directors present, whether
or not a quorum is present, may adjourn any meeting of the Board of Directors to
another time or place. No notice need be given of any adjourned meeting unless
the time and place of the adjourned meeting are not announced at the time of
adjournment, in which case notice conforming to the requirements of Section 2.05
of these By-Laws shall be given to each Director.
Section 2.09. ACTION WITHOUT A MEETING. Any action required or
permitted to be taken at any meeting of the Board of Directors may be taken
without a meeting if all members of the Board of Directors consent thereto in
writing or by electronic transmission, and such writing, writings or electronic
transmission or transmissions are filed with the minutes of proceedings of the
Board of Directors. Such filing shall be in paper form if the minutes are
maintained in paper form and shall be in electronic form if the minutes are
maintained in electronic form.
Section 2.10. REGULATIONS; MANNER OF ACTING. To the extent consistent
with applicable law, the Certificate of Incorporation and these By-Laws, the
Board of Directors may adopt by resolution such rules and regulations for the
conduct of meetings of the Board of Directors and for the management of the
property, affairs and business of the Corporation as the Board of Directors may
deem appropriate. The Directors shall act only as a Board of Directors and the
individual Directors shall have no power in their individual capacities unless
expressly authorized by the Board of Directors.
Section 2.11. ACTION BY TELEPHONIC COMMUNICATIONS. Members of the Board
of Directors may participate in a meeting of the Board of Directors by means of
conference telephone or other communications equipment by means of which all
persons participating in the meeting can hear each other, and participation in a
meeting pursuant to this provision shall constitute presence in person at such
meeting.
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Section 2.12. RESIGNATIONS. Any Director may resign at any time by
submitting an electronic transmission or by delivering a written notice of
resignation, signed by such Director, to the Chairman of the Board or the
Secretary. Unless otherwise specified therein, such resignation shall take
effect upon delivery.
Section 2.13. REMOVAL OF DIRECTORS. Subject to the rights of the
holders of any class or series of Preferred Stock, if any, to elect additional
Directors under specified circumstances, any Director may be removed at any
time, but only for cause, upon the affirmative vote of the holders of a majority
of the combined voting power of the then outstanding stock of the Corporation
entitled to vote generally in the election of Directors. Any vacancy in the
Board of Directors caused by any such removal may be filled at such meeting by
the stockholders entitled to vote for the election of the Director so removed.
If such stockholders do not fill such vacancy at such meeting, such vacancy may
be filled in the manner provided in Section 2.14 of these By-Laws.
Section 2.14. VACANCIES AND NEWLY CREATED DIRECTORSHIPS. Subject to the
rights of the holders of any class or series of Preferred Stock, if any, to
elect additional Directors under specified circumstances, and except as provided
in Section 2.13, if any vacancies shall occur in the Board of Directors, by
reason of death, resignation, removal or otherwise, or if the authorized number
of Directors shall be increased, the Directors then in office shall continue to
act, and such vacancies and newly created Directorships may be filled by a
majority of the Directors then in office, although less than a quorum. Any
Director filling a vacancy shall be of the same class as that of the Director
whose death, resignation, removal or other event caused the vacancy, and any
Director filling a newly created Directorship shall be of the class specified by
the Board of Directors at the time the newly created Directorships were created.
A Director elected to fill a vacancy or a newly created Directorship shall hold
office until his or her successor has been elected and qualified or until his or
her earlier death, resignation or removal.
Section 2.15. COMPENSATION. The amount, if any, which each Director
shall be entitled to receive as compensation for such Director's services as
such shall be fixed from time to time by resolution of the Board of Directors.
Section 2.16. RELIANCE ON ACCOUNTS AND REPORTS, ETC. A Director, or a
member of any committee designated by the Board of Directors shall, in the
performance of such Director's or member's duties, be fully protected in relying
in good faith upon the records of the Corporation and upon information,
opinions, reports or statements presented to the Corporation by any of the
Corporation's officers or employees, or committees designated by the Board of
Directors, or by any other person as to the matters the Director or the member
reasonably believes are within such other person's professional or expert
competence and who has been selected with reasonable care by or on behalf of the
Corporation.
ARTICLE III
EXECUTIVE COMMITTEE AND OTHER COMMITTEES
Section 3.01. EXECUTIVE COMMITTEE. The Board of Directors shall appoint
an Executive Committee consisting of five (5) Directors. Members of the
Executive Committee shall be appointed by and serve at the pleasure of the Board
of Directors. The Chairman of the Board shall be a member of the Executive
Committee and shall, if present, preside at each meeting of the Executive
Committee. The Chief Executive Officer, if different than the Chairman of the
Board, shall be a member of the Executive Committee and in the event of an
absence or vacancy in the office of the Chairman of the Board, shall preside at
meetings of the Executive Committee. If the Chairman of the Board is also the
Chief Executive Officer, any other member of the Executive Committee, as
determined by the members of the Executive Committee present, shall preside at a
meeting of the Executive Committee in the absence of the Chairman of the Board.
