The following is a summary of financial information. In order to fully understand our consolidated financial information, you should also read Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our 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.
o On October 1, 2001, Spectrum Asset Management became an affiliate of Principal Capital Management, LLC. The acquisition was accounted for using the purchase method and the results of operations of the acquired business have been included in the financial statements from the date of acquisition. We included revenues of $0.8 million in 2001 in our consolidated results of operations and $5.5 million of total assets as of December 31, 2001, in our consolidated financial position.
o In July 1998, we established our residential mortgage loan wholesale distribution system, a new distribution channel, by acquiring ReliaStar Mortgage Corporation for a purchase price of $18.6 million. We have integrated the operations of ReliaStar Mortgage Corporation into Principal Residential Mortgage, Inc., as part of our Mortgage Banking segment.
(3) 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.
(4) Separate account 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 is reflected in both separate account assets and separate account liabilities and does not impact our results of operations.
(5) 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 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 $29.1 million net loss for the period October 26, 2001 through December 31, 2001. In addition, as of December 31, 2001, represents pre-demutualization and IPO retained earnings of $6,700.4
(10)Codification, as adopted by Principal Life on January 1, 2001, has significantly impacted the reporting of Principal Life's statutory premiums and deposits for the year ended December 31, 2001. Under Codification, we no longer report amounts received for deposit-type contracts in the statement of operations as revenue, but rather report these amounts directly as an increase in an appropriate policy reserve account, a treatment that is similar to that under U.S. GAAP. This has the effect of decreasing reported total revenues and total expenses of Principal Life, with no effect to statutory net income or statutory surplus. Premiums and deposits for the years ended December 31, 2000, 1999, 1998 and 1997 included amounts received for deposit-type contracts of $11,273.2 million, $11,571.5 million, $10,312.6 million and $8,694.9 million, respectively.
(12)On August 24, 2001, Principal Life paid a statutory dividend of $250.0 million, which reduced its surplus by that amount. On October 26, 2001, Principal Life received a capital contribution of $1,689.7 million to reimburse Principal Life for policy credits, cash and expenses paid in connection with our demutualization.
(15)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.
The following analysis discusses our financial condition as of December 31, 2001, compared with December 31, 2000, and our consolidated results of operations for the years ended December 31, 2001, 2000 and 1999, 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.
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.
We are a leading provider of retirement savings, investment and insurance products and services. We have four operating segments:
We also have a Corporate and Other segment which consists of the assets and activities that have not been allocated to any other segment.
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;
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. Current 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. Also, 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. Considering these trends, assets under management increased as of December 31, 2001, primarily due to additional gross new deposits, retention of assets from existing clients, and shares of Principal Financial Group stock allocated to the separate account as part of our demutualization. The declining interest rate environment and poor performance in the equity markets in 2001 have decelerated our recent growth in assets under management.
The following table provides a summary of U.S. Asset Accumulation assets under management as of December 31, 2001, 2000 and 1999:
U.S. Asset Accumulation As of Total assets under management - ------------------------------ ------------------------------- (in billions)
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 formally established Principal Capital Management, our U.S-based asset manager, in 1999 to consolidate our investment operations and to enter the third-party institutional asset management market. 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 $1.0 billion during 2001 as a result of the acquisition of Spectrum Asset Management, which became an affiliate of Principal Capital Management on October 1, 2001.
The following table provides a summary of Principal Capital Management's affiliated and third-party assets under management as of December 31, 2001, 2000 and 1999:
Our international asset management and accumulation businesses focus on countries with a trend toward privatization of public retirement pension systems. Our acquisition of BT Financial Group in August 1999 is consistent with this strategy. We are seeking to take advantage of an Australian government requirement for all employers to contribute 8% of an employee's salary to an employer-sponsored defined contribution retirement plan, referred to as superannuation. The required employer contribution is scheduled to rise to 9% in 2002.
Our U.S. individual life insurance premiums have been influenced by both economic and industry trends. Both fee revenues and policyholder liabilities related to our interest-sensitive life insurance products have increased due to customer preference for insurance products with variable investment and tax-advantaged accumulation product options. Premiums and policyholder liabilities related to our individual traditional life insurance products have remained relatively flat.
Improved pricing discipline in our group medical insurance business has affected pricing of premiums. In general, we reacted faster than the industry in 2000 to rising healthcare costs, 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. Sales and lapses improved throughout 2001, and medical premiums grew during the last two quarters of 2001. Medical premiums were also affected by our 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. We continue to sell group medical business in 36 states. We also offer a complete array of non-medical products (life, disability, dental and vision) and administrative services only business in all 50 states and have experienced growth in these products. Our group life insurance premiums declined in 2001 due largely to the loss of two large customers.
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.
Residential mortgage Residential mortgage As of or for the year ended loan production loan servicing portfolio - ---------------------------- --------------------- ------------------------- (in millions)
December 31, 2001........... $ 37,771.3 $ 80,530.5 December 31, 2000........... 8,311.8 55,987.4 December 31, 1999........... 13,307.3 51,875.5
related interest expense in our Corporate and Other segment. The acquired companies now operate under the name of BT Financial Group. We accounted for the acquisition using the purchase method. The results of operations of the acquired companies have been included in our consolidated financial statements from the date of acquisition. We included revenues of $220.9 million, $285.5 million and $116.5 million in our consolidated results of operations for the years ended December 31, 2001, 2000 and 1999, respectively. We included net loss of $14.8 million, net income of $6.5 million and net loss of $3.1 million in our consolidated results of operations for the years ended December 31, 2001, 2000 and 1999, respectively.
We entered into dispositions or disposed of the following businesses, among others, during the past three years:
Coventry Health Care. Effective April 1, 1998, we transferred substantially all of our managed care operations to Coventry Corporation in exchange for a 42% non-majority ownership position in the resulting entity, Coventry Health Care, Inc. ("Coventry"). In September 2000, we sold a portion of our equity ownership position, which reduced our ownership to approximately 25% and resulted in a realized capital gain of $13.9 million, net of tax. The investment in Coventry was $146.0 million and $122.9 million as of December 31, 2001 and 2000, respectively.
We report our investment in Coventry in our Corporate and Other segment and account for it using the equity method. Our share of Coventry's net income was $19.8 million, $20.0 million and $19.1 million for the years ended December 31, 2001, 2000 and 1999, respectively.
On November 30, 2001, we announced we had entered into an agreement to sell our remaining stake of approximately 15.0 million shares of Coventry common stock. The transaction was completed on February 1, 2002.
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. Total assets of our operations in Indonesia as of December 31, 2000, were $3.2 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, 2000 and 1999.
Effective January 1, 2002, we entered into a reinsurance agreement to reinsure certain group medical insurance contracts, which should result in reduced volatility of our group medical insurance earnings.
For the year ended December 31, 2001, we excluded $31.1 million of non-recurring items, net of tax, 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) a cumulative effect of change in accounting related to our implementation of Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") ($10.7 million); and (c) 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, we excluded $101.0 million of non-recurring items, net of tax, from net income for our presentation of consolidated operating earnings. The non-recurring items included the negative effects of: (1) a loss contingency reserve established for sales practices litigation ($93.8 million); and (2) expenses related to our demutualization ($7.2 million).
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 $1.7 million, $0.6 million and $0.3 million for the years ended December 31, 2001, 2000 and 1999, 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 Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk."
In December 2001, Enron Corp., along with certain of its subsidiaries, filed voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy Court. As a result, we recognized realized losses in 2001 for other than temporary impairments of $71.9 million related to our exposure to Enron Corp. and Enron related entities. Also included in net realized capital gains and losses in 2001 were losses of $65.8 million related to the sales of Enron investments. As of December 31, 2001, the remaining carrying amount of our investment in Enron Corp. and Enron related entities was $45.5 million.
Effective October 26, 2001, Principal Mutual Holding Company converted from a mutual insurance holding company ("MIHC") to a stock company. All policyholder membership interests in Principal Mutual Holding Company were extinguished on that date and eligible policyholders of the MIHC 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 connection with the restructuring effective October 26, 2001, Principal Mutual Holding Company and two of its subsidiaries, Principal Financial Group, Inc., an Iowa corporation, and Principal Financial Services, Inc., an Iowa corporation, merged with and into Principal Iowa Newco, Inc., an Iowa corporation, which changed its name to Principal Financial Services, Inc. ("PFSI"). PFSI is a wholly-owned subsidiary of Principal Financial Group, Inc., a Delaware corporation.
On November 9, 2001, we issued 15.0 million additional shares of common stock, at a price of $18.50 per share, as a result of the exercise of over-allotment options granted to underwriters in the IPO. Net proceeds from the over-allotment were $265.4 million.
On September 11, 2001, terrorist attacks in the U.S. resulted in significant loss of life and property, as well as interruption of business activities and an overall disruption of the world economy. As of December 31, 2001, we recognized $6.7 million, net of income tax and reinsurance, in our Life and Health Insurance segment in losses from individual and group life and disability insurance claims from these events.
The impact of the events of September 11, 2001, reduced our assets under management as a result of the declines in the U.S., Australian and other stock markets. These declines in the securities markets and reduced commercial and economic activity suppressed growth in our operating earnings and revenues during 2001.
The increasing complexity of the business environment and applicable authoritative accounting guidance requires us to closely monitor our accounting policies. We have identified four 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.
reviewed periodically for indicators of impairment in value, which in the view of management are other than temporary, including unexpected or adverse changes in the economic or competitive environments in which we operate, and profitability analyses on the relevant subsidiary. If facts and circumstances suggest that a subsidiary's goodwill and other intangibles are impaired, we determine whether the sum of the estimated undiscounted future cash flows of the subsidiary is less than the carrying value. 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 fair value.
Equity securities include 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 as a component of net realized capital gains and 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 as net realized capital losses.
We have developed a margin lending securitization program whereby we sell receivables to an unconsolidated trust that packages and sells interests to investors. We retain interest bearing subordinated tranches. The receivables are sold at face value, which approximates cost and fair value, to an unconsolidated trust, with no gain or loss recognized on the sale. Retained interests are initially carried at cost based on their fair values at the date of transfer, then carried at fair value thereafter.
We recognize impairment losses for fixed maturities and equity securities when declines in value are other than temporary.
Valuation Models and Assumptions. Since many of the SFAS 115 assets 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 as required by SFAS 115. 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.
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 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.
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.
Reserves are the liabilities held on our books representing estimates of the amounts that will come due, at some point in our future, to our contractholders. The methods of establishing reserves are dictated by the FASB and NAIC, 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
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.
