UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 711 High Street, 42-1520346
(State or other jurisdiction Des Moines, Iowa 50392 (I.R.S. Employer
of incorporation or organization) (Address of principal Identification Number)
executive offices)
(515) 247-5111
(Registrant's telephone number,
including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, par value $0.01 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant Item 405 of
Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment of this Form 10-K. |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes |X| No |_|
As of February 28, 2003, there were outstanding 320,269,928 shares of Common
Stock, $0.01 par value per share of the Registrant.
The aggregate market value of the shares of the Registrant's common equity held
by non-affiliates of the Registrant was $8,829,841,915 based on the closing
price of $27.57 per share of Common Stock on the New York Stock Exchange on
February 28, 2003.
Documents Incorporated by Reference
The information required to be furnished pursuant to Part III of this Form 10-K
is set forth in, and is hereby incorporated by reference herein from, the
Registrant's definitive proxy statement for the annual meeting of shareholders
to be held on May 19, 2003, to be filed by the Registrant with the Securities
and Exchange Commission pursuant to Regulation 14A not later than 120 days after
the year ended December 31, 2002.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PART I......................................................................4
Item 1. Business...........................................................4
Item 2. Properties........................................................22
Item 3. Legal Proceedings.................................................23
Item 4. Submission of Matters to a Vote of Security Holders...............23
Executive Officers of the Registrant.......................................24
PART II....................................................................25
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters...........................................................25
Item 6. Selected Financial Data...........................................25
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.......84
Item 8. Financial Statements and Supplementary Data.......................91
Report of Independent Auditors..........................................91
Consolidated Statements of Financial Position...........................92
Consolidated Statements of Operations...................................93
Consolidated Statements of Stockholders' Equity.........................95
Consolidated Statements of Cash Flows...................................96
Notes to Consolidated Financial Statements..............................98
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................160
PART III..................................................................160
Item 10. Directors and Executive Officers of the Registrant..............160
Item 11. Executive Compensation..........................................160
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.................................160
Item 13. Certain Relationships and Related Transactions..................161
Item 14. Controls and Procedures.........................................161
PART IV...................................................................162
Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K........................................................162
Signatures and Certifications ............................................164
Report of Independent Auditors on Schedules............................167
Schedule I - Summary of Investments - Other Than Investments in Related
Parties...................................................168
Schedule II - Condensed Financial Information of Registrant
(Parent Only)............................................169
Schedule III - Supplementary Insurance Information.....................173
Schedule IV - Reinsurance..............................................175
Exhbit Index...........................................................176
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NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including the Management's Discussion and
Analysis of Financial Condition and Results of Operations, contains statements
which constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, including statements relating to
trends in operations and financial results and the business and the products of
the Registrant and its subsidiaries, as well as other statements including words
such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and
other similar expressions. Forward-looking statements are made based upon
management's current expectations and beliefs concerning future developments and
their potential effects on the Company. Such forward-looking statements are not
guarantees of future performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) a decline or increased volatility in the securities markets
could result in investors withdrawing from the markets or decreasing their rates
of investment, either of which could reduce our net income, revenues and assets
under management; (2) our investment portfolio is subject to several risks which
may diminish the value of our invested assets and affect our sales,
profitability and the investment returns credited to our customers; (3)
competition from companies that may have greater financial resources, broader
arrays of products, higher ratings and stronger financial performance may impair
our ability to retain existing customers, attract new customers and maintain our
profitability; (4) a downgrade in Principal Life Insurance Company's ("Principal
Life") financial strength ratings may increase policy surrenders and
withdrawals, reduce new sales and terminate relationships with distributors and
cause some of our existing liabilities to be subject to acceleration, additional
collateral support, changes in terms, or creation of additional financial
obligations; (5) our efforts to reduce the impact of interest rate changes on
our profitability and surplus may not be effective; (6) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (7) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (8) our reserves established for future
policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (9) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends Iowa insurance
laws impose on Principal Life; (10) we may need to fund deficiencies in our
closed block ("Closed Block") assets which benefit only the holders of Closed
Block policies; (11) changes in regulations or accounting standards may reduce
our profitability; (12) litigation and regulatory investigations may harm our
financial strength and reduce our profitability; (13) fluctuations in foreign
currency exchange rates could reduce our profitability; (14) a challenge to the
Insurance Commissioner of the State of Iowa's approval of the plan of conversion
could put the terms of our demutualization in question and reduce the market
price of our common stock; (15) applicable laws and our stockholder rights plan,
certificate of incorporation and by-laws may discourage takeovers and business
combinations that our stockholders might consider in their best interests; (16)
a downgrade in our debt ratings may adversely affect our ability to secure funds
and cause some of our existing liabilities to be subject to acceleration,
additional collateral support, changes in terms, or creation of additional
financial obligations.
3
PART I
ITEM 1. BUSINESS
The Principal Financial Group is a leading provider of retirement savings,
investment and insurance products and services with $111.1 billion in assets
under management and approximately thirteen million customers worldwide as of
December 31, 2002. We were organized as an individual life insurer in 1879,
formed a mutual insurance holding company in 1998, and Principal Financial
Group, Inc. was organized on April 18, 2001, as a Delaware business corporation.
Under the terms of Principal Mutual Holding Company's Plan of Conversion,
effective October 26, 2001 (the "Date of Demutualization"), Principal Mutual
Holding Company converted from a mutual insurance holding company to a stock
company subsidiary of Principal Financial Group, Inc., a Delaware business
corporation. All membership interests in Principal Mutual Holding Company were
extinguished on that date and eligible policyholders received, in aggregate,
260.8 million shares of common stock, $1,177.5 million of cash, and $472.6
million of policy credits as compensation.
In addition, on October 26, 2001, we completed our initial public offering
("IPO") in which we issued 100.0 million shares of common stock at a price of
$18.50 per share, prior to the underwriters' exercise of the overallotment
option. Net proceeds from the IPO were $1,753.9 million, of which $64.2 million
was retained by Principal Financial Group, Inc., and $1,689.7 million was
contributed to Principal Life. Proceeds were net of offering costs of $96.5
million and a related tax benefit of $0.4 million.
Our U.S. and international operations concentrate primarily on asset management
and accumulation. In addition, we offer a broad range of individual and group
life insurance, group health insurance, individual and group disability
insurance and residential mortgage loan origination and servicing.
We focus on providing retirement products and services to businesses and their
employees. We provided services to more 401(k) plans in the U.S. in 2001 than
any other bank, mutual fund or insurance company, according to surveys conducted
by CFO magazine. We also had the leading market share in 2001 within the 401(k)
market for businesses with less than 500 employees based on number of plans and
number of participants according to the Spectrem Group.
We believe there are attractive growth opportunities in the 401(k) and other
defined contribution pension plan markets in the U.S. and internationally. We
believe our expertise and leadership in serving the U.S. pension plan market
give us a unique competitive advantage in the U.S., as well as in countries with
a trend toward private sector defined contribution pension systems.
OUR OPERATING SEGMENTS
We organize our businesses into four operating segments:
o U.S. Asset Management and Accumulation;
o International Asset Management and Accumulation;
o Life and Health Insurance; and
o Mortgage Banking.
We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.
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The following table summarizes our operating revenues for our products and
services, which are described in each of the subsequent operating segment
discussions:
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
--------------- ----------------- -----------
(IN MILLIONS)
U.S. Asset Management and
Accumulation
Full-service accumulation.... $1,076.5 $1,116.6 $1,210.4
Full-service payout.......... 1,191.8 1,214.8 920.6
Investment-only.............. 886.4 918.1 881.7
--------------- ----------------- ------------
Total pension.............. 3,154.7 3,249.5 3,012.7
Individual annuities......... 303.8 263.3 267.5
Mutual funds................. 113.8 108.3 116.0
Other and eliminations....... 32.2 19.0 1.9
--------------- ----------------- ------------
Total U.S. Asset
Accumulation............. 3,604.5 3,640.1 3,398.1
Eliminations................. (40.4) (35.2) (38.4)
Principal Global Investors... 216.4 194.9 174.2
--------------- ----------------- ------------
Total U.S. Asset Management
and Accumulation......... 3,780.5 3,799.8 3,533.9
International Asset
Management and
Accumulation............. 357.9 508.4 339.2
Life and Health Insurance
Life insurance............... 1,629.6 1,658.7 1,693.1
Health insurance............. 2,058.3 2,061.3 2,221.4
Disability insurance......... 258.9 226.4 208.1
--------------- ----------------- ------------
Total Life and Health
Insurance.................. 3,946.8 3,946.4 4,122.6
Mortgage Banking
Mortgage loan production..... 562.9 354.4 46.0
Mortgage loan servicing...... 590.1 403.0 313.8
--------------- ----------------- ------------
Total Mortgage Banking..... 1,153.0 757.4 359.8
Corporate and Other.......... (15.1) 101.7 98.2
--------------- ----------------- ------------
Total operating revenues..... $9,223.1 $9,113.7 $8,453.7
=============== ================= ============
Total operating revenues..... $9,223.1 $9,113.7 $8,453.7
Net realized/unrealized
capital gains (losses),
including recognition of
front-end fee revenues
and certain market value
adjustments to fee
revenues................... (400.6) (527.4) 140.5
Non-recurring................ - 6.3 -
--------------- ----------------- ------------
Total GAAP revenues.......... $8,822.5 $8,592.6 $8,594.2
=============== ================= ============
U.S. ASSET MANAGEMENT AND ACCUMULATION SEGMENT
Our U.S. Asset Management and Accumulation segment consists of:
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o asset accumulation operations which provide retirement savings and related
investment products and services to businesses, their employees and other
individuals; and
o Principal Global Investors, our U.S.-based asset manager, formerly known as
Principal Capital Management.
For financial results for the U.S. Asset Management and Accumulation segment,
see Item 8. "Financial Statements and Supplementary Data, Notes to Consolidated
Financial Statements, Note 18 Segment Information".
U.S. ASSET ACCUMULATION
Our asset accumulation activities in the U.S. date back to the 1940s when we
first began providing pension plan products and services. We now offer a
comprehensive portfolio of asset accumulation products and services for
retirement savings and investment:
o To businesses of all sizes with a concentration on small and medium-sized
businesses, which we define as businesses with fewer than 1,000 employees.
We offer products and services for defined contribution pension plans,
including 401(k) and 403(b) plans, defined benefit pension plans and
non-qualified executive benefit plans. For more basic investment needs, we
offer SIMPLE IRA and payroll deduction plans;
o To large institutional clients, we also offer investment-only products,
including guaranteed investment contracts and funding agreements; and
o To employees of businesses and other individuals, we offer the ability to
accumulate retirement savings through mutual funds, individual annuities
and bank products.
We organize our U.S. asset accumulation operations into four product and service
categories: pension, mutual funds, individual annuities and Principal Bank.
Our pension products and services are further grouped into three categories:
full-service accumulation, full-service payout and investment-only.
PENSION PRODUCTS
We offer a wide variety of investment and administrative products for defined
contribution pension plans, including 401(k) and 403(b) plans, defined benefit
pension plans and non-qualified executive benefit plans. A 403(b) plan is a plan
described in section 403(b) of the Internal Revenue Code that provides
retirement benefits for employees of tax-exempt organizations and public
schools.
FULL-SERVICE ACCUMULATION. Full-service accumulation products respond to the
needs of plan sponsors seeking both administrative and investment services for
defined contribution plans or defined benefit plans. The investment component of
our defined contribution plans may be in the form of a group annuity contract or
a mutual fund. The investment component of our defined benefit plans is
available only in the form of a group annuity contract.
As of December 31, 2002, we provided full-service accumulation products to
33,228 defined contribution pension plans, of which 26,314 were 401(k) plans,
covering 2.2 million plan participants, and to 3,023 defined benefit pension
plans, covering 253,380 plan participants. As of December 31, 2002,
approximately 83% of our pension assets under management were managed by
Principal Global Investors. Third-party asset managers provide asset management
services with respect to a majority of the remaining assets.
Prior to 2001, annuities were the only product through which we delivered both
administrative and investment services to our defined contribution plan and
defined benefit plan customers. Under U.S. federal securities laws, neither the
6
annuity nor the underlying investment options are required to be registered with
the SEC. Beginning January 2001, we began to offer administrative and investment
services to defined contribution plan customers through Principal Advantage, a
new 401(k) product based on our recently expanded mutual fund, Principal
Investors Fund. We offer funds covering the full range of stable value, equity,
fixed income and international investment options managed by our affiliated
asset manager, Principal Global Investors, as well as third-party asset
managers.
FULL-SERVICE PAYOUT. Full-service payout products respond to the needs of
pension plan participants who, upon retirement or termination of their
employment, leave their pension plans, and who seek both administrative and
investment services for distributions from the plans they are leaving. Plan
participants who seek these services include those departing pension plans we
service, as well as pension plans other providers service. We offer both
flexible income option products and single premium group annuities. Flexible
income option products allow the customer to control the rate of distribution,
or payout, and provide limited performance guarantees. Single premium group
annuities are immediate or deferred annuities that provide a current or future
specific income amount, fully guaranteed by us. Both products are available to
defined contribution and defined benefit plan participants. For both products,
we make regular payments to individuals, invest the underlying assets on their
behalf and provide tax reporting to them.
Single premium group annuities are traditionally used in conjunction with
defined benefit plans, particularly those where the plan is being terminated. In
such instances, the plan sponsor transfers all its obligations under the plan to
an insurer by paying a single premium. Increasingly, these products are
purchased by defined contribution plan participants who reach retirement age.
Plan sponsors restrict their purchases to insurance companies with superior or
excellent financial quality ratings because the Department of Labor has mandated
that annuities be purchased only from the "safest available" insurer.
Premium received from full-service payout products are in the form of single
payments. As a result, the level of new premiums can fluctuate depending on the
number of retirements and large-scale annuity sales in a particular fiscal
quarter. Assets under management relating to single premium group annuities
generate a spread between the investment income earned by us and the amount
credited to the customer. Assets under management relating to flexible income
option products may generate either spread or fee revenue depending on the
investment options elected by the customer.
INVESTMENT-ONLY. The three primary products for which we provide investment-only
services are: guaranteed investment contracts ("GICs"); funding agreements; and
other investment-only products.
GICs and funding agreements pay a specified rate of return. The rate of return
can be a floating rate based on an external market index or a fixed rate. All of
our investment-only products contain provisions disallowing or limiting early
surrenders, including penalties for early surrenders and minimum notice
requirements. Put provisions give customers the option to terminate a contract
prior to maturity, provided they give us a minimum notice period.
Deposits to investment-only products are predominantly in the form of single
payments. As a result, the level of new deposits can fluctuate from one fiscal
quarter to another. Assets invested in GICs and funding agreements generate a
spread between the investment income earned by us and the amount credited to the
customer. Our other investment-only products consist of separate accounts
invested in either equities or fixed income instruments.
MARKETS AND DISTRIBUTION
We offer our pension products and services to employer-sponsored pension plans,
including qualified and non-qualified defined contribution plans, qualified
defined benefit plans and institutional investors. Our primary target market is
pension plans sponsored by small and medium-sized businesses, which we believe
remains under-penetrated. Only 16% of businesses with less than 100 employees,
and 47% of businesses with between 100 and 500 employees, offered a 401(k) plan
in 2002, according to the Spectrem Group. The same study indicates that 83% of
employers with between 500 and 1000 employees and 93% of employers with 1000 or
more employees offered a 401(k) plan in 2002.
7
FULL-SERVICE ACCUMULATION. We sell our full-service accumulation products and
services nationally, primarily through a captive retirement services sales
force. As of December 31, 2002, 107 retirement services sales representatives in
47 offices, operating as a wholesale distribution network, maintained
relationships with approximately 12,500 independent brokers, consultants and
agents. Retirement services sales representatives are an integral part of the
sales process alongside the referring consultant or independent broker. We
compensate retirement services sales representatives through a blend of salary
and production-based incentives, while we pay independent brokers, consultants
and agents a commission or fee.
As of December 31, 2002, we had a separate staff of 138 service representatives
located in the sales offices who play a key role in the ongoing servicing of
pension plans by: providing local services to our customers, such as renewing
contracts, revising plans and solving any administration problems; communicating
the customers' needs and feedback to us; and helping employees understand the
benefits of their pension plans.
We believe that our approach to pension plan services distribution gives us a
local sales and service presence that differentiates us from many of our
competitors. We have also recently established a number of marketing and
distribution relationships to increase the sales of our accumulation products
with firms such as Frank Russell Investment Management Company, A.G. Edwards and
AON.
We sell our annuity-based products through sales representatives, agents and
brokers who are not required to register with the SEC.
Principal Advantage, our mutual fund-based product, is targeted at defined
contribution plans with over $3.0 million of assets. We sell Principal Advantage
through affiliated registered representatives, stockbrokers, registered
investment advisors and fee-based consultants through sales agreements with
non-affiliated broker-dealers. Principal Advantage gives us access to National
Association of Securities Dealers-registered distributors who are not
traditional sellers of annuity-based products and opens new opportunities for us
in the investment advisor and broker-dealer distribution channels.
We significantly expanded our marketing and product development efforts into the
"not-for-profit" market in 1999, with the acquisition of Professional Pensions,
Inc., which specializes in providing full-service accumulation 403(b) pension
plans to 501(c)(3) not-for-profit organizations. As of December 31, 2002, we
provided pension products and services to 1,031 pension plans sponsored by
educational and not-for-profit organizations with $1,995.9 million of assets
under management.
On June 12, 2002, we announced we had entered into an agreement with KeyCorp
(through affiliates Victory Capital Management and KeyBank National Association)
to offer transition of servicing of KeyCorp's 1,400 employer defined
contribution clients with up to $8.0 billion in assets under management. KeyCorp
transitioned out of the bundled defined contribution business and will recommend
our servicing to its full-service defined contribution clients nationwide.
Impact401k.com is our self-service Internet site, through which plan sponsors
can handle the purchase, enrollment and administration of a 401(k) pension plan
entirely through the Internet. Impact401k.com allows plan participants to gain
on-line access to their accounts, transfer funds between accounts and review
customized investment options. Accordingly, our employees do not have to perform
any administrative activities. Impact401k.com is targeted at smaller businesses
that seek a low cost product, as well as businesses of any size that prefer to
handle administrative activities through the Internet.
FULL-SERVICE PAYOUT AND INVESTMENT-ONLY. Our primary distribution channel for
full-service payout and investment-only products was comprised of 10 specialized
home office marketers as of December 31, 2002, working through consultants and
brokers that specialize in this type of business. Our home office marketers also
make sales directly to institutions. Our nationally dispersed retirement
services sales representatives act as a secondary distribution channel for these
products. Principal Connection also distributes full-service payout products to
participants in plans we service who are terminating employment or retiring.
Principal Connection is our direct response distribution channel for retail
financial services products to individuals. Principal Connection's services are
available over the phone, on the Internet or by mail.
8
We market GICs and funding agreements primarily to pension plan sponsors and
other institutions. We also offer them as part of our full-service accumulation
products. We sell our GICs primarily to plan sponsors for funding of
tax-qualified retirement plans. We sell our funding agreements to institutions
that may or may not be pension funds. Our primary market for funding agreements
is institutional investors in the U.S. and around the world. These investors
purchase debt obligations from a special purpose vehicle which, in turn,
purchases a funding agreement from us with terms similar to those of the debt
obligations. The strength of this market is dependent on debt capital market
conditions. As a result, our sales through this channel can vary widely from one
quarter to another.
MUTUAL FUNDS
We have been providing mutual funds to customers since 1969. We offer mutual
funds to individuals and businesses, for use within variable life and variable
annuity contracts and for use in employer-sponsored pension plans.
PRODUCTS
We were ranked in the top quartile among U.S. mutual fund managers in terms of
total mutual fund assets under management as of November 30, 2002, according to
the Investment Company Institute. The value of our mutual fund assets we managed
was $8.1 billion as of December 31, 2002. We provide accounting, compliance,
corporate governance, product development and transfer agency functions for all
mutual funds we organize. As of December 31, 2002, our mutual fund operations
served approximately 713,800 mutual fund shareholder accounts.
PRINCIPAL MUTUAL FUNDS. Principal Mutual Funds is a family of mutual funds
offered to individuals and businesses, with 22 mutual funds and $3.1 billion in
assets under management as of December 31, 2002. We report the results for these
funds in this segment under "Mutual Funds".
PRINCIPAL VARIABLE CONTRACTS FUND. Principal Variable Contracts Fund is a series
mutual fund which, as of December 31, 2002, provided 28 investment options for
use as funding choices in variable annuity and variable life insurance contracts
issued by Principal Life. As of December 31, 2002, this fund had $2.3 billion in
assets under management. We report the results for the funds backing variable
annuity contracts in this segment under "Individual Annuities." We report the
results for the funds backing variable life insurance contracts in the Life and
Health Insurance segment.
PRINCIPAL INVESTORS FUND. Principal Investors Fund is a recently expanded series
mutual fund, which as of December 31, 2002, offered 46 investment options. This
fund acts as the funding vehicle for Principal Advantage, the defined
contribution product described above under "U.S. Asset Management and
Accumulation Segment-U.S. Asset Accumulation-Pension Services and
Products-Pension Products-Full-service Accumulation." This fund also offers a
retail class of shares to individuals primarily for IRA rollovers. As of
December 31, 2002, this retail class of shares had $523.3 million in assets
under management and all other share classes of Principal Investors Funds,
including seed money, had $2.2 billion of assets under management. We report the
results for this fund, excluding the retail class of shares, under "Pension". We
report the results of the retail class of shares in this segment under "Mutual
Funds."
MARKETS AND DISTRIBUTION
Our markets for retail mutual funds are individuals seeking to accumulate
savings for retirement and other purposes and small businesses seeking to use
mutual funds as the funding vehicle for pension plans, as well as non-qualified
individual savings plans utilizing payroll deductions. We also market our retail
mutual funds to participants in pension plans who are departing their plans and
reinvesting their retirement assets into individual retirement accounts.
Our retail mutual funds are sold primarily through our affiliated financial
representatives, independent brokers registered with our securities
broker-dealer Princor Financial Services Corporation, ("Princor"), registered
9
representatives from other broker-dealers, direct deposits from our employees
and others and Principal Connection. Princor, as the marketing arm of our mutual
fund business, recruits, trains and supervises registered representatives
selling our products.
INDIVIDUAL ANNUITIES
Individual annuities offer a tax-deferred means of accumulating retirement
savings and provide a tax-efficient source of income during the payout period.
PRODUCTS
We offer both fixed and variable annuities to individuals and pension plans.
Individual annuities may be deferred, in which case assets accumulate until the
contract is surrendered, the customer dies or the customer begins receiving
benefits under an annuity payout option, or immediate, in which case payments
begin within one year of issue and continue for a fixed period of time or for
life.
FIXED ANNUITIES. Our individual fixed annuities are predominantly single premium
deferred annuity contracts. These contracts are savings vehicles through which
the customer makes a single deposit with us. Under the contract, the principal
amount is guaranteed and for a specified time period, typically one year, we
credit the customer's account at a fixed interest rate. Thereafter, we reset,
typically annually, the interest rate credited to the contract based upon market
and other conditions. Our major source of income from fixed annuities is the
spread between the investment income we earn on the underlying general account
assets and the interest rate we credit to customers' accounts. We bear the
investment risk because, while we credit customers' accounts with a stated
interest rate, we cannot be certain the investment income we earn on our general
account assets will exceed that rate.
VARIABLE ANNUITIES. Our individual variable annuity products consist almost
entirely of flexible premium deferred variable annuity contracts. These
contracts are savings vehicles through which the customer makes a single deposit
or a series of deposits of varying amounts and intervals. Customers have the
flexibility to allocate their deposits to investment sub-accounts managed by
Principal Global Investors, or third-party asset managers including Fidelity
Investments, AIM Advisors, Inc., Morgan Stanley Asset Management, JPMorgan
Fleming Asset Management, Inc., Janus Capital Corporation, Neuberger Berman
Management, Inc., The Dreyfus Corporation, Templeton Global Advisors Limited,
American Century Investment Management, INVESCO Funds Group, Goldman Sachs Asset
Management, Duncan-Hurst Capital Management, Inc., Turner Investment Partners,
Inc., Bernstein Investment Research and Management, Putnam, UBS Global Asset
Management, Federated Investment Management Company, Founders Asset Management,
LLC, and Berger, LLC. As of December 31, 2002, 60% of our $2.4 billion in
variable annuity account balances was allocated to investment sub-accounts
managed by Principal Global Investors, 25% to investment sub-accounts managed by
third-party asset managers and 15% to our general account, also managed by
Principal Global Investors. The customers bear the investment risk and have the
right to allocate their assets among various separate investment sub-accounts.
The value of the annuity fluctuates in accordance with the experience of the
investment sub-accounts chosen by the customer. Customers have the option to
allocate all or a portion of their account to our general account, in which case
we credit interest at rates we determine, subject to contractual minimums.
Customers may also elect death benefit guarantees. Our major source of revenue
from variable annuities is mortality and expense fees we charge to the customer,
generally determined as a percentage of the market value of the assets held in a
separate investment sub-account.
MARKETS AND DISTRIBUTION
Our target markets for individual annuities include owners, executives and
employees of small and medium-sized businesses, and individuals seeking to
accumulate and/or eventually receive distributions of assets for retirement. We
market both fixed and variable annuities to both qualified and non-qualified
pension plans.
We sell our individual annuity products largely through our affiliated financial
representatives, who accounted for 63%, 74%, 82% of annuity sales for the years
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ended December 31, 2002, 2001 and 2000, respectively. The remaining sales were
made through brokerage general agencies, banks, Principal Connection and
unaffiliated broker-dealer firms.
PRINCIPAL BANK
Principal Bank, our electronic banking operation, is a federal savings bank that
began its activities in February 1998. It offers traditional retail banking
products and services via the telephone, Internet, ATM or by mail. Our current
products and services include checking and savings accounts, money market
accounts, certificates of deposit, consumer loans, first mortgage loans, home
equity loans, credit cards, debit cards, and a college savings program. As of
December 31, 2002, Principal Bank had 85,206 customers and $1,542.4 million in
assets, primarily generated by checking and saving accounts and certificates of
deposit.
We market our Principal Bank products and services to our existing customers and
external prospects, through Principal Connection and other means such as the
Internet, direct mail, and targeted advertising. Through Principal Bank, we also
pursue asset retention strategies with our customers who seek to transfer assets
from our other asset accumulation products by offering them our banking products
and services.
U.S. ASSET MANAGEMENT
PRINCIPAL GLOBAL INVESTORS
In 1999, we established Principal Global Investors to consolidate our extensive
investment management expertise and to focus on marketing our asset management
services to third-party institutional clients. Principal Global Investors
provides asset management services to our U.S. asset accumulation businesses and
third-party institutional clients, as well as our other U.S.-based segments.
Principal Global Investors provides a full range of asset management services
with emphasis on three primary asset classes: (1) equity investments; (2) fixed
income investments; and (3) real estate investments. Principal Global Investors
manages both U.S. and international assets from offices in the U.S. and abroad.
As of December 31, 2002, Principal Global Investors, together with its
affiliates, Principal Real Estate Investors and Spectrum Asset Management,
managed $92.3 billion in assets. Our third-party institutional assets were $14.6
billion as of December 31, 2002, compared to $3.5 billion on January 1, 1999,
the date Principal Global Investors was established.
PRODUCTS
Principal Global Investors provides a full range of asset management services,
with emphasis on three asset classes through a range of investment vehicles
including separate accounts, mutual funds, institutional accounts,
collateralized debt securities and Principal Life's general account:
EQUITY INVESTMENTS. Principal Global Investors manages equity portfolios, which
represented $15.2 billion in assets as of December 31, 2002. Principal Global
Investors provides our clients with access to a broad array of domestic,
international and emerging markets equity capabilities. The domestic equity
products are organized across growth and value styles, with portfolios targeted
to distinct capitalization ranges. As of December 31, 2002, 71% of Principal
Global Investors equity assets under management were derived from our pension
products, 21% from other products of the Principal Financial Group, and the
remaining 8% from third-party institutional clients.
FIXED INCOME INVESTMENTS. Principal Global Investors, along with Spectrum Asset
Management, manages $53.0 billion in fixed income assets as of December 31,
2002. Principal Global Investors and Spectrum Asset Management provide our
clients with access to investment-grade corporate debt, mortgage-backed,
asset-backed and commercial mortgage-backed securities, high yield and municipal
bonds, private and syndicated debt instruments and preferred securities. As of
December 31, 2002, 59% of these assets were derived from our pension products,
24% from other products of the Principal Financial Group, and the remaining 17%
from third-party institutional clients.
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REAL ESTATE INVESTMENTS. Principal Global Investors, through its affiliate
Principal Real Estate Investors, manages a commercial real estate portfolio of
$22.0 billion of assets as of December 31, 2002. Principal Real Estate Investors
provides our clients with a broad range of real estate investment options,
including private real estate equity, commercial mortgages, credit tenant debt,
construction-permanent financing, bridge/mezzanine loans, commercial
mortgage-backed securities and real estate investment trusts. Principal Global
Investors had $0.7 billion of assets under management as of December 31, 2002,
from bridge/mezzanine loans and commercial mortgages which appear on its balance
sheet. The commercial mortgages represent the source of mortgages for our
commercial mortgage-backed securitization program. As of December 31, 2002, 30%
of the commercial real estate portfolio was derived from our pension products,
35% from other products of the Principal Financial Group, and the remaining 35%
from third-party institutional clients.
MARKETS AND DISTRIBUTION
Principal Global Investors employed over 50 institutional sales, relationship
management and client service professionals as of December 31, 2002, who worked
with consultants and directly with large investors to acquire and retain
third-party institutional clients. For the year ended December 31, 2002,
approximately 30% of new institutional clients were originated through direct
client contact by Principal Global Investors representatives, with the balance
derived from contact with both the client and their consultants.
INTERNATIONAL ASSET MANAGEMENT AND ACCUMULATION SEGMENT
Our International Asset Management and Accumulation segment consists of
Principal International and the discontinued operations of BT Financial Group.
Principal International has subsidiaries in Argentina, Chile, Mexico and Hong
Kong and joint ventures in Brazil, Japan, Malaysia and India. We focus on
countries with favorable demographics and a trend toward private sector defined
contribution pension systems. We entered these countries through acquisitions,
start-up operations and joint ventures.
On October 31, 2002, we sold substantially all of BT Financial Group to Westpac
Banking Corporation ("Westpac") for proceeds of A$900.0 million Australian
dollars ("A$") (U.S. $499.4 million), and future contingent proceeds in 2004 of
up to A$150.0 million (approximately U.S. $80.0 million). The contingent
proceeds will be based on Westpac's future success in growing retail funds under
management.
The decision to sell BT Financial Group was made with a view toward focusing our
resources, executing on core strategic priorities and meeting shareholder
expectations. Changing market dynamics since our acquisition of BT Financial
Group, including industry consolidation, led us to conclude that the interests
of The Principal shareholders, BT Financial Group clients and staff would be
best served under Westpac's ownership.
Excluding the contingent proceeds, our estimated after-tax proceeds from the
sale are expected to be approximately U.S. $938.4 million. This amount includes
cash proceeds, expected tax benefits and a gain from unwinding the hedged asset
associated with debt used to acquire BT Financial Group in 1999. We have accrued
for an estimated after-tax loss on disposal of $208.7 million as of December 31,
2002. Future adjustments to the estimated loss are expected to be recorded
through the first half of 2003, as the proceeds from the sale are finalized.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under Statement of Financial Accounting
Standards ("SFAS") 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS, and therefore is still included in our results of continuing operations.
Assets and liabilities related to BT Financial Group have been reclassified to
assets of discontinued operations and liabilities of discontinued operations on
the consolidated statements of financial position for all periods presented. The
results of operations (excluding corporate overhead) for BT Financial Group are
reported as non-recurring items for the International Asset Management and
Accumulation segment.
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For financial results for the International Asset Management and Accumulation
segment see Item 8. "Financial Statements and Supplementary Data, Notes to
Consolidated Financial Statements, Note 18 Segment Information".
PRINCIPAL INTERNATIONAL
The activities of Principal International reflect our efforts to accelerate the
growth of our assets under management by capitalizing on the international trend
toward private sector defined contribution pension systems. Through Principal
International, we offer retirement products and services, annuities, long-term
mutual funds and life insurance. We operate through subsidiaries in Argentina,
Chile, Mexico and Hong Kong and joint ventures in Brazil, Japan, Malaysia and
India.
PRODUCTS, MARKETS AND DISTRIBUTION
ASIA/PACIFIC REGION
HONG KONG. Our subsidiary in Hong Kong is actively competing in the defined
contribution pension plan market. The government requires employers and
employees each to contribute 5% of an employee's income to a Mandatory Provident
Fund. We target small and medium-sized employers and distribute products through
strategic alliances with insurance companies, mutual funds or banks, direct
marketing and through our own sales representatives. Our strategic partners help
distribute our Mandatory Provident Fund products and services, or use our
administrative and investment services in their own products. Our Mandatory
Provident Fund products and services are marketed by agents under the various
distribution arrangements we have with our strategic partners.
INDIA. We own 50% of IDBI-Principal Asset Management Company, Ltd.,
("IDBI-Principal"), a mutual fund company. Our joint venture partner is the
Industrial Development Bank of India, ("IDBI"), a premier development bank in
India. In addition to the current mutual fund business, we are positioning to
compete in the emerging pension and long-term savings market in India. We sell
our mutual funds through regional offices located throughout India and IDBI's
banking offices.
JAPAN. We own 50% of ING/Principal Pensions Company, Ltd., which sells a new
defined contribution pension plan, as a result of legislation adopted in June
2001. This company targets small and medium-sized businesses and offers
full-service record-keeping and plan administration. Our joint venture partner
is ING Insurance International B.V., a member of the ING Group. Our pension
sales representatives distribute our products through ING Life's independent
agents to existing ING Life business clients and also through additional
third-party distribution relationships developed by ING/Principal Pensions
Company, Ltd.
MALAYSIA. We own 30% of Commerce Asset Fund Managers Sendirian Berhad and
Commerce Trust Berhad, two mutual fund and asset management companies. Our joint
venture partner is Commerce Asset Holdings, a large Malaysian bank holding
company. The company markets mutual funds through wholesale bank channels and
its own sales force.
LATIN AMERICA
ARGENTINA. We own a life insurance company and a retirement annuity company (our
"Companies"). Principal Life Compania de Seguros, S.A., our life insurance
company, targets small and medium-sized employers. We sell group and individual
life insurance products through independent brokers. Principal Retiro Compania
de Seguros de Retiro, S.A., our annuity company, provides annuities to
individuals exiting the compulsory private pre-retirement asset accumulation
system. We distribute annuity products through dedicated sales representatives
who sell directly to customers and through independent brokers in Argentina.
While recent adverse economic and political events in Argentina are expected to
impact our ongoing operations, we have been positioning our Companies to work
through this environment since mid-2001 and expect to manage revenues and
expenses accordingly.
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BRAZIL. We own 46% of BrasilPrev Seguros e Previdencia S.A. ("BrasilPrev"), a
private pension company in Brazil, through a joint venture arrangement with
Banco do Brasil, Brazil's largest bank. We are Banco do Brasil's exclusive
partner for distributing pension, retirement and asset accumulation products.
BrasilPrev provides defined contribution products and annuities for the
retirement needs of employers and individuals. Banco do Brasil's employees sell
directly to individual clients through its bank branches. In addition,
BrasilPrev reaches corporate clients through two wholesale distribution
channels: (1) a wholesale distribution channel distributes products through a
network of independent brokers who sell to the public, and (2) another channel
coordinates with Banco do Brasil's corporate account executives to reach Banco
do Brasil's existing corporate clients.
CHILE. We own Principal Compania de Seguros de Vida Chile S.A., a Chilean
insurance company, that primarily sells retirement annuities to individuals
exiting the pre-retirement accumulation system. In July 1998, we acquired
Compania de Seguros de Vida El Roble, S.A., or El Roble, a Chilean life
insurance company. We have fully integrated the operations of El Roble with
those of Principal Compania de Seguros de Vida Chile S.A. We distribute our
annuity products through a network of over 60 captive agents and approximately
450 independent agents as of December 31, 2002. We utilize sales representatives
who sell through brokers, and we also market life insurance products to small
and medium-sized businesses and to individuals through brokers. Based upon
assets, we were ranked as the fourth largest life insurance company in Chile as
of September 30, 2002, according to the Superintendencia de Valores y Seguros,
the Chilean regulatory agency for insurance companies. We also own 60% of
Andueza & Principal Creditos Hipotecarios S.A., in a joint partnership
arrangement with Andueza y Compania Agentes de Mutuos Hipotecarios S.A. Through
this business, we originate, sell and service mortgage loans in Chile. In
November 2001, we acquired 70% of Tanner Administradora de Fondos Mutuos S.A., a
well-known Chilean Mutual Funds Administrator, as part of our strategy to enter
the Voluntary Defined Contribution Market in 2002.
MEXICO. We own Principal Mexico Compania de Seguros S.A. de C.V., ("Principal
Seguros"), a life insurance company, Principal Afore S.A. de C.V., a private
pension company which manages and administers individual retirement accounts
under the mandatory privatized social security system in effect for all
employees in Mexico, and Principal Pensiones S.A. de C.V., ("Principal
Pensiones"), an annuity company. Our focus is on both pre-retirement and
post-retirement savings plans. We distributed Principal Afore S.A. de C.V.'s
products and services through a dedicated sales force of approximately 1,200
sales representatives as of December 31, 2002, who sell directly to individuals.
As of December 31, 2002, Principal Pensiones used 117 employed sales
representatives and independent brokers to distribute annuities directly to
customers. Our life insurance company, Principal Seguros, distributes its
products through an array of independent agents and brokers. In May 2002, we
acquired 100% of Zurich Afore S.A. de C.V. from Zurich Financial Services to
strengthen our competitive position in the Mexican pension market. On November
8, 2002, we signed an agreement to acquire AFORE Tepeyac S.A. de C.V. from
Mapfre American Vida, Caja Madrid and Mapfre Tepeyac for $590.0 million Mexican
Pesos (approximately U.S. $58.0 million). We expect this transaction to be
completed in the first half of 2003.
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LIFE AND HEALTH INSURANCE SEGMENT
Our Life and Health Insurance segment offers (1) individual and group life
insurance (2) group health insurance and (3) individual and group disability
insurance throughout the U.S.
For financial results for the Life and Health Insurance segment see Item 8.
"Financial Statements and Supplementary Data, Notes to Consolidated Financial
Statements, Note 18 Segment Information".
INDIVIDUAL AND GROUP LIFE INSURANCE
We began as an individual life insurer in 1879. We began as a group life insurer
in 1941. Our U.S. operations served approximately 671,000 individual life
policyholders with $88.0 billion of individual life insurance in force as of
December 31, 2002. Group life operations provided products and services to 2.6
million covered lives with $71.8 billion of group life insurance in force as of
December 31, 2002.
We offer a wide array of individual and group life insurance products aimed at
serving our customers' financial needs throughout their lives.
PRODUCTS AND SERVICES
Our individual and group life insurance products include: universal and variable
universal life insurance, traditional life insurance and group life insurance.
UNIVERSAL AND VARIABLE UNIVERSAL LIFE INSURANCE. Universal and variable
universal life insurance products offer life insurance protection for which both
the premium and the death benefit may be adjusted by the policyholder. Our
growth in individual life insurance sales through December 31, 2002, has come
mainly from variable universal life insurance products. Universal and variable
universal life insurance represents 29% of individual life insurance premium and
deposits for the year ended December 31, 2002 and 27% of individual life
insurance in force as of December 31, 2002. Variable universal life insurance
products represented 63% of our universal and variable universal life insurance
deposits for the year ended December 31, 2002. We credit deposits, net of
specified expenses, to an account maintained for the policyholder. Specific
charges are made against the account for the cost of insurance protection and
expenses. For universal life contracts, the entire account balance is invested
in our general account. Interest is credited to the policyholder's account based
on the earnings on general account investments. For variable universal life
contracts, the policyholder may allocate the account balance among our general
account and a variety of separate account choices. Interest is credited on
amounts allocated to the general account in the same manner as for universal
life. Net investment performance on separate account investments is allocated
directly to the policyholder accounts. The policyholder bears the investment
risk on separate account investments. Our profitability is based on charging
sufficient asset-based, premium-based and risk-based fees to cover the cost of
insurance and expenses.
TRADITIONAL LIFE INSURANCE. Traditional life insurance includes participating
whole life, adjustable life products and term life insurance products.
Participating products and term life insurance products represented 16% and 5%,
respectively, of our individual life insurance sales for the year ended December
31, 2002 and 51% and 22% of individual life insurance in force as of December
31, 2002. Adjustable life insurance products provide a guaranteed benefit in
return for the payment of a fixed premium and allow the policyholder to change
the premium and face amount combination. Sales of participating products consist
primarily of premium increase adjustments on our adjustable life products.
Participating policyholders may receive policy dividends as declared by the
board of directors of Principal Life if the combined result of experience
factors, including interest earnings, mortality experience and expenses is
better than the assumptions used in setting the premium. Our profitability is
based on keeping a portion of the favorable experience before crediting the
remainder to policyholders. Term insurance products provide a guaranteed benefit
for a specified period of time in return for the payment of a fixed premium.
Policy dividends are not paid on term insurance. Our profitability is based on
charging a premium that is sufficient to cover the cost of insurance and
expenses while providing us with an appropriate return.
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GROUP LIFE INSURANCE. Group life insurance provides coverage to employees and
their dependents for a specified period. As of December 31, 2002, we had $71.8
billion of group life insurance in force covering 2.6 million lives. We carry
both traditional group life insurance that does not provide for accumulation of
cash values and group universal life, which does provide for accumulation of
cash values. Our group life insurance business remains focused on the
traditional annually renewable term product. Group term life and group universal
life accounted for 91% and 9%, respectively, of our total group life insurance
in force as of December 31, 2002. According to the 2001 LIMRA International,
Inc. Sales and In Force Reports, we were ranked first in the U.S. in terms of
the number of life insurance contracts in force and fourth in terms of the
number of contracts sold.
GROUP HEALTH INSURANCE
We began offering group health insurance in 1941. We offer a wide array of group
health insurance products including medical, dental and vision insurance. In
addition, we offer administrative services on a fee-for-service basis to large
employers in the U.S. As of December 31, 2002, we provided products and services
to 673,000 medical covered members, 1,460,000 dental/vision members and
1,834,000 administrative services only members on a duplicated basis. Members
may be counted multiple times if they have more than one product.
PRODUCTS AND SERVICES
Our U.S. group health insurance products and services include: medical
insurance, dental and vision insurance and fee-for-service.
GROUP MEDICAL INSURANCE. Group medical insurance provides partial reimbursement
of medical expenses for insured employees and their dependents. Employees are
responsible for deductibles, co-payments and co-insurance. We believe our
products are well-positioned to address our customers' preference for a variety
of provider choices and preferred provider discounts. We do not offer
unrestricted indemnity and no longer offer the pure HMO model. As of January 1,
2002, we entered into a reinsurance agreement, which covers all medical
business. Through our wholly-owned subsidiary, HealthRisk Resource Group, Inc.,
we also negotiate discounts with providers on claims for which we have no other
pre-arranged discount.
GROUP DENTAL AND VISION INSURANCE. Group dental and vision insurance plans
provide partial reimbursement for dental and vision expenses. As of December 31,
2002, we had over 34,000 group dental and vision insurance policies in force. We
were the sixth largest group indemnity dental insurer in terms of 2002 sales
through September 30, 2002, based on total indemnity, and the second largest in
terms of number of contracts/employer groups in force based on total indemnity,
according to the September, 30, 2002, LIMRA International, Inc. Sales and In
Force Reports. In addition to indemnity dental, we offer a prepaid dental plan
in Arizona through our Dental Net subsidiary.
FEE-FOR-SERVICE. We offer administration of group disability, medical, dental
and vision services on a fee-for-service basis to larger self-insured employers.
INDIVIDUAL AND GROUP DISABILITY INSURANCE
We began as an individual disability insurer in 1952. We began as a group
disability insurer in 1941. Our U.S. operations served approximately 76,000
individual disability policyholders as of December 31, 2002. Group disability
provided products and services to approximately 700,000 covered members as of
December 31, 2002.
16
We offer a wide array of individual and group disability insurance products
aimed at serving our customer's financial needs throughout their lives.
PRODUCTS AND SERVICES
INDIVIDUAL DISABILITY INSURANCE. Individual disability insurance products
provide a benefit in the event of the disability of the insured. In most
instances, this benefit is in the form of a monthly income. Individual
disability income represents 46% of total disability revenue. In addition to
income replacement, we offer products to pay business overhead expenses for a
disabled business owner, and for the purchase by the other business owners of
the disabled business owner's interests in the business. Our profitability is
based on charging a premium that is sufficient to cover claims and expenses
while providing us with an appropriate return. Our individual disability
business was ranked seventh in the U.S. as of December 31, 2001, in terms of
premium in force, according to the 2001 LIMRA International, Inc. In Force
Report.
GROUP DISABILITY INSURANCE. Group disability insurance provides a benefit to
insured employees who become disabled. Our group disability products include
both short-term and long-term disability. Long-term disability represents 35% of
total disability revenue while short term disability represents 19% of total
disability revenue. In addition, we provide disability management services, or
rehabilitation services, to assist individuals in returning to work as quickly
as possible following disability. We also work with disability claimants to
improve the approval rate of Social Security benefits, thereby reducing payment
of benefits by the amount of Social Security payments received. Our group
disability business was ranked seventh in the U.S. as of December 31, 2001, in
terms of number of contracts/employer groups in force, according to the 2001
LIMRA International, Inc. In Force Reports.
MARKETS AND DISTRIBUTION
We sell our individual life and individual disability income products in all 50
states and the District of Columbia. Our target market is owners and executives
of small and medium-sized businesses, as well as other individuals. Cash value
life insurance provides valuable benefits at death and funding for needs prior
to death, including funding employee benefit liabilities, estate planning,
business continuation or buy-out. We design, market and administer our products
to meet these needs. We have also recently established a number of marketing and
distribution alliances to increase the sales of individual insurance products
with firms such as: AXA, Highland Capital, AG Edwards, Wells Fargo, Piper
Jaffrey, and BISYS. Variable universal life insurance is popular for many
reasons, including higher historical performance of equity investments resulting
in a lower cost of insurance and an increase in values available while still
alive. We also offer products specifically designed to meet the estate planning
needs of business executives. Our individual disability products are also
tailored to the needs of this market. A single large individual life insurance
case of approximately $10.0 million was sold in 2002. No comparable case was
sold in 2001 nor is anticipated for 2003. Excluding this case, small and
medium-sized business sales represented 65% of individual life sales and 45% of
individual disability sales for the year ended December 31, 2002, based on first
year annualized premium.
We distribute our individual insurance products primarily through our affiliated
financial representatives and secondarily through independent brokers.
Affiliated financial representatives were responsible for 72% of individual life
insurance sales (excluding the $10.0 million large case described above, 65%
including this large case), based on first year annualized premium for the year
ended December 31, 2002. We had 1,209 affiliated financial representatives in 46
offices as of December 31, 2002. Although they are independent contractors, we
have a close tie with affiliated financial representatives and offer them
benefits, training and access to tools and expertise. Non-affiliated financial
representatives comprised 76% of individual disability sales (first-year
annualized premium) for the year ended December 31, 2002.
We market our group life, disability, medical, dental and vision insurance
products to small and medium-sized businesses to complement our retirement
services and individual insurance products. We market our fee-for-service
administration capabilities to larger employers that self-insure their
employees' health insurance benefits.
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We sell our group life, disability, dental and fee-for-service products in all
50 states and the District of Columbia. We sell vision coverage in 49 states
plus the District of Columbia. We have chosen to market our group medical
insurance in 35 states and the District of Columbia, which we believe have
attractive market conditions. We consider a market to be attractive if there is
a lack of deep penetration by HMOs and a favorable regulatory environment. We
continually adapt our products and pricing to meet local market conditions.
We distribute our group insurance products through independent benefit brokers,
consultants, financial planners and the same channels that sell our U.S. asset
accumulation products. To reach these independent benefit brokers, consultants
and financial planners, we employ three types of wholesale distributors: our
medical sales representatives, our non-medical sales representatives and an
independent wholesale organization, Rogers Benefit Group, dedicated to marketing
group life, health and disability insurance products. We have also formed a
number of strategic distribution alliances with National Brokerages and regional
Brokerage Agencies.
As of December 31, 2002, we had 95 medical and non-medical sales representatives
and 52 service representatives in 54 offices. Our medical and non-medical sales
representatives accounted for 61%, 64% and 60% of our group insurance sales for
the years ended December 31, 2002, 2001 and 2000, respectively. These
representatives act as a unique combination of wholesalers and brokers. They are
an integral part of the sales process alongside the agent or independent broker.
In addition to a high level of involvement in the sales process, the group sales
force plays a key role in the ongoing servicing of the case by: providing local,
responsive services to our customers, such as renewing contracts, revising plans
and solving any administrative issues; communicating the customers' needs and
feedback to us; and helping employees understand the benefits of their plan.
Compensation for the group sales force is a blend of salary and production-based
incentives.
Rogers Benefit Group is a marketing and service organization that represents
major high quality insurance carriers specializing in individual and group
medical programs, and group life, disability and dental plans. Our relationship
with Rogers Benefit Group dates back to its creation in 1970. It accounted for
39%, 36% and 40% of our group insurance sales for the years ended December 31,
2002, 2001 and 2000, respectively.
MORTGAGE BANKING SEGMENT
We began our residential lending activities in 1936. Our Mortgage Banking
segment is primarily engaged in residential loan production and loan servicing
in the U.S. Through our wholly-owned subsidiary, Principal Residential Mortgage,
Inc., ("Principal Residential Mortgage"), we originate, purchase, sell and
service mortgage loans. We principally originate "A" quality home mortgages and
do not originate subprime mortgages to any material degree, nor do we service or
purchase any subprime mortgage loans. "A" quality loans are generally defined as
loans eligible for sale to the Federal National Mortgage Association, ("Fannie
Mae"), Federal Home Loan Mortgage Corporation, ("Freddie Mac") and using the
Government National Mortgage Association, ("Ginnie Mae") Program. According to
INSIDE MORTGAGE FINANCE, based on the unpaid balance of $107.7 billion in
mortgage loans in its servicing portfolio, Principal Residential Mortgage was
ranked as the eleventh largest mortgage servicer in the U.S. as of December 31,
2002, and was ranked twelfth in production with $46.8 billion of new loans for
the year ended December 31, 2002.
For financial results for Mortgage Banking see Item 8. "Financial Statements and
Supplementary Data, Notes to Consolidated Financial Statements, Note 18 Segment
Information".
LOAN PRODUCTION
Our loan production strategy is to manage our four distribution channels:
correspondent lending, retail origination, wholesale lending and Principal
Residential Mortgage Direct, in a manner that is consistent with our loan
servicing strategy. We obtain new customers through each of our four
distribution channels, with the majority being obtained through our
correspondent lending and wholesale lending operations. Effective February 28,
2003 we will discontinue mortgage loan origination through our retail
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origination channel. Direct lending to retail customers will continue but will
be done entirely through our Mortgage Direct channel.
We originate and purchase conventional mortgage loans, mortgage loans insured by
the Federal Housing Administration, ("FHA"), and mortgage loans partially
guaranteed by the Department of Veterans Affairs, ("VA"). A majority of our
conventional loans are conforming loans that qualify for inclusion in guarantee
programs sponsored by Fannie Mae or Freddie Mac. The remainder of the
conventional loans are non-conforming loans, such as jumbo loans with an
original balance in excess of $300,700 for loans delivered before January 1,
2003, and $322,700 for loans delivered after January 1, 2003, or other loans
that do not meet Fannie Mae or Freddie Mac guidelines. We neither originate nor
purchase "B" or "C" mortgages, defined as lower credit quality loans. However,
we are beginning to originate or purchase "A-" quality residential loans that
are eligible for sale to Fannie Mae or Freddie Mac. We believe this segment
presents opportunities to further penetrate the expanding U.S. housing market
without presenting the types of risks inherent in the subprime sector.
Our guidelines for underwriting conventional conforming loans comply with the
underwriting criteria employed by Fannie Mae and Freddie Mac. Our guidelines for
underwriting FHA-insured and VA-guaranteed loans comply with the criteria
established by those government entities. Our underwriting guidelines and
property standards for conventional non-conforming loans are based on the
underwriting standards employed by private investors for such loans. In
addition, conventional loans having a loan-to-value ratio greater than 80% at
origination, which are originated or purchased by us, are required to have
private mortgage insurance. Insurance premium is paid either by the borrower or
the lender. Our underwriting standards generally allow loan-to-value at
origination of up to 97% for mortgage loans with an original principal balance
of up to $300,700 for loans delivered before January 1, 2003 and $322,700 for
loans delivered after January 1, 2003. To determine whether a prospective
borrower has sufficient monthly income available to meet: (1) the borrower's
monthly obligation on the proposed mortgage loan and (2) monthly housing
expenses and other financial obligations, we generally use the guidelines,
techniques and technology tools provided by our investors.
As a mortgage banker, substantially all loans we originate or purchase are sold
without recourse, subject in the case of VA loans to the limits of the VA's
guaranty. Conforming conventional loans are generally pooled by us and exchanged
for securities guaranteed by Fannie Mae or Freddie Mac. These securities are
then sold to national or regional broker-dealers. Substantially all conventional
loans securitized through Fannie Mae or Freddie Mac are sold, subject to
representations and warranties made by us on a non-recourse basis, whereby
foreclosure losses are generally a liability of Fannie Mae or Freddie Mac.
Substantially all of our FHA-insured and VA-guaranteed mortgage loans sold are
securitized through the Ginnie Mae program. The FHA insures us against
foreclosure loss and the VA provides partial guarantees against foreclosure
loss. To guarantee timely and full payment of principal and interest on Fannie
Mae, Freddie Mac and Ginnie Mae securities, we pay guarantee fees to these
agencies.
We are actively engaged in the loan production business via the following
distribution channels: correspondent lending; retail origination; wholesale and
Principal Residential Mortgage Direct.
CORRESPONDENT LENDING. As of December 31, 2002, we had contracts with 591
lending institutions across the U.S. to purchase prime credit quality loans on
an ongoing basis. According to INSIDE MORTGAGE FINANCE, as of September 30,
2002, we were the sixth largest correspondent lender in the U.S. High quality
financial institutions are approved to do business with us only after we review
their reputation, financial strength and lending expertise. Our "Correspondent
Lending Service Center" on our Internet website currently offers online access
to loan registration, an interactive sellers' procedure manual, seller-specific
rate/price quotations and simplified contact information. We are developing
online technologies to offer automated underwriting systems, pipeline reporting
and account management tools and electronic business-to-business capabilities
for our correspondent sellers. Additionally, we are forging numerous alliances
with third-party service providers to further streamline processes, improve
productivity and provide outstanding customer service.
RETAIL ORIGINATION. Our retail channel originates prime credit quality mortgages
through referrals from real estate agents, builders and personal contact with
19
consumers through our nationwide network, which was comprised of 318 mortgage
loan officers located in 83 offices as of December 31, 2002. Effective February
28, 2003 we will discontinue mortgage loan origination through our retail
origination channel. Direct lending to retail customers will continue entirely
through our Principal Residential Mortgage Direct channel.
WHOLESALE. Our wholesale channel originates or purchases prime credit quality
loans through 13 regional offices that worked directly with 3,465 participating
mortgage loan brokers across the U.S. as of December 31, 2002. Mortgage loan
brokers are approved only after a review of their reputation and mortgage
lending expertise and financial condition. Through the "Wholesale Lending
Service Center" on our Internet website, wholesale lenders can retrieve contact
information and seller specific interest rate quotations. We have developed
plans and are working to provide online registration, automated underwriting
system, pipeline reporting and account management services to our brokers. We
are also developing electronic document delivery and execution capabilities for
wholesale sellers to exchange secure documents with wholesale purchasers.
PRINCIPAL RESIDENTIAL MORTGAGE DIRECT. Our Mortgage Direct channel originates
prime credit quality mortgage loans through direct contact with current and new
customers via telephone and the Internet. The goal of our Internet channel is to
give our current customers access to a customer-focused website, allowing them
to obtain home financing quickly, confidently and at an attractive value, while
preserving acceptable profit margins for us. We believe that providing current
customers with choice, ease of access, convenient processes and simplified
procedures will cause a growing percentage of our customers to choose us for all
of their home financing needs.
LOAN SERVICING
We service residential mortgages in return for a servicing fee. Our servicing
division receives and processes mortgage payments for home owners, remits
payments to investors and others, holds escrow funds, contacts delinquent
borrowers, supervises foreclosures and property dispositions and performs other
miscellaneous duties related to loan administration. We acquire only "A" or "A-"
quality home mortgages for servicing. This practice simplifies the systems
necessary for servicing and reduces the amount of time and money spent on
collections and foreclosure administration activities. Our goal is to service,
on a non-recourse basis, a majority of the loans that we originate. In addition,
we periodically purchase servicing rights, also on a non-recourse basis to us,
on prime quality mortgage loans originated by other lenders. Our purchases focus
primarily on the acquisition of Fannie Mae, Freddie Mac and Ginnie Mae servicing
rights packages. Factors which influence the management of the servicing
portfolio include the expected long-term and short-term profitability of the
servicing rights, customer retention objectives and the potential cross-selling
of retirement investments and insurance and other products to home owners.
Servicing contracts acquired accounted for 22% of our mortgage servicing
portfolio as of December 31, 2002.
The weighted-average interest rate in our servicing portfolio as of December 31,
2002 was 6.66%. As of December 31, 2002, fixed rate loans comprised 96% of the
servicing portfolio and the weighted-average interest rate of the fixed-rate
loans was 6.71%.
In November 1999, we established a wholly-owned reinsurance subsidiary,
Principal Mortgage Reinsurance Company ("PMRC"), which reinsures a portion of
the primary mortgage insurance on loans that we originate or purchase. In return
for our participation in the mortgage insurance risk, we receive a portion of
the mortgage insurance premium.
CORPORATE AND OTHER SEGMENT
Our Corporate and Other segment holds the assets in excess of those needed by
the four operating segments. These assets are primarily comprised of fixed
income securities, common stock and real estate investments. All long-term debt
and inter-segment eliminations are included in this segment.
For financial results for Corporate and Other see Item 8. "Financial Statements
and Supplementary Data, Notes to Consolidated Financial Statements, Note 18
Segment Information".
20
COMPETITION
Competition in our operating segments is based on a number of factors including:
service, product features, price, investment performance, commission structure,
distribution capacity, financial strength ratings and name recognition. We
compete for customers and distributors with a large number of financial services
companies such as banks, mutual funds, broker-dealers, insurers and asset
managers. Some of these companies offer a broader array of products, more
competitive pricing, greater diversity of distribution sources, better brand
recognition or, with respect to insurers, higher financial strength ratings.
Some may also have greater financial resources with which to compete or may have
better investment performance at various times.
Competition in the retirement services market is very fragmented. Our main
competitors in this market include Fidelity, Nationwide, AXA, Mass Mutual and
Manulife. We believe the infrastructure and system support needed to meet the
needs of the small and medium-sized business market is a significant barrier to
entry for our competitors. Many of our competitors in the mutual fund industry
are larger, have been established for a longer period of time, offer less
expensive products, have deeper penetration in key distribution channels and
have more resources than we do. There were over 8,307 mutual funds in the U.S.
as of December 31, 2001, according to the Investment Company Institute 2001
Mutual Fund Fact Book. The institutional asset management market has grown at a
rapid pace over the last decade. Our primary competitors in this market are
large institutional asset management firms, such as J.P. Morgan Chase, Morgan
Stanley Investment Management and T. Rowe Price, some of which offer a broader
array of investment products and services and are better known. The asset
management business has relatively few barriers to entry and continually
attracts new entrants. The variable annuity market is also highly competitive.
As we expand into additional distribution channels for this product, we will
face strong competition from Nationwide and Hartford. Competition in the
international markets in which we operate comes primarily from local financial
services firms and other international companies operating on a stand-alone
basis or in a partnership with local firms, including ING, AXA, Allianz and AIG.
In the highly competitive life and health insurance business, our competitors
include other insurers such as UNUM, Guardian, The Northwestern Mutual Life
Insurance Company, Manulife, Blue Cross and Blue Shield organizations, and
health maintenance organizations such as United HealthCare and Aetna. The
mortgage banking industry is also highly competitive and fragmented and we
compete with other mortgage bankers, commercial banks, savings and loan
associations, credit unions and insurance companies such as Countrywide and
Wells Fargo.
We believe we distinguish ourselves from our competitors through our:
o full-service platform;
o strong customer relationships;
o focus on financial performance; and
o performance-oriented culture.
RATINGS
Insurance companies are assigned financial strength ratings by rating agencies
based upon factors relevant to policyholders. Ratings provide both industry
participants and insurance consumers meaningful information on specific
insurance companies. Higher ratings generally indicate financial stability and a
stronger ability to pay claims.
Principal Life has been assigned the following ratings:
21
RATING AGENCY FINANCIAL STRENGTH RATING RATING STRUCTURE
A.M. Best Company, Inc. A+ ("Superior") with a Second highest of 16
stable outlook rating levels
Fitch Ratings AA ("Very Strong") with Third highest of 24
a stable outlook rating levels
Moody's Investors Service Aa3 ("Excellent") with Fourth highest of 21
a stable outlook rating levels
Standard & Poor's Rating AA ("Very Strong") with Third highest of 21
Services a negative outlook rating levels
A.M. Best's ratings for insurance companies range from "A++" to "S". A.M. Best
indicates that "A++" and "A+" ratings are assigned to those companies that in
A.M. Best's opinion have achieved superior overall performance when compared to
the norms of the life insurance industry and have demonstrated a strong ability
to meet their policyholder and other contractual obligations. Fitch's ratings
for insurance companies range from "AAA" to "D". Fitch indicates that "AA"
ratings are assigned to those companies that have demonstrated financial
strength and a very strong capacity to meet policyholder and contractholder
obligations on a timely basis. Moody's ratings for insurance companies range
from "Aaa" to "C". Moody's indicates that "A ("Excellent")" ratings are assigned
to those companies that have demonstrated excellent financial security. Standard
& Poor's ratings for insurance companies range from "AAA" to "R". Standard &
Poor's indicates that "AA" ratings are assigned to those companies that have
demonstrated very strong financial security. In evaluating a company's financial
and operating performance, these rating agencies review its profitability,
leverage and liquidity, as well as its book of business, the adequacy and
soundness of its reinsurance, the quality and estimated market value of its
assets, the adequacy of its policy reserves, the experience and competency of
its management and other factors.
We believe that our strong ratings are an important factor in marketing our
products to our distributors and customers, since ratings information is broadly
disseminated and generally used throughout the industry. Our ratings reflect
each rating agency's opinion of our financial strength, operating performance
and ability to meet our obligations to policyholders and are not evaluations
directed toward the protection of investors. Such ratings are neither a rating
of securities nor a recommendation to buy, hold or sell any security, including
our common stock.
EMPLOYEES
As of December 31, 2002, we had 15,038 employees. None of our employees is
subject to collective bargaining agreements governing employment with us. We
believe that our employee relations are satisfactory.
INTERNET WEBSITE
Our Internet website can be found at www.principal.com. We make available free
of charge on or through our Internet website, access to our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act as soon as reasonably practicable after such material
is filed with or furnished to the Securities and Exchange Commission.
ITEM 2. PROPERTIES
We own 26 properties in our home office complex in Des Moines, Iowa and in
various other locations. Of these 26 properties, 11 are office buildings, 1 is a
warehouse facility, 13 are parking lots and ramps, and 1 is a park/green space.
Of the office and warehouse space, we occupy approximately 93% of the 2.78
million square feet of space in these buildings. The balance of the space in
these buildings is rented to commercial tenants. Of the parking properties there
are approximately 6,918 stalls. We lease office space for various offices
located throughout the U.S. and internationally. We believe that our owned and
leased properties are suitable and adequate for our current business operations.
22
ITEM 3. LEGAL PROCEEDINGS
We are a plaintiff or defendant in actions arising out of our operations. We
are, from time to time, also involved in various governmental and administrative
proceedings. While the outcomes of any pending or future litigation cannot be
predicted, management does not believe that any pending litigation will have a
material adverse effect on our business, financial condition or results of
operations. However, no assurances can be given that such litigation would not
materially and adversely affect our business, financial condition or results of
operations.
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.
Other companies in the life insurance industry have historically been subject to
substantial litigation resulting from claims, disputes and other matters. Most
recently, such companies have faced extensive claims, including class-action
lawsuits, alleging improper life insurance sales practices. Negotiated
settlements of such class-action lawsuits have had a material adverse effect on
the business, financial condition and results of operations of certain of these
companies.
Principal Life was a defendant in two class-action lawsuits, which alleged
improper sales practices. We have settled these two class-action lawsuits and
have accrued a loss reserve for our best estimate based on information
available. We believe this reserve is sufficient to cover our obligation under
the settlements. 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. We have been notified that some of those who opted out from
the class filed lawsuits and made claims similar to those addressed by the
settlement. Most of those lawsuits and claims have resolved. We accrued a loss
reserve for our best estimate of our potential exposure to the suits and claims.
As uncertainties continue to exist in resolving this matter, it is reasonably
possible that all the actual costs of the suits and claims could exceed our
estimate. The range of any such costs cannot be presently estimated; however, we
believe the additional cost will not have a material impact on our business,
financial condition or results of operations.
A lawsuit was filed on September 27, 2001, in the United States District Court
for the Northern District of Illinois, seeking damages and other relief on
behalf of a putative class of policyholders based on allegations that the plan
of conversion of Principal Mutual Holding Company from a mutual insurance
holding company into a stock company violates the United States Constitution.
The action is captioned ESTHER L. GAYMAN V. PRINCIPAL MUTUAL HOLDING COMPANY, ET
AL. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs filed an appeal on May 15, 2002, with the 7th
Circuit Court of Appeals. On November 22, 2002, the 7th Circuit Court of Appeals
affirmed the District Court's decision.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of Principal Financial
Group, Inc. during the fourth quarter of the fiscal year covered by this report.
23
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information is furnished with respect to each of the executive
officers of the Company, each of whom is elected by and serves at the pleasure
of the Board of Directors.
J. BARRY GRISWELL, 53, has been Chairman, President and Chief Executive Officer
of the Company and Principal Life since 2002, a director of the Company since
2001, and a Principal Life director since 1998. Prior thereto, he had been
President and Chief Executive Officer of the Company since April 2001, and
President and Chief Executive Officer of Principal Life since January 2000.
Prior to January 2000, Mr. Griswell held the following positions with Principal
Life: President from 1998-2000 and Executive Vice President from 1996-1998. He
is a Chartered Life Underwriter, a Chartered Financial Consultant and a LIMRA
Leadership Institute Fellow. He is Chair of the Executive Committee of the
Board.
JOHN E. ASCHENBRENNER, 53, who heads the Life and Health Insurance and Mortgage
Banking segments of our operations has been Executive Vice President of the
Company since April 2001, and Executive Vice President of Principal Life since
January 2000. Prior thereto, he was Senior Vice President of Principal Life from
1996-December 1999. Mr. Aschenbrenner serves as a director of the 24 mutual
funds that comprise the Principal Family of Mutual Funds.
MICHAEL T. DALEY, 46, who heads Marketing and Distribution has been Executive
Vice President of the Company since April 2001, and Executive Vice President of
Principal Life since June 2000. Prior thereto, he was Senior Vice President of
CIGNA Retirement and Investment Services from 1997-2000.
DENNIS P. FRANCIS, 59, has been Chief Executive Officer of Principal Global
Investors since 1999. He has been Senior Vice President of the Company since
April 2001, and Senior Vice President and Chief Investment Officer of Principal
Life since 1998. From 1990-1997, he was Vice President--Commercial Real Estate
of Principal Life.
MICHAEL H. GERSIE, 54, has been Executive Vice President and Chief Financial
Officer of the Company since April 2001, and Executive Vice President and Chief
Financial Officer of Principal Life since January 2000. From 1994-1999, he was
Senior Vice President of Principal Life.
ELLEN Z. LAMALE, 49, has been Senior Vice President and Chief Actuary of the
Company since April 2001, and Senior Vice President and Chief Actuary of
Principal Life since June 1999. From 1992-1999, she was Vice President and Chief
Actuary of Principal Life.
JULIA M. LAWLER, 43, has been Senior Vice President and Chief Investment Officer
of the Company since July 2002. From 2000-2002, she was President of the Real
Estate Equity Group of Principal Global Investors, LLC. From 1999-2000, she was
Vice President-- Capital Markets. From 1998-1999, she was Director--Capital
Markets of Principal Life.
JAMES P. MCCAUGHAN, 49, has been the Executive Vice President of the Company and
global head of asset management for Principal Financial Group since April 2002.
From 2000-2002, he was CEO of the Americas division of Credit Suisse Asset
Management in New York, New York. From 1998-1999, he was President and Chief
Operating Officer of Oppenheimer Capital in New York, New York.
MARY A. O'KEEFE, 46, who heads Corporate Relations and Human Resources, has been
Senior Vice President of the Company since April 2001, and Senior Vice President
of Principal Life since January 1998. From 1994-1997, she was Vice
President--Corporate Relations of Principal Life.
GARY P. SCHOLTEN, 45, has been Senior Vice President and Chief Information
Officer of the Company since November 2002. From 1998-2002, he was Vice
President of retail information services of Principal Life.
KAREN E. SHAFF, 48, has been Senior Vice President and General Counsel of the
Company since April 2001, and Senior Vice President and General Counsel of
Principal Life since January 2000. From June 1999-December 1999, she was Senior
Vice President and Deputy General Counsel of Principal Life, and from 1995-May
1999, she was Vice President and Associate General Counsel of Principal Life.
24
NORMAN R. SORENSEN, 57, has been President of Principal International, Inc.
since 1998, Senior Vice President of the Company since April 2001, and Senior
Vice President of Principal Life since December 1998. From 1989-November 1998,
he was Vice President and Senior Executive--Latin America, American
International Group.
LARRY D. ZIMPLEMAN, 51, has been the head of our International Asset
Accumulation business since January 2003, our U. S. Asset Accumulation business
since February 2002, and Executive Vice President of the Company and Principal
Life since August 2001. Prior to his current position, Mr. Zimpleman was Senior
Vice President of Principal Life from June 1999-August 2001, Vice President from
1998-1999 and Vice President--Pension from 1994-1998. Mr. Zimpleman serves as
Chairman of the Board and a director of each of Principal's 24 Mutual Funds.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock began trading on the New York Stock Exchange ("NYSE") under the
symbol "PFG" on October 23, 2001. Prior to such date, there was no established
public trading market for our common stock. On February 28, 2003, there were
approximately 586,944 stockholders of record of our common stock.
The following table presents the high and low prices for our common stock on the
NYSE for the periods indicated and the dividends declared per share during such
periods.
HIGH LOW DIVIDENDS
-------------- -------------- --------------
2002
First Quarter $27.05 $22.00 -
Second Quarter $31.50 $25.00 -
Third Quarter $30.70 $25.15 -
Fourth Quarter $31.49 $22.50 $0.25
2001
For the period from
October 23, 2001
through December
31, 2001 $24.75 $20.40 -
We declared an annual cash dividend of $0.25 per common share on October 25,
2002, and paid such dividend on December 9, 2002, to shareholders of record on
the close of business on November 8, 2002. Future dividend decisions will be
based on and affected by a number of factors, including our operating results
and financial requirements and the impact of regulatory restrictions. See Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a discussion of regulatory
restrictions on Principal Life's ability to pay us dividends.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected historical consolidated
financial information of Principal Financial Group, Inc. We derived the
consolidated financial information for each of the years ended December 31,
2002, 2001 and 2000 and as of December 31, 2002 and 2001 from our audited
consolidated financial statements and notes to the financial statements included
in this Form 10-K. We derived the consolidated financial information for the
year ended December 31, 1999 and 1998 and as of December 31, 2000, 1999 and 1998
from our audited consolidated financial statements not included in this Form
10-K. The following summary of consolidated financial information has been
prepared in accordance with U.S. GAAP.
The following is a summary of financial information. In order to fully
understand our consolidated financial information, you should also read Item 7.
25
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our audited consolidated financial statements and the notes to
the financial statements included in this Form 10-K. The results for past
accounting periods are not necessarily indicative of the results to be expected
for any future accounting period.
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2002(2) 2001(2) 2000(2) 1999(2) 1998(2)
------------ ----------- ----------- ---------- ------------
($ IN MILLIONS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA(1):
Revenues:
Premiums and other considerations...... $ 3,881.8 $ 4,122.3 $ 3,996.4 $ 3,937.6 $ 3,818.4
Fees and other revenues................ 1,990.8 1,600.7 1,300.6 1,191.8 978.8
Net investment income.................. 3,304.7 3,383.6 3,157.6 3,055.3 2,933.9
Net realized/unrealized capital gains
(losses)............................. (354.8) (514.0) 139.6 404.5 465.8
------------ ----------- ----------- ---------- -----------
Total revenues....................... $ 8,822.5 $ 8,592.6 $ 8,594.2 $ 8,589.2 $ 8,196.9
Income from continuing operations, net of
related income taxes................... $ 619.9 $ 380.7 $ 611.7 $ 745.2 $ 693.0
Income (loss) from discontinued operations,
net of related income taxes (3) ....... (196.7) (11.2) 8.5 (3.1) -
------------ ----------- ----------- ---------- ----------
Income before cumulative effect of
accounting changes..................... 423.2 369.5 620.2 742.1 693.0
Cumulative effect of accounting
changes, net of related income taxes
(4) ................................... (280.9) (10.7) - - -
------------ ----------- ----------- ---------- -----------
Net income................................ $ 142.3 $ 358.8 $ 620.2 $ 742.1 $ 693.0
============ =========== =========== ========== ==========
26
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2002(2) 2001(2) 2000(2) 1999(2) 1998(2)
------------ ----------- ----------- ----------- -----------
($ IN MILLIONS, EXCEPT PER SHARE DATA)
EARNINGS PER SHARE DATA(5):
Income from continuing operations per
share:
Basic.................................. $ 1.77 $ 1.05 N/A N/A N/A
Diluted................................ $ 1.77 $ 1.05 N/A N/A N/A
Net income per share:
Basic.................................. $ 0.41 $ 0.99 N/A N/A N/A
Diluted................................ $ 0.41 $ 0.99 N/A N/A N/A
Common shares outstanding at year-end
(in millions).......................... 334.4 360.1 N/A N/A N/A
Weighted-average common shares
outstanding for the year (in millions). 350.2 362.4 N/A N/A N/A
Weighted-average common shares and
potential common shares outstanding
for the year for computation of diluted 350.7 362.4 N/A N/A N/A
earnings per share (in millions).......