The Secretary shall act as secretary of the Executive Committee and shall keep a
record of all proceedings of the Executive Committee. A majority of the members
of the Executive Committee shall constitute a quorum.
Section 3.02. POWERS OF EXECUTIVE COMMITTEE. The Executive Committee
shall have and, to the extent permitted by law, may exercise all of the powers
of the Board of Directors in the management and affairs of the Corporation
except when the Board of Directors is in session.
Section 3.03. OTHER COMMITTEES. The Board of Directors, by resolution
adopted by the affirmative vote of a majority of Directors then in office, may
establish one (1) or more other committees of the Board of Directors, each
committee to consist of such number of Directors as from time to time may be
fixed by the Board of Directors. Any such committee shall serve at the pleasure
of the Board of Directors. Each such committee shall have the powers and duties
delegated to it by the Board of Directors, subject to the limitations set forth
in applicable Delaware law. The Board of Directors may elect one or more of its
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members as alternate members of any such committee who may take the place of any
absent member or members at any meeting of such committee, upon request of the
Chairman of the Board or the Chairman of such committee.
Section 3.04. POWERS. Each committee, except as otherwise provided in
this section, shall have and may exercise such powers of the Board of Directors
as may be provided by resolution or resolutions of the Board of Directors.
Neither the Executive Committee nor any other committee shall have the power or
authority:
to approve or adopt, or recommend to the stockholders, any action or matter
expressly required by the General Corporation Law to be submitted to the
stockholders for approval; or to adopt, amend or repeal the By-Laws of the
Corporation.
Section 3.05. PROCEEDINGS. Each such committee may fix its own rules of
procedure and may meet at such place (within or without the State of Delaware),
at such time and upon such notice, if any, as it shall determine from time to
time. Each such committee shall keep minutes of its proceedings and shall report
such proceedings to the Board of Directors at the meeting of the Board of
Directors next following any such proceedings.
Section 3.06. QUORUM AND MANNER OF ACTING. Except as may be otherwise
provided in the resolution creating such committee, at all meetings of any
committee, the presence of members (or alternate members) constituting a
majority of the total authorized membership of such committee shall constitute a
quorum for the transaction of business. The act of the majority of the members
present at any meeting at which a quorum is present shall be the act of such
committee. Any action required or permitted to be taken at any meeting of any
such committee may be taken without a meeting, if all members of such committee
shall consent to such action in writing or by electronic transmission and such
writing, writings or electronic transmission or transmissions are filed with the
minutes of the proceedings of the committee. Such filing shall be in paper form
if the minutes are in paper form and shall be in electronic form if the minutes
are maintained in electronic form. The members of any such committee shall act
only as a committee, and the individual members of such committee shall have no
power in their individual capacities unless expressly authorized by the Board of
Directors.
Section 3.07. ACTION BY TELEPHONIC COMMUNICATIONS. Unless otherwise
provided by the Board of Directors, members of any committee may participate in
a meeting of such committee by means of conference telephone or other
communications equipment by means of which all persons participating in the
meeting can hear each other, and participation in a meeting pursuant to this
provision shall constitute presence in person at such meeting.
Section 3.08. ABSENT OR DISQUALIFIED MEMBERS. In the absence or
disqualification of a member of any committee, if no alternate member is present
to act in his or her stead, the member or members thereof present at any meeting
and not disqualified from voting, whether or not he, she or they constitute a
quorum, may unanimously appoint another member of the Board of Directors to act
at the meeting in the place of any such absent or disqualified member.
Section 3.09. RESIGNATIONS. Any member (and any alternate member) of
any committee may resign at any time by delivering a written notice of
resignation, signed by such member, to the Board of Directors or the Chairman of
the Board. Unless otherwise specified therein, such resignation shall take
effect upon delivery.
Section 3.10. REMOVAL. Any member (and any alternate member) of any
committee may be removed at any time, either for or without cause, by resolution
adopted by a majority of the whole Board of Directors.
Section 3.11. VACANCIES. If any vacancy shall occur in any committee,
by reason of disqualification, death, resignation, removal or otherwise, the
remaining members (and any alternate members) shall continue to act, and any
such vacancy may be filled by the Board of Directors.