Fitch Ratings AA ("Very Strong") with a stable Third highest of outlook 24 rating levels
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.
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 approximately 3.1 million shares of Coventry common stock. Total estimated proceeds from the completion of this transaction are $325.2 million and we will recognize an estimated realized capital gain of $183.1 million, $114.6 million net of tax, during the first quarter of 2002.
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, or 46%, increase from the U.S. Asset Management and Accumulation segment, primarily a result of an 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, or 56%, increase from the International Asset Management and Accumulation segment primarily resulted from the sale of a large group annuity contract with life contingencies in Mexico. The increases were partially offset by a $239.4 million, or 7%, 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.
Net investment income increased $222.2 million, or 7%, to $3,394.5 million for the year ended December 31, 2001, from $3,172.3 million for the year ended December 31, 2000. The increase was primarily a result of a $1,742.0 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.
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, or 12%, 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, or 55%, 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, or 6%, decrease from the Life and Health Insurance segment, due to a reduction in group medical insurance business, 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, or 46%, 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 $93.8 million, or 4%, to $2,573.2 million for the year ended December 31, 2001, from $2,479.4 million for the year ended December 31, 2000. The increase was primarily due to a $269.6 million, or 95%, 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 $22.2 million, or 3%, 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 Capital Management's operating expenses related to increases in compensation and recruiting costs and depreciation and securitization expenses. The increases were partially offset by an $89.1 million, or 53%, 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, or 9%, 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. In addition, the increases were partially offset by a $29.9 million, or 8%, decrease from the International Asset Management and Accumulation segment, primarily as a result of the weakening of the Australian dollar versus the U.S. dollar.
Income taxes decreased $161.3 million, or 67%, to $79.0 million for the year ended December 31, 2001, from $240.3 million for the year ended December 31, 2000. The effective income tax rate was 18% for the year ended December 31, 2001, and 28% for the year ended December 31, 2000. The effective income tax
For the year ended December 31, 2001, non-recurring items of $31.1 million, net of tax, included (1) the negative effects of: (a) expenses related to our demutualization ($18.6 million); (b) a cumulative effect of change in accounting related to our implementation of SFAS 133 ($10.7 million); and (c) 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 $101.0 million, net of tax, included the negative effects of: (1) a loss contingency reserve established for sales practices litigation ($93.8 million); and (2) expenses related to our demutualization ($7.2 million).
Premiums and other considerations increased $58.8 million, or 1%, to $3,996.4 million for the year ended December 31, 2000, from $3,937.6 million for the year ended December 31, 1999. The increase reflected a $59.9 million, or 2%, increase from the Life and Heath Insurance segment, primarily the result of increased sales of group dental insurance products and an increase in group medical premiums, primarily attributable to increased sales in 1999 and significant group medical premium rate increases. In addition, the increase was due to a $40.6 million, or 23%, increase from the International Asset Management and Accumulation segment, primarily related to sales of single premium annuities with life contingencies by new annuity companies we established in Mexico in July 1999 and in Argentina in August 1999. The increases were partially offset by a $41.3 million, or 7%, decrease from the U.S. Asset Management and Accumulation segment, primarily related to 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 defined benefit pension plan terminations in the market and our ability to attract new sales.
eliminations included in this segment and the termination of a reinsurance and participation agreement under which we received fee revenues in 1999, but not in 2000. The increases were also partially offset by a $19.5 million, or 5%, decrease from the Mortgage Banking segment, primarily due to a decrease in residential mortgage loan production revenues as a result of the decrease in residential mortgage loan production volume during 2000.
Net investment income increased $100.3 million, or 3%, to $3,172.3 million for the year ended December 31, 2000, from $3,072.0 million for the year ended December 31, 1999. The increase was primarily due to an increase in investment yields due to higher interest rates on new investments. The yield on average invested assets and cash was 7.5% in 2000, compared to 7.4% in 1999. The increase was also due to a $934.8 million, or 2%, increase in average invested assets and cash.
Benefits, claims and settlement expenses decreased $28.6 million, or 1%, to $5,232.3 million for the year ended December 31, 2000, from $5,260.9 million for the year ended December 31, 1999. The decrease was primarily due to a $55.5 million, or 2%, decrease from the Life and Health Insurance segment, primarily resulting from the release of group medical and group Medicare supplement claim reserves established in 1999. The claim reserves were established in 1999 as a result of poor claim experience during the first three quarters of 1999 and an expectation that claims would continue to increase through the second quarter of 2000. Group Medicare supplement benefits, claims and settlement expenses also decreased as a result of our decision to cease new sales of group Medicare supplement insurance effective January 1, 2000, and our decision to reinsure all existing business as of July 1, 2000. In addition, the decrease was related to a $24.7 million, or 1%, decrease from the U.S. Asset Management and Accumulation segment primarily resulting from a decrease in benefit payments and reserve changes reflecting the decrease in our block of pension experience rated business and an increase in our guaranteed business. The decreases were partially offset by a $52.1 million, or 25%, increase from the International Asset Management and Accumulation segment, primarily due to an increase in the change in reserves and policy and contract benefit payments, primarily related to additional sales of annuity products with life contingencies in Mexico, Argentina and Chile.
Dividends to policyholders increased $8.1 million, or 3%, to $312.7 million for the year ended December 31, 2000, from $304.6 million for the year ended December 31, 1999. The increase was primarily attributable to a $12.5 million, or 4%, increase from the Life and Health Insurance segment due to increased dividends on traditional individual life insurance products, a result of a maturing in-force block. The increase was partially offset by a $4.4 million, or 49%, decrease in dividends from the U.S. Asset Management and Accumulation segment, which reflected a decrease in our block of pension experience rated business.
Operating expenses increased $409.1 million, or 20%, to $2,479.4 million for the year ended December 31, 2000, from $2,070.3 million for the year ended December 31, 1999. The increase was primarily due to a $160.2 million, or 76%, increase from the International Asset Management and Accumulation segment, primarily resulting from the inclusion of BT Financial Group in our financial results effective August 1999, including a $23.3 million increase amortization of goodwill and other intangibles. The increase also reflected a $121.5 million, or 20%, increase from the U.S. Asset Management and Accumulation segment, primarily due to a change in our assumptions related to amortization of deferred policy acquisition costs related to pension products and also due to an increase in pension salary and incentive compensation costs and other pension administrative expenses. In addition, the increase was due to a $116.0 million increase from the Corporate and Other segment, primarily related to an increase in our non-recurring loss contingency reserve for sales practices litigation and demutualization costs as well as additional interest costs related to private debt securities and commercial paper issued in connection with our acquisition of BT Financial Group. The increase was also due to a $39.5 million, or 5%, increase from the Life and Health Insurance segment, primarily due to expenses related to our group Medicare supplement business and higher group medical commissions. The increases were partially offset by a $28.1 million, or 9%,
Income taxes decreased $83.2 million, or 26%, to $240.3 million for the year ended December 31, 2000, from $323.5 million for the year ended December 31, 1999. The effective income tax rate was 28% for the year ended December 31, 2000 and 30% for the year ended December 31, 1999. The effective income tax rates for 2000 and 1999 were lower than the corporate income tax rate of 35%, primarily due to income tax deductions allowed for corporate dividends received.
(1) Includes inter-segment eliminations primarily related to internal investment management fee revenues, commission fee revenues paid to U.S. Asset Management and Accumulation agents for selling Life and Health Insurance segment insurance products, and real estate joint venture rental income. The Corporate and Other segment reported rental income from real estate joint ventures for office space used by other segments.
(4) For the year ended December 31, 2001, non-recurring items of $31.1 million, net of tax, included (a) the negative effects of: (i) expenses related to our demutualization ($18.6 million); (ii) a cumulative effect of change in accounting principle related to our implementation of SFAS 133 ($10.7 million); and (iii) an increase to our loss contingency reserve for sales practices litigation ($5.9 million) and (b) 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 $101.0 million, net of tax, included 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).
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 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 Capital Management due to commercial mortgage-backed securitizations.
Net investment income increased $96.7 million, or 4%, to $2,400.6 million for the year ended December 31, 2001, from $2,303.9 million for the year ended December 31, 2000. The increase reflects a $1,423.2 million, or 4%, 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.
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.
Fees and other revenues increased $88.4 million, or 14%, to $704.6 million for the year ended December 31, 2000, from $616.2 million for the year ended December 31, 1999. The increase was primarily related to a $74.2 million increase in administrative fee revenues for pension products and services. The increase in administrative fee revenues reflected an increase in the amortization of front-end fee revenues, a result of a change in our assumptions related to amortization of deferred policy acquisition costs attributable to pension products. We also received higher fee revenues from surrender charges and pension customer-directed investment transfers, reflecting the higher interest rate environment and increased customer account activity. The increase in fee revenues was also due in part to growth in assets under management related to our pension products in 1999. An increase of $13.0 million was primarily due to investment management fee revenues from our mutual fund business and commission fee revenues related to sales of third-party mutual funds. An increase of $5.6 million in individual annuity fees, primarily a result of growth in separate account assets related to individual annuity products, also contributed to the segment increase. The increase in fees and other revenues was partially offset by a $5.6 million decrease in fee revenues related to Principal Capital Management, primarily a result of a decrease in proceeds related to commercial mortgage-backed securitization transactions.
Income taxes decreased $24.2 million, or 17%, to $121.2 million for the year ended December 31, 2000, from $145.4 million for the year ended December 31, 1999. The effective income tax rate for this segment was 25% for the year ended December 31, 2000, and 29% for the year ended December 31, 1999. The effective income tax rates 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 were $356.6 million for the years ended December 31, 2000 and 1999.
Net realized capital losses, as adjusted, increased to $35.9 million for the year ended December 31, 2000, from $35.4 million for the year ended December 31, 1999. This segment recognized net realized capital losses consistent with our change in investment philosophy, which increased portfolio activity. We repositioned the investment portfolio to maximize operating investment returns by selling lower yielding fixed income securities to allow for reinvestment in higher yielding fixed income securities. This repositioning of the portfolio generated net realized capital losses.
The following table presents certain summary financial data relating to the International Asset Management and Accumulation segment for the years indicated:
- -------------------- (1) Excludes net realized capital gains (losses) and their impact on recognition of front-end fee revenues and certain market value adjustments to fee revenues.