Cash dividends per share.................. $ 0.25 N/A N/A N/A N/A
BALANCE SHEET DATA(1):
Total assets.............................. $89,861.3 $88,350.5 $ 84,404.9 $ 83,953.2 $ 74,046.7
Long-term debt............................ $ 1,332.5 $ 1,378.4 $ 1,336.5 $ 1,492.9 $ 670.9
Common stock(6)........................... $ 3.8 $ 3.8 $ - $ - $ -
Additional paid-in capital(7)............. 7,106.3 7,072.5 - - -
Retained earnings (deficit)(8)............ 29.4 (29.1) 6,312.5 5,692.3 4,950.2
Accumulated other comprehensive
income (loss).......................... 635.8 147.5 (60.0) (139.4) 717.0
Treasury stock, at cost................... (1,118.1) (374.4) - - -
------------ ------------ ------------- ----------- -----------
Total stockholders' equity......... $ 6,657.2 $ 6,820.3 $ 6,252.5 $ 5,552.9 $ 5,667.2
============ ============ ============ =========== ===========
27
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
2002(2) 2001(2) 2000(2) 1999(2) 1998(2)
------------ ------------- ------------ ----------- ------------
($ IN MILLIONS, EXCEPT PER SHARE DATA)
OTHER SUPPLEMENTAL DATA:
Net income................................ $ 142.3 $ 358.8 $ 620.2 $ 742.1 $ 693.0
Less:
Net realized/unrealized capital gains
(losses), as adjusted (9)................. (243.9) (321.0) 93.0 265.2 320.7
Non-recurring items(10)................... (363.2) (42.3) (92.5) (3.1) 104.8
------------ ------------- ------------ ----------- ------------
Operating earnings................. $ 749.4 $ 722.1 $ 619.7 $ 480.0 $ 267.5
============ ============= ============ =========== ============
Operating return on average equity(11).... 11.8% 10.9% 10.5% 8.9% 5.8%
Total return on average equity(12)........ 2.2% 5.5% 10.3% 13.9% 15.1%
Assets under management ($ in billions)... $ 111.1 $ 120.2 $ 117.5 $ 116.6 $ 80.4
Number of employees (actual).............. 15,038 17,138 17,473 17,129 15,970
- ---------
(1) We have reclassified periods prior to December 31, 2002, to conform to the
presentation for that period.
(2) For a discussion of items materially affecting the comparability of 2002,
2001, and 2000, please see Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Transactions Affecting
Comparability of Results of Operations and Demutualization and Initial
Public Offering."
Our consolidated financial information for 1999 and 1998 was affected by
the following transactions that affect year-to-year comparability:
o On February 1, 2002, we sold our remaining stake of 15.1 million
shares of Coventry Health Care, We accounted for our investment in
Coventry using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million, $20.2 million, $20.6 million
and $19.1 million for the years ended December 31, 2002, 2001, 2000,
and 1999, respectively. Our share of Coventry's net loss was $9.8
million for the year ended December 31, 1998.
(3) On October 31, 2002, we sold substantially all of BT Financial Group to
Westpac Banking Corporation. BT Financial Group is accounted for as a
discontinued operation and therefore, the results of operations (excluding
corporate overhead) and cash flows have been removed from our income from
continuing operations for all periods presented.
(4) See Item 8. "Financial Statements and Supplementary Data- Notes to
Consolidated Financial Statements, Note 1, Nature of Operations and
Significant Accounting Policies" for a description of recent accounting
changes.
(5) Earnings per share information for 2001 represents unaudited pro forma
earnings per common share for the year ended December 31, 2001. For
purposes of calculating pro forma per diluted share information,
weighted-average shares outstanding were used. For the period January 1,
2001 through October 25, 2001, we estimated 360.8 million common shares
were outstanding. This consists of 260.8 million shares issued to eligible
policyholders in our demutualization and the 100.0 million shares issued in
our initial public offering ("IPO") which closed on October 26, 2001. For
the period October 26, 2001 through December 31, 2001, actual shares
outstanding were used in the weighted-average share calculation.
(6) During 2001, we issued 260.8 million shares of common stock as compensation
in the demutualization, 100.0 million shares of common stock in our IPO and
15.0 million shares of common stock as a result of the exercise of
28
over-allotment options granted to underwriters in the IPO. All shares
issued have a $0.01 per share par value.
(7) As of December 31, 2001, represents: a) additional paid-in capital from the
demutualization resulting from the reclassification of residual retained
earnings of Principal Mutual Holding Company, net of common stock issued
($5,047.7 million); b) net proceeds, net of common stock issued, from the
sale of 100.0 million shares of common stock in our IPO ($1,752.9 million);
c) net proceeds, net of common stock issued, from the exercise of over-
allotment options granted to underwriters in the IPO ($265.2 million); and
d) common stock issued and held in a rabbi trust ($6.7 million).
(8) As of December 31, 2001, represents a $29.1 million net loss for the period
October 26, 2001 through December 31, 2001. Retained earnings as of October
26, 2001, were reclassified to additional paid-in capital as a result of
our demutualization.
(9) Net realized/unrealized capital gains (losses), as adjusted, are net of
income 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 distributed to
customers and certain market value adjustments to fee revenues. Deferred
policy acquisition costs represent commissions and other selling expenses
that vary with and are directly related to the production of business.
These acquisition costs are deferred and amortized in conformity with U.S.
GAAP.
(10) For a discussion of non-recurring items materially affecting the
comparability of 2002, 2001, and 2000, please see Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Results of Operations by Segment."
For the year ended December 31, 1999, we excluded $3.1 million of
non-recurring items, net of income taxes, from net income for our
presentation of operating earnings. The non-recurring items included the
negative effects of the loss from discontinued operations of BT Financial
Group.
For the year ended December 31, 1998, we excluded $104.8 million of
non-recurring items, net of income taxes, from net income for our
presentation of operating earnings. The non-recurring items included: (a)
the positive effects of (i) Principal Life's release of tax reserves and
related accrued interest ($164.4 million) and (ii) accounting changes by
our international operations ($13.3 million); and (b) the negative effects
of (i) a contribution related to permanent endowment of the Principal
Financial Group Foundation ($45.5 million) and (ii) expenses and
adjustments for changes in amortization assumptions for deferred policy
acquisition costs related to our corporate structure change to a mutual
insurance holding company ($27.4 million).
(11) We define operating return on average equity as operating earnings divided
by average total equity, excluding accumulated other comprehensive income.
We have excluded accumulated other comprehensive income due to its
volatility between periods and because such data is often excluded when
evaluating the overall financial performance of insurers. Operating return
on average equity should not be considered a substitute for any U.S. GAAP
measure of performance.
(12) We define total return on average equity as net income divided by average
total equity, excluding accumulated other comprehensive income. We have
excluded accumulated other comprehensive income due to its volatility
between periods and because such data is often excluded when evaluating the
overall financial performance of insurers.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis discusses our financial condition as of December 31,
2002, compared with December 31, 2001, and our consolidated results of
operations for the years ended December 31, 2002, 2001 and 2000, and, where
appropriate, factors that may affect our future financial performance. The
discussion should be read in conjunction with our audited consolidated financial
statements and the related notes to the financial statements and the other
financial information included elsewhere in this Form 10-K.
29
FORWARD-LOOKING INFORMATION
Our narrative analysis below contains forward-looking statements intended to
enhance the reader's ability to assess our future financial performance.
Forward-looking statements include, but are not limited to, statements that
represent our beliefs concerning future operations, strategies, financial
results or other developments, and contain words and phrases such as
"anticipate," "believe," "plan," "estimate," "expect," "intend," and similar
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects on us. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) a decline or increased volatility in the securities markets
could result in investors withdrawing from the markets or decreasing their rates
of investment, either of which could reduce our net income, revenues and assets
under management; (2) our investment portfolio is subject to several risks which
may diminish the value of our invested assets and affect our sales,
profitability and the investment returns credited to our customers; (3)
competition from companies that may have greater financial resources, broader
arrays of products, higher ratings and stronger financial performance may impair
our ability to retain existing customers, attract new customers and maintain our
profitability; (4) a downgrade in Principal Life Insurance Company's ("Principal
Life") financial strength ratings may increase policy surrenders and
withdrawals, reduce new sales and terminate relationships with distributors and
cause some of our existing liabilities to be subject to acceleration, additional
collateral support, changes in terms, or creation of additional financial
obligations; (5) our efforts to reduce the impact of interest rate changes on
our profitability and surplus may not be effective; (6) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (7) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (8) our reserves established for future
policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (9) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends Iowa insurance
laws impose on Principal Life; (10) we may need to fund deficiencies in our
closed block ("Closed Block") assets which benefit only the holders of Closed
Block policies; (11) changes in regulations or accounting standards may reduce
our profitability; (12) litigation and regulatory investigations may harm our
financial strength and reduce our profitability; (13) fluctuations in foreign
currency exchange rates could reduce our profitability; (14) a challenge to the
Insurance Commissioner of the State of Iowa's approval of the plan of conversion
could put the terms of our demutualization in question and reduce the market
price of our common stock; (15) applicable laws and our stockholder rights plan,
certificate of incorporation and by-laws may discourage takeovers and business
combinations that our stockholders might consider in their best interests; and
(16) a downgrade in our debt ratings may adversely affect our ability to secure
funds and cause some of our existing liabilities to be subject to acceleration,
additional collateral support, changes in terms, or creation of additional
financial obligations.
OVERVIEW
We are a leading provider of retirement savings, investment and insurance
products and services. We have four operating segments:
o U.S. Asset Management and Accumulation, which consists of our asset
accumulation operations which provide products and services, including
retirement savings and related investment products and services, and our
asset management operations conducted through Principal Global Investors,
formerly known as Principal Capital Management. 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.
30
o International Asset Management and Accumulation, which consists of
Principal International, offers retirement products and services,
annuities, long-term mutual funds and life insurance through subsidiaries
in Argentina, Chile, Mexico and Hong Kong and joint ventures in Brazil,
Japan, India and Malaysia. Prior to October 31, 2002, the operating segment
included BT Financial Group, an Australia based asset manager. We sold
substantially all of BT Financial Group, effective October 31, 2002. See
"Transactions Affecting Comparability of Results of Operations."
o Life and Health Insurance, which provides life insurance, health insurance
as well as disability insurance throughout the U.S. Our life insurance
products include universal and variable universal life, traditional life,
and group life. Our health insurance products include medical insurance,
dental and vision insurance, and administrative services. Our disability
insurance products include individual and group disability insurance.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.
PROFITABILITY
Our profitability depends in large part upon our:
o amount of assets under management;
o spreads we earn on our policyholders' general account balances;
o ability to generate fee revenues greater than the amount it costs us to
administer pension products, manage investments for retail and
institutional clients and provide other administrative services;
o ability to price our life and health insurance products at a level that
enables us to earn a margin over the cost of providing benefits and the
expense of acquiring and administering those products, which is primarily a
function of competitive conditions, persistency, our ability to assess and
manage trends in mortality and morbidity experience, our ability to
generate investment earnings and our ability to maintain expenses in
accordance with pricing assumptions;
o ability to effectively monitor and price residential mortgage loans we
originate, purchase, and sell and to manage the expenses we incur in
servicing residential mortgage loans;
o ability to effectively hedge the effect of interest rate changes on our
residential mortgage servicing rights;
o ability to manage our investment portfolio to maximize investment returns
and minimize risks such as interest rate changes or defaults or impairments
of invested assets;
o ability to effectively hedge fluctuations in foreign currency to U.S.
dollar exchange rates; and
o ability to manage our operating expenses.
CRITICAL ACCOUNTING POLICIES
The increasing complexity of the business environment and applicable
authoritative accounting guidance requires us to closely monitor our accounting
policies. We have identified three critical accounting policies that are complex
and require significant judgment. A summary of our critical accounting policies
is intended to enhance the reader's ability to assess our financial condition
and results of operations and the potential volatility due to changes in
estimates and changes in guidance.
31
VALUATION OF INVESTED ASSETS
VALUATION POLICIES. We classify our investments into one of three categories:
held-to-maturity, available-for-sale or trading. We determine the appropriate
classification of fixed maturity securities at the time of purchase. Fixed
maturity securities include bonds, mortgage-backed securities and redeemable
preferred stock. We classify our fixed maturity securities as either
available-for-sale or trading and, accordingly, carry them at fair value.
Unrealized gains and losses related to available-for-sale securities are
reflected in stockholders' equity net of related deferred policy acquisition
costs and applicable taxes. Unrealized gains and losses related to trading
securities are reflected in net income as net realized/unrealized capital gains
(losses). The cost of fixed maturity securities is adjusted for amortization of
premiums and accrual of discounts, both computed using the interest method. The
cost of fixed maturity securities is adjusted for declines in value that are
other than temporary. Impairments in value deemed to be other than temporary are
reported in net income as a component of net realized/unrealized capital gains
(losses). For loan-backed and structured securities, we recognize income using a
constant effective yield based on currently anticipated prepayments as
determined by broker-dealer surveys or internal estimates and the estimated
lives of the securities.
Equity securities include mutual funds, common stock and non-redeemable
preferred stock. The cost of equity securities is adjusted for declines in value
that are other than temporary. Impairments in value deemed to be other than
temporary are reported in net income as a component of net realized/unrealized
capital gains (losses). Equity securities are classified as available-for-sale
and, accordingly, are carried at fair value. Unrealized gains and losses related
to available-for-sale securities are reflected in stockholders' equity net of
related deferred policy acquisition costs and applicable taxes.
Real estate investments are reported at cost less accumulated depreciation. The
initial cost bases of properties acquired through loan foreclosures are the
lower of the fair market values of the properties at the time of foreclosure or
the outstanding loan balance. Buildings and land improvements are generally
depreciated on the straight-line method over the estimated useful life of
improvements, and tenant improvement costs are depreciated on the straight-line
method over the term of the related lease. We recognize impairment losses for
our properties when indicators of impairment are present and a property's
expected undiscounted cash flows are not sufficient to recover the property's
carrying value. In such cases, the cost bases of the properties are reduced to
fair value. Real estate expected to be disposed is carried at the lower of cost
or fair value, less cost to sell, with valuation allowances established
accordingly and depreciation no longer recognized. Any impairment losses and any
changes in valuation allowances are reported in net income as net
realized/unrealized capital gains (losses).
Commercial and residential mortgage loans are generally reported at cost
adjusted for amortization of premiums and accrual of discounts, computed using
the interest method, and net of valuation allowances. Residential mortgage loans
held for sale and commercial mortgage loans held for sale are carried at lower
of cost or fair value, less cost to sell, and reported as mortgage loans in the
statements of financial position.
Mortgage loans on real estate are considered impaired when, based on current
information and events, it is probable that we will be unable to collect all
amounts due according to contractual terms of the loan agreement. When we
determine that a loan is impaired, a provision for loss is established for the
difference between the carrying amount of the mortgage loan and the estimated
value. Estimated value is based on either the present value of the expected
future cash flows discounted at the loan's effective interest rate, the loan's
observable market price or fair value of the collateral. The provision for
losses is reported as a net realized/unrealized capital loss on our consolidated
statements of operations. Mortgage loans deemed to be uncollectible are charged
against the allowance for losses, and subsequent recoveries are credited to the
allowance for losses. The allowance for losses is maintained at a level believed
adequate by us to absorb estimated probable credit losses. Our periodic
evaluation of the adequacy of the allowance for losses is based on our past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of the
underlying collateral, composition of the loan portfolio, current economic
conditions and other relevant factors. The evaluation is inherently subjective
as it requires estimating the amounts and timing of future cash flows expected
to be received on impaired loans that may change.
32
We sell commercial mortgage loans to an unconsolidated qualified special purpose
entity which then issues mortgage-backed securities. We may retain immaterial
interests in the loans by purchasing portions of the securities from the
issuance. Gain or loss on the sales of the mortgages is reported as fees and
other revenues and depends in part on the previous carrying amounts of the
financial assets involved in the transfer, which is allocated between the assets
sold and the retained interests based on their relative fair value at the date
of transfer. Fair values are determined by quoted market prices of external
buyers of each class of security purchased. The retained interests are
thereafter carried at fair value with other fixed maturity investments and
classified as available-for-sale.
We also sell residential mortgage loans and retain servicing rights which are
retained interests in the sold loans. Gain or loss on the sales of the loans is
reported as fees and other revenues and depends in part on the previous carrying
amounts of the loans sold and the interests retained based on their relative
fair values at the date of the transfer. To obtain fair values, quoted market
prices are used if available. However, quotes are generally not available for
retained interests, so we estimate fair value based on the present value of the
future expected cash flows using our best estimates of assumptions we believe
market participants would use to value such interests.
Corporate private placement bonds represent a primary area of credit risk
exposure. The corporate private placement bond portfolio is diversified by
issuer and industry. We monitor the restrictive bond covenants which are
intended to regulate the activities of issuers and control their leveraging
capabilities.
VALUATION MODELS AND ASSUMPTIONS. Since many of the fixed maturity securities
that we invest in are private market assets, there are not readily available
market quotes available to determine the fair market value of these assets.
These assets are valued by discounting future cash flows. The discount rate is
based on a Treasury curve sourced from Bloomberg, credit spreads provided by
Capital Management Sciences, and a liquidity-spread add-on determined by us. The
spreads used are unique by credit rating for each asset. We also determine the
credit ratings used in the process.
We must also determine the fair value of our non-exchange traded derivative
contracts. Many of these values are calculated via models built in Bloomberg and
are validated by confirmations with the counterparties and our valuation model.
Assumptions including prepayment speeds, defaults, and losses are used in the
assessment of both the base case and subsequent testing of yields and valuations
of asset-backed securities and commercial mortgage backed securities.
The assessment of the other than temporary losses and write-downs of invested
assets (private bonds, mortgages, and real estate) also involves significant
judgment. Both the recognition of a triggering event (timing) and the market
value of private assets involves subjective assessments by us. In addition, the
determination of the calculation and the adequacy of the mortgage loan reserve
are also subjective. Our assessment of the adequacy of this reserve is based on
our past experience, known and inherent risks in the portfolio, adverse
situations that may affect a borrower's ability to repay, the estimated value of
the underlying security, composition of the portfolio, and current economic
conditions.
INSURANCE RESERVES AND DEFERRED POLICY ACQUISITION COSTS
INSURANCE RESERVES. Contractholder and policyholder liabilities (contractholder
funds, future policy benefits and claims and other policyholder funds) include
reserves for investment contracts and reserves for universal life, limited
payment, participating and traditional life insurance policies. Investment
contracts are contractholders' funds on deposit with us and generally include
reserves for pension and annuity contracts. Reserves on investment contracts are
equal to the cumulative deposits less any applicable charges plus credited
interest.
Reserves for universal life insurance contracts are equal to cumulative premiums
less charges plus credited interest which represents the account balances that
accrue to the benefit of the policyholders. Reserves for non-participating term
33
life insurance contracts are computed on a basis of assumed investment yield,
mortality, morbidity and expenses, including a provision for adverse deviation,
which generally varies by plan, year of issue and policy duration. Investment
yield is based on our experience. Mortality, morbidity and withdrawal rate
assumptions are based on our experience and are periodically reviewed against
both industry standards and experience.
Reserves for participating life insurance contracts are based on the net level
premium reserve for death and endowment policy benefits. This net level premium
reserve is calculated based on dividend fund interest rate and mortality rates
guaranteed in calculating the cash surrender values described in the contract.
The amount of dividends to policyholders is approved annually by Principal
Life's board of directors. The amount of dividends to be paid to policyholders
is determined after consideration of several factors including interest,
mortality, morbidity and other expense experience for the year and judgment as
to the appropriate level of statutory surplus to be retained by Principal Life.
At the end of the reporting period, Principal Life establishes a dividend
liability for the pro-rata portion of the dividends expected to be paid on or
before the next policy anniversary date.
Some of our policies and contracts require payment of fees in advance for
services that will be rendered over the estimated lives of the policies and
contracts. These payments are established as unearned revenue reserves upon
receipt and included in other policyholder funds in the consolidated statements
of financial position. These unearned revenue reserves are amortized to
operations over the estimated lives of these policies and contracts in relation
to the emergence of estimated gross profit margins.
The liability for unpaid accident and health claims is an estimate of the
ultimate net cost of reported and unreported losses not yet settled. This
liability is estimated using actuarial analyses and case basis evaluations.
Although considerable variability is inherent in such estimates, we believe that
the liability for unpaid claims is adequate. These estimates are continually
reviewed and, as adjustments to this liability become necessary, such
adjustments are reflected in current operations.
Reserves are liabilities representing estimates of the amounts that will come
due, at some point in our future, to our contractholders. The methods of
establishing reserves are prescribed by U.S. GAAP, allowing for some degree of
managerial judgment. As a basis for making management decisions, we conduct
studies of our experience: mortality, morbidity, investment and expense. We
compare our results to that of the industry to ensure actuarial credibility.
Once this information is gathered, following common industry practices, the
reserves are set. Our reserve levels are reviewed throughout the year using
internal analysis, the annual audit, and statutory asset adequacy analysis. To
the extent experience indicates a potential redundancy/deficiency, reserves
would be released/increased.
DEFERRED POLICY ACQUISITION COSTS. Commissions and other costs (underwriting,
issuance and agency expenses and first-year bonus interest) that vary with and
are primarily related to the acquisition of new and renewal insurance policies
and investment contract business are capitalized to the extent recoverable.
Maintenance costs and acquisition costs that are not deferrable are charged to
operations as incurred.
Deferred policy acquisition costs for universal life-type insurance contracts
and participating life insurance policies and investment contracts are being
amortized over the lives of the policies and contracts in relation to the
emergence of estimated gross profit margins. This amortization is adjusted
retrospectively when estimates of current or future gross profits and margins to
be realized from a group of products and contracts are revised. The deferred
policy acquisition costs of non-participating term life insurance policies are
being amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policyholder liabilities.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs would be written off to the extent
that it is determined that future policy premiums and investment income or gross
profit margins would not be adequate to cover related losses and expenses.
34
Excluding non-participating term life insurance policies, the deferred policy
acquisition cost asset is amortized in relation to the gross profits of the
underlying policies, over the expected lifetime of these policies. At issue, the
pattern of expected gross profits is established based on our expectation of
future profit margins. These profit margins contain assumptions relating to
mortality, morbidity, investment yield and expenses. As actual experience
emerges, the profit margins may vary from those expected either in magnitude or
timing. For our universal life and investment contracts, we are required by
accounting practice to reflect the actual gross profits of the underlying
policies. In addition, we are required to revise our assumptions regarding
future experience as soon as the current assumptions become no longer
actuarially credible. Both actions, reflecting actual experience and changing
future estimates, can cause changes in the amount of the asset and the pattern
of future amortization.
MORTGAGE LOAN SERVICING RIGHTS
Mortgage loan servicing rights represent the cost of purchasing or originating
the right to receive cash flows from servicing mortgage loans. Servicing rights
are recorded at the time of sale of the underlying mortgage loans where the
servicing is retained. The total cost of the mortgage loans, which includes the
cost to acquire the servicing rights, is allocated to the mortgage loans and the
servicing rights based on their relative fair values at the date of sale. Cost
basis also includes adjustments resulting from the application of hedge
accounting. Capitalized servicing rights are carried at the lower of cost or
market value. The capitalized value is amortized in proportion to, and over the
period of, estimated net servicing income.
Capitalized mortgage loan servicing rights are periodically assessed for
impairment based on the estimated fair value of those rights. Fair values are
estimated using estimates of discounted future net cash flows over the expected
life using loan prepayment, discount rate, ancillary fee income and other
economic factors we believe market participants would use to value such assets.
For purposes of performing our impairment evaluation, we stratify the servicing
portfolio on the basis of certain predominant risk characteristics, including
loan type and note rate. To the extent that the carrying value of the servicing
rights exceeds fair value for any stratum, a valuation allowance is established,
which may be adjusted in the future as the value of the servicing rights
increase or decrease. This valuation allowance is recognized in the consolidated
statements of operations during the period in which impairment occurs.
We must exercise certain judgments and make estimates in the application of this
policy. We have some discretion in determining interest rate assumptions to use
in its estimates, but we are guided by the benchmark curve of LIBOR/Swap term
structure, the volatility of interest rates derived from historical volatility
in LIBOR/Swap rates, and the addition of mortgage spread to the modeled 10-year
swap rate to derive the mortgage refinancing rate.
We develop prepayment models internally by examining the historical prepayment
experience of our portfolio, given the historical interest rate environment.
Servicing cost assumptions are derived from budgeted costs, interest
differential, and foreclosure losses based on historical evidence, and
amortization based on expected non-discounted cash flows. Servicing revenue
assumptions are derived from historical experience and include principal and
interest float, escrow float, prepayment float, late charges collected, and
ancillary income.
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during the past three years:
AFORE TEPEYAC S.A. DE C.V. On November 8, 2002, we signed an agreement to
acquire AFORE Tepeyac S.A. de C.V. in Mexico from Mapfre American Vida, Caja
Madrid and Mapfre Tepeyac for MX$590.0 million Mexican Pesos
("MX$")(approximately U.S. $58.0 million). We expect this transaction to be
completed in the first half of 2003 when the operations will be integrated into
Principal International, Inc., as a part of our International Asset Management
and Accumulation segment.
35
ZURICH AFORE S.A. DE C.V. On May 31, 2002, we purchased a 100% ownership of
Zurich AFORE S.A. de C.V. ("Zurich AFORE") in Mexico from Zurich Financial
Services for MX$480.5 million (approximately U.S. $49.0 million). The operations
of Zurich AFORE have been integrated into Principal International, Inc., as a
part of our International Asset Management and Accumulation segment.
SPECTRUM ASSET MANAGEMENT. On October 1, 2001, Spectrum Asset Management
("Spectrum") became an affiliate of Principal Global Investors. 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. In October 2002, we purchased the remaining 20% of Spectrum. We
included revenues of $5.9 million and $0.8 million for the years ended December
31, 2002 and 2001, respectively, in our consolidated results of operations.
DISPOSITIONS
We entered into disposition agreements or disposed of the following businesses,
among others, during the past three years:
BT FINANCIAL GROUP. On October 31, 2002, we sold substantially all of BT
Financial Group to Westpac Banking Corporation ("Westpac") for proceeds of
A$900.0 million Australian dollars ("A$") (U.S. $499.4 million), and future
contingent proceeds in 2004 of up to A$150.0 million (approximately U.S. $80.0
million). The contingent proceeds will be based on Westpac's future success in
growing retail funds under management.
Excluding contingent proceeds, our estimated after-tax proceeds from the sale
are expected to be approximately U.S. $938.4 million. This amount includes cash
proceeds, expected tax benefits, and gain from unwinding the hedged asset
associated with debt used to acquire BT Financial Group in 1999. We have accrued
for an estimated after-tax loss on disposal of $208.7 million as of December 31,
2002. This loss is recorded in the loss from discontinued operations in the
consolidated statement of operations. Future adjustments to the estimated loss
are expected to be recorded through the first half of 2003, as the proceeds from
the sale are finalized.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, and therefore is still included in
the our results of continuing operations. Assets and liabilities related to BT
Financial Group have been reclassified to assets of discontinued operations and
liabilities of discontinued operations on our consolidated statements of
financial position for all periods presented. Additionally, the results of
operations (excluding corporate overhead) for BT Financial Group are reported as
non-recurring items in our International Asset Management and Accumulation
segment. Selected financial information for the discontinued operations is as
follows:
36
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
---------- ----------- ---------
(IN MILLIONS, EXCEPT AS INDICATED)
Total assets under management
($ in billions)....................$ - $ 21.6 $ 25.4
========== =========== =========
Total revenues ....................$ 139.7 $ 220.9 $ 285.5
========== =========== =========
Loss from continuing operations
corporate overhead) ..............$ (2.6) $ (3.6) $ (2.0)
Income (loss) from discontinued
operations:
Income (loss) before income taxes.. 17.7 (15.6) 20.2
Income taxes (benefits)............ 5.7 (4.4) 11.7
---------- ----------- ---------
Income (loss) from discontinued
operations........................ 12.0 (11.2) 8.5
Income (loss) on disposal, net of
related income taxes.............. (208.7) - -
---------- ----------- ---------
Income (loss) from discontinued
operations, net of related income
taxes............................. (196.7) (11.2) 8.5
Cumulative effect of accounting
change, net of related income
taxes............................. (255.4) - -
---------- ----------- ---------
Net income (loss)..................$(454.7) $ (14.8) $ 6.5
========== =========== =========
COVENTRY HEALTH CARE. On February 1, 2002, we sold our remaining stake of 15.1
million shares of Coventry Health Care, Inc. ("Coventry") common stock and a
warrant, exercisable for 3.1 million shares of Coventry common stock. We
received proceeds of $325.4 million, resulting in a net realized capital gain of
$183.0 million, or $114.5 million net of income taxes.
We reported our investment in Coventry in our Corporate and Other segment and
accounted for it using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million, $20.2 million and $20.6 million for the
years ended December 31, 2002, 2001 and 2000, 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 years ended December 31, 2001 and
2000.
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 tax,
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 years ended December 31, 2002 and
2001, respectively. We included revenues of $49.4 million and net loss of $1.2
million from our operations in Spain in our consolidated results of operations
for the year ended December 31, 2000.
OTHER TRANSACTIONS
37
SALE OF RETAIL MORTGAGE LENDING BRANCH OFFICES. On January 29, 2003, Principal
Residential Mortgage, Inc. ("Principal Residential Mortgage"), announced the
decision to focus its retail consumer loan origination business within its
Mortgage Direct operation, which originates loans across the nation via phone
and online. The company will also continue to concentrate on growing its
Correspondent Lending, Wholesale and Servicing businesses.
On February 5, 2003, Principal Residential Mortgage announced it had signed a
definitive agreement to sell the retail mortgage lending branches to American
Home Mortgage, Inc. ("American Home Mortgage"), an independent retail mortgage
banking company. American Home Mortgage will pay Principal Residential Mortgage
a guaranteed profit margin on its current application pipeline, purchase the
assets of the branch network and assume related liabilities. The sale is
expected to close in the first quarter of 2003, pending regulatory approvals and
other normal closing conditions.
KEYCORP. On June 12, 2002, we announced we had entered into an agreement with
KeyCorp (through affiliates Victory Capital Management and KeyBank National
Association) to offer transition of servicing of KeyCorp's 1,400 employer
defined contribution clients with up to $8.0 billion in assets under management.
KeyCorp transitioned out of the bundled defined contribution business and will
recommend our servicing to its full-service defined contribution clients
nationwide.
MEDICARE SUPPLEMENT REINSURANCE TRANSACTION. Effective July 1, 2000, we entered
into a reinsurance agreement with General & Cologne Life Re of America to
reinsure 100% of our Medicare supplement insurance business. Medicare supplement
insurance premiums were $98.4 million for the year ended December 31, 2000.
FLUCTUATIONS IN FOREIGN CURRENCY TO U.S. DOLLAR EXCHANGE RATES
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
In January 2002, the Argentine government ended its tie of the Argentine peso to
the U.S. dollar, creating a dual currency system with an official fixed exchange
rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and a
"free" floating exchange rate for other transactions, subsequently floating the
Argentine peso in February. The devaluation did not materially impact our
consolidated results of operations.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
operating earnings and net income. Our consolidated operating earnings were
negatively impacted $4.1 million and $1.8 million for the years ended December
31, 2002 and 2001 and positively impacted $0.6 million for the year ended
December 31, 2000, 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 7A. "Quantitative and Qualitative
Disclosures about Market Risk."
DEMUTUALIZATION AND INITIAL PUBLIC OFFERING
Effective October 26, 2001, Principal Mutual Holding Company converted from a
mutual insurance holding company to a stock company. All membership interests in
Principal Mutual Holding Company were extinguished on that date and eligible
policyholders received, in aggregate, 260.8 million shares of common stock,
$1,177.5 million of cash and $472.6 million of policy credits as compensation.
In addition, on October 26, 2001, we completed our initial public offering
("IPO") in which we issued 100.0 million shares of common stock at a price of
$18.50 per share, prior to the underwriters' exercise of the overallotment
option. Net proceeds from the IPO were $1,753.9 million, of which $64.2 million
38
was retained by Principal Financial Group, Inc., and $1,689.7 million was
contributed to Principal Life. Proceeds were net of offering costs of $96.5
million and a related tax benefit of $0.4 million.
Costs relating to the demutualization, excluding costs relating to the IPO were
$2.0 million, $18.6 million and $7.2 million, net of income taxes, in 2002, 2001
and 2000, respectively. Demutualization expenses consist primarily of printing
and mailing costs and our aggregate cost of engaging independent accounting,
actuarial, financial, investment banking, legal and other consultants to advise
us on the demutualization. In addition, our costs include the costs of the
advisors of the Insurance Commissioner of the State of Iowa and the New York
State Insurance Department, other regulatory authorities and internal allocated
costs for staff and related costs associated with the demutualization.
PENSION EXPENSE
The 2003 pension expense for substantially all of our employees and certain
agents is expected to be approximately $60.2 million. This is an increase of
$53.7 million over the 2002 pension expense of $6.5 million. This increase is
primarily due to the impact of low interest rates and the equity market
downturn. The discount rate used to value the liabilities was lowered to 6.5%
from the 2002 discount rate of 7.5% and the return on assets assumption was
lowered to 8.5% from the 2002 return on assets assumption of 9.0%.
RECENT ACCOUNTING CHANGES
The Derivative Implementation Group has recently released Statement 133
Implementation Issue No. 36, "Embedded Derivatives: Bifurcation of a Debt
Instrument that Incorporates Both Interest Rate Risk and Credit Rate Risk
Exposures that are Unrelated or Only Partially Related to the Creditworthiness
of the Issuer of that Instrument" ("DIG B36"). DIG B36 addresses whether SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133") requires bifurcation of a debt instrument into a debt host contract and an
embedded derivative if the debt instrument incorporates both interest rate risk
and credit risk exposures that are unrelated or only partially related to the
creditworthiness of the issuer of that instrument. DIG 36 has been exposed for
comment by the FASB. It is not expected to be finalized by the FASB until
sometime in the second quarter of 2003. We are currently reviewing our contracts
and assessing the impact of the emerging guidance. We do not anticipate that
this will result in a material impact to our financial results, financial
position or cash flows.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"), which provides guidance related to
identifying variable interest entities and determining whether such entities
should be consolidated. FIN 46 is effective immediately for variable interest
entities created after January 31, 2003 and effective 3rd quarter 2003 for any
variable interest entities existing on or before January 31, 2003. We have
initiated an assessment and are currently evaluating interests in entities that
may be considered variable interest entities. We have currently identified one
variable interest entity, which meets the definition of FIN 46 and was created
before January 31, 2003. The impact would be the consolidation of $4.1 billion
in assets and $4.1 billion of liabilities, unless the current structure is
modified. The ultimate impact of adopting FIN 46 on the consolidated financial
statements is still being reviewed.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others ("FIN 45") which requires certain guarantees to be
recorded at fair value instead of when a loss is probable and reasonably
estimated. FIN 45 also requires disclosures even when the likelihood of making
any payments under the guarantee is remote. Although liability recognition only
applies to guarantees issued or amended after January 1, 2003, disclosure
requirements are effective for year-end 2002. See "Item 8. Financial Statements
and Supplementary Data - Notes to Consolidated Financial Statements, Note 14,
Commitments and Contingencies."
39
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
years indicated:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ----------- -----------
INCOME STATEMENT DATA: (IN MILLIONS)
Revenues:
Premiums and other considerations...$ 3,881.8 $ 4,122.3 $ 3,996.4
Fees and other revenues............. 1,990.8 1,600.7 1,300.6
Net investment income............... 3,304.7 3,383.6 3,157.6
Net realized/unrealized capital
gains (losses).................... (354.8) (514.0) 139.6
------------ ----------- -----------
Total revenues....................... 8,822.5 8,592.6 8,594.2
Expenses:
Benefits, claims and settlement
expenses.......................... 5,216.9 5,482.1 5,232.3
Dividends to policyholders.......... 316.6 313.7 312.7
Operating expenses.................. 2,623.2 2,332.7 2,209.0
------------ ----------- -----------
Total expenses........................ 8,156.7 8,128.5 7,754.0
------------ ----------- -----------
Income from continuing operations
before income taxes.............. 665.8 464.1 840.2
Income taxes.......................... 45.9 83.4 228.5
------------ ----------- ----------
Income from continuing operations,
net of related income taxes......... 619.9 380.7 611.7
Income (loss) from discontinued
operations, net of related income
taxes............................. (196.7) (11.2) 8.5
------------ ----------- -----------
Income before cumulative effect of
accounting changes................ 423.2 369.5 620.2
Cumulative effect of accounting
change, net of related income
taxes............................. (280.9) (10.7) -
------------ ----------- -----------
Net income..........................$ 142.3 $ 358.8 $ 620.2
============ =========== ===========
OTHER DATA:
Net income............................$ 142.3 $ 358.8 $ 620.2
Less:
Net realized/unrealized
capital gains (losses),
as adjusted....................... (243.9) (321.0) 93.0
Non-recurring items................ (363.2) (42.3) (92.5)
------------ ----------- -----------
Operating earnings....................$ 749.4 $ 722.1 $ 619.7
============ =========== ===========
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums and other considerations decreased $240.5 million, or 6%, to $3,881.8
million for the year ended December 31, 2002, from $4,122.3 million for the year
ended December 31, 2001. The decrease reflected a $183.0 million decrease from
the International Asset Management and Accumulation segment primarily resulting
from decreased sales of single premium annuities with life contingencies due to
the sale of a large group annuity contract in 2001 and to a lesser extent,
prolonged government retention of potential annuitants in 2002 in Mexico. In
addition, the decrease reflected a $37.7 million decrease from the Life and
Health Insurance segment, primarily related to the reclassification of revenues
from our group universal life insurance product from premiums to fee revenues
and the shift in customer preference from individual traditional life insurance
products to individual universal and variable universal life insurance products,
partially offset by strong disability insurance sales in 2002. The decrease also
reflected a $19.8 million 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.
Fees and other revenues increased $390.1 million, or 24%, to $1,990.8 million
for the year ended December 31, 2002, from $1,600.7 million for the year ended
40
December 31, 2001. The increase was primarily due to a $326.9 million increase
from the Mortgage Banking segment primarily resulting from mortgage loan
production fee revenues, reflecting the increase in mortgage loan production
volume. The increase was also due to a $56.5 million increase from the Life and
Health Insurance segment, primarily related to the reclassification of revenues
from our group universal life insurance product and growth in our individual
universal and variable universal life insurance business. The increase also
related to a $15.7 million increase from the U.S. Asset Management and
Accumulation segment primarily related to higher fee income from improved cash
flows and a reduction in losses from market value fee adjustments on our
participating business from pension products. In addition, the increases
reflected a $10.3 million increase from the International Asset Management and
Accumulation segment primarily as a result of an increase in the number of
retirement plan participants due to the acquisition of Zurich AFORE in Mexico.
Net investment income decreased $78.9 million, or 2%, to $3,304.7 million for
the year ended December 31, 2002, from $3,383.6 million for the year ended
December 31, 2001. The decrease was primarily related to a decrease in
investment yields. The yield on average invested assets and cash was 6.9% for
the year ended December 31, 2002, compared to 7.7% for the year ended December
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 average
investment yields due in part to a lower interest rate environment and to a
lesser extent, due to a decrease in commercial mortgage loan prepayment fee
income. The decrease was partially offset by a $3,565.1 million, or 8%, increase
in average invested assets and cash.
Net realized/unrealized capital losses decreased $159.2 million, or 31%, to
$354.8 million for the year ended December 31, 2002, from $514.0 million for the
year ended December 31, 2001. The decrease was due to the $183.0 million capital
gain realized as the result of the sale of our investment in Coventry in
February 2002 and the $38.4 million loss on the sale of our operations in Spain
in 2001, a $79.7 million decrease in losses on fixed maturity securities sales,
and a $58.5 million decrease in losses on equity securities sales. These
decreases were partially offset by an increase of $109.9 million in other than
temporary impairments of fixed maturity securities, a $19.7 million increase in
the other than temporary declines in the value of equity securities, an increase
of $54.1 million in mark to market losses on certain seed money investments, and
an increase of $28.0 million in losses on derivatives.
Benefits, claims and settlement expenses decreased $265.2 million, or 5%, to
$5,216.9 million for the year ended December 31, 2002, from $5,482.1 million for
the year ended December 31, 2001. The decrease was partially due to a $149.5
million decrease from the International Asset Management and Accumulation
segment due to higher reserve changes and policy and contract benefit payments
recognized in 2001 due to the sale of a large group annuity contract, and to a
lesser extent, prolonged government retention of potential annuitants in 2002 in
Mexico. The decrease was also due to a $57.6 million decrease from the Life and
Health Insurance segment, primarily due to amounts received from a reinsurer and
lower death claims. In addition, the decrease was due to a $52.8 million
decrease from the U.S. Asset Management and Accumulation segment, primarily
reflecting a decrease in interest credited to customers and a decrease in sales
of single premium group annuities with life contingencies.
Dividends to policyholders increased $2.9 million to $316.6 million for the year
ended December 31, 2002, from $313.7 million for the year ended December 31,
2001. The increase was attributable to a $2.9 million increase from the U.S.
Asset Management and Accumulation segment, resulting from an increase in
dividends for our pension full-service accumulation products.
Operating expenses increased $290.5 million, or 12%, to $2,623.2 million for the
year ended December 31, 2002, from $2,332.7 million for the year ended December
31, 2001. The increase was largely due to a $355.9 million increase from the
Mortgage Banking segment primarily resulting from growth in the mortgage loan
servicing portfolio, an increase in impairment of capitalized mortgage servicing
rights net of servicing hedge activity and an increase in the mortgage loan
production volume. The increase was partially offset by a $43.1 million decrease
from the Corporate and Other segment, primarily due to expenses recognized in
2001 related to our demutualization, federal income tax interest related to the
settlement of an IRS audit issue in 2002, offset partially by an increase to a
loss contingency reserve established for sales practices litigation in 2002. In
addition, the increases were partially offset by a $13.7 million decrease from
41
the International Asset Management and Accumulation segment, primarily related
to the weakening of the Argentine peso versus the U.S. dollar and of the general
economic environment in Argentina. A decrease of $10.4 million from the U.S.
Asset Management and Accumulation segment primarily reflected operational
efficiencies including lower staffing levels and an increase in capitalization
of deferred policy acquisition costs ("DPAC") from increased sales of selected
pension products.
Income taxes decreased $37.5 million, or 45%, to $45.9 million for the year
ended December 31, 2002, from $83.4 million for the year ended December 31,
2001. The effective income tax rate was 7% for the year ended December 31, 2002,
and 18% for the year ended December 31, 2001. The effective income tax rates for
the years ended December 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. Our effective income tax rate was also reduced in 2001 due
to additional tax benefits related to excess tax over book capital losses
realized from the sales of our operations in Spain and Indonesia. The effective
tax rate decreased to 7% in 2002 from 18% in 2001 primarily due to the favorable
settlement of an IRS audit issue in 2002.
As a result of the foregoing factors and the inclusion of loss from discontinued
operations and the cumulative effect of accounting changes, net of related
income taxes, net income decreased $216.5 million, or 60%, to $142.3 million for
the year ended December 31, 2002, from $358.8 million for the year ended
December 31, 2001. The loss from discontinued operations was related to our sale
of BT Financial Group. The cumulative effect of accounting changes were related
to our implementation of SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS
("SFAS 142") in 2002 and SFAS 133 in 2001.
For the year ended December 31, 2002, non-recurring items of $363.2 million, net
of income taxes, included (1) the negative effects of: (a) a cumulative effect
of accounting change related to our implementation of SFAS 142 ($280.9 million);
(b) the loss on discontinued operations of BT Financial Group ($196.7 million);
(c) an increase to a loss contingency reserve established for sales practices
litigation ($21.6 million); and (d) expenses related to our demutualization
($2.0 million) and (2) the positive effect of the settlement of an IRS audit
issue ($138.0 million). For the year ended December 31, 2001, non-recurring
items of $42.3 million, net of income taxes, included (1) the negative effects
of: (a) expenses related to our demutualization ($18.6 million); (b) the loss
from discontinued operations of BT Financial Group ($11.2 million); (c) a
cumulative effect of accounting change related to our implementation of SFAS 133
($10.7 million); and (d) an increase to a loss contingency reserve established
for sales practices litigation ($5.9 million) and (2) the positive effect of
investment income generated from the proceeds of our IPO ($4.1 million).
As a result of the foregoing factors and the exclusion of net
realized/unrealized capital losses, as adjusted and nonrecurring items,
operating earnings increased $27.3 million, or 4%, to $749.4 million for the
year ended December 31, 2002, from $722.1 million for the year ended December
31, 2001. The increase resulted from a $31.9 million increase from the Life and
Health Insurance segment, primarily a result of improved medical and dental loss
ratios. The increase was also due to a $17.2 million increase from the
International Asset Management and Accumulation segment, primarily related to
improved earnings of Principal International. In addition, the increase was due
to a $17.1 million increase from the U.S Asset Management and Accumulation
segment primarily reflecting higher fees from improved cash flows and a decrease
in expenses resulting from a decrease in interest credited to customers. An
increase of $16.2 million from the Mortgage Banking segment was primarily due to
an increase in mortgage loan production volume. The increases were partially
offset by a $55.1 million 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 and due to a decrease of average investment yields
for the segment.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Premiums and other considerations increased $125.9 million, or 3%, to $4,122.3
million for the year ended December 31, 2001, from $3,996.4 million for the year
ended December 31, 2000. The increase reflected a $240.9 million increase from
the U.S. Asset Management and Accumulation segment, primarily a result of an
42
increase in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. The premium income we receive from these contracts fluctuates due
to the variability in the number and size of pension plan terminations in the
market, the interest rate environment and our ability to attract new sales. In
addition, a $124.4 million increase from the International Asset Management and
Accumulation segment primarily resulting from increased sales of single premium
annuities with life contingencies due to the sale of a large group annuity
contract in Mexico. The increases were partially offset by a $239.4 million
decrease from the Life and Health Insurance segment, related to our decision to
reinsure 100% of our group Medicare supplement insurance business effective July
1, 2000. Life and Health Insurance segment premiums also decreased due to group
medical premium rate increases in 2000, which led to increased lapses and lower
sales in 2001.
Fees and other revenues increased $300.1 million, or 23%, to $1,600.7 million
for the year ended December 31, 2001, from $1,300.6 million for the year ended
December 31, 2000. The increase was primarily due to a $350.8 million increase
from the Mortgage Banking segment primarily resulting from mortgage loan
production fee revenues, reflecting the increase in mortgage loan production
volume. The increase was also due to a $26.7 million increase from the Life and
Health Insurance segment, primarily related to an increase in group health
fee-for-service fee revenues, a result of growth in the business and fee rate
increases, and an increase in universal and variable universal life insurance
fee revenues, a result of growth in that block of business. In addition, the
increase was related to a $16.6 million increase from the International Asset
Management and Accumulation segment, primarily a result of an increase in the
number of retirement plan participants in Mexico. The increases were partially
offset by an $85.8 million decrease from the U.S. Asset Management and
Accumulation segment primarily related to a decrease in surrender charge and
market value fee adjustments from pension products, primarily due to a declining
interest rate environment and a decrease in the recognition of front-end fee
revenues, a result of changes in assumptions consistent with unlocking of
deferred policy acquisition costs in 2001.
Net investment income increased $226.0 million, or 7%, to $3,383.6 million for
the year ended December 31, 2001, from $3,157.6 million for the year ended
December 31, 2000. The increase was primarily a result of a $1,846.2 million, or
4%, increase in average invested assets and cash and also from an increase in
investment yields, primarily resulting from our investment policy during 2000 to
reposition the investment portfolio to maximize investment returns by selling
lower yielding fixed income securities to allow for reinvestment in higher
yielding fixed income securities. The yield on average invested assets and cash
was 7.7% for the year ended December 31, 2001, compared to 7.5% for the year
ended December 31, 2000.
Net realized/unrealized capital losses increased $653.6 million to $514.0
million of net realized/unrealized capital losses for the year ended December
31, 2001, from $139.6 million of net realized/unrealized capital gains for the
year ended December 31, 2000. Realized capital losses of $137.7 million related
to sales and impairments of our investment in Enron and related entities in
2001. These entities are in the process of bankruptcy proceedings. We sold our
investment in United Payors and United Providers, and realized a capital gain of
$90.6 million during the year ended December 31, 2000. We realized a capital
loss of $38.4 million on the sale of our operations in Spain in 2001. We
realized $22.0 million in losses in our international operations from the
restructuring of government bonds in Argentina and $6.7 million of realized
losses in our U.S. operations related to Argentine-based-bonds in 2001. The
decrease also related to permanent impairments of other fixed maturity and
equity securities which were $152.6 million, during the year ended December 31,
2001.
Benefits, claims and settlement expenses increased $249.8 million, or 5%, to
$5,482.1 million for the year ended December 31, 2001, from $5,232.3 million for
the year ended December 31, 2000. The increase was primarily due to a $272.5
million increase from the U.S. Asset Management and Accumulation segment,
primarily reflecting the increase in reserves resulting from an increase in
sales of single premium group annuities with life contingencies. The increase
was also due to a $145.3 million increase from the International Asset
Management and Accumulation segment due to an increase in the change in reserves
and policy and contract benefit payments, primarily the result of the sale of a
large group annuity contract with life contingencies in Mexico. The increases
were partially offset by a $168.4 million decrease from the Life and Health
Insurance segment, due to a reduction in group medical insurance business,
43
improved group medical insurance claim experience and our decision to reinsure
100% of our group Medicare supplement insurance business effective July 1, 2000.
Dividends to policyholders increased $1.0 million to $313.7 million for the year
ended December 31, 2001, from $312.7 million for the year ended December 31,
2000. The increase was attributable to a $2.1 million increase from the U.S.
Asset Management and Accumulation segment, resulting from an increase in
dividends for our pension full-service accumulation products. The increase was
offset by a $1.1 million decrease from the Life and Health Insurance segment due
to a change in methodology of estimating dividends. Additionally, the dividends
in the Closed Block were reduced due to accumulated experience losses.
Operating expenses increased $123.7 million, or 6%, to $2,332.7 million for the
year ended December 31, 2001, from $2,209.0 million for the year ended December
31, 2000. The increase was primarily due to a $269.6 million increase from the
Mortgage Banking segment primarily resulting from an impairment of mortgage loan
servicing rights and, to a lesser extent, due to growth in the mortgage loan
servicing portfolio and an increase in the mortgage loan production volume. The
increase also reflected a $22.0 million increase from the U.S. Asset Management
and Accumulation segment, primarily reflecting an increase in Principal Bank
operating expenses related to growth in bank operations and an increase in
Principal Global Investors' operating expenses related to increases in
compensation and recruiting costs and depreciation and securitization expenses.
The increases were partially offset by an $89.3 million decrease from the
Corporate and Other segment, primarily related to a non-recurring loss
contingency reserve established during the year ended December 31, 2000, for
sales practices litigation. The increases were also partially offset by a $79.0
million decrease from the Life and Health Insurance segment due to our decision
to reinsure 100% of our group Medicare supplement insurance business effective
July 1, 2000.
Income taxes decreased $145.1 million, or 64%, to $83.4 million for the year
ended December 31, 2001, from $228.5 million for the year ended December 31,
2000. The effective income tax rate was 18% for the year ended December 31,
2001, and 27% for the year ended December 31, 2000. The effective income tax
rates for the years ended December 31, 2001 and 2000, were lower than the
corporate income tax rate of 35% primarily due to income tax deductions allowed
for corporate dividends received. Our effective income tax rate was also reduced
in 2001 due to additional tax benefits related to excess tax over book capital
losses realized from the sales of our operations in Spain and Indonesia. The
decrease in the effective tax rate to 18% in 2001 from 27% in 2000 was primarily
due to the decrease in net income before income taxes relative to our permanent
tax differences, which did not decrease.
As a result of the foregoing factors and the inclusion of loss or income from
discontinued operations and the cumulative effect of accounting change, net of
related income taxes, net income decreased $261.4 million, or 42%, to $358.8
million for the year ended December 31, 2001, from $620.2 million for the year
ended December 31, 2000. The loss or income from discontinued operations was
related to our sale of BT Financial Group. The cumulative effect of accounting
change was related to our implementation of SFAS 133.
For the year ended December 31, 2001, we excluded $42.3 million of non-recurring
items, net of income taxes, from net income for our presentation of consolidated
operating earnings. The non-recurring items included the (1) negative effects
of: (a) expenses related to our demutualization ($18.6 million); (b) the loss
from discontinued operations of BT Financial Group ($11.2 million); (c) a
cumulative effect of change in accounting related to our implementation of SFAS
133 ($10.7 million); and (d) an increase to our loss contingency reserve for
sales practices litigation ($5.9 million) and (2) the positive effect of
investment income generated from the proceeds of our IPO ($4.1 million). For the
year ended December 31, 2000, non-recurring items of $92.5 million, net of
income taxes, included the (1) negative effects of: (a) a loss contingency
reserve established for sales practices litigation ($93.8 million); and (b)
expenses related to our demutualization ($7.2 million) and (2) the positive
effect of the income from the discontinued operations of BT Financial Group
($8.5 million).
As a result of the foregoing factors and the exclusion of net
realized/unrealized capital gains (losses), as adjusted and nonrecurring items,
operating earnings increased $102.4 million, or 17%, to $722.1 million for the
44
year ended December 31, 2001, from $619.7 million for the year ended December
31, 2000. The increase resulted from a $76.7 million increase from the Mortgage
Banking segment, primarily due to an increase in mortgage loan production
volume. The increase was also due to a $38.9 million increase from the Life and
Health Insurance segment, primarily a result of individual disability insurance
reserve strengthening during 2000, and improved margins on individual life
insurance business resulting from higher investment yields. In addition, the
increase reflects a $19.2 million increase from the International Asset
Management and Accumulation segment, primarily related to improved earnings of
Principal International. The increases were partially offset by a $29.6 million
decrease from the Corporate and Other segment, primarily due to a net recovery
in 2000 of previously paid interest related to a successful tax audit appeal.
RESULTS OF OPERATIONS BY SEGMENT
We evaluate segment performance by segment operating earnings, which excludes
the effect of net realized/unrealized capital gains and losses, as adjusted, and
non-recurring events and transactions. Segment operating earnings are determined
by adjusting U.S. GAAP net income for net realized/unrealized capital gains and
losses, as adjusted, and non-recurring items that we believe are not indicative
of overall operating trends. While these items may be significant components in
understanding and assessing our consolidated financial performance, we believe
the presentation of segment operating earnings enhances the understanding of our
results of operations by highlighting earnings attributable to the normal,
recurring operations of our businesses. However, segment operating earnings are
not a substitute for net income determined in accordance with U.S. GAAP.
The following table presents segment information as of or for the years ended
December 31, 2002, 2001 and 2000:
45
AS OF OR FOR YEAR ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
----------- ---------- ----------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and..............$ 3,780.5 $ 3,799.8 $ 3,533.9
Accumulation
International Asset Management and
Accumulation..................... 357.9 508.4 339.2
Life and Health Insurance.............. 3,946.8 3,946.4 4,122.6
Mortgage Banking....................... 1,153.0 757.4 359.8
Corporate and Other(1)................. (15.1) 101.7 98.2
----------- ---------- ----------
Total operating revenues............... 9,223.1 9,113.7 8,453.7
Net realized/unrealized capital gains
(losses), including recognition
of front-end fee revenues and
certain market valuue adjustments
to fee revenues.................. (400.6) (527.4) 140.5
Non-recurring interest income(2)....... - 6.3 -
----------- ---------- ----------
Total consolidated revenues......$ 8,822.5 $ 8,592.6 $ 8,594.2
=========== ========== ==========
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and
Accumulation ....................$ 370.9 $ 353.8 $ 356.6
International Asset Management and
Accumulation..................... 19.5 2.3 (16.9)
Life and Health Insurance................ 233.1 201.2 162.3
Mortgage Banking......................... 142.9 126.7 50.0
Corporate and Other ..................... (17.0) 38.1 67.7
----------- ---------- ----------
Total operating earnings......... 749.4 722.1 619.7
Net realized/unrealized capital gains
losses as adjusted(3)............ (243.9) (321.0) 93.0
Non-recurring items(4)................... (363.2) (42.3) (92.5)
----------- ---------- ----------
U.S. GAAP REPORTED:
Net income.......................$ 142.3 $ 358.8 $ 620.2
=========== ========== ==========
U.S. GAAP REPORTED NET INCOME (LOSS)
BY SEGMENT:
U.S. Asset Management and
Accumulation ....................$ 120.4 $ 178.3 $ 320.7
International Asset Management and
Accumulation..................... (441.1) (38.1) (7.1)
Life and Health Insurance................ 178.5 167.5 209.6
Mortgage Banking......................... 142.9 126.7 50.0
Corporate and Other ..................... 141.6 (75.6) 47.0
----------- ---------- ----------
Total net income..................$ 142.3 $ 358.8 $ 620.2
=========== ========== ==========
TOTAL ASSETS BY SEGMENT:
U.S. Asset Management and
Accumulation(5).................$70,371.9 $68,543.8 $65,795.9
International Asset Management and
Accumulation..................... 2,202.5 4,956.9 5,525.9
Life and Health Insurance................ 11,356.3 10,776.2 10,569.0
Mortgage Banking......................... 3,740.1 2,718.8 1,556.3
Corporate and Other(6)................... 2,190.5 1,354.8 957.8
----------- ---------- ----------
Total assets.....................$89,861.3 $88,350.5 $84,404.9
=========== ========== ==========
- ----------------------
(1) Includes inter-segment eliminations primarily related to internal
investment management fee revenues, commission fee revenues paid to U.S.
Asset Management and Accumulation agents for selling Life and Health
Insurance segment insurance products, internal interest paid to our
Mortgage Banking segment for escrow accounts deposited with our U.S. Asset
Management and Accumulation segment and real estate joint venture rental
income. In 2001, the Corporate and Other segment reported rental income
from real estate joint ventures for office space used by other segments.
(2) For the year ended December 31, 2001, non-recurring interest income
included the positive effect of investment income generated from the
proceeds of our IPO.
(3) Net realized/unrealized capital gains (losses) include unrealized gains
(losses) on mark to market changes of certain seed money investments as
well as unrealized gains on certain derivatives. Net realized/unrealized
capital gains (losses), as adjusted, are net of income taxes, net realized
capital gains distributed to customers, related changes in the amortization
46
pattern of deferred policy acquisition costs, recognition of front-end fee
revenues for sales charges on pension products and services and certain
market value adjustments to fee revenues.
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------
2002 2001 2000
-------------- -------------- -------------
(IN MILLIONS)
Net realized/unrealized
capital gains (losses)..$ (354.8) $ (514.0) $ 139.6
Certain market value
adjustments to fee
revenues................ (31.8) (14.9) -
Recognition of front-end
fee revenues............ (14.0) 1.5 0.9
-------------- -------------- -------------
Net realized/unrealized
capital gains (losses),
including recognition of
front-end fee
revenues and certain
market value
adjustments to fee
revenues................ (400.6) (527.4) 140.5
Amortization of deferred
policy acquisition costs
related to net
realized capital gains
(losses)................ 35.4 18.6 (0.3)
Capital gains distributed to
customers............... (12.7) - -
-------------- -------------- -------------
Net realized/unrealized capital
gains (losses),
including recognition
of front-end fee
revenues and certain
market value adjustments
to fee revenues, net of
related amortization of
deferred policy
acquisition costs and
capital gains
distributed to
customers............... (377.9) (508.8) 140.2
Income tax effect............... 134.0 187.8 (47.2)
-------------- -------------- -------------
Net realized/unrealized capital
gains (losses), as adjusted.....$ (243.9) $ (321.0) $ 93.0
============== ============== =============
(4) For the year ended December 31, 2002, non-recurring items of $363.2
million, net of income taxes, included (1) the negative effects of: (a) a
cumulative effect of accounting change related to our implementation of
SFAS 142 ($280.9 million); (b) the loss on discontinued operations of BT
Financial Group ($196.7 million); (c) an increase to a loss contingency
reserve established for sales practices litigation ($21.6 million); and (d)
expenses related to our demutualization ($2.0 million) and (2) the positive
effect of the settlement of an IRS audit issue ($138.0 million). For the
year ended December 31, 2001, non-recurring items of $42.3 million, net of
income taxes, included (1) the negative effects of: (a) expenses related to
our demutualization ($18.6 million); (b) the loss on discontinued
operations of BT Financial Group ($11.2 million); (c) a cumulative effect
of change in accounting principle related to our implementation of SFAS 133
($10.7 million); and (d) an increase to our loss contingency reserve for
sales practices litigation ($5.9 million) and (2) the positive effect of
investment income generated from the proceeds of our IPO ($4.1 million).
For the year ended December 31, 2000, non-recurring items of $92.5 million,
net of income taxes, included (1) the negative effects of: (a) a loss
contingency reserve established for sales practices litigation ($93.8
million) and (b) expenses related to our demutualization ($7.2 million) and
(2) the positive effect of the income from discontinued operations of BT
Financial Group ($8.5 million).
(5) U.S. Asset Management and Accumulation assets increased $1.3 billion at
December 31, 2001, primarily due to shares of the Principal Financial Group
stock allocated to a separate account, a result of our demutualization.
Activity of the separate account was reflected in both separate account
assets and separate account liabilities and did not impact our results of
operations.
47
(6) Includes inter-segment elimination amounts related to internally generated
mortgage loans and an internal line of credit. The U.S. Asset Management
and Accumulation segment and Life and Health Insurance segment reported
mortgage loan assets issued for real estate joint ventures. These mortgage
loans were reported as liabilities in the Corporate and Other segment. In
addition, the Corporate and Other segment managed a revolving line of
credit used by other segments.
U.S. ASSET MANAGEMENT AND ACCUMULATION SEGMENT
ASSET ACCUMULATION TRENDS
Our sales of pension and other asset accumulation products and services in the
U.S. have been affected by overall trends in the U.S. retirement services
industry, as our customers have begun to rely less on defined benefit retirement
plans, social security and other government programs. Recent trends in the work
environment include a more mobile workforce and the desire of employers to shift
the market risk of retirement investments to employees by offering defined
contribution plans rather than defined benefit plans. These trends are
increasing the demand for defined contribution pension arrangements such as
401(k) plans, mutual funds or variable annuities. The "baby-boom" generation of
U.S. workers has reached an age at which saving for retirement is critical and
it continues to seek tax-advantaged investment products for retirement. Also,
the Economic Growth and Tax Relief Reconciliation Act of 2001 had many of its
provisions become effective in 2002, which increased allowed contribution limits
and a number of other opportunities to save for retirement. Considering these
trends, asset accumulation account values increased as of December 31, 2002,
primarily due to significant additional gross new deposits and retention of
assets from existing clients. The declining interest rate environment and poor
performance in the equity markets in 2002 and 2001 have slowed our recent growth
in asset accumulation account values.
The following table provides a summary of U.S. Asset Accumulation account values
as of December 31, 2002 and 2001:
U.S. ASSET ACCUMULATION
AS OF TOTAL ACCOUNT VALUES
- ------------------------------ -------------------------------
(IN BILLIONS)
December 31, 2002 ......... $ 73.8
December 31, 2001 ......... 71.0
ASSET MANAGEMENT TRENDS
Asset management services have been among the most profitable and rapidly
growing sectors of the financial services industry, at both the retail and
institutional level. We seek to take advantage of current trends, which indicate
that both retail and institutional investors embrace specialization, providing
increased fees to successful active managers with expertise in specialty and
niche areas. Our U.S. third-party assets under management increased $6.7 billion
during 2002.
The following table provides a summary of Principal Global Investors' affiliated
and third-party assets under management as of December 31, 2002, 2001 and 2000:
PRINCIPAL GLOBAL INVESTORS
------------------------------------------------------------
AFFILATED THIRD-PARTY
ASSETS ASSETS TOTAL ASSETS
UNDER UNDER UNDER
AS OF MANAGEMENT MANAGEMENT MANAGEMENT
- ------ -------------------- ----------------- ---------------
(IN BILLIONS)
December 31, 2002 $77.7 $14.6 $92.3
December 31, 2001 77.8 7.9 85.7
December 31, 2000 76.5 6.7 83.2
U.S. ASSET MANAGEMENT AND ACCUMULATION SEGMENT SUMMARY FINANCIAL DATA
The following table presents certain summary financial data relating to the U.S.
Asset Management and Accumulation segment for the years indicated:
48
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
------------- -------------- ---------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other
considerations............. $ 746.5 $ 766.3 $ 525.4
Fees and other
revenues................... 681.2 633.1 704.6
Net investment income....... 2,352.8 2,400.4 2,303.9
-------------- -------------- ---------------
Total operating
revenues................... 3,780.5 3,799.8 3,533.9
Expenses:
Benefits, claims and
settlement expenses,
including dividends
to policyholders........... 2,539.9 2,589.8 2,315.2
Operating expenses.......... 773.4 773.7 740.9
-------------- -------------- ---------------
Total expenses............. 3,313.3 3,363.5 3,056.1
-------------- -------------- ---------------
Pre-tax operating
earnings................... 467.2 436.3 477.8
Income taxes................. 96.3 82.5 121.2
-------------- -------------- ---------------
Operating earnings........... 370.9 353.8 356.6
Net realized/unrealized
capital losses, as
adjusted................... (250.5) (164.7) (35.9)
Non-recurring items......... - (10.8) -
-------------- -------------- ---------------
U.S. GAAP REPORTED:
Net income................... $ 120.4 $ 178.3 $ 320.7
============== ============== ===============
___________________
(1) Excludes net realized/unrealized capital losses and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums and other considerations decreased $19.8 million, or 3%, to $746.5
million for the year ended December 31, 2002, from $766.3 million for the year
ended December 31, 2001. The decrease primarily resulted from a $59.5 million
decrease in pension full-service payout sales of single premium group annuities
with life contingencies, which are typically used to fund defined benefit plan
terminations. The premium income received from these contracts fluctuates due to
the variability in the number and size of pension plan terminations, the
interest rate environment, and the ability to attract new sales. Partially
offsetting this decrease was a $39.7 million increase in premium primarily
resulting from higher individual payout annuity sales.
Fees and other revenues increased $48.1 million, or 8%, to $681.2 million for
the year ended December 31, 2002, from $633.1 million for the year ended
December 31, 2001. Pension fees and other revenues increased $27.2 million. The
increase primarily resulted from higher fee income generated from improved net
cash flows in 2002 and a reduction of losses due to market value fee adjustments
on our participating business recognized in the prior year. The increase also
resulted from netting the change in unearned revenue for selected products with
the related unlocking of DPAC in operating expenses. Prior to the third quarter
of 2002, the impact was reported separately in fees and other revenue and
operating expenses. In addition, Principal Global Investors recognized a $19.3
million increase in fees and other revenue. This increase was primarily due to a
reclassification of market value and hedging activities from net investment
income to fees and other revenue and an increase in investment management and
transaction fees.
Net investment income decreased $47.6 million, or 2%, to $2,352.8 million for
the year ended December 31, 2002, from $2,400.4 million for the year ended
December 31, 2001. The decrease was primarily due to a decrease in the average
yield on invested assets and cash, which was 6.7% for the year ended December
49
31, 2002, compared to 7.3% for the year ended December 31, 2001. The decrease
was partially offset by a $2,129.3 million, or 6%, increase in average invested
assets and cash.
Benefits, claims and settlement expenses, including dividends to policyholders,
decreased $49.9 million, or 2%, to $2,539.9 million for the year ended December
31, 2002, from $2,589.8 million for the year ended December 31, 2001. The
decrease primarily resulted from a $97.0 million decrease in pension benefits,
claims and settlement expenses. This decrease was largely due a decrease in
interest credited to customers from our full-service accumulation and
investment-only businesses resulting from a lower interest rate environment in
2002. Also contributing to the overall decrease was a decrease in full-service
payout sales of single premium group annuities with life contingencies.
Partially offsetting this decrease was a $44.2 million increase, which primarily
resulted from an increase in reserves resulting from higher individual payout
annuity sales.
Operating expenses decreased $0.3 million to $773.4 million for the year ended
December 31, 2002, from $773.7 million for the year ended December 31, 2001. The
decrease was primarily due to a $22.5 million decrease in pension operating
expenses. This decrease was largely due to operational efficiencies including
lower staff levels in addition to an increase in capitalization of DPAC
resulting from an increase in sales of selected products. Offsetting the overall
decrease was a $12.9 million increase in Principal Global Investors operating
expenses due to an increase in employee costs resulting from the acquisition of
Spectrum in the fourth quarter of 2001 and higher incentive compensation
accruals in 2002. In addition, individual annuity operating expenses increased
$7.3 million mainly due to an increase in DPAC amortization resulting from the
decline in the stock market and an increase in corporate expense allocations in
2002. Also contributing to the increase was a $6.4 million increase in our
mutual fund operating expenses. This increase primarily relates to increased
commission expense generated from sales of variable life and annuity contracts.
Of this increase, $2.6 million relates to sales within the segment and is
eliminated at an operating segment level.
Income taxes increased $13.8 million, or 17%, to $96.3 million for the year
ended December 31, 2002, from $82.5 million for the year ended December 31,
2001. The effective income tax rate for this segment was 21% for the year ended
December 31, 2002, and 19% for the year ended December 31, 2001. The effective
income tax rates for the year ended December 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 $17.1
million, or 5%, to $370.9 million for the year ended December 31, 2002, from
$353.8 million for the year ended December 31, 2001.
Net realized/unrealized capital losses, as adjusted, increased $85.8 million, or
52%, to $250.5 million for the year ended December 31, 2002, from $164.7 million
for the year ended December 31, 2001. The increase includes capital losses
related to other than temporary declines in the value of certain fixed maturity
securities for the year ended December 31, 2002.
As a result of the foregoing factors, net income decreased $57.9 million, or
32%, to $120.4 million for the year ended December 31, 2002, from $178.3 million
for the year ended December 31, 2001. For the year ended December 31, 2001, net
income included the negative effect of non-recurring items totaling $10.8
million, net of income taxes, related to a cumulative effect of accounting
change related to our implementation of SFAS 133.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Premiums and other considerations increased $240.9 million, or 46%, to $766.3
million for the year ended December 31, 2001, from $525.4 million for the year
ended December 31, 2000. The increase primarily resulted from a $236.5 million
increase in premiums from single premium group annuities with life
contingencies, which are typically used to fund defined benefit pension plan
terminations. Despite a less attractive economic environment in late 2001,
strong sales early in 2001 resulted in increased premiums for the year. Sales
were not as strong late in the year due to poor economic conditions. The premium
income we receive from these contracts fluctuates due to the variability in the
50
number and size of pension plan terminations in the market, the interest rate
environment and our ability to attract new sales.
Fees and other revenues decreased $71.5 million, or 10%, to $633.1 million for
the year ended December 31, 2001, from $704.6 million for the year ended
December 31, 2000. A decrease of $83.4 million related to a decrease in
surrender charge and market value adjustment revenues from pension products,
primarily due to the declining interest rate environment; a decrease in
recognition of front-end fee revenues due to changes in assumptions consistent
with unlocking of deferred policy acquisition costs during 2001; and a decrease
in fee revenues due to generally poor performance in the equity markets,
resulting in a lower asset base in 2001. A decrease of $7.6 million resulted
from intra-segment eliminations. In addition, a $7.4 million decrease reflected
lower commission fee revenues primarily from sales of variable products and
third-party mutual funds and lower mutual fund fee revenues from a decrease in
mutual fund assets under management. The decreases were partially offset by an
increase of $27.8 million from Principal Global Investors due to commercial
mortgage-backed securitizations.
Net investment income increased $96.5 million, or 4%, to $2,400.4 million for
the year ended December 31, 2001, from $2,303.9 million for the year ended
December 31, 2000. The increase reflects a $1,425.0 million, or 5%, increase in
average invested assets and cash for the segment. The yield on average invested
assets and cash was 7.3% for the years ended December 31, 2001 and 2000.
Benefits, claims and settlement expenses, including dividends to policyholders,
increased $274.6 million, or 12%, to $2,589.8 million for the year ended
December 31, 2001, from $2,315.2 million for the year ended December 31, 2000.
An increase of $272.4 million in our pension full-service payout business
reflected the increase in reserves resulting from an increase in sales of single
premium group annuities with life contingencies. An additional $23.2 million
increase from our pension investment-only business related to an increase in
interest credited due to growth in our investment-only business. Partially
offsetting the increases was a $30.7 million decrease in our pension
full-service accumulation business reflecting a decrease in interest credited,
primarily a result of a declining interest rate environment.
Operating expenses increased $32.8 million, or 4%, to $773.7 million for the
year ended December 31, 2001, from $740.9 million for the year ended December
31, 2000. An increase of $36.8 million from Principal Bank resulted primarily
from growth in bank operations. Additionally, an increase of $27.0 million from
Principal Global Investors resulted primarily from an increase in compensation
and recruiting costs due to growth in operations, an increase in depreciation
expense of capitalized system implementation costs, and an increase in
securitization expenses due to an increase in the number of securitization
transactions closed in 2001. The increases were partially offset by an $18.8
million decrease from our pension business due to a decrease in the amortization
of deferred policy acquisition costs from unlocking to reflect changes in
assumptions for equity market performance. The pension expense decrease was
partially offset by increases in expenses for sales and marketing initiatives;
write-off of the remaining goodwill for Trustar, our pension administration only
subsidiary; general growth in operations and amortization of software costs. The
increase in segment operating expenses was also partially offset by a $7.6
million decrease from intra-segment eliminations. Also offsetting the increases
was a $4.6 million decrease from our individual annuity business reflecting
decreases in non-deferrable expenses and amortization of deferred policy
acquisition costs. The amortization of deferred policy acquisition costs was
lower in 2001 as the impact of unlocking the amortization for actual experience
was less in 2001 than in 2000.