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ARTICLE IV
OFFICERS
Section 4.01. CHIEF EXECUTIVE OFFICER. The Board of Directors shall
elect a Chief Executive Officer to serve at the pleasure of the Board of
Directors who shall (a) supervise the carrying out of policies adopted or
approved by the Board of Directors, (b) exercise a general supervision and
superintendence over all the business and affairs of the Corporation, and (c)
possess such other powers and perform such other duties as may be assigned to
him or her by these By-Laws, as may from time to time be assigned by the Board
of Directors and as may be incident to the office of Chief Executive Officer.
Section 4.02. SECRETARY OF THE CORPORATION. The Board of Directors
shall appoint a Secretary of the Corporation to serve at the pleasure of the
Board of Directors. The Secretary of the Corporation shall (a) keep minutes of
all meetings of the stockholders and of the Board of Directors, (b) authenticate
records of the Corporation and (c) in general, have such powers and perform such
other duties as may be assigned to him or her by these By-Laws, as may from time
to time be assigned to him or her by the Board of Directors or the Chief
Executive Officer and as may be incident to the office of Secretary of the
Corporation.
Section 4.03. OTHER OFFICERS ELECTED BY BOARD OF DIRECTORS. At any
meeting of the Board of Directors, the Board of Directors may elect a President,
Vice Presidents, a Chief Financial Officer, a Treasurer, Assistant Treasurers,
Assistant Secretaries, or such other officers of the Corporation as the Board of
Directors may deem necessary, to serve at the pleasure of the Board of
Directors. Other officers elected by the Board of Directors shall have such
powers and perform such duties as may be assigned to such officers by or
pursuant to authorization of the Board of Directors or by the Chief Executive
Officer.
Section 4.04. OTHER OFFICERS. The Board of Directors may authorize the
Corporation to elect or appoint other officers, each of whom shall serve at the
pleasure of the Corporation. Officers elected or appointed by the Corporation
shall have such powers and perform such duties as may be assigned to them by the
Corporation.
Section 4.05. SALARIES. The salaries of all officers and agents of
the Corporation shall be fixed by or pursuant to authorization of the Board of
Directors.
Section 4.06. REMOVAL AND RESIGNATION; VACANCIES. Any officer may be
removed for or without cause at any time by the Board of Directors. Any officer
may resign at any time by delivering a written notice of resignation, signed by
such officer, to the Board of Directors or the Chief Executive Officer. Unless
otherwise specified therein, such resignation shall take effect upon delivery.
Any vacancy occurring in any office of the Corporation by death, resignation,
removal or otherwise, shall be filled by or pursuant to authorization of the
Board of Directors.
Section 4.07. AUTHORITY AND DUTIES OF OFFICERS. The officers of the
Corporation shall have such authority and shall exercise such powers and perform
such duties as may be specified in these By-Laws, except that in any event each
officer shall exercise such powers and perform such duties as may be required by
law.
ARTICLE V
CAPITAL STOCK
Section 5.01. CERTIFICATES OF STOCK, UNCERTIFICATED SHARES. The shares
of the Corporation shall be represented by certificates, provided that the Board
of Directors may provide by resolution or resolutions that some or all of any or
all classes or series of the stock of the Corporation shall be uncertificated
shares. Any such resolution shall not apply to shares represented by a
certificate until each such certificate is surrendered to the Corporation.
Notwithstanding the adoption of such a resolution by the Board of Directors,
every holder of stock in the Corporation represented by certificates and upon
request every holder of uncertificated shares shall be entitled to have a
certificate signed by, or in the name of, the Corporation, by the Chairman of
the Board, the Chief Executive Officer or the President, and by the Chief
Financial Officer, the Treasurer or an Assistant Treasurer, or the Secretary of
the Corporation or an Assistant Secretary, representing the number of shares
registered in certificate form. Such certificate shall be in such form as the
Board of Directors may determine, to the extent consistent with applicable law,
the Certificate of Incorporation and these By-Laws.
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Section 5.02. SIGNATURES; FACSIMILE. All signatures on the certificate
referred to in Section 5.01 of these By-Laws may be in facsimile, engraved or
printed form, to the extent permitted by law. In case any officer, transfer
agent or registrar who has signed, or whose facsimile, engraved or printed
signature has been placed upon a certificate shall have ceased to be such
officer, transfer agent or registrar before such certificate is issued, it may
be issued by the Corporation with the same effect as if he or she were such
officer, transfer agent or registrar at the date of issue.