Fees and other revenues decreased $45.1 million, or 15%, to $260.1 million for the year ended December 31, 2001, from $305.2 million for the year ended December 31, 2000. A decrease of $61.7 million of fee revenues contributed by BT Financial Group resulted from declining assets under management for the year ended December 31, 2001, the weakening of the Australian dollar versus the U.S. dollar and divestiture of non-core businesses in 2001. The decrease was
As a result of the foregoing factors, operating loss increased $0.4 million, or 5%, to $8.9 million for the year ended December 31, 2001, from $8.5 million for the year ended December 31, 2000.
Net realized capital gains (losses), as adjusted, decreased $30.6 million to $29.2 million of net realized capital losses for the year ended December 31, 2001, from $1.4 million of net realized capital gains for the year ended December 31, 2000. The decrease 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 decrease related to losses resulting from the permanent impairment of certain fixed maturity securities in Argentina.
Fees and other revenues increased $199.6 million to $305.2 million for the year ended December 31, 2000, from $105.6 million for the year ended December 31, 1999. The increase was primarily related to a $180.2 million increase resulting from the contribution of fee revenues by BT Financial Group, which we acquired in August 1999. In addition, an $8.1 million increase was primarily due to lower fees and other revenues recognized for the year ended December 31, 1999, related to El Roble in Chile. An additional $6.5 million increase was primarily attributable to higher fee revenues from administering retirement funds in
Net investment income increased $10.9 million, or 12%, to $105.0 million for the year ended December 31, 2000, from $94.1 million for the year ended December 31, 1999. An $11.3 million increase was primarily attributable to an increase in average invested assets in Principal International. In addition, an $11.2 million increase resulted from our equity method investment gains related to our pro rata share of net income, excluding the effect of goodwill amortization, of BrasilPrev Previdencia Privada S.A., a pension company in Brazil in which we acquired a minority interest in October 1999. The increases were partially offset by an $8.7 million decrease related to the inclusion of BT Financial Group, primarily related to its margin lending business. The margin lending business was securitized in late 1999, which resulted in a shift of income generation from net investment income to fee revenues in 2000. The increases were also partially offset by a $3.1 million equity method investment loss related to our pro rata share of net loss of ING/Principal Pensions Co., Ltd., a pension company in Japan in which we acquired a minority interest in January 2000.
Benefits, claims and settlement expenses increased $52.1 million, or 25%, to $262.2 million for the year ended December 31, 2000, from $210.1 million for the year ended December 31, 1999. The increase was primarily due to an increase in reserve changes and policy and contract benefit payments of $18.5 million in Mexico and $18.4 million in Argentina, the result of increased sales of single premium annuities with life contingencies. In addition, a $13.4 million increase in reserve changes and policy and contract benefit payments in Chile primarily resulted from the increased sales of annuity products and the implementation of a new reserve calculation method to refine reserve calculations.
Operating expenses increased $160.2 million, or 76%, to $372.3 million for the year ended December 31, 2000, from $212.1 million for the year ended December 31, 1999. The increase was primarily due to a $151.1 million increase resulting from the inclusion of operating expenses incurred by BT Financial Group, including a $23.3 million increase in amortization of goodwill and other intangibles. The increase also included $6.0 million of amortization of goodwill and present value of future profits related to BrasilPrev, which we acquired in October 1999.
As a result of the foregoing factors, operating loss decreased $29.9 million, or 78%, to $8.5 million for the year ended December 31, 2000, from $38.4 million for the year ended December 31, 1999.
For the year ended December 31, ---------------------------- 2001 2000 1999 -------- -------- -------- (in millions)
Operating Earnings Data: Operating Revenues(1): Premiums and other considerations........... $3,011.1 $3,250.5 $3,190.6 Fees and other revenues..................... 256.7 230.0 180.2 Net investment income....................... 678.6 642.1 614.7 -------- -------- -------- Total operating revenues.................. 3,946.4 4,122.6 3,985.5
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. Group Medicare supplement insurance premiums decreased $98.4 million, resulting from our decision to reinsure 100% of this business effective July 1, 2000. Group medical premium rate increases in 2000 led to increased lapses and lower sales, which resulted in a $95.0 million decrease in premiums. Group life insurance premiums decreased $55.8 million, primarily due to the loss of two large customers and, to a lesser extent, a result of declines in sales during 2001 as we transitioned to a newly established dedicated non-medical sales force. Group life sales also decreased as a result of pricing actions on our group medical business, as these products are often sold together. Increases in group dental premiums of $11.3 million partially offset the declines in other products. The increases were primarily due to a larger membership base early in the year due to an increase in sales in 2000 and also due to increases in dental premium rates.
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 group fee-for-service business increased $23.6 million, primarily due to growth in that business and, to a lesser extent, increases in fee rates. Fee revenues from individual interest-sensitive life insurance products increased $10.5 million, a result of continued growth in that business. The growth reflected a continued shift in customer preference from individual traditional life insurance products to individual universal life and individual variable universal life insurance products. The increases were partially offset by a $6.8 million decrease in individual traditional life insurance fee revenues, primarily related to classifying fees from reinsurance ceded for traditional life insurance as operating expenses. The fees from reinsurance were previously reported as fee revenues.
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. Group medical insurance benefits, claims and settlement expenses decreased $61.1 million, due to a reduction in business and to improved claim experience, partially offset by reserve releases during the year ended December 31, 2000. Group Medicare supplement insurance benefits, claims and settlement expenses decreased $59.3 million, resulting from our decision to reinsure 100% of this business effective July 1, 2000. Group life insurance benefits, claims and settlement expenses decreased $48.0 million due to the loss of two large customers and an overall decline in business. Individual disability benefits, claims and settlement expenses decreased $29.8 million, primarily a result of claim reserve strengthening during 2000.
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. Group life and health insurance operating expenses decreased $57.5 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 group life and health insurance business. Individual life and disability insurance operating expenses decreased $13.4 million primarily due to a decrease in commission expense resulting from classifying fees from reinsurance ceded for traditional life insurance as operating expenses. The fees from reinsurance were previously reported as fee revenues. Operating expenses also decreased due to unlocking of individual disability insurance deferred policy acquisition costs in 2000, a result of changes in profitability assumptions. The decreases were partially offset by lower capitalization of deferred policy acquisition costs related to lower sales of individual life insurance.
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.
Fees and other revenues increased $49.8 million, or 28%, to $230.0 million for the year ended December 31, 2000, from $180.2 million for the year ended December 31, 1999. Fee revenues from individual interest-sensitive life insurance products increased $27.4 million, a result of growth in that block of business. The growth reflects a continued shift in customer preference from individual traditional life insurance products to individual universal life and individual variable life insurance products. Fee revenues from our group fee-for-service business increased $20.3 million, primarily due to increases in members and fees.
Operating expenses increased $41.6 million, or 5%, to $913.6 million for the year ended December 31, 2000, from $872.0 million for the year ended December 31, 1999. Group life and health insurance operating expenses increased $26.0 million, primarily due to expenses related to our group Medicare supplement business, and a write-down of goodwill related to group Medicare supplement insurance. Group life and health insurance operating expenses also increased due to an increase in commissions, resulting from higher commission scales, an increase in premium, and settlements with wholesale distributors related to discontinued group health business. These increases were offset by a decrease in general expenses related to both our group medical and group Medicare supplement insurance products. Individual life and disability insurance operating expenses also increased $15.6 million, primarily due to an increase in amortization of deferred policy acquisition costs related to individual disability insurance.
As a result of the foregoing factors, net income increased $108.8 million, or 108%, to $209.6 million for the year ended December 31, 2000, from $100.8 million for the year ended December 31, 1999.
The following table presents certain summary financial data relating to the Mortgage Banking segment for the years indicated:
Total operating revenues decreased $38.5 million, or 10%, to $359.8 million for the year ended December 31, 2000, from $398.3 million for the year ended December 31, 1999. The decrease was primarily due to a $65.8 million decrease in mortgage loan production revenues, reflecting the decrease in mortgage loan production volume during 2000. The decrease in total revenues was partially offset by a $27.3 million increase in mortgage loan servicing revenues, primarily due to growth in the average balance of the mortgage loan servicing portfolio. Additionally, an increase in mortgage loan servicing fee revenues was the result of the sale of mortgage loan servicing rights, representing approximately $1.0 billion from the mortgage loan servicing portfolio, as part of our mortgage loan servicing strategy.
Total expenses decreased $28.1 million, or 9%, to $282.7 million for the year ended December 31, 2000, from $310.8 million for the year ended December 31, 1999. The decrease was primarily due to a $26.0 million decrease in expenses related to mortgage loan servicing, primarily a result of net gains we earned on hedges related to our servicing portfolio in 2000. In the second quarter of 2000, we shifted our servicing hedge portfolio from U.S. Treasury-related instruments to London Inter-Bank Offer Rate based hedges including swaps and swaptions, which resulted in net gains of $10.2 million. The decrease was also due to a $2.1 million decrease in mortgage loan production expenses related to the decrease in mortgage loan production volume during 2000.
As a result of the foregoing factors, operating earnings and net income decreased $6.8 million, or 12%, to $50.0 million for the year ended December 31, 2000, from $56.8 million for the year ended December 31, 1999.
The following table presents certain summary financial data relating to the Corporate and Other segment for the years indicated:
For the year ended December 31, ------------------------- 2001 2000 1999 ------- ------- ------- (in millions) Operating Earnings Data: Operating Revenues(1): Total operating revenues...................... $ 100.8 $ 97.1 $ 61.9
Total operating revenues increased $3.7 million, or 4%, to $100.8 million for the year ended December 31, 2001, from $97.1 million for the year ended December 31, 2000. Net investment income increased $14.0 million, reflecting an increase in average invested assets and cash. In addition, inter-segment eliminations included in this segment resulted in a $1.7 million increase, 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.
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 capital gains (losses), as adjusted, decreased $173.6 million to $93.3 million of net realized capital losses for the year ended December 31, 2001, from $80.3 million of net realized capital gains for the year ended December 31, 2000. The decrease was primarily due to an increase in net realized
Total expenses decreased $39.7 million, or 73%, to $14.4 million for the year ended December 31, 2000, from $54.1 million for the year ended December 31, 1999. Interest expense related to IRS tax audit matters decreased $40.8 million, primarily due to a net recovery of previously paid interest related to a successful tax audit appeal. Expenses also decreased $33.2 million due to the cessation of interim service agreements with Coventry at the end of 1999. A $9.0 million decrease in operating expenses was related to a change in inter-segment eliminations included in this segment. The decreases were partially offset by $31.2 million of additional interest expense for the year ended December 31, 2000, on private debt securities and commercial paper issued in connection with the acquisition of BT Financial Group in August 1999. In addition, a $10.0 million increase was related primarily to corporate initiatives funded by this segment.