Income taxes decreased $38.7 million, or 32%, to $82.5 million for the year
ended December 31, 2001, from $121.2 million for the year ended December 31,
2000. The effective income tax rate for this segment was 19% for the year ended
December 31, 2001, and 25% for the year ended December 31, 2000. The effective
income tax rates for the years ended December 31, 2001 and 2000, were lower than
the corporate income tax rate of 35%, as a result of income tax deductions
allowed for corporate dividends received, for which an estimated benefit
recognition rate increased during 2001 compared to 2000, and other tax-exempt
income.
51
As a result of the foregoing factors, operating earnings decreased $2.8 million,
or 1%, to $353.8 million for the year ended December 31, 2001, from $356.6
million for the year ended December 31, 2000.
Net realized/unrealized capital losses, as adjusted, increased $128.8 million to
$164.7 million for the year ended December 31, 2001, from $35.9 million for the
year ended December 31, 2000. The increase includes realized capital losses of
$62.3 million related to sales and impairments of our investment in Enron and
related entities. Other permanent impairments of certain fixed maturity
securities were $92.1 million during the year ended December 31, 2001. The
increase also reflects the current period impact of SFAS 133 for derivatives and
fewer real estate sales in the year ended December 31, 2001, compared to the
year ended December 31, 2000. The increases were partially offset by the
positive effects of a change in the mortgage loan valuation allowance, primarily
reflecting the decrease in the amount invested in commercial mortgage loans.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2001, net income decreased $142.4 million, or
44%, to $178.3 million for the year ended December 31, 2001, from $320.7 million
for the year ended December 31, 2000. Non-recurring items for the year ended
December 31, 2001, had a negative impact on net income of $10.8 million, net of
income taxes, due to the cumulative effect of accounting change, net of income
taxes, related to our implementation of SFAS 133.
INTERNATIONAL ASSET MANAGEMENT AND ACCUMULATION SEGMENT
ASSET ACCUMULATION TRENDS
Our international asset management and accumulation businesses focus on
countries with a trend toward privatization of public retirement pension systems
requiring employees who join the labor force to contribute to a private pension
plan. With variations depending upon the specific country, we have targeted
these markets for sales of retirement and related products and services,
including defined contribution pension plans, annuities and long-term mutual
funds to individuals and businesses. In several of our international markets, we
complement our sales of these products with sales of life insurance products.
We have pursued our international strategy through a combination of start-ups,
acquisitions and joint ventures, which require infusions of capital consistent
with our strategy of long-term growth and profitability.
The following table provides a summary of Principal International assets under
management as of December 31, 2002, 2001 and 2000:
PRINCIPAL INTERNATIONAL
AS OF TOTAL ASSETS UNDER MANAGEMENT
- ------------------------------ -------------------------------
(IN BILLIONS)
December 31, 2002 ......... $ 4.4
December 31, 2001 ......... 3.7
December 31, 2000 ......... 3.0
52
INTERNATIONAL ASSET MANAGEMENT AND ACCUMULATION SEGMENT SUMMARY FINANCIAL DATA
The following table presents certain summary financial data relating to the
International Asset Management and Accumulation segment for the years indicated:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
------------- --------------- --------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues (1):
Premiums and other
considerations............. $ 161.9 $ 344.9 $ 220.5
Fees and other revenues..... 56.4 46.1 29.5
Net investment income....... 139.6 117.4 89.2
------------- --------------- --------------
Total operating
revenues................... 357.9 508.4 339.2
Expenses:
Benefits, claims and
settlement expenses........ 243.8 407.5 262.2
Operating expenses.......... 87.5 101.2 100.8
------------- --------------- --------------
Total expenses.......... 331.3 508.7 363.0
------------- --------------- --------------
Pre-tax operating
earnings (loss).............. 26.6 (0.3) (23.8)
Income taxes (benefits)....... 7.1 (2.6) (6.9)
------------- --------------- --------------
Operating earnings (loss)..... 19.5 2.3 (16.9)
Net realized/unrealized
capital gains (losses),
as adjusted.................. 12.4 (29.2) 1.3
Non-recurring items........... (473.0) (11.2) 8.5
------------- --------------- --------------
U.S. GAAP REPORTED:
Net loss...................... $ (441.1) $ (38.1) $ (7.1)
============= =============== =============
OTHER DATA:
Operating earnings (loss):
Principal
International.............. $ 22.1 $ 5.9 $ (14.8)
BT Financial
Group...................... (2.6) (3.6) (2.1)
Net income (loss):
Principal
International............. $ 13.6 $ (23.3) $ (13.6)
BT Financial Group........ (454.7) (14.8) 6.5
_______________________
(1) Excludes net realized/unrealized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums and other considerations decreased $183.0 million, or 53%, to $161.9
million for the year ended December 31, 2002, from $344.9 million for the year
ended December 31, 2001. A decrease of $145.0 million in Mexico was the result
of decreased sales of single premium annuities with life contingencies primarily
due to the sale of a large group annuity contract in 2001 and to a lesser extent
prolonged government retention of potential annuitants in 2002. A decrease of
$23.9 million in Argentina was primarily due to the weakening of the Argentine
peso versus the U.S. dollar and of the general economic environment. In
addition, a decrease of $13.5 million in Chile was primarily a result of the
weakening of the Chilean peso versus the U.S. dollar and to a lesser extent
decreased sales of single premium annuities with life contingencies due to
market contraction.
53
Fees and other revenues increased $10.3 million, or 22%, to $56.4 million for
the year ended December 31, 2002, from $46.1 million for the year ended December
31, 2001. An increase of $9.5 million in Mexico was a result of an increase in
the number of retirement plan participants due to the acquisition of Zurich
AFORE. In addition, an increase of $1.9 million in Hong Kong was primarily due
to an increase in assets under management.
Net investment income increased $22.2 million, or 19%, to $139.6 million for the
year ended December 31, 2002, from $117.4 million for the year ended December
31, 2001. The increase was primarily related to a $217.3 million, or 18%,
increase in average invested assets and cash, excluding our equity investment in
subsidiaries. The increase was partially offset by a decrease in investment
yields. The yield on average invested assets and cash, excluding our equity
investment in subsidiaries, was 9.5% for the year ended December 31, 2002,
compared to 9.6% for the year ended December 31, 2001.
Benefits, claims and settlement expenses decreased $163.7 million, or 40%, to
$243.8 million for the year ended December 31, 2002, from $407.5 million for the
year ended December 31, 2001. A $134.5 million decrease in Mexico was the result
of higher reserve changes and policy and contract benefit payments recognized in
2001 due to the sale of a large group annuity contract with life contingencies
and to a lesser extent prolonged government retention of potential annuitants in
2002. A decrease of $20.4 million in Argentina was primarily related to the
weakening of the Argentine peso versus the U.S. dollar and of the general
economic environment. In addition, a decrease of $8.1 million in Chile was
primarily a result of the weakening of the Chilean peso versus the U.S. dollar,
partially offset by higher interest credited to customers.
Operating expenses decreased $13.7 million, or 14%, to $87.5 million for the
year ended December 31, 2002, from $101.2 million for the year ended December
31, 2001. An $11.0 million decrease in Argentina was primarily related to the
weakening of the Argentine peso versus the U.S. dollar and of the general
economic environment. Operating expenses incurred by BT Financial Group were
$4.0 million for the year ended December 31, 2002 and $5.5 million for the year
ended December 31, 2001. These expenses represent corporate overhead allocated
to BT Financial Group and do not qualify for discontinued operations treatment.
Income tax expense increased $9.7 million to $7.1 million of income tax expense
for the year ended December 31, 2002, from a $2.6 million income tax benefit for
the year ended December 31, 2001. The increase was primarily a result of an
increase in pre-tax operating earnings.
As a result of the foregoing factors, operating earnings increased $17.2 million
to $19.5 million for the year ended December 31, 2002, from $2.3 million for the
year ended December 31, 2001.
Net realized/unrealized capital gains, as adjusted, increased $41.6 million to
$12.4 million of net realized capital gains for the year ended December 31,
2002, from $29.2 million of net realized capital losses for the year ended
December 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 $17.7 million increase was primarily related to losses resulting
from the permanent impairment of certain fixed maturity securities in Argentina
in 2001.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2002, net loss increased $403.0 million to
$441.1 million for the year ended December 31, 2002, from $38.1 million for the
year ended December 31, 2001. For the year ended December 31, 2002, net loss
included the negative effect of non-recurring items totaling $473.0 million, net
of income taxes, related to: (1) the cumulative effect of accounting change, a
result of our implementation of SFAS 142 ($276.3 million) and (2) the loss from
discontinued operations of BT Financial Group ($196.7 million). For the year
ended December 31, 2001, net loss included the negative effect of non-recurring
items totaling $11.2 million, net of income taxes, related to the loss from
discontinued operations of BT Financial Group.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
54
Premiums and other considerations increased $124.4 million, or 56%, to $344.9
million for the year ended December 31, 2001, from $220.5 million for the year
ended December 31, 2000. An increase of $166.4 million in Mexico was the result
of increased sales of single premium annuities with life contingencies,
primarily resulting from the sale of a large group annuity contract. The
increase was partially offset by the loss of $36.4 million of premiums and other
considerations due to the February 2001 divestiture of our operations in Spain.
Fees and other revenues increased $16.6 million, or 56%, to $46.1 million for
the year ended December 31, 2001, from $29.5 million for the year ended December
31, 2000. An increase of $10.3 million in Mexico was a result of an increase in
the number of retirement plan participants. In addition, an increase of $4.3
million in Hong Kong was primarily due to deposits growth resulting from sales
to plans established under the new Mandatory Provident Fund that started in
December 2000.
Net investment income increased $28.2 million, or 32%, to $117.4 million for the
year ended December 31, 2001, from $89.2 million for the year ended December 31,
2000. The increase was primarily related to a $209.3 million, or 21%, increase
in average invested assets and cash and an increase in investment yields,
excluding our equity investment in subsidiaries. The yield on average invested
assets and cash, excluding our equity investment in subsidiaries, was 9.6% for
the year ended December 31, 2001, compared to 8.0% for the year ended December
31, 2000. The increase in investment yields was primarily due to the impact of
inflation on nominal yields in Chile, which was offset by a corresponding
increase in reserve changes.
Benefits, claims and settlement expenses increased $145.3 million, or 55%, to
$407.5 million for the year ended December 31, 2001, from $262.2 million for the
year ended December 31, 2000. An increase in reserve changes and policy and
contract benefit payments of $171.6 million in Mexico was primarily the result
of the sale of a large group annuity contract with life contingencies. An
increase of $15.1 million in Chile primarily related to an increase in reserve
changes to reflect the impact of inflation adjustments. The increases were
partially offset by the loss of $43.8 million of benefits, claims and settlement
expenses resulting from the divestiture of our operations in Spain.
Operating expenses increased $0.4 million to $101.2 million for the year ended
December 31, 2001, from $100.8 million for the year ended December 31, 2000.
Operating expenses incurred by BT Financial Group were $5.4 million for the year
ended December 31, 2001 and $3.2 million for the year ended December 31, 2000.
These expenses represent corporate overhead allocated to BT Financial Group and
do not qualify for discontinued operations treatment.
Income tax benefits decreased $4.3 million, or 62%, to $2.6 million for the year
ended December 31, 2001, from $6.9 million for the year ended December 31, 2000.
The decrease was primarily a result of a decrease in pre-tax operating loss.
As a result of the foregoing factors, operating earnings increased $19.2 million
to $2.3 million of operating earnings for the year ended December 31, 2001, from
a $16.9 million operating loss for the year ended December 31, 2000.
Net realized/unrealized capital losses, as adjusted, increased $30.5 million to
$29.2 million of net realized capital losses for the year ended December 31,
2001, from $1.3 million of net realized capital gains for the year ended
December 31, 2000. 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 $13.9 million increase related to losses resulting from the
permanent impairment of certain fixed maturity securities in Argentina.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2001, net loss increased $31.0 million to $38.1
million for the year ended December 31, 2001, from $7.1 million for the year
ended December 31, 2000. For the year ended December 31, 2001, net loss included
the negative effect of non-recurring items totaling $11.2 million, net of income
taxes, related to the loss from discontinued operations of BT Financial Group.
For the year ended December 31, 2000, net loss included the positive effect of
55
non-recurring items totaling $8.5 million, net of income taxes, related to the
income from discontinued operations of BT Financial Group.
LIFE AND HEALTH INSURANCE SEGMENT
INDIVIDUAL AND GROUP LIFE INSURANCE TRENDS
Our life insurance premiums have been influenced by both economic and industry
trends. We are seeing a shift in sales from traditional life insurance products
with premiums to universal and variable universal products with deposits and
fees. Premiums related to our individual traditional life insurance products
have declined due to the shift in customer preference. Our group life insurance
premiums declined in 2001 due largely to the loss of two large customers.
The following table provides a summary of our life insurance fee revenues,
premiums, premium equivalents, and policyholder liabilities as of or for the
years ended December 31, 2002, 2001 and 2000:
LIFE INSURANCE
----------------------------------------------------------------------------------------
INDIVIDUAL UNIVERSAL AND
VARIABLE UNIVERSAL LIFE INDIVIDUAL GROUP LIFE
INSURANCE TRADITIONAL LIFE INSURANCE INSURANCE
------------------------------- -------------------------------- -----------------
PREMIUMS AND
AS OF OR FOR THE YEAR FEE POLICYHOLDER POLICYHOLDER PREMIUM
ENDED REVENUES LIABILITIES(1) PREMIUMS LIABILITIES EQUIVALENTS
- -------------------------- ----------- ---------------- ------------ --------------- -----------------
(IN MILLIONS)
December 31, 2002....... $129.5 $1,900.9 $ 737.2 $ 5,851.4 $ 217.6
December 31, 2001....... 99.6 1,748.5 766.2 5,712.7 221.8
December 31, 2000....... 89.1 1,567.5 772.8 5,522.7 277.7
_____________________
(1) Includes separate account liabilities for policies with variable investment
options.
HEALTH INSURANCE TRENDS
Improved pricing discipline in our group medical insurance business has affected
premium growth during the past few years. In general, we reacted faster than the
industry in 2000 to rising healthcare costs by raising our prices. That action
depressed sales and increased lapses, causing a loss of membership and total
premiums that continued into 2001. Our price increases have subsided to match
cost trends, and competitors have increased their pricing more recently. While
sales and lapses improved in 2001 and 2002, inforce covered members continued to
decline but at a much slower pace. Decreases in premium due to loss of
membership were offset by increased premium per member. Some of the decline in
members during the past few years was due to strategic decisions to exit
under-performing and non-strategic businesses and markets. Effective January 1,
2000, we ceased new sales of our Medicare supplement insurance product and
effective July 1, 2000, reinsured all existing Medicare supplement business.
More recently, we began to exit the small case medical business in Florida. We
continue to sell group medical business in 35 states plus the District of
Columbia. We also offer dental business in 50 states plus the District of
Columbia, vision coverage in 49 states plus the District of Columbia, and
administrative services only business in all 50 states plus the District of
Columbia.
Our health insurance premiums and premium equivalents for the years ended
December 31, 2002, 2001 and 2000 were as follows:
56
PREMIUMS AND PREMIUM EQUIVALENTS
----------------------------------------------------------------
GROUP MEDICAL GROUP DENTAL AND
FOR THE YEAR ENDED INSURANCE(1) VISION INSURANCE FEE-FOR-SERVICE
- ---------------------------- ------------------ ------------------- -------------------
(IN MILLIONS)
December 31, 2002........... $ 1,620.5 $ 343.5 $ 2,108.7
December 31, 2001........... 1,610.3 351.1 1,828.2
December 31, 2000........... 1,815.6 340.4 1,502.2
____________________
(1) Effective January 1, 2000, we ceased new sales of our Medicare supplement
insurance and effective July 1, 2000, reinsured all existing Medicare
supplement business. Beginning September 1, 2002, we began non-renewing
small group medical business in the state of Florida.
INDIVIDUAL AND GROUP DISABILITY INSURANCE TRENDS
Premium growth for our group and individual disability business in 2002 and 2001
is being driven by growing sales and stable persistency. This has been a result
of more focused distribution on these product lines.
The following table provides a summary of our disability insurance premiums,
premium equivalents, and policyholder liabilities as of or for the years ended
December 31, 2002, 2001 and 2000:
DISABILITY INSURANCE
---------------------------------------------------------------
GROUP DISABILITY
INDIVIDUAL DISABILITY INSURANCE INSURANCE
------------------------------------ ----------------------
POLICYHOLDER PREMIUMS AND PREMIUM
AS OF OR FOR THE YEAR ENDED PREMIUMS LIABILITIES EQUIVALENTS
- ----------------------------------- -------------- ----------------- ----------------------
(IN MILLIONS)
December 31, 2002........... $ 93.5 $ 426.8 $ 111.0
December 31, 2001........... 83.2 381.5 98.2
December 31, 2000........... 74.2 338.9 94.5
57
LIFE AND HEALTH INSURANCE SEGMENT SUMMARY FINANCIAL DATA
The following table presents certain summary financial data relating to the Life
and Health Insurance segment for the years indicated:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
------------- --------------- --------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues (1):
Premiums and other
considerations............. $2,973.4 $ 3,011.1 $ 3,250.5
Fees and other revenues..... 313.2 256.7 230.0
Net investment income....... 660.2 678.6 642.1
------------- --------------- --------------
Total operating
revenues................... 3,946.8 3,946.4 4,122.6
Expenses:
Benefits, claims and
settlement expenses........ 2,433.4 2,491.0 2,659.4
Dividends to policyholders.. 307.0 307.0 308.1
Operating expenses.......... 851.2 842.7 913.6
------------- --------------- --------------
Total expenses.......... 3,591.6 3,640.7 3,881.1
------------- --------------- --------------
Pre-tax operating earnings.... 355.2 305.7 241.5
Income taxes.................. 122.1 104.5 79.2
------------- --------------- --------------
Operating earnings............ 233.1 201.2 162.3
Net realized/unrealized
capital gains (losses),
as adjusted.................. (50.0) (33.8) 47.3
Non-recurring items........... (4.6) 0.1 -
------------- --------------- --------------
U.S. GAAP REPORTED:
Net income.................... $ 178.5 $ 167.5 $ 209.6
============= =============== =============
- ------------
(1) Excludes net realized/unrealized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums and other considerations decreased $37.7 million, or 1%, to $2,973.4
million for the year ended December 31, 2002, from $3,011.1 million for the year
ended December 31, 2001. Life insurance premiums decreased $63.2 million,
primarily resulting from the reclassification of revenues from our group
universal life insurance product from premium to fee revenues and the continued
shift of customer preference from traditional life insurance products to
fee-based universal and variable universal life insurance products. Partially
offsetting the decrease was a $23.1 million increase in disability insurance
premiums due to strong sales in 2002.
Fees and other revenues increased $56.5 million, or 22%, to $313.2 million for
the year ended December 31, 2002, from $256.7 million for the year ended
December 31, 2001. Fee revenues from our life insurance business increased $50.2
million, primarily due to the reclassification of revenues from our group
universal life product to fee revenues from premium and the continued shift in
customer preference, as previously mentioned. Fee revenues from our health
insurance business increased $6.3 million, primarily a result of selling
additional services to existing fee-for-service customers and related price
increases.
Net investment income decreased $18.4 million, or 3%, to $660.2 million for the
year ended December 31, 2002, from $678.6 million for the year ended December
31, 2001. The decrease primarily reflects lower average investment yields due in
part to an overall lower interest rate environment. The yield on average
58
invested assets and cash was 7.1% for the year ended December 31, 2002, compared
to 7.6% for the year ended December 31, 2001. Partially offsetting the decrease
was a $357.8 million, or 4%, increase in average invested assets and cash for
the segment.
Benefits, claims and settlement expenses decreased $57.6 million, or 2%, to
$2,433.4 million for the year ended December 31, 2002, from $2,491.0 million for
the year ended December 31, 2001. Health insurance benefits, claims and
settlement expenses decreased $40.8 million, primarily due to amounts received
from a reinsurer. Life insurance benefits, claims and settlement expenses
decreased $27.9 million primarily due to lower death claims and a lower reserve
increase related to a decrease in premium. Partially offsetting these decreases
was an $11.1 million increase in disability insurance benefits, claims and
settlement expenses, primarily a result of growth in the business.
Operating expenses increased $8.5 million, or 1%, to $851.2 million for the year
ended December 31, 2002, from $842.7 million for the year ended December 31,
2001. Disability insurance operating expenses increased $4.8 million due to
expenses associated with higher sales, increased commissions on higher premiums,
and increased amortization of DPAC on a growing block of business. Life
insurance operating expenses increased $2.5 million primarily due to an increase
in compensation costs partially offset by an increase in the capitalization of
DPAC related to higher sales and the reclassifying of fees received from
reinsurance ceded from fee revenue to operating expenses. In addition, Health
operating expenses increased $1.2 million, primarily a result of increased
commissions partially offset by several one-time expenses in 2001.
Income taxes increased $17.6 million, or 17%, to $122.1 million for the year
ended December 31, 2002, from $104.5 million for the year ended December 31,
2001. The effective income tax rate for the segment was 34% for the years ended
December 31, 2002 and 2001. The effective income tax rates for the years ended
December 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 $31.9
million, or 16%, to $233.1 million for the year ended December 31, 2002, from
$201.2 million for the year ended December 31, 2001.
Net realized/unrealized capital losses, as adjusted, increased $16.2 million to
$50.0 million for the year ended December 31, 2002, from $33.8 million for the
year ended December 31, 2001. The increase includes an increase in realized
capital losses related to other than temporary declines in the value of certain
fixed maturity securities partially offset by lower capital losses on the sales
of fixed maturity securities.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2002, net income increased $11.0 million, or 7%,
to $178.5 million for the year ended December 31, 2002, from $167.5 million for
the year ended December 31, 2001. Non-recurring items for the year ended
December 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 year ended December 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.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Premiums and other considerations decreased $239.4 million, or 7%, to $3,011.1
million for the year ended December 31, 2001, from $3,250.5 million for the year
ended December 31, 2000. Health insurance premiums decreased $181.0 million,
primarily resulting from our decision to reinsure 100% of the group Medicare
supplement business effective July 1, 2000 and group medical premium rate
increases in 2000, which led to increased lapses and lower sales. Life insurance
premiums decreased $71.3 million, primarily due to the loss of two large group
life customers and, to a lesser extent, a result of the continued shift from
individual traditional life insurance products to individual universal and
variable universal life insurance products. Group life sales also decreased as a
result of pricing actions on our group medical business, as these products are
often sold together.
59
Fees and other revenues increased $26.7 million, or 12%, to $256.7 million for
the year ended December 31, 2001, from $230.0 million for the year ended
December 31, 2000. Fee revenues from our health insurance business increased
$24.4 million, primarily due to growth in the group fee-for-service business
and, to a lesser extent, increases in fee rates. Fee revenues from the life
insurance business increased $3.5 million, a result of continued growth from the
individual universal and variable universal life insurance product partially
offset by a decrease in individual traditional life insurance fee revenues
related to classifying fees from reinsurance ceded for traditional life
insurance as operating expenses. The fees from reinsurance were previously
reported as fee revenues.
Net investment income increased $36.5 million, or 6%, to $678.6 million for the
year ended December 31, 2001, from $642.1 million for the year ended December
31, 2000. The increase was primarily due to a $265.1 million, or 3%, increase in
average invested assets and cash for the segment. Net investment income also
increased due to an increase in average investment yields for the segment. The
yield on average invested assets and cash was 7.6% for the year ended December
31, 2001, compared to 7.4% for the year ended December 31, 2000.
Benefits, claims and settlement expenses decreased $168.4 million, or 6%, to
$2,491.0 million for the year ended December 31, 2001, from $2,659.4 million for
the year ended December 31, 2000. Health insurance benefits, claims and
settlement expenses decreased $114.1 million primarily due to a reduction in
group medical business and our decision to reinsure 100% of the group Medicare
supplement business effective July 1, 2000. In general, health insurance
benefits as a percentage of premiums decreased due to improved pricing,
resulting in lower loss ratios. These decreases were partially offset by reserve
releases during the year ended December 31, 2000. Life insurance benefits,
claims and settlement expenses decreased $32.9 million primarily due to the loss
of two large group life customers and an overall decline in group life business.
Disability insurance benefits, claims and settlement expenses decreased $21.4
million, primarily a result of claim reserve strengthening during 2000.
Dividends to policyholders decreased $1.1 million to $307.0 million for the year
ended December 31, 2001, from $308.1 million for the year ended December 31,
2000. The decrease was primarily a result of a change in methodology of
estimating dividends. Additionally, the dividends in the Closed Block were
reduced due to accumulated experience losses.
Operating expenses decreased $70.9 million, or 8%, to $842.7 million for the
year ended December 31, 2001, from $913.6 million for the year ended December
31, 2000. Health insurance operating expenses decreased $51.5 million, primarily
due to our decision to reinsure 100% of our group Medicare supplement insurance
business effective July 1, 2000 and due to expense management in response to an
overall decline in health insurance business. Life insurance operating expenses
decreased $11.8 million primarily due to a decrease in commission expense
resulting from classifying fees from reinsurance ceded for traditional life
insurance as operating expenses rather than fee revenues, a decrease in company
sponsored benefit plan expenses, and a decrease in commissions resulting from
lower sales. The decreases in life insurance operating expenses were partially
offset by lower capitalization of deferred policy acquisition costs related to
lower sales of individual life insurance. Disability insurance operating
expenses decreased $7.6 million due to unlocking of individual disability
insurance deferred policy acquisition costs in 2000, a result of changes in
profitability assumptions.
Income taxes increased $25.3 million, or 32%, to $104.5 million for the year
ended December 31, 2001, from $79.2 million for the year ended December 31,
2000. The effective income tax rate for the segment was 34% for the year ended
December 31, 2001, and 33% for the year ended December 31, 2000. The effective
income tax rate for the year ended December 31, 2001, was lower than the
corporate income tax rate of 35% primarily due to tax-exempt income. The
effective income tax rate for the year ended December 31, 2000, was lower than
the corporate income tax rate of 35%, primarily due to tax-exempt income and a
reduction in a tax reserve as a result of a favorable IRS audit event.
As a result of the foregoing factors, operating earnings increased $38.9
million, or 24%, to $201.2 million for the year ended December 31, 2001, from
$162.3 million for the year ended December 31, 2000.
60
Net realized/unrealized capital losses, as adjusted, increased $81.1 million to
$33.8 million of net realized/unrealized capital losses for the year ended
December 31, 2001, from $47.3 million of net realized/unrealized capital gains
for the year ended December 31, 2000. The decrease primarily related to the sale
of our investment in United Payors and United Providers. In 2000, we sold our
remaining investment and realized an after-tax capital gain of $58.9 million. To
a lesser extent, the decrease was due to an increase in losses from permanent
impairments of fixed maturity securities during 2001, including $16.6 million of
net realized capital losses related to our investment in Enron and related
entities.
As a result of the foregoing factors and the inclusion of non-recurring items
for the year ended December 31, 2001, net income decreased $42.1 million, or
20%, to $167.5 million for the year ended December 31, 2001, from $209.6 million
for the year ended December 31, 2000. Non-recurring items for the year ended
December 31, 2001, had a positive impact on net income of $0.1 million, net of
income taxes, due to the cumulative effect of accounting change, a result of our
implementation of SFAS 133.
MORTGAGE BANKING SEGMENT
MORTGAGE BANKING TRENDS
We believe residential mortgages play a central role in the financial planning
activities of individuals in the U.S. As a result, our mortgage banking
operations complement our portfolio of market-driven financial products and
services.
Interest rate trends significantly impact our residential mortgage business.
Starting in early 2001 interest rates declined resulting in increases in the
production of both purchase and refinance mortgage loans throughout the
industry. This trend continued through all of 2002.
We manage growth in the mortgage loan servicing portfolio through retention of
mortgage loan production and the acquisition, and occasional sale, of mortgage
servicing rights. Our servicing portfolio grew at a compound annual rate of 39%
between December 31, 2000 and December 31, 2002. Growth was steady during this
period and resulted from strong mortgage loan production net of servicing
portfolio prepayments, strong servicing acquisitions and very few servicing
sales.
Our residential mortgage loan production and the unpaid principal balances in
our residential mortgage loan servicing portfolio as of or for the years ended
December 31, 2002, 2001 and 2000 were as follows:
RESIDENTIAL MORTGAGE RESIDENTIAL MORTGAGE
AS OF OR FOR THE YEAR ENDED LOAN PRODUCTION LOAN SERVICING PORTFOLIO
- ------------------------------------------ -------------------------- -------------------------
(IN MILLIONS)
December 31, 2002................ $ 46,811.2 $ 107,745.3
December 31, 2001................ 37,771.3 80,530.5
December 31, 2000................ 8,311.8 55,987.4
MORTGAGE BANKING SEGMENT SUMMARY FINANCIAL DATA
The following table presents certain summary financial data relating to the
Mortgage Banking segment for the years indicated:
61
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
2002 2001 2000
----------- ----------- ------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues(1):
Loan servicing................ $ 590.1 $ 403.0 $ 313.8
Loan production............... 562.9 354.4 46.0
----------- ----------- ------------
Total operating revenues.. 1,153.0 757.4 359.8
Expenses:
Loan servicing................ 711.8 407.3 215.3
Loan production............... 196.4 145.0 67.4
----------- ----------- ------------
Total expenses............ 908.2 552.3 282.7
----------- ----------- ------------
Pre-tax operating earnings......... 244.8 205.1 77.1
Income taxes....................... 101.9 78.4 27.1
----------- ----------- ------------
Operating earnings................. 142.9 126.7 50.0
Net realized/unrealized capital
gains (losses), as adjusted..... - - -
Non-recurring items................ - - -
----------- ----------- ------------
U.S. GAAP REPORTED:
Net income......................... $ 142.9 $ 126.7 $ 50.0
=========== =========== ============
- ------------
(1) Excludes net realized/unrealized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Total operating revenues increased $395.6 million, or 52%, to $1,153.0 million
for the year ended December 31, 2002, from $757.4 million for the year ended
December 31, 2001. Residential mortgage loan production revenues increased
$208.5 million primarily due to an increase in mortgage loan production, which
increased to $46.8 billion for the year ended December 31, 2002, compared to
$37.8 billion for the same period a year ago. A $187.1 million increase in
residential mortgage loan servicing revenues reflects an increase in the
residential mortgage loan servicing portfolio. The average balance of the
servicing portfolio was $95.7 billion for the year ended December 31, 2002,
compared to $65.8 billion for the same period a year ago. In addition, mortgage
loan servicing revenues increased due to a gain on the sale of approximately
$300.0 million of delinquent Government National Mortgage Association ("GNMA")
loans during the second quarter of 2002. This sale generated revenues of $15.0
million in 2002 with no corresponding sale of loans in 2001.
Total expenses increased $355.9 million, or 64%, to $908.2 million for the year
ended December 31, 2002, from $552.3 million for the year ended December 31,
2001. A $304.5 million increase in residential mortgage loan servicing expenses
resulted from increased expenses related to growth in the servicing portfolio
and a $137.3 million increase in impairment of capitalized mortgage servicing
rights net of servicing hedge activity. Residential mortgage loan production
expenses increased $51.4 million reflecting the increase in residential mortgage
loan production volume.
Income taxes increased $23.5 million, or 30%, to $101.9 million for the year
ended December 31, 2002, from $78.4 million for the year ended December 31,
2001. The increase in income taxes primarily resulted from an increase in
pre-tax operating earnings. The effective income tax rate for this segment was
42% for the year ended December 31, 2002, and 38% for the year ended December
31, 2001. The increase in the effective tax rate to 42% for the year ended
December 31, 2002, from 38% for the year ended December 31, 2001, was primarily
due to the cumulative effect of increasing deferred tax liabilities and deferred
tax expense for a change in the state income tax apportionment factor, a result
of our sale of substantially all of BT Financial Group.
62
As a result of the foregoing factors, operating earnings and net income
increased $16.2 million, or 13%, to $142.9 million for the year ended December
31, 2002, from $126.7 million for the year ended December 31, 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total operating revenues increased $397.6 million to $757.4 million for the year
ended December 31, 2001, from $359.8 million for the year ended December 31,
2000. A $308.4 million increase in mortgage loan production revenues reflects
the increase in mortgage loan production volume during the year ended December
31, 2001. In addition, an increase of $89.2 million in mortgage loan servicing
revenues reflects the growth in the mortgage loan servicing portfolio. The
decline in interest rates in 2001 resulted in mortgage loan production of $37.8
billion for the year ended December 31, 2001, compared to $8.3 billion for the
same period a year ago. The average balance of the servicing portfolio was $65.8
billion for the year ended December 31, 2001, compared to $52.6 billion for the
same period a year ago.
Total expenses increased $269.6 million, or 95%, to $552.3 million for the year
ended December 31, 2001, from $282.7 million for the year ended December 31,
2000. A $192.0 million increase in mortgage loan servicing expenses was
primarily a result of an impairment of capitalized mortgage loan servicing
rights and, to a lesser extent, due to growth in the mortgage loan servicing
portfolio. The impairment was partially offset by an increase in net gains on
servicing hedge activity recognized in the year ended December 31, 2001,
compared to the year ended December 31, 2000. Mortgage loan production expenses
increased $77.6 million, reflecting the increase in mortgage loan production
volume.
Income taxes increased $51.3 million to $78.4 million for the year ended
December 31, 2001, from $27.1 million for the year ended December 31, 2000. The
effective income tax rate for this segment was 38% for the year ended December
31, 2001, and 35% for the year ended December 31, 2000. The effective income tax
rate for the year ended December 31, 2001, was higher that the corporate income
tax rate of 35% due to the allocation of deferred state taxes, relating to both
current and prior years, recorded in 2001. This allocation will increase the
effective income tax rate for this segment in future reporting periods.
As a result of the foregoing factors, operating earnings and net income
increased $76.7 million to $126.7 million for the year ended December 31, 2001,
from $50.0 million for the year ended December 31, 2000.
CORPORATE AND OTHER SEGMENT
CORPORATE AND OTHER SEGMENT SUMMARY FINANCIAL DATA
The following table presents certain summary financial data relating to the
Corporate and Other segment for the years indicated:
63
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------
2002 2001 2000
--------------- ------------- -----------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating Revenues (1):
Total operating revenues.... $ (15.1) $ 101.7 $ 98.2
Expenses:
Total expenses.............. 33.4 44.2 15.5
--------------- ------------- -----------
Pre-tax operating earnings
(loss)...................... (48.5) 57.5 82.7
Income taxes (benefits)...... (31.5) 19.4 15.0
--------------- ------------- -----------
Operating earnings (loss).... (17.0) 38.1 67.7
Net realized/unrealized
capital gains (losses), as
adjusted.................... 44.2 (93.3) 80.3
Non-recurring items.......... 114.4 (20.4) (101.0)
--------------- -------------- -----------
U.S. GAAP REPORTED:
Net income (loss)............ $ 141.6 $ (75.6) $ 47.0
=============== ============= ===========
- ------------
(1) Excludes net realized/unrealized capital gains (losses) and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Total operating revenues decreased $116.8 million to a negative $15.1 million
for the year ended December 31, 2002, from a positive $101.7 million for the
year ended December 31, 2001. Net investment income decreased $62.8 million,
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. In addition, net investment income decreased $39.3 million
due to a decrease of average investment yields for the segment. The decrease in
total revenues was also partially due to a $21.9 million increase in
inter-segment eliminations included in this segment, which was primarily offset
by a corresponding change in total expenses.
Total expenses decreased $10.8 million, or 24%, to $33.4 million for the year
ended December 31, 2002, from $44.2 million for the year ended December 31,
2001. Inter-segment eliminations included in this segment increased $21.0
million, resulting in a decrease in total expenses. In addition, a $6.8 million
decrease related to a prior year write-off of a non-invested asset. These
decreases were partially offset by an $11.0 million increase in interest
expense, primarily due to interest related to federal income tax audit
activities as well as a $6.8 million increase due to costs associated with
operating as a public company.
Income tax benefits increased $50.9 million to a $31.5 million income tax
benefit for the year ended December 31, 2002, from $19.4 million of income tax
expense for the year ended December 31, 2001. The increase was primarily a
result of a decrease in pre-tax operating earnings. The increase was also due to
a decrease in income tax reserves established for contested IRS tax audit
matters.
As a result of the foregoing factors, operating earnings decreased $55.1 million
to $17.0 million of operating loss for the year ended December 31, 2002, from
$38.1 million of operating earnings for the year ended December 31, 2001.
Net realized/unrealized capital gains, as adjusted, increased $137.5 million to
$44.2 million of net realized/unrealized capital gains for the year ended
December 31, 2002, from $93.3 million of net realized/unrealized capital losses
for the year ended December 31, 2001. The increase was primarily due to realized
capital gains related to the sale of our investment in Coventry in February
64
2002, and to a lesser extent, other sales of invested assets. The increases were
partially offset by the mark to market of certain seed money investments.
As a result of the foregoing factors and the inclusion of non-recurring items,
net income increased $217.2 million to $141.6 million of net income for the year
ended December 31, 2002, from $75.6 million of net loss for the year ended
December 31, 2001. For the year ended December 31, 2002, net income included the
effect of non-recurring items totaling $114.4 million, net of income taxes,
related to: (1) the positive effect of the settlement of an IRS audit issue
($138.0 million) and (2) the negative effects of (a) an increase in our loss
contingency reserve for sales practices litigation ($21.6 million) and (b)
expenses related to our demutualization ($2.0 million). For the year ended
December 31, 2001, net loss included the effect of non-recurring items totaling
$20.4 million, net of income taxes, related to: (1) the negative effects of (a)
expenses related to our demutualization ($18.6 million) and (b) an increase in
our loss contingency reserve for sales practices litigation ($5.9 million) and
(2) the positive effect of investment income generated from the proceeds of our
IPO ($4.1 million).
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total operating revenues increased $3.5 million, or 4%, to $101.7 million for
the year ended December 31, 2001, from $98.2 million for the year ended December
31, 2000. Net investment income increased $14.0 million, reflecting an increase
in average invested assets and cash. The increase in total revenues was also
partially due to a $1.7 million decrease in inter-segment eliminations included
in this segment, which was offset by a corresponding change in total expenses.
The increases were partially offset by an $11.2 million decrease in net
investment income due to a decrease in average investment yields for the
segment.
Total expenses increased $28.7 million to $44.2 million for the year ended
December 31, 2001, from $15.5 million for the year ended December 31, 2000.
Interest expense increased $32.3 million, primarily due to a net recovery in
2000 of previously paid interest related to a successful tax audit appeal. An
increase of $6.8 million related to the write-off of a non-invested asset.
Interest expense on short-term borrowings increased $3.1 million. The increase
in total expenses was also partially due to a $1.7 million decrease in
inter-segment eliminations included in this segment. The increases were
partially offset by a $9.3 million decrease of interest expense as a result of
extinguishment of commercial real estate debt on home office properties. In
addition, interest expense on private debt securities and commercial paper
issued in connection with the acquisition of BT Financial Group decreased $5.9
million, a result of the impact of the weakening of the Australian dollar versus
the U.S. dollar and repayment of the commercial paper.
Income tax expense increased $4.4 million, or 29%, to $19.4 million for the year
ended December 31, 2001, from $15.0 million for the year ended December 31,
2000. The increase was primarily due to tax-exempt income in 2000, and, to a
lesser extent, due to a decrease in income tax reserves established for
contested IRS tax audit matters in 2000.
As a result of the foregoing factors, operating earnings decreased $29.6
million, or 44%, to $38.1 million for the year ended December 31, 2001, from
$67.7 million for the year ended December 31, 2000.
Net realized/unrealized capital gains (losses), as adjusted, decreased $173.6
million to $93.3 million of net realized/unrealized capital losses for the year
ended December 31, 2001, from $80.3 million of net realized/unrealized capital
gains for the year ended December 31, 2000. The decrease was primarily due to an
increase in net realized capital losses for the year ended December 31, 2001, on
sales of equity securities and real estate. The decrease included $10.5 million
of net realized capital losses related to our investment in Enron and related
entities.
As a result of the foregoing factors and the inclusion of non-recurring items,
net loss increased $122.6 million to a net loss of $75.6 million for the year
ended December 31, 2001, from $47.0 million of net income for the year ended
December 31, 2000. For the year ended December 31, 2001, net income included the
effect of non-recurring items totaling $20.4 million, net of income taxes,
related to: (1) the negative effects of (a) expenses related to our
demutualization ($18.6 million) and (b) an increase in our loss contingency
reserve for sales practices litigation ($5.9 million) and (2) the positive
effect of investment income generated from the proceeds of our IPO ($4.1
65
million). For the year ended December 31, 2000, net income included the negative
effects of non-recurring items totaling $101.0 million, net of income taxes,
related to: (1) a loss contingency reserve established for sales practices
litigation ($93.8 million) and (2) expenses related to our demutualization ($7.2
million).
LIQUIDITY AND CAPITAL RESOURCES
THE HOLDING COMPANIES
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. Our parent holding
company, Principal Financial Group, Inc., is a Delaware business corporation,
whose assets primarily consist of the outstanding capital stock of its
subsidiaries. As a holding company, Principal Financial Group Inc.'s ability to
meet cash requirements, including the payments of dividends on common stock and
the repurchase of stock, substantially depends upon dividends from subsidiaries,
primarily Principal Life. The payment of stockholder dividends by Principal Life
to its parent company is limited by Iowa laws. Under Iowa laws, Principal Life
may pay dividends only from the earned surplus arising from its business and
must receive the prior approval of the Insurance Commissioner of the State of
Iowa ("the Commissioner") to pay a stockholder dividend if such a stockholder
dividend would exceed certain statutory limitations. The current statutory
limitation is the greater of:
o 10% of Principal Life's statutory policyholder surplus as of the previous
year-end; or
o the statutory net gain from operations from the previous calendar year.
Iowa law gives the Commissioner discretion to disapprove requests for dividends
in excess of these limits. Based on this limitation and 2002 statutory results,
Principal Life could pay approximately $746.6 million in stockholder dividends
in 2003 without exceeding the statutory limitation. Principal Life was able to
pay approximately $640.3 million in statutory dividends in 2002 based on its
2001 statutory financial results without being subject to the restrictions on
payment of extraordinary stockholder dividends.
Total stockholder dividends paid by Principal Life to its parent company in 2002
and 2001 were $590.2 million and $734.7 million, respectively.
Another source of liquidity is issuance of our common stock. In 2002, proceeds
from the issuance of our common stock were $22.0 million. In 2001, net proceeds
from our IPO totaled $1,753.9 million, of which we retained $64.2 million for
working capital, payment of dividends, and other general corporate purposes. The
remaining $1,689.7 million was contributed to Principal Life principally to fund
demutualization compensation to policyholders in the form of policy credits and
cash, and to cover certain expenses related to our demutualization. In addition,
net proceeds from the issuance of additional shares for the exercise of the
over-allotment options granted to the underwriters in the IPO, totaled $265.4
million, all of which we retained for repurchase of shares issued in the
exercise of the over-allotment options.
In 2002, we paid $83.8 million in dividends to shareholders. We paid a dividend
of $0.25 per share on December 9, 2002, to shareholders of record as of November
8, 2002.
In the last two years, our board of directors has authorized various repurchase
programs under which we are allowed to purchase shares of our outstanding common
stock. Shares repurchased under these programs are accounted for as treasury
stock, carried at cost and reflected as a reduction to stockholders' equity.
On November 26, 2002, our board of directors authorized a third repurchase
program of up to $300.0 million of our outstanding common stock. The repurchases
will be made in the open market or through privately negotiated transactions,
from time to time, depending on market conditions. No purchases were made under
this program as of December 31, 2002.
66
Earlier in 2002, our board of directors authorized two repurchase programs that
were completed with the purchase of 27.0 million shares in the open market at an
aggregate cost of $750.0 million.
On November 27, 2001, our board of directors authorized a repurchase program of
up to 15.3 million shares of our outstanding common stock. This program was
completed by December 31, 2001, with the purchase of 13.0 million shares through
an accelerated share repurchase program and 2.3 million shares through the open
market and privately negotiated transactions at an aggregate cost of $367.7
million. The 13.0 million shares purchased under the accelerated share
repurchase program were subject to a future contingent purchase price
adjustment. The adjustment was based upon the difference between the market
price of our common stock as of December 14, 2001, and its volume
weighted-average price over an extended trading period as outlined in the
forward stock purchase contract. Settlement of this contract occurred in
February 2002 with a cash payment of $0.4 million.
Sources of liquidity also include facilities for short-term and long-term
borrowing as needed, arranged through our intermediate holding company,
Principal Financial Services Inc. ("PFSI"), and its subsidiaries. See
"Contractual Obligations and Commercial Commitments" below.
PRINCIPAL LIFE
Historically, the principal cash flow sources for Principal Life have been
premiums from life and health insurance products, pension and annuity deposits,
asset management fee revenues, administrative services fee revenues, income from
investments, proceeds from the sales or maturity of investments, long-term debt
and short-term borrowings. Cash outflows consist primarily of payment of
benefits to policyholders and beneficiaries, income and other taxes, current
operating expenses, payment of dividends to policyholders, payments in
connection with investments acquired, payments made to acquire subsidiaries,
payment of dividends to parent, and payments relating to policy and contract
surrenders, withdrawals, policy loans, interest expense and repayment of
short-term borrowings and long-term debt.
Principal Life maintains investment strategies generally intended to provide
adequate funds to pay benefits without forced sales of investments. Products
having liabilities with longer lives, such as life insurance and full-service
payout pension products, are matched with assets having similar estimated lives
such as mortgage loans, long-term bonds and private placement bonds.
Shorter-term liabilities are matched with investments such as short and
medium-term fixed maturities. In addition, highly liquid, high quality
short-term investments are held to fund anticipated operating expenses,
surrenders, withdrawals and development and maintenance expenses associated with
new products and technologies. Our privately placed fixed maturity securities,
commercial mortgage loans and real estate investments are generally less liquid
than our publicly traded fixed maturity securities. As of December 31, 2002 and
2001, these asset classes represented approximately 43% and 49%, respectively,
of the value of our consolidated invested assets. See Item 7A. "Quantitative and
Qualitative Disclosures about Market Risk-Interest Rate Risk" for a discussion
of duration matching.
Life insurance companies generally produce a positive cash flow from operations,
as measured by the amount by which cash inflows are adequate to meet benefit
obligations to policyholders and normal operating expenses as they are incurred.
The remaining cash flow is generally used to increase the asset base to provide
funds to meet the need for future policy benefit payments and for writing and
acquiring new business. It is important to match the investment portfolio
maturities to the cash flow demands of the type of annuity, investment or
insurance product being provided. Principal Life continuously monitors benefits,
surrenders and maturities to provide projections of future cash requirements. As
part of this monitoring process, Principal Life performs cash flow testing of
many of its assets and liabilities under various scenarios to evaluate the
adequacy of reserves. In developing its investment strategy, Principal Life
establishes a level of cash and securities which, combined with expected net
cash inflows from operations, maturities of fixed maturity investments and
principal payments on mortgage-backed securities and commercial mortgage loans,
are believed adequate to meet anticipated short-term and long-term benefit and
expense payment obligations. There can be no assurance that future experience
regarding benefits and surrenders will be similar to historic experience since
67
withdrawal and surrender levels are influenced by such factors as the interest
rate environment and the claims paying ability and financial strength ratings of
Principal Life.
Principal Life takes into account asset-liability management considerations in
the product development and design process. Contract terms of 95% and 96% of
Principal Life's universal and variable universal life insurance products as of
December 31, 2002 and 2001, respectively, include surrender and withdrawal
provisions which mitigate the risk of losses due to early withdrawals. These
provisions generally do one or more of the following: limit the amount of
penalty-free withdrawals; limit the circumstances under which withdrawals are
permitted; or assess a surrender charge or market value adjustment relating to
the underlying assets. The market value adjustment feature in Principal Life's
fixed annuity products adjusts the surrender value of a contract in the event of
surrender prior to the end of the contract period to protect Principal Life
against losses due to higher interest rates at the time of surrender.
Our GICs and funding agreements contain provisions limiting early surrenders,
including penalties for early surrenders and minimum notice requirements. Put
provisions give customers the option to terminate a contract prior to maturity,
provided they give a minimum notice period.
The following table presents U.S. GAAP reserves for guaranteed investment
contracts and funding agreements by withdrawal provisions as of December 31,
2002 and 2001:
AS OF DECEMBER 31,
-------------------------------------
2002 2001
-------------- ---------------
(IN MILLIONS)
BOOK VALUE OUT(1)
Puttable:
Less than 30 days' put................... $ - $ -
30 to 89 days' put....................... - -
90 to 180 days' put...................... - -
More than 180 days' put.................. 55.1 55.1
No active put provision(2)............... - -
------------------ ---------------
Total puttable........................ 55.1 55.1
Surrenderable:
Book value out without surrender
charge.................................. 9.5 22.9
Book value out with surrender charge..... 869.5 396.3
------------------- ---------------
Total surrenderable................... 879.0 419.2
------------------- ---------------
Total book value out.............. 934.1 474.3
MARKET VALUE OUT(3)
Less than 30 days' notice.................. 8.4 26.9
30 to 89 days' notice...................... 116.3 281.9
90 to 180 days' notice..................... 981.2 1,133.6
More than 180 days' notice................. 4,623.8 4,795.6
No active surrender provision.............. 71.0 238.5
------------------ ---------------
Total market value out................ 5,800.7 6,476.5
Not puttable or surrenderable.............. 13,405.9 11,502.1
------------------- ---------------
Total GICs and funding agreements..... $ 20,140.7 $18,452.9
=================== ===============
- ----------------------
(1) Book Value Out: The amount equal to the sum of deposits less withdrawals
with interest accrued at the contractual interest rate.
(2) Contracts currently in initial lock-out period but which will become
puttable with 90 days' notice at some time in the future.
68
(3) Market Value Out: The amount equal to the book value out plus a market
value adjustment to adjust for changes in interest rates.
INTERNATIONAL OPERATIONS
We expect to receive approximately $938.4 million of proceeds from our sale of
substantially all of BT Financial Group to Westpac. This amount includes cash
proceeds, expected tax benefits, and a gain from unwinding the hedged asset
associated with debt used to acquire BT Financial Group in 1999. An additional
future contingent receipt of $80.0 million may by received in 2004, if Westpac
experiences growth in their retail assets under management. As of December 31,
2002, we have received $667.5 million of the expected proceeds.
Our Brazilian and Chilean operations, along with one of our Mexican companies,
produced positive cash flow from operations for the years ended December 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 an infusion of capital of $95.8 million for the year ended
December 31, 2002, primarily to fund our acquisitions of Zurich AFORE and AFORE
Tepeyac in Mexico. We have also required infusions of capital of $44.7 million
and $75.8 million for the years ended December 31, 2001 and 2000, respectively,
primarily to meet the cash outflow requirements of our international operations.
These other international operations are primarily in the start-up stage or are
expanding in the short-term. Our capital funding of these operations is
consistent with our long-term strategy to establish viable companies that can
sustain future growth from internally generated sources.
SOURCES AND USES OF CASH OF CONSOLIDATED OPERATIONS
Net cash provided by operating activities was $5,564.0 million, $4,057.4 million
and $2,792.2 million for the years ended December 31, 2002, 2001 and 2000,
respectively. The increase in 2002 compared to 2001 is primarily related to an
increase in mortgage banking servicing and production fees, an increase in funds
collected on behalf of investors, related to mortgage banking services,
increases in bank deposits, as well as decreases in income tax payments and cash
paid for benefits, claims and settlement expenses. The increase in 2001 compared
to 2000 resulted primarily from increases in mortgage banking servicing and
production fees, increases in single premium annuity sales, in addition to
increases in funds collected on behalf of investors, related to mortgage banking
services.
Net cash used in investing activities was $4,078.1 million, $3,738.0 million and
$1,393.4 million for the years ended December 31, 2002, 2001 and 2000,
respectively. The increase in cash used in 2002 compared to 2001 was primarily
due to an increase during 2002 in the volume of net mortgage loans purchased and
sold. Also contributing to the increase in cash used was the decline in real
estate sales from the prior year. Offsetting these increases in cash used was
the sale of substantially all of BT Financial Group, as well as the sale of our
shares of Coventry stock. The increase in cash used in 2001 compared to 2000
resulted from an increase in the volume of mortgage loans purchased and sold in
2001 as well as an increase in net mortgage loan servicing rights purchased, as
a result of increased mortgage loan production in 2001.
Net cash used in financing activities was $1,008.5 million, $549.2 million and
$1,006.9 million for the years ended December 31, 2002, 2001 and 2000,
respectively. The increase in net cash used in 2002 compared to 2001 is
primarily from the non-recurrence of the impact from the prior year's IPO, in
addition to the repurchase of shares or our common stock and payments of
dividends in 2002. Partially offsetting the increases in cash used was an
increase in investment contract deposits, net of withdrawals. The decrease in
cash used in 2001 compared to 2000 was primarily due to the receipt of net
proceeds from issuance of common stock in conjunction with our IPO. Partially
offsetting this decrease in cash used were payments made to eligible
policyholders as part of our demutualization and the repurchase of shares of our
common stock.
Given the historical cash flow of our subsidiaries and the financial results of
these subsidiaries, we believe the cash flow from our consolidated operating
activities over the next year will provide sufficient liquidity for our
operations, as well as satisfy interest payments and any payments related to
debt servicing.
69
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following tables present payments due by period for contractual obligations
as of December 31, 2002 and 2001:
AS OF DECEMBER 31, 2002
-----------------------------------------------------------------------
LESS
THAN 1 4 - 5 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS YEARS YEARS
- ------------------------------------ ----------- ---------- ------------ ---------- ------------
(IN MILLIONS)
Long-term debt(1)............... $1,332.5 $ 116.9 $ 326.3 $ 117.7 $ 771.6
Operating leases(2)............. 153.3 51.6 55.9 22.5 23.3
Non-recourse medium-term
notes(3)...................... 3,583.5 573.3 1,357.9 133.0 1,519.3
----------- ---------- ------------ ---------- ------------
Total contractual cash
obligations................ $5,069.3 $ 741.8 $1,740.1 $ 273.2 $ 2,314.2
=========== ========== ============ ========== ============
AS OF DECEMBER 31, 2001
-----------------------------------------------------------------------
LESS
THAN 1 4 - 5 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS YEARS YEARS
- ------------------------------------ ----------- ---------- ------------ ---------- ------------
(IN MILLIONS)
Long-term debt(1)............... $1,378.4 $ 165.1 $ 288.8 $ 5.4 $ 919.1
Operating leases(2)............. 205.2 57.3 81.3 42.4 24.2
Non-recourse medium-term
notes(3)...................... 3,298.4 160.2 966.3 813.4 1,358.5
----------- ---------- ------------ ---------- ------------
Total contractual cash
obligations................ $4,882.0 $ 382.6 $ 866.2 $ 518.0 $ 3,115.2
=========== ========== ============ ========== ============
- ---------------
(1) The following are included in long-term debt:
On August 25, 1999, we 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. We 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. The long-term debt resides in our
wholly-owned subsidiary, PFSI.
On March 10, 1994, Principal Life issued $300.0 million of surplus notes,
including $200.0 million due March 1, 2024, at a 7.875% annual interest
rate and the remaining $100.0 million due March 1, 2044, at an 8% annual
interest rate. No affiliates of ours hold any portion of the notes. Each
payment of interest and principal on the notes, however, may be made only
with the prior approval of the Commissioner and only to the extent that
Principal Life has sufficient surplus earnings to make such payments. For
each of the years ended December 31, 2002, 2001 and 2000, interest of $23.8
million was approved by the Commissioner, paid and charged to expense.
Long-term debt also includes mortgages and other notes payable related to
real estate developments. Along with certain subsidiaries, we had $378.0
million in credit facilities with various financial institutions, in
addition to obtaining loans with various lenders to finance real estate
developments. Outstanding principal balances as of December 31, 2002, range
from $0.2 million to $100.9 million per development with interest rates
generally ranging from 6.0% to 8.6%. Outstanding principal balances as of
70
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.
(3) Non-recourse medium term notes represent claims under funding agreements
issued to institutional investors in international markets. Principal Life
has a $4.0 billion European medium term note program, under which a
consolidated offshore special purpose entity was created to issue
nonrecourse medium-term notes. Under the program, the proceeds of each note
issuance are used to purchase a funding agreement from Principal Life,
which is used to secure that particular series of notes. The payment terms
of any particular series of notes match the payment terms of the funding
agreement that secures that series. Claims for principal and interest under
those international funding agreements are afforded equal priority of
claims of life insurance and annuity policyholders under insolvency
provisions of Iowa Insurance Laws and, accordingly, are reported as
contractholder funds liabilities in Principal Life's consolidated statement
of financial position.
The components of short-term debt as of December 31, 2002 and 2001, are as
follows:
AS OF DECEMBER 31,
----------------------------
2002 2001
------------ ------------
(IN MILLIONS)
Commercial paper..................... $ 157.5 $ 199.9
Other recourse short-term debt....... 38.6 22.0
Non-recourse short-term debt......... 368.7 289.7
------------ ------------
Total short-term debt............. $ 564.8 $ 511.6
============ ============
Short-term debt consists primarily of commercial paper and outstanding balances
on revolving credit facilities with various financial institutions. As of
December 31, 2002, we had credit facilities with various financial institutions
in an aggregate amount of $1.4 billion. These credit facilities include $700.0
million in credit facilities to finance a commercial mortgage-backed securities
("CMBS") pipeline, and $100.0 million in credit facilities to purchase certain
CMBS securities for investment purposes. In addition, we may borrow up to $600.0
million on a back-stop facility to support our $1.0 billion commercial paper
program, of which there were no outstanding balances as of December 31, 2002.
The weighted-average interest rates on short-term borrowings as of December 31,
2002 and 2001, were 1.80% and 2.30%, respectively.
OFF-BALANCE SHEET ARRANGEMENTS
We have entered into certain contracts to: 1) fund residential mortgage loan
production, and 2) sell qualifying delinquent residential mortgage 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 $47.1 billion and $38.0 billion in
mortgage loans to PRMCR in 2002 and 2001, respectively. The maximum amount of
mortgage loans, which can be warehoused in PRMCR, has increased from $1.0
billion at inception to $4.0 billion as of December 31, 2002. PRMCR held $4.0
billion and $3.0 billion in mortgage loans held for sale as of December 31, 2002
and 2001, respectively. The portfolio of loans held for sale by PRMCR must meet
portfolio criteria, eligibility representations, and portfolio aging
limitations. Based on these eligibility representations, we are required to
71
repurchase ineligible loans from PRMCR. During 2002, we repurchased $51.9
million of ineligible loans from PRMCR.
PRMCR is capitalized by equity certificates owned by third party investors not
affiliated with us or our affiliates, directors, or officers and thus, is not
consolidated. The equity holders bear the risk of loss on defaulted mortgages.
At December 31, 2002 and 2001, PRMCR had outstanding equity certificates of
$193.0 million. PRMCR also issues short-term secured liquidity notes as well as
medium term notes to provide funds for its purchase of mortgage loans from us.
At December 31, 2002, PRMCR had outstanding secured liquidity notes of $2.2
billion, three-year fixed term notes of $800.0 million and five-year variable
term notes of $800.0 million. At December 31, 2001, PRMCR had outstanding
secured liquidity notes of $1.3 billion, three-year fixed term notes of $800.0
million and five-year variable term notes of $800.0 million. All borrowings are
collateralized by the assets of PRMCR.
We paid a commitment fee to PRMCR based on the overall warehouse limit. PRMCR
used a portion of the fee to fund a cash collateral account maintained at PRMCR.
These funds are available as additional collateral to cover credit related
losses on defaulted mortgage loans. The balance in the account was $24.0 million
at December 31, 2002 and 2001, and is reflected in other assets on our
consolidated statements of financial position. We maintain a right to the
servicing of the mortgage loans held by PRMCR and retain servicing upon the sale
of the majority of the mortgage loans to the final investors. As the servicer,
we receive a monthly servicing fee and may earn additional incentive servicing
fees upon successful completion of our servicing responsibilities. We received
$23.3 million and $12.6 million in servicing and incentive servicing fees from
PRMCR in 2002 and 2001, respectively. Any unpaid and earned incentive fees as
well as any remaining amounts in the cash collateral account will be returned to
us upon the termination of PRMCR. Additionally, as the servicer, we are required
to advance to PRMCR those payments due from borrowers, but not received, as of
specified cutoff dates. In addition, we perform certain secondary marketing,
accounting and various administrative functions on behalf of PRMCR. In order to
hedge interest rate risk and non-credit related market value risk associated
with its inventory of mortgage loans held for sale, PRMCR entered into swaps
with counterparties not affiliated with us or PRMCR. The swap counterparties are
required to maintain certain minimum ratings as approved by the rating agencies.
Through separate swap agreements with the swap counterparties that mirror the
original swaps with PRMCR, the interest rate risk and non-credit related market
value components are swapped back to us.
DELINQUENT RESIDENTIAL MORTGAGE LOAN FUNDING. In October 2000, our mortgage
banking segment created a wholly-owned, unconsolidated qualifying special
purpose entity, Principal Residential Mortgage Funding, LLC ("PRMF"), to provide
an off-balance sheet source of funding for up to $250.0 million of qualifying
delinquent mortgage loans. The limit was increased to $550.0 million in December
2002. We sell qualifying delinquent FHA and VA mortgage loans to PRMF which then
transfers the loans to Principal Residential Mortgage EBO Trust ("Trust"), an
unaffiliated Delaware business trust. The Trust funds its acquisitions of
mortgage loans by selling participation certificates, representing an undivided
interest in the Trust, to commercial paper conduit purchasers, who are not
affiliated with us or any of our affiliates, directors or officers. At December
31, 2002 and 2001, the Trust held $405.1 million and $273.5 million in mortgage
loans, respectively. and had outstanding participation certificates of $382.8
million and $256.9 million, respectively.
Residential mortgage loans typically remain in the Trust until they are
processed through the foreclosure claim process, are paid-off or reinstate.
Mortgage loans that reinstate are no longer eligible to remain in the Trust and
are required to be removed at fair market value by us at the monthly settlement
date following reinstatement.
We are retained as the servicer of the mortgage loans and also perform
accounting and various administrative functions on behalf of PRMF, in our
capacity as the managing member of PRMF. As the servicer, we receive a servicing
fee pursuant to the pooling and servicing agreement. We may also receive a
successful servicing fee only after all other conditions in the monthly cash
flow distribution are met. We received $23.4 million and $8.5 million in
servicing and successful servicing fees from PRMF in 2002 and 2001,
respectively. At December 31, 2002 and 2001, our residual interest in such cash
flows was $32.7 million and $21.5 million, respectively, and was recorded in
72
other assets 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, reduced by 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 trust 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 weighted average coupon of mortgage loans in the Trust less
a spread.
GUARANTEES AND INDEMNIFICATIONS
Our fundamental business approach is to avoid guarantees or other commitments to
or on behalf of affiliated companies of Principal Financial Group, Inc.
Affiliates are encouraged to operate as autonomously as possible; however, there
are instances where a rated entity within Principal Financial Group, Inc.
provides a guarantee to or on behalf of an affiliate. The guarantees typically
supplement a partially secured transaction, but require the additional
enhancement provided by the guarantee to make the transaction more economical
for our organization.
Various businesses throughout our organization have a range of standard
guarantees and commitments to or on behalf of affiliated entities within the
organization in connection with managing the risks of these businesses. We
continually manage liabilities that have any acceleration, additional collateral
support, changes in terms, or creation of additional financial obligations in
our regular liquidity analysis. We have found all of these obligations to be
manageable and do not believe they materially impact our liquidity or capital
resources.
In the normal course of business, we have provided guarantees to third parties
primarily on behalf of real estate associates, a former subsidiary and joint
ventures. These agreements generally expire from 2003 through 2015. The
estimated maximum exposure under these agreements is approximately $155.0
million; however, we believe the likelihood is remote that material payments
will be required and therefore have not accrued for a liability on our
consolidated statement of financial position. Should we be required to perform
under these guarantees, we could recover a portion of the loss from third
parties through recourse provisions included in agreements with such parties,
the sale of assets held as collateral that can be liquidated in the event that
performance is required under the guarantees or other recourse available to us,
minimizing the impact to our results of operations.
We are also subject to certain indemnification obligations under agreements with
previously sold subsidiaries and other transactions arising under the normal
course of business. While we are unable to estimate with certainty the ultimate
legal and financial liability with respect to these indemnifications, we believe
the likelihood is remote that material payments would be required under such
indemnifications and therefore would not result in a material adverse affect on
our business, financial position or results of operations.
INVESTMENTS
We had total consolidated assets as of December 31, 2002, of $89.9 billion, of
which $49.0 billion were invested assets. The rest of our total consolidated
assets are comprised primarily of separate account assets for which we do not
bear investment risk. Because we generally do not bear any investment risk on
assets held in separate accounts, the discussion and financial information below
does not include such assets. Of our invested assets, $47.5 billion were held by
our U.S. operations and the remaining $1.5 billion were held by our
International Asset Management and Accumulation segment.
U.S. INVESTMENT OPERATIONS
Our U.S. invested assets are managed by Principal Global Investors, a subsidiary
of Principal Life. Our primary investment objective is to maximize after-tax
returns consistent with acceptable risk parameters. We seek to protect
73
policyholders' benefits by optimizing the risk/return relationship on an ongoing
basis, through asset/liability matching, reducing the credit risk, avoiding high
levels of investments that may be redeemed by the issuer, maintaining
sufficiently liquid investments and avoiding undue asset concentrations through
diversification. We are exposed to three primary sources of investment risk:
o credit risk, relating to the uncertainty associated with the continued
ability of a given obligor to make timely payments of principal and
interest;
o interest rate risk, relating to the market price and/or cash flow
variability associated with changes in market yield curves; and
o equity risk, relating to adverse fluctuations in a particular common stock.
Our ability to manage credit risk is essential to our business and our
profitability. We devote considerable resources to the credit analysis of each
new investment. We manage credit risk through industry, issuer and asset class
diversification. Our Investment Committee, appointed by our board of directors,
establishes all investment policies and reviews and approves all investments. As
of December 31, 2002, there are eleven members on the Investment Committee, one
of whom is a member of our board of directors. The remaining members are senior
management members representing various areas of our company.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. We assess option risk in all investments
we make and, when we take that risk, we price for it accordingly.
Our Fixed Income Securities Committee, consisting of fixed income securities
senior management members, approves the credit rating for the fixed maturity
securities we purchase. Teams of security analysts organized by industry focus
either on the public or private markets and analyze and monitor these
investments. In addition, we have teams who specialize in residential
mortgage-backed securities, commercial mortgage-backed securities and public
below investment grade securities. We establish a credit reviewed list of
approved public issuers to provide an efficient way for our portfolio managers
to purchase liquid bonds for which credit review has already been completed.
Issuers remain on the list for 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.
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.
74
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 67%
and the debt service coverage ratio at loan inception was 1.9 times as of
December 31, 2002.
We have limited exposure to equity risk in our common stock portfolio. Equity
securities accounted for only 1% of our U.S. invested assets as of December 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 7A. "Quantitative and Qualitative Disclosures about
Market Risk".
OVERALL COMPOSITION OF U.S. INVESTED ASSETS
U.S. invested assets as of December 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. The following
discussion analyzes the composition of U.S. invested assets, but excludes
invested assets of the participating separate accounts.
U.S. INVESTED ASSETS
AS OF DECEMBER 31, AS OF DECEMBER 31,
--------------------- ----------------------
2002 2001
--------------------- ----------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
---------- -------- --------- --------
($ IN MILLIONS)
Fixed maturity securities
Public......................................... $ 22,766.8 48% $ 18,227.6 42%
Private........................................ 10,440.3 22 10,800.2 25
Equity securities................................. 358.1 1 812.3 2
Mortgage loans
Commercial .................................... 9,365.8 20 9,740.4 22
Residential.................................... 1,463.6 3 1,144.2 3
Real estate held for sale ........................ 179.5 - 390.7 1
Real estate held for investment................... 1,042.1 2 783.4 2
Policy loans...................................... 818.5 2 831.9 2
Other investments ................................ 1,075.5 2 663.7 1
----------- ----- ----------- -----
Total invested assets.......................... $ 47,510.2 100% $ 43,394.4 100%
===== =====
Cash and cash equivalents......................... 941.5 495.8
----------- -----------
Total invested assets and cash ................ $ 48,451.7 $ 43,890.2
=========== ===========
75
We actively manage public fixed maturity securities, including our portfolio of
residential mortgage-backed securities, in order to provide liquidity and
enhance yield and total return. Our residential mortgage-backed securities are
managed to reduce the risk of prepayment by holding securities that trade close
to par. This active management has resulted in the realization of capital gains
and losses with respect to such investments.
FIXED MATURITY SECURITIES
Fixed maturity securities consist of short-term investments, publicly traded
debt securities, privately placed debt securities and redeemable preferred
stock, and represented 70% of total U.S. invested assets as of December 31, 2002
and 67% as of December 31, 2001. The fixed maturity securities portfolio was
comprised, based on carrying amount, of 69% in publicly traded fixed maturity
securities and 31% in privately placed fixed maturity securities as of December
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 December 31, 2002, were $3.8 billion of
securities eligible for resale to qualified institutional buyers under Rule 144A
under the Securities Act of 1933. Fixed maturity securities were diversified by
category of issuer as of December 31, 2002, and December 31, 2001, as shown in
the following table:
U.S. INVESTED ASSETS
FIXED MATURITY SECURITIES BY TYPE OF ISSUER
AS OF DECEMBER 31, AS OF DECEMBER 31,
--------------------- ----------------------
2002 2001
--------------------- ----------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
------------ ------- ------------ -------
($ IN MILLIONS)
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies................ $ 518.6 2% $ 15.1 -%
States and political subdivisions...................... 426.3 1 317.5 1
Foreign governments.................................... 380.5 1 603.5 2
Corporate - public..................................... 17,061.2 52 13,038.8 45
Corporate - private.................................... 8,777.5 26 9,171.1 32
Residential pass-through securities.................... 2,327.0 7 2,855.5 10
Commercial MBS......................................... 2,476.4 7 1,874.1 6
Asset-backed securities................................ 1,239.6 4 1,152.2 4
------------ ------- ------------ -------
Total fixed maturities............................. $ 33,207.1 100% $ 29,027.8 100%
============ ======= ============ =======
We held $6,043.0 million of mortgage-backed and asset-backed securities as of
December 31, 2002, and $5,881.8 million as of December 31, 2001.
We believe that it is desirable to hold residential mortgage-backed securities
due to their credit quality and liquidity as well as portfolio diversification
characteristics. Our portfolio is comprised of GNMA, FNMA and FHLMC pass-through
securities and is actively managed to reduce the risk of prepayment by holding
securities that are trading close to par.
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
76
issuer/servicer risk where collateral values can become impaired in the event of
servicer credit deterioration.
Our ABS portfolio is diversified both by type of asset and by issuer. We
actively monitor holdings of asset-backed securities to ensure that the risk
profile of each security improves or remains consistent. If we are not receiving
an adequate yield for the risk, relative to other investment opportunities, we
will attempt to sell the security. Prepayments in the ABS portfolio are, in
general, insensitive to changes in interest rates or are insulated to such
changes by call protection features. In the event that we are subject to
prepayment risk, we monitor the factors that impact the level of prepayment and
prepayment speed for those asset-backed securities. To the extent we believe
that prepayment risk increases, we may attempt to sell the security and reinvest
in another security that offers better yield relative to the risk. In addition,
we diversify the risks of asset-backed securities by holding a diverse class of
securities, which limits our exposure to any one security.
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 international exposure in our U.S. invested assets totaled $4,259.7 million,
or 13%, of total fixed maturity securities, as of December 31, 2002, comprised
of corporate and foreign government fixed maturity securities. Of the $4,259.7
million as of December 31, 2002, investments totaled $1,259.3 million in the
United Kingdom, $849.7 million in the continental European Union, $550.7 million
in Asia, $354.9 million in Australia, $353.0 million in South America and $21.3
million in Japan. The remaining $870.8 million was invested in 12 other
countries. All international fixed maturity securities held by our U.S.
operations are either denominated in U.S. dollars or have been swapped into U.S.
dollar equivalents. Our international investments are analyzed internally by
country and industry credit investment professionals. We control concentrations
using issuer and country level exposure benchmarks, which are based on the
credit quality of the issuer and the country. Our investment policy limits total
international fixed maturity securities investments to 15% of total statutory
general account assets with a 4% limit in emerging markets. Exposure to Canada
is not included in our international exposure due to its treatment by the NAIC.
As of December 31, 2002, our investments in Canada totaled $1,261.1 million.
As of December 31, 2002, no individual non-government issuer represented more
than 1% of U.S. invested assets.
The Securities Valuation Office of the NAIC evaluates most of the fixed maturity
securities that we and other U.S. insurance companies hold. The Securities
Valuation Office evaluates the bond investments of insurers for regulatory
reporting purposes and assigns securities to one of six investment categories.
The NAIC Designations closely mirror the nationally recognized securities rating
organizations' credit ratings for marketable bonds. NAIC Designations 1 and 2
include bonds considered investment grade by such rating organizations. Bonds
are considered investment grade when rated "Baa3" or higher by Moody's, or
"BBB-" or higher by Standard & Poor's. NAIC Designations 3 through 6 are
referred to as below investment grade. Bonds are considered below investment
grade when rated "Ba1" or lower by Moody's, or "BB+" or lower by Standard &
Poor's.
We also monitor the credit drift of our corporate fixed maturity securities
portfolio. Credit drift is defined as the ratio of the percentage of rating
downgrades, including defaults, divided by the percentage of rating upgrades. We
measure credit drift once each fiscal year, assessing the changes in our
internally developed credit ratings that have occurred during the year. Standard
& Poor's annual credit ratings drift ratio measures the credit rating change,
within a specific year, of companies that have been assigned ratings by Standard
& Poor's. The annual internal credit drift ratio on corporate fixed maturity
securities we held in our general account was 3.48 times compared to the
Standard & Poor's drift ratio of 4.14 times, as of December 31, 2002.