Section 5.03. LOST, STOLEN OR DESTROYED CERTIFICATES. The Board of
Directors may direct that a new certificate be issued in place of any
certificate theretofore issued by the Corporation alleged to have been lost,
stolen or destroyed, upon delivery to the Corporation of an affidavit of the
owner or owners of such certificate, setting forth such allegation. The
Corporation may require the owner of such lost, stolen or destroyed certificate,
or his or her legal representative, to give the Corporation a bond sufficient to
indemnify it against any claim that may be made against it on account of the
alleged loss, theft or destruction of any such certificate or the issuance of
any such new certificate.
Section 5.04. TRANSFER OF STOCK. Upon surrender to the Corporation or
the transfer agent of the Corporation of a certificate for shares, duly endorsed
or accompanied by appropriate evidence of succession, assignment or authority to
transfer, the Corporation shall issue a new certificate to the person entitled
thereto, cancel the old certificate and record the transaction upon its books.
Within a reasonable time after the transfer of uncertificated stock, the
Corporation shall send to the registered owner thereof a written notice
containing the information required to be set forth or stated on certificates
pursuant to the laws of the General Corporation Law of the State of Delaware.
Subject to the provisions of the Certificate of Incorporation and these By-Laws,
the Board of Directors may prescribe such additional rules and regulations as it
may deem appropriate relating to the issue, transfer and registration of shares
of the Corporation.
Section 5.05. RECORD DATE. In order to determine the stockholders
entitled to notice of or to vote at any meeting of stockholders or any
adjournment thereof, the Board of Directors may fix, in advance, a record date,
which record date shall not precede the date on which the resolution fixing the
record date is adopted by the Board of Directors, and which shall not be more
than sixty (60) nor fewer than ten (10) days before the date of such meeting. A
determination of stockholders of record entitled to notice of or to vote at a
meeting of stockholders shall apply to any adjournment of the meeting, provided,
however, that the Board of Directors may fix a new record date for the adjourned
meeting.
In order that the Corporation may determine the stockholders entitled to receive
payment of any dividend or other distribution or allotment of any rights of the
stockholders entitled to exercise any rights in respect of any change,
conversion or exchange of stock, or for the purpose of any other lawful action,
the Board of Directors may fix a record date, which record date shall not
precede the date upon which the resolution fixing the record date is adopted,
and which record date shall be not more than sixty (60) days prior to such
action. If no record date is fixed, the record date for determining stockholders
for any such purpose shall be at the close of business on the day on which the
Board of Directors adopts the resolution relating thereto.
Section 5.06. REGISTERED STOCKHOLDERS. Prior to due surrender of a
certificate for registration of transfer, the Corporation may treat the
registered owner as the person exclusively entitled to receive dividends and
other distributions, to vote, to receive notice and otherwise to exercise all
the rights and powers of the owner of the shares represented by such
certificate, and the Corporation shall not be bound to recognize any equitable
or legal claim to or interest in such shares on the part of any other person,
whether or not the Corporation shall have notice of such claim or interests.
Whenever any transfer of shares shall be made for collateral security, and not
absolutely, it shall be so expressed in the entry of the transfer if, when the
certificates are presented to the Corporation for transfer or uncertificated
shares are requested to be transferred, both the transferor and transferee
request the Corporation to do so.
Section 5.07. TRANSFER AGENT AND REGISTRAR. The Board of Directors may
appoint one (1) or more transfer agents and one (1) or more registrars, and may
require all certificates representing shares to bear the signature of any such
transfer agents or registrars.
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SECTION VI
INDEMNIFICATION
Section 6.01. NATURE OF INDEMNITY. The Corporation shall indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding (a "Proceeding"),
whether civil, criminal, administrative or investigative, by reason of the fact
that he or she is or was or has agreed to become a Director or officer of the
Corporation, or is or was serving or has agreed to serve at the request of the
Corporation as a Director or officer, of another corporation, partnership, joint
venture, trust or other enterprise, or by reason of any action alleged to have
been taken or omitted in such capacity, and may indemnify any person who was or
is a party or is threatened to be made a party to such a Proceeding by reason of
the fact that he or she is or was or has agreed to become an employee or agent
of the Corporation, or is or was serving or has agreed to serve at the request
of the Corporation as an employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him or her or on his or her behalf in connection with such
Proceeding and any appeal therefrom, if he or she acted in good faith and in a
manner he or she reasonably believed to be in or not opposed to the best
interests of the Corporation, and, with respect to any criminal Proceeding, had
no reasonable cause to believe his or her conduct was unlawful; except that in
the case of a Proceeding by or in the right of the Corporation to procure a
judgment in its favor (1) such indemnification shall be limited to expenses
(including attorneys' fees) actually and reasonably incurred by such person in
the defense or settlement of such Proceeding, and (2) no indemnification shall
be made in respect of any claim, issue or matter as to which such person shall
have been adjudged to be liable to the Corporation unless and only to the extent
that the Delaware Court of Chancery or the court in which such Proceeding was
brought shall determine upon application that, despite the adjudication of
liability but in view of all the circumstances of the case, such person is
fairly and reasonably entitled to indemnity for such expenses which the Delaware
Court of Chancery or such other court shall deem proper. Notwithstanding the
foregoing, but subject to Section 6.05 of these By-Laws, the Corporation shall
not be obligated to indemnify a Director or officer of the Corporation in
respect of a Proceeding (or part thereof) instituted by such Director or
officer, unless such Proceeding (or part thereof) has been authorized by the
Board of Directors.