As a result of the foregoing factors, operating earnings increased $58.2 million to $67.7 million for the year ended December 31, 2000, from $9.5 million for the year ended December 31, 1999.
Net realized capital gains, as adjusted, decreased $204.2 million, or 72%, to $80.3 million for the year ended December 31, 2000, from $284.5 million for the year ended December 31, 1999. The decrease was primarily due to decreased sales of invested assets, primarily equity securities, for the year ended December 31, 2000. We sold a significant portion of our equity securities portfolio in 1999 and 1998 to reduce our exposure to common stock and to realize appreciation.
o 10% of Principal Life's policyholder surplus as of the previous year-end; or
o the net gain from operations from the previous calendar year.
Iowa law gives the Commissioner discretion to disapprove requests for dividends in excess of these limits. Based on this limitation and 2001 statutory results, Principal Life could pay approximately $640.3 million in stockholder dividends in 2002 without exceeding the statutory limitation. Principal Life was able to pay approximately $760.9 million in statutory dividends in 2001 based on its 2000 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 2001 and 2000 were $734.7 million and $538.8 million, respectively. On February 26, 2002, Principal Life declared an ordinary dividend of $390.0 million payable to its parent on or about April 5, 2002.
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.
Net cash used in investing activities was $3,698.4 million and $1,273.3 million for the years ended December 31, 2001 and 2000, respectively. The decrease in cash from investing activities was primarily due to a significant increase during 2001 in the volume of net mortgage loans purchased and sold. Also contributing to the decrease in cash was an increase in net mortgage loan servicing rights purchased, also a result of increased mortgage loan production volume in 2001 and an increase in net cash invested in available-for-sale securities during 2001 compared to 2000.
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.
products and technologies. See Item 7A, "Quantitative and Qualitative Disclosures about Market Risk-Interest Rate Risk" for a discussion of duration matching.
Book Value Out(1) Puttable: Less than 30 days' put...................... $ - $ - 30 to 89 days' put.......................... - 100.6 90 to 180 days' put......................... - 379.9 More than 180 days' put..................... 55.1 150.9 No active put provision(2).................. - - ----------- ----------- Total puttable........................... 55.1 631.4
Market Value Out(3) Less than 30 days' notice..................... 26.9 42.9 30 to 89 days' notice......................... 281.9 284.6 90 to 180 days' notice........................ 1,133.6 992.6 More than 180 days' notice.................... 4,795.6 5,004.4 No active surrender provision................. 238.5 297.9 ----------- ----------- Total market value out................... 6,476.5 6,622.4
Not puttable or surrenderable................. 11,502.1 10,521.3 ----------- ----------- Total GICs and funding agreements........ $ 18,452.9 $ 17,948.3 =========== =========== - -------------------- (1) Book Value Out: The amount equal to the sum of deposits less withdrawals with interest accrued at the contractual interest rate.
Principal International maintains investment strategies generally intended to provide adequate funds to pay benefits without forced sales of investments. Highly liquid, high quality short-term government securities and other liquid investment grade fixed maturities are held to fund anticipated operating cash outflows and development and maintenance expenses associated with new products and technologies.
Our Brazilian and Chilean operations produced positive cash flow from operations in 2001 and in 2000. These cash flows have been historically maintained at the local country level for strategic expansion purposes. Our other international operations have required infusions of capital of $44.7 million, $75.8 million and $126.8 million for the years ended December 31, 2001, 2000 and 1999, respectively, to meet the cash outflow requirements of those operations or to fund acquisitions. These other operations are primarily in the start-up stage or are expanding in the short term. Our capital funding of these operations is consistent with our long-term strategy to establish viable companies that can sustain future growth from internally generated sources.
The following tables present payments due by period for contractual obligations as of December 31, 2001 and 2000:
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty Limited, our wholly-owned indirect subsidiary, issued $665.0 million of unsecured redeemable long-term debt ($200.0 million of 7.95% notes due August 15, 2004, and $465.0 million in 8.2% notes due August 15, 2009). Interest on the notes is payable semiannually on February 15 and August 15 of each year, commencing February 15, 2000. Principal Financial Group (Australia) Holdings Pty Limited used the net proceeds from the notes to partially fund the purchase of the outstanding stock of several companies affiliated with Bankers Trust Australia Group. On December 28, 2001, all of the long-term debt obligations of Principal Financial Group (Australia) Holdings Pty Limited were assumed by its parent, PFSI.
The mortgages and other notes payable are financings for real estate developments. We have obtained loans with various lenders to finance these developments. Outstanding principal balances as of December 31, 2001, range from $0.1 million to $101.9 million per development with interest rates generally ranging from 7.2% to 8.6%. Outstanding principal balances as of December 31, 2000, range from $0.5 million to $102.8 million per development with interest rates generally ranging from 6.9% 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.
As of December 31, ---------------------------- 2001 2000 ------------ ------------ (in millions)
Commercial paper..................... $ 199.9 $ 29.9 Other recourse short-term debt....... 22.0 16.6 Non-recourse short-term debt......... 289.7 413.0 ------------ ------------ Total short-term debt............. $ 511.6 $ 459.5 ============ ============
The weighted-average interest rates on short-term borrowings as of December 31, 2001 and 2000, were 2.30% and 7.17%, respectively.
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 $38.0 billion and $5.3 billion in mortgage loans to PRMCR in 2001 and 2000, 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, 2001. PRMCR held $3.0 billion in mortgage loans held for sale as of December 31, 2001. The portfolio of loans
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, 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, 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 maintain a right to the servicing of the mortgage loans held by PRMCR and upon the sale of the majority of the mortgage loans to the final investors. In addition, we perform certain secondary marketing, accounting and various administrative functions on behalf of PRMCR. As servicer, we receive a monthly servicing fee, and may receive an excess servicing fee if funds are available within PRMCR. Additionally, as servicer we are required to advance to PRMCR those payments due from borrowers, but not received, as of specified cut-off dates. We received $12.6 million and $2.2 million in servicing fees from PRMCR in 2001 and 2000, respectively.
We are retained as the servicer of the mortgage loans and also perform accounting and various administrative functions on behalf of PRMF, in its capacity as the managing member of PRMF. As the servicer, we receive a servicing fee pursuant to the pooling and servicing agreement. We may also receive a successful servicing fee only after all other conditions in the monthly cash flow distribution are met. At December 31, 2001, our residual interest in such cash flows was $21.5 million and was recorded in other investments on the consolidated statements of financial position. The value of the residual interest was based on the net present value of expected cash flows from PRMF, as well as estimates of foreclosure losses associated with the related loans. We are required to advance funds for payment of interest on the participation certificates and other carrying costs, if sufficient cash is not available in the collection account to meet this obligation.
Our U.S. invested assets are managed by Principal Capital Management, a subsidiary of Principal Life. Our primary investment objective is to maximize after-tax returns consistent with acceptable risk parameters. We seek to protect policyholders' benefits by optimizing the risk/return relationship on an ongoing basis, through asset/liability matching, reducing the credit risk, avoiding high levels of investments that may be redeemed by the issuer, maintaining sufficiently liquid investments and avoiding undue asset concentrations through diversification. We are exposed to three primary sources of investment risk:
o 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, 2001, there are ten members on the Investment Committee, two of whom are members of our board of directors. The remaining eight members are senior management members representing various areas of our company.
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.
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. From 1998 through December 31, 2001, the weighted average loan-to-value ratio at origination for brick and mortar commercial mortgages in our portfolio was in the 65%-68% range and debt service coverage ratios at loan inception in the 1.6-1.7 times range.
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".
U.S. invested assets as of December 31, 2001, were predominantly of high quality and broadly diversified across asset class, individual credit, industry and geographic location. As shown in the following table, the major categories of U.S. invested assets are fixed maturity securities and commercial mortgages. The remainder is invested in real estate, equity securities and other assets. In addition, policy loans are included in our invested assets. We combined our invested assets in the Closed Block with invested assets outside the Closed Block in view of the similar asset quality characteristics of the two portfolios. The following discussion analyzes the composition of U.S. invested assets, which includes $4,169.1 million in invested assets of the Closed Block as of December 31, 2001, but excludes invested assets of the participating separate accounts.
The international exposure in our U.S. invested assets totaled $3,877.4 million, or 13%, of total fixed maturity securities, as of December 31, 2001, comprised of corporate and foreign government fixed maturity securities. Of the $3,877.4 million as of December 31, 2001, investments totaled $1,177.6 million in the United Kingdom, $653.8 million in the continental European Union, $511.0 million in Asia, $383.2 million in South America, $336.8 million in Australia and $25.7 million in Japan. The remaining $789.3 million was invested in 14 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, 2001, our investments in Canada totaled $852.1 million.
We believe that our long-term fixed maturity securities portfolio is well diversified among industry types and between publicly traded and privately placed securities. Each year we direct the majority of our net cash inflows into investment grade fixed maturity securities. We typically invest up to 7% of general account cash flow in below investment grade assets. While the general account investment returns have improved due to the below investment grade asset class, we manage its growth strategically by limiting it to 10% of the total fixed maturity securities portfolio.
The following tables show the carrying amount of our corporate fixed maturity securities by industry category, as well as the percentage of the total corporate portfolio that each industry category comprises as of December 31, 2001, and December 31, 2000. The tables also show by industry category the relative amounts of publicly traded and privately placed securities.
We held $5,881.8 million of mortgage-backed and asset-backed securities as of December 31, 2001, and $6,416.3 million as of December 31, 2000. The following table presents the types of mortgage-backed securities ("MBSs"), as well as other asset-backed securities, held for the years indicated:
We believe that it is desirable to hold residential mortgage-backed securities due to their credit quality and liquidity as well as portfolio diversification characteristics. Our portfolio is comprised of GNMA, FNMA and FHLMC pass-through securities and is actively managed to ensure that the securities held are trading close to or below par, in order to reduce risk of prepayments. As of December 31, 2001, we held no collateralized mortgage obligations in our U.S. invested asset portfolio.
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:
Our equity securities consist primarily of investments in common stocks. We classify our investment in common stocks as available for sale and report them at fair value. We report unrealized gains and losses on common stocks as a separate component of other comprehensive income, net of deferred income taxes and an adjustment for the effect on deferred acquisition costs that would have occurred if such gains and losses had been realized.