77
The following table presents our total fixed maturity securities by NAIC
Designation and the equivalent ratings of the nationally recognized securities
rating organizations as of December 31, 2002, and December 31, 2001, as well as
the percentage, based on estimated fair value, that each designation comprises:
U.S. INVESTED ASSETS
TOTAL FIXED MATURITY SECURITIES BY CREDIT QUALITY
AS OF DECEMBER 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............. $ 15,377.5 $16,539.9 50% $14,139.9 $ 14,756.2 51%
2 Baa.................. 12,921.8 13,657.4 41 11,720.0 12,034.6 42
3 Ba................... 2,168.8 2,080.8 6 1,602.0 1,560.4 5
4 B.................... 506.2 434.5 1 401.7 372.1 1
5 Caa and lower........ 215.6 162.5 1 92.4 90.8 -
6 In or near
default.............. 371.0 332.0 1 240.9 213.7 1
----------- ---------- ---------- ----------- ----------- ---------
Total fixed
maturities....... $ 31,560.9 $33,207.1 100% $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. Our current policy is to limit the
percentage of cash flow invested in below investment grade assets to 7% of cash
flow. As of December 31, 2002, we had invested 5% of new cash flow for the year
in below investment grade assets. While the general account investment returns
have improved due to the below investment grade asset class, we manage its
growth strategically by limiting it to 10% of the total fixed maturity
securities portfolios.
We invest in privately placed fixed maturity securities to enhance the overall
value of the portfolio, increase diversification and obtain higher yields than
are possible with comparable quality public market securities. Generally,
private placements provide broader access to management information,
strengthened negotiated protective covenants, call protection features and,
where applicable, a higher level of collateral. They are, however, generally not
freely tradable because of restrictions imposed by federal and state securities
laws and illiquid trading markets. As of December 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 91%.
The following tables show the carrying amount of our corporate fixed maturity
securities by Salomon industry category, as well as the percentage of the total
corporate portfolio that each Salomon industry category comprises as of December
31, 2002, and December 31, 2001.
78
U.S. INVESTED ASSETS
CORPORATE FIXED MATURITY SECURITIES PORTFOLIO BY SALOMON INDUSTRY
AS OF DECEMBER 31, AS OF DECEMBER 31,
----------------------- ---------------------
2002 2001
----------------------- ---------------------
% OF % OF
CARRYING AMOUNT TOTAL CARRYING AMOUNT TOTAL
----------------- --------- --------------- ------
($ IN MILLIONS)
INDUSTRY CLASS
Finance - Bank.......................... $ 2,431.5 9% $ 1,663.7 8%
Finance - Insurance..................... 1,006.8 4 356.9 2
Finance - Other......................... 3,199.0 12 2,820.0 13
Industrial - Construction............... 958.2 4 619.7 3
Industrial - Energy..................... 2,959.5 11 2,486.1 11
Industrial - Manufacturing.............. 5,882.5 23 4,767.7 21
Industrial - Other...................... 133.1 1 85.6 -
Industrial - Service.................... 3,932.7 15 3,137.0 14
Industrial - Transport.................. 1,058.9 4 1,357.7 6
Utility - Electric...................... 2,539.4 10 2,727.0 12
Utility - Other......................... 161.4 1 172.5 1
Utility - Telecom....................... 1,575.7 6 2,016.0 9
---------- ------ ---------- -------
Total............................... $ 25,838.7 100% $ 22,209.9 100%
========== ====== ========== =======
We monitor any decline in the credit quality of fixed maturity securities
through the designation of "problem securities", "potential problem securities"
and "restructured securities". We define problem securities in our fixed
maturity portfolio as securities: (i) as to which principal and/or interest
payments are in default or (ii) issued by a company that went into bankruptcy
subsequent to the acquisition of such securities. We define potential problem
securities in our fixed maturity portfolio as securities included on an internal
"watch list" for which management has concerns as to the ability of the issuer
to comply with the present debt payment terms and which may result in the
security becoming a problem or being restructured. The decision whether to
classify a performing fixed maturity security as a potential problem involves
significant subjective judgments by our management as to the likely future
industry conditions and developments with respect to the issuer. We define
restructured securities in our fixed maturity portfolio as securities where a
concession has been granted to the borrower related to the borrower's financial
difficulties that would not have otherwise been considered. We determine that
restructures should occur in those instances where greater economic value will
be realized under the new terms than through liquidation or other disposition
and may involve a change in contractual cash flows.
In July 2002, WorldCom Inc. filed a voluntary petition for Chapter 11
reorganization with the U.S. Bankruptcy Court. We recognized realized losses for
other than temporary impairments during the second quarter of 2002. Our
remaining investment in WorldCom Inc. is classified in our problem fixed
maturity securities portfolio in the amount of $13.4 million as of December 31,
2002.
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
$47.2 million as of December 31, 2002.
The following table presents the total carrying amount of our fixed maturity
portfolio, as well as its problem, potential problem and restructured fixed
maturities for the years indicated:
79
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED FIXED MATURITIES AT CARRYING AMOUNT
AS OF DECEMBER 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
($ IN MILLIONS)
Total fixed maturity securities (public and private)............ $ 33,207.1 $ 29,027.8
================ =============
Problem fixed maturity securities............................... $ 262.0 $ 198.8
Potential problem fixed maturity securities..................... 508.4 365.1
Restructured fixed maturity securities.......................... 103.9 110.8
---------------- -------------
Total problem, potential problem and restructured fixed
maturity securities........................................ $ 874.3 $ 674.7
================ =============
Total problem, potential problem and restructured fixed
maturity securities as a percent of total fixed maturity
securities................................................. 3% 2%
MORTGAGE LOANS
Mortgage loans comprised 23% and 25% of total U.S. invested assets as of
December 31, 2002, and December 31, 2001, respectively. Mortgage loans consist
of commercial and residential loans. Commercial mortgage loans comprised
$9,365.8 million as of December 31, 2002, and $9,740.4 million as of December
31, 2001, or 86% and 89%, of total mortgage loan investments, respectively.
Residential mortgages comprised $1,463.6 million and $1,144.2 million, or 14%
and 11%, of total mortgage loan investments as of December 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.
COMMERCIAL MORTGAGE LOANS. Commercial mortgages play an important role in our
investment strategy by:
o providing strong risk adjusted relative value in comparison to other
investment alternatives;
o enhancing total returns; and
o providing strategic portfolio diversification.
As a result, we have focused on constructing a solid, high quality portfolio of
mortgages. Our portfolio is generally comprised of mortgages with conservative
loan-to-value ratios, high debt service coverages and general purpose property
types with a strong credit tenancy.
Our commercial loan portfolio consists of primarily non-recourse, fixed rate
mortgages on fully or near fully leased properties. The mortgage portfolio is
comprised of general-purpose industrial properties, manufacturing office
properties and credit oriented retail properties.
California accounted for 21% of our commercial mortgage loan portfolio as of
December 31, 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
80
commercial mortgage loan portfolio might suffer under a variety of seismic
events.
Our commercial loan portfolio is highly diversified by borrower. As of December
31, 2002, 43% of the U.S. commercial mortgage loan portfolio was comprised of
mortgage loans with principal balances of less than $10.0 million. The total
number of commercial mortgage loans outstanding as of December 31, 2002 and
December 31, 2001 was 1,529 and 1,646, respectively. The average loan size of
our commercial mortgage portfolio was $6.2 million as of December 31, 2002. As
of such dates, all such loans were performing.
We actively monitor and manage our commercial mortgage loan portfolio.
Substantially all loans within the portfolio are analyzed regularly, based on a
proprietary risk rating cash flow model, in order to monitor the financial
quality of these assets and are internally rated. Based on ongoing monitoring,
mortgage loans with a likelihood of becoming delinquent are identified and
placed on an internal "watch list". Among criteria which would indicate a
potential problem are: imbalances in ratios of loan to value or contract rents
to debt service, major tenant vacancies or bankruptcies, borrower sponsorship
problems, late payments, delinquent taxes and loan relief/restructuring
requests.
We state commercial mortgage loans at their unpaid principal balances, net of
discount accrual and premium amortization, valuation allowances and write downs
for impairment. We provide a valuation allowance for commercial mortgage loans
based on past loan loss experience and for specific loans considered to be
impaired. Mortgage loans are considered impaired when, based on current
information and events, it is probable that all amounts due according to the
contractual terms of the loan agreement may not be collected. When we determine
that a loan is impaired, we establish a valuation allowance for loss for the
excess of the carrying value of the mortgage loan over its estimated fair value.
Estimated fair value is based on either the present value of expected future
cash flows discounted at the loan's original effective interest rate, the loan's
observable market price or the fair value of the collateral. We record increases
in such valuation allowances as realized investment losses and, accordingly, we
reflect such losses in our consolidated results of operations. Such increases
(decreases) in valuation allowances aggregated $(7.1) million for the year ended
December 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
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.
81
The following table represents our commercial mortgage valuation allowance for
the years indicated:
U.S. INVESTED ASSETS
COMMERCIAL MORTGAGE VALUATION ALLOWANCE
AS OF DECEMBER 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
($ IN MILLIONS)
Beginning balance.......................................... $ 90.7 $ 108.0
Provision.................................................. 33.5 12.0
Release due to write downs, sales and foreclosures......... (40.6) (29.3)
--------------- ---------------
Ending balance....................................... $ 83.6 $ 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 years indicated:
U.S. INVESTED ASSETS
PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED COMMERCIAL MORTGAGES AT CARRYING AMOUNT
AS OF DECEMBER 31, AS OF DECEMBER 31,
------------------- -------------------
2002 2001
------------------- -------------------
($ IN MILLIONS)
Total commercial mortgages ................................ $ 9,365.8 $ 9,740.4
============== ===============
Problem commercial mortgages(1)............................ $ 77.2 $ 47.1
Potential problem commercial mortgages .................... 50.4 98.9
Restructured commercial mortgages ......................... 46.9 42.4
-------------- ---------------
Total problem, potential problem and
restructured commercial mortgages .................... $ 174.5 $ 188.4
============== ===============
Total problem, potential problem and restructured
commercial mortgages as a percent of total commercial 2% 2%
- --------------------
(1) Problem commercial mortgages included mortgage loans in foreclosure of $0.4
million as of December 31, 2002. There were no mortgage loans in
foreclosure as of December 31, 2001.
82
EQUITY REAL ESTATE
We hold commercial equity real estate as part of our investment portfolio. As of
December 31, 2002, and December 31, 2001, the carrying amount of equity real
estate investment was $1,221.6 million and $1,174.1 million, or 2% and 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.
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale". Real estate held for investment totaled $1,042.1
million as of December 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 years ended December 31, 2002 and
December 31, 2001, there were no such impairment adjustments.
The carrying amount of real estate held for sale as of December 31, 2002, and
December 31, 2001, was $179.5 million and $390.7 million, net of valuation
allowances of $19.3 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 December 31, 2002. By property type, there is
a concentration in office buildings that represented approximately 31% of the
equity real estate portfolio as of December 31, 2002.
OTHER INVESTMENTS
Our other investments totaled $1,075.5 million as of December 31, 2002, compared
to $663.7 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 $348.8 million in other investments as of December 31, 2002. The remaining
invested assets include minority interests in unconsolidated entities and
properties owned jointly with venture partners and operated by the partners.
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.
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. Although we
lend from time to time during the financial reporting quarters, we have no
securities on loan as of December 31, 2002.
INTERNATIONAL INVESTMENT OPERATIONS
As of December 31, 2002, our international investment operations consist of the
investments of Principal International comprised of $1.5 billion in invested
assets. Invested assets related to BT Financial Group have been reclassified to
assets of discontinued operations on our consolidated statements of financial
83
position. Principal Global Investors works with each Principal International
affiliate to develop investment policies and strategies that are consistent with
the products they offer. Due to the regulatory constraints in each country, each
company maintains its own investment policies, which are approved by Principal
Global Investors. Each international affiliate is required to submit a
compliance report relative to its strategy to Principal Global Investors.
Principal Global Investors employees and international affiliate company credit
analysts jointly review each corporate credit annually.
OVERALL COMPOSITION OF INTERNATIONAL INVESTED ASSETS
As shown in the following table, the major categories of international invested
assets as of December 31, 2002, and December 31, 2001, were fixed maturity
securities and residential mortgage loans:
INTERNATIONAL INVESTED ASSETS
AS OF DECEMBER 31, AS OF DECEMBER 31,
--------------------- ---------------------
2002 2001
--------------------- ---------------------
CARRYING % OF CARRYING % OF
AMOUNT TOTAL AMOUNT TOTAL
---------- --------- ----------- -------
($ IN MILLIONS)
Fixed maturity securities
Public......................................... $ 998.6 67% $ 941.3 68%
Private........................................ 81.7 6 61.0 4
Equity securities................................. 20.6 1 24.9 2
Mortgage loans
Residential.................................... 252.5 17 181.1 13
Real estate held for investment................... 7.4 1 7.7 1
Other investments ................................ 124.6 8 168.6 12
---------- ------ ----------- -------
Total invested assets.......................... $ 1,485.4 100% $ 1,384.6 100%
====== =======
Cash and cash equivalents......................... 97.1 65.4
----------- -----------
Total invested assets and cash ................ $ 1,582.5 $ 1,450.0
=========== ===========
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK EXPOSURES AND RISK MANAGEMENT
Market risk is the risk that we will incur losses due to adverse fluctuations in
market rates and prices. Our primary market risk exposure is to changes in
interest rates, although we also have exposures to changes in equity prices and
foreign currency exchange rates.
The active management of market risk is an integral part of our operations. We
manage our overall market risk exposure within established risk tolerance ranges
by using the following approaches:
o rebalance our existing asset or liability portfolios;
o control the risk structure of newly acquired assets and liabilities; or
o use derivative instruments to modify the market risk characteristics of
existing assets or liabilities or assets expected to be purchased.
INTEREST RATE RISK
84
Interest rate risk is the risk that we will incur economic losses due to adverse
changes in interest rates. Our exposure to interest rate risk stems largely from
our substantial holdings of guaranteed fixed rate liabilities in our U.S. Asset
Management and Accumulation segment.
We manage the interest rate risk inherent in our assets relative to the interest
rate risk inherent in our liabilities. One of the measures we use to quantify
this exposure is duration. To calculate duration, we project asset and liability
cash flows. These cash flows are discounted to a net present value basis using a
spot yield curve, which is a blend of the spot yield curves for each of the
asset types in the portfolio. Duration is calculated by re-calculating these
cash flows and re-determining the net present value based upon an alternative
level of interest rates, and determining the percentage change in fair value.
As of December 31, 2002, the difference between the asset and liability
durations on our primary duration managed portfolio was 0.09 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 $26,344.1 million as of December 31, 2002.
For products such as whole life insurance and term life insurance that are less
sensitive to interest rate risk, and for other products such as single premium
deferred annuities, we manage interest rate risk based on a modeling process
that considers the target average life, maturities, crediting rates and
assumptions of policyholder behavior. As of December 31, 2002, the
weighted-average difference between the asset and liability durations on these
portfolios was (0.49) 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 $10,145.7 million as of December 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 $5,577.6 million as of December
31, 2002.
Using the assumptions and data in effect as of December 31, 2002, we estimate
that a 100 basis point immediate, parallel increase in interest rates increases
the net fair value of our portfolio by $25.9 million. The following table
details the estimated changes by risk management strategy:
AS OF
RISK MANAGEMENT DECEMBER 31, 2002 NET FAIR VALUE
STRATEGY VALUE OF TOTAL ASSETS CHANGE
- --------------------------------------------------- ------------------------- ---------------------
(IN MILLIONS)
Primary duration-managed........................... $ 26,344.1 $ (23.7)
Duration-monitored................................. 10,145.7 49.6
Non duration-managed............................... 5,577.6 -
------------------------- ---------------------
Total.............................................. $ 42,067.4 $ 25.9
========================= =====================
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.
85
We manage interest rate risk on our mortgage loan pipeline by buying and selling
mortgage-backed securities in the forward markets, over-the-counter options on
mortgage-backed securities, U.S. Treasury and Eurodollar futures contracts and
options on futures contracts. We also use interest rate floors, futures
contracts, options on futures contracts, swaps and swaptions, mortgage-backed
securities and principal-only strips in hedging a portion of our portfolio of
mortgage servicing rights from prepayment risk associated with changes in
interest rates.
We measure pipeline interest rate risk exposure by adjusting the at-risk
pipeline in light of the theoretical optionality of each applicant's rate/price
commitment. The at-risk pipeline, which consists of closed loans and rate locks,
is then refined at the product type level to express each product's sensitivity
to changes in market interest rates in terms of a single current coupon MBS
duration ("benchmark interest rate"). Suitable hedges are selected and a similar
methodology applied to this hedge position. The variety of hedging instruments
allows us to match the behavior of the financial instrument with that of the
different types of loans originated. Price sensitivity analysis is performed at
least once daily. The face amount of the loans in the pipeline as of December
31, 2002, was $12.9 billion. Due to the impact of our hedging activities, we
estimate that a 100 basis point immediate and sustained increase in the
benchmark interest rates decreases the December 31, 2002, net position value by
$60.8 million.
The financial risk associated with our mortgage servicing operations is the risk
that the fair value of the servicing asset falls below its U.S. GAAP book value.
To measure this risk, we analyze each servicing risk tranche's U.S. GAAP book
value in relation to the then current fair value for similar servicing rights.
We perform this valuation using option-adjusted spread valuation techniques
applied to each risk tranche. We produce tranche fair values at least monthly
and model our net servicing hedge position at least daily.
The fair value of the servicing asset declines as interest rates decrease due to
possible mortgage loan servicing rights impairment that may result from
increased current and projected future prepayment activity. The change in value
of the servicing asset due to interest rate movements is partially offset by the
use of financial instruments, including derivative contracts that typically
increase in aggregate value when interest rates decline. Based on values as of
December 31, 2002, a 100 basis point immediate parallel and sustained decrease
in interest rates produces a $4.0 million decline in value of the servicing
asset of our Mortgage Banking segment, net of the impact of these hedging
vehicles, due to the differences between fair values and U.S. GAAP book values.
CASH FLOW VOLATILITY
Cash flow volatility arises as a result of several factors. One is the inherent
difficulty in perfectly matching the cash flows of new asset purchases with that
of new liabilities. Another factor is the inherent cash flow volatility of some
classes of assets and liabilities. In order to minimize cash flow volatility, we
manage differences between expected asset and liability cash flows within
pre-established guidelines.
We also seek to minimize cash flow volatility by restricting the portion of
securities with redemption features held in our invested asset portfolio. These
asset securities include redeemable corporate securities, mortgage-backed
securities or other assets with options that, if exercised, could alter the
expected future cash inflows. In addition, we limit sales liabilities with
features such as puts or other options that may change the cash flow profile of
the liability portfolio.
DERIVATIVES
We use various derivative financial instruments to manage our exposure to
fluctuations in interest rates, including interest rate swaps, principal-only
swaps, interest rate floors, swaptions, U.S. Treasury futures, Treasury rate
guarantees, interest rate lock commitments and mortgage-backed forwards and
options. We use interest rate futures contracts and mortgage-backed forwards to
hedge changes in interest rates subsequent to the issuance of an insurance
liability, such as a guaranteed investment contract, but prior to the purchase
of a supporting asset, or during periods of holding assets in anticipation of
near term liability sales. We use interest rate swaps and principal-only swaps
primarily to more closely match the interest rate characteristics of assets and
86
liabilities. They can be used to change the sensitivity to the interest rate of
specific assets and liabilities as well as an entire portfolio. Occasionally, we
will sell a callable liability or a liability with attributes similar to a call
option. In these cases, we will use interest rate swaptions or similar products
to hedge the risk of early liability payment thereby transforming the callable
liability into a fixed term liability.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. An example of an investment we limit
because of the option risk is residential mortgage-backed securities. We assess
option risk in all investments we make and, when we assume such risk, we seek to
price for it accordingly to achieve an appropriate return on our investments.
We have increased our credit exposure through credit default swaps by investing
in subordinated tranches of a synthetic collateralized debt obligation. The
outstanding notional amount as of December 31, 2002 was $500.0 million and the
mark to market value was $3.0 million pre-tax. We also invested in credit swaps
creating replicated assets with a notional of $205.3 million and mark to market
value of $(2.1) million as of December 31, 2002.
In conjunction with our use of derivatives, we are exposed to counterparty risk,
or the risk that counterparty fails to perform the terms of the derivative
contract. We actively manage this risk by:
o establishing exposure limits which take into account non-derivative
exposure we have with the counterparty as well as derivative exposure;
o performing similar credit analysis prior to approval on each derivatives
counterparty that we do when lending money on a long-term basis;
o diversifying our risk across numerous approved counterparties;
o limiting exposure to A+ credit or better;
o conducting stress-test analysis to determine the maximum exposure created
during the life of a prospective transaction; and
o daily monitoring of counterparty credit ratings.
All new derivative counterparties are approved by the investment committee. We
believe the risk of incurring losses due to nonperformance by our counterparties
is manageable.
The notional amounts used to express the extent of our involvement in swap
transactions represent a standard measurement of the volume of our swap
business. Notional amount is not a quantification of market risk or credit risk
and it may not necessarily be recorded on the balance sheet. Notional amounts
represent those amounts used to calculate contractual flows to be exchanged and
are not paid or received, except for contracts such as currency swaps. Actual
credit exposure represents the amount owed to us under derivative contracts as
of the valuation date. The following tables present our position in, and credit
exposure to, derivative financial instruments as of December 31, 2002, and
December 31, 2001:
87
DERIVATIVE FINANCIAL INSTRUMENTS - NOTIONAL AMOUNTS
AS OF DECEMBER 31, AS OF DECEMBER 31,
--------------------- ----------------------
2002 2001
--------------------- ----------------------
NOTIONAL % OF NOTIONAL % OF
AMOUNT TOTAL AMOUNT TOTAL
------------- --------- ---------- -------
($ IN MILLIONS)
Mortgage-backed forwards and options............ $ 17,494.9 33% $ 9,250.7 34%
Swaptions ...................................... 9,772.5 18 3,570.0 13
Interest rate swaps............................. 9,719.2 18 3,272.5 12
Interest rate lock commitments.................. 8,198.1 15 2,565.9 9
Foreign currency swaps.......................... 3,217.0 6 4,091.9 15
U.S. Treasury futures (LIBOR)................... 2,225.0 4 - -
Interest rate floors............................ 1,650.0 3 3,400.0 12
Credit default swaps ........................... 705.2 1 - -
Bond forwards................................... 363.7 1 357.4 1
U.S. Treasury futures........................... 271.1 1 186.6 1
Principal Only swaps............................ 123.6 - 250.0 1
Treasury rate guarantees........................ 63.0 - 88.0 -
Call options.................................... 30.0 - 30.0 -
Currency forwards............................... 0.2 - 393.4 2
Total return swaps.............................. - - 25.0 -
------------- -------- ---------- -------
Total........................................ $ 53,833.5 100% $27,481.4 100%
============= ======== ========== =======
DERIVATIVE FINANCIAL INSTRUMENTS - CREDIT EXPOSURES
AS OF DECEMBER 31, AS OF DECEMBER 31,
--------------------- ----------------------
2002 2001
--------------------- ----------------------
CREDIT % OF CREDIT % OF
EXPOSURE TOTAL EXPOSURE TOTAL
------------- --------- ------------- ------
($ IN MILLIONS)
Foreign currency swaps.......................... $ 195.0 68% $ 101.1 33%
Interest rate swaps............................. 48.4 17 78.4 25
Swaptions ...................................... 31.4 11 8.7 3
Credit default swaps............................ 8.9 3 - -
Interest rate floors............................ 1.7 1 13.2 4
Call options.................................... 0.4 - 8.9 3
Currency forwards............................... - - 55.3 18
Total return swaps.............................. - - 0.1 -
Mortgage-backed forwards and options............ - - 41.7 14
------------- --------- ------------- ------
Total........................................ $ 285.8 100% $ 307.4 100%
============= ========= ============= ======
The following table shows the interest rate sensitivity of our derivatives
measured in terms of fair value. These exposures will change as a result of
ongoing portfolio and risk management activities.
88
AS OF DECEMBER 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.................. $ 9,719.2 4.90(1) $ 74.6 $ 147.1 $ (230.1)
Principal-only swaps................. 123.6 1.82(1) 10.6 3.1 (11.7)
Interest rate floors................. 1,650.0 3.50(2) 38.9 41.6 (23.3)
U.S. Treasury futures................ 271.1 0.22(3) (1.5) (1.9) 0.9
U.S. Treasury futures (LIBOR)........ 2,225.0 0.86(3) (5.6) (3.9) 5.6
Swaptions............................ 9,772.5 1.09(4) 289.3 232.8 (25.3)
Treasury rate guarantees............. 63.0 0.10(5) (5.3) (1.0) 3.3
Bond forwards........................ 363.7 0.73(5) 49.9 27.6 5.6
Mortgage-backed forwards and options. 17,494.9 0.07(5) (152.2) (56.4) 162.2
Interest rate lock commitments....... 8,198.1 0.12(6) 59.7 128.6 (225.1)
----------- ---------- ----------- -----------
Total............................. $ 49,881.1 $ 358.4 $ 517.6 $ (337.9)
=========== ========== =========== ===========
- --------------------
(1) Based on maturity date of swap.
(2) Based on maturity date of of floor.
(3) Based no maturity date.
(4) Based on option date of swaption.
(5) Based on settlement date.
(6) Based on expiration date.
We use U.S. Treasury futures to manage our over/under commitment position, and
our position in these contracts changes daily.
DEBT ISSUED AND OUTSTANDING
As of December 31, 2002, the aggregate fair value of debt was $1,459.3 million.
A 100 basis point, immediate, parallel decrease in interest rates would increase
the fair value of debt by approximately $62.2 million.
AS OF DECEMBER 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...................... $ 219.1 $ 215.7 $ 212.4
8.2% notes payable, due 2009....................... 572.6 542.8 514.8
7.875% surplus notes payable, due 2024............. 218.6 209.2 195.4
8% surplus notes payable, due 2044................. 117.0 105.1 94.4
Non-recourse mortgages and notes payable........... 271.6 263.9 256.7
Other mortgages and notes payable.................. 122.6 122.6 122.6
--------------- --------------- ---------------
Total long-term debt............................ $ 1,521.5 $ 1,459.3 $ 1,396.3
=============== =============== ===============
EQUITY RISK
Equity risk is the risk that we will incur economic losses due to adverse
fluctuations in a particular common stock. As of December 31, 2002, the fair
value of our equity securities was $378.7 million. A 10% decline in the value of
the equity securities would result in an unrealized loss of $37.9 million.
FOREIGN CURRENCY RISK
89
Foreign currency risk is the risk that we will incur economic losses due to
adverse fluctuations in foreign currency exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional amount of our currency swap agreements associated with
foreign-denominated liabilities as of December 31, 2002, was $2,934.6 million.
We also have fixed maturity securities that are denominated in foreign
currencies. However, we use derivatives to hedge the foreign currency risk, both
interest payments and the final maturity payment, of these funding agreements
and securities. As of December 31, 2002, the fair value of our foreign currency
denominated fixed maturity securities was $311.2 million. We use currency swap
agreements of the same currency to hedge the foreign currency exchange risk
related to these investments. The notional amount of our currency swap
agreements associated with foreign-denominated fixed maturity securities as of
December 31, 2002, was $282.4 million. With regard to our international
operations, we attempt to do as much of our business as possible in the
functional currency of the country of operation. At times, however, we are
unable to do so, and in these cases, we use foreign exchange derivatives to
hedge the resulting risks.
We estimate that as of December 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.
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.
90
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors................................................91
Audited Consolidated Financial Statements
Consolidated Statements of Financial Position..............................92
Consolidated Statements of Operations......................................93
Consolidated Statements of Stockholders' Equity............................95
Consolidated Statements of Cash Flows......................................96
Notes to Consolidated Financial Statements.................................98
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Principal Financial Group, Inc.
We have audited the accompanying consolidated statements of financial position
of Principal Financial Group, Inc. ("the Company"), as of December 31, 2002 and
2001, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Principal
Financial Group, Inc. at December 31, 2002 and 2001, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its methods of accounting for derivative instruments and hedging
activities, discontinued operations and goodwill and other intangible assets in
response to new accounting standards that became effective January 1, 2001 and
2002, respectively.
/s/ Ernst & Young LLP
Des Moines, Iowa
January 31, 2003
91
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
2002 2001
------------------ ------------------
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale....................................... $34,185.7 $30,012.3
Fixed maturities, trading.................................................. 101.7 17.8
Equity securities, available-for-sale...................................... 378.7 837.2
Mortgage loans............................................................. 11,081.9 11,065.7
Real estate................................................................ 1,229.0 1,181.8
Policy loans............................................................... 818.5 831.9
Other investments.......................................................... 1,200.1 832.3
------------------ ------------------
Total investments....................................................... 48,995.6 44,779.0
Cash and cash equivalents.................................................. 1,038.6 561.2
Accrued investment income.................................................. 646.3 594.1
Premiums due and other receivables......................................... 459.7 489.0
Deferred policy acquisition costs.......................................... 1,414.4 1,372.5
Property and equipment..................................................... 482.5 494.2
Goodwill................................................................... 106.5 104.0
Other intangibles.......................................................... 88.8 61.5
Mortgage loan servicing rights............................................. 1,518.6 1,779.2
Separate account assets.................................................... 33,501.4 34,376.0
Assets of discontinued operations.......................................... - 2,974.3
Other assets............................................................... 1,608.9 765.5
------------------ ------------------
Total assets............................................................ $89,861.3 $88,350.5
================== ==================
LIABILITIES
Contractholder funds....................................................... $26,315.0 $24,684.4
Future policy benefits and claims.......................................... 14,736.4 14,034.6
Other policyholder funds................................................... 642.9 589.1
Short-term debt............................................................ 564.8 511.6
Long-term debt............................................................. 1,332.5 1,378.4
Income taxes currently payable............................................. - 35.1
Deferred income taxes...................................................... 1,177.7 853.6
Separate account liabilities............................................... 33,501.4 34,376.0
Liabilities of discontinued operations..................................... - 1,773.3
Other liabilities.......................................................... 4,933.4 3,294.1
------------------ ------------------
Total liabilities....................................................... 83,204.1 81,530.2
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500.0 million shares authorized,
376.7 million and 375.8 million shares issued, and 334.4 million and
360.1 million shares outstanding in 2002 and 2001, respectively......... 3.8 3.8
Additional paid-in capital................................................. 7,106.3 7,072.5
Retained earnings (deficit)................................................ 29.4 (29.1)
Accumulated other comprehensive income..................................... 635.8 147.5
Treasury stock, at cost (42.3 million and 15.7 million shares in 2002 and
2001, respectively)..................................................... (1,118.1) (374.4)
------------------ ------------------
Total stockholders' equity.............................................. 6,657.2 6,820.3
------------------ ------------------
Total liabilities and stockholders' equity.............................. $89,861.3 $88,350.5
================== ==================
SEE ACCOMPANYING NOTES.
92
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
(IN MILLIONS)
REVENUES
Premiums and other considerations............... $3,881.8 $4,122.3 $3,996.4
Fees and other revenues......................... 1,990.8 1,600.7 1,300.6
Net investment income........................... 3,304.7 3,383.6 3,157.6
Net realized/unrealized capital gains (losses).. (354.8) (514.0) 139.6
------------------ ------------------ ------------------
Total revenues................................ 8,822.5 8,592.6 8,594.2
EXPENSES
Benefits, claims, and settlement expenses....... 5,216.9 5,482.1 5,232.3
Dividends to policyholders...................... 316.6 313.7 312.7
Operating expenses.............................. 2,623.2 2,332.7 2,209.0
------------------ ------------------ ------------------
Total expenses................................ 8,156.7 8,128.5 7,754.0
------------------ ------------------ ------------------
Income from continuing operations before income
taxes........................................ 665.8 464.1 840.2
Income taxes.................................... 45.9 83.4 228.5
------------------ ------------------ ------------------
Income from continuing operations, net of 619.9 380.7 611.7
related income taxes.........................
Income (loss) from discontinued operations, net
of related income taxes...................... (196.7) (11.2) 8.5
------------------ ------------------ ------------------
Income before cumulative effect of accounting
changes...................................... 423.2 369.5 620.2
Cumulative effect of accounting changes, net
of related income taxes...................... (280.9) (10.7) -
------------------ ------------------ ------------------
Net income...................................... $ 142.3 $ 358.8 $ 620.2
================== ================== ==================
93
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
FOR THE YEAR ENDED PRO FORMA (UNAUDITED) FOR
THE YEAR ENDED DECEMBER
DECEMBER 31, 2002 31, 2001
--------------------------- ---------------------------
EARNINGS PER COMMON SHARE
Basic and diluted earnings per common share:
Income from continuing operations, net of
related income taxes........................ $ 1.77 $ 1.05
Loss from discontinued operations, net of
related income taxes........................ (0.56) (0.03)
--------------------------- ---------------------------
Income before cumulative effect of
accounting changes.......................... 1.21 1.02
Cumulative effect of accounting changes,
net of related income taxes................. (0.80) (0.03)
--------------------------- ---------------------------
Net income.................................... $ 0.41 $ 0.99
=========================== ===========================
The unaudited pro forma earnings per common share information above gives effect
to the Demutualization and Initial Public Offering completed on October 26,
2001, as if they occurred on January 1, 2001 (see Note 20 to the consolidated
financial statements).
SEE ACCOMPANYING NOTES.
94
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
ADDITIONAL RETAINED OTHER TOTAL
COMMON PAID-IN EARNINGS COMPREHENSIVE TREASURY STOCKHOLDERS' OUTSTANDING
STOCK CAPITAL (DEFICIT) INCOME (LOSS) STOCK EQUITY SHARES
---------- ---------- ----------- -------------- -------- ------------- ---------------
(IN MILLIONS) (IN THOUSANDS)
BALANCES AT JANUARY 1, 2000....$ - $ - $5,692.3 $(139.4) $ - $5,552.9
Comprehensive income:
Net income.................. - - 620.2 - - 620.2
Net unrealized gains........ - - - 351.9 - 351.9
Provision for deferred
income taxes.............. - - - (120.0) - (120.0)
Foreign currency
translation adjustment.... - - - (152.5) - (152.5)
-------------
Comprehensive income.......... 699.6
---------- ---------- ----------- -------------- -------- ------------- ---------------
BALANCES AT DECEMBER 31,
2000........................ - - 6,312.5 (60.0) - 6,252.5
Demutualization transaction.... 2.6 5,047.7 (6,700.4) - - (1,650.1) 260,805.9
Stock issued and held in
rabbi trusts................ - 6.7 - - (6.7) - (363.7)
Initial public offering........ 1.0 1,752.9 - - - 1,753.9 100,000.0
Shares issued.................. 0.2 265.2 - - - 265.4 15,000.0
Treasury stock acquired....... - - - - (367.7) (367.7) (15,300.0)
Comprehensive income:
Net income before
demutualization........... - - 387.9 - - 387.9
Net loss after
demutualization........... - - (29.1) - - (29.1)
----------- --------------
Net income for the year..... - - 358.8 - - 358.8
Net unrealized gains........ - - - 451.6 - 451.6
Provision for deferred
income taxes.............. - - - (158.1) - (158.1)
Foreign currency
translation adjustment.... - - - (71.8) - (71.8)
Cumulative effect of
accounting change, net
of related income taxes... - - - (14.2) - (14.2)
--------------
Comprehensive income........... 566.3
---------- ---------- ----------- -------------- -------- ------------- ---------------
BALANCES AT DECEMBER 31,
2001........................ 3.8 7,072.5 (29.1) 147.5 (374.4) 6,820.3 360,142.2
Shares issued.................. - 22.0 - - - 22.0 904.9
Stock-based compensation....... - 10.5 - - - 10.5
Treasury stock acquired and
sold, net.................... - 1.3 - - (743.7) (742.4) (26,627.8)
Dividends to stockholders...... - - (83.8) - - (83.8)
Comprehensive income:
Net income.................. - - 142.3 - - 142.3
Net unrealized gains........ - - - 618.8 - 618.8
Provision for deferred
income taxes.............. - - - (217.1) - (217.1)
Foreign currency
translation adjustment.... - - - 86.6 - 86.6
--------------
Comprehensive income........... 630.6
---------- ---------- ----------- -------------- -------- ------------- ---------------
BALANCES AT DECEMBER 31,
2002........................ $3.8 $7,106.3 $ 29.4 $ 635.8 $(1,118.1) $6,657.2 334,419.3
========== ========== =========== ============== ========= ============= ===============
SEE ACCOMPANYING NOTES.
95
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
----------------- ---------------- -----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income............................................ $ 142.3 $ 358.8 $ 620.2
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss (income) from discontinued operations, net
of related income taxes........................ 196.7 11.2 (8.5)
Cumulative effect of accounting changes,
net of related income taxes.................... 280.9 10.7 -
Amortization of deferred policy
acquisition costs.............................. 144.5 159.9 238.6
Additions to deferred policy acquisition costs... (323.4) (261.7) (263.9)
Accrued investment income........................ (52.2) (66.2) (60.1)
Premiums due and other receivables............... 25.2 (47.3) (74.8)
Contractholder and policyholder liabilities
and dividends.................................. 2,154.4 2,005.0 1,478.5
Current and deferred income taxes................ 408.4 98.8 188.5
Net realized/unrealized capital (gains) losses... 354.8 514.0 (139.6)
Depreciation and amortization expense............ 106.0 103.4 99.8
Amortization of mortgage servicing rights........ 364.9 213.0 157.8
Stock-based compensation......................... 10.5 - -
Mortgage servicing rights valuation adjustments.. 926.7 101.8 54.8
Other............................................ 824.3 856.0 500.9
----------------- ---------------- -----------------
Net adjustments....................................... 5,421.7 3,698.6 2,172.0
----------------- ---------------- -----------------
Net cash provided by operating activities............. 5,564.0 4,057.4 2,792.2
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases......................................... (16,683.5) (14,871.8) (13,051.0)
Sales............................................. 8,460.0 6,707.7 7,366.0
Maturities........................................ 4,473.3 4,729.5 2,675.3
Net cash flows from trading securities................ (82.4) (17.0) -
Mortgage loans acquired or originated................. (50,217.3) (40,456.9) (10,507.5)
Mortgage loans sold or repaid......................... 50,027.7 40,908.6 12,026.8
Purchase of mortgage servicing rights................. (931.7) (968.4) (235.9)
Proceeds from sale of mortgage servicing rights....... 8.6 31.5 53.1
Real estate acquired.................................. (273.8) (290.0) (324.4)
Real estate sold...................................... 255.7 803.8 796.9
Net change in property and equipment.................. (59.5) (90.6) (72.2)
Net proceeds (disbursements) from sales of
subsidiaries....................................... 500.8 (7.9) -
Purchases of interest in subsidiaries, net
of cash acquired................................... (54.5) (11.1) (27.4)
Net change in other investments....................... 498.5 (205.4) (93.1)
----------------- ---------------- -----------------
Net cash used in investing activities................. (4,078.1) (3,738.0) (1,393.4)
96
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
----------------- ---------------- -----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock............................. $ 22.0 $ 2,019.3 $ -
Payments to eligible policyholders under plan
of conversion..................................... - (1,177.5) -
Acquisition and sales of treasury stock, net......... (742.4) (367.7) -
Dividends to stockholders............................ (83.8) - -
Issuance of long-term debt........................... 64.1 149.2 230.4
Principal repayments of long-term debt............... (110.0) (204.4) (120.7)
Net proceeds (repayments) of short-term
borrowings........................................ 53.2 52.1 (87.9)
Investment contract deposits......................... 7,014.1 5,054.9 3,982.6
Investment contract withdrawals...................... (7,225.7) (6,075.1) (5,011.3)
----------------- ---------------- -----------------
Net cash used in financing activities................ (1,008.5) (549.2) (1,006.9)
----------------- ---------------- -----------------
Net increase (decrease) in cash and cash
equivalents....................................... 477.4 (229.8) 391.9
Cash and cash equivalents at beginning of year....... 561.2 791.0 399.1
----------------- ---------------- -----------------
Cash and cash equivalents at end of year............. $1,038.6 $ 561.2 $ 791.0
================= ================ =================
SCHEDULE OF NONCASH TRANSACTIONS
Policy credits to eligible policyholders under plan
of conversion..................................... $ 472.6
================
Stock issued in exchange for membership interest..... $ 5,050.3
================
Net transfer of noncash assets and liabilities to an
unconsolidated entity in exchange for a minority
interest.......................................... $ (255.0)
=================
SEE ACCOMPANYING NOTES.
97
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Principal Financial Group, Inc. and its consolidated subsidiaries, is a
diversified financial services organization engaged in promoting retirement
savings and investment and insurance products and services in the U.S. and
selected international markets. In addition, we offer residential mortgage loan
origination and servicing in the U.S.
DEMUTUALIZATION AND INITIAL PUBLIC OFFERING
Under the terms of Principal Mutual Holding Company's Plan of Conversion,
effective October 26, 2001 (the "Date of Demutualization"), Principal Mutual
Holding Company converted from a mutual insurance holding company ("MIHC") to a
stock company, subsidiary of Principal Financial Group, Inc., a Delaware
business corporation. All membership interests in Principal Mutual Holding
Company were extinguished on that date and eligible policyholders received, in
aggregate, 260.8 million shares of common stock, $1,177.5 million of cash and
$472.6 million of policy credits as compensation.
In addition, on October 26, 2001, we completed our initial public offering
("IPO") in which we issued 100.0 million shares of common stock at a price of
$18.50 per share, prior to the underwriters' exercise of the overallotment
option. Net proceeds from the IPO were $1,753.9 million, of which $64.2 million
was retained by Principal Financial Group and $1,689.7 million was contributed
to Principal Life Insurance Company. Proceeds were net of offering costs of
$96.5 million and a related tax benefit of $0.4 million.
Costs relating to the demutualization, excluding costs relating to the IPO, were
$2.0 million, $18.6 million and $7.2 million, net of income taxes, in 2002, 2001
and 2000, respectively. Demutualization expenses consist primarily of printing
and mailing costs and the aggregate cost of engaging independent accounting,
actuarial, financial, investment banking, legal and other consultants to advise
us on the demutualization. In addition, these costs include the costs of the
advisors of the Insurance Commissioner of the State of Iowa and the New York
State Insurance Department, other regulatory authorities and internal allocated
costs for staff and related costs associated with the demutualization.
BASIS OF PRESENTATION
The accompanying consolidated financial statements, which include our
majority-owned subsidiaries, have been prepared in conformity with accounting
principles generally accepted in the U.S. ("U.S. GAAP"). Less than
majority-owned entities in which we had at least a 20% interest are reported on
the equity basis in the consolidated statements of financial position as other
investments. All significant intercompany accounts and transactions have been
eliminated.
CLOSED BLOCK
At the time the MIHC structure was created in 1998, Principal Life Insurance
Company ("Principal Life") formed and began operating a closed block ("Closed
Block") for the benefit of individual participating dividend-paying policies in
force on that date. See Note 8 for further details regarding the Closed Block.
98
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of our consolidated financial statements and accompanying notes
requires management to make estimates and assumptions that affect the amounts
reported and disclosed. These estimates and assumptions could change in the
future as more information becomes known, which could impact the amounts
reported and disclosed in the consolidated financial statements and accompanying
notes.
ACCOUNTING CHANGES
The Financial Accounting Standards Board (the "FASB") issued Interpretation No.
46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("FIN 46"), in January 2003. FIN
46 provides guidance related to identifying variable interest entities and
determining whether such entities should be consolidated. In addition, FIN 46
also provides guidance related to the initial and subsequent measurement of
assets, liabilities and noncontrolling interests of newly consolidated variable
interest entities and requires disclosures for both the primary beneficiary of a
variable interest entity and other beneficiaries of the entity. FIN 46 is
effective immediately for variable interest entities created, or interests in
variable interest entities obtained, after January 31, 2003. For those variable
interest entities created, or interests in variable interest entities obtained,
on or before January 31, 2003, the guidance in FIN 46 must be applied in the
first fiscal year or interim period beginning after June 15, 2003. We have
initiated an assessment and are currently evaluating interests in entities that
may be considered variable interest entities. The ultimate impact of adopting
FIN 46 on the consolidated financial statements is still being reviewed. Refer
to the Residential Mortgage Banking Activities section of Note 5 for further
information on variable interest entities and the effects that FIN 46 may have
on our financial statements in the future.
In December 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND
DISCLOSURE AN AMENDMENT OF FASB STATEMENT NO. 123 ("SFAS 148"), which is
effective for fiscal years ending after December 15, 2002. SFAS 148 provides
alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation and
requires disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation.
In addition, SFAS 148 amends Accounting Principles Board ("APB") Opinion No. 28,
INTERIM FINANCIAL REPORTING, to require disclosure about those effects in
interim financial information. We are applying the prospective method of
transition as prescribed by SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("SFAS 123").
SFAS 123 encourages but does not require companies to record compensation cost
for stock-based employee compensation plans based on the fair value of options
granted. Effective July 1, 2002, we adopted the fair value method for
stock-based compensation as defined in SFAS 123 in accounting for our
stock-based compensation plans. SFAS 123, which indicates that the fair value
method is the preferable method of accounting, requires that the fair value
method for stock-based compensation be applied as of the beginning of the fiscal
year in which it is adopted for all stock-based awards granted subsequent to
such date. The financial statements for the first two quarters of 2002 were not
restated for this change since its effects were not materially different from
amounts reported for both financial position and results of operations. Such
effects for the first two quarters were charged against income in the third
quarter of 2002 and were not material to such results of operations. Prior to
January 1, 2002, we applied the intrinsic value method (as permitted under SFAS
123) defined in APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES and
related Interpretations, which excluded employee options and stock purchases
from compensation expense.
99
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In November 2002, the FASB issued Interpretation No. 45, GUARANTOR'S ACCOUNTING
AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF
INDEBTEDNESS OF OTHERS ("FIN 45"). FIN 45 requires certain guarantees to be
recorded at fair value instead of when a loss is probable and reasonably
estimable as defined by SFAS No. 5, ACCOUNTING FOR CONTINGENCIES. FIN 45 also
requires a guarantor to make significant new disclosures, even when the
likelihood of making any payments under the guarantee is remote. The liability
recognition requirements of FIN 45 are effective for those guarantees that are
issued or amended as of January 1, 2003 or later. The disclosure requirements
are effective for financial statements of annual periods ending after December
15, 2002. Refer to Note 14 for further information regarding our guarantees.
In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS ("SFAS 141"),
and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS ("SFAS 142"). SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001, and requires separate recognition of
intangible assets apart from goodwill, if such intangible assets meet certain
criteria. SFAS 142, effective January 1, 2002, prohibits the amortization of
goodwill and intangible assets with indefinite useful lives. Intangible assets
with finite 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, which we plan to
do in the fourth quarter each year.
Our initial adoption of SFAS 142 on January 1, 2002, required us to perform a
two-step fair-value based goodwill impairment test. The first step of the test
compared the estimated fair value of the reporting unit to its carrying value,
including goodwill. If the carrying value exceeded fair value, a second step was
performed, which compared the implied fair value of the applicable reporting
unit's goodwill with the carrying amount of that goodwill, to measure the
goodwill impairment, if any. Additionally, we were required to perform an
impairment test on our indefinite-lived intangible assets, which consisted of a
comparison of the fair value of an intangible asset with its carrying amount.
Our measurements of fair value were based on evaluations of future discounted
cash flows, product level analysis, market performance assumptions and cash flow
assumptions. These evaluations utilized the best information available in the
circumstances, including reasonable and supportable assumptions and projections.
The discounted cash flow evaluations considered earnings scenarios and the
likelihood of possible outcomes. Collectively, these evaluations were
management's best estimate of projected future cash flows.
As a result of performing the two-step impairment test, we recorded goodwill
impairments of $196.5 million, $20.9 million and $4.6 million, net of income
taxes, related to our BT Financial Group, Principal International and Life and
Health Insurance operations, respectively. Additionally, as a result of
performing the indefinite-lived intangible asset impairment test, we recognized
an after-tax impairment of $58.9 million to our brand name and management rights
intangible asset related to BT Financial Group.
100
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
These impairments, recognized January 1, 2002, as a cumulative effect of a
change in accounting principle, were reported in our operating segments as
follows (in millions):
INTERNATIONAL
ASSET MANAGEMENT LIFE AND HEALTH
AND ACCUMULATION INSURANCE CONSOLIDATED
-------------------- ------------------ ------------------
Goodwill................................. $321.2 $4.6 $325.8
Indefinite-lived intangibles............. 89.8 - 89.8
Income tax impact........................ (134.7) - (134.7)
-------------------- ------------------ ------------------
Total impairment, net of income taxes..... $276.3 $4.6 $280.9
==================== ================== ==================
Net income and earnings per share (basic and diluted) for the years ended
December 31, 2002, 2001 and 2000, adjusted for the effects of SFAS 142 related
to non-amortization of goodwill and indefinite-lived intangibles, are as follows
(in millions, except per share data):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001(1) 2000
---------------- ----------------- ------------
Reported net income............................. $ 142.3 $358.8 $620.2
Adjustment for amortization expense:
Goodwill (2)................................... - 9.2 11.3
Amortization included in discontinued
operations (see Note 3) ....................... - 38.9 37.0
---------------- ----------------- ------------
Total amortization expense ..................... - 48.1 48.3
Tax impacts of amortization expense ............ - (14.6) (14.2)
---------------- ----------------- ------------
Adjusted net income............................. 142.3 392.3 654.3
Adjustment for cumulative effect of accounting
changes, net of related income taxes........... 280.9 10.7 -
---------------- ----------------- ------------
Adjusted income before cumulative effect of
accounting changes............................. $ 423.2 $403.0 $654.3
================ ================= ============
Basic and diluted earnings per share:
Reported net income............................. $ 0.41 $ 0.99 N/A
Adjustment for amortization expense:
Goodwill....................................... - 0.02 N/A
Amortization included in discontinued
operations..................................... - 0.11 N/A
---------------- ----------------- ------------
Total amortization expense ..................... - 0.13 N/A
Tax impacts of amortization expense ............ - (0.04) N/A
---------------- ----------------- ------------
Adjusted net income ............................ 0.41 1.08 N/A
Adjustment for cumulative effect of accounting
changes, net of related income taxes.......... 0.80 0.03 N/A
---------------- ----------------- ------------
Adjusted income before cumulative effect of
accounting changes............................. $ 1.21 $ 1.11 N/A
================ ================= ============
(1) For purposes of our unaudited basic and diluted pro-forma earnings per
share calculations for the period January 1, 2001 through October 25, 2001,
we estimated 360.8 million shares to be outstanding. For the period October
26, 2001 through December 31, 2001, actual shares outstanding were used in
the weighted-average share calculation.
(2) Includes amortization expenses related to our equity investment
subsidiaries.
101
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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
("APB 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 APB 30). We adopted SFAS 144 on January 1, 2002, which did not have a
significant impact on our consolidated financial statements as of the adoption
date. On August 25, 2002, we entered into an agreement to sell substantially all
of BT Financial Group (see Note 3). The sale of BT Financial Group is accounted
for under the provisions of SFAS 144 and consistent with such guidance, the BT
Financial Group results and loss on sale are reported as a discontinued
operation.
Effective January 1, 2001, we adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"), as amended by SFAS No. 138,
ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES -
AN AMENDMENT OF FASB STATEMENT NO. 133. As amended, SFAS 133 requires, among
other things, that all derivatives be recognized in the consolidated statement
of financial position as either assets or liabilities that are measured at fair
value. SFAS 133 also establishes special accounting for qualifying hedges, which
allows for matching the timing of gain or loss recognition on the hedging
instrument with the recognition of the corresponding changes in value of the
hedged item. Changes in the fair value of a derivative qualifying as a hedge are
recognized in earnings or directly in stockholders' equity depending on the
instrument's intended use. For derivatives that are not designated as hedges or
that do not meet the hedge accounting criteria in SFAS 133, changes in fair
value are required to be recognized in earnings in the period of change.
At January 1, 2001, our 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.
102
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, money market instruments and
other debt issues with a maturity date of three months or less when purchased.
INVESTMENTS
We classify our investments into one of three categories: held-to-maturity,
available-for-sale or trading. We determine the appropriate classification of
fixed maturity securities at the time of purchase. Fixed maturity securities
include bonds, mortgage-backed securities and redeemable preferred stock. We
classify fixed maturity securities as either available-for-sale or trading and,
accordingly, carry them at fair value. (See Note 16 for policies related to the
determination of fair value.) Unrealized gains and losses related to
available-for-sale securities are reflected in stockholders' equity net of
related deferred policy acquisition costs and applicable taxes. Unrealized gains
and losses related to trading securities are reflected in net income as net
realized/unrealized capital gains (losses).
The cost of fixed maturity securities is adjusted for amortization of premiums
and accrual of discounts, both computed using the interest method. The cost of
fixed maturity securities is adjusted for declines in value that are other than
temporary. Impairments in value deemed to be other than temporary are reported
in net income as a component of net realized/unrealized capital gains (losses).
For loan-backed and structured securities, we recognize income using a constant
effective yield based on currently anticipated prepayments as determined by
broker-dealer surveys or internal estimates and the estimated lives of the
securities.
Equity securities include mutual funds, common stock and nonredeemable preferred
stock. The cost of equity securities is adjusted for declines in value that are
other than temporary. Impairments in value deemed to be other than temporary are
reported in net income as a component of net realized/unrealized capital gains
(losses). Equity securities are classified as available-for-sale and,
accordingly, are carried at fair value. (See Note 16 for policies related to the
determination of fair value.) Unrealized gains and losses related to
available-for-sale securities are reflected in stockholders' equity net of
related deferred policy acquisition costs and applicable taxes.
Real estate investments are reported at cost less accumulated depreciation. The
initial cost bases of properties acquired through loan foreclosures are the
lower of the fair market values of the properties at the time of foreclosure or
the outstanding loan balance. Buildings and land improvements are generally
depreciated on the straight-line method over the estimated useful life of
improvements, and tenant improvement costs are depreciated on the straight-line
method over the term of the related lease. We recognize impairment losses for
properties when indicators of impairment are present and a property's expected
undiscounted cash flows are not sufficient to recover the property's carrying
value. In such cases, the cost bases of the properties are reduced to fair
value. Real estate expected to be disposed is carried at the lower of cost or
fair value, less cost to sell, with valuation allowances established accordingly
and depreciation no longer recognized. Any impairment losses and any changes in
valuation allowances are reported in net income as net realized/unrealized
capital gains (losses).
103
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Commercial and residential mortgage loans are generally reported at cost
adjusted for amortization of premiums and accrual of discounts, computed using
the interest method, and net of valuation allowances. Any changes in the
valuation allowances are reported in net income as net realized/unrealized
capital gains (losses). We measure impairment based upon the present value of
expected cash flows discounted at the loan's effective interest rate or the
loan's observable market price. If foreclosure is probable, the measurement of
any valuation allowance is based upon the fair value of the collateral. We have
residential mortgage loans held-for-sale in the amount of $638.9 million and
$476.1 million and commercial mortgage loans held-for-sale in the amount of
$444.2 million and $493.5 million at December 31, 2002 and 2001, respectively,
which are carried at lower of cost or fair value, less cost to sell, and
reported as mortgage loans in the statements of financial position.
Net realized capital gains and losses on sales of investments are determined on
the basis of specific identification. In general, in addition to realized
capital gains and losses on investment sales, unrealized gains and losses
related to other than temporary impairments, trading securities, market value
changes in certain seed money investments, fair value hedge ineffectiveness,
derivatives not designated as hedges and changes in the mortgage loan allowance
are reported in net income as net realized/unrealized capital gains (losses).
Unrealized gains and losses on derivatives within our mortgage banking segment
are reported as either operating expenses or fees and other revenues depending
on the nature of the hedge and are excluded from net realized/unrealized capital
gains (losses). Investment gains and losses on sales of certain real estate
held-for-sale, which do not meet the criteria for classification as a
discontinued operation, are reported as net investment income and are also
excluded from net realized/unrealized capital gains (losses).
Policy loans and other investments, excluding investments in unconsolidated
entities, are primarily reported at cost.
SECURITIZATIONS
We sell commercial mortgage loans to an unconsolidated qualified special purpose
entity which then issues mortgage-backed securities. We may retain immaterial
interests in the loans by purchasing portions of the securities from the
issuance. Gain or loss on the sales of the mortgages is reported as fees and
other revenues and depends in part on the previous carrying amounts of the
financial assets involved in the transfer, which is allocated between the assets
sold and the retained interests based on their relative fair value at the date
of transfer. Fair values are determined by quoted market prices of external
buyers of each class of security purchased. The retained interests are
thereafter carried at fair value with other fixed maturity investments and
classified as available-for-sale.
We also sell residential mortgage loans and retain servicing rights which are
retained interests in the sold loans. Gain or loss on the sales of the loans is
reported as fees and other revenues and depends in part on the previous carrying
amounts of the loans sold and the interests retained based on their relative
fair values at the date of the transfer. To obtain fair values, quoted market
prices are used if available. However, quotes are generally not available for
retained interests, so we estimate fair value based on the present value of the
future expected cash flows using management's best estimates of assumptions we
believe market participants would use to value such interests.
104
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MORTGAGE LOAN SERVICING RIGHTS
Mortgage loan servicing rights represent the cost of purchasing or originating
the right to receive cash flows from servicing mortgage loans. Servicing rights
are recorded at the time of sale of the underlying mortgage loans where the
servicing is retained. The total cost of the mortgage loans, which includes the
cost to acquire the servicing rights, is allocated to the mortgage loans and the
servicing rights based on their relative fair values at the date of sale. Cost
basis also includes adjustments resulting from the application of hedge
accounting. Capitalized servicing rights are carried at the lower of cost or
market value. The capitalized value is amortized in proportion to, and over the
period of, estimated net servicing income.
Capitalized mortgage loan servicing rights are periodically assessed for
impairment based on the estimated fair value of those rights. Fair values are
estimated using estimates of discounted future net cash flows over the expected
life using loan prepayment, discount rate, ancillary fee income and other
economic factors we believe market participants would use to value such assets.
For purposes of performing our impairment evaluation, we stratify the servicing
portfolio on the basis of certain predominant risk characteristics, including
loan type and note rate. To the extent that the carrying value of the servicing
rights exceeds fair value for any stratum, a valuation allowance is established,
which may be adjusted in the future as the value of the servicing rights
increase or decrease. This valuation allowance is recognized in the consolidated
statements of operations during the period in which impairment occurs.
Activity in the valuation allowance for mortgage loan servicing rights is
summarized as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
--------------- --------------- ---------------
Balance at beginning of year.............................. $198.1 $ 2.3 $2.9
Impairments............................................... 318.3 196.0 1.1
Recoveries................................................ (22.7) (0.2) (1.7)
--------------- --------------- ---------------
Balance at end of year.................................... $493.7 $ 198.1 $2.3
=============== =============== ===============
During 2002, impairments reflect the results of increased mortgage loan
prepayments due to the continued reduction in market interest rates during the
year.
DERIVATIVES
Effective January 1, 2001, all derivatives are recognized as either assets or
liabilities in the statement of financial position and measured at fair value.
If certain conditions are met, a derivative may be specifically designated as
one of the following:
(a) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment;
(b) a hedge of the exposure to variable cash flows of a forecasted transaction;
(c) a hedge of the foreign currency exposure of an unrecognized firm
commitment, an available-for-sale security or a
foreign-currency-denominated forecasted transaction.
105
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Our accounting for the ongoing changes in fair value of a derivative depends on
the intended use of the derivative and the designation as described above and is
determined when the derivative contract is entered into or at the time of
redesignation under FAS 133. Hedge accounting is used for derivatives that are
specifically designated in advance as hedges and that reduce our exposure to an
indicated risk by having a high correlation between changes in the value of the
derivatives and the items being hedged at both the inception of the hedge and
throughout the hedge period.
For derivatives hedging the exposure to changes in fair value of a recognized
asset or liability, the change in fair value of the derivative is recognized in
earnings in the period of change together with the offsetting change in fair
value on the hedged item attributable to the risk being hedged. The effect of
such accounting is to reflect in earnings the extent to which the hedge is not
effective in achieving offsetting changes in fair value.
For derivatives hedging the exposure to variable cash flows, the effective
portion of the derivative's change in fair value is initially deferred and
reported as a component of other comprehensive income and subsequently
reclassified into earnings when each variable cash flow occurs and is recognized
in earnings. The ineffective portion of the change in fair value is reported in
earnings in the period of change. For derivatives that are terminated prior to
maturity, any accumulated gain or loss is recognized in earnings immediately if
the hedged item is also terminated. If the hedged item is not terminated, then
the accumulated gain or loss is amortized into earnings over the remaining life
of the hedged item.
For derivatives hedging the foreign currency exposure of an unrecognized firm
commitment or an available-for-sale security, the change in fair value of the
derivative is recognized in earnings in the period of change together with the
offsetting change in fair value on the hedged item attributable to the risk
being hedged. The effect of such accounting is to reflect in earnings the extent
to which the hedge is not effective in achieving offsetting changes in fair
value.
For derivatives hedging the foreign currency exposure of a
foreign-currency-denominated forecasted transaction, the change in fair value is
initially deferred and reported as a component of other comprehensive income and
subsequently reclassified into earnings when the forecasted transaction occurs
and is recognized in earnings. The ineffective portion of the change in fair
value is reported in earnings in the period of change.
For derivatives not designated as a hedging instrument, the change in fair value
is recognized in earnings in the period of change.
A minimum variance technique is used to test the effectiveness of cashflow and
fair value relationships whereby the profitability distribution of net fair
value or cashflows for the hedging and hedged items are combined. If the
coefficient of variation (standard deviation divided by mean) of the probability
distribution is 1% or less, then the hedging relationship is deemed to be
effective.
Prior to the January 1, 2001 adoption of SFAS No. 133, we used future contracts,
mortgage-backed securities forwards, interest rate and principal only swap and
floor agreements, options on futures contracts and currency rate swap agreements
to hedge and manage our exposure to changes in interest rate levels and foreign
exchange rate fluctuations, and to manage duration mismatch of assets and
liabilities. Futures contracts were marked to market and settled daily with the
net gain or loss at expiration or termination of the contracts recorded in net
106
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
realized/unrealized capital gains (losses) on our consolidated statements of
operations. Outstanding mortgage-backed forwards were reported as commitments,
and upon settlement, the net gain or loss was reported in net
realized/unrealized capital gains (losses). For interest rate and currency swaps
held by Principal Life, the net amounts paid or received and net amounts accrued
through the end of the accounting period were included in net investment income.
Any discounts or premiums related to these instruments were amortized to net
investment income over the life of the contract. Gains or losses on contracts
terminated early were recognized immediately in net realized/unrealized capital
gains (losses). Unrealized gains or losses on interest rate swap contracts and
currency swaps were not recognized in income. We primarily utilized interest
rate floors, futures and options on futures contracts and interest rate and
principal only swaps in hedging our portfolio of mortgage servicing rights. The
realized and unrealized gains and losses on servicing derivatives accounted for
as effective hedges were considered in the periodic assessment of mortgage
servicing rights impairment. The realized and unrealized gains and losses on
servicing derivatives not considered effective hedges were recorded in our
results of operations. We managed 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, futures
contracts and options on treasury futures contracts. The unrealized gains and
losses on these derivatives were included in the lower of cost or market
calculation of mortgage loans held-for-sale.
CONTRACTHOLDER AND POLICYHOLDER LIABILITIES
Contractholder and policyholder liabilities (contractholder funds, future policy
benefits and claims and other policyholder funds) include reserves for
investment contracts and reserves for universal life, limited payment,
participating and traditional life insurance policies. Investment contracts are
contractholders' funds on deposit with us and generally include reserves for
pension and annuity contracts. Reserves on investment contracts are equal to the
cumulative deposits less any applicable charges plus credited interest.
Reserves for universal life insurance contracts are equal to cumulative premiums
less charges plus credited interest which represents the account balances that
accrue to the benefit of the policyholders. Reserves for nonparticipating term
life insurance contracts are computed on a basis of assumed investment yield,
mortality, morbidity and expenses, including a provision for adverse deviation,
which generally varies by plan, year of issue and policy duration. Investment
yield is based on our experience. Mortality, morbidity and withdrawal rate
assumptions are based on our experience and are periodically reviewed against
both industry standards and experience.
Reserves for participating life insurance contracts are based on the net level
premium reserve for death and endowment policy benefits. This net level premium
reserve is calculated based on dividend fund interest rate and mortality rates
guaranteed in calculating the cash surrender values described in the contract.
Participating business represented approximately 32%, 35% and 34% of our life
insurance in force and 74%, 76% and 79% of the number of life insurance policies
in force at December 31, 2002, 2001 and 2000, respectively. Participating
business represented approximately 68%, 57% and 61% of life insurance premiums
for the years ended December 31, 2002, 2001 and 2000, respectively.
The amount of dividends to policyholders is approved annually by Principal
Life's Board of Directors. The amount of dividends to be paid to policyholders
is determined after consideration of several factors including interest,
mortality, morbidity and other expense experience for the year and judgment as
to the appropriate level of statutory surplus to be retained by Principal Life.
At the end of the reporting period, Principal Life establishes a dividend
liability for the pro rata portion of the dividends expected to be paid on or
before the next policy anniversary date.
107
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Some of our policies and contracts require payment of fees in advance for
services that will be rendered over the estimated lives of the policies and
contracts. These payments are established as unearned revenue reserves upon
receipt and included in other policyholder funds in the consolidated statements
of financial position. These unearned revenue reserves are amortized to
operations over the estimated lives of these policies and contracts in relation
to the emergence of estimated gross profit margins.
The liability for unpaid accident and health claims is an estimate of the
ultimate net cost of reported and unreported losses not yet settled. This
liability is estimated using actuarial analyses and case basis evaluations.
Although considerable variability is inherent in such estimates, we believe that
the liability for unpaid claims is adequate. These estimates are continually
reviewed and, as adjustments to this liability become necessary, such
adjustments are reflected in current operations.
RECOGNITION OF PREMIUMS AND OTHER CONSIDERATIONS, FEES AND OTHER REVENUES AND
BENEFITS
Traditional individual life and health insurance products include those products
with fixed and guaranteed premiums and benefits and consist principally of whole
life and term life insurance policies. Premiums from these products are
recognized as premium revenue when due.
Immediate annuities with life contingencies include products with fixed and
guaranteed annuity considerations and benefits and consist principally of group
and individual single premium annuities with life contingencies. Annuity
considerations from these products are recognized as revenue when due.
Group life and health insurance premiums are generally recorded as premium
revenue over the term of the coverage. Some group contracts allow for premiums
to be adjusted to reflect emerging experience. Such adjusted premiums are
recognized in the period that the related experience emerges. Fees for contracts
providing claim processing or other administrative services are recorded over
the period the service is provided.
Related policy benefits and expenses for individual and group life, annuity and
health insurance products are associated with earned premiums and result in the
recognition of profits over the expected lives of the policies and contracts.
Universal life-type policies are insurance contracts with terms that are not
fixed and guaranteed. Amounts received as payments for such contracts are not
reported as premium revenues. Revenues for universal life-type insurance
contracts consist of policy charges for the cost of insurance, policy initiation
and administration, surrender charges and other fees that have been assessed
against policy account values. Policy benefits and claims that are charged to
expense include interest credited to contracts and benefit claims incurred in
the period in excess of related policy account balances.
Investment contracts do not subject us to risks arising from policyholder
mortality or morbidity and consist primarily of Guaranteed Investment Contracts
("GICs"), funding agreements and certain deferred annuities. Amounts received as
payments for investment contracts are established as investment contract
liability balances and are not reported as premium revenues. Revenues for
investment contracts consist of investment income and policy administration
charges. Investment contract benefits that are charged to expense include
benefit claims incurred in the period in excess of related investment contract
liability balances and interest credited to investment contract liability
balances.
108
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fees and other revenues are earned for asset management services provided to
retail and institutional clients based largely upon contractual rates applied to
the market value of the client's portfolio. Additionally, fees and other
revenues are earned for administrative services performed including
recordkeeping and reporting services for retirement savings plans. Fees and
other revenues received for performance of asset management and administrative
services are recognized as revenue when the service is performed.
Fees and other revenues arising from the residential mortgage banking operations
consist of revenues earned for servicing and originating residential mortgage
loans as well as marketing other products to servicing portfolio customers. Net
revenues are also recognized upon the sale of residential mortgage loans and
residential mortgage loan servicing rights and are recorded in fees and other
revenues and determined using the specific identification basis. Servicing
revenues are recognized as the mortgage loan is serviced over the life of the
mortgage loan. Mortgage loans originated are sold in the secondary mortgage
markets, shortly after origination. As a result, mortgage loan origination fee
revenues are recognized when the mortgage loans are sold. Fee revenues received
for marketing other products to servicing portfolio customers are recognized
when the service is performed.
DEFERRED POLICY ACQUISITION COSTS
Commissions and other costs (underwriting, issuance and agency expenses and
first-year bonus interest) that vary with and are primarily related to the
acquisition of new and renewal insurance policies and investment contract
business are capitalized to the extent recoverable. Maintenance costs and
acquisition costs that are not deferrable are charged to operations as incurred.
Deferred policy acquisition costs for universal life-type insurance contracts
and participating life insurance policies and investment contracts are being
amortized over the lives of the policies and contracts in relation to the
emergence of estimated gross profit margins. This amortization is adjusted
retrospectively when estimates of current or future gross profits and margins to
be realized from a group of products and contracts are revised. The deferred
policy acquisition costs of nonparticipating term life insurance policies are
being amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policyholder liabilities.
Deferred policy acquisition costs are subject to recoverability testing at the
time of policy issue and loss recognition testing at the end of each accounting
period. Deferred policy acquisition costs would be written off to the extent
that it is determined that future policy premiums and investment income or gross
profit margins would not be adequate to cover related losses and expenses.
REINSURANCE
We enter into reinsurance agreements with other companies in the normal course
of business. We may assume reinsurance from or cede reinsurance to other
companies. Assets and liabilities related to reinsurance ceded are reported on a
gross basis. Premiums and expenses are reported net of reinsurance ceded. We are
contingently liable with respect to reinsurance ceded to other companies in the
event the reinsurer is unable to meet the obligations it has assumed. At
December 31, 2002, 2001 and 2000, respectively, we had reinsured $17.8 billion,
$15.6 billion and $13.2 billion of life insurance in force, representing 13%,
12% and 9% of total net life insurance in force through a single third-party
reinsurer. To minimize the possibility of losses, we evaluate the financial
condition of our reinsurers and monitor concentrations of credit risk.
109
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The effects of reinsurance on premiums and other considerations and policy and
contract benefits and changes in reserves were as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Premiums and other considerations:
Direct........................................ $4,080.1 $4,329.9 $4,142.1
Assumed....................................... 130.6 56.0 24.6
Ceded......................................... (328.9) (263.6) (170.3)
------------------ ------------------ ------------------
Net premiums and other considerations............ $3,881.8 $4,122.3 $3,996.4
================== ================== ==================
Benefits, claims and settlement expenses:
Direct........................................ $5,459.8 $5,700.3 $5,387.8
Assumed....................................... 10.6 7.4 1.9
Ceded......................................... (253.5) (225.6) (157.4)
------------------ ------------------ ------------------
Net benefits, claims and settlement expenses..... $5,216.9 $5,482.1 $5,232.3
================== ================== ==================
SEPARATE ACCOUNTS
The separate account assets and liabilities presented in the consolidated
financial statements represent the fair market value of funds that are
separately administered by us for contracts with equity, real estate and
fixed-income investments. Generally, the separate account contract owner, rather
than us, bears the investment risk of these funds. The separate account assets
are legally segregated and are not subject to claims that arise out of any other
business of ours. We receive a fee for administrative, maintenance and
investment advisory services that is included in the consolidated statements of
operations. Net deposits, net investment income and realized and unrealized
capital gains and losses on the separate accounts are not reflected in the
consolidated statements of operations.
At December 31, 2002 and 2001, the separate accounts include a separate account
valued at $1.0 billion and $1.3 billion, respectively, which primarily includes
shares of our stock that were allocated and issued to eligible participants of
qualified employee benefit plans administered by us as part of the policy
credits issued under the demutualization. These shares are included in both
basic and diluted earnings per share calculations. The separate account shares
are recorded at fair value and are reported as separate account assets and
separate account liabilities in the consolidated statement of financial
position. Activity of the separate account shares is reflected in both the
separate account assets and separate account liabilities and does not impact our
results of operations.
INCOME TAXES
We file a U.S. consolidated income tax return that includes all of our
qualifying subsidiaries. Our policy of allocating income tax expenses and
benefits to companies in the group is generally based upon pro rata contribution
of taxable income or operating losses. We are taxed at corporate rates on
taxable income based on existing tax laws. Current income taxes are charged or
credited to operations based upon amounts estimated to be payable or recoverable
as a result of taxable operations for the current year. Deferred income taxes
are provided for the tax effect of temporary differences in the financial
reporting and income tax bases of assets and liabilities and net operating
losses using enacted income tax rates and laws. The effect on deferred tax
assets and deferred tax liabilities of a change in tax rates is recognized in
operations in the period in which the change is enacted.
110
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN EXCHANGE
Assets and liabilities of our foreign subsidiaries and affiliates denominated in
non-U.S. dollars are translated into U.S. dollar equivalents at the year-end
spot foreign exchange rates. Resulting translation adjustments are reported as a
component of stockholders' equity, along with any related hedge effects.
Revenues and expenses for these entities are translated at the weighted-average
exchange rates for the year. Revenue, expense and other foreign currency
transactions and translation adjustments for foreign subsidiaries and affiliates
with the U.S. dollar as the functional currency that affect cash flows are
reported in current operations, along with related hedge effects.
GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles include the cost of acquired subsidiaries in
excess of the fair value of the net tangible assets recorded in connection with
acquisitions. Due to the adoption of SFAS 142, goodwill and indefinite-lived
intangible assets were no longer amortized after January 1, 2002. Intangible
assets with a finite useful life continue to be amortized on a straight-line
basis generally over a period of 15 to 30 years. Goodwill and indefinite-lived
intangible assets not subject to amortization will be tested for impairment on
an annual basis during the fourth quarter each year, or more frequently if
events or changes in circumstances indicate that the asset might be impaired.
Goodwill impairment testing involves a two-step process described further in the
accounting changes section within Note 1. Impairment testing for
indefinite-lived intangible assets consists of a comparison of the fair value of
the intangible asset with its carrying value.
Other intangible assets with finite useful lives continue to be reviewed
periodically for indicators of impairment in value. If facts and circumstances
suggest possible impairment, the sum of the estimated undiscounted future cash
flows expected to result from the use of the asset is compared to the current
carrying value of the asset. If the undiscounted future cash flows are less than
the carrying value, an impairment loss is recognized for the excess of the
carrying amount of assets over their fair value. Prior to January 1, 2002, this
impairment method was used for all intangible assets and goodwill.
EARNINGS PER SHARE
Basic earnings per share is calculated by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period and excludes the dilutive effect of stock options. The calculation of
diluted earnings per share reflects the dilution that would have occurred had
the stock options been exercised, resulting in the issuance of common stock.
STOCK-BASED COMPENSATION
At December 31, 2002, we have four stock-based compensation plans, which are
described more fully in Note 19. We used the fair value method and the intrinsic
value method in 2002 and 2001, respectively, for these plans.
111
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Awards under our plans vest over periods ranging from three months to three
years. Therefore, the cost related to stock-based compensation included in the
determination of net income for 2002 is less than that which would have been
recognized if the fair value based method had been applied to all awards since
the inception of our stock-based compensation plans. Had compensation expense
for our stock option awards and employees' purchase rights been determined based
upon fair values at the grant dates for awards under the plans in accordance
with SFAS 123, our net income and earnings per share would have been reduced to
the pro forma amounts indicated below. For the purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period.
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 (1)
------------------- -------------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Net income, as reported............................................ $142.3 $358.8
Add: Stock-based compensation expense
included in reported net income, net of related tax effects.. 11.8 6.6
Deduct: Total stock-based compensation expense
determined under fair value based method for all awards,
net of related tax effects................................... 15.1 7.9
------------------- -------------------
Pro forma net income............................................... $139.0 $357.5
=================== ===================
Earnings per share:
Basic:
As reported....................................................... $0.41 $0.99
Pro forma......................................................... $0.40 $0.99
Diluted:
As reported....................................................... $0.41 $0.99
Pro forma......................................................... $0.40 $0.99
(1) Calculation of weighted-average shares included in the December 31, 2001,
pro forma disclosures is described in Note 20.
RECLASSIFICATIONS
Reclassifications have been made to the 2000 and 2001 consolidated financial
statements to conform to the 2002 presentation.
112
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. GOODWILL AND OTHER INTANGIBLE ASSETS
Amortized intangible assets were as follows (in millions):
AS OF DECEMBER 31, 2002 AS OF DECEMBER 31, 2001
------------------------------------- ------------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
--------- --------------- --------- --------- ------------- -------------
Value of insurance
in force acquired.... $83.5 $6.6 $76.9 $54.4 $7.2 $47.2
Other .................. 1.6 0.4 1.2 2.1 0.2 1.9
--------- --------------- --------- --------- ------------- -------------
Total amortized
intangibles ......... $85.1 $7.0 $78.1 $56.5 $7.4 $49.1
========= =============== ========= ========= ============= =============
Unamortized intangible assets were as follows (in millions):
AS OF DECEMBER 31,
2002 2001
---------------------- ----------------------
NET CARRYING NET CARRYING
AMOUNT AMOUNT
---------------------- ----------------------
Other indefinite-lived
intangible assets .............................. $10.7 $12.4
====================== ======================
The amortization expense for intangible assets with finite useful lives was $2.6
million, $2.5 million and $2.8 million for 2002, 2001 and 2000, respectively. At
December 31, 2002, the estimated amortization expense for the next five years is
as follows (in millions):
Estimated
amortization
expense
--------------------
2003........................................ $2.9
2004........................................ 2.7
2005........................................ 2.5
2006........................................ 2.3
2007........................................ 2.2
113
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
The changes in the carrying amount of goodwill reported in our operating
segments for 2002 were as follows (in millions):
U.S. ASSET INTERNATIONAL LIFE AND
MANAGEMENT AND ASSET MANAGEMENT HEALTH MORTGAGE
ACCUMULATION AND ACCUMULATION INSURANCE BANKING CONSOLIDATED
--------------- ------------------ ------------- -------------- ----------------
Balance at January 1, 2002..... $12.5 $33.7 $49.4 $8.4 $ 104.0
Goodwill from acquisitions..... 10.7 - - - 10.7
Goodwill disposed of
during the period.............. - - (0.7) - (0.7)
Cumulative effect of
accounting change (1).......... - - (4.6) - (4.6)
Foreign currency translation... - (2.9) - - (2.9)
---------------------------------- -------------- -------------- ----------------
Balance at December 31, 2002... $23.2 $30.8 $44.1 $8.4 $ 106.5
================================== ============== ============== ================
(1) Excludes goodwill impairments of $300.3 million related to BT Financial
Group (see Note 3) and $20.9 million related to an equity investment
subsidiary of Principal International.
3. DISCONTINUED OPERATIONS
On October 31, 2002, we sold substantially all of BT Financial Group to Westpac
Banking Corporation ("Westpac") for proceeds of A$900.0 million Australian
dollars ("A$") (U.S. $499.4 million), and future contingent proceeds in 2004 of
up to A$150.0 million (approximately U.S. $80.0 million). The contingent
proceeds will be based on Westpac's future success in growing retail funds under
management.
The decision to sell BT Financial Group was made with a view toward focusing our
resources, executing on core strategic priorities and meeting shareholder
expectations. Changing market dynamics since our acquisition of BT Financial
Group, including industry consolidation, led us to conclude that the interests
of BT Financial Group clients and staff would be best served under Westpac's
ownership.
Excluding the contingent proceeds, our estimated after-tax proceeds from the
sale are expected to be approximately U.S. $938.4 million. This amount includes
cash proceeds, expected tax benefits and a gain from unwinding the hedged asset
associated with debt used to acquire BT Financial Group in 1999. We have accrued
for an estimated after-tax loss on disposal of $208.7 million as of December 31,
2002. Future adjustments to the estimated loss are expected to be recorded
through the first half of 2003, as the proceeds from the sale are finalized.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, and therefore is still
included in our results of continuing operations. Assets and liabilities related
to BT Financial Group have been reclassified to assets of discontinued
operations and liabilities of discontinued operations on the consolidated
statements of financial position for all periods presented. The results of
114
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DISCONTINUED OPERATIONS (CONTINUED)
operations (excluding corporate overhead) for BT Financial Group are reported as
non-recurring items for the International Asset Management and Accumulation
segment in the Segment Information note (Note 18). Additionally, the information
included in the notes to the financial statements exclude information applicable
to BT Financial Group, unless otherwise noted.
Selected financial information for the discontinued operations is as follows:
AS OF
DECEMBER 31, 2001 (1)
-------------------------
(IN MILLIONS)
ASSETS
Goodwill and other intangibles ................... $ 993.0
Separate account assets .......................... 1,488.8
Other assets ..................................... 492.5
-------------------------
Total assets of discontinued operations ... $ 2,974.3
=========================
LIABILITIES
Separate account liabilities...................... $ 1,488.8
Other liabilities ................................ 284.5
-------------------------
Total liabilities of discontinued
operations ................................ $ 1,773.3
=========================
(1) As BT Financial Group was sold on October 31, 2002, there is no balance
sheet data to present as of December 31, 2002.
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------- --------------- -----------------
(IN MILLIONS)
Total revenues......................................... $ 139.7 $ 220.9 $ 285.5
============= =============== =================
Loss from continuing operations, net of related income
taxes (corporate overhead)........................ $ (2.6) $ (3.6) $ (2.0)
Income (loss) from discontinued operations:
Income (loss) before income taxes...................... 17.7 (15.6) 20.2
Income taxes (benefits)................................ 5.7 (4.4) 11.7
------------- --------------- -----------------
Income (loss) from discontinued operations (1)......... 12.0 (11.2) 8.5
Loss on disposal, net of related income tax benefit of
$89.6 million..................................... (208.7) - -
------------- --------------- -----------------
Income (loss) from discontinued operations, net of (196.7) (11.2) 8.5
related income taxes..............................
Cumulative effect of accounting change, net of related
income taxes...................................... (255.4) - -
------------- --------------- -----------------
Net income (loss)...................................... $ (454.7) $ (14.8) $ 6.5
============= =============== =================
(1) The 2002 summary results of operations information is for the 10 months
ended October 31, 2002, the date of sale of BT Financial Group.
115
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. OTHER DIVESTITURES
In September 2000, we sold a portion of our equity ownership position in
Coventry Health Care, Inc., which reduced our ownership to approximately 25% and
resulted in a realized capital gain of $13.9 million, net of income tax. The
investment in Coventry Health Care, Inc. was $146.0 million at December 31,
2001. On February 1, 2002, we sold our remaining stake of 15.1 million shares in
Coventry Health Care, Inc. common stock and a warrant, exercisable for 3.1
million shares of Coventry Health Care, Inc. common stock. Total proceeds from
the completion of this transaction were $325.4 million, which resulted in a
realized capital gain of $114.5 million, net of income tax.
5. INVESTMENTS
FIXED MATURITIES AND EQUITY SECURITIES
The cost, gross unrealized gains and losses and fair value of fixed maturities
and equity securities available-for-sale as of December 31, 2002 and 2001, are
summarized as follows (in millions):
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------------- ---------------- ---------------- ----------------
DECEMBER 31, 2002
Fixed maturities:
U.S. government and agencies.......... $ 502.6 $ 19.5 $ - $ 522.1
Foreign governments................... 595.5 64.4 - 659.9
States and political subdivisions..... 399.2 33.1 5.9 426.4
Corporate - public.................... 16,672.0 1,101.0 281.7 17,491.3
Corporate - private................... 8,522.7 523.0 186.5 8,859.2
Mortgage-backed and other
asset-backed securities............... 5,819.6 421.7 14.5 6,226.8
---------------- ---------------- ---------------- ----------------
Total fixed maturities................ $ 32,511.6 $ 2,162.7 $ 488.6 $ 34,185.7
================ ================ ================ ================
Total equity securities............... $ 381.0 $ 9.9 $ 12.2 $ 378.7
================ ================ ================ ================
DECEMBER 31, 2001
Fixed maturities:
U.S. government and agencies.......... $ 15.4 $ 0.1 $ 0.1 $ 15.4
Foreign governments................... 876.5 53.0 3.2 926.3
States and political subdivisions..... 302.1 20.1 4.7 317.5
Corporate - public.................... 13,049.2 513.6 160.4 13,402.4
Corporate - private................... 9,030.8 325.6 124.3 9,232.1
Mortgage-backed and other
asset-backed securities............... 5,891.3 253.5 26.2 6,118.6
---------------- ---------------- ---------------- ----------------
Total fixed maturities................ $ 29,165.3 $ 1,165.9 $ 318.9 $ 30,012.3
================ ================ ================ ================
Total equity securities............... $ 902.8 $ 15.7 $ 81.2 $ 837.2
================ ================ ================ ================
116
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
The cost and fair value of fixed maturities available-for-sale at December 31,
2002, by expected maturity, were as follows (in millions):
COST FAIR VALUE
------------------- ------------------
Due in one year or less............................................ $ 1,824.9 $ 1,843.4
Due after one year through five years.............................. 9,855.0 10,328.2
Due after five years through ten years............................. 7,726.5 8,245.7
Due after ten years................................................ 7,285.6 7,541.6
------------------- ------------------
26,692.0 27,958.9
Mortgage-backed and other asset-backed securities.................. 5,819.6 6,226.8
------------------- ------------------
Total.............................................................. $ 32,511.6 $ 34,185.7
=================== ==================
The above summarized activity is based on expected maturities. Actual maturities
may differ because borrowers may have the right to call or prepay obligations.
Corporate private placement bonds represent a primary area of credit risk
exposure. The corporate private placement bond portfolio is diversified by
issuer and industry. We monitor the restrictive bond covenants which are
intended to regulate the activities of issuers and control their leveraging
capabilities.
NET INVESTMENT INCOME
Major categories of net investment income are summarized as follows (in
millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Fixed maturities, available-for-sale............ $2,219.7 $2,207.0 $1,880.7
Fixed maturities, trading....................... 5.2 - -
Equity securities, available-for-sale........... 27.6 27.7 72.6
Mortgage loans.................................. 816.5 884.2 1,022.9
Real estate..................................... 85.7 178.2 171.3
Policy loans.................................... 57.6 57.5 55.1
Cash and cash equivalents....................... 16.8 28.1 26.7
Other........................................... 175.1 103.6 67.0
------------------ ------------------ ------------------
3,404.2 3,486.3 3,296.3
Less investment expenses........................ (99.5) (102.7) (138.7)
------------------ ------------------ ------------------
Net investment income........................... $3,304.7 $3,383.6 $3,157.6
================== ================== ==================
117
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
NET REALIZED/UNREALIZED CAPITAL GAINS AND LOSSES
The major components of net realized/unrealized capital gains (losses) on
investments are summarized as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Fixed maturities, available-for-sale:
Gross gains...................................... $ 172.3 $ 75.8 $ 29.1
Gross losses..................................... (538.5) (408.8) (155.0)
Fixed maturities, trading:
Gross gains...................................... 4.0 0.9 -
Gross losses..................................... (0.1) (0.1) -
Equity securities, available-for-sale:
Gross gains...................................... 4.1 9.4 84.2
Gross losses..................................... (32.8) (76.9) (5.0)
Mortgage loans................................... (10.3) 10.7 8.6
Real estate...................................... 9.3 (19.0) 82.3
Other, including unrealized derivative
gains (losses)................................... 37.2 (106.0) 95.4
----------------- ------------------ ------------------
Net realized/unrealized capital gains (losses)... $(354.8) $ (514.0) $ 139.6
================== ================== ==================
Proceeds from sales of investments (excluding call and maturity proceeds) in
fixed maturities were $8.2 billion, $5.7 billion and $5.7 billion in 2002, 2001
and 2000, respectively. Of the 2002, 2001 and 2000 proceeds, $4.3 billion, $1.6
billion and $2.6 billion, respectively, relate to sales of mortgage-backed
securities. Our mortgage-backed portfolio is actively managed to reduce the risk
of prepayment by purchasing securities that are trading close to par. Gross
gains of $88.2 million, $22.5 million and $2.0 million and gross losses of $11.6
million, $5.0 million and $40.1 million in 2002, 2001 and 2000, respectively,
were realized on sales of mortgage-backed securities.
We recognize impairment losses for fixed maturities and equity securities when
declines in value are other than temporary. Realized losses related to other
than temporary impairments were $357.0 million, $227.4 million and $6.1 million
in 2002, 2001 and 2000, respectively.
NET UNREALIZED GAINS AND LOSSES ON AVAILABLE-FOR-SALE SECURITIES
The net unrealized gains and losses on investments in fixed maturities and
equity securities available-for-sale are reported as a separate component of
equity, reduced by adjustments to deferred policy acquisition costs and unearned
revenue reserves that would have been required as a charge or credit to
operations had such amounts been realized and a provision for deferred income
taxes.
118
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
The cumulative amount of net unrealized gains and losses on available-for-sale
securities was as follows (in millions):
AS OF DECEMBER 31,
2002 2001
---------------- -----------------
Net unrealized gains on fixed maturities, available-for-sale (1)....... $1,671.4 $827.0
Net unrealized losses on equity securities, available-for-sale......... (4.6) (42.4)
Adjustments for assumed changes in amortization patterns:
Deferred policy acquisition costs...................................... (226.2) (104.6)
Unearned revenue reserves.............................................. 13.6 7.2
Net unrealized losses on derivative instruments........................ (167.1) (52.5)
Net unrealized loss on policyholder dividend obligation................ (33.6) -
Provision for deferred income taxes.................................... (431.5) (214.4)
--------------- -----------------
Net unrealized gains on available-for-sale securities................. $ 822.0 $420.3
================ =================
(1) Excludes net unrealized gains (losses)on fixed maturities,
available-for-sale included in fair value hedging relationships.
COMMERCIAL MORTGAGE LOANS
Commercial mortgage loans represent a primary area of credit risk exposure. At
December 31, 2002 and 2001, the commercial mortgage portfolio is diversified by
geographic region and specific collateral property type as follows (dollars in
millions):
AS OF DECEMBER 31,
2002 2001
--------------------------------- ---------------------------
CARRYING PERCENT CARRYING PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
--------------- ---------------- ---------- ---------------
GEOGRAPHIC DISTRIBUTION
New England........................... $ 387.6 4.1% $ 327.4 3.4%
Middle Atlantic....................... 1,617.0 17.3 1,606.3 16.5
East North Central.................... 913.7 9.8 930.1 9.5
West North Central.................... 311.5 3.3 397.8 4.1
South Atlantic........................ 2,180.8 23.3 2,403.0 24.7
East South Central.................... 345.5 3.7 338.5 3.5
West South Central.................... 641.8 6.9 769.0 7.9
Mountain.............................. 711.8 7.6 637.7 6.5
Pacific............................... 2,339.7 24.9 2,421.3 24.8
Valuation allowance................... (83.6) (0.9) (90.7) (0.9)
--------------- ---------------- -------------- ---------------
Total................................. $ 9,365.8 100.0% $ 9,740.4 100.0%
=============== ================ ============== ===============
PROPERTY TYPE DISTRIBUTION
Office................................ $ 3,166.2 33.8% $ 3,252.5 33.4%
Retail................................ 2,836.0 30.3 3,106.5 31.9
Industrial............................ 2,802.6 29.9 2,948.9 30.3
Apartments............................ 475.4 5.1 349.8 3.6
Hotel................................. 57.4 0.6 61.6 0.6
Mixed use/other....................... 111.8 1.2 111.8 1.1
Valuation allowance................... (83.6) (0.9) (90.7) (0.9)
--------------- ---------------- -------------- ---------------
Total................................ $ 9,365.8 100.0% $ 9,740.4 100.0%
=============== ================ ============== ===============
119
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
COMMERCIAL AND RESIDENTIAL MORTGAGE LOAN LOSS ALLOWANCE
Mortgage loans on real estate are considered impaired when, based on current
information and events, it is probable that we will be unable to collect all
amounts due according to contractual terms of the loan agreement. When we
determine that a loan is impaired, a provision for loss is established equal to
the- difference between the carrying amount of the mortgage loan and the
estimated value. Estimated value is based on either the present value of the
expected future cash flows discounted at the loan's effective interest rate, the
loan's observable market price or fair value of the collateral. The provision
for losses is included in net realized/unrealized capital gains (losses) on our
consolidated statements of operations. Mortgage loans deemed to be uncollectible
are charged against the allowance for losses, and subsequent recoveries are
credited to the allowance for losses.
The allowance for losses is maintained at a level believed adequate by
management to absorb estimated probable credit losses. Management's periodic
evaluation of the adequacy of the allowance for losses is based on 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 be susceptible to significant change.
Impaired mortgage loans along with the related allowance for losses were as
follows (in millions):
AS OF DECEMBER 31,
2002 2001
------------------ ------------------
Impaired loans with allowance for
losses.................................. $ 123.0 $ 97.6
Allowance for losses.................... (26.9) (17.0)
------------------ ------------------
Net impaired loans...................... $ 96.1 $ 80.6
================== ==================
The average recorded investment in impaired mortgage loans and the interest
income recognized on impaired mortgage loans were as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
-------------- --------------- -------------
Average recorded investment
in impaired loans.............. $88.4 $74.4 $72.8
Interest income recognized
on impaired loans.............. 8.6 12.5 12.6
120
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
All interest income on impaired commercial mortgage loans was recognized on the
cash basis of income recognition, whereas, interest income on impaired
residential mortgage loans was recognized on the accrual basis.
A summary of the changes in the commercial and residential mortgage loan
allowance for losses is as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Balance at beginning of year..................... $92.3 $110.4 $117.8
Provision for losses............................. 35.1 11.2 5.4
Releases due to write-downs,
sales and foreclosures.......................... (40.4) (29.3) (12.8)
------------------ ------------------ ------------------
Balance at end of year........................... $87.0 $ 92.3 $110.4
================== ================== ==================
RESIDENTIAL MORTGAGE BANKING ACTIVITIES
We were servicing approximately 920,000 and 741,000 residential mortgage loans
with aggregate principal balances of approximately $107,745.3 million and
$80,530.5 million at December 31, 2002 and 2001, respectively. In connection
with these mortgage servicing activities, we held funds in trust for others
totaling approximately $646.7 million and $508.9 million at December 31, 2002
and 2001, respectively. As of December 31, 2002 and 2001, $273.9 million and
$252.4 million, respectively, of the funds held in trust were held in our
banking subsidiary. In connection with our loan administration activities, we
advance payments of property taxes and insurance premiums and also advance
principal and interest payments to investors in advance of collecting funds from
specific mortgagors. In addition, we make certain payments of attorney fees and
other costs related to loans in foreclosure. These amounts receivable are
recorded, at cost, as other assets in our consolidated statements of financial
position. Amounts advanced are considered in management's evaluation of the
adequacy of the mortgage loan allowance for losses.
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 $47.1 billion and
$38.0 billion in mortgage loans to PRMCR in 2002 and 2001, respectively. The
maximum amount of mortgage loans, which can be warehoused in PRMCR, has
increased from $1.0 billion at inception to $4.0 billion as of December 31,
2002. PRMCR held $4.0 billion and $3.0 billion in mortgage loans held-for-sale
as of December 31, 2002 and 2001, respectively. The portfolio of loans
held-for-sale by PRMCR must meet portfolio criteria, eligibility representations
and portfolio aging limitations. Based on these eligibility representations, we
are required to repurchase ineligible loans from PRMCR. During 2002, we
repurchased $51.9 million of ineligible loans from PRMCR.
PRMCR is capitalized by equity certificates owned by third party investors not
affiliated with us or our affiliates, directors or officers and, thus, is not
consolidated. The equity holders bear the risk of loss on defaulted mortgages.
At December 31, 2002 and 2001, PRMCR had outstanding equity certificates of
$193.0 million. PRMCR also issues short-term secured liquidity notes as well as
medium term notes to provide funds to purchase mortgage loans from us. At
December 31, 2002, PRMCR had outstanding secured liquidity notes of $2.2
billion, three-year fixed term notes of $800.0 million and five-year variable
term notes of $800.0 million. At December 31, 2001, PRMCR had outstanding
secured liquidity notes of $1.3 billion, three-year fixed term notes of $800.0
121
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
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 mortgage loans. The balance in the account was $24.0 million
at December 31, 2002 and 2001, and is reflected in other assets on our
consolidated statements of financial position. We maintain a right to the
servicing of the mortgage loans held by PRMCR and retain servicing upon the sale
of the majority of the mortgage loans to the final investors. As the servicer,
we receive a monthly servicing fee and may earn additional incentive servicing
fees upon successful completion of our servicing responsibilities. We received
$23.3 million and $12.6 million in servicing and incentive servicing fees from
PRMCR in 2002 and 2001, respectively. Any unpaid and earned incentive fees as
well as any remaining amounts in the cash collateral account will be returned to
us upon the termination of PRMCR. Additionally, as the servicer, we are required
to advance to PRMCR those payments due from borrowers, but not received, as of
specified cutoff dates. In addition, we perform certain secondary marketing,
accounting and various administrative functions on behalf of PRMCR. In order to
hedge interest rate risk and non-credit-related market value risk associated
with its inventory of mortgage loans held-for-sale, PRMCR entered into swaps
with counterparties not affiliated with us or PRMCR. The swap counterparties are
required to maintain certain minimum ratings as approved by the rating agencies.
Through separate swap agreements with the swap counterparties that mirror the
original swaps with PRMCR, the interest rate risk and non-credit-related market
value components are swapped back to us.
Upon the effective date of FIN 46, as described in Note 1, we will be required
to consolidate PRMCR unless its current structure is modified. If FIN 46 was
effective as of December 31, 2002, the impact would be the consolidation of $4.1
billion in assets and liabilities.
In October 2000, our mortgage banking segment created a wholly owned,
unconsolidated qualifying special purpose entity, Principal Residential Mortgage
Funding, LLC ("PRMF"), to provide an off-balance-sheet source of funding for up
to $250.0 million of qualifying delinquent mortgage loans. The limit was
increased to $550.0 million in December 2002. We sell qualifying delinquent FHA
and VA mortgage loans to PRMF which then transfers the loans to Principal
Residential Mortgage EBO Trust ("Trust"), an unaffiliated Delaware business
trust. The Trust funds its acquisitions of the mortgage loans by selling
participation certificates, representing an undivided interest in the Trust, to
commercial paper conduit purchasers, who are not affiliated with us or any of
our affiliates, directors or officers. At December 31, 2002 and 2001, the Trust
held $405.1 million and $273.5 million in mortgage loans, respectively, and had
outstanding participation certificates of $382.8 million and $256.9 million,
respectively.
Mortgage loans typically remain in the Trust until they are processed through
the foreclosure claim process, are paid off or reinstated. Mortgage loans that
reinstate are no longer eligible to remain in the Trust and are required to be
removed at fair market value by us at the monthly settlement date following
reinstatement.
122
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
We are retained as the servicer of the mortgage loans and also perform
accounting and various administrative functions on behalf of PRMF, in our
capacity as the managing member of PRMF. As the servicer, we receive a servicing
fee pursuant to the pooling and servicing agreement. We may also receive a
successful servicing fee only after all other conditions in the monthly cash
flow distribution are met. We received $23.4 million and $8.5 million in
servicing and successful servicing fees from PRMF in 2002 and 2001,
respectively. At December 31, 2002 and 2001, our residual interest in such cash
flows was $32.7 million and $21.5 million, respectively, and was recorded in
other assets on our consolidated statements of financial position. The value of
the residual interest was based on the net present value of expected cash flows
from PRMF, reduced by 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 trust collection account to meet this obligation.
Both the Trust and us, 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 weighted-average coupon of mortgage loans in the
Trust less a spread.
Based on PRMF's classification as a qualifying special purpose entity pursuant
to the guidance of SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF
FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES - A REPLACEMENT OF FASB
STATEMENT NO. 125, PRMF will not be required to be consolidated under the
provisions of FIN 46.
REAL ESTATE
Depreciation expense on invested real estate was $31.8 million, $20.2 million
and $29.3 million in 2002, 2001 and 2000, respectively. Accumulated depreciation
was $157.3 million and $142.4 million as of December 31, 2002 and 2001,
respectively.
OTHER INVESTMENTS
Other investments include minority interests in unconsolidated entities and
properties owned jointly with venture partners and operated by the partners.
Total assets of the unconsolidated entities amounted to $3,637.9 million and
$4,768.8 million at December 31, 2002 and 2001, respectively. Total revenues of
the unconsolidated entities were $618.8 million, $2,855.2 million and $2,226.3
million in 2002, 2001 and 2000, respectively. During 2002, 2001 and 2000, we
included $19.2 million, $48.8 million and $39.1 million, respectively, in net
investment income representing our share of current year net income of the
unconsolidated entities. At December 31, 2002, our net investment in
unconsolidated entities was $22.3 million, which primarily included our minority
interests in domestic and international joint ventures and partnerships. At
December 31, 2001, our net investment in unconsolidated entities was $234.8
million, which primarily included our ownership interest in Coventry Health
Care, Inc. in addition to our minority interests in joint ventures and
partnerships. On February 1, 2002, we sold our minority interest in Coventry
Health Care, Inc. (See Note 4).
In the ordinary course of our business and as part of our investment operations,
we have also entered into long term contracts to make and purchase loans
aggregating $525.1 million and $432.9 million at December 31, 2002 and 2001,
respectively.
123
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS (CONTINUED)
With the adoption of SFAS 133 on January 1, 2001, derivatives are reflected on
our consolidated statements of financial position and reported as a component of
other investments. Certain seed money investments, which were reclassified from
equity securities to other invested assets as of September 30, 2002, are carried
at fair value with changes in fair value included in net income as net
realized/unrealized capital gains (losses).
6. SECURITIZATION TRANSACTIONS
COMMERCIAL MORTGAGE LOANS
We sell commercial mortgage loans in securitization transactions and retain
primary servicing responsibilities and other immaterial interests. We receive
annual servicing fees approximating 0.01%, which approximates cost. The
investors and the securitization entities have no recourse to our other assets
for failure of debtors to pay when due. The value of our retained interests is
subject primarily to credit risk.
In 2002 and 2001, we recognized gains of $17.2 million and $18.3 million,
respectively, on the securitization of commercial mortgage loans.
Key economic assumptions used in measuring the retained interests at the date of
securitization resulting from transactions completed included a cumulative
default rate between 6% and 11% during 2002 and 4% and 8% during 2001. The
assumed range of the loss severity, as a percentage of defaulted loans, was
between 12% and 32% during 2002 and 12% and 25% during 2001. The low end of the
loss severity range relates to a portfolio of seasoned loans. The high end of
the loss severity range relates to a portfolio of newly issued loans.
At December 31, 2002, the fair values of retained interests related to the
securitizations of commercial mortgage loans were $229.6 million. Key economic
assumptions and the sensitivity of the current fair values of residual cash
flows were tested to one and two standard deviations from the expected rates.
The changes in the fair values at December 31, 2002, as a result of these
assumptions were not significant.
RESIDENTIAL MORTGAGE LOANS
We sell residential mortgage loans and retain servicing responsibilities
pursuant to the terms of the applicable servicing agreements. These sales are
generally transacted on a non-recourse basis. We receive annual servicing fees
approximating 0.4% of the outstanding principal balances on the underlying
loans. The value of the servicing rights is subject to prepayment and interest
rate risks on the transferred mortgage loans.
In 2002, 2001 and 2000, we recognized gains of $373.9 million, $237.2 million
and $9.4 million, respectively, on the sales of residential mortgage loans.
The key economic assumptions used in determining the fair value of mortgage
servicing rights at the date of loan sale for sales completed in 2002, 2001 and
2000 were as follows:
2002 2001 2000
------------------- -------------------- ------------------
Weighted-average life (years)................... 6.42 7.84 6.87
Weighted-average prepayment speed............... 11.91% 9.48% 11.81%
Yield to maturity discount rate................. 6.75% 7.45% 10.74%
124
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. SECURITIZATION TRANSACTIONS (CONTINUED)
Prepayment speed is the constant prepayment rate that results in the
weighted-average life disclosed above.
At December 31, 2002, key economic assumptions and the sensitivity of the
current fair value of the mortgage servicing rights to immediate 10% and 20%
adverse changes in those assumptions were as follows (dollars in millions):
Fair value of mortgage servicing rights........... $1,527.6
Expected weighted-average life (in years)......... 4.2
Prepayment speed *................................ 19.80%
Decrease in fair value of 10% adverse change...... $ 96.4
Decrease in fair value of 20% adverse change...... $ 182.0
Yield to maturity discount rate *................. 5.53%
Decrease in fair value of 10% adverse change...... $ 63.9
Decrease in fair value of 20% adverse change...... $ 127.7
* Represents the weighted average prepayment speed and discount rate for the
life of the mortgage servicing rights asset using our Option Adjusted
Spread/Monte Carlo simulation of 160 interest rate paths.
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10% variation in assumptions
generally cannot be extrapolated because the relationship of the change in the
assumption to the change in fair value may not be linear. Also, in the above
table, the effect of a variation in a particular assumption on the fair value of
the servicing rights is calculated independently without changing any other
assumption. In reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities. For example, changes in
prepayment speed estimates could result in changes in the discount rate.
SECURITIZATION TRANSACTIONS CASH FLOWS
The table below summarizes cash flows for securitization transactions (in
millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
---------------------- ---------------------- ----------------------
Proceeds from new securitizations...... $48,749.4 $39,200.6 $9,927.6
Servicing fees received................ 443.1 307.8 237.5
Other cash flows received on
retained interests..................... 74.9 51.6 29.4
7. DERIVATIVES HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING
Derivatives are generally held for purposes other than trading and are primarily
used to hedge or reduce exposure to interest rate and foreign currency risks
associated with assets held or expected to be purchased or sold and liabilities
incurred or expected to be incurred. Additionally, derivatives are used to
change the characteristics of our asset/liability mix consistent with our risk
management activities.
125
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DERIVATIVES HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING (CONTINUED)
Our risk of loss is typically limited to the fair value of our derivative
instruments and not to the notional or contractual amounts of these derivatives.
Risk arises from changes in the fair value of the underlying instruments. We are
also exposed to credit losses in the event of nonperformance of the
counterparties. Our current credit exposure is limited to the value of
derivatives that have become favorable to us. This credit risk is minimized by
purchasing such agreements from financial institutions with high credit ratings
and by establishing and monitoring exposure limits. We also utilize various
credit enhancements, including collateral and credit triggers to reduce the
credit exposure to our derivative instruments.
Our derivative transactions are generally documented under International Swaps
and Derivatives Association, Inc. Master Agreements. Management believes that
such agreements provide for legally enforceable set-off and close-out netting of
exposures to specific counterparties. Under such agreements, in connection with
an early termination of a transaction, we are permitted to set off our
receivable from a counterparty against our payables to the same counterparty
arising out of all included transactions.
Prior to the application of the aforementioned credit enhancements, the gross
exposure to credit risk with respect to these derivative instruments was $424.4
million at December 31, 2002, and $307.4 million at December 31, 2001.
Subsequent to the application of such credit enhancements, the net exposure to
credit risk was $285.8 million at December 31, 2002, and $307.4 million at
December 31, 2001.
126
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DERIVATIVES HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING (CONTINUED)
The notional amounts and credit exposure of our derivative financial instruments
by type were as follows (in millions):
AS OF DECEMBER 31,
2002 2001
------------------- ------------------
NOTIONAL AMOUNTS OF DERIVATIVE INSTRUMENTS WITH
REGARD TO U.S. OPERATIONS
Foreign currency swaps.............................................. $ 3,217.0 $ 4,091.9
Interest rate floors................................................ 1,650.0 3,400.0
Interest rate swaps................................................. 5,930.1 3,522.5
Mortgage-backed forwards and options................................ 17,494.9 9,250.7
Swaptions........................................................... 9,772.5 3,570.0
Bond forwards....................................................... 363.7 357.4
Interest rate lock commitments...................................... 8,198.0 2,565.9
Call options........................................................ 30.0 30.0
U.S. Treasury futures............................................... 271.1 186.6
Currency forwards................................................... - 380.0
Treasury rate guarantees............................................ 63.0 88.0
Warehouse SRP....................................................... 3,912.7 -
Credit default swap long............................................ 705.3 -
U.S. LIBOR.......................................................... 2,225.0 -
Other............................................................... - 25.0
------------------- ------------------
53,833.3 27,468.0
NOTIONAL AMOUNTS OF DERIVATIVE INSTRUMENTS WITH
REGARD TO INTERNATIONAL OPERATIONS
Currency forwards.................................................. 0.2 13.4
------------------- ------------------
Total notional amounts at end of year.............................. $53,833.5 $27,481.4
=================== ==================
CREDIT EXPOSURE OF DERIVATIVE INSTRUMENTS WITH
REGARD TO U.S. OPERATIONS
Foreign currency swaps............................................. $ 195.0 $ 101.1
Interest rate floors............................................... 1.7 13.2
Interest rate swaps................................................ 48.4 78.4
Mortgage-backed forwards and options............................... - 41.7
Swaptions.......................................................... 31.4 8.7
Call options....................................................... 0.4 8.9
Currency forwards.................................................. - 55.3
Credit default swap long........................................... 8.9 -
Other............................................................... - 0.1
------------------- ------------------
Total credit exposure at end of year................................ $ 285.8 $ 307.4
=================== ==================
127
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DERIVATIVES HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING (CONTINUED)
The net interest effect of interest rate and currency swap transactions is
recorded as an adjustment to net investment income or interest expense, as
appropriate, over the periods covered by the agreements. The cost of derivative
instruments related to residential mortgage loan servicing rights is included in
the basis of the derivatives. These derivatives are marked to market with the
changes in market value reported in operating expenses on the consolidated
statements of operations.
The fair value of our derivative instruments classified as assets at December
31, 2002 and 2001, was $1,129.9 million and $298.8 million, respectively. Of
this amount, the fair value of derivatives related to investment hedges at
December 31, 2002 and 2001, was $348.8 million and $116.5 million, respectively,
and was reported with other invested assets on the consolidated statements of
financial position. The fair value of derivatives related to residential
mortgage loan servicing rights and residential mortgage loans at December 31,
2002 and 2001, was $781.1 million and $182.3 million, respectively, and was
reported with other assets on the consolidated statements of financial position.
The fair value of derivative instruments classified as liabilities at December
31, 2002 and 2001, was $454.4 million and $449.7 million, respectively, and was
reported with other liabilities on the consolidated statements of financial
position.
FAIR VALUE HEDGES
We use fixed-to-floating rate interest rate swaps to more closely align the
interest rate characteristics of certain assets and liabilities. In general,
these swaps are used in asset and liability management to modify duration.
We also enter into currency exchange swap agreements to convert certain foreign
denominated assets and liabilities into U.S. dollar floating-rate denominated
instruments to eliminate the exposure to future currency volatility on those
items.
In 2002 and 2001, we recognized a pretax net gain of $50.5 million and $95.5
million, respectively, relating to our fair value hedges. These net gains
consisted of the following components:
FOR THE YEAR ENDED DECEMBER 31,
2002 2001
------------------ ------------------
Net gain (loss) related to the ineffective portion of our fair
value hedges of residential mortgage loan servicing rights....... $(6.6) $151.7
Net gain (loss) related to the change in the value of the servicing
hedges that were excluded from the assessment of hedge
effectiveness.................................................... 77.1 (43.6)
Net loss related to the ineffective portion of our
investment hedge................................................. (20.0) (12.6)
------------------ ------------------
Net gain relating to fair value hedges.............................. $50.5 $ 95.5
================== ==================
The net gain (loss) on servicing hedges was reported with operating expenses and
the net loss on our investment hedges was reported with net realized/unrealized
capital gains (losses) on our consolidated statements of operations.
CASH FLOW HEDGES
We also utilize floating-to-fixed rate interest rate swaps to match cash flows.
128
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DERIVATIVES HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING (CONTINUED)
We entered into currency exchange swap agreements to convert both principal and
interest payments of certain foreign denominated assets and liabilities into
U.S. dollar denominated fixed-rate instruments to eliminate the exposure to
future currency volatility on those items.
In 2002 and 2001, we recognized a $74.5 million and $5.8 million, respectively,
after-tax decrease in value related to cash flow hedges in accumulated other
comprehensive income. During this time period, none of our cash flow hedges have
been discontinued because it was probable that the original forecasted
transaction would not occur by the end of the originally specified time period.
We have reclassified $17.8 million net losses from accumulated comprehensive
income into earnings in during 2002 (none was transferred during 2001), and we
expect to reclassify $54.3 million net losses in the next 12 months.
In most cases, zero hedge ineffectiveness for cash flow hedges is assumed
because the derivative instrument was constructed such that all terms of the
derivative match the hedged risk in the hedged item. As a result, we have
recognized an immaterial amount in earnings due to cash flow hedge
ineffectiveness.
DERIVATIVES NOT DESIGNATED AS HEDGING INSTRUMENTS
We attempt to match the timing of when interest rates are committed on insurance
products, residential mortgage loans and other new investments. However, timing
differences may occur and can expose us to fluctuating interest rates. To offset
this risk, we use mortgage-backed forwards, over-the-counter options on
mortgage-backed securities, U.S. Treasury futures contracts, options on Treasury
futures, Treasury rate guarantees and interest rate floors to economically hedge
anticipated transactions and to manage interest rate risk. Futures contracts are
marked to market and settled daily, which minimizes the counterparty risk.
Forward contracts are marked to market no less than quarterly. Our interest rate
lock commitments on residential mortgage loans are also accounted for as
derivatives.
Occasionally, we will sell a callable investment-type contract and may use
interest rate swaptions or similar instruments to transform the callable
liability into a fixed term liability. In addition, we may sell an
investment-type contract with attributes tied to market indices, in which case
we write an equity call option to convert the overall contract into a fixed-rate
liability, essentially eliminating the equity component altogether. We have also
entered into credit default swaps to exchange the credit default swap risk of
one bond for that of another.
Although the above-mentioned derivatives are effective hedges from an economic
standpoint, they do not meet the requirements for hedge accounting treatment
under SFAS 133. As such, periodic changes in the market value of these
instruments flow directly into net income. In 2002 and 2001, gains of $19.1
million and $68.3 million, respectively, were recognized in income from market
value changes of derivatives not receiving hedge accounting treatment.
In 2002, we entered into an interest rate swap as part of a structuring process
of an investment grade collateralized debt obligation ("CDO") issuance. Due to
market conditions, the CDO was never issued. The pre-tax loss realized on the
termination of the interest rate swap was $17.3 million.
129
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CLOSED BLOCK
In connection with the 1998 MIHC formation, Principal Life formed a Closed Block
to provide reasonable assurance to policyholders included therein that, after
the formation of the MIHC, assets would be available to maintain dividends in
aggregate in accordance with the 1997 policy dividend scales, if the experience
underlying such scales continued. Assets of Principal Life were allocated to the
Closed Block in an amount that produces cash flows which, together with
anticipated revenue from policies and contracts included in the Closed Block,
were expected to be sufficient to support the Closed Block policies, including,
but not limited to, provisions for payment of claims, certain expenses, charges
and taxes, and to provide for continuation of policy and contract dividends in
aggregate in accordance with the 1997 dividend scales, if the experience
underlying such scales continues, and to allow for appropriate adjustments in
such scales, if such experience changes. Due to adjustable life policies being
included in the Closed Block, the Closed Block is charged with amounts necessary
to properly fund for certain adjustments, such as face amount and premium
increases, that are made to these policies after the Closed Block inception
date. These amounts are referred to as Funding Adjustment Charges and are
treated as capital transfers from the Closed Block.
Assets allocated to the Closed Block inure solely to the benefit of the holders
of policies included in the Closed Block. Closed Block assets and liabilities
are carried on the same basis as other similar assets and liabilities. Principal
Life will continue to pay guaranteed benefits under all policies, including the
policies within the Closed Block, in accordance with their terms. If the assets
allocated to the Closed Block, the investment cash flows from those assets and
the revenues from the policies included in the Closed Block, including
investment income thereon, prove to be insufficient to pay the benefits
guaranteed under the policies included in the Closed Block, Principal Life will
be required to make such payments from their general funds. No additional
policies were added to the Closed Block, nor was the Closed Block affected in
any other way, as a result of the demutualization.
A policyholder dividend obligation is required to be established for earnings in
the Closed Block that are not available to shareholders. A model of the Closed
Block was established to produce the pattern of expected earnings in the Closed
Block (adjusted to eliminate the impact of related amounts in accumulated other
comprehensive income). If actual cumulative earnings of the Closed Block are
greater than the expected cumulative earnings of the Closed Block, only the
expected cumulative earnings will be recognized in income with the excess
recorded as a policyholder dividend obligation. This policyholder dividend
obligation represents undistributed accumulated earnings that will be paid to
Closed Block policyholders as additional policyholder dividends unless offset by
future performance of the Closed Block that is less favorable than originally
expected. If actual cumulative performance is less favorable than expected, only
actual earnings will be recognized in income. At December 31, 2002, cumulative
actual earnings have been less than cumulative expected earnings. However,
cumulative net unrealized gains were greater than expected resulting in the
recognition of a policyholder dividend obligation of $33.6 million as of
December 31, 2002.
130
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CLOSED BLOCK (CONTINUED)
Closed Block liabilities and assets designated to the Closed Block were as
follows:
AS OF DECEMBER 31,
2002 2001
------------------------- -------------------------
(IN MILLIONS)
CLOSED BLOCK LIABILITIES
Future policy benefits and claims................... $5,320.0 $5,248.7
Other policyholder funds............................ 33.0 20.3
Policyholder dividends payable...................... 374.3 376.6
Policyholder dividend obligation.................... 33.6 -
Other liabilities................................... 20.1 11.8
------------------------- -------------------------
Total Closed Block liabilities...................... 5,781.0 5,657.4
ASSETS DESIGNATED TO THE CLOSED BLOCK
Fixed maturities, available-for-sale................ 2,707.0 2,466.3
Equity securities, available-for-sale............... 23.4 23.4
Mortgage loans...................................... 862.9 880.0
Real estate......................................... 0.5 -
Policy loans........................................ 776.1 792.5
Other investments................................... 19.8 6.9
------------------------- -------------------------
Total investments................................... 4,389.7 4,169.1
Cash and cash equivalents (deficit)................. (5.4) (8.0)
Accrued investment income........................... 77.5 77.2
Deferred tax asset.................................. 68.5 80.8
Premiums due and other receivables.................. 29.5 33.3
------------------------- -------------------------
Total assets designated to the Closed Block......... 4,559.8 4,352.4
------------------------- -------------------------
Excess of Closed Block liabilities over assets
designated to the Closed Block...................... 1,221.2 1,305.0
Amounts included in other
comprehensive income................................ 77.8 43.6
------------------------- -------------------------
Maximum future earnings to be recognized from Closed
Block assets and liabilities........................ $1,299.0 $1,348.6
========================= =========================
131
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CLOSED BLOCK (CONTINUED)
Closed Block revenues and expenses were as follows:
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ----------------------
(IN MILLIONS)
REVENUES
Premiums and other considerations......... $710.0 $ 742.1 $ 752.4
Net investment income..................... 309.9 311.8 289.9
Net realized/unrealized capital losses.... (40.8) (19.7) (4.9)
------------------ ------------------ ----------------------
Total revenues............................ 979.1 1,034.2 1,037.4
EXPENSES
Benefits, claims and settlement
expenses.................................. 583.3 614.4 601.2
Dividends to policyholders................ 305.2 305.8 307.7
Operating expenses........................ 12.3 12.7 13.6
------------------ ------------------ ----------------------
Total expenses............................ 900.8 932.9 922.5
------------------ ------------------ ----------------------
Closed Block revenue, net of Closed Block
expenses, before income taxes............. 78.3 101.3 114.9
Income taxes.............................. 25.2 33.5 38.4
------------------ ------------------ ----------------------
Closed Block revenue, net of Closed Block
expenses and income taxes................. 53.1 67.8 76.5
Funding adjustment charges................ (3.5) (7.6) (12.0)
------------------ ------------------ ----------------------
Closed Block revenue, net of Closed Block
expenses, income tax and funding
adjustment charges........................ $ 49.6 $ 60.2 $ 64.5
================== ================== ======================
The change in maximum future earnings of the Closed Block was as follows:
AS OF DECEMBER 31,
2002 2001
----------------------- -------------------------
(IN MILLIONS)
Beginning of year.................................... $ 1,348.6 $ 1,408.8
End of year.......................................... 1,299.0 1,348.6
----------------------- -------------------------
Change in maximum future earnings.................... $ (49.6) $ (60.2)
======================= =========================
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.
132
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs deferred and amortized in 2002, 2001 and 2000 were as
follows (in millions):
AS OF DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Balance at beginning of year..................... $1,372.5 $1,333.3 $1,430.9
Cost deferred during the year.................... 323.4 261.7 263.9
Amortized to expense during the year............. (144.5) (159.9) (238.6)
Effect of unrealized gains....................... (137.0) (62.6) (122.9)
------------------ ------------------ ------------------
Balance at end of year........................... $1,414.4 $1,372.5 $1,333.3
================== ================== ==================
10. INSURANCE LIABILITIES
CONTRACTHOLDER FUNDS
Major components of contractholder funds in the consolidated statements of
financial position are summarized as follows (in millions):
AS OF DECEMBER 31,
2002 2001
------------------- ------------------
Liabilities for investment-type contracts:
Guaranteed investment contracts.................................... $13,894.4 $14,123.5
U.S. funding agreements............................................ 107.8 307.1
International funding agreements backing medium-term
notes.............................................................. 3,583.5 3,298.4
International funding agreements................................... 2,555.0 723.9
Other investment-type contracts.................................... 1,775.3 2,276.3
------------------- ------------------
Total liabilities for investment-type contracts.................... 21,916.0 20,729.2
Liabilities for individual annuities............................... 2,900.4 2,557.6
Universal life and other reserves.................................. 1,498.6 1,397.6
------------------- ------------------
Total contractholder funds......................................... $26,315.0 $24,684.4
=================== ==================
Our guaranteed investment contracts and funding agreements contain provisions
limiting early surrenders, including penalties for early surrenders and minimum
notice requirements. Put provisions give customers the option to terminate a
contract prior to maturity, provided they give a minimum notice period.
Funding agreements are issued to nonqualified institutional investors both in
domestic and international markets. We have a $4.0 billion international
program, under which a consolidated offshore special purpose entity was created
to issue nonrecourse medium-term notes. Under the program, the proceeds of each
note series issuance are used to purchase a funding agreement from us, which is
used to secure that particular series of notes. The payment terms of any
particular series of notes match the payment terms of the funding agreement that
secures that series. Claims for principal and interest under those international
funding agreements are afforded equal priority to claims of life insurance and
annuity policyholders under insolvency provisions of Iowa Insurance Laws and,
accordingly, are reported as contractholder funds liabilities in our
133
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INSURANCE LIABILITIES (CONTINUED)
consolidated statements of financial position. In general, the medium-term note
funding agreements do not give the contractholder the right to terminate prior
to contractually stated maturity dates, absent the existence of certain
circumstances which are largely within our control. As of December 31, 2002, the
contractual maturities were 2003 - $573.3 million; 2004 - $562.8 million; 2005 -
$795.1 million; 2006 - $107.7 million; 2007 - $25.3 million and thereafter -
$1,519.3 million.
In February 2001, we agreed to issue up to $3.0 billion of funding agreements
under another program to support the prospective issuance by an unaffiliated
entity of medium-term notes in both domestic and international markets.
Subsequently in April 2002, we agreed to an additional issuance of up to $1.0
billion to the same program bringing the total program authorized amount to $4.0
billion. The unaffiliated entity is an unconsolidated qualifying special purpose
entity. The funding agreements issued to the unaffiliated entity are reported as
contractholder funds liabilities in our consolidated statements of financial
position. As of December 31, 2002, $2,555.0 million have been issued under this
program.
FUTURE POLICY BENEFITS AND CLAIMS
Activity in the liability for unpaid accident and health claims, which is
included with future policy benefits and claims in the consolidated statements
of financial position, is summarized as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Balance at beginning of year..................... $ 714.8 $ 705.0 $ 721.7
Incurred:
Current year.................................. 1,588.3 1,597.1 1,788.1
Prior years................................... 0.6 (17.5) (17.8)
------------------ ------------------ ------------------
Total incurred................................... 1,588.9 1,579.6 1,770.3
Payments:
Current year.................................. 1,333.2 1,283.2 1,447.3
Prior years................................... 271.2 286.6 339.7
------------------ ------------------ -----------------
Total payments................................... 1,604.4 1,569.8 1,787.0
Balance at end of year:
Current year.................................. 255.1 313.9 340.8
Prior years................................... 444.2 400.9 364.2
------------------ ------------------ ------------------
Total balance at end of year..................... $ 699.3 $ 714.8 $ 705.0
================== ================== ==================
The activity summary in the liability for unpaid accident and health claims
shows an increase (decrease) of $0.6 million, $(17.5) million and $(17.8)
million for the year ended December 31, 2002, 2001 and 2000, respectively,
relating to prior years. Such liability adjustments, which affected current
operations during 2002, 2001 and 2000, respectively, resulted from developed
claims for prior years being different than were anticipated when the
liabilities for unpaid accident and health claims were originally estimated.
These trends have been considered in establishing the current year liability for
unpaid accident and health claims.
134
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. DEBT
SHORT-TERM DEBT
Short-term debt consists primarily of commercial paper and outstanding balances
on revolving credit facilities with various financial institutions. At December
31, 2002, we, including certain subsidiaries, had credit facilities with various
financial institutions in an aggregate amount of $1.4 billion. These credit
facilities include $600.0 million on a back-stop facility to support our $1.0
billion commercial paper program, $700.0 million in credit facilities to finance
a CMBS pipeline, and $100.0 million in credit facilities to purchase certain
CMBS securities for investment purposes.
The weighted-average interest rates on short-term borrowings as of December 31,
2002 and 2001, were 1.8% and 2.3%, respectively.
The components of short-term debt as of December 31, 2002 and 2001, were as
follows (in millions):
AS OF DECEMBER 31,
2002 2001
------------------- ------------------
Commercial paper.................................................... $157.5 $199.9
Other recourse short-term debt...................................... 38.6 22.0
Nonrecourse short-term debt......................................... 368.7 289.7
------------------- ------------------
Total short-term debt............................................... $564.8 $511.6
=================== ==================
LONG-TERM DEBT
The components of long-term debt as of December 31, 2002 and 2001, were as
follows (in millions):
AS OF DECEMBER 31,
2002 2001
------------------- ------------------
7.95% notes payable, due 2004....................................... $ 199.2 $ 199.1
8.2% notes payable, due 2009........................................ 464.7 464.6
7.875% surplus notes payable, due 2024.............................. 199.0 199.0
8% surplus notes payable, due 2044.................................. 99.1 99.1
Nonrecourse mortgages and notes payable............................. 248.0 247.5
Other mortgages and notes payable................................... 122.5 169.1
------------------- ------------------
Total long-term debt................................................ $ 1,332.5 $ 1,378.4
=================== ==================
The amounts included above are net of the discount and direct costs associated
with issuing these notes, which are being amortized to expense over their
respective terms using the interest method.
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty. Limited,
a wholly owned indirect subsidiary, 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 their parent,
Principal Financial Services, Inc.
135
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. DEBT (CONTINUED)
On March 10, 1994, Principal Life issued $300.0 million of surplus notes,
including $200.0 million due March 1, 2024, at a 7.875% annual interest rate and
the remaining $100.0 million due March 1, 2044, at an 8% annual interest rate.
None of our affiliates hold any portion of the notes. Each payment of interest
and principal on the notes, however, may be made only with the prior approval of
the Commissioner of Insurance of the State of Iowa (the "Commissioner") and only
to the extent that Principal Life has sufficient surplus earnings to make such
payments. For each of the years ended December 31, 2002, 2001 and 2000, interest
of $23.8 million was approved by the Commissioner, paid and charged to expense.
Subject to Commissioner approval, the surplus notes due March 1, 2024, may be
redeemed at Principal Life's election on or after March 1, 2004, in whole or in
part at a redemption price of approximately 103.6% of par. The approximate 3.6%
premium is scheduled to gradually diminish over the following ten years. These
surplus notes may then be redeemed on or after March 1, 2014, at a redemption
price of 100% of the principal amount plus interest accrued to the date of
redemption.
In addition, subject to Commissioner approval, the notes due March 1, 2044, may
be redeemed at Principal Life's election on or after March 1, 2014, in whole or
in part at a redemption price of approximately 102.3% of par. The approximate
2.3% premium is scheduled to gradually diminish over the following ten years.
These notes may be redeemed on or after March 1, 2024, at a redemption price of
100% of the principal amount plus interest accrued to the date of redemption.
The mortgages and other notes payable are financings for real estate
developments. We, including certain subsidiaries, had $378.0 million in credit
facilities with various financial institutions, in addition to obtaining loans
with various lenders to finance these developments. Outstanding principal
balances as of December 31, 2002, range from $0.2 million to $100.9 million per
development with interest rates generally ranging from 6.0% to 8.6%. Outstanding
principal balances as of December 31, 2001, range from $0.1 million to $101.9
million per development with interest rates generally ranging from 7.2% to 8.6%.
At December 31, 2002, future annual maturities of the long-term debt were as
follows (in millions):
2003.................................................................$ 116.9
2004................................................................. 296.6
2005................................................................. 29.7
2006................................................................. 20.9
2007................................................................. 96.8
Thereafter........................................................... 771.6
-----------
Total future maturities of the long-term debt....................... $1,332.5
===========
Cash paid for interest for 2002, 2001 and 2000 was $118.5 million, $98.1 million
and $116.8 million, respectively. These amounts include interest paid on taxes
during these years.
136
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INCOME TAXES
Our income tax expense from continuing operations was as follows (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Current income taxes (benefit):
Federal.......................................... $ (40.2) $ 30.7 $178.6
State and foreign................................ 41.7 29.0 12.1
Net realized/unrealized capital gains (losses)... (74.3) (214.1) 29.5
------------------ ------------------ ------------------
Total current income taxes (benefit)................ (72.8) (154.4) 220.2
Deferred income taxes............................... 118.7 237.8 8.3
------------------ ------------------ ------------------
Total income taxes.................................. $ 45.9 $ 83.4 $228.5
================== ================== ==================
Our provision for income taxes may not have the customary relationship of taxes
to income. Differences between the prevailing corporate income tax rate of 35%
times the pretax income and our effective tax rate on pretax income are
generally due to inherent differences between income for financial reporting
purposes and income for tax purposes and the establishment of adequate
provisions for any challenges of the tax filings and tax payments to the various
taxing jurisdictions. A reconciliation between the corporate income tax rate and
the effective tax rate from continuing operations is as follows:
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ------------------ ------------------
Statutory corporate tax rate.................... 35% 35% 35%
Dividends received deduction.................... (11) (13) (7)
Interest exclusion from taxable income.......... (2) (3) (2)
Federal tax settlement for prior years.......... (17) - -
Other........................................... 2 (1) 1
------------------ ------------------ ------------------
Effective tax rate.............................. 7% 18% 27%
================== ================== ==================
Significant components of our net deferred income taxes were as follows (in
millions):
AS OF DECEMBER 31,
2002 2001
------------------- ------------------
Deferred income tax assets (liabilities):
Insurance liabilities............................................ $ 263.1 $ 229.9
Deferred policy acquisition costs................................ (446.0) (390.7)
Net unrealized gains on available-for-sale securities............ (430.1) (218.9)
Mortgage loan servicing rights................................... (429.6) (355.2)
Other............................................................ (118.2) (90.3)
------------------- ------------------
Total net deferred income tax liabilities........................... $ (1,160.8) $(825.2)
=================== ==================
At December 31, 2002 and 2001, respectively, our net deferred tax liability is
comprised of international net deferred tax assets of $16.9 million and $28.4
million which have been included in other assets and $1,177.7 and $853.6 million
of U.S. net deferred tax liabilities which have been included in deferred income
taxes in the consolidated statements of financial position.
137
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INCOME TAXES (CONTINUED)
The Internal Revenue Service (the "Service") has completed examination of the
U.S. consolidated federal income tax returns for 1998 and prior years. The
Service has also begun to examine returns for 1999 and 2000. We believe that
there are adequate defenses against or sufficient provisions for any challenges.
Undistributed earnings of certain foreign subsidiaries are considered
indefinitely reinvested. A tax liability will be recognized when we expect
distribution of earnings in the form of dividends, sale of the investment or
otherwise.
Net cash received for income taxes in 2002 was $189.3 million primarily due to
refunds for 2001 capital losses and the favorable settlement of an Internal
Revenue Service audit issue. Cash paid for income taxes in 2001 and 2000 was
$76.4 million and $115.3 million, respectively.
13. EMPLOYEE AND AGENT BENEFITS
We have defined benefit pension plans covering substantially all of our
employees and certain agents. Some of these plans provide supplemental pension
benefits to employees with salaries and/or pension benefits in excess of the
qualified plan limits imposed by federal tax law. The employees and agents are
generally first eligible for the pension plans when they reach age 21. For plan
participants employed prior to January 1, 2002, the pension benefits are based
on the greater of a final average pay benefit or a cash balance benefit. The
final average pay benefit is based on the years of service and generally the
employee's or agent's average annual compensation during the last five years of
employment. Partial benefit accrual of final average pay benefits is recognized
from first eligibility until retirement based on attained service divided by
potential service to age 65 with a minimum of 35 years of potential service. The
cash balance portion of the plan started on January 1, 2002. An employee's
account will be credited with an amount based on the employee's salary, age and
service. These credits will accrue with interest. For plan participants hired on
and after January 1, 2002, only the cash balance plan applies. Our policy is to
fund the cost of providing pension benefits in the years that the employees and
agents are providing service to us. Our funding policy for all plans is to
deposit the U.S. GAAP-related net periodic pension cost using long-term
assumptions, unless the U.S. GAAP funded status is positive, in which case no
deposit is made.
For 2002, the plan assets include $79.4 million in Principal Financial Group
stock held under a separate account under an annuity contract. These assets were
received in the qualified defined benefit plan as a result of the
demutualization. For 2001, the value of the demutualization funds was $56.7
million, which was amortized over the remaining service period of plan
participants.
We also provide certain health care, life insurance and long-term care benefits
for retired employees. Retiree health benefits are provided for employees hired
prior to January 1, 2002, while retiree long-term care benefits are provided for
employees whose retirement was effective prior to July 1, 2000. Covered
employees are first eligible for these postretirement benefits when they reach
age 57 and have completed ten years of service with us. Partial benefit accrual
of these health, life and long-term care benefits is recognized from the
employee's date of hire until retirement based on attained service divided by
potential service to age 65 with a minimum of 35 years of potential service. Our
policy is to fund the cost of providing retiree benefits in the years that the
employees are providing service to us. Our funding policy for all plans is to
deposit the U.S. GAAP-related net periodic postretirement benefit cost using
long-term assumptions unless the U.S. GAAP funded status is positive, in which
case no deposit is made.
138
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. EMPLOYEE AND AGENT BENEFITS (CONTINUED)
For 2001, as a result of the demutualization, the postretirement benefit plans
received $11.3 million in compensation, which was used to pay benefit claims and
participant contributions, with the remainder to be amortized over the remaining
service period of plan participants.
The plans' combined funded status, reconciled to amounts recognized in the
consolidated statements of financial position and consolidated statements of
operations, was as follows (dollars in millions):
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
--------------- ------------- ---------------------------------
AS OF DECEMBER 31, AS OF DECEMBER 31,
2002 2001 2002 2001
--------------- -------------- ---------------- ---------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year..... $ (856.0) $ (797.3) $ (231.1) $ (221.8)
Service cost................................ (36.5) (31.2) (9.4) (8.3)
Interest cost............................... (63.0) (59.3) (17.8) (15.6)
Actuarial loss.............................. (124.4) (42.0) (36.6) (25.7)
Participant contributions................... - - (1.5) (1.3)
Benefits paid............................... 33.5 31.7 9.0 10.9
Other....................................... - 42.1 7.2 30.7
--------------- -------------- ---------------- ---------------
Benefit obligation at end of year........... $(1,046.4) $ (856.0) $ (280.2) $ (231.1)
=============== ============== ================ ===============
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning
of year.................................. $ 952.5 $ 1,115.4 $ 362.3 $ 359.8
Actual return (loss) on plan assets......... (32.2) (15.7) (2.2) 5.6
Employer contribution....................... 6.5 9.0 1.3 1.4
Participant contributions................... - - 1.5 1.3
Benefits paid............................... (33.5) (31.7) (8.9) (5.7)
Other....................................... - (124.5) - -
--------------- -------------- ---------------- ---------------
Fair value of plan assets at end of year.... $ 893.3 $ 952.5 $ 354.0 $ 362.4
=============== ============== ================ ===============
Funded (underfunded) status................. $ (153.1) $ 96.5 $ 73.8 $ 131.3
Unrecognized net actuarial (gain) loss...... 183.7 (65.3) 70.7 (0.6)
Unrecognized prior service cost (benefit)... 5.9 7.6 (32.6) (28.2)
Unamortized transition asset................ (0.5) (2.7) - -
--------------- -------------- ---------------- ---------------
Other assets - prepaid benefit cost......... $ 36.0 $ 36.1 $ 111.9 $ 102.5
=============== ============== ================ ===============
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER
31
Discount rate............................... 6.50% 7.50% 6.50% 7.50%
139
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. EMPLOYEE AND AGENT BENEFITS (CONTINUED)
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
------------------------------------ ------------------------------------------
FOR THE YEAR ENDED DECEMBER 31, FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000 2002 2001 2000
------------ ----------- ----------- --------- ------------- ---------------
COMPONENTS OF NET PERIODIC
BENEFIT COST
Service cost................ $36.5 $ 31.2 $ 35.0 $ 9.4 $ 8.3 $ 10.4
Interest cost............... 63.0 59.3 57.5 17.8 15.6 19.0
Expected return on plan
assets................... (84.6) (99.2) (81.3) (32.8) (32.3) (25.1)
Amortization of prior
service cost
(benefit)................ 1.7 1.7 1.7 (2.7) (2.6) -
Amortization of transition
(asset) obligation....... (2.2) (11.5) (11.5) - 0.3 2.3
Recognized net actuarial
(gain) loss.............. (7.9) (14.1) (12.5) 0.2 (1.3) (1.1)
------------ ----------- ----------- --------- ------------- ----------------
Net periodic benefit cost $ 6.5 $(32.6) $(11.1) $ (8.1) $ (12.0) $ 5.5
(income)................. ============ =========== =========== ========= ============= ================
For 2002, the higher benefits and compensation limits of the Economic Growth and
Tax Relief Reconciliation Act of 2001 were recognized in the defined benefit
plans. In 2001, we reclassified assets supporting nonqualified pension plan
liabilities through a reduction in contractholder funds and an increase in
invested assets. The pension plans' gains and losses are amortized using a
straight-line amortization method over the average remaining service period of
employees. For the qualified pension plan, there is no corridor recognized in
determining the amount to amortize; for the nonqualified pension plans, the
corridor allowed under SFAS No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, is used.
The projected benefit obligation for the pension plans with projected benefit
obligations in excess of plan assets was $180.6 million and $147.8 million as of
December 31, 2002 and 2001, respectively. The accumulated benefit obligation for
the pension plans with accumulated benefit obligations in excess of plan assets
was $125.1 million and $115.9 million as of December 31, 2002 and 2001,
respectively. These obligations relate to the nonqualified pension plan
liabilities. The nonqualified plans have assets that are housed in trusts that
fail to meet the requirements to be included in plan assets under SFAS No. 87,
EMPLOYERS' ACCOUNTING FOR PENSIONS. The prepaid benefit costs and accrued
benefit costs are $175.1 million and $(139.1) million, respectively, as of
December 31, 2002, and $165.0 million and $(128.9) million, respectively, as of
December 31, 2001.
Effective for 2003, we amended the method for determining postretirement retiree
health plan contributions. As a result of this change, the accumulated
postretirement obligation decreased by $7.2 million. As part of the substantive
plan, the retiree health contributions are assumed to be adjusted in the future
as claim levels change.
The accumulated postretirement benefit obligation and fair value of plan assets
for the postretirement plans with accumulated postretirement benefit obligations
in excess of plan assets were $90.2 million and $80.0 million, respectively, as
of December 31, 2002, and $2.3 million and $1.1 million, respectively, as of
December 31, 2001. The prepaid benefit costs and accrued benefit costs are
$112.5 million and $(0.7) million, respectively, as of December 31, 2002, and
$103.2 million and $(0.7) million, respectively, as of December 31, 2001.
140
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. EMPLOYEE AND AGENT BENEFITS (CONTINUED)
For 2002 and 2001, the expected long-term rates of return on plan assets for
pension benefits were 8.5% and 9.0%, respectively, on a pretax basis. The
assumed rate of increase in future compensation levels was 5.0% for both 2002
and 2001.
For 2002 and 2001, the expected long-term rates of return on plan assets for
other postretirement benefits varied by benefit type, employee group and tax
status of the trust. For 2002, the rates ranged from 7.25% to 8.25%. For 2001,
the rates ranged from 7.8% to 9.3% on a pretax basis.
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligations starts at 15% in 2002 and declines to an
ultimate rate of 5% in 2009. Assumed health care cost trend rates have a
significant effect on the amounts reported for the health care plans.
A one-percentage-point change in assumed health care cost trend rates would have
the following effects (in millions):
1-PERCENTAGE-POINT 1-PERCENTAGE-POINT
INCREASE DECREASE
------------------- -------------------
Effect on total of service and interest cost components.......... $ 8.4 $ (6.6)
Effect on accumulated postretirement benefit obligation.......... 61.8 (49.4)
In addition, we have defined contribution plans that are generally available to
all employees and agents who are age 21 or older. Eligible participants may
contribute up to 20% of their compensation. We match the participant's
contribution at a 50% contribution rate up to a maximum contribution of 3% of
the participant's compensation. The defined contribution plan allows employees
to choose among various investment options, including our common stock.
Effective September 1, 2002, the employer stock fund was converted to an
employee stock purchase plan. We contributed $18.9 million in 2002, $17.9
million in 2001 and $16.0 million in 2000 to these defined contribution plans.
As a result of the demutualization, the defined contribution plans received
$19.7 million in compensation, which was allocated to participant accounts.
14. COMMITMENTS AND CONTINGENCIES
LITIGATION
We are a plaintiff or defendant in actions arising out of our operations. We
are, from time to time, also involved in various governmental and administrative
proceedings. While the outcome of any pending or future litigation cannot be
predicted, management does not believe that any pending litigation will have a
material adverse effect on our business, financial condition or results of
operations. However, no assurances can be given that such litigation would not
materially and adversely affect our business, financial condition or results of
operations.
141
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
Other companies in the life insurance industry have historically been subject to
substantial litigation resulting from claims disputes and other matters. Most
recently, such companies have faced extensive claims, including class-action
lawsuits, alleging improper life insurance sales practices. Negotiated
settlements of such class-action lawsuits have had a material adverse effect on
the business, financial condition and results of operations of certain of these
companies.
Principal Life was a defendant in two class-action lawsuits which alleged
improper sales practices. We have settled these two class-action lawsuits and
have accrued a loss reserve for our best estimate based on information
available. We believe this reserve is sufficient to cover our obligation under
the settlements. 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. We have been notified that some of those who opted out from
the class filed lawsuits and made claims similar to those addressed by the
settlement. Most of those lawsuits and claims have been resolved. We accrued a
loss reserve for our best estimate of our potential exposure to the suits and
claims. As uncertainties continue to exist in resolving this matter, it is
reasonably possible that all the actual costs of the suits and claims could
exceed our estimate. The range of any such costs cannot be presently estimated;
however, we believe the additional costs will not have a material impact on our
business, financial condition or results of operations.
A lawsuit was filed on September 27, 2001, in the United States District Court
for the Northern District of Illinois, seeking damages and other relief on
behalf of a putative class of policyholders based on allegations that the plan
of conversion of Principal Mutual Holding Company from a mutual insurance
holding company into a stock company violates the United States Constitution.
The action is captioned ESTHER L. GAYMAN V. PRINCIPAL MUTUAL HOLDING COMPANY, ET
AL. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs filed an appeal on May 15, 2002, with the 7th
Circuit Court of Appeals. On November 22, 2002, the 7th Circuit Court of Appeals
affirmed the District Court's decision.
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.
142
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
GUARANTEES AND INDEMNIFICATIONS
In the normal course of business, we have provided guarantees to third parties
primarily related to a former subsidiary, joint ventures and industrial revenue
bonds. These agreements generally expire from 2003 through 2015. The estimated
maximum exposure under these agreements is approximately $155.0 million;
however, we believe the likelihood is remote that material payments will be
required and therefore have not accrued for a liability on our consolidated
statement of financial position. Should we be required to perform under these
guarantees, we could recover a portion of the loss from third parties through
recourse provisions included in agreements with such parties, the sale of assets
held as collateral that can be liquidated in the event that performance is
required under the guarantees or other recourse available to us, minimizing the
impact to our results of operations.
We are also subject to various indemnification obligations issued in conjunction
with certain transactions, primarily divestitures and the sale of residential
mortgage loans and servicing rights by our mortgage banking segment, whose terms
range in duration and often are not explicitly defined. Generally, a maximum
obligation is not explicitly stated; therefore, the overall maximum amount of
the obligation under the indemnifications cannot be reasonably estimated. While
we are unable to estimate with certainty the ultimate legal and financial
liability with respect to these indemnifications, we believe the likelihood is
remote that material payments would be required under such indemnifications and
therefore such indemnifications would not result in a material adverse effect on
our business, financial position or results of operations.
SECURITIES HELD FOR COLLATERAL
We held $774.7 million in mortgage-backed securities in trust at December 31,
2002, to satisfy collateral requirements associated with our mortgage banking
segment and derivatives credit support agreements.
15. STOCKHOLDERS' EQUITY
COMMON STOCK
As a result of the demutualization and initial public offering described in Note
1, we have one class of capital stock, common stock ($.01 par value, 2,500.0
million shares authorized).
On December 9, 2002, we paid an annual dividend of $83.8 million, equal to $0.25
per share, to shareholders of record as of November 8, 2002.
In the last two years, our board of directors has authorized various repurchase
programs under which we are allowed to purchase shares of our outstanding common
stock. Shares repurchased under these programs are accounted for as treasury
stock, carried at cost and reflected as a reduction to stockholders' equity.
On November 26, 2002, our board of directors authorized a repurchase program of
up to $300.0 million of our outstanding common stock. The repurchases will be
made in the open market or through privately negotiated transactions, from time
to time, depending on market conditions. No purchases were made under this
program as of December 31, 2002.
Earlier in 2002, our board of directors authorized two other repurchase programs
that were completed with an aggregate purchase of 27.0 million shares in the
open market at a total cost of $750.0 million.
143
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCKHOLDERS' EQUITY (CONTINUED)
On November 27, 2001, our board of directors authorized a repurchase program of
up to 15.3 million shares of our outstanding common stock. This program was
completed by December 31, 2001, with the purchase of 13.0 million shares through
an accelerated share repurchase program and 2.3 million shares in the open
market and through privately negotiated transactions at an aggregate cost of
$367.7 million. The 13.0 million shares purchased under the accelerated share
repurchase program were subject to a future contingent purchase price
adjustment. The adjustment was based upon the difference between the market
price of our common stock as of December 14, 2001, and its volume
weighted-average price over an extended trading period as outlined in the
forward stock purchase contract. Settlement of this contract occurred in
February 2002 with a cash payment of $0.4 million.
As a result of the demutualization, 363.7 thousand shares with a value of $6.7
million were issued to rabbi trusts held by us for certain benefit plans. These
shares were reported as treasury stock and additional paid-in capital in the
consolidated statements of stockholders' equity at December 31, 2001. In
February 2002, these shares were sold, which generated proceeds of $8.0 million,
with a cost of $6.7 million.