The termination of any Proceeding by judgment, order settlement, conviction, or
upon a plea of NOLO CONTENDERE or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner which he
or she reasonably believed to be in or not opposed to the best interests of the
Corporation, and, with respect to any criminal Proceeding, had reasonable cause
to believe that his or her conduct was unlawful.
Section 6.02. SUCCESSFUL DEFENSE. To the extent that a present or
former Director or officer of the Corporation has been successful on the merits
or otherwise in defense of any Proceeding referred to in Section 6.01 hereof or
in defense of any claim, issue or matter therein, such person shall be
indemnified against expenses (including attorneys' fees) actually and reasonably
incurred by such person in connection therewith.
Section 6.03. DETERMINATION THAT INDEMNIFICATION IS PROPER. Any
indemnification of a present or former Director or officer of the Corporation
under Section 6.01 hereof (unless ordered by a court) shall be made by the
Corporation unless a determination is made that indemnification of the present
or former Director or officer is not proper in the circumstances because he or
she has not met the applicable standard of conduct set forth in Section 6.01
hereof. Any indemnification of a present or former employee or agent of the
Corporation under Section 6.01 hereof (unless ordered by a court) may be made by
the Corporation upon a determination that indemnification of the present or
former employee or agent is proper in the circumstances because he or she has
met the applicable standard of conduct set forth in Section 6.01 hereof. Any
such determination shall be made, with respect to a person who is a Director or
officer at the time of such determination, (1) by a majority vote of the
Directors who are not parties to such Proceeding, even though less than a
quorum, or (2) by a committee of such Directors designated by majority vote of
such Directors, even though less than a quorum, or (3) if there are no such
Directors, or if such Directors so direct, by independent legal counsel in a
written opinion, or (4) by the stockholders.
Section 6.04. ADVANCE PAYMENT OF EXPENSES. Expenses (including
attorneys' fees) incurred by a Director or officer in defending any civil,
criminal, administrative or investigative Proceeding shall be paid by the
Corporation in advance of the final disposition of such Proceeding upon receipt
of an undertaking by or on behalf of the Director or officer to repay such
amount if it shall ultimately be determined that such person is not entitled to
be indemnified by the Corporation as authorized in this Article. Such expenses
(including attorneys' fees) incurred by former Directors and officers or other
employees and agents may be so paid upon such terms and conditions, if any, as
the Corporation deems appropriate. The Board of Directors may authorize the
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Corporation's counsel to represent such Director, officer, employee or agent in
any Proceeding, whether or not the Corporation is a party to such Proceeding.
Section 6.05. PROCEDURE FOR INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Any indemnification of a Director or officer of the Corporation under Sections
6.01 and 6.02, or advance of costs, charges and expenses to a Director or
officer under Section 6.04 of these By-Laws, shall be made promptly, and in any
event within thirty (30) days, upon the written request of the Director or
officer. If a determination by the Corporation that the Director or officer is
entitled to indemnification pursuant to this Article VI is required, and the
Corporation fails to respond within thirty (30) days to a written request for
indemnity, the Corporation shall be deemed to have approved such request. If the
Corporation denies a written request for indemnity or advancement of expenses,
in whole or in part, or if payment in full pursuant to such request is not made
within thirty (30) days, the right to indemnification or advances as granted by
this Article VI shall be enforceable by the Director or officer in any court of
competent jurisdiction. Such person's costs and expenses incurred in connection
with successfully establishing his or her right to indemnification, in whole or
in part, in any such Proceeding shall also be indemnified by the Corporation. It
shall be a defense to any such Proceeding (other than an action brought to
enforce a claim for the advance of costs, charges and expenses under Section
6.04 of these By-Laws where the required undertaking, if any, has been received
by the Corporation) that the claimant has not met the standard of conduct set
forth in Section 6.01 of these By-Laws, but the burden of proving such defense
shall be on the Corporation. Neither the failure of the Corporation (including
its Board of Directors, its independent legal counsel, and its stockholders) to
have made a determination prior to the commencement of such action that
indemnification of the claimant is proper in the circumstances because he or she
has met the applicable standard of conduct set forth in Section 6.01 of these
By-Laws, nor the fact that there has been an actual determination by the
Corporation (including its Board of Directors, its independent legal counsel,
and its stockholders) that the claimant has not met such applicable standard of
conduct, shall be a defense to the action or create a presumption that the
claimant has not met the applicable standard of conduct.