Investments in equity securities, totaled $808.7 million and $666.0 million, which represented 2% of U.S. invested assets as of December 31, 2001, and December 31, 2000, respectively. Investments in company-sponsored funds totaled $463.3 million, or 57%, of our U.S. equity securities as of December 31, 2001. These sponsored funds are intended to be marketed to our asset management clients. Of company-sponsored funds, $313.6 million represented underlying investments in publicly-traded equities, $144.0 million represented investments in publicly-traded fixed income securities and $5.7 million in balanced funds which represented investments in both publicly-traded equities and fixed income securities as of December 31, 2001. The remaining balance of equity securities is a mixture of public and private securities acquired for investment purposes or which were acquired through equity participation features of below investment grade bonds or through recoveries of defaulted securities.
Mortgage loans comprised 25% of total U.S. invested assets as of December 31, 2001, and 27% as of December 31, 2000. Mortgage loans consist of commercial and residential loans. Commercial mortgage loans comprised $9,740.4 million as of December 31, 2001, and $10,775.3 million as of December 31, 2000, or 89% and 95%, of total mortgage loan investments, respectively. Residential mortgages comprised $1,144.2 million and $550.5 million, or 11% and 5%, of total mortgage loan investments as of December 31, 2001, and December 31, 2000, 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;
The following is a summary of our commercial mortgage loans by property type and region as of December 31, 2001, and December 31, 2000:
Office........................ $ 3,252.5 33% $ 3,273.5 30% Retail........................ 3,106.5 32 3,612.7 34 Industrial.................... 2,948.9 30 3,381.6 31 Apartments.................... 349.8 4 419.7 4 Mixed use/other............... 111.8 1 130.2 1 Hotel......................... 61.6 1 65.6 1 Valuation allowance........... (90.7) (1) (108.0) (1) ---------- ----- ---------- ----- Total...................... $ 9,740.4 100% $10,775.3 100% ========== ===== ========== =====
Due in one year or less................ $ 732.6 8% $ 675.8 6% Due after one year through five years.. 3,180.8 32 3,033.4 28 Due after five years through ten years. 2,890.8 29 3,900.7 36 Due after ten years.................... 3,026.9 31 3,273.4 30 ---------- ----- ---------- ----- Total............................... $ 9,831.1 100% $10,883.3 100% ========== ===== ========== =====
We actively monitor and manage our commercial mortgage loan portfolio. Substantially all loans within the portfolio are analyzed regularly, based on a proprietary risk rating cash flow model, in order to monitor the financial quality of these assets and are internally rated. Based on ongoing monitoring, mortgage loans with a likelihood of becoming delinquent are identified and placed on an internal "watch list". Among criteria which would indicate a potential problem are: imbalances in ratios of loan to value or contract rents to debt service, major tenant vacancies or bankruptcies, borrower sponsorship problems, late payments, delinquent taxes and loan relief/restructuring requests.
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.
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:
- -------------------- (1) Problem commercial mortgages included mortgage loans in foreclosure of $6.0 million as of December 31, 2000. There were no mortgage loans in foreclosure as of December 31, 2001.
We hold commercial equity real estate as part of our investment portfolio. As of December 31, 2001, and December 31, 2000, the carrying amount of equity real estate investment was $1,174.1 million and $1,391.8 million, or 3% and 4% of U.S. invested assets, respectively. We own real estate, real estate acquired upon foreclosure of commercial mortgage loans and interests, both majority owned and non-majority owned, in real estate joint ventures. We continue to focus on a long-term strategy of reducing our real estate equity portfolio.
Equity real estate is categorized as either "real estate held for investment" or "real estate held for sale". Real estate held for investment totaled $783.4 million as of December 31, 2001, and $696.4 million as of December 31, 2000. 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, 2001 and December 31, 2000, there were no such impairment adjustments.
Equity real estate is distributed across geographic regions of the country with larger concentrations in the South Atlantic, Pacific, and West South Central regions of the United States as of December 31, 2001. By property type, there is a concentration in office buildings that represented approximately 36% of the equity real estate portfolio as of December 31, 2001. Our largest equity real estate holding as of December 31, 2001 consisted of an office/industrial park located in Durham, North Carolina with an aggregate carrying value of approximately $148.3 million and represented approximately 13% of total U.S. equity real estate assets and 0.3% of U.S. invested assets. The ten largest real estate properties as of December 31, 2001 comprised 47% of total U.S. equity real estate assets and 1% of total U.S. invested assets. In addition, our equity real estate includes our investment in BT Hotels. As of December 31, 2001, BT Hotels was fully consolidated into our financial statements and is reflected in the International region and Hotel/Motel property type in the following investment schedules:
As of December 31, ------------------------------------------ 2001 2000 ------------------- ------------------- Carrying % of Carrying % of Amount Total Amount Total ---------- ----- ---------- ----- ($ in millions)
South Atlantic............. $ 376.4 32% $ 431.7 31% West South Central......... 236.4 20 362.2 26 International.............. 223.6 19 - - Pacific.................... 183.8 16 384.6 28 East North Central......... 62.3 5 120.7 9 East South Central......... 32.3 3 21.5 1 West North Central......... 28.0 2 19.0 1 New England................ 14.3 1 14.5 1 Mountain................... 8.8 1 8.9 1 Middle Atlantic............ 8.2 1 28.7 2 ---------- ----- ---------- ----- Total................... $ 1,174.1 100% $ 1,391.8 100% ========== ===== ========== ===== - -------------------- (1) Regions are defined by the American Council of Life Insurers.
Office..................... $ 422.9 36% $ 615.5 44% Hotel/Motel................ 223.6 19 - - Industrial................. 221.6 19 413.6 30 Retail..................... 138.9 12 152.7 11 Service Center............. 63.1 5 120.1 9 Land....................... 53.3 5 89.9 6 Apartments................. 50.7 4 - - ---------- ----- ---------- ----- Total................... $ 1,174.1 100% $ 1,391.8 100% ========== ===== ========== =====
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, 2001, was $3,130.9 million. We also have fixed maturity securities that are denominated in foreign currencies. However, we use derivatives to hedge the foreign currency risk of these funding agreements and securities. As of December 31, 2001, the fair value of our foreign currency denominated fixed maturity securities was $304.6 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, 2001, was $296.0 million.
o establishing exposure limits which take into account non-derivative exposure we have with the counterparty as well as derivative exposure;
Foreign currency swaps................. $ 101.1 33% $ 45.3 42% Interest rate swaps.................... 78.4 25 14.1 13 Currency forwards...................... 55.3 18 5.5 5 Mortgage-backed forwards and options... 41.7 14 - - Interest rate floors................... 13.2 4 20.0 18 Call options........................... 8.9 3 12.3 11 Swaptions ............................. 8.7 3 11.8 11 Other.................................. 0.1 - - - -------- ----- -------- ----- Total............................... $ 307.4 100% $ 109.0 100% ======== ===== ======== =====
Our other investments totaled $678.4 million as of December 31, 2001, compared to $681.2 million as of December 31, 2000. Our investment in Coventry is included in other investments as we accounted for it using the equity method. As of December 31, 2001, our carrying value in Coventry was $146.0 million. With the adoption of SFAS 133 on January 1, 2001, derivatives were reflected on our balance sheet and accounted for $116.5 million in other investments as of December 31, 2001. The remaining invested assets include leases and other private equity investments.
The following table illustrates the yields on average assets for each of the components of our investment portfolio for the years ended December 31, 2001, 2000 and 1999:
Fixed maturity securities consist primarily of publicly traded debt securities and represented 73% of total international invested assets as of December 31, 2001, and 71% as of December 31, 2000. Fixed maturity securities were diversified by type of issuer as of December 31, 2001, and for the year ended December 31, 2000, as shown in the following table:
The fixed maturity securities held by the international operations have not been rated by external agencies and cannot be presented in a comparable rating agency equivalent.
The international operations held $20.1 million of restructured government bonds in Argentina, which represented 2% of international fixed maturity securities as of December 31, 2001.
Our Chilean operations originate and purchase residential mortgage loans. Residential mortgage loans comprised $181.1 million, or 13%, of international invested assets as of December 31, 2001, and $166.9 million, or 12%, as of December 31, 2000.
The derivative contracts outstanding as of December 31, 2000 related to the 144A debt issued to purchase BT Financial Group in 1999. On December 28, 2001, all obligations of the long-term debt were assumed by Principal Financial Services, Inc., and as of that date Principal Financial Group (Australia) Holdings Pty Limited's obligations ceased. In conjunction with the move of the debt, the outstanding derivative contracts were assigned to PFSI. The following tables present our position in, and credit exposure to, derivative financial instruments as of December 31, 2001, and December 31, 2000.
Report of Management...................................... 111 Report of Independent Auditors............................ 112 Audited Consolidated Financial Statements Consolidated Statements of Financial Position.......... 113 Consolidated Statements of Operations.................. 114 Consolidated Statements of Stockholders' Equity........ 115 Consolidated Statements of Cash Flows.................. 116 Notes to Consolidated Financial Statements............ 118
Management is responsible for maintaining systems of internal accounting controls designed to provide reasonable assurance as to the integrity of the financial records and the protection of corporate assets. Principal Financial Group, Inc. supports and manages an active program designed to monitor compliance with policies and procedures and evaluate internal control.
By: /s/ Douglas C. Cunningham ----------------------------------- Douglas C. Cunningham Vice President and Corporate Controller
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, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
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, Principal Financial Group, Inc., a Delaware business corporation. All policyholder membership interests in Principal Mutual Holding Company were extinguished on that date and eligible policyholders of the MIHC 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.
On the Date of Demutualization, Principal Mutual Holding Company and two of its subsidiaries, Principal Financial Group, Inc., an Iowa corporation, and Principal Financial Services, Inc., an Iowa corporation, merged with and into Principal Iowa Newco, Inc., an Iowa corporation, which changed its name to Principal Financial Services, Inc. ("PFSI"). PFSI is a wholly-owned subsidiary of Principal Financial Group, Inc., a Delaware corporation.
In addition, on October 26, 2001, the Company completed its initial public offering ("IPO") in which the Company issued 100.0 million shares of common stock at a price of $18.50 per share. 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 Insurance Company. Proceeds were net of offering costs of $96.5 million and a related tax benefit of $0.4 million.
The accompanying consolidated financial statements of the Company and its 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 the Company has 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.