OTHER COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes all changes in stockholders' equity during
a period except those resulting from investments by stockholders and
distributions to stockholders.
The components of accumulated other comprehensive income (loss) were as follows
(in millions):
NET UNREALIZED
GAINS (LOSSES) NET UNREALIZED FOREIGN ACCUMULATED
ON GAINS (LOSSES) CURRENCY OTHER
AVAILABLE-FOR- ON DERIVATIVES TRANSLATION COMPREHENSIVE
SALE SECURITIES INSTRUMENTS ADJUSTMENT INCOME (LOSS)
---------------- --------------- ----------- ------------------
BALANCES AT JANUARY 1, 2000.......... $ (98.5) $ (3.5) $ (37.4) $ (139.4)
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale.............. 721.8 - - 721.8
Net change in unrealized gains
(losses) on equity securities,
available-for-sale.............. (261.1) - - (261.1)
Adjustments for assumed changes in
amortization pattern:
Deferred policy acquisition
costs...................... (122.6) - - (122.6)
Unearned revenue reserves....... 15.1 - - 15.1
Net change in unrealized gains
(losses) on derivative
instruments..................... - (1.3) - (1.3)
Provision for deferred income tax
benefit (expense)............... (120.5) 0.5 - (120.0)
Change in net foreign currency
translation adjustment.......... - - (152.5) (152.5)
---------------- --------------- ----------- ------------------
BALANCES AT DECEMBER 31, 2000........ 134.2 (4.3) (189.9) (60.0)
144
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCKHOLDERS' EQUITY (CONTINUED)
NET UNREALIZED
GAINS (LOSSES) NET UNREALIZED FOREIGN ACCUMULATED
ON GAINS (LOSSES) CURRENCY OTHER
AVAILABLE-FOR- ON DERIVATIVES TRANSLATION COMPREHENSIVE
SALE SECURITIES INSTRUMENTS ADJUSTMENT INCOME (LOSS)
---------------- --------------- ----------- ------------------
BALANCES AT JANUARY 1, 2001.......... $134.2 $ (4.3) $(189.9) $ (60.0)
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale................ 511.0 - - 511.0
Net change in unrealized gains
(losses) on equity securities,
available-for-sale................ 6.5 - - 6.5
Adjustments for assumed changes
in amortization pattern:
Deferred policy acquisition
costs....................... (61.3) - - (61.3)
Unearned revenue reserves....... 4.3 - - 4.3
Net change in unrealized gains
(losses) on derivative
instruments....................... - (8.9) - (8.9)
Provision for deferred income tax
benefit (expense)................. (161.2) 3.1 - (158.1)
Change in net foreign currency
translation adjustment............ - - (71.8) (71.8)
Cumulative effect of accounting
change, net of related income
taxes............................. 20.9 (24.0) (11.1) (14.2)
---------------- --------------- ----------- ------------------
BALANCES AT DECEMBER 31, 2001........ 454.4 (34.1) (272.8) 147.5
Net change in unrealized gains
(losses) on fixed maturities,
available-for-sale................ 844.4 - - 844.4
Net change in unrealized gains
(losses) on equity securities,
available-for-sale................ 37.8 - - 37.8
Adjustments for assumed changes in
amortization pattern:
Deferred policy acquisition
costs......................... (121.6) - - (121.6)
Unearned revenue reserves....... 6.4 - - 6.4
Net change in unrealized gains
(losses) on derivative
instruments....................... - (114.6) - (114.6)
Net change in unrealized gains
(losses) on policyholder dividend
obligation........................ (33.6) - - (33.6)
Provision for deferred income tax
benefit (expense)................. (257.2) 40.1 - (217.1)
Change in net foreign currency
translation adjustment............. - - 86.6 86.6
---------------- --------------- ----------- ------------------
BALANCES AT DECEMBER 31, 2002........ $930.6 $(108.6) $(186.2) $635.8
================ =============== =========== ==================
145
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. STOCKHOLDERS' EQUITY (CONTINUED)
The following table sets forth the adjustments necessary to avoid duplication of
items that are included as part of net income for a year that had been part of
other comprehensive income in prior years (in millions):
AS OF DECEMBER 31,
2002 2001 2000
--------------- -------------- ---------------
Unrealized gains on available-for-sale securities
arising during the year............................. $642.1 $537.7 $261.8
Adjustment for realized losses on available-for-sale
securities included in net income................... (240.4) (247.3) (29.9)
--------------- -------------- ---------------
Unrealized gains on available-for-sale securities, as
adjusted............................................ $401.7 $290.4 $231.9
=============== ============== ===============
The above table is presented net of income tax, related changes in the
amortization patterns of deferred policy acquisition costs and unearned revenue
reserves.
DIVIDEND LIMITATIONS
Under Iowa law, Principal Life may pay stockholder dividends only from the
earned surplus arising from its business and must receive the prior approval of
the Commissioner to pay a stockholder dividend if such a stockholder dividend
would exceed certain statutory limitations. The current statutory limitation is
the greater of 10% of Principal Life's policyholder surplus as of the preceding
year-end or the net gain from operations from the previous calendar year. Based
on this limitation and 2002 statutory results, Principal Life could pay
approximately $746.6 million in stockholder dividends in 2003 without exceeding
the statutory limitation.
In 2002, 2001 and 2000, Principal Life notified the Commissioner in advance of
all stockholder dividend payments. Total stockholder dividends paid to its
parent company in 2002, 2001 and 2000 were $590.2 million, $734.7 million and
$538.8 million, respectively.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following discussion describes the methods and assumptions we utilize in
estimating our fair value disclosures for financial instruments. Certain
financial instruments, particularly policyholder liabilities other than
investment-type contracts, are excluded from these fair value disclosure
requirements. The techniques utilized in estimating the fair values of financial
instruments are affected by the assumptions used, including discount rates and
estimates of the amount and timing of future cash flows. Care should be
exercised in deriving conclusions about our business, its value or financial
position based on the fair value information of financial instruments presented
below. The estimates shown are not necessarily indicative of the amounts that
would be realized in a one-time, current market exchange of all of our financial
instruments.
146
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
We define fair value as the quoted market prices for those instruments that are
actively traded in financial markets. In cases where quoted market prices are
not available, fair values are estimated using present value or other valuation
techniques. The fair value estimates are made at a specific point in time, based
on available market information and judgments about the financial instrument,
including estimates of timing, amount of expected future cash flows and the
credit standing of counterparties. Such estimates do not consider the tax impact
of the realization of unrealized gains or losses. In many cases, the fair value
estimates cannot be substantiated by comparison to independent markets. In
addition, the disclosed fair value may not be realized in the immediate
settlement of the financial instrument.
Fair values of public debt and equity securities have been determined by us from
public quotations, when available. Private placement securities and other fixed
maturities and equity securities are valued by discounting the expected total
cash flows. Market rates used are applicable to the yield, credit quality and
average maturity of each security.
Fair values of commercial mortgage loans are determined by discounting the
expected total cash flows using market rates that are applicable to the yield,
credit quality and maturity of each loan. Fair values of residential mortgage
loans are determined by a pricing and servicing model using market rates that
are applicable to the yield, rate structure, credit quality, size and maturity
of each loan.
The fair values for assets classified as policy loans, other investments
excluding equity investments in subsidiaries, cash and cash equivalents and
accrued investment income in the accompanying consolidated statements of
financial position approximate their carrying amounts.
Mortgage loan servicing rights represent the present value of estimated future
net revenues from contractually specified servicing fees. The fair value was
estimated with a valuation model using an internal prepayment model and
discounted at a spread to London Interbank Offered Rates.
The fair values of our reserves and liabilities for investment-type insurance
contracts are estimated using discounted cash flow analyses based on current
interest rates being offered for similar contracts with maturities consistent
with those remaining for the investment-type contracts being valued.
Investment-type insurance contracts include insurance, annuity and other policy
contracts that do not involve significant mortality or morbidity risk and that
are only a portion of the policyholder liabilities appearing in the consolidated
statements of financial position. Insurance contracts include insurance, annuity
and other policy contracts that do involve significant mortality or morbidity
risk. The fair values for our insurance contracts, other than investment-type
contracts, are not required to be disclosed. We do consider, however, the
various insurance and investment risks in choosing investments for both
insurance and investment-type contracts.
Fair values for debt issues are estimated using discounted cash flow analysis
based on our incremental borrowing rate for similar borrowing arrangements.
147
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and estimated fair values of our financial instruments were
as follows (in millions):
AS OF DECEMBER 31,
2002 2001
---------------------------------- ---------------------------------
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
---------------- ----------------- ---------------- ----------------
ASSETS (LIABILITIES)
Fixed maturities, available-for-
sale ............................. $34,185.7 $34,185.7 $30,012.3 $30,012.3
Fixed maturities, trading ........... 101.7 101.7 17.8 17.8
Equity securities, available-for-
sale ............................. 378.7 378.7 837.2 837.2
Mortgage loans....................... 11,081.9 11,240.4 11,065.7 11,345.7
Policy loans......................... 818.5 818.5 831.9 831.9
Other investments.................... 1,148.3 1,148.3 552.8 552.8
Cash and cash equivalents............ 1,038.6 1,038.6 561.2 561.2
Investment-type insurance
contracts......................... (24,816.5) (25,660.9) (23,286.8) (23,642.4)
Short-term debt...................... (564.8) (564.8) (511.6) (511.6)
Long-term debt....................... (1,332.5) (1,348.1) (1,378.4) (1,383.0)
17. STATUTORY INSURANCE FINANCIAL INFORMATION
Principal Life, the largest indirect subsidiary of Principal Financial Group,
Inc., prepares statutory financial statements in accordance with the accounting
practices prescribed or permitted by the Insurance Division of the Department of
Commerce of the State of Iowa (the "State of Iowa"). The State of Iowa
recognizes only statutory accounting practices prescribed or permitted by the
State of Iowa for determining and reporting the financial condition and results
of operations of an insurance company to determine its solvency under the Iowa
Insurance Law. The National Association of Insurance Commissioners' ("NAIC")
Accounting Practices and Procedures manual ("NAIC SAP") has been adopted as a
component of prescribed or permitted practices by the State of Iowa. The
Commissioner has the right to permit other specific practices that deviate from
prescribed practices.
In 2002, Principal Life received written approval from the State of Iowa to
recognize as admitted assets those assets pledged by Principal Life on behalf of
a wholly owned subsidiary instead of nonadmitting such assets. At December 31,
2002, the statutory surplus of Principal Life was $698.7 million greater than it
would have been if NAIC SAP had been followed for this transaction. This
permitted practice has no effect on Principal Life's net income for the year
then ended.
Life and health insurance companies are subject to certain risk-based capital
("RBC") requirements as specified by the NAIC. Under those requirements, the
amount of capital and surplus maintained by a life and health insurance company
is to be determined based on the various risk factors related to it. If the
State of Iowa were to rescind its permission for the transaction described
above, Principal Life's regulatory total adjusted capital would not fall below
the authorized control level RBC amount. However, if such permission were
rescinded, it is likely Principal Life would restructure or discontinue its
program to pledge assets on behalf of its wholly owned subsidiary. At December
31, 2002, Principal Life meets the RBC requirements.
148
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. STATUTORY INSURANCE FINANCIAL INFORMATION (CONTINUED)
Statutory net income and statutory capital and surplus of Principal Life are as
follows (in millions):
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------ ----------------- ------------------
Statutory net income............................... $ 402.1 $ 415.0 $ 912.6
Statutory surplus.................................. 3,339.2 3,483.8 3,356.4
18. SEGMENT INFORMATION
We provide financial products and services through the following segments: U.S.
Asset Management and Accumulation, International Asset Management and
Accumulation, Life and Health Insurance and Mortgage Banking. In addition, there
is a Corporate and Other segment. The segments are managed and reported
separately because they provide different products and services, have different
strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and
related financial products and services primarily to businesses, their employees
and other individuals and provides asset management services to our asset
accumulation business, the life and health insurance operations and third-party
clients.
The International Asset Management and Accumulation segment provides life
insurance and retirement and related financial products and services primarily
to businesses, their employees and other individuals principally in Chile,
Brazil, Mexico, India, Japan, Argentina, Hong Kong and Malaysia. On October 31,
2002, we sold substantially all of BT Financial Group (an asset management
company operating in Australia and New Zealand), described further in Note 3. As
a result, the results of operations (excluding corporate overhead) for BT
Financial Group are reported as non-recurring items for all periods presented.
The Life and Health insurance segment provides individual life and disability
insurance to the owners and employees of businesses and other individuals in the
U.S. and provides group life and health insurance to businesses in the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers primarily in the U.S.
The Corporate and Other segment manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate and
Other segment primarily reflect our financing activities, 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.
149
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
The Corporate and Other segment includes an equity ownership interest in
Coventry Health Care, Inc. The ownership interest was sold in February 2002,
described further in Note 4. The Corporate and Other segment's equity in
earnings of Coventry Health Care, Inc., which was included in net investment
income, was $2.1 million, $20.2 million and $20.6 million for the year ended
December 31, 2002, 2001 and 2000, respectively.
We evaluate segment performance on segment operating earnings, which is
determined by adjusting U.S. GAAP net income for net realized/unrealized capital
gains and losses, as adjusted, and nonrecurring items which management believes
are not indicative of overall operating trends. Net realized/unrealized capital
gains and losses, as adjusted, are net of income taxes, related changes in the
amortization pattern of deferred policy acquisition costs, recognition of
front-end fee revenues for sales charges on pension products and services, net
realized capital gains credited to customers and certain market value
adjustments to fee revenues. Segment operating revenues exclude net
realized/unrealized capital gains and their impact on recognition of front-end
fee revenues. While these items may be significant components in understanding
and assessing the consolidated financial performance, management believes the
presentation of segment operating earnings enhances the understanding of our
results of operations by highlighting earnings attributable to the normal,
recurring operations of the business. However, segment operating earnings are
not a substitute for net income determined in accordance with U.S. GAAP.
In 2002, non-recurring items of $363.2 million, net of income taxes, included
(1) the negative effects of (a) a cumulative effect of accounting change related
to the implementation of SFAS 142 ($280.9 million); (b) an estimated loss from
the discontinued operations of BT Financial Group ($196.7 million); (c) an
increase to a loss contingency reserve established for sales practice litigation
($21.6 million); and (d) expenses related to the demutualization ($2.0 million);
and (2) the positive effect of the settlement of an IRS audit issue ($138.0
million).
In 2001, non-recurring items of $42.3 million, net of income taxes, included (1)
the negative effects of (a) expenses related to the demutualization ($18.6
million); (b) a loss from the discontinued operations of BT Financial Group
($11.2 million); (c) a cumulative effect of change in accounting principle
related to the implementation of SFAS 133 ($10.7 million); and (d) an increase
to a loss contingency reserve established for sales practices litigation ($5.9
million); and (2) the positive effect of investment income generated from the
proceeds of the IPO ($4.1 million).
In 2000, non-recurring items of $92.5 million, net of income taxes, included (1)
the negative effects of (a) a loss contingency reserve established for sales
practices litigation ($93.8 million); and (b) expenses related to the
development of a plan of demutualization ($7.2 million); and (2) the positive
effect of the income from discontinued operations of BT Financial Group ($8.5
million).
The accounting policies of the segments are similar to those as described in
Note 1, with the exception of capital allocation. We allocate capital to our
segments based upon an internal capital model that allows management to more
effectively manage our capital.
150
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
The following tables summarize selected financial information on a continuing
basis by segment as of or for the years ended December 31, 2002, 2001 and 2000,
and reconciles segment totals to those reported in the consolidated financial
statements (in millions):
U.S. ASSET INTERNATIONAL
MANAGEMENT ASSET LIFE AND
AND MANAGEMENT AND HEALTH MORTGAGE CORPORATE
ACCUMULATION ACCUMULATION INSURANCE BANKING AND OTHER CONSOLIDATED
------------- ---------------- ----------- --------- ----------- --------------
2002
Revenues:
Operating revenues...... $ 3,780.5 $ 357.9 $ 3,946.8 $1,153.0 $ (15.1) $ 9,223.1
Net realized/unrealized
capital gains
(losses)............. (357.8) 30.2 (93.6) - 66.4 (354.8)
Recognition of
front-end fee
revenues............. (14.0) - - - - (14.0)
Capital gains
distributed
as market value
adjustment........... (31.8) - - - - (31.8)
------------- ---------------- ----------- --------- ----------- --------------
Revenues............... $ 3,376.9 $ 388.1 $ 3,853.2 $1,153.0 $ 51.3 $ 8,822.5
============= ================ =========== ========= =========== ==============
Net income:
Operating earnings
(loss)................ $ 370.9 $ 19.5 $ 233.1 $ 142.9 $ (17.0) $ 749.4
Net realized/unrealized
capital gains
(losses), as adjusted. (250.5) 12.4 (50.0) - 44.2 (243.9)
Nonrecurring items..... - (473.0) (4.6) - 114.4 (363.2)
------------ ---------------- ----------- --------- ----------- --------------
Net income (loss)...... $ 120.4 $ (441.1) $ 178.5 $ 142.9 $ 141.6 $ 142.3
============= ================ =========== ========= =========== ==============
Assets................. $ 70,371.9 $ 2,202.5 $ 11,356.3 $ 3,740.1 $ 2,190.5 $ 89,861.3
============= ================ =========== ========= =========== ==============
Other segment data:
Revenues from external
external customers.... $ 3,321.7 $ 386.3 $ 3,858.6 $1,139.8 $ 116.1 $ 8,822.5
Intersegment
revenues.............. 55.2 1.8 (5.4) 13.2 (64.8) -
Interest expense....... 3.5 0.7 0.5 - 49.3 54.0
Income tax expense
(benefit)............. (38.2) 10.7 95.3 101.9 (123.8) 45.9
Amortization of
intangibles........... 0.2 2.3 0.1 - - 2.6
151
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
U.S. ASSET INTERNATIONAL
MANAGEMENT ASSET LIFE AND
AND MANAGEMENT AND HEALTH MORTGAGE CORPORATE
ACCUMULATION ACCUMULATION INSURANCE BANKING AND OTHER CONSOLIDATED
------------- ---------------- ----------- --------- ----------- -------------
2001
Revenues:
Operating revenues...... $ 3,799.8 $ 508.4 $ 3,946.4 $ 757.4 $ 101.7 $ 9,113.7
Net realized/unrealized
capital losses......... (248.6) (60.0) (62.2) - (143.2) (514.0)
Recognition of
front-end fee revenues 1.5 - - - - 1.5
Capital gains
distributed as market
value adjustment....... (14.9) - - - - (14.9)
Investment income
generated from IPO
proceeds............... - - - - 6.3 6.3
------------- ---------------- ----------- --------- ----------- --------------
Revenues................ $ 3,537.8 $ 448.4 $ 3,884.2 $ 757.4 $ (35.2) $ 8,592.6
============= ================ =========== ========= =========== ==============
Net income:
Operating earnings...... $ 353.8 $ 2.3 $ 201.2 $ 126.7 $ 38.1 $ 722.1
Net realized/unrealized
capital losses, as
adjusted............... (164.7) (29.2) (33.8) - (93.3) (321.0)
Nonrecurring items...... (10.8) (11.2) 0.1 - (20.4) (42.3)
------------- ---------------- ----------- --------- ----------- --------------
Net income (loss)....... $ 178.3 $ (38.1) $ 167.5 $ 126.7 $ (75.6) $ 358.8
============= ================ =========== ========= =========== ==============
Assets.................. $ 68,543.8 $ 4,956.9 $ 10,776.2 $2,718.8 $1,354.8 $ 88,350.5
============= ================ =========== ========= =========== ==============
Other segment data:
Revenues from external
customers.............. $ 3,483.2 $ 447.0 $ 3,888.3 $ 746.8 $ 27.3 $ 8,592.6
Intersegment revenues... 54.6 1.4 (4.1) 10.6 (62.5) -
Interest expense........ 3.3 0.6 0.8 - 71.5 76.2
Income tax expense
(benefit).............. (6.3) (33.4) 86.2 78.4 (41.5) 83.4
Amortization of
goodwill and other
intangibles............ 3.2 3.7 4.1 0.7 - 11.7
152
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
U.S. ASSET INTERNATIONAL
MANAGEMENT ASSET LIFE AND
AND MANAGEMENT AND HEALTH MORTGAGE CORPORATE
ACCUMULATION ACCUMULATION INSURANCE BANKING AND OTHER CONSOLIDATED
------------- ---------------- ----------- --------- ----------- -------------
2000
Revenues:
Operating revenues...... $ 3,533.9 $ 339.2 $ 4,122.6 $ 359.8 $ 98.2 $ 8,453.7
Net realized/unrealized
capital gains losses.. (53.8) 2.8 70.8 - 119.8 139.6
Recognition of
front-end fee revenues. 0.9 - - - - 0.9
------------- ---------------- ----------- --------- ----------- --------------
Revenues................ $ 3,481.0 $ 342.0 $ 4,193.4 $ 359.8 $ 218.0 $ 8,594.2
============= ================ =========== ========= =========== ==============
Net income:
Operating earnings
(loss)............... $ 356.6 $ (16.9) $ 162.3 $ 50.0 $ 67.7 $ 619.7
Net realized/unrealized
capital gains (losses)
as adjusted............ (35.9) 1.3 47.3 - 80.3 93.0
Nonrecurring items...... - 8.5 - - (101.0) (92.5)
------------- ---------------- ----------- --------- ----------- --------------
Net income (loss)....... $ 320.7 $ (7.1) $ 209.6 $ 50.0 $ 47.0 $ 620.2
============= ================ =========== ========= =========== ==============
Assets.................. $65,795.9 $ 5,525.9 $10,569.0 $1,556.3 $ 957.8 $84,404.9
============= ================ =========== ========= =========== ==============
Other segment data:
Revenues from external
customers.............. $ 3,439.7 $ 340.6 $ 4,196.9 $ 359.8 $ 257.2 $ 8,594.2
Intersegment revenues... 41.3 1.4 (3.5) - (39.2) -
Interest expense........ - - - - 78.2 78.2
Income tax expense
(benefit).............. 101.9 (5.4) 104.7 27.1 0.2 228.5
Amortization of
goodwill and other
intangibles............ 1.0 4.6 7.7 0.8 - 14.1
153
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
The following table summarizes our operating revenues (in millions):
FOR THE YEAR ENDED DECEMBER 31,
2002 2001 2000
------------------- ------------------ ------------------
U.S. Asset Management and Accumulation
Full-service accumulation................ $1,076.5 $1,116.6 $1,210.4
Full-service payout...................... 1,191.8 1,214.8 920.6
Investment only.......................... 886.4 918.1 881.7
------------------- ------------------ ------------------
Total pension.......................... 3,154.7 3,249.5 3,012.7
Individual annuities..................... 303.8 263.3 267.5
Mutual funds............................. 113.8 108.3 116.0
Other and eliminations................... 32.2 19.0 1.9
------------------- ------------------ ------------------
Total U.S. Asset Accumulation........ 3,604.5 3,640.1 3,398.1
Eliminations............................. (40.4) (35.2) (38.4)
Principal Global Investors............... 216.4 194.9 174.2
------------------- ------------------ ------------------
Total U.S. Asset Management and
Accumulation........................... 3,780.5 3,799.8 3,533.9
International Asset Management and
Accumulation........................... 357.9 508.4 339.2
Life and Health Insurance
Life insurance........................... 1,629.6 1,658.7 1,693.1
Health insurance......................... 2,058.3 2,061.3 2,221.4
Disability insurance..................... 258.9 226.4 208.1
------------------- ------------------ ------------------
Total Life and Health Insurance........ 3,946.8 3,946.4 4,122.6
Mortgage Banking
Mortgage loan production................. 562.9 354.4 46.0
Mortgage loan servicing.................. 590.1 403.0 313.8
------------------- ------------------ ------------------
Total Mortgage Banking................. 1,153.0 757.4 359.8
Corporate and Other...................... (15.1) 101.7 98.2
------------------- ------------------ ------------------
Total operating revenues................. $9,223.1 $9,113.7 $8,453.7
=================== ================== ==================
Total operating revenues................. $9,223.1 $9,113.7 $8,453.7
Net realized/unrealized capital gains,
(losses) including recognition of
front-end fee revenues and certain
market value adjustments to fee
revenues............................... (400.6) (527.4) 140.5
Non-recurring............................ - 6.3 -
------------------- ------------------ ------------------
Total GAAP revenues...................... $8,822.5 $8,592.6 $8,594.2
=================== ================== ==================
154
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
We operate in the U.S. and in selected markets internationally (including Chile,
Brazil, Mexico, India, Japan, Argentina, Hong Kong and Malaysia). The following
table summarizes selected financial information by geographic location as of or
for the year ended December 31 (in millions):
LONG-LIVED NET INCOME
REVENUES ASSETS ASSETS (LOSS)
----------------- ------------------- ---------------- ------------------
2002
U.S............................ $8,434.4 $562.3 $87,658.8 $583.4
International.................. 388.1 115.5 2,202.5 (441.1)
----------------- ------------------- ---------------- ------------------
Total.......................... $8,822.5 $677.8 $89,861.3 $142.3
================= =================== ================ ==================
2001
U.S............................ $8,144.2 $565.4 $83,393.6 $396.9
International.................. 448.4 94.3 4,956.9 (38.1)
----------------- ------------------- ---------------- ------------------
Total.......................... $8,592.6 $659.7 $88,350.5 $358.8
================= =================== ================ ==================
2000
U.S............................ $8,252.2 $533.3 $78,879.0 $627.3
International.................. 342.0 101.9 5,525.9 (7.1)
----------------- ------------------- ---------------- ------------------
Total.......................... $8,594.2 $635.2 $84,404.9 $620.2
================= =================== ================ ==================
Long-lived assets include property and equipment and goodwill and other
intangibles.
Our 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.
19. STOCK-BASED COMPENSATION PLANS
As of December 31, 2002, we sponsor the Stock Incentive Plan, Directors Stock
Plan, Stock Purchase Plan and Long Term Performance Plan.
Under the terms of the Stock Incentive Plan, grants may be nonqualified stock
options, incentive stock options qualifying under Section 422 of the Internal
Revenue Code, restricted stock, restricted stock units and stock appreciation
rights. Total options granted under this plan were 1.5 million and 3.7 million
options in 2002 and 2001, respectively. Options outstanding under the Stock
Incentive Plan were granted at a price equal to the market value of our common
stock on the date of grant, graded or cliff-vested over a three-year period for
employees still employed or under contract, and expire ten years after the grant
date.
155
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The Directors Stock Plan provides for the grant of nonqualified stock options,
restricted stock or restricted stock units to our nonemployee directors. The
total number of shares to be issued under this plan may not exceed 500,000
shares. Options granted under the Directors Stock Plan have an exercise price
equal to the fair market value of the common stock on the date of the grant and
a term equal to the earlier of three years from the date the participant ceases
to provide service or the tenth anniversary of the date the option was granted.
Since no options were to become exercisable for directors earlier than eighteen
months following October 26, 2001, the date of demutualization, option grants
made in 2002 under this plan will cliff-vest one year from grant date. Going
forward, options will vest quarterly over a one-year period unless services to
us cease, at which time, all vesting stops. Options granted under this plan
amounted to 52,000 options in 2002. There were no grants under this plan in
2001.
Beginning in 2002, 16,641 restricted stock units were issued pursuant to the
Directors Stock Plan at a weighted-average award price of $28.02 to all
directors in office. The number received by each director is prorated with
respect to the amount of time remaining in the director's term. Restrictions on
the sale or transfer of restricted stock units shall lapse in installments from
the date of grant to the date of the end of the director's term. No restrictions
shall lapse earlier than eighteen months following October 26, 2001, the date of
demutualization. When service to the company ceases, all vesting stops and
unvested units are forfeited. The unamortized deferred compensation was $0.1
million at December 31, 2002.
We also maintain the Long Term Performance Plan, which provides the opportunity
for eligible executives to share in the success of Principal Financial Group,
Inc., if specified minimum corporate performance objectives are achieved over a
three-year period. This plan was amended in May 2001, to utilize stock as an
option for payment starting with payments in 2003. For the years ended December
31, 2002 and 2001, we recorded compensation expense of $4.4 million and $13.7
million, respectively, related to the plan.
The maximum number of shares of common stock we may issue under the Stock
Incentive Plan, together with an excess plan (a nonqualified defined
contribution retirement plan), the Directors Stock Plan, the Long Term
Performance Plan, and any new plan awarding our common stock, in the five years
following the completion of the initial public offering, is 6% of the number of
shares outstanding immediately following the completion of the IPO. As of
December 31, 2002, a total of 17,493,989 shares are available to be made
issuable by us for these plans.
Under our Stock Purchase Plan, participating employees have the opportunity to
purchase shares of our common stock on a quarterly basis. The maximum amount an
employee may contribute during any plan year is the lesser of $10,000, or such
greater or lesser amount as determined by the plan administrator, and 10% of the
employee's salary. Employees may purchase shares of our common stock at a price
equal to 85% of the share's fair market value as of the beginning or end of the
quarter, whichever is lower. Under the Stock Purchase Plan, employees purchased
713,886 and 320,406 shares during 2002 and 2001, respectively. In 2002, an
additional 5,415 shares were purchased from dividends and reinvested into
participants' accounts.
The maximum number of shares of common stock that we may issue under the Stock
Purchase Plan is 2% of the number of shares outstanding immediately following
the completion of the IPO. As of December 31, 2002, a total of 6,181,826 shares
are available to be made issuable by us for this plan.
156
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. STOCK-BASED COMPENSATION PLANS (CONTINUED)
In 2001, compensation expense was recognized for stock option awards issued to
career agents using the fair value method as prescribed in FASB Interpretation
No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION - AN
INTERPRETATION OF APB OPINION NO. 25. The compensation cost that has been
charged against income for the Stock Incentive Plan, Directors Stock Plan and
Stock Purchase Plan was $10.5 million and $0.01 million for 2002 and 2001,
respectively.
The weighted-average estimated fair value of stock options granted during 2002
and 2001 using the Black-Scholes option valuation model was $10.19 and $6.07 per
share, respectively. The fair value of each option was estimated on the date of
grant using the Black-Scholes option pricing model and the following
assumptions:
2002 2001
------------- -------------
Dividend yield................... .91 % 1.12 %
============= =============
Expected volatility.............. 32.5 % 37.5 %
============= =============
Risk-free interest rate.......... 4.7 % 3.7 %
============= =============
Expected life (in years)......... 6 3
============= =============
The fair value of the employees' purchase rights, which represent a price equal
to 15% of the share's fair market value under the Stock Purchase Plan, was $1.6
million in 2001.
The following is a summary of the status of all of our stock option plans as of
December 31, 2002, and related changes during the year then ended:
NUMBER OF SHARES WEIGHTED-AVERAGE
EXERCISE PRICE
------------------- -------------------
Options outstanding at January 1, 2001........................... - $ -
Granted........................................................ 3,671,000 22.33
Exercised...................................................... - -
Canceled....................................................... 32,800 22.33
-------------------
Options outstanding at December 31, 2001. 3,638,200 22.33
Granted........................................................ 1,492,905 27.59
Exercised...................................................... 600 22.33
Canceled....................................................... 993,380 23.08
-------------------
Options outstanding at December 31, 2002......................... 4,137,125 $ 24.05
===================
Options exercisable at December 31, 2001........................ 1,000 $ 22.33
===================
Options exercisable at December 31, 2002......................... 22,000 $ 22.33
===================
At December 31, 2002, we had 4.1 million stock options outstanding with a
weighted-average remaining contractual life of 9 years and a weighted-average
exercise price of $24.05.
157
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. EARNINGS PER SHARE
After our IPO, SFAS No. 128, EARNINGS PER SHARE, was adopted, which requires
disclosure of basic and diluted earnings per share.
For purposes of our unaudited basic and diluted pro forma earnings per share
calculations for the period January 1, 2001 through October 25, 2001, the
weighted-average number of shares outstanding was assumed to be 360.8 million
shares. These shares represent 260.8 million shares issued to policyholders
entitled to receive compensation in the demutualization and 100.0 million shares
sold to investors in the IPO, prior to the underwriters' exercise of the
overallotment option. The shares issued to the policyholders include 56.2
million shares issued as policy credits and held in one of our separate
accounts.
Reconciliations of weighted-average shares outstanding and income from
continuing operations for basic and diluted net earnings per share for the years
ended December 31, 2002 and 2001, are presented below:
PRO FORMA (UNAUDITED)
--------------------------------------
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 2002 DECEMBER 31, 2001
-------------------------------------- --------------------------------------
WEIGHTED PER WEIGHTED PER
AVERAGE SHARE AVERAGE SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
----------- ------------- ------------ ----------- ------------ -------------
(IN MILLIONS) (IN MILLIONS)
Basic earnings per share:
Income from continuing
operations................ $619.9 350.2 $1.77 $380.7 362.4 $1.05
Dilutive effects:
Stock options (1).......... 0.4 -
Long-term performance
plan...................... 0.1 -
Restricted stock units
(2)....................... - -
----------- -------------- ------------ ----------- ------------ -------------
Diluted earnings per
share..................... $619.9 350.7 $1.77 $380.7 362.4 $1.05
=========== ============== ============ =========== ============ =============
(1) The dilutive effect of the stock options did not meet specified reporting
thresholds in 2001.
(2) The dilutive effect of the restricted stock units did not meet specified
reporting thresholds.
The calculation of diluted earnings per share for the year ended December 31,
2002, excludes the incremental effect related to certain outstanding stock-based
compensation grants due to their anti-dilutive effect.
The calculation of diluted earnings per share for the year ended December 31,
2001, excludes the incremental effect related to a treasury stock repurchase
forward contract. This contract's inception price is in excess of the average
volume weighted-average price for purchases of our stock during the period the
contract has been outstanding, resulting in an antidilutive effect.
158
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
21. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for 2002
and 2001:
FOR THE THREE MONTHS ENDED
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------------------------------------------------------------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
2002
Total revenues........................ $2,227.8 $2,335.5 $1,995.9 $2,263.3
Total expenses........................ 1,877.8 2,187.2 1,950.9 2,140.8
Income from continuing operations,
net of related income taxes.......... 243.7 116.4 42.6 217.2
Income (loss) from discontinued
operations, net of related
income taxes......................... 2.3 3.8 (201.0) (1.8)
Net income (loss)..................... (34.9) 120.2 (158.4) 215.4
Basic earnings per share for income
from continuing operations, net of
related income taxes................. $ 0.68 $ 0.33 $ 0.12 $ 0.65
Basic earnings per share for net
income (loss)........................ (0.10) 0.34 (0.46) 0.64
Diluted earnings per share for income
from continuing operations, net of
related income taxes ................ 0.68 0.33 0.12 0.64
Diluted earnings per share for net
income (loss)........................ (0.10) 0.34 (0.45) 0.64
2001
Total revenues........................ $2,171.2 $2,024.7 $2,405.0 $1,991.7
Total expenses........................ 2,025.1 1,875.3 2,250.6 1,977.5
Income from continuing operations,
net of related income taxes.......... 120.9 118.3 119.9 21.6
Income (loss) from discontinued
operations, net of related income
taxes................................ (4.9) 0.8 (4.1) (3.0)
Net income............................ 105.3 119.1 115.8 18.6
Basic earnings per share for income
from continuing operations, net of
related income taxes (1)............. N/A N/A N/A $ 0.06
Basic earnings per share
for net income....................... N/A N/A N/A 0.05
Diluted earnings per share for income
from continuing operations, net of
related income taxes (1)............. N/A N/A N/A 0.06
Diluted earnings per share for net
income............................... N/A N/A N/A 0.05
(1) Fourth quarter 2001 earnings per share are on a pro forma basis as our IPO
did not close until October 26, 2001. See Note 1. Actual net income per
common share for the period from October 26, 2001 through December 31,
2001, was $(0.08) for basic and diluted computations.
159
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by Item 10 pertaining to directors is set forth in
Principal Financial Group, Inc.'s proxy statement relating to the 2003 annual
shareholders meeting (the "Proxy Statement") which will be filed with the
Securities and Exchange Commission ("SEC") on or about April 3, 2003, under the
captions, "Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance." Such information is incorporated herein by reference. The
information called for by Item 10 pertaining to executive officers can be found
in Part I of this Form 10-K under the caption, "Executive Officers of the
Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 pertaining to executive compensation is
set forth in the Proxy Statement under the caption, "Executive Compensation,"
and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCK MATTERS
The information called for by Item 12 pertaining to security ownership of
certain beneficial owners and management is set forth in the Proxy Statement
under the caption, "Security Ownership of Certain Beneficial Owners and
Management," and is incorporated herein by reference.
EQUITY COMPENSATION PLAN INFORMATION
In general, the Company has four compensation plans under which its equity
securities are authorized for issuance to employees or directors: the Principal
Financial Group, Inc. Stock Incentive Plan, the Principal Financial Group, Inc.
Employee Stock Purchase Plan, the Principal Financial Group, Inc. Long-Term
Performance Plan, and the Principal Financial Group, Inc. Directors Stock Plan.
The following table shows the number of shares of common stock issuable upon
exercise of options outstanding at December 31, 2002, the weighted average
exercise price of those options, and the number of shares of common stock
remaining available for future issuance at December 31, 2002, excluding shares
issuable upon exercise of outstanding options.
160
(A) (B) (C)
NUMBER OF SECURITIES TO NUMBER OF SECURITIES REMAINING
BE ISSUED UPON WEIGHTED-AVERAGE AVAILABLE FOR FUTURE ISSUANCE
EXERCISE OF OUTSTANDING EXERCISE PRICE OF UNDER COMPENSATION PLANS
OPTIONS, WARRANTS AND OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY RIGHTS WARRANTS AND RIGHT IN COLUMN (A))
- ---------------------- ------------------------- ------------------------- --------------------------------
Equity compensation 4,137,125 (2) $24.05 23,675,815 (3)
plans approved by
the Company's
stockholders (1)
Equity compensation -0- N/A -0-
plans not approved
by the Company's
stockholders
-------
(1) Each of the four compensation plans under which the Company's equity
securities are authorized for issuance to employees or directors were
approved by the Company's sole stockholder, Principal Mutual Holding
Company, prior to the Company's initial public offering of Common Stock on
October 23, 2001. None of the four compensation plans have been approved by
the Company's stockholders subsequent to such date.
(2) Includes 4,085,125 options outstanding under the 2001 Stock Incentive Plan
and 52,000 options outstanding under the 2001 Directors Stock Plan. Does
not include 16,641 Board restricted stock units.
(3) The maximum number of shares of Common Stock that may be awarded under the
Long-Term Performance Plan, the Stock Incentive Plan, the Directors Stock
Plan, and any new plan awarding shares of Common Stock, in the five years
following the completion of the Demutualization is 6% of the number of
shares outstanding immediately following the completion of the
Demutualization, unless the shareholders vote to increase the maximum
number. This number includes 6,181,826 shares remaining for issuance under
the Employee Stock Purchase Plan and 17,493,989 shares available for
issuance from the 6%.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 pertaining to certain relationships and
related transactions is set forth in the Proxy Statement under the captions,
"Compensation Committee Interlocks and Insider Participation" and "Certain
Relationships and Related Transactions," and is incorporated herein by
reference.
ITEM 14. CONTROLS AND PROCEDURES
In order to ensure that the information that we must disclose in our filings
with the SEC is recorded, processed, summarized and reported on a timely basis,
we have adopted disclosure controls and procedures. Our Chief Executive Officer,
J. Barry Griswell, and our Chief Financial Officer, Michael H. Gersie, have
reviewed and evaluated our disclosure controls and procedures as of February 21,
2003, and have concluded that our disclosure controls and procedures are
effective.
There were no significant changes in our internal controls, or in other factors
that could significantly affect our internal controls subsequent to February 21,
2003.
161
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a. Documents filed as part of this report.
1. Financial Statements (see Item 8. Financial Statements and
Supplementary Data)
Report of Independent Auditors
Audited Consolidated Financial Statements
Consolidated Statements of Financial Position
Consolidated Statements of Operations
Consolidated Statements of Stockholders` Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Report of Independent Auditors on Schedules
Schedule I - Summary of Investments - Other Than Investments in
Related Parties
Schedule II - Condensed Financial Information of Registrant
(Parent Only)
Schedule III - Supplementary Insurance Information
Schedule IV - Reinsurance
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
3. Exhibits
EXHIBIT
NUMBER DESCRIPTION
2.1 Plan of Conversion**
2.2 Share Sale Deed, dated as of June 17, 1999, among BT Investments
(Australia) LLC, BT Foreign Investment Corporation, BT New Zealand
Limited, BT International (Delaware), Inc., BT Nominees (H.K.)Limited,
Deutsche Bank AG, Bankers Trust Corporation, Principal Financial Group
(Australia) Pty Limited and Principal Financial Services, Inc.**
2.3 Deed to Amend the Share Sale Deed, dated as of August 31, 1999, among
BT Investments (Australia) LLC, BT Foreign Investment Corporation, BT
New Zealand Limited, BT International (Delaware), Inc., BT Nominees
(H.K.) Limited, Deutsche Bank AG, Bankers Trust Corporation, Principal
Financial Group (Australia) Pty Limited and Principal Financial
Services, Inc.**
2.4 Second Amendment to the Share Sale Deed, dated as of March 14, 2001,
among BT Investments (Australia) LLC, BT Foreign Investment
Corporation, Deutsche New Zealand Limited (formerly called BT New
Zealand Limited), BT International (Delaware), Inc., DB Nominees
(H.K.) Limited (formerly called BT Nominees (H.K.) Limited), Deutsche
Bank AG, Bankers Trust Corporation, Principal Financial Group
(Australia) Pty Limited and Principal Financial Services, Inc.**
3.1 Form of Amended and Restated Certificate of Incorporation of Principal
Financial Group, Inc. (included in Exhibit 2.1)**
3.2 Form of By-Laws of Principal Financial Group, Inc. (included in
Exhibit 2.1)**
4.1 Form of Certificate for the Common Stock of Principal Financial Group,
Inc., par value $0.01 per share**
4.2 Amended and Restated Stockholder Rights Agreement, dated as of October
22, 2001*
10.1 Principal Financial Group, Inc. Stock Incentive Plan**
10.2 Principal Financial Group Long-Term Performance Plan**
10.3 Resolution of the Human Resources Committee of the Board of Directors
of Principal Financial Group, Inc. amending the Principal Financial
Group Long-Term Performance Plan, as of October 31, 2002*
10.4 Principal Financial Group Incentive Pay Plan (PrinPay), amended and
restated effective January 1, 2002***
10.5 Principal Financial Group, Inc. Directors Stock Plan**
10.6 Principal Select Savings Excess Plan**
10.7 Supplemental Executive Retirement Plan for Employees**
10.8 Employment Agreement, dated as of May 19, 2000, among Principal Mutual
Holding Company, Principal Financial Group, Inc., Principal Financial
Services, Inc., Principal Life Insurance Company and J. Barry
Griswell**
162
10.9 Change-of-Control Supplement and Amendment to Employment Agreement,
dated as of October 19, 2000, among Principal Mutual Holding Company,
Principal Financial Group, Inc., Principal Financial Services, Inc.,
Principal Life Insurance Company and J. Barry Griswell**
10.10 Form of Principal Mutual Holding Company and Principal Life Insurance
Company Change of Control Employment Agreement (Tier One Executives)
among Principal Mutual Holding Company, Principal Financial Group,
Inc., Principal Financial Services, Inc., Principal Life Insurance
Company and an Executive**
10.11 Compensatory Arrangement, dated as of March 14, 2002, between Princpal
Life Insurance Company and James P. McCaughan.****
10.12 Compensatory Agreement, dated as of April 26, 2001, between
Principal Life Insurance Company and Michael T. Daley*
10.10 Fiscal Agency Agreement, dated as of August 25, 1999, among Principal
Financial Group (Australia) Holdings Pty Limited, Principal Financial
Services, Inc. and U.S. Bank Trust National Association**
21 Principal Financial Group, Inc. Member Companies as of December 31,
2001*
23 Consent of Ernst & Young LLP*
24 Power of Attorney*
99.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - J. Barry Griswell*
99.2 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of
the United States Code - Michael H. Gersie*
* Filed herewith.
** Incorporated by reference to the exhibit with the same number filed
with Principal Financial Group, Inc.'s Registration Statement on Form
S-1, as amended (Commission File No. 333-62558).
*** Incorporated by reference to exhibit number 10.4 filed with Principal
Financial Group, Inc.'s Annual Report on Form 10-K for the year ended
December 31, 2001, (Commission File No. 1-16725).
**** Incorporated by reference to exhibit number 10.11 filed with Principal
Financial Group, Inc.'s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002, (Commission File No. 1-16725).
b. Reports on Form 8-K
The Current Report on Form 8-K (Item 9), dated November 7, 2002, was
filed November 7, 2002.
c. See Item 15(a)3.
d. See Item 15(a)2.
163
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
PRINCIPAL FINANCIAL GROUP, INC.
Dated: March 5, 2003 By /S/ MICHAEL H. GERSIE
-------------------------------
Michael H. Gersie
Executive Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
Dated: March 5, 2003
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
------------------------------- ----------------------
J. Barry Griswell Charles S. Johnson
Chairman, President, Chief Director
Executive Officer and Director
By /S/ MICHAEL H. GERSIE By /S/ MICHAEL H. GERSIE*
------------------------------- ----------------------
Michael H. Gersie William T. Kerr
Executive Vice President and Chief Director
Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
------------------------------- ----------------------
Betsy J. Bernard Richard L. Keyser
Director Director
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
------------------------------- ----------------------
Jocelyn Carter-Miller Victor H. Loewenstein
Director Director
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
------------------------------- ----------------------
Gary E. Costley Federico F. Pena
Director Director
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
-------------------------------- ----------------------
David J. Drury Donald M. Stewart
Director Director
By /S/ MICHAEL H. GERSIE* By /S/ MICHAEL H. GERSIE*
-------------------------------- ----------------------
C. Daniel Gelatt, Jr. Elizabeth E. Tallett
Director Director
By /S/ MICHAEL H. GERSIE*
Sandra L. Helton
Director
* ATTORNEY-IN-FACT AND AGENT
164
STATEMENT UNDER OATH OF PRINCIPAL EXECUTIVE OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO
EXCHANGE ACT FILINGS
I, J. Barry Griswell, certify that:
1. I have reviewed this annual report on Form 10-K of Principal Financial
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 5, 2003
/S/ J. BARRY GRISWELL
---------------------------
J. Barry Griswell
Chairman, President and
Chief Executive Officer
165
STATEMENT UNDER OATH OF PRINCIPAL FINANCIAL OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO
EXCHANGE ACT FILINGS
I, Michael H. Gersie, certify that:
1. I have reviewed this annual report on Form 10-K of Principal Financial
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 5, 2003 /S/ MICHAEL H. GERSIE
----------------------------
Michael H. Gersie
Executive Vice President
and Chief Financial Officer
166
REPORT OF INDEPENDENT AUDITORS ON SCHEDULES
The Board of Directors and Stockholders Principal Financial Group, Inc.
We have audited the consolidated financial statements of Principal Financial
Group, Inc. (the Company) as of December 31, 2002 and 2001, and for each of the
three years in the period ended December 31, 2002, and have issued our report
thereon dated January 31, 2003 (included elsewhere in this Form 10-K). Our
audits also included the financial statement schedules listed in the Index at
Item 15(a) of this Form 10-K. These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedules referred to above,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Des Moines, Iowa
January 31, 2003
167
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2002
AMOUNT AS SHOWN
IN THE STATEMENT
OF FINANCIAL
TYPE OF INVESTMENT COST VALUE POSITION
- ------------------------------------------------------------------ ------------- -------------- ---------------------
(IN MILLIONS)
Fixed maturities, available-for-sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $ 502.6 $ 522.1 $ 522.1
States, municipalities and political subdivisions............ 399.2 426.4 426.4
Foreign governments.......................................... 595.5 659.9 659.9
Public utilities............................................. 3,033.7 2,980.0 2,980.0
Convertibles and bonds with warrants attached................ 73.2 74.6 74.6
Redeemable preferred......................................... 406.8 410.6 410.6
All other corporate bonds.................................... 21,681.0 22,885.3 22,885.3
Mortgage-backed and other asset-backed securities............ 5,819.6 6,226.8 6,226.8
------------- -------------- ---------------------
Total fixed maturities, available-for-sale................... 32,511.6 34,185.7 34,185.7
Fixed maturities, trading.................................... 97.0 101.7 101.7
Equity securities, available-for-sale Common stocks:
Banks, trust and insurance companies......................... 19.9 19.7 19.7
Industrial, miscellaneous and all other...................... 97.6 96.9 96.9
Non-redeemable preferred stock............................... 263.5 262.1 262.1
------------- -------------- --------------------
Total equity securities, available-for-sale.................. 381.0 378.7 378.7
Mortgage loans (1)........................................... 11,168.9 XXXX 11,081.9
Real estate, net:
Real estate acquired in satisfaction of debt(2).............. 22.9 XXXX 21.0
Other real estate(2)......................................... 1,225.4 XXXX 1,208.0
Policy loans................................................. 818.5 XXXX 818.5
Other investments(3)......................................... 1,065.2 XXXX 1,200.1
------------- ---------------------
Total investments............................................ $ 47,290.5 XXXX $ 48,995.6
============= =====================
- ------------
(1) The amount shown in the Statement of Financial Position for mortgage loans
differs from cost as commercial and residential mortgage loans are
generally reported at cost adjusted for amortization of premiums and
accrual of discounts, computed using the interest method, and net of
valuation differences.
(2) The amounts shown in the Statement of Financial Position for real estate
differ from cost due to properties which were determined to be impaired.
The cost bases of these properties are reduced to fair value. Real estate
expected to be disposed is carried at the lower of cost or fair value, less
cost to sell, with valuation allowances established.
(3) The amount shown in the Statement of Financial Position for other
investments differs from cost due to accumulated earnings from minority
interests in unconsolidated entities and properties owned jointly with
venture partners and operated by the partners. Other investments also
includes derivatives and certain seed money investments, which are reported
at fair value.
168
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT ONLY)
($ IN MILLIONS, EXCEPT PER SHARE DATA)
STATEMENT OF FINANCIAL POSITION
DECEMBER 31,
------------------------------------------
2002 2001
------------------- -------------------
ASSETS:
Cash.............................................. $ 332.1 $ 37.1
Income taxes receivable........................... 1.4 0.2
Investment in subsidiary ......................... 6,333.7 6,783.2
------------------- -------------------
Total assets...................................... $ 6,667.2 $6,820.5
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY:
LIABILITIES:
Amounts payable to subsidiary .................... $ 1.6 $ 0.2
Deferred income taxes............................. 8.4 -
------------------- -------------------
Total liabilities................................. 10.0 0.2
STOCKHOLDERS' EQUITY:
Common stock, par value $.01 per share - 2,500.0
million shares authorized, 376.7 million and
375.8 million shares issued, 334.4 million and
360.1 million shares outstanding in 2002 and 2001,
respectively...................................... 3.8 3.8
Additional paid-in capital........................ 7,106.3 7,072.5
Retained earnings (deficit) ...................... 29.4 (29.1)
Accumulated other comprehensive income.... ....... 635.8 147.5
Treasury stock, at cost (42.3 million and 15.7
million shares in 2002 and 2001,
respectively).....................................
(1,118.1) (374.4)
------------------- -------------------
Total stockholders' equity........................ 6,657.2 6,820.3
------------------- -------------------
Total liabilities and stockholders' equity........ $ 6,667.2 $6,820.5
=================== ===================
SEE ACCOMPANYING NOTES.
169
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT ONLY)
(CONTINUED)
($ IN MILLIONS)
STATEMENT OF OPERATIONS
YEAR ENDED FOR THE PERIOD
DECEMBER OCTOBER 26 THROUGH
31, 2002 DECEMBER 31, 2001
---------------------- -----------------------
REVENUES:
Net investment income ................................. $ 4.0 $ 0.7
---------------------- -----------------------
Total revenues......................................... 4.0 0.7
EXPENSES:
Other operating costs and expenses .................... 7.1 0.3
---------------------- -----------------------
Total expenses......................................... 7.1 0.3
---------------------- -----------------------
Income (loss) before income taxes...................... (3.1) 0.4
Income taxes (benefits) ............................... (1.3) 0.2
---------------------- -----------------------
Net income (loss) after taxes.......................... (1.8) 0.2
Equity in the net income (loss) of subsidiary.......... 144.1 (29.3)
---------------------- -----------------------
Net income (loss)...................................... $ 142.3 $(29.1)
====================== =======================
SEE ACCOMPANYING NOTES.
170
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT ONLY)
(CONTINUED)
STATEMENT OF CASH FLOWS
(IN MILLIONS)
FOR THE PERIOD
YEAR ENDED DECEMBER OCTOBER 26 THROUGH
31, 2002 DECEMBER 31, 2001
---------------------- -----------------------
Net income (loss) .......................................... $ 142.3 $ (29.1)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Equity in the net income (loss) of subsidiary .............. (144.1) 29.3
Increase in amounts payable to subsidiary................... 1.4 0.2
Increase (decrease) in income taxes......................... 7.2 (0.2)
Stock-based compensation.................................... 0.4 -
---------------------- -----------------------
Net cash provided by operating activities................... 7.2 0.4
Cash flows from investing activities:
Capital contributed to subsidiary .......................... - (1,689.7)
Dividend received from subsidiary .......................... 1,100.0 75.0
---------------------- -----------------------
Net cash provided by (used in) investing activities. 1,100.0 (1,614.7)
Cash flows from financing activities:
Issuance of common stock.................................... 22.0 2,019.3
Dividends to stockholders................................... (83.8) -
Acquisition of treasury stock............................... (750.4) (367.7)
---------------------- -----------------------
Net cash provided by (used in) financing activities. (812.2) 1,651.6
Net increase in cash and cash equivalents................... 295.0 37.1
Cash and cash equivalents at beginning of period............ 37.1 -
---------------------- -----------------------
Cash and cash equivalents at end of year.................... $ 332.1 $ 37.1
====================== =======================
SEE ACCOMPANYING NOTES.
171
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT ONLY)
(CONTINUED) NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying condensed financial statements should be read in
conjunction with the consolidated financial statements and notes thereto of
Principal Financial Group, Inc.
In the parent company only financial statements, our investments in
subsidiaries are stated at cost plus equity in undistributed earnings of
subsidiaries.
(2) CASH DIVIDENDS FROM SUBSIDIARY
The parent company received cash dividends totaling $1,100.0 million and
$75.0 million in 2002 and 2001, respectively, from its subsidiary.
172
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
AS OF DECEMBER 31, 2002, 2001 AND 2000 AND FOR EACH OF THE YEARS THEN ENDED
DEFERRED FUTURE CONTRACTHOLDER
POLICY POLICY AND OTHER
ACQUISITION BENEFITS AND POLICYHOLDER
SEGMENT COSTS CLAIMS FUNDS
---------- --------------- -------------- ----------------
(IN MILLIONS)
2002:
U.S. Asset Management and Accumulation................... $ 501.7 $ 6,956.3 $ 24,985.6
International Asset Management and Accumulation.......... 40.0 1,101.5 25.2
Life and Health Insurance................................ 872.7 6,675.6 2,024.2
Mortgage Banking......................................... - - -
Corporate and Other...................................... - 3.0 (77.1)
--------------- -------------- --------------
Total.................................................... $ 1,414.4 $ 14,736.4 $ 26,957.9
=============== ============== ==============
2001:
U.S. Asset Management and Accumulation................... $ 411.6 $ 6,463.2 $ 23,421.7
International Asset Management and Accumulation.......... 50.2 1,022.7 32.4
Life and Health Insurance................................ 910.7 6,544.4 1,880.2
Mortgage Banking......................................... - - -
Corporate and Other...................................... - 4.3 (60.8)
--------------- -------------- --------------
Total................................................... $ 1,372.5 $ 14,034.6 $ 25,273.5
=============== ============== ==============
2000:
U.S. Asset Management and Accumulation................... $ 368.9 $ 6,065.5 $ 23,046.1
International Asset Management and Accumulation.......... 37.8 971.8 52.5
Life and Health Insurance................................ 926.6 6,304.5 1,799.0
Mortgage Banking......................................... - - -
Corporate and Other...................................... - 4.2 -
--------------- -------------- --------------
Total.................................................... $ 1,333.3 $ 13,346.0 $ 24,897.6
=============== ============== ==============
173
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION, (CONTINUED)
AS OF DECEMBER 31, 2002, 2001 AND 2000 AND FOR EACH OF THE YEARS THEN ENDED
AMORTIZATION
BENEFITS, OF DEFERRED
PREMIUMS AND NET CLAIMS AND POLICY OTHER
OTHER INVESTMENT SETTLEMENT ACQUISITION OPERATING
SEGMENT CONSIDERATIONS INCOME (1) EXPENSES COSTS EXPENSES(1)
- ------- -------------- ---------- ------------ ------------- -------------
(IN MILLIONS)
2002:
U.S. Asset Management and Accumulation........ $ 746.5 $ 2,352.8 $ 2,530.3 $ 57.1 $ 697.7
International Asset Management
and Accumulation........................... 161.9 139.6 258.0 3.4 84.1
Life and Health Insurance..................... 2,973.4 660.2 2,433.4 84.0 750.4
Mortgage Banking.............................. - 99.8 - - 908.2
Corporate and Other........................... - 52.3 (4.8) - 38.3
-------------- ---------- ------------ ------------- -------------
Total .................................... $ 3,881.8 $ 3,304.7 $ 5,216.9 $ 144.5 $2,478.7
============== ========== ============ ============= =============
2001:
U.S. Asset Management and Accumulation........ $ 766.3 $ 2,400.4 $ 2,583.1 $ 64.9 $ 700.3
International Asset Management
and Accumulation........................... 344.9 117.4 407.5 3.1 98.1
Life and Health Insurance..................... 3,011.1 678.6 2,491.0 91.9 740.7
Mortgage Banking.............................. - 31.1 - - 552.3
Corporate and Other........................... - 156.1 0.5 - 81.4
-------------- ---------- ------------ ------------- -------------
Total .................................... $ 4,122.3 $ 3,383.6 $ 5,482.1 $ 159.9 $2,172.8
============== ========== ============ ============= =============
2000:
U.S. Asset Management and Accumulation........ $ 525.4 $ 2,303.9 $ 2,310.6 $ 123.7 $ 619.5
International Asset Management
and Accumulation........................... 220.5 89.2 262.2 2.0 98.8
Life and Health Insurance..................... 3,250.5 642.1 2,659.4 113.0 798.6
Mortgage Banking.............................. - (15.7) - - 282.7
Corporate and Other........................... - 138.1 0.1 - 170.7
-------------- ---------- ------------ ------------- -------------
Total .................................... $ 3,996.4 $ 3,157.6 $ 5,232.3 $ 238.7 $ 1,970.3
============== ========== ============ ============= =============
(1) Allocations of net investment income and certain operating expenses are
based on a number of assumptions and estimates, and reported operating
results would change by segment if different methods were applied.
174
SCHEDULE IV - REINSURANCE
AS OF DECEMBER 31, 2002, 2001 AND 2000 AND FOR EACH OF THE YEARS THEN ENDED
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED TO
AMOUNT COMPANIES COMPANIES AMOUNT NET
------------- ------------- ----------- -------- ---------------
($ IN MILLIONS)
2002:
Life insurance in force....................... $ 166,330.2 $ 30,421.5 $ 1,885.7 $ 137,794.4 1.4%
============= ============= =========== ============
Premiums:
Life insurance............................. $ 1,751.2 $ 57.7 $ 130.6 $ 1,824.1 7.2%
Accident and health insurance.............. 2,328.9 271.2 - 2,057.7 -%
------------- ------------- ----------- ------------
Total................................... $ 4,080.1 $ 328.9 $ 130.6 $ 3,881.8 3.4%
============= ============= =========== ============
2001:
Life insurance in force....................... $ 160,920.4 $ 27,049.9 $ 1,439.0 $ 135,309.5 1.1%
============= ============= =========== ============
Premiums:
Life insurance............................. $ 2,085.4 $ 52.4 $ 56.0 $ 2,089.0 2.7%
Accident and health insurance.............. 2,244.5 211.2 - 2,033.3 -%
------------- ------------- ----------- ------------
Total................................... $ 4,329.9 $ 263.6 $ 56.0 $ 4,122.3 1.4%
============= ============= =========== ============
2000:
Life insurance in force....................... $ 165,912.8 $ 23,094.5 $ 1,173.9 $ 143,992.2 0.8%
============= ============= =========== ============
Premiums:
Life insurance............................. $ 1,815.7 $ 48.7 $ 24.6 $ 1,791.6 1.4%
Accident and health insurance.............. 2,326.4 121.6 - 2,204.8 -%
------------- ------------- ----------- ------------
Total................................... $ 4,142.1 $ 170.3 $ 24.6 $ 3,996.4 0.6%
============= ============= =========== ============
175
EXHIBIT
NUMBER DESCRIPTION Page
2.1 Plan of Conversion**
2.2 Share Sale Deed, dated as of June 17, 1999,...........
among BT Investments (Australia) LLC, BT Foreign
Investment Corporation, BT New Zealand Limited, BT
International (Delaware), Inc., BT Nominees (H.K.)Limited,
Deutsche Bank AG, Bankers Trust Corporation, Principal
Financial Group (Australia) Pty Limited and Principal
Financial Services, Inc.**................................
2.3 Deed to Amend the Share Sale Deed, dated as of August
31, 1999, among BT Investments (Australia) LLC, BT Foreign
Investment Corporation, BT New Zealand Limited,
BT International (Delaware), Inc., BT Nominees (H.K.)
Limited, Deutsche Bank AG, Bankers Trust Corporation,
Principal Financial Group (Australia) Pty Limited
and Principal Financial Services, Inc.**................
2.4 Second Amendment to the Share Sale Deed, dated as
of March 14, 2001, among BT Investments
(Australia) LLC, BT Foreign Investment Corporation,
Deutsche New Zealand Limited (formerly called BT New
Zealand Limited), BT International (Delaware), Inc.,
DB Nominees (H.K.) Limited (formerly called BT Nominees
(H.K.) Limited), Deutsche Bank AG, Bankers Trust
Corporation, Principal Financial Group (Australia)
Pty Limited and Principal Financial Services, Inc.**......
3.1 Form of Amended and Restated Certificate of
Incorporation of Principal Financial Group, Inc.
(included in Exhibit 2.1)**...............................
3.2 Form of By-Laws of Principal Financial Group,
Inc. (included in Exhibit 2.1)**........................
4.1 Form of Certificate for the Common Stock of
Principal Financial Group, Inc., par value $0.01 per
share**...................................................
4.2 Amended and Restated Stockholder Rights Agreement,
dated as of October 22, 2001*............................. 178
10.1 Principal Financial Group, Inc. Stock Incentive Plan**....
10.2 Principal Financial Group Long-Term Performance Plan**....
10.3 Resolution of the Human Resources Committee of the Board
of Directors of Principal Financial Group, Inc. amending
the Principal Financial Group Long-Term Performance Plan
as of October 31, 2002*................................... 238
10.4 Principal Financial Group Incentive Pay Plan............
(PrinPay), amended and restated effective January
1, 2002***................................................
10.5 Principal Financial Group, Inc. Directors Stock Plan**....
10.6 Principal Select Savings Excess Plan**....................
10.7 Supplemental Executive Retirement Plan for Employees**....
10.8 Employment Agreement, dated as of May 19, 2000,
among Principal Mutual Holding Company, Principal
Financial Group, Inc., Principal Financial Services,
Inc., Principal Life Insurance Company and
J. Barry Griswell**......................................
176
10.9 Change-of-Control Supplement and Amendment to
Employment Agreement, dated as of October 19, 2000,
among Principal Mutual Holding Company, Principal
Financial Group, Inc., Principal Financial Services,
Inc., Principal Life Insurance Company and J. Barry
Griswell**................................................
10.10 Form of Principal Mutual Holding Company and Principal
Life Insurance Company Change of Control Employment
Agreement (Tier One Executives) among Principal Mutual
Holding Company, Principal Financial Group, Inc.,
Principal Financial Services, Inc., Principal Life
Insurance Company and an Executive**......................
10.11 Compensatory Arrangement, dated as of March 14, 2002,
between Princpal Life Insurance Company and James
P. McCaughan.****.........................................
10.12 Compensatory Agreement, dated as of 2001, between
Principal Life Insurance Company and Michael T. Daley*.... 239
10.13 Fiscal Agency Agreement, dated as of August 25, 1999,
among Principal Financial Group (Australia) Holdings
Pty Limited, Principal Financial Services, Inc. and
U.S. Bank Trust National Association**....................
21 Principal Financial Group, Inc. Member Companies as
of December 31, 2001*..................................... 242
23 Consent of Ernst & Young LLP*............................. 247
24 Power of Attorney*........................................ 248
99.1 Certification Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code - J.
Barry Griswell*........................................... 249
99.2 Certification Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code - Michael
H. Gersie*................................................ 250
* Filed herewith.
** Incorporated by reference to the exhibit with the same number filed
with Principal Financial Group, Inc.'s Registration Statement on Form
S-1, as amended (Commission File No. 333-62558).
*** Incorporated by reference to exhibit number 10.4 filed with Principal
Financial Group, Inc.'s Annual Report on Form 10-K for the year ended
December 31, 2001, (Commission File No. 1-16725).
***** Incorporated by reference to exhibit number 10.11 filed with Principal
Financial Group, Inc.'s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002, (Commission File No. 1-16725).
177
EXHIBIT 4.2
AMENDED AND RESTATED
RIGHTS AGREEMENT
Amended and Restated Rights Agreement, dated as of October 22, 2001 (the
"AGREEMENT"), by and between Principal Financial Group, Inc., a Delaware
corporation (the "CORPORATION"), and Mellon Investor Services LLC, a New Jersey
limited liability company, as Rights Agent (the "RIGHTS AGENT"), as amended and
restated by this amendment dated December 3, 2002 and effective as of October
22, 2001.
W I T N E S S E T H :
WHEREAS, the parties hereto have agreed to amend and restate the Rights
Agreement dated as of October 22, 2001 (the "ORIGINAL RIGHTS AGREEMENT");
WHEREAS, the parties intend, nothwithstanding such amendment and restatement,
that this Agreement continues to speak as of October 22, 2001;
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth herein, the
parties hereto, effective as October 22, 2001, hereby amend and restate the
Original Rights Agreement in its entirety as follows:
WHEREAS, the Board of Directors of the Corporation has authorized the issuance
of one Right (as hereinafter defined) (subject to adjustment) with respect to
each share of Common Stock (as hereinafter defined) of the Corporation issued
between October 22, 2001 (the "RECORD DATE") (whether originally issued or
delivered from the Corporation's treasury) and the earlier of the Distribution
Date (as hereinafter defined) or the Expiration Date (as hereinafter defined)
and, to the extent provided in Section 22 hereof, with respect to each such
share issued after the Distribution Date and prior to the Expiration Date, each
Right initially representing the right to purchase one one-thousandth of a share
of Series A Junior Participating Preferred Stock of the Corporation having the
rights and preferences set forth in the Certificate of Designation attached
hereto as EXHIBIT A, upon the terms and subject to the conditions hereinafter
set forth (the "RIGHTS");
NOW, THEREFORE, in consideration of the premises and the mutual agreements
herein set forth, the parties hereby agree as follows:
Section 1. CERTAIN DEFINITIONS. For purposes of this Agreement, the following
terms have the meanings indicated:
(a) "ACQUIRING PERSON" shall mean any Person who or which, together with all
Affiliates and Associates of such Person, shall be the Beneficial Owner of
178
10% or more of the shares of Common Stock of the Corporation then
outstanding, but shall not include any Exempt Person. Notwithstanding the
foregoing:
(i) no Person shall become an "ACQUIRING PERSON" as the result of an
acquisition of shares of Common Stock by the Corporation which, by
reducing the number of shares of Common Stock outstanding, increases
the proportionate number of shares Beneficially Owned by such Person
to 10% or more of the shares of Common Stock of the Corporation then
outstanding, provided, HOWEVER, that if a Person shall become the
Beneficial Owner of 10% or more of the shares of Common Stock of the
Corporation by reason of share purchases by the Corporation and shall,
after such share purchases by the Corporation, become the Beneficial
Owner of any additional shares of Common Stock of the Corporation
(other than from the Corporation pursuant to a stock dividend or stock
split), then such Person shall be deemed to be an "ACQUIRING PERSON"
unless, upon becoming the Beneficial Owner of such additional shares
of Common Stock of the Corporation, such Person is not then the
Beneficial Owner of 10% or more of the shares of Common Stock of the
Corporation then outstanding;
(ii) if the Board of Directors of the Corporation determines in good faith
that a Person who would otherwise be an "ACQUIRING PERSON" has become
such inadvertently (including, without limitation, because (A) such
Person was unaware that he or it Beneficially Owned a percentage of
Common Stock that would otherwise cause such Person to be an
"ACQUIRING PERSON" or (B) such Person was aware of the extent of his
or its Beneficial Ownership but had no actual knowledge of the
consequences of such Beneficial Ownership under this Agreement) and
without any intention of changing or influencing control of the
Corporation, and if such Person as promptly as practicable has
divested or divests himself or itself of Beneficial Ownership of a
sufficient number of shares of Common Stock so that such Person would
no longer be an "ACQUIRING PERSON," then such Person shall not be
deemed to be or to have become an "ACQUIRING PERSON" for any purposes
of this Agreement; and
(iii)no Person shall become an "ACQUIRING PERSON" by virtue of beneficial
ownership of Common Stock of the Corporation by any Affiliate and/or
Associate of such Person, which Affiliate and/or Associate is deemed
to be an Affiliate and/or Associate of such Person solely by reason of
such Affiliate and/or Associate being a director or officer of the
Corporation.
(b) "ACT" shall have the meaning set forth in Section 9(c) hereof.
(c) "ADJUSTMENT SHARES" shall have the meaning set forth in Section 11(a)(ii)
hereof.
179
(d) "AFFILIATE" and "ASSOCIATE," when used with reference to any Person, shall
have the respective meanings ascribed to such terms in Rule 12b-2 of the
General Rules and Regulations under the Securities Exchange Act of 1934, as
amended (the "EXCHANGE ACT"), as in effect on the date of this Agreement.
(e) "AGREEMENT" shall have the meaning set forth in the first paragraph hereof.
(f) A Person shall be deemed the "BENEFICIAL OWNER" of and shall be deemed to
"BENEFICIALLY OWN" any securities:
(i) which such Person or any of such Person's Affiliates or Associates,
directly or indirectly, has the right to acquire (whether such right
is exercisable immediately or only after the passage of time) pursuant
to any agreement, arrangement or understanding (whether or not in
writing), or upon the exercise of conversion rights, exchange rights,
rights, warrants or options, or otherwise; PROVIDED, HOWEVER, that a
Person shall not be deemed the "BENEFICIAL OWNER" of, or to
"BENEFICIALLY OWN," (A) securities tendered pursuant to a tender or
exchange offer made by or on behalf of such Person or any of such
Person's Affiliates or Associates until such tendered securities are
accepted for payment or exchange, or (B) securities issuable upon
exercise of Rights at any time prior to the occurrence of a Section
11(a)(ii) Event or a Section 13 Event, or (C) securities issuable upon
exercise of Rights from and after the occurrence of a Section
11(a)(ii) Event or a Section 13 Event, which Rights were acquired by
such Person or any of such Person's Affiliates or Associates prior to
the Distribution Date or pursuant to Section 3(a) or Section 22 hereof
("ORIGINAL RIGHTS") or pursuant to Section 11(i) hereof in connection
with an adjustment made with respect to any Original Rights;
(ii) which such Person or any of such Person's Affiliates or Associates,
directly or indirectly, has or shares the right to vote or dispose of,
including pursuant to any agreement, arrangement or understanding
(whether or not in writing); PROVIDED, HOWEVER, that a Person shall
not be deemed the "BENEFICIAL OWNER" of, or to "BENEFICIALLY OWN," any
security if the agreement, arrangement or understanding to vote such
security (A) arises solely from a revocable proxy or consent given in
response to a public proxy or consent solicitation made pursuant to,
and in accordance with, the Exchange Act and the applicable rules and
regulations thereunder and (B) is not also then reportable by such
Person on Schedule 13D under the Exchange Act (or any comparable or
successor report); or
(iii)which are beneficially owned, directly or indirectly, by any other
Person and with respect to which such Person or any of such Person's
180
Affiliates or Associates has any agreement, arrangement or
understanding (whether or not in writing) for the purpose of
acquiring, holding, voting (except pursuant to a revocable proxy or
consent as described in the proviso to subparagraph (ii) of this
paragraph (f)) or disposing of such securities of the Corporation;
PROVIDED, HOWEVER, that nothing in this paragraph (f) shall cause a
person engaged in business as an underwriter of securities to be the
"BENEFICIAL OWNER" of, or to "BENEFICIALLY OWN," any securities
acquired through such person's participation in good faith in a firm
commitment underwriting until the expiration of forty days after the
date of such acquisition.
(g) "BOOK-ENTRY" shall mean an uncertificated book entry for the Corporation's
Common Stock.
(h) "BUSINESS DAY" shall mean any day other than a Saturday,
Sunday or day on which banking institutions in the City of New York, or the
city in which the office of the Rights Agent is located, is authorized or
obligated by law or executive order to close.
(i) "CERTIFICATE OF DESIGNATION" shall mean the Form of Certificate of
Designation of Series A Junior Participating Preferred Stock setting forth
the powers, preferences, rights, qualifications, limitations and
restrictions of such series of preferred stock of the Corporation, a copy
of which is attached hereto as Exhibit A.
(j) "CLOSE OF BUSINESS" on any given date shall mean 5:00 P.M., Eastern time,
on such date; PROVIDED, HOWEVER, that if such date is not a Business Day,
it shall mean 5:00 P.M., Eastern time, on the next succeeding Business Day.
(k) "COMMON STOCK" when used with reference to the Corporation shall mean the
Common Stock, par value $0.01 per share, of the Corporation. "COMMON STOCK"
when used with reference to any Person other than the Corporation which is
organized in corporate form shall mean the capital stock with the greatest
voting power, or the equity securities or other equity interest having
power to control or direct the management, of such Person or, if such
Person is a Subsidiary of another Person, the Person which ultimately
controls such first-mentioned Person and which has issued any such
outstanding capital stock, equity securities or equity interests. "COMMON
STOCK" when used with reference to any Person which is not organized in
corporate form shall mean units of beneficial interest which (I) shall
represent the right to participate generally in the profits and losses of
such Person (including, without limitation, any flow-through tax benefits
resulting from an ownership interest in such Person) and which (II) shall
be entitled to exercise the greatest voting power of such Person or, in the
case of a limited partnership, shall have the power to remove the general
partner or partners.
(l) "COMMON STOCK EQUIVALENTS" shall have the meaning set forth in Section
11(a)(iii) hereof.
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(m) "CORPORATION" shall have the meaning set forth in the first paragraph of
this Agreement.
(n) "CURRENT MARKET PRICE" shall have the meaning set forth in Section 11(d)
hereof.
(o) "CURRENT VALUE" shall have the meaning set forth in Section 11(a)(iii)
hereof.
(p) "DISTRIBUTION DATE" shall have the meaning specified in Section 3(a)
hereof.
(q) "EQUIVALENT PREFERENCE STOCK" shall have the meaning set forth in Section
11(b) hereof.
(r) "EXCHANGE ACT" shall have the meaning specified in Section 1(d) hereof.
(s) "EXEMPT PERSON" means the Corporation, any Subsidiary of the Corporation,
any employee benefit plan of the Corporation or any Subsidiary of the
Corporation, or any Person organized, appointed or established by the
Corporation or such Subsidiary as a fiduciary for or pursuant to the terms
of any such employee benefit plan or for the purpose of funding any such
plan or funding other employee benefits for employees of the Corporation or
of any Subsidiary of the Corporation.
(t) "EXPIRATION DATE" shall have the meaning specified in Section 7(a) hereof.
(u) "FINAL EXPIRATION DATE" shall have the meaning specified in Section 7(a)
hereof.
(v) "NASDAQ" shall have the meaning set forth in Section 11(d)(i) hereof.
(w) "ORIGINAL RIGHTS" shall have the meaning specified in Section 1(f)(i)
hereof.
(x) "ORIGINAL RIGHTS AGREEMENT" shall have the meaning set forth in the WHEREAS
clause at the beginning of this Agreement.
(y) "PERSON" shall mean any individual, firm, corporation, limited liability
company, association, unincorporated organization, partnership, trust or
other entity and shall include any successor (by merger or otherwise) of
such entity.
(z) "PREFERRED STOCK" shall mean shares of Series A Junior Participating
Preferred Stock, par value $0.01 per share, of the Corporation, having the
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rights, preferences and limitations set forth in the Certificate of
Designation, and, to the extent there are not a sufficient number of shares
of Series A Junior Participating Preferred Stock authorized to permit the
full exercise of the then outstanding Rights, any other series of preferred
stock of the Corporation designated for such purpose by the Board of
Directors of the Corporation containing terms substantially similar to the
terms of the Series A Junior Participating Preferred Stock.
(aa) "PRINCIPAL PARTY" shall have the meaning set forth in Section 13(b) hereof.
(bb) "PURCHASE PRICE" shall have the meaning set forth in Section 4 hereof.
(cc) "RECORD DATE" shall have the meaning set forth in the WHEREAS clause at the
beginning of this Agreement.
(dd) "REDEMPTION PRICE" shall have the meaning set forth in Section 23(a)
hereof.
(ee) "RIGHT CERTIFICATE" shall have the meaning set forth in Section 3(a)
hereof.
(ff) "RIGHTS" shall have the meaning set forth in the WHEREAS clause at the
beginning of this Agreement.
(gg) "RIGHTS AGENT" shall have the meaning set forth in the first paragraph of
this Agreement.
(hh) "SECTION 11(A)(II) EVENT" shall have the meaning set forth in Section
11(a)(ii) hereof.
(ii) "SECTION 13 EVENT" shall have the meaning set forth in Section 13(a)
hereof.
(jj) "SPREAD" shall have the meaning set forth in Section 11(a)(iii) hereof.
(kk) "STOCK ACQUISITION TIME" shall mean the time of occurrence of whichever of
the following first occurs: (I) the first public announcement (which, for
purposes of this definition, shall include, without limitation, a report
filed pursuant to Section 13(d) of the Exchange Act) by the Corporation or
an Acquiring Person that an Acquiring Person has become such or (II) the
communication to the Corporation (including, without limitation, to the
directors of the Corporation) of any notice (including, without limitation,
any written consent or notice related thereto) from the Acquiring Person
indicating or reflecting that the Acquiring Person has become such.
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(ll) "SUBSIDIARY" shall mean, with respect to any Person, any corporation or
other entity of which securities or other ownership interests having
ordinary voting power sufficient, in the absence of contingencies, to elect
a majority of the board of directors or other persons performing similar
functions are at the time beneficially owned, directly or indirectly, by
such Person, or otherwise controlled by such Person.
(mm) "SUBSTITUTION PERIOD" shall have the meaning set forth in Section
11(a)(iii) hereof.
(nn) "TRADING DAY" shall have the meaning set forth in Section 11(d)(i) hereof.
(oo) "VOTING STOCK" shall mean (I) the shares of Common Stock of the Corporation
and (II) any other shares of capital stock of the Corporation entitled to
vote generally in the election of directors or entitled to vote together
with the shares of Common Stock in respect of any merger, consolidation,
sale of all or substantially all of the Corporation's assets, liquidation,
dissolution or winding up.
Section 2. APPOINTMENT OF RIGHTS AGENT. The Corporation hereby appoints the
Rights Agent to act as agent for the Corporation in accordance with the terms
and conditions hereof, and the Rights Agent hereby accepts such appointment. The
Corporation may from time to time act as co-Rights Agent or appoint such
co-Rights Agents as it may deem necessary or desirable, upon 10 days' prior
written notice to the Rights Agent. The Rights Agent shall have no duty to
supervise, and shall in no event be liable for, the acts or omissions of any
such co-Rights Agent. Any actions which may be taken by the Rights Agent
pursuant to the terms of this Agreement may be taken by any such Co-Rights
Agent.
Section 3. ISSUE OF RIGHT CERTIFICATES.
(a) Until the earlier of the Close of Business on (I) the tenth Business Day
after the date on which the Stock Acquisition Time occurs, or (II) the
tenth Business Day (or such specified or unspecified later date on or after
the Record Date as may be determined by action of the Board of Directors of
the Corporation prior to such time as any Person becomes an Acquiring
Person) after the commencement by any Person (other than an Exempt Person)
of, or the first public announcement of the intention of any Person (other
than an Exempt Person) to commence, a tender or exchange offer for an
amount of Common Stock of the Corporation which, together with the shares
of such stock already owned by such Person, constitutes 10% or more of the
outstanding Common Stock of the Corporation (including any such date which
is after the date of this Agreement and prior to the issuance of the
Rights) (the earlier of (i) and (ii) being herein referred to as the
"DISTRIBUTION DATE"), (X) the Rights will be evidenced (subject to the
provisions of paragraph (b) of this Section 3) by the Book-Entries, or
certificates, for shares of Common Stock of the Corporation registered in
the names of the holders of Common Stock of the Corporation (which
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Book-Entries, or certificates, for Common Stock of the Corporation shall be
deemed also to be certificates for Rights) and not by separate Book
Entries, or Right Certificates, and (Y) the Rights will be transferable
only in connection with the transfer of the underlying Common Stock. As
soon as practicable after the Distribution Date and after the Rights Agent
has been provided with all necessary information, the Rights Agent will
send, by first-class, insured, postage-prepaid mail, to each record holder
of Common Stock of the Corporation as of the Close of Business on the
Distribution Date, at the address of such holder shown on the records of
the Corporation, a Right Certificate, in substantially the form of EXHIBIT
B hereto (a "RIGHT CERTIFICATE"), evidencing one Right for each share of
Common Stock of the Corporation so held, subject to adjustment and to the
provisions of Section 14(a) hereof. As of the Close of Business on the
Distribution Date, the Rights will be evidenced solely by such Right
Certificates.
(b) On the Record Date or as soon as practicable thereafter, the Corporation
will send a copy of a Summary of Rights to Purchase Preferred Stock, in
substantially the form attached hereto as EXHIBIT C, by first-class,
postage-prepaid mail, to each record holder of its Common Stock as of the
Close of Business on the Record Date, at the address of such holder shown
on the records of the Corporation. With respect to Book-Entries or
certificates for Common Stock of the Corporation outstanding as of the
Record Date, until the earlier of the Distribution Date or the Expiration
Date, the Rights will be evidenced by such Book-Entries or certificates for
Common Stock together with the Summary of Rights. Until the earlier of the
Distribution Date or the Expiration Date, the transfer of any Common Stock
represented by a Book-Entry or the surrender for transfer of any
certificate for Common Stock of the Corporation outstanding on the Record
Date, with or without a copy of the Summary of Rights, shall also
constitute the transfer of the Rights associated with the Common Stock
represented by such Book-Entry or certificate.
(c) Certificates issued by the Corporation for Common Stock (whether upon
transfer of outstanding Common Stock, original issuance or disposition from
the Corporation's treasury) after the Record Date but prior to the earlier
of the Distribution Date or the Expiration Date shall also be deemed to be
certificates for the Rights and shall have impressed on, printed on,
written on or otherwise affixed to them the following legend:
This certificate also evidences and entitles the holder hereof to
certain Rights as set forth in a Rights Agreement between the
Corporation and Mellon Investor Services LLC, a New Jersey limited
liability company, as Rights Agent, as it may be amended from time to
time (the "Rights Agreement"), the terms of which are hereby
incorporated herein by reference and a copy of which is on file at the
principal executive offices of the Corporation. Under certain
circumstances, as set forth in the Rights Agreement, such Rights will
be evidenced by separate certificates and will no longer be evidenced
by this certificate. The Corporation will mail to the holder of this
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certificate a copy of the Rights Agreement (as in effect on the date
of mailing) without charge promptly after receipt of a written request
therefor. UNDER CERTAIN CIRCUMSTANCES SET FORTH IN THE RIGHTS
AGREEMENT, RIGHTS BENEFICIALLY OWNED BY AN ACQUIRING PERSON, OR ANY
ASSOCIATE OR AFFILIATE THEREOF (AS SUCH TERMS ARE DEFINED IN THE
RIGHTS AGREEMENT), WHETHER CURRENTLY HELD BY OR ON BEHALF OF SUCH
PERSON OR BY ANY SUBSEQUENT HOLDER, MAY BECOME NULL AND VOID.
With respect to such certificates containing the foregoing legend, until the
earlier of (I) the Distribution Date or (II) the Expiration Date, the Rights
associated with the Common Stock of the Corporation represented by such
certificates shall be evidenced by such certificates alone and registered
holders of Common Stock of the Corporation shall also be the registered holders
of the associated Rights, and the surrender for transfer of any of such
certificates shall also constitute the transfer of the Rights associated with
the Common Stock of the Corporation represented by such certificates.
Section 4. FORM OF RIGHT CERTIFICATES. The Right Certificates (and the forms of
election to purchase, certification and assignment to be printed on the reverse
thereof) shall each be substantially in the form set forth in EXHIBIT B hereto
and may have such marks of identification or designation and such legends,
summaries or endorsements printed thereon as the Corporation may deem
appropriate, which do not affect the rights, duties or responsibilities of the
Rights Agent, and as are not inconsistent with the provisions of this Agreement,
or as may be required to comply with any applicable law or with any rule or
regulation made pursuant thereto or with any rule or regulation of any stock
exchange on which the Rights may from time to time be listed, or to conform to
usage. Subject to the provisions of Sections 11 and 22 hereof, the Right
Certificates, whenever distributed, shall be dated as of the Record Date and on
their face shall entitle the holders thereof to purchase such number of one
one-thousandths of a share of Preferred Stock as shall be set forth therein at
the price per one one-thousandths of a share of Preferred Stock set forth
therein (the "PURCHASE PRICE"), but the amount and type of securities
purchasable upon the exercise of each Right and the Purchase Price thereof shall
be subject to adjustment as provided in this Agreement.
Section 5. COUNTERSIGNATURE AND REGISTRATION.
(a) The Right Certificates shall be executed on behalf of the Corporation
manually or by facsimile by the Chief Financial Officer, the Treasurer, the
Chief Executive Officer, the President or the Senior Vice President and
General Counsel and also by the Chief Financial Officer, the Treasurer, the
Secretary or any Assistant Secretary. The Right Certificates shall be
countersigned by the Rights Agent manually and shall not be valid for any
purpose unless so countersigned. In case any officer of the Corporation who
shall have signed any of the Right Certificates shall cease to be such
officer of the Corporation before countersignature by the Rights Agent and
issuance and delivery by the Corporation, such Right Certificates,
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nevertheless, may be countersigned by the Rights Agent, and issued and
delivered by the Corporation with the same force and effect as though the
person who signed such Right Certificates had not ceased to be such officer
of the Corporation; and any Right Certificate may be signed on behalf of
the Corporation by any person who, at the actual date of the execution of
such Right Certificate, shall be a proper officer of the Corporation to
sign such Right Certificate, although at the date of the execution of this
Rights Agreement any such person was not such an officer.
(b) Following the Distribution Date and receipt by the Rights Agent of all
necessary information, the Rights Agent will keep or cause to be kept, at
its office designated for such purpose, books in any form or medium
(including electronic media) for registration and transfer of the Right
Certificates issued hereunder. Such books shall show the names and
addresses of the respective holders of the Right Certificates, the number
of Rights evidenced by each of the Right Certificates on its face and the
date and certificate number of each of the Right Certificates.
Section 6. TRANSFER, SPLIT UP, COMBINATION AND EXCHANGE OF RIGHT CERTIFICATES;
MUTILATED, DESTROYED, LOST OR STOLEN RIGHT CERTIFICATES.
(a) Subject to the provisions of Sections 7(e) and 14 hereof, at any time after
the Close of Business on the Distribution Date, and at or prior to the
Close of Business on the Expiration Date, any Right Certificate or Right
Certificates may be transferred, split up, combined or exchanged for
another Right Certificate or Right Certificates, entitling the registered
holder to purchase a like number of shares of Preferred Stock (or other
securities, cash or assets, as the case may be) as the Right Certificate or
Right Certificates surrendered then entitled such holder (or former holder
in the case of a transfer) to purchase. Any registered holder desiring to
transfer, split up, combine or exchange any Right Certificate or Right
Certificates shall make such request in writing delivered to the Rights
Agent, and shall surrender the Right Certificate or Right Certificates to
be transferred, split up, combined or exchanged at the office of the Rights
Agent designated for such purpose. Neither the Rights Agent nor the
Corporation shall be obligated to take any action whatsoever with respect
to the transfer of any such surrendered Right Certificate or Right
Certificates until the registered holder shall have completed and signed
the certificate contained in the form of assignment on the reverse side of
such Right Certificate or Right Certificates and shall have provided such
additional evidence of the identity of the Beneficial Owner (or former
Beneficial Owner) or Affiliates or Associates thereof as the Corporation
shall reasonably request. Thereupon the Rights Agent shall, subject to
Sections 7(e) and 14 hereof, countersign and deliver to the Person entitled
thereto a Right Certificate or Right Certificates, as the case may be, as
so requested. The Corporation may require payment from the holders of Right
Certificates of a sum sufficient to cover any tax or governmental charge
that may be imposed in connection with any transfer, split up, combination
or exchange of such Right Certificates. The Rights Agent shall have no duty
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or obligation under this Section 6 unless and until it is reasonably
satisfied that all such taxes and/or charges have been paid in full.
(b) Upon receipt by the Corporation and the Rights Agent of evidence reasonably
satisfactory to them of the loss, theft, destruction or mutilation of a
valid Right Certificate, and, in case of loss, theft or destruction, of
indemnity or security satisfactory to them, and reimbursement to the
Corporation and the Rights Agent of all reasonable expenses incidental
thereto, and upon surrender to the Rights Agent and cancellation of the
Right Certificate if mutilated, the Corporation will execute and deliver a
new Right Certificate of like tenor to the Rights Agent for
countersignature and delivery to the registered owner in lieu of the Right
Certificate so lost, stolen, destroyed or mutilated.
Section 7. EXERCISE OF RIGHTS; PURCHASE PRICE; EXPIRATION DATE OF RIGHTS.
(a) Subject to Section 7(e) hereof, the registered holder of any Right
Certificate may exercise the Rights evidenced thereby (except as otherwise
provided herein including, without limitation, the restrictions on
exercisability set forth in Sections 9(c), 11(a)(iii) and 23(a) hereof) in
whole or in part at any time after the Distribution Date upon surrender of
the Right Certificate, with the form of election to purchase and
certificate on the reverse side thereof duly executed, to the Rights Agent
at the office of the Rights Agent designated for such purpose, together
with payment of the Purchase Price for each one one-thousandth of a share
of Preferred Stock as to which the Rights are exercised, at or prior to the
earliest of (I) the Close of Business on October 22, 2011 (the "FINAL
EXPIRATION DATE"), (II) the time at which the Rights are redeemed as
provided in Section 23 or (III) the time at which the Rights are exchanged
as provided in Section 24 (the earliest of (i), (ii) and (iii) being herein
referred to as the "EXPIRATION DATE").
(b) The Purchase Price for each one one-thousandth of a share of Preferred
Stock issued pursuant to the exercise of a Right shall initially be
$100.00, shall be subject to adjustment from time to time as provided in
Sections 11 and 13 hereof and shall be payable in lawful money of the
United States of America in accordance with paragraph (c) below.
(c) Except as otherwise provided herein, upon receipt of a Right Certificate
representing exercisable Rights, with the form of election to purchase and
certificate duly executed, accompanied by payment (in cash, or by certified
bank check or money order payable to the order of the Corporation) of the
Purchase Price for the Preferred Stock (or other shares, securities, cash
or other assets, as the case may be) to be purchased and an amount equal to
any applicable transfer tax required to be paid by the holder of the Rights
pursuant hereto in cash, or by certified bank check or money order payable
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to the order of the Corporation, the Rights Agent shall, subject to Section
20(k) hereof, (I) (A) promptly requisition from any transfer agent of the
Preferred Stock (or make available, if the Rights Agent is the transfer
agent for such shares) certificates for the number of shares of Preferred
Stock to be purchased (and the Corporation hereby irrevocably authorizes
its transfer agent to comply with all such requests), or (B) if the
Corporation shall have elected to deposit the total number of shares of
Preferred Stock issuable upon exercise of the Rights hereunder with a
depositary agent, requisition from the depositary agent depositary receipts
representing interests in such number of one one-thousandths of a share of
Preferred Stock as are to be purchased (in which case certificates for the
shares of Preferred Stock represented by such receipts shall be deposited
by the transfer agent with the depositary agent) and the Corporation hereby
directs the depositary agent to comply with such request, (II) when
appropriate, requisition from the Corporation the amount of cash to be paid
in lieu of issuance of fractional shares in accordance with Section 14
hereof, (III) promptly after receipt of such certificates or depositary
receipts, cause the same to be delivered to or upon the order of the
registered holder of such Right Certificate, registered in such name or
names as may be designated by such holder, and (IV) when appropriate, after
receipt, promptly deliver such cash in lieu of fractional shares to or upon
the order of the registered holder of such Right Certificate.
(d) In case the registered holder of any Right Certificate shall exercise less
than all the Rights evidenced thereby, a new Right Certificate evidencing
Rights equivalent to the Rights remaining unexercised shall be issued by
the Rights Agent and delivered to, or upon the order of, the registered
holder of such Right Certificate, registered in such name or names as may
be designated by such holder, subject to the provisions of Section 6 and
Section 14 hereof.
(e) Notwithstanding anything in this Agreement to the contrary, from and after
the first occurrence of a Section 11(a)(ii) Event, any Rights beneficially
owned by (I) an Acquiring Person or any Affiliate or Associate of an
Acquiring Person, (II) a transferee of any such Acquiring Person (or of any
such Affiliate or Associate) who becomes a transferee after such Acquiring
Person becomes such or (III) a transferee of any such Acquiring Person (or
of any such Affiliate or Associate) who becomes a transferee prior to or
concurrently with such Acquiring Person becoming such and receives such
Rights pursuant to either (A) a transfer (whether or not for consideration)
from such Acquiring Person to holders of equity interests in such Acquiring
Person or to any Person with whom such Acquiring Person has any continuing
agreement, arrangement or understanding regarding the transferred Rights or
(B) a transfer which the Board of Directors of the Corporation has
determined is part of a plan, arrangement or understanding which has as a
primary purpose or effect the avoidance of this Section 7(e), shall become
null and void without any further action, and no holder of such Rights
shall have any rights whatsoever with respect to such Rights, whether under
any provision of this Agreement or otherwise. The Corporation shall notify
the Rights Agent when this Section 7(e) applies and shall use all
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reasonable efforts to ensure that the provisions of this Section 7(e) are
complied with, but neither the Corporation nor the Rights Agent shall have
any liability to any holder of Right Certificates or other Person as a
result of the Corporation's failure to make any determinations with respect
to an Acquiring Person or any of its Affiliates, Associates or transferees
hereunder.
(f) Notwithstanding anything in this Agreement to the contrary, neither the
Rights Agent nor the Corporation shall be obligated to undertake any action
with respect to a registered holder of any Right Certificate upon the
occurrence of any purported transfer pursuant to Section 6 or exercise as
set forth in this Section 7 unless such registered holder shall have (I)
properly completed and signed the certificate following the form of
assignment or election to purchase set forth on the reverse side of the
Right Certificate surrendered for such assignment or exercise and (II)
provided such additional evidence of the identity of the Beneficial Owner
(or former Beneficial Owner) or Affiliates or Associates thereof as the
Corporation or the Rights Agent shall reasonably request.
Section 8. CANCELLATION AND DESTRUCTION OF RIGHT CERTIFICATES. All Right
Certificates surrendered for the purpose of exercise, transfer, split up,
combination or exchange shall, if surrendered to the Corporation or to any of
its agents, be delivered to the Rights Agent for cancellation or in canceled
form, or, if surrendered to the Rights Agent, shall be canceled by it, and no
Right Certificates shall be issued in lieu thereof except as expressly permitted
by any of the provisions of this Agreement. The Corporation shall deliver to the
Rights Agent for cancellation and retirement, and the Rights Agent shall so
cancel and retire, any other Right Certificate purchased or acquired by the
Corporation otherwise than upon the exercise thereof. The Rights Agent shall
deliver all canceled Right Certificates to the Corporation, or shall, at the
written request of the Corporation, destroy such canceled Right Certificates and
in such case shall deliver a certificate of destruction thereof to the
Corporation.
Section 9. RESERVATION AND AVAILABILITY OF CAPITAL STOCK.
(a) The Corporation covenants and agrees that it will cause to be reserved and
kept available out of its authorized and unissued shares of Preferred Stock
(and, following the occurrence of a Section 11(a)(ii) Event or a Section 13
Event, out of its authorized and unissued shares of Common Stock or other
securities or out of its authorized and issued shares held in its
treasury), the number of shares of Preferred Stock (and, following the
occurrence of a Section 11(a)(ii) Event or a Section 13 Event, Common Stock
of the Corporation or other securities) that, as provided in this
Agreement, will be sufficient to permit the exercise in full of all
outstanding Rights.
(b) So long as the Preferred Stock (and, following the occurrence of a Section
11(a)(ii) Event or a Section 13 Event, Common Stock of the Corporation or
other securities) issuable upon the exercise of Rights may be listed on any
stock exchange, the Corporation shall use its best efforts to cause, from
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and after such time as the Rights become exercisable, all shares reserved
for such issuance to be listed on such exchange upon official notice of
issuance upon such exercise.
(c) The Corporation shall use its best efforts to (I) file, as soon as
practicable following the earliest date after the first occurrence of a
Section 11(a)(ii) Event or a Section 13 Event in which the consideration to
be delivered by the Corporation upon exercise of the Rights has been
determined in accordance with this Agreement, or as soon as is required by
law following the Distribution Date, as the case may be, a registration
statement under the Securities Act of 1933, as amended (the "ACT"), with
respect to the securities purchasable upon exercise of the Rights on an
appropriate form, (II) cause such registration statement to become
effective as soon as practicable after such filing and (III) cause such
registration statement to remain effective (with a prospectus at all times
meeting the requirements of the Act) until the earlier of (A) the date as
of which the Rights are no longer exercisable for such securities and (B)
the Expiration Date. The Corporation will also take such action as may be
appropriate under, or to ensure compliance with, the securities or "blue
sky" laws of the various states in connection with the exercisability of
the Rights. The Corporation may, acting by resolution of its Board of
Directors, temporarily suspend, for a period of time not to exceed 90 days
after the date set forth in clause (i) of the first sentence of this
Section 9(c), the exercisability of the Rights in order to prepare and file
such registration statement and permit it to become effective. Upon any
such suspension, the Corporation shall promptly notify the Rights Agent
thereof and shall issue a public announcement stating that the
exercisability of the Rights has been temporarily suspended, as well as a
public announcement (with prompt notice thereof to the Rights Agent) at
such time as the suspension is no longer in effect. Notwithstanding any
provision of this Agreement to the contrary, the Rights shall not be
exercisable in any jurisdiction if the requisite qualifications in such
jurisdiction shall not have been obtained.
(d) The Corporation covenants and agrees that it will take all such action as
may be necessary to ensure that all one one-thousandths of a share of
Preferred Stock (and, following the occurrence of a Section 11(a)(ii) Event
or a Section 13 Event, Common Stock of the Corporation or other securities)
delivered upon exercise of Rights shall, at the time of delivery of the
certificates for such shares (subject to payment of the Purchase Price), be
duly and validly authorized and issued and fully paid and nonassessable.
(e) The Corporation further covenants and agrees that it will pay when due and
payable any and all taxes and charges which may be payable in respect of
the issuance or delivery of the Right Certificates or of any shares of
Preferred Stock (or shares of Common Stock of the Corporation or other
securities, as the case may be) upon the exercise of Rights. The
Corporation shall not, however, be required to pay any tax or charge which
may be payable in respect of any transfer or delivery of Right Certificates
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to a Person other than, or the issuance or delivery of certificates or
depositary receipts for shares of Preferred Stock (or shares of Common
Stock of the Corporation or other securities, as the case may be) in a name
other than that of, the registered holder of the Right Certificate
evidencing Rights surrendered for exercise or to issue or deliver any
certificates for shares of Preferred Stock (or Common Stock of the
Corporation or other securities, as the case may be) or depositary receipts
for Preferred Stock upon the exercise of any Rights until any such tax or
charge shall have been paid (any such tax or charge being payable by the
holder of such Right Certificate at the time of surrender) or until it has
been established to the Corporation's satisfaction that no such tax or
charge is due.
Section 10. PREFERRED STOCK RECORD DATE. Each Person in whose name any
certificate for a number of one one-thousandths of a share of Preferred Stock
(or shares of Common Stock of the Corporation or other securities, as the case
may be) is issued upon the exercise of Rights shall for all purposes be deemed
to have become the holder of record of shares of Preferred Stock (or shares of
Common Stock of the Corporation or other securities, as the case may be)
represented thereby on, and such certificate shall be dated, the date upon which
the Right Certificate evidencing such Rights was duly surrendered and payment of
the Purchase Price (and any applicable taxes or charges) was made; PROVIDED,
HOWEVER, that if the date of such surrender and payment is a date upon which the
Corporation's transfer books for the Preferred Stock (or Common Stock or other
securities, as the case may be) are closed, such Person shall be deemed to have
become the record holder of such shares (fractional and otherwise) on, and such
certificate shall be dated, the next succeeding Business Day on which the
Corporation's transfer books for the Preferred Stock (or Common Stock or other
securities, as the case may be) are open. Prior to the exercise of the Rights
evidenced thereby, the holder of a Right Certificate shall not be entitled to
any rights of a stockholder of the Corporation with respect to shares for which
the Rights shall be exercisable, including, without limitation, the right to
vote, to receive dividends or other distributions or to exercise any preemptive
rights, and shall not be entitled to receive any notice of any proceedings of
the Corporation, except as provided herein.
Section 11. ADJUSTMENT OF PURCHASE PRICE, NUMBER AND KIND OF SHARES OR NUMBER OF
RIGHTS. The Purchase Price, the number and kind of shares, or fractions thereof,
covered by each Right and the number of Rights outstanding are subject to
adjustment from time to time as provided in this Section 11.
(a) (i) In the event the Corporation shall at any time after the date of this
Agreement (A) declare or pay a dividend on the Preferred Stock payable in
shares of Preferred Stock, (B) subdivide the outstanding Preferred Stock
into a greater number of shares, (C) combine or consolidate the outstanding
Preferred Stock into a smaller number of shares or (D) issue any shares of
its capital stock in a reclassification of the Preferred Stock (including
any such reclassification in connection with a consolidation or merger in
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which the Corporation is the continuing or surviving corporation), except
as otherwise provided in Section 7(e) and this Section 11(a), the Purchase
Price in effect at the time of the record date for such dividend or of the
effective date of such subdivision, combination or reclassification, and
the number and kind of shares of Preferred Stock or capital stock, as the
case may be, issuable on such date, shall be proportionately adjusted so
that the holder of any Right exercised after such time shall be entitled to
receive, upon payment of the Purchase Price then in effect, the aggregate
number and kind of shares of Preferred Stock or capital stock, as the case
may be, which, if such Right had been exercised immediately prior to such
date and at a time when the Preferred Stock or capital stock, as the case
may be, transfer books of the Corporation were open, he would have owned
upon such exercise and been entitled to receive by virtue of such dividend,
subdivision, combination or reclassification. If an event occurs which
would require an adjustment under both Section 11(a)(i) and Section
11(a)(ii) hereof, the adjustment provided for in this Section 11(a)(i)
shall be in addition to, and shall be made prior to, any adjustment
required pursuant to Section 11(a)(ii) hereof.
(ii) In the event (a "SECTION 11(A)(II) EVENT") that any Person, alone or
together with its Affiliates and Associates, shall become an Acquiring
Person, then each holder of a Right, except as provided below and in
Section 7(e) hereof, shall thereafter have the right to receive, upon
exercise thereof at the then current Purchase Price in accordance with the
terms of this Agreement, in lieu of a number of one one-thousandths of a
share of Preferred Stock, such number of shares of Common Stock of the
Corporation as shall equal the result obtained by (X) multiplying the then
current Purchase Price by the number of one one-thousandths of a share of
Preferred Stock for which a Right was exercisable immediately prior to the
first occurrence of such Section 11(a)(ii) Event, whether or not such Right
was then exercisable, and (Y) dividing that product (which, following such
first occurrence, shall thereafter be adjusted as appropriate in accordance
with Section 11(f) hereof and, as so adjusted, shall be referred to as the
"PURCHASE PRICE" for each Right and for all purposes of this Agreement) by
50% of the Current Market Price per share of the Common Stock of the
Corporation on the date of such first occurrence (such number of shares
being hereinafter referred to as the "ADJUSTMENT SHARES"). The Corporation
shall notify the Rights Agent as to any Persons who are deemed by the
Corporation to be Acquiring Persons or Associates, Affiliates or
transferees (as described in subparagraphs (ii) and (iii) of Section 7(e)
hereof) of such Persons and shall identify any Rights pertaining thereto.
(iii)In lieu of issuing shares of Common Stock of the Corporation in
accordance with Section 11(a)(ii) hereof, the Corporation, acting by
resolution of its Board of Directors, may, and, in the event that the
number of shares of Common Stock which are authorized by the Corporation's
Certificate of Incorporation but not outstanding or reserved for issuance
for purposes other than upon exercise of the Rights are not sufficient to
permit exercise in full of the Rights in accordance with Section 11(a)(ii)
hereof, the Corporation, acting by
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resolution of its Board of Directors, shall (A) determine the excess
of (1) the value of the Adjustment Shares issuable upon the exercise
of a Right (the "CURRENT VALUE"), over (2) the Purchase Price
attributable to each Right (such excess, the "SPREAD") and (B) with
respect to each Right (subject to Section 7(e) hereof), make adequate
provision to substitute for all or any part of the Adjustment Shares,
upon payment of the applicable Purchase Price, (1) cash, (2) a
reduction in the Purchase Price, (3) Preferred Stock or other equity
securities of the Corporation (including, without limitation, shares,
or units of shares, of preferred stock which the Board of Directors of
the Corporation has deemed to have the same value as shares of Common
Stock of the Corporation (such Preferred Stock or shares or units of
preferred stock hereinafter called "COMMON STOCK EQUIVALENTS")), (4)
debt securities of the Corporation, (5) other assets or (6) any
combination of the foregoing, which, when combined with the Adjustment
Shares (if any) to be issued, has an aggregate value equal to the
Current Value, where such aggregate value has been determined by
action of the Board of Directors of the Corporation based upon the
advice of a nationally recognized investment banking firm selected by
the Board of Directors of the Corporation; PROVIDED, HOWEVER, if the
Corporation shall not have made adequate provision to deliver value
pursuant to clause (B) above within 30 days following the first
occurrence of a Section 11(a)(ii) Event, then the Corporation shall be
obligated to deliver, upon the surrender for exercise of a Right and
without requiring payment of the Purchase Price, shares of Common
Stock of the Corporation (to the extent available) and then, if
necessary, cash, which shares or cash have an aggregate value equal to
the Spread. If, after the occurrence of a Section 11(a)(ii) Event, the
number of shares of Common Stock that are authorized by the
Corporation's certificate of incorporation but not outstanding or
reserved for issuance for purposes other than upon exercise of the
Rights are not sufficient to permit exercise in full of the Rights in
accordance with Section 11(a)(ii) hereof and the Corporation, acting
by resolution of its Board of Directors, shall determine in good faith
that it is likely that sufficient additional shares of its Common
Stock could be authorized for issuance upon exercise in full of the
Rights, the 30 day period set forth above may be extended to the
extent necessary, but not more than 90 days after the occurrence of
such Section 11(a)(ii) Event, in order that the Corporation may seek
stockholder approval for the authorization of such additional shares
(such period as it may be extended, the "SUBSTITUTION PERIOD"). To the
extent that the Corporation determines that some action is to be taken
pursuant to the terms of this Section 11(a)(iii), the Corporation (X)
shall provide, subject to Section 7(e) hereof, that such action shall
apply uniformly to all outstanding Rights and (Y) may suspend the
exercisability of the Rights until the expiration of the Substitution
Period in order to seek such stockholder approval for the
authorization of additional shares or to decide the appropriate form
of distribution to be made pursuant to the first sentence of this
Section 11(a)(iii) and to determine the value thereof. In the event of
any such suspension, the Corporation shall promptly notify the Rights
Agent thereof and shall issue a public announcement stating that the
exercisability of the Rights has been temporarily suspended, as well
as a public announcement (with prompt notice thereof to the Rights
Agent) at such time as the suspension is no longer in effect. For
purposes of this Section 11(a)(iii), the value of the Common Stock of
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the Corporation shall be the Current Market Price per share of the
Common Stock of the Corporation on the date of the first occurrence of
the Section 11(a)(ii) Event, and the per share or per unit value of
any Common Stock Equivalents shall be deemed to equal the Current
Market Price per share of the Common Stock of the Corporation on such
date.
(b) In the event that the Corporation shall fix a record date for the issuance
of rights, options or warrants to all holders of shares of Preferred Stock
entitling them (for a period expiring within 45 calendar days after such
record date) to subscribe for or purchase Preferred Stock (or shares having
the same rights, privileges and preferences as the shares of Preferred
Stock ("EQUIVALENT PREFERENCE STOCK")) or securities convertible into
shares of Preferred Stock or Equivalent Preference Stock at a price per
share of Preferred Stock or Equivalent Preference Stock (or having a
conversion price per share, if a security convertible into shares of
Preferred Stock or Equivalent Preference Stock) less than the Current
Market Price per share of the Preferred Stock (as defined in Section 11(d))
on such record date, the Purchase Price to be in effect after such record
date shall be determined by multiplying the Purchase Price in effect
immediately prior to such record date by a fraction, the numerator of which
shall be the number of shares of Preferred Stock outstanding on such record
date plus the number of additional shares of Preferred Stock and/or
Equivalent Preference Stock which the aggregate offering price of the total
number of shares so to be offered (and/or the aggregate initial conversion
price of the convertible securities so to be offered) would purchase at
such Current Market Price, and the denominator of which shall be the number
of shares of Preferred Stock outstanding on such record date plus the
number of additional shares of Preferred Stock or Equivalent Preference
Stock to be offered for subscription or purchase (or into which the
convertible securities so to be offered are initially convertible). In case
such subscription price may be paid in a consideration part or all of which
shall be in a form other than cash, the value of such consideration shall
be as determined in good faith by the Board of Directors of the
Corporation, whose determination shall be described in a statement filed
with the Rights Agent and shall be conclusive for all purposes. Such
adjustment shall be made successively whenever such a record date is fixed;
and in the event that such rights, options or warrants are not so issued,
the Purchase Price shall be adjusted to be the Purchase Price which would
then be in effect if such record date had not been fixed.
(c) In case the Corporation shall fix a record date for the making of a
distribution to all holders of Preferred Stock (including any such
distribution made in connection with a consolidation or merger in which the
Corporation is the continuing or surviving corporation) of evidences of
indebtedness or assets (other than a regular periodic cash dividend or a
dividend payable in Preferred Stock, but including any dividend payable in
stock other than Preferred Stock) or subscription rights or warrants
(excluding those referred to in Section 11(b) hereof), the Purchase Price
to be in effect after such record date shall be determined by multiplying
the Purchase Price in effect immediately prior to such record date by a
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fraction, the numerator of which shall be the Current Market Price per
share of Preferred Stock on such record date, less the fair market value
(as determined in good faith by the Board of Directors of the Corporation,
whose determination shall be described in a statement filed with the Rights
Agent and shall be conclusive for all purposes) of the portion of the
assets or evidences of indebtedness so to be distributed or of such
subscription rights or warrants applicable to one share of Preferred Stock,
and the denominator of which shall be such Current Market Price per share
of Preferred Stock. Such adjustments shall be made successively whenever
such a record date is fixed, and in the event that such distribution is not
so made, the Purchase Price shall again be adjusted to be the Purchase
Price which would then be in effect if such record date had not been fixed.
(d) (i) For the purpose of any computation hereunder, the "CURRENT MARKET
PRICE" per share of Common Stock of the Corporation on any date shall be
deemed to be the average of the daily closing prices per share of such
Common Stock of the Corporation for the 30 consecutive Trading Days
immediately prior to, but not including, such date; PROVIDED, HOWEVER, that
in the event that the Current Market Price per share of Common Stock of the
Corporation is determined during a period following the announcement by the
issuer of such Common Stock of (A) a dividend or distribution on such
Common Stock payable in shares of such Common Stock or securities
convertible into such Common Stock (other than the Rights) or (B) any
subdivision, combination or reclassification of such Common Stock, and
prior to the expiration of the 30 Trading Days after the ex-dividend date
for such dividend or distribution, or the record date for such subdivision,
combination or reclassification, as the case may be, then, and in each such
case, the Current Market Price shall be appropriately adjusted to take into
account the ex-dividend trading. The closing price for each day shall be
the last sale price, regular way, or, in case no such sale takes place on
such day, the average of the closing bid and asked prices, regular way, in
either case as reported in the principal consolidated transaction reporting
system with respect to securities listed or admitted to trading on the New
York Stock Exchange or, if the shares of Common Stock of the Corporation
are not listed or admitted to trading on the New York Stock Exchange, as
reported in the principal consolidated transaction reporting system with
respect to securities listed on the principal national securities exchange
on which the shares of Common Stock of the Corporation are listed or
admitted to trading or, if the shares of Common Stock of the Corporation
are not listed or admitted to trading on any national securities exchange,
the last quoted price or, if not so quoted, the average of the high bid and
low asked prices in the over-the-counter market, as reported by the
National Association of Securities Dealers Automated Quotation System
("NASDAQ") or such other system then in use, or, if on any such date the
shares of Common Stock of the Corporation are not quoted by any such
organization, the average of the closing bid and asked prices as furnished
by a professional market maker making a market in shares of Common Stock of
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the Corporation selected by the Corporation, acting by resolution of the
Board of Directors of the Corporation, or, if on any such date no market
maker is making a market in shares of Common Stock of the Corporation, the
fair value of such shares on such date as determined in good faith by the
Corporation, acting by resolution of the Board of Directors of the
Corporation (which determination shall be described in a statement filed
with the Rights Agent and shall be conclusive for all purposes). The term
"TRADING DAY" shall mean a day on which the principal national securities
exchange on which the shares of Common Stock of the Corporation are listed
or admitted to trading is open for the transaction of business or, if the
shares of Common Stock of the Corporation are not listed or admitted to
trading on any national securities exchange, a Business Day.
(ii) For the purpose of any computation hereunder, the "CURRENT MARKET
PRICE" per share of Preferred Stock shall be determined in the same manner
as set forth for the Common Stock of the Corporation in Section 11(d)(i)
hereof (other than the last clause of the second sentence thereof). If the
Current Market Price per share of Preferred Stock cannot be determined in
the manner provided above or if the Preferred Stock is not publicly held or
listed or traded in a manner described in Section 11(d)(i) hereof, the
Current Market Price per share of Preferred Stock shall be conclusively
deemed to be an amount equal to 1000 (as such number may be appropriately
adjusted for such events as stock splits, stock dividends and
recapitalizations with respect to the Common Stock of the Corporation
occurring after the date of this Agreement) multiplied by the Current
Market Price per share of the Common Stock of the Corporation. If neither
the Common Stock of the Corporation nor the Preferred Stock is publicly
held or so listed or traded, the Current Market Price per share of
Preferred Stock shall mean the fair value per share as determined in good
faith by the Corporation, acting by resolution of its Board of Directors,
whose determination shall be described in a statement filed with Rights
Agent and shall be conclusive for all purposes. For all purposes of this
Agreement, the Current Market Price of one one-thousandth of a share of
Preferred Stock shall be equal to the Current Market Price of one share of
Preferred Stock divided by 1000.
(e) Anything herein to the contrary notwithstanding, no adjustment in the
Purchase Price shall be required unless such adjustment would require an
increase or decrease of at least 1% in such price; PROVIDED, HOWEVER, that
any adjustments which by reason of this Section 11(e) are not required to
be made shall be carried forward and taken into account in any subsequent
adjustment. All calculations under this Section 11 shall be made to the
nearest cent or to the nearest ten-thousandth of a share of Common Stock or
other share or the nearest one-millionth of a share of Preferred Stock, as
the case may be. Notwithstanding the first sentence of this Section 11(e),
any adjustment required by this Section 11 shall be made no later than the
earlier of (I) three years from the date of the transaction which mandates
such adjustment or (II) the Expiration Date.
(f) If as a result of an adjustment made pursuant to Section 11(a) or Section
13(a) hereof, the holder of any Right thereafter exercised shall become
entitled to receive any shares of capital stock of the Corporation other
than Preferred Stock, thereafter the Purchase Price and the number of such
other shares so receivable upon exercise of any Right shall be subject to
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adjustment from time to time in a manner and on terms as nearly equivalent
as practicable to the provisions with respect to the Preferred Stock
contained in Sections 11(a), (b), (c), (e), (g), (h), (i), (j), (k) and (m)
inclusive, and the provisions of Sections 7, 9, 10, 13 and 14 with respect
to the Preferred Stock shall apply on like terms to any such other shares;
PROVIDED, HOWEVER, that the Corporation shall not be liable for its
inability to reserve and keep available for issuance upon exercise of the
Rights pursuant to Section 11(a)(ii) a number of shares of its Common Stock
greater than the number then authorized by the Certificate of Incorporation
of the Corporation but not outstanding or reserved for any other purpose.
(g) All Rights originally issued by the Corporation subsequent to any
adjustment made to the Purchase Price hereunder shall evidence the right to
purchase, at the adjusted Purchase Price, the number of one one-thousandths
of a share of Preferred Stock purchasable from time to time hereunder upon
exercise of the Rights, all subject to further adjustment as provided
herein.
(h) Unless the Corporation shall have exercised its election as provided in
Section 11(i), upon each adjustment of the Purchase Price as a result of
the calculations made in Section 11(b) and (c), each Right outstanding
immediately prior to the making of such adjustment shall thereafter
evidence the right to purchase, at the adjusted Purchase Price, that number
of one one-thousandths of a share of Preferred Stock (calculated to the
nearest one-millionth of a share of Preferred Stock) obtained by (I)
multiplying (A) the number of one one-thousandths of a share covered by a
Right immediately prior to such adjustment of the Purchase Price by (B) the
Purchase Price in effect immediately prior to such adjustment of the
Purchase Price and (II) dividing the product so obtained by the Purchase
Price in effect immediately after such adjustment of the Purchase Price.
(i) The Corporation may elect on or after the date of any adjustment of the
Purchase Price to adjust the number of Rights, in substitution for any
adjustment in the number of one one-thousandths of a share of Preferred
Stock purchasable upon the exercise of a Right. Each of the Rights
outstanding after such adjustment of the number of Rights shall be
exercisable for the number of one one-thousandths of a share of Preferred
Stock for which a Right was exercisable immediately prior to such
adjustment. Each Right held of record prior to such adjustment of the
number of Rights shall become that number of Rights (calculated to the
nearest one-hundred-thousandth) obtained by dividing the Purchase Price in
effect immediately prior to adjustment of the Purchase Price by the
Purchase Price in effect immediately after adjustment of the Purchase
Price. The Corporation shall make a public announcement and promptly notify
the Rights Agent of its election to adjust the number of Rights, indicating
the record date for the adjustment, and, if known at the time, the amount
of the adjustment to be made. This record date may be the date on which the
Purchase Price is adjusted or any day thereafter, but, if the Right
Certificates have been issued, shall be at least 10 days later than the
date of the public announcement. If Right Certificates have been issued,
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upon each adjustment of the number of Rights pursuant to this Section
11(i), the Corporation shall, as promptly as practicable, cause to be
distributed to holders of record of Right Certificates on such record date
Right Certificates evidencing, subject to Section 14 hereof, the additional
Rights to which such holders shall be entitled as a result of such
adjustment, or, at the option of the Corporation, shall cause to be
distributed to such holders of record in substitution and replacement for
the Right Certificates held by such holders prior to the date of
adjustment, and upon surrender thereof, if required by the Corporation, new
Right Certificates evidencing all the Rights to which such holders shall be
entitled after such adjustment. Right Certificates so to be distributed
shall be issued, executed and countersigned in the manner provided for
herein (and may bear, at the option of the Corporation, the adjusted
Purchase Price) and shall be registered in the names of the holders of
record of Right Certificates on the record date specified in the public
announcement.
(j) Irrespective of any adjustment or change in the Purchase Price or the
number of shares of Preferred Stock, or fraction thereof, issuable upon the
exercise of the Rights, the Right Certificates theretofore and thereafter
issued may continue to express the Purchase Price per one one-thousandth of
a share and the number of shares which were expressed in the initial Right
Certificates issued hereunder.
(k) Before taking any action that would cause an adjustment reducing the
Purchase Price below the then par value, if any, of the one one-thousandth
of a share of Preferred Stock issuable upon exercise of the Rights, the
Corporation shall take any corporate action which may, in the opinion of
its counsel, be necessary in order that the Corporation may validly and
legally issue fully paid and nonassessable shares of Preferred Stock at
such adjusted Purchase Price.
(l) In any case in which this Section 11 shall require that an adjustment in
the Purchase Price be made effective as of a record date for a specified
event, the Corporation may elect to defer (and shall promptly notify the
Rights Agent on any such election) until the occurrence of such event the
issuing to the holder of any Right exercised after such record date the
Preferred Stock, or a fraction thereof, and other capital stock or
securities of the Corporation, if any, issuable upon such exercise over and
above the Preferred Stock and other capital stock or securities of the
Corporation, if any, issuable upon such exercise on the basis of the
Purchase Price in effect prior to such adjustment; PROVIDED, HOWEVER, that
the Corporation shall deliver to such holder a due bill or other
appropriate instrument evidencing such holder's right to receive such
additional shares (fractional or otherwise) or securities upon the
occurrence of the event requiring such adjustment.
(m) Anything in this Section 11 to the contrary notwithstanding, the
Corporation, acting by resolution of its Board of Directors shall be
entitled to make such reductions in the Purchase Price, in addition to
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those adjustments expressly required by this Section 11, as and to the
extent that it in its sole discretion shall determine to be advisable in
order that any consolidation or subdivision of the Preferred Stock,
issuance wholly for cash of any Preferred Stock at less than the Current
Market Price, issuance wholly for cash of Preferred Stock or securities
which by their terms are convertible into or exchangeable for Preferred
Stock, stock dividends or issuance of rights, options or warrants referred
to hereinabove in this Section 11, hereafter made by the Corporation to
holders of its Preferred Stock shall not be taxable to such stockholders.
(n) The Corporation covenants and agrees that it shall not, at any time after
the Distribution Date, (I) consolidate with any other Person (other than a
Subsidiary of the Corporation in a transaction which complies with Section
11(o) hereof), (II) merge with or into any other Person (other than a
Subsidiary of the Corporation in a transaction which complies with Section
11(o) hereof) or (III) sell or transfer (or permit any Subsidiary to sell
or transfer), in one transaction or a series of related transactions,
assets, cash flow or earning power aggregating more than 50% of the assets,
cash flow or earning power of the Corporation and its Subsidiaries (taken
as a whole) to any other Person or Persons (other than the Corporation or
any of its Subsidiaries in one or more transactions each of which complies
with Section 11(o) hereof) if (X) at the time of or immediately after such
consolidation, merger or sale there are any rights, warrants or other
instruments or securities outstanding or agreements in effect which would
substantially diminish or otherwise eliminate the benefits intended to be
afforded by the Rights or (Y) prior to, simultaneously with or immediately
after such consolidation, merger or sale, the stockholders of the Person
who constitutes, or would constitute, the "PRINCIPAL PARTY" for purposes of
Section 13(a) hereof shall have received a distribution of Rights
previously owned by such Person or any of its Affiliates and Associates.
(o) The Corporation covenants and agrees that, after the Distribution Date, it
will not, except as permitted by Section 23, Section 24 or Section 27
hereof, take (or permit any Subsidiary to take) any action if at the time
such action is taken it is reasonably foreseeable that such action will
diminish substantially or eliminate the benefits intended to be afforded by
the Rights.
(p) Anything in this Agreement to the contrary notwithstanding, in the event
the Corporation shall at any time after the date of this Agreement and
prior to the Distribution Date (I) declare or pay any dividend on its
Common Stock payable in Common Stock of the Corporation or (II) subdivide
its outstanding Common Stock into a greater number of shares (by
reclassification or otherwise than by payment of dividends in Common Stock)
or (III) combine or consolidate its outstanding Common Stock into a smaller
number of shares, then in any such case, (X) the number of one
one-thousandths of a share of Preferred Stock purchasable after such event
upon proper exercise of each Right shall be determined by multiplying the
number of one one-thousandths of a share of Preferred Stock so purchasable
immediately prior to such event by a fraction, the numerator of which is
the number of shares of Common Stock of the Corporation outstanding
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immediately before such event and the denominator of which is the number of
shares of such Common Stock outstanding immediately after such event and
(Y) action shall be taken such that each share of Common Stock of the
Corporation outstanding immediately after such event shall have issued with
respect to it that number of Rights which each share of Common Stock of the
Corporation outstanding immediately prior to such event had issued with
respect to it. The adjustments provided for in this Section 11(p) shall be
made successively whenever such a dividend is declared or paid or such a
subdivision, combination or consolidation is effected. If an event occurs
which would require an adjustment under Section 11(a)(ii) and this Section
11(p), the adjustments provided for in this Section 11(p) shall be in
addition and prior to any adjustment required pursuant to Section
11(a)(ii).
Section 12. CERTIFICATE OF ADJUSTED PURCHASE PRICE OR NUMBER OF SHARES. Whenever
an adjustment is made as provided in Sections 11 or 13, the Corporation shall
(A) promptly prepare a certificate setting forth such adjustment and a brief
statement of the facts and the computations accounting for such adjustment, (B)
promptly file with the Rights Agent and with each transfer agent for its Common
Stock and Preferred Stock a copy of such certificate and (C) mail a brief
summary thereof to each holder of a Right Certificate (or if prior to the
Distribution Date, to each holder of a certificate representing shares of its
Common Stock) in accordance with Section 26 of this Agreement. Notwithstanding
the foregoing sentence, the failure of the Corporation to make such certificates
or give such notice shall not affect the validity or the force or effect of the
requirement for such adjustment. The Rights Agent shall be fully protected in
relying on any such certificate and on any adjustment therein contained and
shall not have any duty with respect to and shall not be deemed to have
knowledge of any adjustments unless and until it shall have received such
certificate. Any adjustment to be made pursuant to Sections 11 and 13 shall be
effective as of the date of the event giving rise to such adjustment.
Section 13. CONSOLIDATION, MERGER OR SALE OR TRANSFER OF ASSETS, CASH FLOW OR
EARNING POWER.
(a) In the event (a "SECTION 13 EVENT") that, following the Stock Acquisition
Time, directly or indirectly, (X) the Corporation shall consolidate or
otherwise combine with or merge with or into, any other Person (other than
a wholly owned Subsidiary of the Corporation in a transaction which
complies with Section 11(o) hereof) and the Corporation shall not be the
surviving or continuing corporation of such consolidation, combination or
merger, (Y) any Person (other than a wholly owned Subsidiary of the
Corporation in a transaction which complies with Section 11(o) hereof)
shall consolidate or otherwise combine with or merge with or into the
Corporation and the Corporation shall be the surviving or continuing
corporation of such consolidation, combination or merger and, in connection
therewith, all or part of the Common Stock of the Corporation shall be
changed into or exchanged for stock or other securities of the Corporation
or any other Person or cash or any other property or (Z) the Corporation
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shall sell or otherwise transfer (or one or more of its Subsidiaries shall
sell or otherwise transfer), in one or more transactions, assets, cash flow
or earning power aggregating more than 50% of the assets, cash flow or
earning power of the Corporation and its Subsidiaries (taken as a whole and
calculated on the basis of the Corporation's most recent regularly prepared
financial statement) to any other Person or Persons (other than the
Corporation or any wholly owned Subsidiary of the Corporation in one or
more transactions each of which complies with Section 11(o) hereof), then,
and in each such case (except as provided in Section 13(d) hereof), proper
provision shall be made so that (I) each holder of a Right (except as
provided in Section 7(e) hereof) shall thereafter have the right to
receive, upon the exercise thereof at the then current Purchase Price in
accordance with the terms of this Agreement, such number of validly
authorized and issued, fully paid, nonassessable and freely tradable shares
of Common Stock of the Principal Party (as hereinafter defined), not
subject to any liens, encumbrances, rights of call, rights of first refusal
or other adverse claims, as shall be equal to the result obtained by
dividing the then current Purchase Price by 50% of the Current Market Price
per share of Common Stock of such Principal Party on the date of
consummation of such merger, consolidation, sale or transfer (PROVIDED that
the Purchase Price and the number of shares of Common Stock of such
Principal Party so receivable upon exercise of a Right shall, from and
after such Section 13 Event, be subject to further adjustment in accordance
with Section 11(f) hereof to reflect any events occurring in respect of the
Common Stock of such Principal Party after the occurrence of such Section
13 Event); (II) such Principal Party shall thereafter be liable for, and
shall assume, by virtue of such Section 13 Event, all the obligations and
duties of the Corporation pursuant to this Agreement; (III) the term
"CORPORATION" shall thereafter be deemed to refer to such Principal Party,
it being specifically intended that the provisions of Section 11 hereof
shall apply only to such Principal Party following the first occurrence of
a Section 13 Event; (IV) such Principal Party shall take such steps
(including, but not limited to, the reservation of a sufficient number of
shares of its Common Stock in accordance with Section 9 hereof) in
connection with such consummation as may be necessary to assure that the
provisions hereof shall thereafter be applicable, as nearly as reasonably
may be possible, in relation to its shares of Common Stock thereafter
deliverable upon the exercise of the Rights; and (V) the provisions of
Section 11(a)(ii) hereof shall be of no effect following the first
occurrence of any Section 13 Event.
(b) "PRINCIPAL PARTY" shall mean:
(i) in the case of any transaction described in clause (x) or (y) of
the first sentence of Section 13(a) hereof: (A) the Person that
is the issuer of any securities into which shares of Common Stock
of the Corporation are converted in such merger or consolidation,
or (B) if no securities are so issued, (X) the Person that is the
other party to such merger, if such Person survives such merger,
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or (Y) if the Person that is the other party to the merger does
not survive the merger, the Person that does survive the merger
(including the Corporation if it survives) or (Z) the Person
resulting from the consolidation; and
(ii) in the case of any transaction described in clause (z) of the
first sentence of Section 13(a) hereof, the Person that is the
party receiving the greatest portion of the assets, cash flow or
earning power transferred pursuant to such transaction or
transactions;
PROVIDED, HOWEVER, that in any such case, (1) if the Common Stock of such Person
is not at such time and has not been continuously over the preceding 12 month
period registered under Section 12 of the Exchange Act, and such Person is a
direct or indirect Subsidiary of another Person the Common Stock of which is and
has been so registered, "PRINCIPAL PARTY" shall refer to such other Person; and
(2) in case such Person is a Subsidiary, directly or indirectly, of more than
one Person, the Common Stocks of two or more of which are and have been so
registered, "PRINCIPAL PARTY" shall refer to whichever of such Persons is the
issuer of the Common Stock having the greatest aggregate market value.
(c) The Corporation shall not consummate any Section 13 Event unless the
Principal Party shall have a sufficient number of authorized shares of its
Common Stock which have not been issued or reserved for issuance to permit
the exercise in full of the Rights in accordance with this Section 13 and
unless prior thereto the Corporation and such issuer shall have executed
and delivered to the Rights Agent a supplemental agreement containing the
provisions set forth in paragraphs (a) and (b) of this Section 13 and
further providing that, as soon as practicable after the date of any such
Section 13 Event, the Principal Party will:
(i) prepare and file a registration statement under the Act with respect
to the Rights and the securities purchasable upon exercise of the
Rights on an appropriate form and will use its best efforts to cause
such registration statement to (A) become effective as soon as
practicable after such filing and (B) remain effective (with a
prospectus at all times meeting the requirements of the Act) until the
Expiration Date; and
(ii) deliver to holders of the Rights historical financial statements for
the Principal Party and each of its Affiliates which comply in all
respects with the requirements for registration on Form 10 under the
Exchange Act.
The provisions of this Section 13 shall similarly apply to successive
mergers or consolidations or sales or other transfers. In the event that a
Section 13 Event shall occur at any time after the occurrence of a Section
11(a)(ii) Event, the Rights which have not theretofore been exercised shall
thereafter, subject to Section 7(e) hereof, become exercisable in the
manner described in Section 13(a) hereof.
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(d) The Corporation covenants and agrees that it will not, after the occurrence
of a Section 11(a)(ii) Event, engage in any Section 13 Event if at the time
of or after such event there are any charter or by-law provisions or any
rights, warrants or other instruments outstanding or any other action taken
which would diminish or otherwise eliminate the benefits intended to be
afforded by the Rights.
Section 14. FRACTIONAL RIGHTS AND FRACTIONAL SHARES.
(a) The Corporation shall not be required to issue fractions of Rights or to
distribute Right Certificates which evidence fractional Rights. In lieu of
such fractional Rights, there shall be paid to the registered holders of
the Right Certificates with regard to which such fractions of Rights would
otherwise be issuable an amount in cash equal to the same fraction of the
current market value of a whole Right. For the purposes of this Section
14(a), the current market value of a whole Right shall be the closing price
of the Rights for the Trading Day immediately prior to the date on which
such fractional Rights would have been otherwise issuable. The closing
price of the Rights for any day shall be the last sale price, regular way,
or, in case no such sale takes place on such day, the average of the
closing bid and asked prices, regular way, in either case as reported in
the principal consolidated transaction reporting system with respect to
securities listed or admitted to trading on the New York Stock Exchange or,
if the Rights are not listed or admitted to trading on the New York Stock
Exchange, as reported in the principal consolidated transaction reporting
system with respect to securities listed on the principal national
securities exchange on which the Rights are listed or admitted to trading
or, if the Rights are not listed or admitted to trading on any national
securities exchange, the last quoted price or, if not so quoted, the
average of the high bid and low asked prices in the over-the-counter
market, as reported by NASDAQ or such other system then in use, or, if on
any such date the Rights are not quoted by any such organization, the
average of the closing bid and asked prices as furnished by a professional
market maker making a market in the Rights (selected by the Corporation,
acting by resolution of its Board of Directors). If on any such date no
such market maker is making a market in the Rights, the fair value of the
Rights on such date as determined in good faith by the Corporation, acting
by resolution of its Board of Directors shall be used.
(b) The Corporation shall not be required to issue fractions of shares of
Preferred Stock (other than fractions which are integral multiples of one
one-thousandth of a share of Preferred Stock) upon exercise of the Rights
or to distribute certificates which evidence fractional shares (other than
fractions which are integral multiples of one one-thousandth of a share of
Preferred Stock). Fractions of Preferred Stock in integral multiples of one
one-thousandth of a share of Preferred Stock may, at the election of the
Corporation, be evidenced by depositary receipts, pursuant to an
appropriate agreement between the Corporation and a depositary selected by
it, provided that such agreement shall provide that the holders of
depositary receipts shall have all the rights, privileges and preferences
to which they are entitled as beneficial owners of the Preferred Stock. In
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lieu of fractional shares which are not integral multiples of one
one-thousandth of a share of Preferred Stock, the Corporation shall pay to
the registered holders of Right Certificates at the time such Right
Certificates are exercised as herein provided an amount in cash equal to
the same fraction of the current market value of one share of Preferred
Stock. For purposes of this Section 14(b), the current market value of a
share of Preferred Stock shall be the closing price of a share of Preferred
Stock (as determined pursuant to Section 11(d)(ii) hereof) for the Trading
Day immediately prior to the date of such exercise.
(b) Following the occurrence of a Section 11(a)(ii) Event or a Section 13
Event, the Corporation shall not be required to issue fractions of shares
of its Common Stock upon exercise of the Rights or to distribute
certificates or Book-Entries which evidence fractional shares of its Common
Stock. In lieu of fractional shares of its Common Stock, the Corporation
may pay to the registered holders of Right Certificates at the time such
Rights are exercised as herein provided an amount in cash equal to the same
fraction of the current market value of one share of its Common Stock. For
purposes of this Section 14(c), the current market value of one share of
Common Stock of the Corporation shall be the closing price of one share of
Common Stock of the Corporation (as determined pursuant to Section 11(d)(i)
hereof) for the Trading Day immediately prior to the date of such exercise.
(c) The holder of a Right by the acceptance of the Right expressly waives his
right to receive any fractional Rights or any fractional shares upon
exercise of a Right except as permitted by this Section 14.
Section 15. RIGHTS OF ACTION. All rights of action in respect of this Agreement,
except the rights of action vested in the Rights Agent pursuant to this
Agreement are vested in the respective registered holders of the Right
Certificates (and, prior to the Distribution Date, the registered holders of
Common Stock of the Corporation); and any registered holder of any Right
Certificate (or, prior to the Distribution Date, of Common Stock of the
Corporation), without the consent of the Rights Agent or of any holder of any
other Right Certificate (or, prior to the Distribution Date, of Common Stock of
the Corporation) may, in his own behalf and for his own benefit, enforce, and
may institute and maintain any suit, action or proceeding against the
Corporation to enforce, or otherwise act in respect of, his right to exercise
the Rights evidenced by such Right Certificate in the manner provided in such
Right Certificate and in this Agreement. Without limiting the foregoing or any
remedies available to the holders of Rights, it is specifically acknowledged
that the holders of Rights would not have an adequate remedy at law for any
breach of this Agreement and will be entitled to specific performance of the
obligations hereunder and injunctive relief against actual or threatened
violations of the obligations of any Person subject to this Agreement.
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Section 16. AGREEMENT OF RIGHT HOLDERS. Every holder of a Right by accepting
such Right consents and agrees with the Corporation and the Rights Agent and
with every other holder of a Right that:
(a) prior to the Close of Business on the earlier of the Distribution Date or
the Expiration Date, the Rights shall be evidenced by the Book-Entries or
certificates for shares of Common Stock of the Corporation registered in
the name of the holders of such shares (which Book-Entries or certificates
for shares of Common Stock of the Corporation shall also constitute
certificates for Rights) and each Right will be transferable only in
connection with the transfer of Common Stock of the Corporation;
(b) after the Distribution Date, the Right Certificates are transferable only
on the registry books of the Rights Agent if surrendered at the office of
the Rights Agent designated for such purposes, duly endorsed or accompanied
by a proper instrument of transfer;
(c) the Corporation and the Rights Agent shall deem and treat the Person in
whose name the Right Certificate (or, prior to the Distribution Date, the
associated Common Stock Book-Entry or certificate) is registered as the
absolute owner thereof and of the Rights evidenced thereby (notwithstanding
any notations of ownership or writing on the Right Certificate or the
associated Common Stock certificate made by anyone other than the
Corporation or the Rights Agent) for all purposes whatsoever, and neither
the Corporation nor the Rights Agent shall be affected by any notice to the
contrary; and
(d) notwithstanding anything in this Agreement to the contrary, neither the
Corporation nor the Rights Agent shall have any liability to any holder of
a Right or other Person as a result of its inability to perform any of its
obligations under this Agreement by reason of any preliminary or permanent
injunction or other order, decree, judgment or ruling (whether
interlocutory or final) issued by a court of competent jurisdiction or by a
governmental, regulatory or administrative agency or commission, or any
statute, rule, regulation or executive order promulgated or enacted by any
governmental authority, prohibiting or otherwise restraining performance of
such obligation; PROVIDED, HOWEVER, the Corporation must use its best
efforts to have any such order, decree, judgment or ruling lifted or
otherwise overturned as soon as possible.
Section 17. RIGHT CERTIFICATE HOLDER NOT DEEMED A STOCKHOLDER. No holder, as
such, of any Right or Right Certificate shall be entitled to vote, receive
dividends or be deemed for any purpose the holder of the number of one
one-thousandths of a share of Preferred Stock or any other securities of the
Corporation which may at any time be issuable on the exercise of the Rights
represented thereby, nor shall anything contained herein or in any Right
Certificate be construed to confer upon the holder of any Right or Right
Certificate, as such, any of the rights of a stockholder of the Corporation or
any right to vote for the election of directors or upon any matter submitted to
stockholders at any meeting thereof, or to give or withhold consent to any
206
corporate action, or to receive notice of meetings or other actions affecting
stockholders (except as provided in Section 24), or to receive dividends or
subscription rights, or otherwise, until the Right or Rights evidenced by such
Right Certificate shall have been exercised in accordance with the provisions
hereof.
Section 18. CONCERNING THE RIGHTS AGENT.
(a) The Corporation agrees to pay to the Rights Agent reasonable compensation
for all services rendered by it hereunder and, from time to time, on demand
of the Rights Agent, its reasonable expenses and counsel fees and other
disbursements incurred in the preparation, delivery, administration,
amendment and execution of this Agreement and the exercise and performance
of its duties hereunder. The Corporation also agrees to indemnify the
Rights Agent for, and to hold it harmless against, any loss, liability,
damage, judgment, fine, penalty, claim, demand, settlement, cost or
expense, incurred without gross negligence, bad faith or willful misconduct
(as each is finally determined by a court of competent jurisdiction) on the
part of the Rights Agent, for any action taken, suffered, or omitted by the
Rights Agent in connection with the acceptance and administration of this
Agreement, including the costs and expenses of defending against any claim
of liability. The indemnity provided herein shall survive the termination
of this Agreement, the termination and the expiration of the Rights and the
resignation or removal of the Rights Agent. The costs and expenses incurred
in enforcing this right of indemnification shall be paid by the Corporation
promptly upon the request of the Rights Agent.
(b) The Rights Agent shall be authorized to rely on, shall be protected and
shall incur no liability for or in respect of any action taken, suffered or
omitted by it in connection with the acceptance and administration of this
Agreement or the exercise or performance of its duties hereunder in
reliance upon any Right Certificate or certificate for Preferred Stock or
Common Stock of the Corporation or for other securities of the Corporation,
instrument of assignment or transfer, power of attorney, endorsement,
affidavit, letter, notice, direction, consent, certificate, statement or
other paper or document believed by it to be genuine and to be signed,
executed and, where necessary, verified or acknowledged by the proper
Person or Persons.
Section 19. MERGER OR CONSOLIDATION OR CHANGE OF NAME OF RIGHTS AGENT.
(a) Any Person into which the Rights Agent or any successor Rights Agent may be
merged or with which it may be consolidated, or any Person resulting from
any merger or consolidation to which the Rights Agent or any successor
Rights Agent shall be a party, or any Person succeeding to the shareholder
services business of the Rights Agent or any successor Rights Agent, shall
be the successor to the Rights Agent under this Agreement without the
execution or filing of any paper or any further act on the part of any of
207
the parties hereto; PROVIDED, HOWEVER, that such Person would be eligible
for appointment as a successor Rights Agent under the provisions of Section
21 hereof. The purchase of all or substantially all of the Rights Agent's
assets employed in the performance of transfer agent activities shall be
deemed a merger or consolidation for purposes of this Section 19. In case
at the time such successor Rights Agent shall succeed to the agency created
by this Agreement, any of the Right Certificates shall have been
countersigned but not delivered, any such successor Rights Agent may adopt
the countersignature of the predecessor Rights Agent and deliver such Right
Certificates so countersigned; and in case at that time any of the Right
Certificates shall not have been countersigned, any successor Rights Agent
may countersign such Right Certificates either in the name of the
predecessor Rights Agent or in the name of the successor Rights Agent; and
in all such cases such Right Certificates shall have the full force
provided in the Right Certificates and in this Agreement.
(b) In case at any time the name of the Rights Agent shall be changed and at
such time any of the Right Certificates shall have been countersigned but
not delivered, the Rights Agent may adopt the countersignature under its
prior name and deliver Right Certificates so countersigned; and in case at
that time any of the Right Certificates shall not have been countersigned,
the Rights Agent may countersign such Right Certificates either in its
prior name or in its changed name; and in all such cases such Right
Certificates shall have the full force provided in the Right Certificates
and in this Agreement.
Section 20. DUTIES OF RIGHTS AGENT. The Rights Agent undertakes only the duties
and obligations expressly imposed by this Agreement (and no implied duties or
obligations) upon the following terms and conditions, by all of which the
Corporation and the holders of Right Certificates, by their acceptance thereof,
shall be bound:
(a) The Rights Agent may consult with legal counsel selected by it (which may
be legal counsel for the Corporation), and the advice or opinion of such
counsel shall be full and complete authorization and protection to the
Rights Agent, and the Rights Agent shall incur no liability for or in
respect of any action taken, suffered or omitted by it in good faith and in
accordance with such advice or opinion.
(b) Whenever in the performance of its duties under this Agreement the Rights
Agent shall deem it necessary or desirable that any fact or matter
(including, without limitation, the identity of an Acquiring Person and the
determination of the Current Market Price per share of Preferred Stock and
Common Stock) be proved or established by the Corporation prior to taking,
suffering or omitting any action hereunder, such fact or matter (unless
other evidence in respect thereof be herein specifically prescribed) may be
deemed to be conclusively proved and established by a certificate signed by
the Chairman of the Board, the Chief Executive Officer, the President (if
any) or the Senior Vice President and General Counsel and by the Treasurer
208
or the Secretary of the Corporation and delivered to the Rights Agent; and
such certificate shall be full authorization and protection to the Rights
Agent, and the Rights Agent shall have no liability for or in respect of
any action taken, suffered or omitted in good faith by it under the
provisions of this Agreement in reliance upon such certificate.
(c) The Rights Agent shall be liable hereunder only for its own gross
negligence, bad faith or willful misconduct (as each is finally determined
by a court of competent jurisdiction). Anything to the contrary
notwithstanding, in no event shall the Rights Agent be liable for special,
indirect, consequential or incidental loss or damages of any kind
whatsoever (including but not limited to lost profits), even if the Rights
Agent has been advised of the likelihood of such loss or damage. This
Section 20(c) shall survive the termination of this Agreement, the
termination and expiration of the Rights, and the resignation or removal of
the Rights Agent.
(d) The Rights Agent shall not be liable for or by reason of any of the
statements of fact or recitals contained in this Agreement or in the Right
Certificates (except its countersignature thereof) or be required to verify
the same, but all such statements and recitals are and shall be deemed to
have been made by the Corporation only.
(e) The Rights Agent shall not have any liability for, nor be under any
responsibility in respect of the validity of this Agreement or the
execution and delivery hereof (except the due execution hereof by the
Rights Agent) or in respect of the validity or execution of any Right
Certificate (except its countersignature thereof); nor shall it be liable
or responsible for any breach by the Corporation of any covenant or
condition contained in this Agreement or in any Right Certificate; nor
shall it be responsible for any adjustment required under the provisions of
Section 11 or Section 13 or responsible for the manner, method or amount of
any such adjustment or the ascertaining of the existence of facts that
would require any such adjustment (except with respect to the exercise of
Rights evidenced by Right Certificates after actual notice of any such
adjustment); nor shall it be liable or responsible for any determination by
the Board of Directors of the Corporation of the Current Market Price of
the Preferred Stock or Common Stock of the Corporation; nor shall it by any
act hereunder be deemed to make any representation or warranty as to the
authorization or reservation of any shares of Common Stock of the
Corporation or Preferred Stock or other securities to be issued pursuant to
this Agreement or any Right Certificate or as to whether any shares of
Preferred Stock or Common Stock of the Corporation or other securities
will, when issued, be validly authorized and issued, fully paid and
nonassessable.
(f) The Corporation agrees that it will perform, execute, acknowledge and
deliver or cause to be performed, executed, acknowledged and delivered all
such further and other acts, instruments and assurances as may reasonably
be required by the Rights Agent for the carrying out or performing by the
Rights Agent of the provisions of this Agreement.
209
(g) The Rights Agent is hereby authorized and directed to accept instructions
with respect to the performance of its duties hereunder from the Chairman
of the Board, the Chief Executive Officer, the President (if any), the
Senior Vice President and General Counsel, the Secretary or the Treasurer
of the Corporation, and to apply to such officers for advice or
instructions in connection with its duties, and such advice or instructions
shall be full authorization and protection to the Rights Agent and the
Rights Agent shall incur no liability for or in respect of any action
taken, suffered or omitted to be taken by it in good faith in accordance
with the advice or instructions of any such officer.
(h) The Rights Agent and any stockholder, director, Affiliate, officer or
employee of the Rights Agent may buy, sell or deal in any of the Rights or
other securities of the Corporation or become pecuniarily interested in any
transaction in which the Corporation may be interested, or contract with or
lend money to the Corporation or otherwise act as fully and freely as
though it were not Rights Agent under this Agreement. Nothing herein shall
preclude the Rights Agent from acting in any other capacity for the
Corporation or for any other Person.
(i) The Rights Agent may execute and exercise any of the rights or powers
hereby vested in it or perform any duty hereunder either itself or by or
through its attorneys or agents, and the Rights Agent shall not be
answerable or accountable for any act, omission, default, neglect or
misconduct of any such attorneys or agents or for any loss to the
Corporation, to holders of the Rights or any other Person resulting from
any such act, omission, default, neglect or misconduct, PROVIDED reasonable
care was exercised in the selection and continued employment thereof.
(j) No provision of this Agreement shall require the Rights Agent to expend or
risk its own funds or otherwise incur any financial liability in the
performance of any of its duties hereunder or in the exercise of its rights
if there should be reasonable grounds for believing that repayment of such
funds or adequate indemnification against such risk or liability is not
reasonably assured for it.
(k) If, with respect to any Right Certificate surrendered to the Rights Agent
for exercise or transfer, the certificate attached to the form of
assignment or form of election to purchase, as the case may be, has either
not been completed properly or indicates an affirmative response to clause
1 and/or 2 thereof, the Rights Agent shall not take any further action with
respect to such requested exercise or transfer without first consulting
with the Corporation.
Section 21. CHANGE OF RIGHTS AGENT. The Rights Agent or any successor Rights
Agent may resign and be discharged from its duties under this Agreement upon 30
210
days' notice in writing mailed to the Corporation and to each transfer agent of
the Common Stock of the Corporation and Preferred Stock by registered or
certified mail, and to the holders of the Right Certificates by first-class
mail. The Corporation may remove the Rights Agent or any successor Rights Agent
upon 30 days' notice in writing, mailed to the Rights Agent or successor Rights
Agent, as the case may be, and to each transfer agent of the Common Stock of the
Corporation and Preferred Stock by registered or certified mail, and to the
holders of the Right Certificates by first-class mail. If the Rights Agent shall
resign or be removed or shall otherwise become incapable of acting, the
Corporation shall appoint a successor to the Rights Agent. If the Corporation
shall fail to make such appointment within a period of 30 days after giving
notice of such removal or after it has been notified in writing of such
resignation or incapacity by the resigning or incapacitated Rights Agent or by
the holder of a Right Certificate (who shall, with such notice, submit his Right
Certificate for inspection by the Corporation), then the registered holder of
any Right Certificate may apply to any court of competent jurisdiction for the
appointment of a new Rights Agent. Any successor Rights Agent, whether appointed
by the Corporation or by such a court, shall be a Person organized and doing
business under the laws of the United States, or any state of the United States,
so long as such Person is in good standing, is authorized under such laws to
exercise shareholders services powers and is subject to supervision or
examination by federal or state authority and which has at the time of its
appointment as Rights Agent a combined capital and surplus of at least $50
million. After appointment, the successor Rights Agent shall be vested with the
same powers, rights, duties and responsibilities as if it had been originally
named as Rights Agent without further act or deed; but the predecessor Rights
Agent shall deliver and transfer to the successor Rights Agent any property at
the time held by it hereunder and execute and deliver any further assurance,
conveyance, act or deed necessary for the purpose. Not later than the effective
date of any such appointment, the Corporation shall file notice thereof in
writing with the predecessor Rights Agent and each transfer agent of its Common
Stock and Preferred Stock, and mail a notice thereof in writing to the
registered holders of the Right Certificates. Failure to give any notice
provided for in this Section 21, however, or any defect therein, shall not
affect the legality or validity of the resignation or removal of the Rights
Agent or the appointment of the successor Rights Agent, as the case may be.
Section 22. ISSUANCE OF NEW RIGHT CERTIFICATES. Notwithstanding any of the
provisions of this Agreement or of the Rights to the contrary, the Corporation
may, at its option, issue new Right Certificates evidencing Rights in such form
as may be approved by resolution of its Board of Directors, to reflect any
adjustment or change in the Purchase Price and the number or kind or class of
shares of stock or other securities or property purchasable under the Right
Certificates made in accordance with the provisions of this Agreement. In
addition, in connection with the issuance or sale of shares of its Common Stock
following the Distribution Date (other than upon exercise of a Right) and prior
to the Expiration Date, the Corporation (A) shall, with respect to shares of
Common Stock so issued or sold pursuant to the exercise of stock options or
under any employee plan or arrangement, or upon the exercise, conversion or
211
exchange of securities, notes or debentures issued by the Corporation, and (B)
may, in any other case, if deemed necessary or appropriate by the Board of
Directors of the Corporation, issue Right Certificates representing the
appropriate number of Rights in connection with such issuance or sale; PROVIDED,
HOWEVER, that (I) no such Right Certificate shall be issued if and to the extent
that the Corporation shall be advised by counsel that such issuance would create
a significant risk of material adverse tax consequences to the Corporation or
the Person to whom such Right Certificate would be issued and (II) no such Right
Certificate shall be issued if and to the extent that appropriate adjustment
shall otherwise have been made in lieu of the issuance thereof.
Section 23. REDEMPTION.
(a) The Corporation may, by resolution of its Board of Directors, at its
option, at any time prior to the earlier of (X) the Stock Acquisition Time
or (Y) the Close of Business on the Final Expiration Date, redeem all but
not less than all of the then outstanding Rights at a redemption price of
$.001 per Right (payable in cash, shares of Common Stock (based on the
Current Market Price of the Common Stock at the time of redemption) or any
other form of consideration deemed appropriate by the Board of Directors of
the Corporation), appropriately adjusted to reflect any stock split, stock
dividend or similar transaction occurring after the date hereof (such
redemption price being hereinafter referred to as the "REDEMPTION PRICE").
(b) Immediately upon the action of the Board of Directors of the Corporation
ordering the redemption of the Rights (or at such time subsequent to such
action as the Board of Directors may determine), and without any further
action and without any notice, the right to exercise the Rights will
terminate and the only right thereafter of the holders of Rights shall be
to receive the Redemption Price. Within 10 days after the action of the
Board of Directors ordering the redemption of the Rights, the Corporation
shall give notice of such redemption to the holders of the then outstanding
Rights and to the Rights Agent by mailing such notice to all such holders
at their last addresses as they appear upon the registry books of the
Rights Agent or, prior to the Distribution Date, on the registry books of
the transfer agent for the Common Stock of the Corporation. Any notice
which is mailed in the manner herein provided shall be deemed given,
whether or not the holder receives the notice. Each such notice of
redemption will state the method by which the payment of the Redemption
Price will be made. Neither the Corporation nor any of its Affiliates or
Associates may redeem, acquire or purchase any Rights at any time in any
manner other than that specifically set forth in this Section 23 or Section
24 hereof and other than in connection with the repurchase of Common Stock
of the Corporation prior to the Distribution Date.
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Section 24. EXCHANGE.
(a) The Board of Directors of the Corporation may, at its option, at any time
after any Person becomes an Acquiring Person, exchange all or part of the
then outstanding and exercisable Rights (which shall not include Rights
that have become null and void pursuant to the provisions of Section 7(e)
hereof) for shares of Common Stock at an exchange ratio of one share of
Common Stock per Right, appropriately adjusted to reflect any stock split,
stock dividend or similar transaction occurring after the date hereof (such
exchange ratio being hereinafter referred to as the "EXCHANGE RATIO").
Notwithstanding the foregoing, the Board of Directors shall not be
empowered to effect such exchange at any time after any Person (other than
an Exempt Person), together with all Affiliates and Associates of such
Person, becomes the Beneficial Owner of 50% or more of the shares of Common
Stock then outstanding.
(b) Immediately upon the action of the Board of Directors of the Corporation
ordering the exchange of any Rights pursuant to paragraph (a) of this
Section 24 and without any further action and without any notice, the right
to exercise such Rights shall terminate and the only right thereafter of a
holder of such Rights shall be to receive that number of shares of Common
Stock equal to the number of such Rights held by such holder multiplied by
the Exchange Ratio. The Corporation shall promptly give public notice of
any such exchange (with prompt notice thereof to the Rights Agent);
PROVIDED, HOWEVER, that the failure to give, or any defect in, such notice
shall not affect the validity of such exchange. The Corporation promptly
shall mail a notice of any such exchange to all of the holders of such
Rights at their last addresses as they appear upon the registry books of
the Rights Agent. Any notice which is mailed in the manner herein provided
shall be deemed given, whether or not the holder receives the notice. Each
such notice of exchange will state the method by which the exchange of the
shares of Common Stock for Rights will be effected and, in the event of any
partial exchange, the number of Rights which will be exchanged. Any partial
exchange shall be effected PRO RATA based on the number of Rights (other
than Rights which have become void pursuant to the provisions of Section
7(e) hereof) held by each holder of Rights.
(c) In any exchange pursuant to this Section 24, the Corporation, at its
option, may substitute shares of Preferred Stock (or any other series of
preferred stock of the Corporation containing terms substantially similar
to the terms of the Preferred Stock) for some or all of the shares of
Common Stock exchangeable for Rights, at the initial rate of one
one-thousandth of a share of Preferred Stock (or of such other series of
preferred stock of the Corporation) for each share of Common Stock, as
appropriately adjusted to reflect adjustments in the voting rights of the
Preferred Stock pursuant to the terms thereof, so that the fraction of a
share of Preferred Stock (or of such other series of preferred stock of the
Corporation) delivered in lieu of each share of Common Stock shall have the
same voting rights as one share of Common Stock.
(d) In the event that there shall not be sufficient shares of Common Stock or
Preferred Stock (or any other series of preferred stock of the Corporation
containing terms substantially similar to the terms of the Preferred Stock)
213
issued but not outstanding or authorized but unissued to permit any
exchange of Rights as contemplated in accordance with this Section 24, the
Corporation shall take all such action as may be necessary to authorize
additional shares of Common Stock or Preferred Stock (or such other series
of preferred stock of the Corporation) for issuance upon exchange of the
Rights.
(e) The Corporation shall not be required to issue fractions of shares of
Common Stock or to distribute Book-Entries or certificates which evidence
fractional shares of Common Stock. In lieu of such fractional shares, the
Corporation shall pay to the registered holders of the Right Certificates
with regard to which such fractional shares would otherwise be issuable an
amount in cash equal to the same fraction of the current market value of a
whole share of Common Stock. For the purposes of this paragraph (d), the
current market value of a whole share of Common Stock shall be the closing
price of a share of Common Stock (as determined pursuant to the second
sentence of Section 11(d) hereof) for the Trading Day immediately prior to
the date of exchange pursuant to this Section 24.
Section 25. NOTICE OF CERTAIN EVENTS.
(a) In case the Corporation shall at any time after the earlier of the
Distribution Date or the Stock Acquisition Time propose (i) to pay any
dividend payable in stock of any class to the holders of its Preferred
Stock or to make any other distribution to the holders of its Preferred
Stock (other than a regular periodic dividend out of earnings or retained
earnings of the Corporation), or (II) to offer to the holders of Preferred
Stock options, rights or warrants to subscribe for or to purchase any
additional Preferred Stock or shares of stock of any class or any other
securities, rights or options, or (III) to effect any reclassification of
the Preferred Stock (other than a reclassification involving only the
subdivision of outstanding shares of Preferred Stock), or (IV) to effect
any merger, consolidation or other combination into or with, or to effect
any sale or other transfer (or to permit one or more of its Subsidiaries to
effect any sale or other transfer), in one or more transactions, of more
than 50% of the assets, cash flow or earning power of the Corporation and
its Subsidiaries (taken as a whole) to, any other Person, or (V) to effect
the liquidation, dissolution or winding up of the Corporation, then, in
each such case, the Corporation shall give to the Rights Agent and each
holder of a Right, in accordance with Section 26 hereof, a notice of such
proposed action, which shall specify the record date for the purposes of
such stock dividend or distribution of rights or warrants, or the date on
which such reclassification, merger, consolidation, combination, sale,
transfer, liquidation, dissolution or winding up is to take place and the
date of participation therein by the holders of Common Stock of the
Corporation or Preferred Stock, if any such date is to be fixed, and such
notice shall be so given in the case of any action covered by clause (i) or
(ii) above at least twenty days prior to the record date for determining
holders of Preferred Stock for purposes of such action, and in the case of
any such other action, at least twenty days prior to the date of the taking
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of such proposed action or the date of participation therein by the holders
of Common Stock of the Corporation or Preferred Stock, whichever shall be
the earlier. The failure to give notice required by this Section 25 or any
defect therein shall not affect the legality or validity of the action
taken by the Corporation or the vote upon any such action.
(b) In case any of the events set forth in Section 11(a)(ii) or Section 13(a)
of this Agreement shall occur, then, in any such case, (I) the Corporation
shall as soon as practicable thereafter give to the Rights Agent and to
each holder of a Right, to the extent feasible and in accordance with
Section 26, a notice of the occurrence of such event, which shall specify
the event and the consequences of the event to holders of Rights under
Section 11(a)(ii) or Section 13(a) hereof, and (II) all references in
Section 25(a) hereof to Preferred Stock shall be deemed thereafter to refer
also to Common Stock or other securities issuable in respect of the Rights.
Section 26. NOTICES. Notices or demands authorized by this Agreement to be given
or made by the Rights Agent or by the holder of any Right Certificate to or on
the Corporation shall be sufficiently given or made if sent by first-class mail,
postage prepaid, addressed (until another address is filed in writing with the
Rights Agent) as follows:
Principal Financial Group, Inc.
711 High Street
Des Moines, Iowa 50392
Attention: Corporate Secretary
Subject to the provisions of Section 21, any notice or demand authorized by this
Agreement to be given or made by the Corporation or by the holder of any Right
Certificate to or on the Rights Agent shall be sufficiently given or made if
sent by first-class mail, postage prepaid, addressed (until another address is
filed in writing with the Corporation) as follows:
Mellon Investor Services LLC
85 Challenger Road
Ridgefield Park, NJ 07660
Attention: Gary Wozniak
Notices or demands authorized by this Agreement to be given or made by the
Corporation or the Rights Agent to the holder of any Right Certificate (or if
prior to the Distribution Date to each holder of a certificate representing
shares of Common Stock of the Corporation) shall be sufficiently given or made
if sent by first-class mail, postage prepaid, addressed to such Right holder (or
215
if prior to the Distribution Date to such holder of Common Stock of the
Corporation) at the address of such holder as shown on the registry books of the
Corporation.
Section 27. SUPPLEMENTS AND AMENDMENTS. Prior to the Stock Acquisition Time and
subject to the penultimate sentence of this Section 27, the Corporation may, by
resolution of its Board of Directors, and the Rights Agent shall, if the
Corporation so directs, supplement or amend any provision of this Agreement in
any respect whatsoever (including, without limitation, any extension of the
period in which the Rights may be redeemed) without the approval of any holders
of certificates representing shares of Common Stock of the Corporation. From and
after the Stock Acquisition Time and subject to the penultimate sentence of this
Section 27, without the approval of any holders of certificates representing
shares of Common Stock of the Corporation or of Right Certificates, the
Corporation may, by resolution of its Board of Directors, and the Rights Agent
shall, if the Corporation so directs, supplement or amend this Agreement in
order (I) to cure any ambiguity, (II) to correct or supplement any provision
contained herein which may be defective or inconsistent with any other
provisions herein, (III) to shorten or lengthen any time period hereunder or
(IV) to change or supplement or make any other provisions in any manner which
the Corporation may deem necessary or desirable, which shall not adversely
affect the interests of, or diminish substantially or eliminate the benefits
intended to be afforded by the Rights to, the holders of Right Certificates
(other than an Acquiring Person or an Affiliate or Associate of any such
Person); PROVIDED, HOWEVER, that this Agreement may not be supplemented or
amended to lengthen, pursuant to clause (iii) of this sentence, (A) a time
period relating to when the Rights may be redeemed or to modify the ability (or
inability) of the Board of Directors of the Corporation to redeem the Rights, in
either case at such time as the Rights are not then redeemable or (B) any other
time period unless such lengthening is for the purpose of protecting, enhancing
or clarifying the rights of or the benefits to the holders of Rights (other than
an Acquiring Person or an Affiliate or Associate of any such Person). Upon the
delivery of a certificate from an appropriate officer of the Corporation which
states that the proposed supplement or amendment is in compliance with the terms
of this Section 27 and PROVIDED that such supplement or amendment does not,
without prior consent of the Rights Agent, change or increase the Rights Agent's
duties, liabilities or obligations hereunder, the Rights Agent shall execute
such supplement or amendment. Notwithstanding anything contained in this
Agreement to the contrary, no supplement or amendment shall be made which
changes the Redemption Price or the Final Expiration Date. Prior to the
Distribution Date, the interests of the holders of Rights shall be deemed
coincident with the interests of the holders of Common Stock.
Section 28. SUCCESSORS. All the covenants and provisions of this Agreement by or
for the benefit of the Corporation or the Rights Agent shall bind and inure to
the benefit of their respective successors and assigns hereunder.
Section 29. DETERMINATIONS AND ACTIONS BY THE BOARD OF DIRECTORS, ETC.
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(a) For all purposes of this Agreement, any calculation of the number of shares
of Common Stock outstanding at any particular time, including for purposes
of determining the particular percentage of such outstanding shares of
Common Stock of which any Person is the Beneficial Owner, shall be made in
accordance with the last sentence of Rule 13d-3(d)(1)(i) of the General
Rules and Regulations under the Exchange Act. The Board of Directors of the
Corporation shall have the exclusive power and authority to administer this
Agreement and to exercise all rights and powers specifically granted to
such Board of Directors, or as may be necessary or advisable in the
administration of this Agreement, including, without limitation, the right
and power to (I) interpret the provisions of this Agreement and (II) make
all determinations deemed necessary or advisable for the administration of
this Agreement (including, without limitation, a determination to redeem or
not redeem the Rights or to amend the Agreement). All such actions,
calculations, interpretations and determinations (including, for purposes
of clause (y) below, all omissions with respect to the foregoing) which are
done or made by the Board of Directors of the Corporation or the
Corporation in good faith, (X) shall be final, conclusive and binding on
the Corporation, the Rights Agent, the holders of the Right Certificates
and all other parties and (y) shall not subject the Board of Directors of
the Corporation to any liability to the holders of the Rights and Right
Certificates. The Rights Agent shall assume that all such actions,
calculations, interpretations and determinations which are done or made by
the Board of Directors were done or made in good faith.
(b) Nothing contained in this Agreement shall be deemed to be in derogation of
the obligation of the Board of Directors of the Corporation to exercise its
fiduciary duty. Without limiting the foregoing, nothing contained in this
Agreement shall be construed to suggest or imply that the Board of
Directors of the Corporation shall not be entitled to reject any tender
offer, or to take any other action (including, without limitation, the
commencement, prosecution, defense or settlement of any litigation and the
submission of additional or alternative offers or other proposals) with
respect to any tender offer that the Board of Directors believes is
necessary or appropriate in the exercise of such fiduciary duty.
Section 30. BENEFITS OF THIS AGREEMENT. Nothing in this Agreement shall be
construed to give to any Person other than the Corporation, the Rights Agent and
the registered holders of the Right Certificates (and, prior to the Distribution
Date, registered holders of the Common Stock of the Corporation) any legal or
equitable right, remedy or claim under this Agreement; but this Agreement shall
be for the sole and exclusive benefit of the Corporation, the Rights Agent and
the registered holders of the Right Certificates (and, prior to the Distribution
Date, registered holders of the Common Stock of the Corporation).
Section 31. SEVERABILITY. If any term, provision, covenant or restriction of
this Agreement is held by a court of competent jurisdiction or other authority
to be invalid, void or unenforceable, the remainder of the terms, provisions,
217
covenants and restrictions of this Agreement shall remain in full force and
effect and shall in no way be affected, impaired or invalidated; PROVIDED,
HOWEVER, that notwithstanding anything in this Agreement to the contrary, if any
such term, provision, covenant or restriction is held by such court or authority
to be invalid, void or unenforceable and the Board of Directors of the
Corporation determines in its good faith judgment that severing the invalid
language from this Agreement would adversely affect the purpose or effect of
this Agreement, the right of redemption set forth in Section 23 hereof shall be
reinstated and shall not expire until the Close of Business on the tenth
Business Day following the date of such determination by the Board of Directors.
Section 32. GOVERNING LAW. This Agreement and each Right Certificate issued
hereunder shall be deemed to be a contract made under the laws of the State of
Delaware and for all purposes shall be governed by and construed in accordance
with the laws of such State applicable to contracts to be made and performed
entirely within such State.
Section 33. COUNTERPARTS. This Agreement may be executed in any number of
counterparts and each of such counterparts shall for all purposes be deemed to
be an original, and all such counterparts shall together constitute but one and
the same instrument.
Section 34. DESCRIPTIVE HEADINGS. Descriptive headings of the several Sections
of this Agreement are inserted for convenience only and shall not control or
affect the meaning or construction of any of the provisions hereof.
SIGNATURE
IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed
and their respective corporate seals to be hereunto affixed and attested, all as
of the day and year first above written.
Attest: PRINCIPAL FINANCIAL GROUP, INC.
By /s/ Joyce N. Hoffman By /s/ Karen E. Shaff
Name: Joyce N. Hoffman Name: Karen E. Shaff
Title: Senior Vice President Title: Senior Vice President and
Coporate Secretary General Counsel
Attest: Mellon Investor Services LLC,
as Rights Agent
By /s/ James J. Mabli By /s/ Marie Sandauer
Name: James J. Mabli Name: Marie Sandauer
Title: Vice President Title: Vice President and Regional
Manager
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EXHIBIT A
PRINCIPAL FINANCIAL GROUP, INC.
Certificate of Designation,
Preferences and Rights
Pursuant to Section 151
of the General Corporation Law
of the State of Delaware
--------------------
Certificate of Designation,
Preferences and Rights
of
Series A Junior Participating Preferred Stock
I, [officer], being the [title] of Principal Financial Group, Inc., a
corporation organized and existing under the General Corporation Law of Delaware
(the "CORPORATION"), do hereby certify:
FIRST: That, pursuant to authority expressly vested in the Board of Directors of
the Corporation by the provisions of its Certificate of Incorporation, the Board
of Directors on , duly adopted the following resolution:
RESOLVED, that, pursuant to the authority vested in the Board in accordance with
the provisions of the Amended and Restated Certificate of Incorporation of the
Corporation, a Series A Junior Participating Preferred Stock, par value $0.01
per share, of the Corporation (the "Series A Preferred Stock") be, and it hereby
is, created, and that the designation and the voting powers, preferences and
relative participating, optional and other special rights of the shares of such
series, and the qualifications, limitations or restrictions thereof be set forth
in Exhibit A to the Rights Agreement (the "Certificate of Designation for the
Series A Preferred Stock"); and
FURTHER RESOLVED, that the aggregate number of shares of the preferred stock of
the Corporation that shall constitute the Series A Preferred Stock shall be
2,500,000 shares.
SECOND: That the designation and the voting powers, preferences and relative
participating, optional and other special rights of the shares of such series,
and the qualifications, limitations or restrictions thereof are as follows:
Section 1. DESIGNATION AND NUMBER OF SHARES. 2,500,000 shares of the Preferred
Stock of the Corporation shall constitute a series of Preferred Stock designated
as Series A Junior Participating Preferred Stock (hereinafter referred to as the
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"SERIES A PREFERRED STOCK"). Such number of shares may be increased or decreased
by resolution of the Board of Directors; PROVIDED, that no decrease shall reduce
the number of shares of Series A Preferred Stock to a number less than the
number of shares then outstanding plus the number of shares reserved for
issuance upon the exercise of outstanding options, rights or warrants or upon
the conversion of any outstanding securities issued by the Corporation
convertible into Series A Preferred Stock.
Section 2. DIVIDENDS AND DISTRIBUTIONS.
(A) Subject to the rights of the holders of any shares of any series of
Preferred Stock (or any similar stock) ranking prior and superior to the
Series A Preferred Stock with respect to dividends, the holders of shares
of Series A Preferred Stock, in preference to the holders of Common Stock,
par value $0.01 of the Corporation (the "COMMON STOCK") and of any other
junior stock which may be outstanding, shall be entitled to receive, when,
as and if declared by the Board of Directors out of funds legally available
for the purpose, annual dividends payable in cash on the fifteenth day of
December in each year (each such date being referred to herein as a
"DIVIDEND PAYMENT DATE"), commencing on the first Dividend Payment Date
after the first issuance of a share or fraction of a share of Series A
Preferred Stock, in an amount per share (rounded to the nearest cent) equal
to the greater of (A) $10.00 per share, or (B) subject to the provision for
adjustment hereinafter set forth, 1000 times the aggregate per share amount
of all cash dividends, and 1000 times the aggregate per share amount
(payable in kind) of all non-cash dividends or other distributions, other
than a dividend payable in shares of Common Stock or a subdivision of the
outstanding shares of Common Stock (by reclassification or otherwise),
declared on the Common Stock since the immediately preceding Dividend
Payment Date, or, with respect to the first Dividend Payment Date, since
the first issuance of any share or fraction of a share of Series A
Preferred Stock. In the event the Corporation shall at any time declare or
pay any dividend on Common Stock payable in shares of Common Stock, or
effect a subdivision or combination or consolidation of the outstanding
shares of Common Stock (by reclassification or otherwise) into a greater or
lesser number of shares of Common Stock, then in each such case the amount
to which holders of shares of Series A Preferred Stock were entitled
immediately prior to such event under clause (b) of the preceding sentence
shall be adjusted by multiplying such amount by a fraction, the numerator
of which is the number of shares of Common Stock outstanding immediately
after such event and the denominator of which is the number of shares of
Common Stock that were outstanding immediately prior to such event.
(B) The Corporation shall declare a dividend or distribution on the Series A
Preferred Stock as provided in paragraph (A) of this Section immediately
after it declares a dividend or distribution on the Common Stock (other
than a dividend payable in shares of Common Stock); PROVIDED that, in the
event no dividend or distribution shall have been declared on the Common
Stock during the period between any Dividend Payment Date and the next
220
subsequent Dividend Payment Date, a dividend of $10.00 per share on the
Series A Preferred Stock shall nevertheless be payable on such subsequent
Dividend Payment Date.
(C) Dividends shall begin to accrue and be cumulative on outstanding shares
or Series A Preferred Stock from the Dividend Payment Date next preceding
the date of issue of such shares of Series A Preferred Stock, unless the
date of issue of such shares is prior to the record date for the first
Dividend Payment Date, in which case dividends on such shares shall begin
to accrue from the date of issue of such shares, or unless the date of
issue is a Dividend Payment Date or is a date after the record date for the
determination of holders of shares of Series A Preferred Stock entitled to
receive a quarterly dividend and before such Dividend Payment Date, in
either of which events such dividends shall begin to accrue and be
cumulative from such Dividend Payment Date. Accrued but unpaid dividends
shall accumulate but shall not bear interest. Dividends paid on the shares
of Series A Preferred Stock in an amount less than the total amount of such
dividends at the time accrued and payable on such shares shall be allocated
PRO RATA on a share-by-share basis among all such shares at the time
outstanding. The Board of Directors may fix a record date for the
determination of holders of shares of Series A Preferred Stock entitled to
receive payment of a dividend or distribution declared thereon, which
record date shall be not more than 60 days prior to the date fixed for the
payment thereof.
Section 3. VOTING RIGHTS. The holders of shares of Series A Preferred Stock
shall have the following voting rights:
(A) Subject to the provisions for adjustment as hereinafter set forth, each
share of Series A Preferred Stock shall entitle the holder thereof to 1000
votes (and each one one-thousandth of a share of Series A Preferred Stock
shall entitle the holder thereof to one vote) on all matters submitted to a
vote of the stockholders of the Corporation. In the event the Corporation
shall at any time declare or pay any dividend on Common Stock payable in
shares of Common Stock or effect a subdivision or combination or
consolidation of the outstanding shares of Common Stock or effect a
subdivision or combination or consolidation of the outstanding shares of
Common Stock (by reclassification or otherwise) into a greater or lesser
number of shares of Common Stock, then in each such case the number of
votes per share to which holders of shares of Series A Preferred Stock were
entitled immediately prior to such event shall be adjusted by multiplying
such number by a fraction, the numerator of which is the number of shares
of Common Stock outstanding immediately after such event and the
denominator of which is the number of shares of Common Stock that were
outstanding immediately prior to such event.
(B) Except as otherwise provided herein, in the Certificate of
Incorporation, in any other certificate of designation creating a series of
preferred stock or any similar stock, or by law, the holders of shares of
221
Series A Preferred Stock and the holders of shares of Common Stock and any
other capital stock of the Corporation having general voting rights shall
vote together as one class on all matters submitted to a vote of
stockholders of the Corporation.
(C) Except as provided herein, in Section 10 or by applicable law, holders
of Series A Preferred Stock shall have no special voting rights and their
consent shall not be required (except to the extent they are entitled to
vote with holders of Common Stock as set forth herein) for authorizing or
taking any corporate action.
Section 4. CERTAIN RESTRICTIONS.
(A) Whenever quarterly dividends or other dividends or distributions
payable on the Series A Preferred Stock as provided in Section 2 are in
arrears, thereafter and until all accrued and unpaid dividends and
distributions, whether or not declared, on shares of Series A Preferred
Stock outstanding shall have been paid in full, the Corporation shall not:
(i) declare or pay dividends on, make any other distributions on any
shares or stock ranking junior (either as to dividends or upon
liquidation, dissolution or winding-up) to the Series A Preferred
Stock;
(ii) declare or pay dividends, or make any other distributions, on any
shares of stock ranking on a parity (either as to dividends or upon
liquidation, dissolution or winding up) with the Series A Preferred
Stock except dividends paid ratably on the Series A Preferred Stock,
and all such parity stock on which dividends are payable or in arrears
in proportion to the total amounts to which the holders of all such
shares are then entitled;
(iii)redeem or purchase or otherwise acquire for consideration shares of
any stock ranking junior (either as to dividends or upon liquidation,
dissolution or winding-up) to the Series A Preferred Stock, PROVIDED
that the Corporation may at any time redeem, purchase or otherwise
acquire shares of any such junior stock in exchange for shares of any
stock of the Corporation ranking junior (either as to dividends or
upon dissolution, liquidation or winding up) to the Series A Preferred
Stock; or
(iv) purchase or otherwise acquire for consideration any shares of Series A
Preferred Stock, or any shares of stock ranking on a parity (either as
to dividends or upon liquidation, dissolution or winding-up) with the
Series A Preferred Stock, except in accordance with a purchase offer
made in writing or by publication (as determined by the Board of
Directors) to all holders of such shares upon such terms as the Board
of Directors, after consideration of the respective annual dividend
rates and other relative rights and preferences of the respective
222
series and classes, shall determine in good faith will result in fair
and equitable treatment among the respective series or classes.
(v) The Corporation shall not permit any subsidiary of the Corporation to
purchase or otherwise acquire for consideration any shares of stock of
the Corporation unless the Corporation could, under paragraph (A) of
this Section 4, purchase or otherwise acquire such shares at such time
and in such manner.
Section 5. REACQUIRED SHARES. Any shares of Series A Preferred Stock purchased
or otherwise acquired by the Corporation in any manner whatsoever, shall be
retired and canceled promptly after the acquisition thereof. All such shares
shall upon their cancellation become authorized but unissued shares of preferred
stock, without designation as to series, and may be reissued as part of a new
series of preferred stock to be created by resolution or resolutions of the
Board of Directors, subject to the conditions and restrictions on issuance set
forth herein, in the Restated Certificate of Incorporation, in any other
certificate of designation creating a series of preferred stock or any similar
stock or as otherwise required by law.
Section 6. LIQUIDATION, DISSOLUTION OR WINDING-UP. Upon any voluntary or
involuntary liquidation, dissolution or winding-up of the Corporation, no
distribution shall be made (A) to the holders of shares of stock ranking junior
(either as to dividends or upon liquidation, dissolution or winding-up) to the
Series A Preferred Stock unless prior thereto, the holders of shares of Series A
Preferred Stock shall have received the higher of (I) $1000 per share, plus an
amount equal to accrued and unpaid dividends and distributions thereon, whether
or not declared, to the date of such payment, or (II) an aggregate amount per
share, subject to the provision for adjustment hereinafter set forth, equal to
1000 times the aggregate amount to be distributed per share to holders of Common
Stock; nor shall any distribution be made (B) to the holders of stock ranking on
a parity (either as to dividends or upon liquidation, dissolution or winding-up)
with the Series A Preferred Stock, except distributions made ratably on the
Series A Preferred Stock and all other such parity stock in proportion to the
total amounts to which the holders of all such shares are entitled upon such
liquidation, dissolution or winding-up. In the event the Corporation shall at
any time declare or pay any dividend on Common Stock payable in shares of Common
Stock, or effect a subdivision or combination or consolidation of the
outstanding shares of Common Stock (by reclassification or otherwise) into a
greater or lesser number of shares of Common Stock, then in each such case the
aggregate amount to which holders of shares of Series A Preferred Stock were
entitled immediately prior to such event under the provision in clause (A) of
the preceding sentence shall be adjusted by multiplying such amount by a
fraction the numerator of which is the number of shares of Common Stock
outstanding immediately after such event and the denominator of which is the
number of shares of Common Stock that were outstanding immediately prior to such
event.
223
Section 7. CONSOLIDATION, MERGER, ETC. In case the Corporation shall enter into
any consolidation, merger, combination or other transaction in which the shares
of Common Stock are exchanged for or changed into other stock or securities,
cash and/or any other property, or otherwise changed, then in any such case each
share of Series A Preferred Stock shall at the same time be similarly exchanged
or changed into an amount per share (subject to the provision for adjustment
hereinafter set forth) equal to 1000 times the aggregate amount of stock,
securities, cash and/or any other property (payable in kind), as the case may
be, into which or for which each share of Common Stock is changed or exchanged.
In the event the Corporation shall at any time declare or pay any dividend on
Common Stock payable in shares of Common Stock, or effect a subdivision or
combination or consolidation of the outstanding shares of Common Stock (by
reclassification or otherwise) into a greater or lesser number of shares of
Common Stock, then in each such case the amount set forth in the preceding
sentence with respect to the exchange or change of shares of Series A Preferred
Stock shall be adjusted by multiplying such amount by a fraction the numerator
of which is the number of shares of Common Stock outstanding immediately after
such event and the denominator of which is the number of shares of Common Stock
that were outstanding immediately prior to such event.
Section 8. NO REDEMPTION. The shares of Series A Preferred Stock shall not be
redeemable
Section 9. RANK. Unless otherwise provided in the Restated Certificate of
Incorporation of the Corporation or a Certificate of Designation relating to a
subsequent series of preferred stock of the Corporation, the Series A Preferred
Stock shall rank junior to all other series of the Corporation's preferred stock
as to the payment of dividends and the distribution of assets on liquidation,
dissolution or winding-up, and senior to the Common Stock of this Corporation.
Section 10. AMENDMENT. The Restated Certificate of Incorporation of the
Corporation, as amended, shall not be amended in any manner which would
materially alter or change the powers, preferences or special rights of the
Series A Preferred Stock so as to affect them adversely without the affirmative
vote of the holders of at least two-thirds of the outstanding shares of Series A
Preferred Stock, voting together as a single series.
Section 11. FRACTIONAL SHARES. Series A Preferred Stock may be issued in
fractions of a share (in one one-thousandths of a share and integral multiples
thereof) which shall entitle the holder, in proportion to such holder's
fractional shares, to exercise voting rights, receive dividends, participate in
distributions and to have the benefit of all other rights of holders of Series A
Preferred Stock.
224
IN WITNESS WHEREOF, this Certificate of Designation is executed on behalf of the
Corporation by its [title] and attested by its Secretary this th day of , .
----------------------------
Name: [officer]
Title: [title]
ATTEST:
- -----------------------------
Name:
Title:
225
EXHIBIT B
[Form of Right Certificate]
Certificate No. R- ______ Rights
NOT EXERCISABLE AFTER __________ ____, 2011 OR EARLIER IF THE BOARD OF DIRECTORS
ORDERS THE REDEMPTION OR EXCHANGE OF THE RIGHTS. THE RIGHTS ARE SUBJECT TO
REDEMPTION AT $.001 PER RIGHT AND TO EXCHANGE ON THE TERMS SET FORTH IN THE
RIGHTS AGREEMENT. UNDER CERTAIN CIRCUMSTANCES, RIGHTS BENEFICIALLY OWNED BY AN
ACQUIRING PERSON OR AN AFFILIATE OR ASSOCIATE THEREOF (AS SUCH TERMS ARE DEFINED
IN THE RIGHTS AGREEMENT) AND ANY SUBSEQUENT HOLDER OF SUCH RIGHTS MAY BECOME
NULL AND VOID. THE RIGHTS SHALL NOT BE EXERCISABLE, AND SHALL BE VOID SO LONG AS
HELD, BY A HOLDER IN ANY JURISDICTION WHERE THE REQUISITE QUALIFICATION TO THE
ISSUANCE TO SUCH HOLDER, OR THE EXERCISE BY SUCH HOLDER, OF THE RIGHTS IN SUCH
JURISDICTION SHALL NOT HAVE BEEN OBTAINED OR BE OBTAINABLE.
Rights Certificate
PRINCIPAL FINANCIAL GROUP, INC.
This certifies that __________, or registered assigns, is the registered owner
of the number of Rights set forth above, each of which entitles the owner
thereof, subject to the terms, provisions and conditions of the Rights
Agreement, dated as of _______ ____, 2001, as the same may be amended from time
to time (the "RIGHTS AGREEMENT"), between Principal Financial Group, Inc., a
Delaware corporation (the "CORPORATION"), and Mellon Investor Services LLC, a
New Jersey limited liability company (the "RIGHTS Agent"), to purchase from the
Corporation at any time after the Distribution Date (as such term is defined in
the Rights Agreement) and prior to 5:00 P.M. (Eastern time) on_________ ____,
2011, at the principal office of the Rights Agent, or its successors as Rights
Agent, one one-thousandth of a fully paid nonassessable share of Series A Junior
Participating Preferred Stock, par value $0.01 per share (the "PREFERRED
STOCK"), of the Corporation, at a purchase price of $______ per one
one-thousandth of a share of Preferred Stock (the "PURCHASE PRICE"), upon
presentation and surrender of this Right Certificate with the Form of Election
to Purchase and the Certificate contained therein duly executed. The number of
Rights evidenced by this Right Certificate (and the number of one one-thousands
of a share of Preferred Stock which may be purchased upon exercise thereof) set
forth above, and the Purchase Price per one one-thousandth of a share of
226
Preferred Stock set forth above, are the number and Purchase Price as of , ,
based on the shares of Preferred Stock as constituted at such date.
From and after the first occurrence of a Section 11(a)(ii) Event (as defined in
the Rights Agreement), if the Rights evidenced by this Right Certificate are
beneficially owned by (I) an Acquiring Person or an Affiliate or Associate
thereof (as such terms are defined in the Rights Agreement), (II) a transferee
of any such Acquiring Person (or of any Associate or Affiliate thereof) who
becomes a transferee after such Acquiring Person (or any Associate or Affiliate
thereof) becomes such or (III) under certain circumstances specified in the
Rights Agreement, a transferee of such Acquiring Person (or of any Associate or
Affiliate thereof) who becomes a transferee prior to or concurrently with such
Acquiring Person becoming such, such Rights shall become null and void and no
holder hereof shall have any right with respect to such Rights from and after
the occurrence of such Section 11(a)(ii) Event.
The Rights evidenced by this Right Certificate shall not be exercisable, and
shall be void so long as held, by a holder in any jurisdiction where the
requisite qualification to the issuance to such holder, or the exercise by such
holder, of the Rights in such jurisdiction shall not have been obtained or be
obtainable.
As provided in the Rights Agreement, the Purchase Price and the number of one
one-thousandths of a share of Preferred Stock or the number and kind of other
securities which may be purchased upon the exercise of the Rights evidenced by
this Right Certificate are subject to modification and adjustment upon the
happening of certain events, including Section 11(a)(ii) Events and Section 13
Events (as defined in the Rights Agreement).
This Right Certificate is subject to all of the terms, provisions and conditions
of the Rights Agreement, as it may be amended from time to time, which terms,
provisions and conditions are hereby incorporated herein by reference and made a
part hereof and to which Rights Agreement reference is hereby made for a full
description of the rights, limitations of rights, obligations, duties and
immunities hereunder of the Rights Agent, the Corporation and the holders of the
Right Certificates, which limitations of rights include the temporary suspension
of the exercisability of such Rights under the specific circumstances set forth
in the Rights Agreement. Copies of the Rights Agreement are on file at the
principal executive offices of the Corporation and the above-mentioned office of
the Rights Agent and are also available upon written request to the Rights
Agent.
This Right Certificate, with or without other Right Certificates, upon surrender
at the principal office of the Rights Agent, may be exchanged for another Right
Certificate or Right Certificates of like tenor and date evidencing Rights
entitling the holder to purchase a like aggregate number of one one-thousandths
of a share of Preferred Stock as the Rights evidenced by the Right Certificate
or Right Certificates surrendered shall have entitled such holder to purchase.
227
If this Right Certificate shall be exercised in part, the holder shall be
entitled to receive upon surrender hereof another Right Certificate or Right
Certificates for the number of whole Rights not exercised.
Subject to the provisions of the Rights Agreement, the Rights evidenced by this
Right Certificate may be redeemed by the Corporation at a redemption price of
$.001 per Right at any time prior to the earlier of (I) the Stock Acquisition
Time (as defined in the Rights Agreement) and (II) the close of business on the
Expiration Date (as defined in the Rights Agreement). Subject to the provisions
of the Rights Agreement, the rights evidenced by this Right Certificate may be
exchanged in whole or part for shares of Common Stock or fractional shares of
Preferred Stock (or any other substantially similar series of preferred stock of
the Corporation).
No fractional shares of Preferred Stock will be issued upon the exercise of any
Right or Rights evidenced hereby (other than fractions which are integral
multiples of one one-thousandth of a share of Preferred Stock, which may, at the
election of the Corporation, be evidenced by depositary receipts), but in lieu
thereof a cash payment will be made, as provided in the Rights Agreement.
Other than those provisions relating to the redemption price of the Rights and
the Expiration Date, any of the provisions of the Rights Agreement may be
amended by the Board of Directors of the Corporation in any respect whatsoever
up until the Stock Acquisition Time and thereafter in certain respects which do
not adversely affect the interests of holders of Right Certificates (other than
an Acquiring Person or the Affiliates or Associates thereof).
No holder of this Right Certificate shall be entitled to vote or receive
dividends or be deemed for any purpose the holder of shares of Preferred Stock
or of any other securities of the Corporation which may at any time be issuable
on the exercise hereof, nor shall anything contained in the Rights Agreement or
herein be construed to confer upon the holder hereof, as such, any of the rights
of a stockholder of the Corporation or any right to vote for the election of
directors or upon any matter submitted to stockholders at any meeting thereof,
or to give or withhold consent to any corporate action, or to receive notice of
meetings or other actions affecting stockholders (except as provided in the
Rights Agreement), or to receive dividends or subscription rights, or otherwise,
until the Right or Rights evidenced by this Right Certificate shall have been
exercised as provided in the Rights Agreement.
This Right Certificate shall not be valid or obligatory for any purpose until it
shall have been countersigned by the Rights Agent.
228
WITNESS the facsimile signature of the proper officers of the Corporation and
its corporate seal. Dated as of ______ _____, -----.
ATTEST: PRINCIPAL FINANCIAL GROUP, INC.
__________________________ By ____________________________
Secretary Title:
Countersigned:
MELLON INVESTOR SERVICES LLC
By _______________________
Authorized Signature
229
[Form of Reverse Side of Right Certificate]
FORM OF ASSIGNMENT
(To be executed by the registered holder if such
holder desires to transfer the Right Certificate.)
FOR VALUE RECEIVED ____________________________ hereby sells, assigns and
transfers unto
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(Please print name and address of transferee) this Right Certificate, together
with all right, title and interest therein, and does hereby irrevocably
constitute and appoint _____________________ Attorney, to transfer the within
Right Certificate on the books of the within named Corporation, with full power
of substitution. Dated:_____________, ____
--------------------------
Signature
Signatures Guaranteed:
The undersigned hereby certifies that (1) the Rights evidenced by this Right
Certificate are not beneficially owned by an Acquiring Person or an Affiliate or
Associate thereof (as defined in the Rights Agreement); and (2) after due
inquiry and to the best knowledge of the undersigned, it [ ] did [ ] did not
acquire the Rights evidenced by this Right Certificate from any Person who is,
was or subsequently became an Acquiring Person or an Affiliate or Associate
thereof.
---------------------------
Signature
230
The signature to the foregoing Assignment must correspond to the name as written
upon the face of this Right Certificate in every particular, without alteration
or enlargement or any change whatsoever.
231
FORM OF ELECTION TO PURCHASE
(To be executed if holder desires to
exercise the Right Certificate.)
To Principal Financial Group, Inc.:
The undersigned hereby irrevocably elects to exercise _______________ Rights
represented by this Right Certificate to purchase the shares of Preferred Stock
issuable upon the exercise of such Rights (or such other securities of the
Corporation or of any other Person which may be issuable upon the exercise of
the Rights) and requests that certificates for such shares be issued in the name
of:
Please insert social security or other identifying number
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(Please print name and address)
If such number of Rights shall not be all the Rights evidenced by this Right
Certificate, a new Right Certificate for the balance remaining of such Rights
shall be registered in the name of and delivered to: Please insert social
security or other identifying number
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(Please print name and address)
Dated:__________________, ____
232
[Form of Election to Purchase -- continued]
--------------------------
Signature
(Signature must conform in all respects to name of holder as specified on the
face of this Right Certificate.)
Signature Guaranteed:
- --------------------------------------------------------------------------------
(To be completed if applicable)
The undersigned hereby certifies that (1) the Rights evidenced by this Right
Certificate are not beneficially owned by an Acquiring Person or an Affiliate or
Associate thereof (as defined in the Rights Agreement); (2) after due inquiry
and to the best knowledge of the undersigned, it [ ] did [ ] did not acquire the
Rights evidenced by this Right Certificate from any Person who is, was or
subsequently became an Acquiring Person of an Affiliate or Associate thereof.
---------------------------
Signature
- --------------------------------------------------------------------------------
NOTICE
In the event the certification set forth above in the Forms of Assignment and
Election is not completed, the Corporation will deem the beneficial owner of the
Rights evidenced by this Right Certificate to be an Acquiring Person or an
Affiliate or Associate thereof (as defined in the Rights Agreement) and, in the
case of an Assignment, will affix a legend to that effect on any Right
Certificates issued in exchange for this Rights Certificate.
233
EXHIBIT C
UNDER CERTAIN CIRCUMSTANCES, RIGHTS BENEFICIALLY OWNED BY AN ACQUIRING PERSON OR
AN AFFILIATE OR ASSOCIATE THEREOF (AS SUCH TERMS ARE DEFINED IN THE RIGHTS
AGREEMENT) AND ANY SUBSEQUENT HOLDER OF SUCH RIGHTS MAY BECOME NULL AND VOID.
PRINCIPAL FINANCIAL GROUP, INC.
SUMMARY OF RIGHTS TO PURCHASE
PREFERRED STOCK
The Board of Directors of Principal Financial Group, Inc. (the "CORPORATION")
has authorized the issuance of one Preferred Share Purchase Right (a "RIGHT")
for each outstanding share of Common Stock, par value $0.01 per share, of the
Corporation (the "COMMON STOCK"). The following is a summary of the terms of the
Rights.
Each Right entitles the registered holder to purchase from the Corporation one
one-thousandth of a share of Series A Junior Participating Preferred Stock, par
value $0.01 per share, of the Corporation (the "PREFERRED STOCK") at a price of
$______ per one one-thousandth of a share of Preferred Stock, subject to
adjustment (the "PURCHASE PRICE"). The description and terms of the Rights are
set forth in a Rights Agreement, dated as of October 22, 2001(the Rights
Agreement, as it may be amended from time to time, is hereinafter referred to as
the "RIGHTS AGREEMENT") between the Corporation and Mellon Investor Services
LLC, a New Jersey limited liability company, as Rights Agent (the "RIGHTS
AGENT").
Initially, the Rights will be attached to all Common Stock book-entries or
certificates representing shares then outstanding, and no separate book-entries
or certificates representing the Rights ("RIGHT CERTIFICATES") will be
distributed. The Rights will separate from the Common Stock and a "DISTRIBUTION
DATE" will occur upon the earlier to occur of (I) ten days following the time
(the "STOCK ACQUISITION TIME") of a public announcement or notice to the
Corporation that a person or group of affiliated or associated persons (an
"ACQUIRING PERSON") acquired, or obtained the right to acquire, beneficial
ownership of 10% or more of the outstanding Common Stock of the Corporation, and
(II) ten business days (or, if determined by the Board of Directors, a specified
or unspecified later date) following the commencement or announcement of an
intention to make a tender offer or exchange offer which, if successful, would
cause the bidder to own 10% of more of the outstanding Common Stock.
The Rights Agreement provides that, until the Distribution Date, (I) the Rights
will be transferred with and only with the Common Stock, (II) new Common Stock
234
certificates issued after __________ ____, 2001, upon transfer, new issuance or
reissuance of the Common Stock, will contain a notation incorporating the Rights
Agreement by reference and (III) the surrender for transfer of any of the Common
Stock book-entries or certificates outstanding will also constitute the transfer
of the Rights associated with the shares of Common Stock represented by such
certificate or book-entry. As soon as practicable following the Distribution
Date, separate Right Certificates will be mailed to holders of record of the
Common Stock as of the close of business on the Distribution Date and such
separate Right Certificates alone will evidence the Rights. Except in connection
with issuance of Common Stock pursuant to employee stock plans, options and
certain convertible securities, and except as otherwise determined by the Board
of Directors, only shares of Common Stock issued prior to the Distribution Date
will be issued with Rights.
The Rights are not exercisable until the Distribution Date. The Rights will
expire on __________ ____, 2011, unless earlier redeemed or exchanged by the
Corporation as described below.
In the event that, after the Stock Acquisition Time, the Corporation is acquired
in a merger or other business combination transaction (except certain
transactions with a person who became an Acquiring Person as a result of a
tender offer described in the next succeeding paragraph) or 50% or more of its
assets, cash flow or earning power is sold, proper provision shall be made so
that each holder of a Right shall thereafter have the right to receive, upon the
exercise thereof at the then current exercise price of the Right, that number of
shares of common stock of the acquiring corporation which at the time of such
transaction would have a market value (as defined in the Rights Agreement) of
two times the Purchase Price of the Right. In the event that, after the Stock
Acquisition Time, the Corporation were the surviving corporation of a merger and
its Common Stock were changed or exchanged, proper provision shall be made so
that each holder of a Right will thereafter have the right to receive upon
exercise that number of shares of common stock of the Corporation having a
market value of two times the exercise price of the Right.
In the event that a person or group becomes an Acquiring Person, each holder of
a Right (other than the Acquiring Person) will thereafter have the right to
receive upon exercise that number of shares of Common Stock (or, in certain
circumstances, cash, a reduction in the Purchase Price, Preferred Stock, other
equity securities of the Corporation, debt securities of the Corporation, other
property or a combination thereof) having a market value (as defined in the
Rights Agreement) of two times the Purchase Price of the Right. Notwithstanding
any of the foregoing, following the occurrence of any of the events set forth in
this paragraph, all Rights that are, or (under certain circumstances specified
in the Rights Agreement) were, beneficially owned by any Acquiring Person (or an
affiliate, associate or transferee thereof) will be null and void. A person will
not be an Acquiring Person if the Board of Directors of the Corporation
determines that such person or group became an Acquiring Person inadvertently
235
and such person or group promptly divests itself of a sufficient number of
shares of Common Stock so that such person or group is no longer an Acquiring
Person.
The Purchase Price payable, and the number of shares of Preferred Stock or other
securities or property issuable, upon exercise of the Rights are subject to
adjustment from time to time to prevent dilution (I) in the event of a stock
dividend on, or a subdivision, combination or reclassification of, the Preferred
Stock, (II) upon the grant to holders of Preferred Stock of certain rights or
warrants to subscribe for Preferred Stock or convertible securities at less than
the current market price of Preferred Stock or (III) upon the distribution to
holders of Preferred Stock of evidences of indebtedness or assets (excluding
regular periodic cash dividends or dividends payable in Preferred Stock) or of
subscription rights or warrants (other than those referred to above). The number
of Rights and number of shares of Preferred Stock issuable upon the exercise of
each Right are also subject to adjustment in the event of a stock split,
combination or stock dividend on the Common Stock.
With certain exceptions, no adjustment in the Purchase Price will be required
until cumulative adjustments require an adjustment of at least 1% in such
Purchase Price. No fractional shares of Preferred Stock will be issued (other
than fractions which are integral multiples of one one-thousandth of a share of
Preferred Stock which may, upon the election of the Corporation, be evidenced by
depositary receipts) and, in lieu thereof, an adjustment in cash will be made
based on the market price of the Preferred Stock on the last trading date prior
to the date of exercise.
At any time prior to the earlier of the Stock Acquisition Time and the
Expiration Date (as defined in the Rights Agreement), the Board of Directors may
redeem the Rights in whole, but not in part, at a price of $.001 per Right (the
"REDEMPTION PRICE"). Immediately upon the action of the Board of Directors
ordering redemption of the Rights, the Rights will terminate and the only right
of the holders of Rights will be to receive the Redemption Price.
At any time after a person becomes an Acquiring Person and prior to the
acquisition by such Person of 50% or more of the outstanding shares of Common
Stock, the Board of Directors of the Corporation may exchange the Rights (other
than Rights beneficially owned by such Person which have become void), in whole
or part, at an exchange ratio of one share of Common Stock per Right (subject to
adjustment). The Corporation, at its option, may substitute one-thousandth
(subject to adjustment) of a share of Preferred Stock (or other series of
substantially similar preferred stock of the Corporation) for each share of
Common Stock to be exchanged.
Each share of Preferred Stock purchasable upon exercise of the Rights will have
a minimum preferential dividend of $10 per year, but will be entitled to
receive, in the aggregate, a dividend of 1000 times the dividend declared on the
shares of Common Stock. In the event of liquidation, the holders of the shares
236
of Preferred Stock will be entitled to receive a minimum liquidation payment of
$1000 per share, but will be entitled to receive an aggregate liquidation
payment equal to 1000 times the payment made per share of Common Stock. Each
share of Preferred Stock will have one thousand votes, voting together with the
shares of Common Stock. In the event of any merger, consolidation or other
transaction in which shares of Common Stock are exchanged, each share of
Preferred Stock will be entitled to receive 1000 times the amount and type of
consideration received per share of Common Stock. The rights of the shares of
Preferred Stock as to dividends and liquidation, and in the event of mergers and
consolidations, are protected by anti-dilution provisions.
Until a Right is exercised, the holder thereof, as such, will have no rights as
a stockholder of the Corporation, other than rights resulting from such holder's
ownership of shares of Common Stock, including, without limitation, the right to
vote or to receive dividends. While the distribution of the Rights will not be
taxable to stockholders or to the Corporation, stockholders may, depending upon
the circumstances, recognize taxable income in the event that the Rights become
exercisable for Common Stock (or other consideration) of the Corporation or for
common stock of the acquiring corporation as set forth above.
Other than those provisions relating to the Redemption Price and expiration date
of the Rights, any of the provisions of the Rights Agreement may be amended by
the Board of Directors prior to the Stock Acquisition Time. After such time, the
provisions of the Rights Agreement may be amended by the Board of Directors in
order to cure any ambiguity, to correct or supplement defective or inconsistent
provisions, to shorten or lengthen any time period under the Rights Agreement,
to make changes which do not adversely affect the interests of the holders of
Rights (excluding the interests of any Acquiring Person) or to shorten or
lengthen any time period under the Rights Agreement; PROVIDED, HOWEVER, that no
amendment to adjust the time period governing redemption shall be made at such
time as the Rights are not redeemable.
The term "VOTING STOCK" means (I) the shares of Common Stock of the Corporation
and (II) any other shares of capital stock of the Corporation entitled to vote
generally in the election of directors or entitled to vote together with the
shares of Common Stock in respect of any merger, consolidation, sale of all or
substantially all of the Corporation's assets, liquidation, dissolution or
winding up.
A copy of the Rights Agreement has been filed with the Securities and Exchange
Commission as an Exhibit to the Corporation's Registration Statement on Form S-1
dated ___________ ____, 2001. Copies of the Rights Agreement are available free
of charge from the Corporation. This summary description of the Rights does not
purport to be complete and is qualified in its entirety by reference to the
Rights Agreement, as it may be amended from time to time, which is hereby
incorporated herein by reference.
237
Exhibit 10.3
RESOLVED, that the Principal Financial Group Long-Term Performance Plan (as
amended and restated as of January 1, 2001) ("Plan") be amended to clarify
Section 4.9(c) of the Plan to read as follows:
(c) Distribution of Deferral Account. Final Performance Units deferred that
were payable in Common Stock shall be distributed in Common Stock. The
number of shares distributed shall be equal to the number of shares that
would have originally been distributed in the absence of deferral, adjusted
for stock splits, stock dividends and reinvestment of cash dividends
between the end of the Performance Period for which the Final Performance
Units were granted and the date the deferred amounts are actually
distributed. Final Performance Units deferred that were payable in cash
shall be distributed in cash. The amount of cash distributed shall be based
on the End Imputed Value for the last Performance Period ended prior to the
distribution. The number of shares distributed shall be equal to the number
of shares that would have originally been distributed in the absence of
deferral, adjusted for stock splits, stock dividends and reinvestment of
cash dividends between the end of the Performance Period for which the
Final Performance Units were granted and the date the deferred amounts are
actually distributed. The amount distributed upon termination of the
Participant's employment for any reason except Retirement or if the
Participant becomes Disabled shall be based on the average fair market
value of Principal Financial Group, Inc. stock during the 20 business days
prior to the distribution. If the End Imputed Value is calculated based on
the quotient set forth in Article II, then End Imputed Value shall be
adjusted, if necessary, to make the denominator equal to the number of
Initial Performance Units established for the Performance Period for which
the Final Performance Units were granted.
238
EXHIBIT 10.12
Michael Daley
270 Farmstead Hill Road
Fairfield, CT 06430
Dear Mike
It is with great pleasure that I offer you the position of Executive Vice
President of Principal Life Insurance Company with a start date of June 5, 2000.
This offer is subject to approval of the Principal's Board of Directors and they
meet on Monday, May 15. Please respond to this offer no later than May 10, 2000.
As Executive Vice President, you will report to me, and will receive a
compensation package consisting of cash compensation and full participation in
the benefits available to executive vice presidents, as well as a comprehensive
relocation package:
I. Annual Cash Compensation
A. Base Compensation. Your base compensation will be $350,000.
B. PrinPay. The annual incentive pay plan has a target award of 45% for
executive vice presidents. The award is based on the prior year's
earnings, and is paid early in the following year, if performance
goals are met. The level of the payout is dependent upon meeting
certain corporate and business unit financial, customer service,
internal process and learning and growth goals. The range of payouts
could be 0 - 200% of the 45% award target. You will receive a prorata
portion of this award for the time you work in 2000.
C. Long Term Incentive Plan. Our long term incentive compensation plan
has a performance unit concept. It will grant participants performance
units designed to reward them for three year cumulative corporate ROE
and earnings performance, based on a pre-determined formula. It will
contain an incentive opportunity targeted at 60% of base pay for
executive vice presidents. The plan will also have additional upside
(and downside) potential, depending on certain thresholds and target
levels being met. The bonus based on 2000 base pay will be payable in
2003, and will be based on corporate performance in 2000, 2001 and
2002. You will
239
participate as if you were employed for all of 2000. A brief
description of the plan is included.
In recognition of the stock options you have had, you will receive a
bonus to be paid early in 2001 and 2002. These bonuses will be
equivalent to the Long Term Incentive Plan payments you would have
received had you been employed in 1998 and 1999.
II. In addition to generous health 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 with an annual cost of
living adjustment.
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 the first
session of planning through Ernst & Young.
F. Additional fringe benefits, including membership in a private club in
downtown Des Moines with dining facilities.
G. You will have eighty (80) hours of Paid Time Off ("PTO") at the outset
of your employment, and will then accrue eight (8) additional PTO
hours per bi-weekly pay period.
III. Given that you will be moving your family from Fairfield, Connecticut,
Principal will also pay your relocation costs, including:
A. The costs of moving your household goods from Fairfield to the Des
Moines area.
240
B. The normal and customary closing costs for your home in Des Moines
that are normally incurred by the buyer in securing a mortgage and
transferring title, as well as two house hunting trips to Des Moines
for you and your spouse. We will also pay the realtor's fees for
selling your home in Fairfield.
C. We will also pay for housing costs as needed while you maintain your
residence in Fairfield for up to six months.
We very much want you to join our team, and look forward to your answer. Please
call me should you have any questions.
Sincerely,
/s/ J. Barry Griswell
_____________________________________
J. Barry Griswell
President and Chief Executive Officer
Phone: (515) 247-5749
Fax: (515) 248-8617
241
Exhibit 21
PROPRIETARY INFORMATION
================================================================================
PRINCIPAL FINANCIAL GROUP, INC. - Member Companies
12/31/2001
================================================================================
Jurisdiction of
ENTITY NAME Incorporation
================================================================================
ANDUEZA & PRINCIPAL CREDITOS HIPOTECARIOS S.A. Chile
- --------------------------------------------------------------------------------
BENEFIT FIDUCIARY CORPORATION Rhode Island
- --------------------------------------------------------------------------------
BOSTON INSURANCE TRUST, INC. Massachusetts
- --------------------------------------------------------------------------------
BRASILPREV PREVIDENCIA PRIVADA S.A. Brazil
- --------------------------------------------------------------------------------
DELAWARE CHARTER GUARANTEE & TRUST COMPANY Delaware
- --------------------------------------------------------------------------------
DENTAL-NET, INC. Arizona
- --------------------------------------------------------------------------------
DISTRIBUIDORA PRINCIPAL MEXICO, S.A. de C.V. Mexico
- --------------------------------------------------------------------------------
EMPLOYERS DENTAL SERVICES, INC. Arizona
- --------------------------------------------------------------------------------
EQUITY FC, LTD. Iowa
- --------------------------------------------------------------------------------
EXECUTIVE BENEFIT SERVICES, INC. North Carolina
- --------------------------------------------------------------------------------
EXECUTIVE BROKER DEALER SERVICES, LLC North Carolina
- --------------------------------------------------------------------------------
HEALTHRISK RESOURCE GROUP, INC. Iowa
- --------------------------------------------------------------------------------
IDBI-PRINCIPAL ASSET MANAGEMENT COMPANY India
- --------------------------------------------------------------------------------
IDBI-PRINCIPAL TRUSTEE COMPANY LIMITED India
- --------------------------------------------------------------------------------
ING/PRINCIPAL PENSIONS CO., LTD Japan
- --------------------------------------------------------------------------------
INSOURCE GROUP, LLC Delaware
- --------------------------------------------------------------------------------
PATRICIAN ASSOCIATES, INC. California
- --------------------------------------------------------------------------------
PETULA ASSOCIATES, LTD. Iowa
- --------------------------------------------------------------------------------
PETULA PROLIX DEVELOPMENT COMPANY Iowa
- --------------------------------------------------------------------------------
PFG DO BRASIL LTDA Brazil
- --------------------------------------------------------------------------------
PPI EMPLOYEE BENEFITS CORPORATION Connecticut
- --------------------------------------------------------------------------------
PREFERRED PRODUCT NETWORK, INC. Delaware
- --------------------------------------------------------------------------------
242
- --------------------------------------------------------------------------------
PRINCIPAL AFORE, S.A., DE C.V. Mexico
- --------------------------------------------------------------------------------
PRINCIPAL ASSET MANAGEMENT COMPANY (ASIA) LTD. Hong Kong
- --------------------------------------------------------------------------------
PRINCIPAL ASSET MARKETS, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL AUSTRALIA (HOLDINGS) PTY LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL BANK Federal
- --------------------------------------------------------------------------------
PRINCIPAL CAPITAL FUTURES TRADING ADVISOR, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL CAPITAL GLOBAL INVESTORS LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL COMMERCIAL ACCEPTANCE, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL COMMERCIAL FUNDING, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL COMPANIA DE SEGUROS DE VIDA CHILE S.A. Chile
- --------------------------------------------------------------------------------
PRINCIPAL CONSULTING (INDIA) PRIVATE LIMITED India
- --------------------------------------------------------------------------------
PRINCIPAL DELAWARE NAME HOLDING COMPANY, INC. Delaware
- --------------------------------------------------------------------------------
PRINCIPAL DEVELOPMENT ASSOCIATES, INC. California
- --------------------------------------------------------------------------------
PRINCIPAL DEVELOPMENT INVESTORS, L.L.C. Delaware
- --------------------------------------------------------------------------------
PRINCIPAL ENTERPRISE CAPITAL, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL FC, LTD. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL ADVISORS, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL GROUP (MAURITIUS) LTD. Mauritius
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL GROUP INVESTMENTS (AUSTRALIA) PTY LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL GROUP, INC. Delaware
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL SERVICES (AUSTRALIA), INC. Iowa
- --------------------------------------------------------------------------------
243
- --------------------------------------------------------------------------------
PRINCIPAL FINANCIAL SERVICES, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL GENERATION PLANT, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (ASIA) LIMITED Hong Kong
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (AUSTRALIA) LIMITED Australia
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (AUSTRALIA) SERVICE COMPANY PTY LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (EUROPE) LIMITED United Kingdom
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (IRELAND) LTD Ireland
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS (SIGNAPORE) LIMITED Singapore
- --------------------------------------------------------------------------------
PRINCPAL GLOBAL INVESTORS TRUST Delaware
- --------------------------------------------------------------------------------
PRINCIPAL GLOBAL INVESTORS, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL HEALTH CARE, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL HOLDING COMPANY Iowa
- --------------------------------------------------------------------------------
PRINCIPAL HOTEL LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL HOTELS AUSTRALIA PTY LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL HOTELS HOLDINGS PTY LTD Australia
- --------------------------------------------------------------------------------
PRINCIPAL INSURANCE COMPANY (HONG KONG) LIMITED Hong Kong
- --------------------------------------------------------------------------------
PRINCIPAL INTERNATIONAL (ASIA) LIMITED Hong Kong
- --------------------------------------------------------------------------------
PRINCIPAL INTERNATIONAL ARGENTINA, S.A. Argentina
- --------------------------------------------------------------------------------
PRINCIPAL INTERNATIONAL DE CHILE S.A. Chile
- --------------------------------------------------------------------------------
PRINCIPAL INTERNATIONAL HOLDING COMPANY, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL INTERNATIONAL, INC. Iowa
- --------------------------------------------------------------------------------
244
- --------------------------------------------------------------------------------
PRINCPAL INVESTMENTS (AUSTRALIA) LIMITED Delaware
- --------------------------------------------------------------------------------
PRINCIPAL INVESTORS CORPORATION New Jersey
- --------------------------------------------------------------------------------
PRINCIPAL LIFE COMPANIA DE SEGUROS DE VIDA, S.A. Argentina
- --------------------------------------------------------------------------------
PRINCIPAL LIFE INSURANCE COMPANY Iowa
- --------------------------------------------------------------------------------
PRINCIPAL MANAGEMENT CORPORATION Iowa
- --------------------------------------------------------------------------------
PRINCIPAL MEXICO COMPANIA DE SEGUROS, S.A. de C.V. Mexico
- --------------------------------------------------------------------------------
PRINCIPAL MEXICO SERVICIOS, S.A. de C.V. Mexico
- --------------------------------------------------------------------------------
PRINCIPAL MORTGAGE REINSURANCE COMPANY Vermont
- --------------------------------------------------------------------------------
PRINCIPAL NET LEASE INVESTORS, L.L.C. Delaware
- --------------------------------------------------------------------------------
PRINCIPAL PENSIONES, S.A. DE C.V. Mexico
- --------------------------------------------------------------------------------
PRINCIPAL PORTFOLIO SERVICES, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL REAL ESTATE INVESTORS (AUSTRALIA) LIMITED Australia
- --------------------------------------------------------------------------------
PRINCIPAL REAL ESTATE INVESTORS, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL RESIDENTIAL MORTGAGE FUNDING, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL RESIDENTIAL MORTGAGE SERVICING, LLC Delaware
- --------------------------------------------------------------------------------
PRINCIPAL RESIDENTIAL MORTGAGE, INC. Iowa
- --------------------------------------------------------------------------------
PRINCIPAL RETIRO COMPANIA DE SEGUROS DE RETIRO, S.A. Argentina
- --------------------------------------------------------------------------------
PRINCIPAL SIEFORE, S.A. DE C.V. Mexico
- --------------------------------------------------------------------------------
PRINCIPAL SPECTRUM ASSOCIATES, INC. California
- --------------------------------------------------------------------------------
PRINCIPAL TACTICAL ASSET MANAGEMENT PTY LTC Mexico
- --------------------------------------------------------------------------------
PRINCIPAL TANNER ADMINISTRADORA GENERAL DE FONDOS MUTUOS S.A. Chile
- --------------------------------------------------------------------------------
245
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PRINCIPAL TRUST COMPANY (ASIA) LIMITED Hong Kong
- --------------------------------------------------------------------------------
PRINCIPAL WHOLESALE MORTGAGE, INC. Iowa
- --------------------------------------------------------------------------------
PRINCOR FINANCIAL SERVICES CORPORATION Iowa
- --------------------------------------------------------------------------------
PROFESSIONAL PENSIONS, INC. Connecticut
- --------------------------------------------------------------------------------
SPECTRUM ASSET MANAGEMENT, INC. Connecticut
- --------------------------------------------------------------------------------
ZAO PRINCIPAL INTERNATIONAL Russia
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246
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-72006) pertaining to Principal Financial Group, Inc. Stock Incentive
Plan, Principal Financial Group Long-Term Performance Plan, Principal Financial
Group, Inc. Directors Stock Plan, and Principal Financial Group, Inc. Employee
Stock Purchase Plan and in the Registration Statement (Form S-8 No. 333-72002)
pertaining to The Principal Select Savings Excess Plan, Nonqualified Defined
Contribution Plan for Designated Participants, The Principal Select Savings Plan
for Individual Field, and The Principal Select Savings Plan for Employees of our
reports dated January 31, 2003, with respect to the consolidated financial
statements and schedules of Principal Financial Group, Inc. included in the
Annual Report (Form 10-K) for the year ended December 31, 2002.
/s/ Ernst & Young LLP
Des Moines, Iowa
March 3, 2003
247
Exhibit 24
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and appoints J.
Barry Griswell, Michael H. Gersie, Karen E. Shaff and Joyce N. Hoffman, and each
of them, as such person's true and lawful attorney-in-fact and agent, with full
power of substitution and resubstitution, to sign on such person's behalf
individually and in each capacity stated below the Annual Report on Form 10-K
under the Securities Exchange Act of 1934, as amended, of Principal Financial
Group, Inc., and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent, and each of them, full power and
authority to do and perform each and every thing requisite and necessary to be
done in connection therewith, as fully to all intents and purposes as such
person could do in person, hereby ratifying and confirming all that such
attorney-in-fact or agent may lawfully do or cause to be done by virtue hereof.
Dated February 24, 2003
/s/ J. Barry Griswell /s/ Charles S. Johnson
J. Barry Griswell Charles S. Johnson
Chairman, President and Chief Director
Executive Officer, Director
/s/ Michael H. Gersie /s/ William T. Kerr
Michael H. Gersie William T. Kerr
Executive Vice President and Chief Director
Financial Officer
/s/ Betsy J. Bernard /s/ R. L. Keyser
Betsy J. Bernard Richard L. Keyser
Director Director
/s/ J. Carter-Miller /s/ Victor H. Loewenstein
Jocelyn Carter-Miller Victor H. Loewenstein
Director Director
/s/ Gary E. Costley /s/ Federico F. Pena
Gary E. Costley Federico F. Pena
Director Director
/s/ D. J. Drury /s/ Donald M. Stewart
David J. Drury Donald M. Stewart
Director Director
/s/ Daniel Gelatt /s/ Elizabeth E. Tallett
C. Daniel Gelatt, Jr. Elizabeth E. Tallett
Director Director
/s/ Sandra L. Helton
Sandra L. Helton
Director
248
Exhibit 99.1
CERTIFICATION PURSUANT TO SECTION 1350 OF CHAPTER 63
OF TITLE 18 OF THE UNITED STATES CODE
I, J. Barry Griswell, Chairman, President and Chief Executive Officer of
Principal Financial Group, Inc., certify that (i) the Form 10-K for the year
ended December 31, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934 and (ii) the information contained
in the Form 10-K for the year ended December 31, 2002 fairly presents, in all
material respects, the financial condition and results of operations of
Principal Financial Group, Inc.
/s/ J. Barry Griswell
------------------------------------
J. Barry Griswell
Chairman, President and Chief
Executive Officer
Date: March 5, 2003
249
Exhibit 99.2
CERTIFICATION PURSUANT TO SECTION 1350 OF CHAPTER 63
OF TITLE 18 OF THE UNITED STATES CODE
I, Michael H. Gersie, Executive Vice President and Chief Financial Officer of
Principal Financial Group, Inc., certify that (i) the Form 10-K for the year
ended December 31, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934 and (ii) the information contained
in the Form 10-K for the year ended December 31, 2002 fairly presents, in all
material respects, the financial condition and results of operations of
Principal Financial Group, Inc.
/s/ Michael H. Gersie
--------------------------------------------
Michael H. Gersie
Executive Vice President and Chief
Financial Officer
Date: March 5, 2003
250