Section 6.06. SURVIVAL; PRESERVATION OF OTHER RIGHTS. The foregoing
indemnification provisions shall be deemed to be a contract between the
Corporation and each Director, officer, employee and agent who serves in any
such capacity at any time while these provisions as well as the relevant
provisions of the Delaware General Corporation Law are in effect and any repeal
or modification thereof shall not affect any right or obligation then existing
with respect to any state of facts then or previously existing or any Proceeding
previously or thereafter brought or threatened based in whole or in part upon
any such state of facts. Such a "contract right" may not be modified
retroactively without the consent of such Director, officer, employee or agent.
The indemnification provided by this Article VI shall not be deemed exclusive of
any other rights to which those indemnified may be entitled under any by-law,
agreement, vote of stockholders or disinterested Directors or otherwise, both as
to action in such person's official capacity and as to action in another
capacity while holding such office, and shall continue as to a person who has
ceased to be a Director, officer, employee or agent and shall inure to the
benefit of the heirs, executors and administrators of such a person.
Section 6.07. INSURANCE. The Corporation may purchase and maintain
insurance on behalf of any person who is or was or has agreed to become a
Director, officer, employee or agent of the Corporation, or is or was serving at
the request of the Corporation as a Director or officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise
against any liability asserted against such person and incurred by such person
or on such person's behalf in any such capacity, or arising out of such person's
status as such, whether or not the Corporation would have the power to indemnify
him or her against such liability under the provisions of this Article VI.
Section 6.08. SEVERABILITY. If this Article VI or any portion hereof
shall be invalidated on any ground by any court of competent jurisdiction, then
the Corporation shall nevertheless indemnify each Director or officer and may
indemnify each employee or agent of the Corporation as to costs, charges and
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement with respect to a Proceeding, whether civil, criminal, administrative
or investigative, including a Proceeding by or in the right of the Corporation,
to the fullest extent permitted by any applicable portion of this Article VI
that shall not have been invalidated and to the fullest extent permitted by
applicable law.
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SECTION VII
OFFICES
Section 7.01. INITIAL REGISTERED OFFICE. The initial registered
office of the Corporation in the State of Delaware shall be located at
Corporation Trust Center, 1209 N. Orange Street in the City of Wilmington,
County of New Castle.
Section 7.02. OTHER OFFICES. The Corporation may maintain offices or
places of business at such other locations within or without the State of
Delaware as the Board of Directors may from time to time determine or as the
business of the Corporation may require.
SECTION VIII
GENERAL PROVISIONS
Section 8.01. DIVIDENDS. Subject to any applicable provisions of law
and the Certificate of Incorporation, dividends upon the shares of the
Corporation may be declared by the Board of Directors at any regular or special
meeting of the Board of Directors and any such dividend may be paid in cash,
property, or shares of the Corporation's capital stock.
A member of the Board of Directors, or a member of any committee designated by
the Board of Directors shall be fully protected in relying in good faith upon
the records of the Corporation and upon such information, opinions, reports or
statements presented to the Corporation by any of its officers or employees, or
committees of the Board of Directors, or by any other person as to matters the
Director reasonably believes are within such other person's professional or
expert competence and who has been selected with reasonable care by or on behalf
of the Corporation, as to the value and amount of the assets, liabilities and/or
net profits of the Corporation, or any other facts pertinent to the existence
and amount of surplus or other funds from which dividends might properly be
declared and paid.
Section 8.02. RESERVES. There may be set aside out of any funds of the
Corporation available for dividends such sum or sums as the Board of Directors
from time to time, in its absolute discretion, thinks proper as a reserve or
reserves to meet contingencies, or for equalizing dividends, or for repairing or
maintaining any property of the Corporation or for such other purpose as the
Board of Directors shall think conducive to the interest of the Corporation, and
the Board of Directors may similarly modify or abolish any such reserve.