Total assets of the unconsolidated entities amounted to $4,768.8 million at December 31, 2001, and $3,098.5 million at December 31, 2000. Total revenues of the unconsolidated entities were $2,855.2 million, $2,226.3 million and $1,978.9 million in 2001, 2000 and 1999, respectively. During 2001, 2000 and 1999, the Company included $53.2 million, $39.1 million and $107.7 million, respectively, in net investment income representing the Company's share of current year net income of the unconsolidated entities. The unconsolidated entities primarily include the Company's 23% interest in Coventry Health Care, Inc. and minority interests in domestic and international (Brazil, India and Japan) joint ventures and partnerships. The Company's net investment in these Companies at December 31, 2001 and 2000, was $165.3 million and $145.0 million, respectively.
The preparation of the Company's 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.
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.
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 140") was issued in September 2000 and was effective for transfers, servicings and extinguishments occurring after March 31, 2001. SFAS 140 replaced SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 125"). Although SFAS 140 clarified or amended various aspects of SFAS 125, most of the fundamental concepts from SFAS 125 were brought forward without
modification. The Company adopted SFAS 140 on April 1, 2001, and modified its securitization trust agreements to meet the new requirements to enable it to continue recognizing transfers of certain financial instruments as sales. As a result, the adoption of SFAS 140 did not have a significant impact on the Company's consolidated financial statements.
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 as a component of net realized capital gains and losses. For loan-backed and structured securities, the Company recognizes 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 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 as a component of net realized capital gains and losses. Equity securities are classified as available-for-sale and, accordingly, are carried at fair value. (See Note 14 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.
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 as net realized capital losses.
Policy loans and other investments, excluding investments in unconsolidated entities, are primarily reported at cost.
The Company sells commercial mortgage loans to an unconsolidated trust which then issues mortgage-backed securities. The Company may retain interests in the loans by purchasing portions of the securities from the issuance. Gain or loss on the sales of the mortgages 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.
The Company also sells residential mortgage loans and retains servicing rights which are retained interests in the sold loans. Gain or loss on the sales of the loans depends in part on the previous carrying amounts of the financial assets sold and the retained interests 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 the Company estimates fair value based on the present value of the future expected cash flows using management's best estimates of the key assumptions - prepayment speeds and option adjusted spreads commensurate with the risks involved.
The Company has developed a margin lending securitization program whereby the Company sells receivables to an unconsolidated trust that packages and sells interests to investors. The Company retains interest bearing subordinated tranches. The receivables are sold at face value, which approximates cost and fair value, to an unconsolidated trust, with no gain or loss recognized on the sale. Retained interests are initially carried at cost based on their relative fair values at the date of transfer, then carried at fair value thereafter.
The Company's 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. Hedge accounting is used for derivatives that are specifically designated in advance as hedges and that reduce the Company's 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 not designated as a hedging instrument, the change in fair value is recognized in earnings in the period of change.
Participating business represented approximately 35%, 34% and 34% of the Company's life insurance in force and 76%, 79% and 78% of the number of life insurance policies in force at December 31, 2001, 2000 and 1999, respectively. Participating business represented approximately 57%, 61% and 63% of life insurance premiums for the years ended December 31, 2001, 2000 and 1999, respectively.
Some of the Company's 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, the Company believes 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.
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
The Company enters into reinsurance agreements with other companies in the normal course of business. The Company 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. The Company is 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, 2001, 2000 and 1999, respectively, the Company had reinsured $15.6 billion, $13.2 billion, and $10.2 billion of life insurance in force, representing 12%, 9% and 7% of total net life insurance in force through a single third-party reinsurer. To minimize the possibility of losses, the Company evaluates the financial condition of its reinsurers and continually monitors concentrations of credit risk.
At December 31, 2001, the Separate Accounts included a separate account valued at $1.3 billion which primarily included shares of the Company's stock that were allocated and issued to eligible participants of qualified employee benefit plans administered by the Company as part of the policy credits issued under the Company's demutualization. These shares are included in both basic and diluted earnings per share calculations. The separate account shares are recorded at fair value and are reported as separate account assets and separate account liabilities in the consolidated statement of financial position. Activity of the separate account shares is reflected in both the separate account assets and separate account liabilities and does not impact the Company's results of operations.
The Company files a U.S. consolidated income tax return that includes all of its qualifying subsidiaries and has a policy of allocating income tax expenses and benefits to companies in the group generally based upon pro rata contribution of taxable income or operating losses. The Company is 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.
Goodwill and other intangibles include the cost of acquired subsidiaries in excess of the fair value of the tangible net assets recorded in connection with acquisitions. These assets are amortized on a straight-line basis generally over 8 to 40 years. At December 31, 2001, the weighted-average amortization period for goodwill and other intangibles was 22.4 years and 36.8 years, respectively. The carrying amounts of goodwill and other intangibles are reviewed periodically for indicators of impairment in value, which in the view of management are other than temporary, including unexpected or adverse changes in the economic or competitive environments in which the Company operates and profitability analyses on the relevant subsidiary. If facts and circumstances suggest that a subsidiary's goodwill and other intangibles are impaired, the Company determines whether the sum of the estimated undiscounted future cash flows of the subsidiary are less than the carrying value. 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.
Premiums due and other receivables include life and health insurance premiums due, reinsurance recoveries, guaranty funds receivable or on deposit, receivables from the sale of securities and other receivables.
For the year ended December 31, 2001 2000 1999 ---------- ---------- ----------
During 2001, impairments reflect the results of increased mortgage loan prepayments due to the continued reduction in market interest rates during the year.
Reclassifications have been made to the 1999 and 2000 consolidated financial statements to conform to the 2001 presentation.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). This Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and amends Accounting Principles Board ("APB") Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("Opinion 30"), establishing a single accounting model for the disposal of long-lived assets. SFAS 144 generally retains the basic provisions of existing guidance, but broadens the presentation of any discontinued operations to include a component of an entity (rather than a segment of a business as defined in Opinion 30). The provisions of SFAS 144 are effective for fiscal years beginning after December 15, 2001, and are not expected to have a significant impact on the Company's consolidated financial statements.
During the past three years, the Company has acquired a number of businesses, all of which were recorded using the purchase method of accounting. Accordingly, the results of operations of the acquired companies have been included in the consolidated results from their respective acquisition dates.
The Company made various acquisitions during 2001 at purchase prices aggregating $12.0 million. Such acquired companies had total assets at December 31, 2001, and total 2001 revenue of $13.3 million and $3.9 million, respectively.
During 2000, various acquisitions of joint ventures were made by the Company at purchase prices aggregating $27.4 million. During 2000, the Company included $(2.0) million in net investment income representing the Company's share of current year net losses of the acquired joint ventures. These joint ventures are part of the unconsolidated entities described in Note 1.
On August 31, 1999, the Company acquired the outstanding stock of several companies affiliated with Bankers Trust Australia Group ("Acquired Companies") from Deutsche Bank AG at a purchase price of $1,445.6 million. In connection with the acquisition, the Company and Deutsche Bank AG agreed to the sale of the investment banking operations of the Acquired Companies to Macquarie Bank Limited, with net proceeds of $63.7 million from this transaction being included in the acquired assets.
The purchase price and $9.4 million of direct acquisition costs have been allocated to the assets acquired and liabilities assumed based on their respective fair market values at the acquisition date. The allocation included identifiable intangibles represented by management rights for the funds management business and the brand name of $897.4 million and $38.5 million of workforce intangibles, with $408.6 million of resulting goodwill, which are being amortized on a straight-line basis over 40, 8 and 25 years, respectively. Refinements in the allocation were made in 2000 as accounting completion and valuation studies were finalized.
During 1999, various other acquisitions were made by the Company at purchase prices aggregating $121.5 million. Such acquired companies had total assets of $126.9 million at December 31, 1999, and total revenue of $11.2 million during 1999.
On September 25, 2001, the Company disposed of all the stock of PT Asuransi Jiwa Principal Indonesia, a subsidiary in Indonesia. The Company currently has no business operations in Indonesia. Total assets of the Company's operations in Indonesia as of June 30, 2001, were $3.4 million. The Company included nominal revenues and net loss from operations in Indonesia in the consolidated results of operations for the years ended December 31, 2000 and 1999.
On February 15, 2001, the Company disposed of all the stock of Principal International Espana, S.A. de Seguros de Vida, a subsidiary in Spain, for nominal proceeds, resulting in a net realized capital loss of $38.4 million, ceasing the business operations in Spain. Total assets of the operations in Spain as of December 31, 2000, were $222.7 million. The Company included revenues of $49.4 million and $51.7 million in the results of operations for the years ended December 31, 2000 and 1999, respectively. The Company included a net loss of $1.2 million and net income of $0.9 million in the results of operations for the years ended December 31, 2000 and 1999, respectively.
For the year ended December 31, 2001 2000 1999 --------- --------- ---------
The major components of net realized capital gains (losses) on investments are summarized as follows (in millions):
For the year ended December 31, 2001 2000 1999 -------- -------- --------
- ------------------ (1) Excludes net unrealized gains (losses) on fixed maturities, available-for-sale included in fair value hedging relationships.
Commercial mortgage loans represent a primary area of credit risk exposure. At December 31, 2001 and 2000, the commercial mortgage portfolio is diversified by geographic region and specific collateral property type as follows (dollars in millions):
Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to contractual terms of the loan agreement. When the Company determines 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 capital loss.
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 the Company's 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.
Balance at beginning of year............ $110.4 $117.8 $113.0 Provision for losses.................... 11.2 5.4 9.2 Releases due to write-downs, sales and foreclosures.......................... (29.3) (12.8) (4.4) --------- --------- --------- Balance at end of year.................. $ 92.3 $110.4 $117.8 ========= ========= =========
PRMCR is capitalized by equity certificates owned by third party investors not affiliated with the Company or its affiliates, directors or officers and thus, is not consolidated with the Company. The equity holders bear the risk of loss on defaulted mortgages. At December 31, 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 the Company. 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.
The Company paid a commitment fee to PRMCR based on the overall warehouse limit. PRMCR used a portion of the fee to fund a cash collateral account maintained at PRMCR. These funds are available as additional collateral to cover credit related losses on defaulted loans. The balance in the account was $24.0 million at December 31, 2001. Any remaining amounts in the cash collateral account will be returned to the Company upon the termination of PRMCR. This right to the return of the cash collateral amount is reflected in other assets on the Company's consolidated statements of financial position.
The Company maintains a right to the servicing of the mortgage loans held by PRMCR and upon the sale of the majority of the mortgage loans to the final investors. In addition, the Company performs certain secondary marketing, accounting and various administrative functions on behalf of PRMCR. As servicer, the Company receives a monthly servicing fee, and may receive an excess servicing fee if funds are available within PRMCR. Additionally, as servicer the Company is required to advance to PRMCR those payments due from borrowers, but not received, as of specified cut-off dates. The Company received $12.6 million and $2.2 million in servicing fees from PRMCR in 2001 and 2000, respectively.
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 the Company 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 the Company.
In October 2000, the Company, through its 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 $357.0 million in December 2001. The Company sells qualifying delinquent loans to PRMF which then transfers the loans to Principal Residential Mortgage EBO Trust ("Trust"), an unaffiliated Delaware business trust. The Trust funds its acquisitions of the mortgage loans by selling participation certificates, representing an undivided interest in the Trust, to commercial paper conduit purchasers, who are not affiliated with the Company or any of its affiliates, directors or officers. At December 31, 2001, PRMF held $273.5 million in mortgage loans and had outstanding participation certificates of $256.9 million.
Real estate holdings and related accumulated depreciation are as follows (in millions):
In 2001 and 2000, the Company recognized gains of $18.3 million and $0.7 million, respectively, on the securitization of commercial mortgage loans.
The Company sells residential mortgage loans and retains servicing responsibilities pursuant to the terms of the applicable agreements. The Company receives annual servicing fees approximating 0.4 percent of the outstanding principal balances on the underlying loans. These sales are generally transacted
on a non-recourse basis. The value of the servicing rights is subject to prepayment and interest rate risks on the transferred assets.
The key economic assumptions used in determining the fair value of mortgage servicing rights at the date of loan sale for sales completed in 2001 and 2000 were as follows:
At December 31, 2001, key economic assumptions and the sensitivity of the current fair value of the mortgage servicing rights to immediate 10 and 20 percent adverse changes in those assumptions are as follows (dollars in millions):
Fair value of mortgage servicing rights.................. $1,811.0 Expected weighted average life (in years)................ 6.8 Prepayment speed......................................... 11.10% Decrease in fair value of 10% adverse change............. $ 67.3 Decrease in fair value of 20% adverse change............. $ 128.9 Yield to maturity discount rate.......................... 8.86% Decrease in fair value of 10% adverse change............. $ 130.0 Decrease in fair value of 20% adverse change............. $ 260.1
The Company sells loans under its margin loan securitization program and retains primary servicing responsibilities and subordinated interests. The Company receives servicing distributions approximating 0.3 percent of the outstanding balance and rights to future cash flows through an excess distribution from the trust, representing the balance remaining after all interest and fees of the trust have been accounted for. The Company's retained interests are subordinated to investors' interests. Retained interests equate to 7% of the outstanding loan balances, of which the Company earns a return of 2.0% over the Australian 30 day Bank Bill swap rate. The investors and the securitization trusts have no recourse to the Company's other assets for failure of debtors to pay when due. The value of the Company's retained interests is subject to market risk and all positions are primarily hedged. No gains or losses on the transaction have been realized to date.
The fair values of the retained interests, $37.8 million at December 31, 2001, are based upon the Company's relative ownership percentage of the outstanding loan balances. At December 31, 2001, the Company utilized the present
Proceeds from new securitizations..................... $39,252.1 $ 9,658.2 Proceeds from advances on margin loans previously securitized......................................... 86.4 16.1 Servicing fees received............................... 309.5 239.3 Other cash flows received on retained interests....... 61.4 42.8
The Company's risk of loss is typically limited to the fair value of its 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. The Company is also exposed to credit losses in the event of nonperformance of the counterparties. The Company's current credit exposure is limited to the value of derivatives that have become favorable to the Company. This credit risk is minimized by purchasing such agreements from financial institutions with high credit ratings and by establishing and monitoring exposure limits.
5. Derivatives Held or Issued for Purposes Other Than Trading (continued)
The notional amounts and credit exposure of the Company's derivative financial instruments by type are as follows (in millions):
Notional amounts of derivative instruments with regard to international operations Foreign currency swaps............................ 13.4 665.0 Interest rate swaps............................... - 665.0 Currency forwards................................. - 380.0 ---------- --------- 13.4 1,710.0 ---------- --------- Total notional amounts at end of year............. $ 27,481.4 $ 12,205.1 ========== ==========
Credit exposure of derivative instruments with regard to U.S. operations Foreign currency swaps............................ $ 101.1 $ 45.3 Interest rate floors.............................. 13.2 20.0 Interest rate swaps............................... 78.4 14.1 Mortgage-backed forwards and options.............. 41.7 - Swaptions......................................... 8.7 11.8 Call options...................................... 8.9 12.3 Currency forwards................................. 55.3 5.5 Other............................................. 0.1 - ---------- ---------- 307.4 109.0
The Company uses 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.
The Company also enters 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.
The Company also utilizes floating-to-fixed rate interest rate swaps to match cash flows.
In 2001, the Company recognized a $5.8 million after-tax decrease in value related to cash flow hedges in accumulated other comprehensive income. During this time period, none of the Company's 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. The Company has not reclassified amounts from accumulated comprehensive income into earnings in the past twelve months, and it does not expect to reclassify any amounts in the next twelve months.
The transition adjustment for the adoption of SFAS 133 resulted in a decrease to other comprehensive income of $36.9 million ($24.0 million after tax) representing the accumulation in other comprehensive income of the effective portion of the Company's cash flow hedges as of January 1, 2001. In 2001, $8.9 million ($5.8 million after tax) of loss representing the effective portion of the change in fair value of derivative instruments designated as cash flow hedges decreased accumulated other comprehensive income resulting in an ending balance of $(45.8) million ($(29.7) million after tax) at December 31, 2001.
Occasionally, the Company 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, the Company may sell an investment-type contract with attributes tied to market indices in which case the Company writes an equity call option to convert the overall contract into a fixed rate liability, essentially eliminating the equity component altogether.
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 similar assets and liabilities held by the Company. 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 its 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, 2001, cumulative actual earnings, including consideration of net unrealized gains, has been less than cumulative expected earnings. Therefore, no policyholder dividend obligation has been recognized.
Closed Block liabilities and assets designated to the Closed Block are as follows:
Assets designated to the Closed Block Fixed maturities, available-for-sale.............. 2,466.3 2,182.2 Equity securities, available-for-sale............. 23.4 - Mortgage loans.................................... 880.0 919.4 Real estate....................................... - 0.2 Policy loans...................................... 792.5 770.0 Other investments................................. 6.9 1.1 -------- -------- Total investments............................... 4,169.1 3,872.9
Cash and cash equivalents (deficit)............... (8.0) 22.7 Accrued investment income......................... 77.2 72.3 Deferred tax asset................................ 80.8 97.8 Premiums due and other receivables................ 33.3 33.8 -------- -------- Total assets designated to the Closed Block..... 4,352.4 4,099.5 -------- --------
Amounts included in other comprehensive income.......................................... 43.6 27.2 -------- -------- Maximum future earnings to be recognized from Closed Block assets and liabilities............. $1,348.6 $1,408.8 ======== ========
For the year ended December 31, 2001 2000 1999 ---------- ---------- ---------- (in millions) Revenues Premiums and other considerations....... $ 742.1 $ 752.4 $ 764.4 Net investment income................... 311.8 289.9 269.2 Net realized capital losses............. (19.7) (4.9) (2.0) ---------- ---------- ---------- Total revenues........................ 1,034.2 1,037.4 1,031.6
Closed Block revenue, net of Closed Block expenses, before income taxes.. 101.3 114.9 107.9 Income taxes............................ 33.5 38.4 37.0 ---------- ---------- ---------- Closed Block revenue, net of Closed Block expenses and income taxes....... 67.8 76.5 70.9 Funding adjustment charges.............. (7.6) (12.0) (12.2) ---------- ---------- ---------- Closed Block revenue, net of Closed Block expenses, income tax and funding adjustment charges............ $ 60.2 $ 64.5 $ 58.7 ========== ========== ==========
Beginning of year.................. $1,408.8 $1,473.3 End of year........................ 1,348.6 1,408.8 ---------- ---------- Change in maximum future earnings.. $ (60.2) $ (64.5) ========== ==========
Balance at beginning of year.......... $1,333.3 $1,430.9 $1,104.7 Cost deferred during the year......... 261.7 263.9 253.9 Amortized to expense during the year.. (159.9) (238.6) (173.8) Effect of unrealized (gains) losses... (62.6) (122.9) 246.1 ---------- ---------- ---------- Balance at end of year................ $1,372.5 $1,333.3 $1,430.9 ========== ========== ==========
Surrenderable: Book value out without surrender charge........ 22.9 Book value out with surrender charge........... 396.3 ----------------- Total surrenderable.............................. 419.2 ----------------- Total book value out............................. 474.3
existence of certain circumstances which are largely within the Company's control. As of December 31, 2001, the contractual maturities were 2002 - $160.2 million; 2003 - $496.1 million; 2004 - $470.2 million; 2005 - $714.5 million; 2006 - $98.9 million; and thereafter - $1,358.5 million.
In February 2001, the Company 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. The unaffiliated entity is not consolidated in the Company's financial statements. The funding agreements issued to the unaffiliated entity are reported as contractholder funds liabilities in the Company's consolidated statement of financial position. As of December 31, 2001, $723.9 million has been issued under this program.
Incurred: Current year................... 1,597.1 1,788.1 1,872.2 Prior years.................... (17.5) (17.8) (6.2) ----------- ----------- ----------- Total incurred................... 1,579.6 1,770.3 1,866.0
Payments: Current year................... 1,283.2 1,447.3 1,466.3 Prior years.................... 286.6 339.7 319.4 ----------- ----------- ----------- Total payments................... 1,569.8 1,787.0 1,785.7
Balance at end of year: Current year................... 313.9 340.8 405.9 Prior years.................... 400.9 364.2 315.8 ----------- ----------- ----------- Total balance at end of year..... $ 714.8 $ 705.0 $ 721.7 =========== =========== ===========
The activity summary in the liability for unpaid accident and health claims shows a decrease of $17.5 million, $17.8 million and $6.2 million to the December 31, 2000, 1999 and 1998 liability for unpaid accident and health claims, respectively, arising in prior years. Such liability adjustments, which affected current operations during 2001, 2000 and 1999, 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.