Section 8.03. EXECUTION OF INSTRUMENTS. The Board of Directors may
authorize, or provide for the authorization of, officers, employees or agents to
enter into any contract or execute and deliver any instrument in the name and on
behalf of the Corporation. Any such authorization must be in writing or by
electronic transmission and may be general or limited to specific contracts or
instruments.
Section 8.04. CORPORATE INDEBTEDNESS. No loan shall be contracted on
behalf of the Corporation, and no evidence of indebtedness shall be issued in
its name, unless authorized by the Board of Directors. Such authorization may be
general or confined to specific instances. Loans so authorized may be effected
at any time for the Corporation from any bank, trust company or other
institution, or from any firm, corporation or individual. All bonds, debentures,
notes and other obligations or evidences of indebtedness of the Corporation
issued for such loans shall be made, executed and delivered as the Board of
Directors shall authorize. When so authorized by the Board of Directors, any
part of or all the properties, including contract rights, assets, business or
good will of the Corporation, whether then owned or thereafter acquired, may be
mortgaged, pledged, hypothecated or conveyed or assigned in trust as security
for the payment of such bonds, debentures, notes and other obligations or
evidences of indebtedness of the Corporation, and of the interest thereon, by
instruments executed and delivered in the name of the Corporation.
Section 8.05. DISPOSITION OF FUNDS. The funds of the Corporation shall
be paid out, transferred or otherwise disposed of only in such manner and under
such controls as may be authorized by resolution of the Board of Directors or as
may be authorized by such officers of the Corporation as the Board of Directors
designates.
Section 8.06. SALE, TRANSFER, ETC. OF SECURITIES. To the extent
authorized by the Board of Directors or by the Chief Executive Officer, the
President, any Vice President, the Secretary of the Corporation, the Chief
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Financial Officer or the Treasurer or any other officers designated by the Board
of Directors or the Chief Executive Officer may sell, transfer, endorse, and
assign any shares of stock, bonds or other securities owned by or held in the
name of the Corporation, and may make, execute and deliver in the name of the
Corporation, under its corporate seal, any instruments that may be appropriate
to effect any such sale, transfer, endorsement or assignment.
Section 8.07. VOTING AS STOCKHOLDER. Unless otherwise determined by
resolution of the Board of Directors, the Chief Executive Officer, the
President, any Executive Vice President or any Senior Vice President shall have
full power and authority on behalf of the Corporation to attend any meeting of
stockholders of any corporation in which the Corporation may hold stock, and to
act, vote (or execute proxies to vote) and exercise in person or by proxy all
other rights, powers and privileges incident to the ownership of such stock.
Such officers acting on behalf of the Corporation shall have full power and
authority to execute any instrument expressing consent to or dissent from any
action of any such corporation without a meeting. The Board of Directors may by
resolution from time to time confer such power and authority upon any other
person or persons.
Section 8.08. FISCAL YEAR. The fiscal year of the Corporation shall
commence on the first day of January of each year (except for the Corporation's
first fiscal year which shall commence on the date of incorporation) and shall
terminate in each case on December 31.
Section 8.09. SEAL. The seal of the Corporation shall be in such form
as the Board of Directors may from time to time determine and shall contain the
name of the Corporation, the year of its incorporation and the words "Corporate
Seal" and "Delaware". The form of such seal shall be subject to alteration by
the Board of Directors. The seal may be used by causing it or a facsimile
thereof to be impressed, affixed or reproduced, or may be used in any other
lawful manner.
Section 8.10. BOOKS AND RECORDS; INSPECTION. Except to the extent
otherwise required by law, the books and records of the Corporation shall be
kept at such place or places within or without the State of Delaware as may be
determined from time to time by the Board of Directors.
ARTICLE IX
AMENDMENT OF BY-LAWS
Section 9.01. AMENDMENT. These By-Laws may be amended, altered
or repealed:
(a) by resolution adopted by a majority of the Board of Directors
at any special or regular meeting of the Board of Directors if,
in the case of such special meeting only, notice of such
amendment, alteration or repeal is contained in the notice
or waiver of notice of such meeting; or at any regular or
special meeting of the stockholders upon the affirmative vote
of the holders of three-fourths (3/4) or more of the combined
voting power of the outstanding shares of the Corporation
entitled to vote generally in the election of Directors if, in
the case of such special meeting only, notice of such amendment,
alteration or repeal is contained in the notice or waiver of
notice of such meeting.
ARTICLE X
CONSTRUCTION
Section 10.01. CONSTRUCTION. In the event of any conflict between the
provisions of these By-Laws as in effect from time to time and the provisions of
the Certificate of Incorporation of the Corporation as in effect from time to
time, the provisions of such Certificate of Incorporation shall be controlling.
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Exhibit 10.11
BY OVERNIGHT MAIL
March 14, 2002
James McCaughan
721 5th Avenue, #53B
New York, NY 10022
Dear Mr. McCaughan:
It is with great pleasure that I offer you the position of Executive Vice
President and Global Head of Asset Management of Principal Life Insurance
Company and President and Chief Executive Officer of Principal Capital
Management, LLC, beginning on April 1, 2002. This offer is contingent on
finalizing reference checks and obtaining the necessary corporate approvals,
which we expect to finalize no later than March 15, 2002. We are also making
this offer with the assumption that you have no non-competition agreement or
other arrangements with Credit Suisse Asset Management that would interfere with
your responsibilities with Principal.
As Executive Vice President, you will report to Barry Griswell, Chairman,
President and Chief Executive Officer, and will receive a compensation package
consisting of cash compensation, stock options and full participation in the
benefits available to an Executive Vice President of Principal.
I. ANNUAL CASH COMPENSATION
A. BASE COMPENSATION. Your annual base compensation will be $500,000.
B. ANNUAL BONUS. Your annual bonus will be 250% of your base compensation. You
will participate in Principal's Annual Incentive Pay Plan ("PrinPay"), as
though you had started employment as of January 1, 2002. Bonus amounts are
based on the Company meeting specified financial and customer service
objectives, as well as your individual performance.
C. LONG TERM BONUS. You will also participate in the Principal's Long Term
Performance Plan effective as of January 1, 2002, with a target bonus of
250%. This includes two components: Fifty percent of this award is a
performance plan based on three year cycles with cumulative earnings and
return on average equity and company stock price driving the value of the
pay out. The second component of your long-term compensation bonus (200%)
will include stock options granted at fair market value with a three-year
ratable vesting schedule and ten-year term.
Annual grants for both of these plans may be influenced by individual
performance, however, as a stated above, your target is 250% of base
salary.
D. MINIMUM GUARANTEE. Your annual bonus and long term bonus grant for 2002
will be guaranteed at 100% of target, and for 2003 your annual bonus and
long term bonus grant will be guaranteed at 80% of target.
II. SEVERANCE.
A. Although you are an at-will employee, if you are terminated by the Company
without cause prior to March 31, 2004, Principal will pay you the base
salary and guaranteed annual bonus you would have received through March
31, 2004 had you not been terminated, in exchange for a release of all
claims against the Company in a form substantially similar to Exhibit A of
the Principal Financial Group, Inc. Change of Control Employment Agreement
between Principal Financial Group, Inc., Principal Life Insurance Company
and you dated March 15, 2002 ("COC Agreement").
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B. If you are terminated after March 31, 2004, without "Cause", as that term
is defined in the COC Agreement, you will be paid (i) one year's base
compensation and one year's annual bonus at target, and (ii) all other
accrued entitlements, in accordance with the terms of the relevant plan, in
exchange for a release of all claims against the Company in a form
substantially similar to Exhibit A of the COC Agreement, and the provisions
of Section 8.2 of the COC Agreement will apply to you for a period of six
months, if the severance referred to in this sentence is paid. Except as
set forth in this letter, the provisions of Section 8.2 (y) will not apply
to you.
II. CHANGE OF CONTROL. As an Executive Vice President of Principal, you will be
expected to sign the enclosed Change of Control Employment Agreement.
Please note that this agreement contains Confidentiality and
Non-Competition provisions.
III. BENEFITS. In addition to generous health insurance benefits, we offer an
executive benefits package. Information is included about the major
benefits and the package includes:
A. Life insurance, dental and vision insurance and long-term disability
insurance. Any eligibility waiting period for these benefits will be
waived. You will also have the opportunity to purchase Group Universal life
insurance and property and casualty insurance.
B. A non-contributory defined benefit pension plan (cash balance plan).
C. A defined contribution (401(k)) plan, with an employer match feature and
attractive investment choices.
D. Non-qualified plans designed to protect executives from government limits.
E. Access to a financial planner. Principal will pay for up to $10,000 of
planning through AMG or Deloitte and Touche in your first year of
employment, and up to $7500 in subsequent years.
F. Additional fringe benefits, including membership in a private club in
downtown Des Moines with dining facilities.
G. You will have eighty hours of Paid Time Off ("PTO") at the outset of your
employment, and will then accrue eight additional PTO hours per biweekly
pay period.
We very much want you to join our team, and would appreciate receiving your
answer by March 15. Please call me should you have any questions.
Sincerely,
Jim DeVries
Vice President - Human Resources
Agreed to by:
/s/ James McCaughan March 15, 2002
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James McCaughan Date
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