The components of long-term debt as of December 31, 2001 and December 31, 2000 are as follows (in millions):
At December 31, 2001, future annual maturities of the long-term debt are as follows (in millions):
Cash paid for interest for 2001, 2000 and 1999, was $98.1 million, $116.8 million and $127.7 million, respectively. These amounts include interest paid on taxes during these years.
The Company's 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 pre-tax income and the Company's effective tax rate on pre-tax 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 is as follows:
Significant components of the Company's net deferred income taxes are as follows (in millions):
December 31, 2001 2000 -------- -------- Deferred income tax assets (liabilities): Insurance liabilities................................... $ 132.2 $ 181.1 Deferred policy acquisition costs....................... (390.7) (360.1) Net unrealized gains on available for sale securities... (218.9) (59.1) Mortgage loan servicing rights.......................... (355.2) (206.3) Other................................................... (13.6) (6.6) -------- -------- Total deferred income tax liabilities..................... $(846.2) $(451.0) ======== ========
Undistributed earnings of certain foreign subsidiaries are considered indefinitely reinvested by the Company. A tax liability will be recognized when the Company expects distribution of earnings in the form of dividends, sale of the investment or otherwise.
As a result of the Company's demutualization, the qualified defined benefit pension plan received $56.7 million in compensation which will 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, is as follows (dollars in millions):
For 2001 and 2000, the expected long-term rates of return on plan assets for other post-retirement benefits varied by benefit type and employee group and ranged from 7.8% to 9.3% and 8.0% to 8.1%, respectively, on a pre-tax basis.
In addition, the Company has 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. The Company matches the participant's contribution at a 50% contribution rate up to a maximum Company contribution of 3% of the participant's compensation in 2001 and 2000, and 2% of the participant's compensation in 1999. The defined contribution plan allows employees to choose among various investment options, including the Company's common stock. The Company contributed $17.9 million in 2001, $16.0 million in 2000 and $11.0 million in 1999 to these defined contribution plans.
As a result of the Company's demutualization, the defined contribution plans received $19.7 million in compensation, which was allocated to participant accounts.
At December 31, 2001, future minimum annual rental commitments under these noncancelable operating leases are as follows (in millions):
Held for Total rental Held for sale investment commitments ------------- ---------- ------------ 2002................................. $ 51.9 $ 72.3 $124.2 2003................................. 49.5 60.0 109.5 2004................................. 46.5 49.0 95.5 2005................................. 40.3 38.5 78.8 2006................................. 36.7 25.7 62.4 Thereafter........................... 202.3 57.7 260.0 ------------- ---------- ------------ Total future minimum lease receipts.. $427.2 $303.2 $730.4 ============= ========== ============
2002.............................................................. $ 60.3 2003.............................................................. 48.5 2004.............................................................. 35.1 2005.............................................................. 23.6 2006.............................................................. 20.9 Thereafter........................................................ 28.2 ------ 216.6
The Company is a plaintiff or defendant in actions arising out of its operations. The Company is, 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 the Company's business, financial condition or results of operations. However, no assurances can be given that such litigation would not materially and adversely affect the Company's business, financial condition or results of operations.
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 is currently a defendant in two class-action lawsuits which allege improper sales practices.
In 2000, the Company reached an agreement in principle to settle these two class-action lawsuits alleging improper sales practices. In April 2001, the proposed settlement of the class-action lawsuits received court approval. In agreeing to the settlement, the Company specifically denied any wrongdoing. The Company has accrued a loss reserve for its best estimate based on information available. As uncertainties continue to exist in resolving this matter, it is reasonably possible that, as the actual cost of the claims subject to alternative dispute resolution becomes available, the final cost of settlement could exceed the Company's estimate. The range of any additional cost related to the settlement cannot be presently estimated; however, the Company believes the settlement will not have a material impact on its business, financial condition or results of operations. 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. The Company has been notified that some of those who opted out from the class will file lawsuits and make claims similar to those addressed by the settlement. Some of these lawsuits are presently on file.
The Company held $759.9 million in mortgage-backed securities in trust at December 31, 2001, to satisfy collateral requirements associated with the Company's mortgage banking segment and derivatives credit support agreements.
As a result of the demutualization and initial public offering described in Note 1, the Company has one class of capital stock, common stock ($.01 par value, 2,500 million shares authorized).
As a result of the demutualization, 363.7 thousand shares with a value of $6.7 million were issued to rabbi trusts held by the Company 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.
The components of accumulated other comprehensive income are as follows (in millions):
In 1999, Principal Life notified the Commissioner in advance of all stockholder dividend payments and received approval for an extraordinary stockholder dividend of $250.0 million. Total stockholder dividends paid to its parent company in 1999 were $509.0 million.
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 Inter-Bank Offer Rates.
The fair values of the Company's reserves and liabilities for investment-type insurance contracts (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) 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). The fair values for the Company's insurance contracts (insurance, annuity and other policy contracts that do involve significant mortality or morbidity risk), other than investment-type contracts, are not required to be disclosed. The Company does 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 the Company's incremental borrowing rate for similar borrowing arrangements.
Principal Life, the largest subsidiary (indirect) 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"). Currently "prescribed" statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC") as well as state laws, regulations and general administrative rules. "Permitted" statutory accounting practices encompass all accounting practices not so prescribed. The impact of any permitted accounting practices on statutory surplus is not material. The accounting practices used to prepare statutory financial statements for regulatory filings differ in certain instances from U.S. GAAP. Prescribed or permitted statutory accounting practices are used by state insurance departments to regulate Principal Life.
The net impact of these changes to Principal Life's statutory-basis capital and surplus as of January 1, 2001, was not significant.
Statutory net income.... $ 415.0 $ 912.6 $ 713.7 Statutory surplus....... 3,483.8 3,356.4 3,151.9
The Company provides financial products and services through the following segments: U.S. Asset Management and Accumulation, International Asset Management and Accumulation, Life and Health Insurance and Mortgage Banking. In addition, there is a Corporate and Other segment. The segments are managed and reported separately because they provide different products and services, have different strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and related financial products and services primarily to businesses, their employees and other individuals and provides asset management services to the Company's asset accumulation business, the life and health insurance operations and third-party clients.
The 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 financing activities for the Company, income on capital not allocated to other segments, intersegment eliminations and non-recurring or other income or expenses not allocated to the segments based on review of the nature of such items.
The Company evaluates segment performance on segment operating earnings, which excludes the effect of net realized capital gains and losses, as adjusted, and non-recurring events and transactions. Net realized capital gains, as adjusted, are net of tax, related changes in the amortization pattern of deferred policy acquisition costs, recognition of front-end fee revenues for sales charges on
pension products and services, net realized capital gains credited to customers and certain market value adjustments to fee revenues. Segment operating revenues exclude net realized capital gains and their impact on recognition of front-end fee revenues. Segment operating earnings is determined by adjusting U.S. GAAP net income for net realized capital gains and losses, as adjusted, and non-recurring items which management believes are not indicative of overall operating trends. While these items may be significant components in understanding and assessing the consolidated financial performance, management believes the presentation of segment operating earnings enhances the understanding of the Company's results of operations by highlighting earnings attributable to the normal, recurring operations of the business. However, segment operating earnings are not a substitute for net income determined in accordance with U.S. GAAP.
The accounting policies of the segments are similar to those as described in Note 1, with the exception of capital allocation. The Company allocates capital to its segments based upon an internal capital model that allows management to more effectively manage the Company's capital.
The following table summarizes selected financial information by segment as of, or for the year ended, December 31 and reconciles segment totals to those reported in the consolidated financial statements (in millions):
Long-lived assets include property and equipment and goodwill and other intangibles.
On May 21, 2001, the Company approved and adopted the Stock Incentive Plan, Board of Directors' Stock Plan ("Directors' Stock Plan") and Employee Stock Purchase Plan ("Stock Purchase Plan"). In addition, the Long Term Performance Plan was amended to utilize stock as an option for payment. The Plan of Conversion of Principal Mutual Holding Company for its demutualization restricts the ability to use stock as a form of payment for awards under the Long Term Performance Plan until at least six months following completion of the IPO.
The Directors' Stock Plan provides for the grant of nonqualified stock options, restricted stock, or restricted stock units to the Company's non-employee 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. Options vest quarterly over a one-year period unless services to the Company cease, at which time, all vesting stops. There were no options, shares of restricted stock, or restricted stock units granted under this plan in 2001.
The Company also maintains its 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. In 2001, the Company recorded compensation expense of $13.7 million related to the plan.
The maximum number of shares of common stock the Company may issue under the Stock Incentive Plan, together with an excess plan (a non-qualified 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, 2001, a total of 21,648,355 shares are available to be made issuable by the Company for these plans.
Under the Company's Stock Purchase Plan, participating employees have the opportunity to purchase shares of the Company's common stock on a quarterly basis. The Stock Purchase Plan provides that eligible employees may contribute 10% of the employee's salary or a maximum of $10,000 to the plan during any year. Employees may purchase shares of the Company's 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. During 2001, employees purchased 320,406 shares under the Stock Purchase Plan at a price of 85% of the share's fair market value of $22.33 per share.
The maximum number of shares of common stock that the Company 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, 2001, a total of 7,216,118 shares are available to be made issuable by the Company for this plan.
Had compensation expense for the Company's stock option awards and employees' purchase rights been determined based upon fair values at the grant dates for awards under the plans in accordance with SFAS No. 123, the Company's 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.
Pro forma for the Pro forma period October 26, 2001 (unaudited) for through the year ended December 31, 2001 December 31, 2001(1) ----------------------- ------------------------ (in millions, except per share data) Net income (loss): As reported............... $(29.1) $358.8 Pro forma (unaudited)..... (30.3) 357.5
Earnings per share: Basic: As reported............. $(0.08) $ 0.99 Pro forma (unaudited)... (0.08) 0.99
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.
Options outstanding at January 1, 2001 - $ - Granted.................................... 3,671,000 22.33 Exercised.................................. - - Cancelled.................................. 32,800 22.33 -------------- Options outstanding at December 31, 2001..... 3,638,200 22.33 ============== Options exercisable at December 31, 2001..... 1,000 22.33
After the Company's IPO, SFAS No. 128, Earnings per Share, was adopted, which requires disclosure of basic and diluted earnings per share.
- --------------------- (1) The dilutive effect of the stock options did not meet specified reporting thresholds.
The calculation of diluted earnings per share for the year ended December 31, 2001 and for the period October 26, 2001 through 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 the Company's stock during the period the contract has been outstanding, resulting in an anti-dilutive effect.
The following is a summary of unaudited quarterly results of operations for 2001 and 2000: