We own 26 properties in our home office complex in Des Moines, Iowa and in various other locations. We occupy approximately 94% of the 4.29 million gross square feet of space in these buildings. The balance of the space in these buildings is rented to commercial tenants. We lease office space for various offices located throughout the U.S. and internationally. We believe that our owned and leased properties are suitable and adequate for our current business operations.
- -------------------- (1) We have reclassified periods prior to December 31, 2001, to conform to the presentation for that period.
(2) Our consolidated financial information was affected by the following transactions that affect year-to-year comparability:
o 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, 1999, 1998 and 1997.
o On February 15, 2001, we disposed of all of the stock of Principal International Espana, S.A. de Seguros de Vida, our subsidiary in Spain, for nominal proceeds, resulting in a net realized capital loss of $38.4 million, or $21.0 million net of tax, ceasing our business operations in Spain. Total assets of our operations in Spain as of December 31, 2000, were $222.7 million. We included revenues of $49.4 million, $51.7 million and $46.0 million in our results of operations for the years ended December 31, 2000, 1999 and 1998, respectively. We included a net loss of $1.2 million and net income of $0.9 million and $2.8 million in our results of operations for the years ended December 31, 2000, 1999 and 1998, respectively. We did not include revenues or net income from our operations in Spain in our consolidated results of operations for the year ended December 31, 2001.
o On August 31, 1999, we acquired the outstanding stock of several companies affiliated with Bankers Trust Australia Group from Deutsche Bank AG at a purchase price of $1.4 billion. We issued unsecured long-term debt of $665.0 million to partially fund the acquisition. We report this debt and related interest expense in our Corporate and Other segment. The acquired companies now operate under the name BT Financial Group. We accounted for the acquisition using the purchase method. We included the results of operations of the acquired companies in our International Asset Management and Accumulation segment and 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 accounted for the purchase price as follows: $897.4 million of identifiable intangibles, consisting primarily of management rights for the fund management business and the BT brand
name, $38.5 million of workforce intangibles and $408.6 million of resulting goodwill, which are being amortized on a straight line basis over 40, 8 and 25 years, respectively.
o We acquired Compania de Seguros de Vida El Roble S.A., or El Roble, a Chilean life insurance company, for a purchase price of $73.4 million in July 1998. We included El Roble's financial results in our International Asset Management and Accumulation segment. We combined the operations of our existing Chilean life insurance affiliate with the operations of El Roble to form Principal International de Chile. Our consolidated financial results related to these companies' combined operations included: total revenues of $217.4 million, $200.2 million, $178.1 million and $155.2 million for the years ended December 31, 2001, 2000, 1999 and 1998, respectively; and net income of $15.0 million, $10.2 million, $0.5 million and $17.0 million for the years ended December 31, 2001, 2000, 1999 and 1998, respectively.
o 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"). Our net equity in the transferred managed care operations had a carrying value of $170.0 million on April 1, 1998. We sold our remaining managed care operations in 1998 for $20.5 million resulting in no realized capital gain or loss. Prior to the transfer to Coventry, our Corporate and Other segment included $266.7 million of managed care revenues in our results for 1998. 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. Our share of Coventry's net loss was $9.8 million for the year ended December 31, 1998. In September 2000, we sold a portion of our equity ownership position, which reduced our ownership interest to approximately 25% and resulted in a net realized capital gain of $13.9 million, net of tax. 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 and a warrant, exercisable for approximately 3.1 million shares of Coventry common stock. The transaction was completed on February 1, 2002. The investment in Coventry was $146.0 million and $122.9 million as of December 31, 2001 and 2000, respectively.
(6) As of December 31, 2001, represents: a) additional paid-in capital from the demutualization resulting from the reclassification of residual retained earnings of Principal Mutual Holding Company, net of common stock issued ($5,047.7 million); b) net proceeds, net of common stock issued, from the sale of 100.0 million shares of common stock in the IPO ($1,752.9 million); c) net proceeds, net of common stock issued, from the exercise of over- allotment options granted to underwriters in the IPO ($265.2 million); and d) common stock issued and held in a rabbi trust ($6.7 million).
million less cash ($1,177.5 million) and policy credits ($472.6 million) distributed as compensation as part of our demutualization and the reclassification of residual retained earnings of Principal Mutual Holding Company to additional paid-in capital of Principal Financial Group, Inc. ($5,050.3 million).
(8) During the fourth quarter of 2001, we purchased 15.3 million shares of our stock at a cost of $367.7 million. The board of directors approved the repurchase of these shares.
(13)Net realized capital gains (losses), 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. Deferred policy acquisition costs represent commissions and other selling expenses that vary with and are directly related to the production of business. These acquisition costs are deferred and amortized in conformity with U.S. GAAP.
Following is a reconciliation of net realized capital gains (losses) from the consolidated financial statements and the adjustment made to calculate segment operating earnings for the years indicated:
(14)For the year ended December 31, 2001, we excluded $31.1 million of non-recurring items, net of tax, from net income for the presentation of operating earnings. The non-recurring items 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 in our loss contingency reserve for sales practices litigation ($5.9 million) and (b) the positive effect of investment income generated by 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 operating earnings. The non-recurring items 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).
For the year ended December 31, 1998, we excluded $104.8 million of non-recurring items, net of tax, from net income for our presentation of operating earnings. The non-recurring items included: (a) the positive effects of (i) Principal Life's release of tax reserves and related accrued interest ($164.4 million) and (ii) accounting changes by our international operations ($13.3 million); and (b) the negative effects of (i) expenses and adjustments for changes in amortization assumptions for deferred policy acquisition costs related to our corporate structure change to a mutual insurance holding company ($27.4 million) and (ii) a contribution related to permanent endowment of the Principal Financial Group Foundation ($45.5 million).
(16)We define total return on average equity as net income divided by average total equity, excluding accumulated other comprehensive income. We have excluded accumulated other comprehensive income due to its volatility between periods and because such data is often excluded when evaluating the overall financial performance of insurers.
Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties including, but not limited to the following: (1) competition from companies that may have greater financial resources, broader arrays of products, higher ratings and stronger financial performance may impair our ability to retain existing customers, attract new customers and maintain our profitability; (2) a decline or increased volatility in the securities markets could result in investors withdrawing from the markets or decreasing their rates of investment, either of which could reduce our net income, revenues and assets under management; (3) a downgrade in Principal Life Insurance Company's ("Principal Life") financial strength ratings may increase policy surrenders and withdrawals, reduce new sales and terminate relationships with distributors; (4) our efforts to reduce the impact of interest rate changes on our profitability and surplus may not be effective; (5) if we are unable to attract and retain sales representatives and develop new distribution sources, sales of our products and services may be reduced; (6) our international businesses face political, legal, operational and other risks that could reduce our profitability in those businesses; (7) fluctuations in foreign currency exchange rates could reduce our profitability; (8) a decline in Australian equity values may reduce the profitability of BT Financial Group; (9) our reserves established for future policy benefits and claims may prove inadequate, requiring us to increase liabilities; (10) our investment portfolio is subject to several risks which may diminish the value of our invested assets and affect our sales, profitability and the investment returns credited to our customers; (11) our ability to pay dividends and meet our obligations may be constrained by the limitations on dividends Iowa insurance laws impose on Principal Life; (12) we may need to fund deficiencies in our closed block ("Closed Block"); assets allocated to the Closed Block benefit only the holders of Closed Block policies; (13) changes in regulations or accounting standards may reduce our profitability; (14) a challenge to the Insurance Commissioner of the State of Iowa's approval of the plan of conversion could put the terms of our demutualization in question and reduce the market price of our common stock; (15) litigation and regulatory investigations may harm our financial strength and reduce our profitability; (16) sales of shares distributed in the demutualization may reduce the market price of our common stock; (17) applicable laws and our stockholder rights plan, certificate of incorporation and by-laws may discourage takeovers and business combinations that our stockholders might consider in their best interests; (18) a downgrade in our debt ratings may adversely affect our ability to secure funds; and (19) the impact of September 11, 2001, terrorist attacks and military and other actions may result in decreases in our net income, revenue and assets under management and may adversely affect our investment portfolio.
o U.S. Asset Management and Accumulation, which consists of our asset accumulation operations which provide products and services, including retirement savings and related investment products and services, and our
asset management operations conducted through Principal Capital Management, our U.S.-based asset manager. We provide a comprehensive portfolio of asset accumulation products and services to businesses and individuals in the U.S., with a concentration on small and medium-sized businesses, which we define as businesses with fewer than 1,000 employees. We offer to businesses products and services for defined contribution pension plans, including 401(k) and 403(b) plans, defined benefit pension plans and non-qualified executive benefit plans. We also offer annuities, mutual funds and bank products and services to the employees of our business customers and other individuals.
o International Asset Management and Accumulation, which consists of BT Financial Group, our Australia-based asset manager, and Principal International. Our acquisition of BT Financial Group in 1999 was a central element in the expansion of our international asset management and accumulation businesses. Through Principal International, we offer retirement products and services, annuities, mutual funds and life insurance through subsidiaries in Argentina, Chile, Mexico and Hong Kong and joint ventures in Brazil, Japan and India.
o ability to effectively hedge fluctuations in foreign currency to U.S. dollar exchange rates; and
December 31, 2001.......... $ 74.6 December 31, 2000.......... 71.0 December 31, 1999.......... 70.3
Principal Capital Management -------------------------------------------- Affiliated Third-party assets under assets under Total assets As of management management under management - -------------------------- ------------ ------------ ---------------- (in billions)
December 31, 2001......... $ 78.4 $ 7.3 $ 85.7 December 31, 2000......... 76.9 6.3 83.2 December 31, 1999......... 77.5 4.7 82.2
The governments of other countries have also instituted privatized pension systems requiring employees who join the labor force to contribute to a private pension system. With variations depending upon the specific country, we have targeted these markets for sales of retirement and related products and services, including defined contribution pension plans, annuities and mutual funds to individuals and businesses. In several of our international markets, we complement our sales of these products with sales of life insurance products.
We have pursued our international strategy through a combination of start-ups, acquisitions and joint ventures, which require infusions of capital consistent with our strategy of long-term growth and profitability.
- -------------------- (1) Includes separate account liabilities for policies with variable investment options.
- ---------- (1) Effective January 1, 2000, we ceased new sales of our Medicare supplement insurance and effective July 1, 2000, reinsured all existing Medicare supplement business.
We manage growth in the mortgage loan servicing portfolio, through retention of mortgage loan production and the sale and acquisition of mortgage loan servicing rights. Our servicing portfolio grew at a compound annual rate of 25% from December 31, 1999 through December 31, 2001, reflecting our increased retention of servicing rights of loans produced and acquisition of servicing rights. Growth in the mortgage loan servicing portfolio was slower in 2000, as a result of a decrease in mortgage loan production and an increase in sales of mortgage loan servicing rights. During 2001, the mortgage loan servicing portfolio grew as a result of an increase in mortgage loan production.
Our residential mortgage loan production and the unpaid principal balances in our residential mortgage loan servicing portfolio as of or for the years ended December 31, 2001, 2000 and 1999 were as follows:
BT Financial Group. On August 31, 1999, we acquired the outstanding stock of several companies affiliated with Bankers Trust Australia Group from Deutsche Bank AG at a purchase price of $1.4 billion. We issued unsecured long-term debt of $665.0 million to partially fund the acquisition. We report this debt and
We accounted for the purchase price as follows: $897.4 million of identifiable intangibles; consisting primarily of management rights for the fund management business and the BT brand name; $38.5 million of workforce intangibles and $408.6 million of resulting goodwill. We are amortizing these intangible assets on a straight-line basis over 40, 8 and 25 years, respectively. We report the goodwill and other intangibles, including the related amortization, in our International Asset Management and Accumulation segment.
The accounting for business combinations, goodwill and other intangible assets changed effective January 1, 2002. The accounting change includes the adoption of a non-amortization, impairment-only model for our goodwill and indefinite-lived intangible assets and a more stringent impairment test methodology (fair value based on discounted cash flows) for measuring and recognizing impairment losses. See "Critical Accounting Policies - Accounting for Business Combinations" for a discussion of our planned adoption of the new accounting statements.
Principal International Espana, S.A. de Seguros de Vida. On February 15, 2001, we disposed of all of the stock of Principal International Espana, S.A. de Seguros de Vida, our subsidiary in Spain, for nominal proceeds, resulting in a realized capital loss of $38.4 million, or $21.0 million net of tax, ceasing our business operations in Spain. Total assets of our operations in Spain as of December 31, 2000, were $222.7 million.
We included revenues of $49.4 million and $51.7 million from our operations in Spain in our consolidated results of operations for the years ended December 31, 2000 and 1999, respectively. Our operations in Spain contributed net loss of $1.2 million and net income of $0.9 million for the years ended December 31, 2000 and 1999, respectively. We did not include revenues or net income from our operations in Spain in our consolidated results of operations for the year ended December 31, 2001.
Effective July 1, 2000, we entered into a reinsurance agreement with General & Cologne Life Re of America to reinsure 100% of our Medicare supplement insurance business. Medicare supplement insurance premiums were $98.4 million and $164.6 million for the years ended December 31, 2000 and 1999, respectively.
In January 2002, the Argentine government ended its tie of the Argentine peso to the U.S. dollar, creating a dual currency system with an official fixed exchange rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and a "free" floating exchange rate for other transactions, subsequently floating the Argentine peso in February. The devaluation is not expected to materially impact our consolidated results of operations.
In addition, on October 26, 2001, we completed our initial public offering ("IPO") in which we issued 100.0 million shares of common stock at a price of $18.50 per share. Net proceeds from the IPO were $1,753.9 million, of which $64.2 million was retained by Principal Financial Group, Inc., and $1,689.7 million was contributed to Principal Life. Proceeds were net of offering costs of $96.5 million and a related tax benefit of $0.4 million.
Some of the assets in our investment portfolio may be adversely affected by the volatility in the securities markets and economic activity caused by the September 11, 2001 terrorist attacks and heightened security measures. In particular, this may lead to possible write-downs, loss of value or impairments with regard to securities issued by companies affected by these events. On December 31, 2001, we held corporate fixed maturity securities in the following sectors impacted most significantly by the September 11, 2001, terrorist attacks (carrying amounts noted in parenthesis): airlines ($245.9 million in public debt and $208.3 million in private debt), comprised mostly of equipment trust certificate transactions secured by aircraft; airline manufacturers and equipment providers ($239.0 million), comprised of public and private unsecured debt; property and casualty insurance companies ($28.9 million), comprised of public unsecured debt; and hotels and gaming companies ($168.9 million), comprised of public and private debt secured by hotel properties. As of December 31, 2001, we have not recognized any related other than temporary impairment of these assets.
Our 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. The carrying amounts of goodwill and other intangibles are
We must exercise certain judgments and make estimates in the application of our policy for business combinations. We have some discretion in determining the fair value of assets acquired and liabilities assumed, lives assigned to acquired intangibles, the resulting amortization period, what indicators will trigger an impairment, whether those indicators are other than temporary, what economic or competitive factors affect valuation, valuation methodology, and key assumptions including discount rates and cash flow estimates.
Valuation Policies. In accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, we are required to classify our investments into one of three categories: held-to-maturity, available-for-sale or trading. We determine the appropriate classification of fixed maturity securities at the time of purchase. Fixed maturity securities include bonds, mortgage-backed securities, and redeemable preferred stock. We classify our fixed maturity securities as either available-for-sale or trading and, accordingly, carry them at fair value. Unrealized gains and losses related to available-for-sale securities are reflected in stockholders' equity net of related deferred policy acquisition costs and applicable taxes. Unrealized gains and losses related to trading securities are reflected in net realized capital gains and losses. The cost of fixed maturity securities is adjusted for amortization of premiums and accrual of discounts, both computed using the interest method. The cost of fixed maturity securities is adjusted for declines in value that are other than temporary. Impairments in value deemed to be other than temporary are reported as a component of net realized capital gains and losses. For loan-backed and structured securities, we recognize income using a constant effective yield based on currently anticipated prepayments as determined by broker-dealer surveys or internal estimates and the estimated lives of the securities.
Commercial and residential mortgage loans are generally reported at cost adjusted for amortization of premiums and accrual of discounts, computed using the interest method, and net of valuation allowances. Any changes in the valuation allowances are reported as net realized capital gains and losses. We measure impairment based upon the present value of expected cash flows discounted at the loan's effective interest rate or the loan's observable market price. If foreclosure is probable, the measurement of any valuation allowance is based upon the fair value of the collateral. Residential mortgage loans held for sale and commercial mortgage loans held for sale are carried at lower of cost or fair value, less cost to sell, and reported as mortgage loans in the statements of financial position.
We also sell residential mortgage loans and retain servicing rights which are retained interests in the sold loans. Gain or loss on the sales of the loans 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 we estimate fair value based on the present value of the future expected cash flows using our best estimates of the key assumptions - prepayment speeds and option adjusted spreads commensurate with the risks involved.
Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to contractual terms of the loan agreement. When we determine that a loan is impaired, a provision for loss is established for the difference between the carrying amount of the mortgage loan and the estimated value. Estimated value is based on either the present value of the expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or fair value of the collateral. The provision for losses is reported as a net realized 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 us to absorb estimated probable credit losses. Our periodic evaluation of the adequacy of the allowance for losses is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. The evaluation is inherently subjective as it requires estimating the amounts and timing of future cash flows expected to be received on impaired loans that may change.
The assessment of the other than temporary losses and write-downs of invested assets (private bonds, mortgages, and real estate) also involves significant judgment. Both the recognition of a triggering event (timing) and the market value of private assets involves subjective assessments by us. In addition, the determination of the calculation and the adequacy of the mortgage loan reserve are also subjective. Our assessment of the adequacy of this reserve is based on our past experience, known and inherent risks in the portfolio, adverse situations that may affect a borrower's ability to repay, the estimated value of the underlying security, composition of the portfolio, and current economic conditions.
Deferred policy acquisition costs. Commissions and other costs (underwriting, issuance and agency expenses and first-year bonus interest) that vary with and are primarily related to the acquisition of new and renewal insurance policies and investment contract business are capitalized to the extent recoverable. Maintenance costs and acquisition costs that are not deferrable are charged to operations as incurred.
Deferred policy acquisition costs for universal life-type insurance contracts and participating life insurance policies and investment contracts are being amortized over the lives of the policies and contracts in relation to the emergence of estimated gross profit margins. This amortization is adjusted retrospectively when estimates of current or future gross profits and margins to be realized from a group of products and contracts are revised. The deferred policy acquisition costs of non-participating term life insurance policies are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policyholder liabilities.
The deferred policy acquisition cost asset is amortized in relation to the gross profits of the underlying policies, over the expected lifetime of these policies. At issue, the pattern of expected gross profits is established based on our expectation of future profit margins. These profit margins contain assumptions relating to mortality, morbidity, investment yield and expenses. As actual experience emerges, the profit margins may vary from those expected either in magnitude or timing. For our universal life and investment contracts, we are required by accounting practice to reflect the actual gross profits of the underlying policies. In addition, we are required to revise our assumptions regarding future experience as soon as the current assumptions become no longer actuarially credible. Both actions, reflecting actual experience and changing future estimates, can cause changes in the amount of the asset and the pattern of future amortization.
Mortgage loan servicing rights represent the cost of purchasing or originating the right to receive cash flows from servicing mortgage loans. These costs are capitalized and amortized to operations over the estimated remaining life of the underlying loans using the interest method and taking into account appropriate prepayment assumptions. Capitalized mortgage loan servicing rights are periodically assessed for impairment, which is recognized in the consolidated statements of operations during the period in which impairment occurs by establishing a corresponding valuation allowance. For purposes of performing impairment evaluation, we stratify the servicing portfolio on the basis of specified predominant risk characteristics, including loan type and note rate. A valuation model is used to determine the fair value of each stratum. Cash flows are calculated using an internal prepayment model and discounted at a spread to London Inter-Bank Offer Rates ("LIBOR"). External valuations are obtained for comparison purposes.
We develop prepayment models internally by examining the historical prepayment experience of our portfolio, given the historical interest rate environment. Servicing cost assumptions are derived from budgeted costs, interest differential, and foreclosure losses based on historical evidence, and amortization based on expected non-discounted cash flows. Servicing revenue assumptions are derived from historical experience and include principal and interest float, escrow float, prepayment float, late charges collected, and ancillary income.
Rating Agency Financial Strength Rating Rating Structure - ------------- ------------------------- ----------------
A.M. Best Company, Inc. A+ ("Superior") with a stable Second highest of outlook 16 rating levels
Moody's Investors Service Aa2 ("Excellent") with a stable Third highest of outlook 21 rating levels
Standard & Poor's Rating AA ("Very Strong") with a Third highest of Services negative outlook 21 rating levels
On February 11, 2002, Fitch Ratings announced that Principal Life Insurance Company's financial strength rating had been lowered from "AA+" to "AA". The "AA" rating is considered to be "Very Strong". The outlook for the rating is "Stable".
On February 26, 2002, the company's board of directors authorized the repurchase of up to $450.0 million of the company's common stock. The repurchases will be made in the open market or through privately negotiated transactions from time to time, depending upon market conditions. Also on that date, Principal Life declared an ordinary dividend of $390.0 million payable to its parent on or about April 5, 2002.
result of declining assets under management for the year ended December 31, 2001, and the weakening of the Australian dollar versus the U.S. dollar.
As a result of the foregoing factors and the inclusion of the cumulative effect of accounting change, net of related income taxes, net income decreased $261.4 million, or 42%, to $358.8 million for the year ended December 31, 2001, from $620.2 million for the year ended December 31, 2000. The cumulative effect of accounting change was related to our implementation of SFAS 133.
As a result of the foregoing factors and the exclusion of net realized capital gains (losses), as adjusted and nonrecurring items, operating earnings increased $82.8 million, or 13%, to $710.9 million for the year ended December 31, 2001, from $628.1 million for the year ended December 31, 2000. The increase resulted from a $76.7 million increase from the Mortgage Banking segment, primarily due to an increase in mortgage loan production volume. The increase was also due to a $38.9 million, or 24%, increase from the Life and Health Insurance segment, primarily a result of individual disability insurance reserve strengthening during 2000, and improved margins on individual life insurance business resulting from higher investment yields. The increases were partially offset by a $29.6 million, or 44%, decrease from the Corporate and Other segment, primarily due to a net recovery in 2000 of previously paid interest related to a successful tax audit appeal.
Fees and other revenues increased $289.0 million, or 22%, to $1,576.3 million for the year ended December 31, 2000, from $1,287.3 million for the year ended December 31, 1999. The increase was primarily due to a $199.6 million increase from the International Asset Management and Accumulation segment, primarily resulting from the inclusion of fees and other revenues contributed by BT Financial Group, which we acquired in August 1999. The increase was also due to a $90.3 million, or 15%, increase from the U.S. Asset Management and Accumulation segment, primarily attributable to an increase in administrative fee revenues, reflecting 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 related to surrender charges, which are fees charged to policyholders when they surrender an annuity for its cash value. Fee revenues also increased due to fees from pension customer-directed investment transfers, reflecting the higher interest rate environment and the resulting increased customer account activity. Fee revenues for U.S. pension products and services also increased, reflecting increased assets under management in 1999. The increase was also due to a $49.8 million, or 28%, increase from the Life and Health Insurance segment, primarily related to growth in our interest-sensitive life insurance block of business and increased fee revenues from our group fee-for-service business, primarily a result of an increase in members and fees. The increases were partially offset by a $31.2 million decrease from the Corporate and Other segment, which reflects a change in inter-segment
Net realized capital gains decreased $264.6 million, or 65%, to $139.9 million for the year ended December 31, 2000, from $404.5 million for the year ended December 31, 1999. The decrease was due in part to a decrease in sales of invested assets, primarily equity securities, in 2000. In 1999, we sold a significant portion of our equity securities portfolio to reduce exposure to common stock and to realize appreciation. We also recognized an increase in net realized capital losses in 2000, compared to 1999, in our fixed income securities portfolio, reflecting our investment philosophy 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. In 1999, we sold a portion of our investment in United Payors and United Providers, a publicly traded service organization that acts as an intermediary between health care payors and health care providers, realizing a capital gain of $27.6 million. In 2000, we sold our remaining investment and realized a capital gain of $90.6 million.
decrease from the Mortgage Banking segment, primarily a result of net gains we earned on hedges related to our servicing portfolio in 2000.
As a result of the foregoing factors, net income decreased $121.9 million, or 16%, to $620.2 million for the year ended December 31, 2000, from $742.1 million for the year ended December 31, 1999.
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).
Operating earnings increased $152.9 million, or 32%, to $628.1 million for the year ended December 31, 2000, from $475.2 million for the year ended December 31, 1999. The increase resulted from a $71.6 million, or 79%, increase from the Life and Health Insurance segment, primarily due to improved earnings from our group medical business. The increase was also due to a $58.2 million increase from the Corporate and Other segment, primarily due to improved investment yields and lower expenses due in part to a net recovery of interest expense related to a successful tax audit appeal. In addition, the increase was due to a $29.9 million, or 78%, increase from the International Asset Management and Accumulation segment due to growth in our international operations, due in part to BT Financial Group, which we acquired in August 1999. Operating earnings from the U.S. Asset Management and Accumulation segment did not change as increases in revenues were offset by increases in expenses. These increases were partially offset by a $6.8 million, or 12%, decrease from the Mortgage Banking segment, primarily due to a decrease in mortgage loan production earnings, reflecting a decrease in production volume.
We evaluate segment performance by segment operating earnings, which excludes the effect of net realized capital gains and losses, as adjusted, and non-recurring events and transactions. Segment operating earnings are determined by adjusting U.S. GAAP net income for net realized capital gains and losses, as adjusted, and non-recurring items that we believe are not indicative of overall operating trends. While these items may be significant components in understanding and assessing our consolidated financial performance, we believe the presentation of segment operating earnings enhances the understanding of our results of operations by highlighting earnings attributable to the normal, recurring operations of our businesses. However, segment operating earnings are not a substitute for net income determined in accordance with U.S. GAAP.
The following table presents segment information as of or for the years ended December 31, 2001, 2000 and 1999:
(3) Net realized capital gains (losses), 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 and certain market value adjustments to fee revenues.
(6) Includes inter-segment elimination amounts related to internally generated mortgage loans and an internal line of credit. The U.S. Asset Management and Accumulation segment and Life and Health Insurance segment reported mortgage loan assets issued for real estate joint ventures. These mortgage loans were reported as liabilities in the Corporate and Other segment. In addition, the Corporate and Other segment managed a revolving line of credit used by other segments.
The following table presents certain summary financial data relating to the U.S. Asset Management and Accumulation segment for the years indicated:
- -------------------- (1) Excludes net realized capital losses and their impact on recognition of front-end fee revenues and certain market value adjustments to fee revenues.
Benefits, claims and settlement expenses, including dividends to policyholders, increased $274.6 million, or 12%, to $2,589.8 million for the year ended December 31, 2001, from $2,315.2 million for the year ended December 31, 2000. An increase of $272.4 million in our pension full-service payout business reflected the increase in reserves resulting from an increase in sales of single premium group annuities with life contingencies. An additional $67.1 million increase from our pension investment-only business related to an increase in interest credited due to growth in our investment-only business. Partially offsetting the increases was a $74.6 million decrease in our pension full-service accumulation business reflecting a decrease in interest credited, primarily a result of a declining interest rate environment.
Operating expenses increased $33.0 million, or 4%, to $773.9 million for the year ended December 31, 2001, from $740.9 million for the year ended December 31, 2000. An increase of $36.8 million from Principal Bank resulted primarily from growth in bank operations. Additionally, an increase of $30.2 million from Principal Capital Management resulted primarily from an increase in compensation and recruiting costs due to growth in operations, an increase in depreciation expense of capitalized system implementation costs, and an increase in securitization expenses due to an increase in the number of securitization transactions closed in 2001. The increases were partially offset by an $18.8 million decrease from our pension business due to a decrease in the amortization of deferred policy acquisition costs from unlocking to reflect changes in assumptions for equity market performance. The pension expense decrease was partially offset by increases in expenses for sales and marketing initiatives; write-off of the remaining goodwill for Trustar, our pension administration only subsidiary; general growth in operations and amortization of software costs. The increase in segment operating expenses was also partially offset by a $7.6 million decrease from intra-segment eliminations. Also offsetting the increases was a $4.4 million decrease from our individual annuity business reflecting decreases in non-deferrable expenses and amortization of deferred policy acquisition costs. The amortization of deferred policy acquisition costs was lower in 2001 as the impact of unlocking the amortization for actual experience was less in 2001 than in 2000.
As a result of the foregoing factors, operating earnings decreased $2.8 million, or 1%, to $353.8 million for the year ended December 31, 2001, from $356.6 million for the year ended December 31, 2000.
Net realized capital losses, as adjusted, increased $128.8 million to $164.7 million for the year ended December 31, 2001, from $35.9 million for the year ended December 31, 2000. The increase includes realized capital losses of $62.3 million related to sales and impairments of our investment in Enron and related entities. These entities are in the process of bankruptcy proceedings. Other permanent impairments of certain fixed maturity securities were $92.1 million during the year ended December 31, 2001. The increase also reflects the current period impact of SFAS 133 for derivatives and fewer real estate sales in the year ended December 31, 2001, compared to the year ended December 31, 2000. The increases were partially offset by the positive effects of a change in the mortgage loan valuation allowance, primarily reflecting the decrease in the amount invested in commercial mortgage loans.
As a result of the foregoing factors, net income decreased to $320.7 million for the year ended December 31, 2000, from $321.2 million for the year ended December 31, 1999.
Premiums and other considerations increased $124.4 million, or 56%, to $344.9 million for the year ended December 31, 2001, from $220.5 million for the year ended December 31, 2000. An increase of $166.4 million in Mexico was the result of increased sales of single premium annuities with life contingencies, primarily resulting from the sale of a large group annuity contract. The increase was partially offset by the loss of $36.4 million of premiums and other considerations due to the February 2001 divestiture of our operations in Spain.
partially offset by a $16.6 million increase in Principal International fee revenues, primarily a result of an increase in the number of retirement plan participants in Mexico and deposits growth in Hong Kong resulting from sales to plans established under the new Mandatory Provident Fund that started in December 2000.
Benefits, claims and settlement expenses increased $145.3 million, or 55%, to $407.5 million for the year ended December 31, 2001, from $262.2 million for the year ended December 31, 2000. An increase in reserve changes and policy and contract benefit payments of $171.6 million in Mexico was primarily the result of the sale of a large group annuity contract with life contingencies. An increase of $15.1 million in Chile primarily related to an increase in reserve changes to reflect the impact of inflation adjustments. The increases were partially offset by the loss of $43.8 million of benefits, claims and settlement expenses resulting from the divestiture of our operations in Spain.
Operating expenses decreased $29.9 million, or 8%, to $342.4 million for the year ended December 31, 2001, from $372.3 million for the year ended December 31, 2000. Operating expenses incurred by BT Financial Group decreased $26.6 million, primarily resulting from the weakening of the Australian dollar versus the U.S. dollar. In addition, staff restructuring efforts undertaken to reduce ongoing operating expenses resulted in a 37% decrease of staff levels and a resulting decrease in salary and incentive costs. The decreases were partially offset by an increase in costs associated with the restructuring efforts and an increase in amortization of goodwill and other intangibles.
Income tax expense (benefits) decreased $11.7 million to a $7.0 million income tax benefit for the year ended December 31, 2001, from $4.7 million of income tax expense for the year ended December 31, 2000. A $16.7 million decrease was primarily due to a decrease in pre-tax operating earnings from BT Financial Group. The decrease was offset by a $5.0 million increase primarily due to an increase in pre-tax operating earnings from Principal International.
As a result of the foregoing factors, net loss increased $31.0 million to $38.1 million for the year ended December 31, 2001, from $7.1 million for the year ended December 31, 2000.
Premiums and other considerations increased $40.6 million, or 23%, to $220.5 million for the year ended December 31, 2000, from $179.9 million for the year ended December 31, 1999. Increases of $16.9 million in Mexico, $16.7 million in Argentina and $5.9 million in Chile were primarily a result of increased sales of single premium annuities with life contingencies. The increased sales in Mexico were primarily a result of sales by Principal Pensiones, S.A. de C.V., an annuity company we established in July 1999. The increased sales in Argentina primarily resulted from sales by an annuity company we established in August 1999.
Mexico, due to the implementation of a more attractive pricing structure for our customers, which also resulted in increased retention of existing accounts and an increased number of covered lives.
Income tax expense (benefits) increased $8.9 million to $4.7 million of income tax expense for the year ended December 31, 2000, from a $4.2 million income tax benefit for the year ended December 31, 1999. The increase was primarily due to $9.1 million of income tax expense related to an increase in pre-tax operating earnings from BT Financial Group.
Net realized capital gains, as adjusted, decreased $6.3 million, or 82%, to $1.4 million for the year ended December 31, 2000, from $7.7 million for the year ended December 31, 1999. The decrease was primarily due to a $4.7 million decrease in net realized capital gains in Principal International, resulting from repositioning of investment portfolios to better match long-term liabilities and assets for the year ended December 31, 1999. In addition, net realized capital gains, as adjusted, in 1999 included a $1.7 million gain on the sale of minority interest in a capital management company, which was sold following the acquisition of BT Financial Group.
As a result of the foregoing factors, net loss decreased $23.6 million, or 77%, to $7.1 million for the year ended December 31, 2000, from $30.7 million for the year ended December 31, 1999.
The following table presents certain summary financial data relating to the Life and Health Insurance segment for the years indicated:
Net realized capital gains (losses), as adjusted................................. (33.8) 47.3 10.1 Non-recurring items........................... 0.1 - - -------- -------- -------- U.S. GAAP Reported: Net income.................................... $ 167.5 $ 209.6 $ 100.8 ======== ======== ======== - -------------------- (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.
Net investment income increased $36.5 million, or 6%, to $678.6 million for the year ended December 31, 2001, from $642.1 million for the year ended December 31, 2000. The increase was primarily due to a $265.1 million, or 3%, increase in
average invested assets and cash for the segment. Net investment income also increased due to an increase in average investment yields for the segment. The yield on average invested assets and cash was 7.6% for the year ended December 31, 2001, compared to 7.4% for the year ended December 31, 2000.
Dividends to policyholders decreased $1.1 million to $307.0 million for the year ended December 31, 2001, from $308.1 million for the year ended December 31, 2000. The decrease was primarily a result of a change in methodology of estimating dividends. Additionally, the dividends in the Closed Block were reduced due to accumulated experience losses.
Income taxes increased $25.3 million, or 32%, to $104.5 million for the year ended December 31, 2001, from $79.2 million for the year ended December 31, 2000. The effective income tax rate for the segment was 34% for the year ended December 31, 2001, and 33% for the year ended December 31, 2000. The effective income tax rate for the year ended December 31, 2001, was lower than the corporate income tax rate of 35% primarily due to tax-exempt income. The effective income tax rate for the year ended December 31, 2000, was lower than the corporate income tax rate of 35%, primarily due to tax-exempt income and a reduction in a tax reserve as a result of a favorable IRS audit event.
Net realized capital gains (losses), as adjusted, decreased $81.1 million to $33.8 million of net realized capital losses for the year ended December 31, 2001, from $47.3 million of net realized capital gains for the year ended December 31, 2000. The decrease primarily related to the sale of our investment in United Payors and United Providers. In 2000, we sold our remaining investment and realized an after-tax capital gain of $58.9 million. To a lesser extent, the decrease was due to an increase in losses from permanent impairments of fixed maturity securities during 2001, including $16.6 million of net realized capital losses related to our investment in Enron and related entities.
As a result of the foregoing factors and the inclusion of non-recurring items for the year ended December 31, 2001, net income decreased $42.1 million, or 20%, to $167.5 million for the year ended December 31, 2001, from $209.6 million for the year ended December 31, 2000. Non-recurring items for the year ended December 31, 2001, had a positive impact on net income of $0.1 million, net of tax, due to the cumulative effect of accounting change, net of income taxes, related to our implementation of SFAS 133.
Premiums and other considerations increased $59.9 million, or 2%, to $3,250.5 million for the year ended December 31, 2000, from $3,190.6 million for the year ended December 31, 1999. Group dental insurance premiums increased $72.3 million, primarily resulting from increased sales of group dental insurance products. Group medical premiums increased $38.3 million, primarily related to an increase in the premium base due to increased sales in late 1999, and
significant group medical premium rate increases. Also contributing to the increase was a $9.6 million increase in individual disability insurance premiums due to continued growth in sales. Group disability insurance premiums increased $8.4 million due to an increase in long-term disability covered members and an increase in short-term disability premium per member. These increases were partially offset by a $66.2 million decrease in group Medicare supplement premium, resulting from our decision to cease new sales of group Medicare supplement insurance in January 2000 and our decision to reinsure 100% of this business effective July 1, 2000.
Net investment income increased $27.4 million, or 4%, to $642.1 million for the year ended December 31, 2000, from $614.7 million for the year ended December 31, 1999. The increase was primarily due to a $483.9 million, or 6%, increase in average invested assets and cash for the segment. The increase in net investment income due to asset growth was partially offset by a decrease in average investment yields for the segment. The yield on average invested assets and cash was 7.4% for the year ended December 31, 2000, compared to 7.5% for the year ended December 31, 1999, due to a decrease in interest credited on assets backing allocated capital. The decrease in interest credited was partially offset by higher interest rates on fixed income investments backing product liabilities.
Dividends to policyholders increased $12.5 million, or 4%, to $308.1 million for the year ended December 31, 2000, from $295.6 million for the year ended December 31, 1999. The increase was due to increased dividends on traditional individual life insurance products, a result of a maturing in-force block.
Income taxes increased $66.9 million to $79.2 million for the year ended December 31, 2000, from $12.3 million for the year ended December 31, 1999. The effective income tax rate for this segment was 33% for the year ended December 31, 2000 and 12% for the year ended December 31, 1999. The effective income tax rate for 2000 was lower than the corporate income tax rate of 35% due to tax-exempt income. The effective income tax rate for 1999 was lower than the corporate income tax rate of 35%, primarily resulting from overestimated deferred taxes related to health insurance reserves in 1998, the effects of which were reversed in 1999 and also due to tax-exempt income.
As a result of the foregoing factors, operating earnings increased $71.6 million, or 79%, to $162.3 million for the year ended December 31, 2000, from $90.7 million for the year ended December 31, 1999.
Net realized capital gains, as adjusted, increased $37.2 million to $47.3 million for the year ended December 31, 2000, from $10.1 million for the year ended December 31, 1999. The increase was primarily due to net realized capital gains, as adjusted, related to the sale of our investment in United Payors and United Providers. We sold a portion of our investment in 1999, realizing an after-tax capital gain of $17.9 million. In 2000, we sold our remaining investment and realized an after-tax capital gain of $58.9 million. The increase in capital gains was partially offset by a $2.3 million increase in net realized capital losses on sales of fixed income securities, as a result of our investment portfolio repositioning strategy to sell lower yielding fixed income securities to allow for reinvestment in higher yielding fixed income securities.
For the year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- (in millions)
Operating Earnings Data: Operating Revenues(1): Loan servicing......................... $ 403.0 $ 313.8 $ 286.5 Loan production........................ 354.4 46.0 111.8 ------- ------- ------- Total operating revenues............ 757.4 359.8 398.3
Expenses: Loan servicing......................... 407.3 215.3 241.3 Loan production........................ 145.0 67.4 69.5 ------- ------- ------- Total expenses...................... 552.3 282.7 310.8 ------- ------- ------- Pre-tax operating earnings............... 205.1 77.1 87.5 Income taxes............................. 78.4 27.1 30.7 ------- ------- ------- Operating earnings....................... 126.7 50.0 56.8
Net realized capital gains (losses), as adjusted.............................. - - - Non-recurring items...................... - - - ------- ------- ------- U.S. GAAP Reported: Net income............................... $ 126.7 $ 50.0 $ 56.8 ======= ======= ======= - -------------------- (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.
Total expenses increased $269.6 million, or 95%, to $552.3 million for the year ended December 31, 2001, from $282.7 million for the year ended December 31, 2000. A $192.0 million increase in mortgage loan servicing expenses was primarily a result of an impairment of capitalized mortgage loan servicing rights and, to a lesser extent, due to growth in the mortgage loan servicing portfolio. The impairment was partially offset by an increase in net gains on servicing hedge activity recognized in the year ended December 31, 2001, compared to the year ended December 31, 2000. Mortgage loan production expenses increased $77.6 million, reflecting the increase in mortgage loan production volume.
Income taxes increased $51.3 million to $78.4 million for the year ended December 31, 2001, from $27.1 million for the year ended December 31, 2000. The effective income tax rate for this segment was 38% for the year ended December 31, 2001, and 35% for the year ended December 31, 2000. The effective income tax rate for the year ended December 31, 2001, was higher that the corporate income tax rate of 35% due to the allocation of deferred state taxes, relating to both current and prior years, recorded in 2001. This allocation will increase the effective income tax rate for this segment to 37% for future reporting periods.
As a result of the foregoing factors, operating earnings and net income increased $76.7 million to $126.7 million for the year ended December 31, 2001, from $50.0 million for the year ended December 31, 2000.
Total expenses increased $28.9 million to $43.3 million for the year ended December 31, 2001, from $14.4 million for the year ended December 31, 2000. Interest expense increased $32.3 million, primarily due to a net recovery in 2000 of previously paid interest related to a successful tax audit appeal. An increase of $6.8 million related to the write-off of a non-invested asset. Interest expense on short-term borrowings increased $3.1 million. Inter-segment eliminations included in this segment resulted in a $1.7 million increase. The increases were partially offset by a $9.3 million decrease of interest expense as a result of extinguishment of commercial real estate debt on home office properties. In addition, interest expense on private debt securities and commercial paper issued in connection with the acquisition of BT Financial Group decreased $5.9 million, a result of the impact of the weakening of the Australian dollar versus the U.S. dollar and repayment of the commercial paper.
Income tax expense increased $4.4 million, or 29%, to $19.4 million for the year ended December 31, 2001, from $15.0 million for the year ended December 31, 2000. The effective income tax rates for this segment were 34% for the year ended December 31, 2001, and 18% for the year ended December 31, 2000. The effective income tax rate for 2001 was lower than the corporate income tax rate of 35% primarily due to tax-exempt income, which was partially offset by an increase in income tax reserves established for contested IRS tax audit matters. The effective income tax rate for 2000 was lower than the corporate income tax rate of 35% primarily due to tax-exempt income, and, to a lesser extent, due to a decrease in income tax reserves established for contested IRS tax audit matters.
capital losses for the year ended December 31, 2001, on sales of equity securities and real estate. The decrease included $10.5 million of net realized capital losses related to our investment in Enron and related entities.
As a result of the foregoing factors and the inclusion of non-recurring items, net loss increased $122.6 million to a net loss of $75.6 million for the year ended December 31, 2001, from $47.0 million of net income for the year ended December 31, 2000. For the year ended December 31, 2001, net income included the effect of non-recurring items totaling $20.4 million, net of tax, related to: (1) the negative effects of (a) expenses of our demutualization ($18.6 million) and (b) an increase in our loss contingency reserve for sales practices litigation ($5.9 million) and (2) the positive effect of investment income generated from the proceeds of our IPO ($4.1 million). For the year ended December 31, 2000, net income included the negative effect of non-recurring items totaling $101.0 million, net of tax, related to: (1) a loss contingency reserve established for sales practices litigation ($93.8 million) and (2) expenses of our demutualization ($7.2 million).
Total operating revenues increased $35.2 million, or 57%, to $97.1 million for the year ended December 31, 2000, from $61.9 million for the year ended December 31, 1999. Net investment income increased $71.0 million, as a result of improved investment yields for the segment. The increase was partially offset by an $11.5 million decrease in net investment income, reflecting a reduction in average invested assets, primarily due to the sale of invested assets in 1999 to partially fund the acquisition of BT Financial Group. The increase in total revenues was also partially offset by a $9.0 million decrease related to a change in inter-segment eliminations included in this segment, which was offset by a corresponding change in total expenses. In addition, the increase was also partially offset by an $8.5 million decrease in fees and other revenues, primarily related to the termination of a reinsurance and participation agreement under which we continued to receive fee revenues in 1999, but not in 2000. Net investment income also decreased $5.0 million related to our pro rata share of net loss of HealthExtras, Inc., a company in which we hold a minority interest.
Income tax expense (benefits) increased $16.7 million to $15.0 million of income tax expense for the year ended December 31, 2000, from a $1.7 million income tax benefit for the year ended December 31, 1999. The increase was primarily a result of an increase in pre-tax operating earnings, which included tax-exempt income. The effective income tax rate for this segment was lower than the corporate income tax rate of 35% for the years ended December 31, 2000 and 1999 because of tax-exempt income.
Another source of liquidity is issuance of our common stock. In 2001, net proceeds from our IPO totaled $1,753.9 million, of which we retained $64.2 million for working capital, payment of dividends, and other general corporate purposes. The remaining $1,689.7 million was contributed to Principal Life Insurance Company principally to fund demutualization compensation to policyholders in the form of policy credits and cash, and to cover certain expenses related to our demutualization. In addition, net proceeds from the issuance of additional shares for the exercise of the over-allotment options granted to the underwriters in the IPO, totaled $265.4 million, all of which we retained for repurchase of shares issued in the exercise of the over-allotment options. The repurchase of these shares was approved by the board of directors. Through December 31, 2001, we purchased the full amount of shares approved by the board.
In addition to the sources of cash flows previously mentioned, we have various sources of short-term funding, consisting primarily of commercial paper and outstanding balances on revolving credit facilities with various financial institutions. As of December 31, 2001, we have credit facilities with various financial institutions in an aggregate amount of $1.4 billion. Committed lines of credit totaling $600.0 million, of which there were no outstanding balances as of December 31, 2001, also support cash flow requirements. These lines of credit are available to provide backup of the commercial paper programs. In addition, we have $780.0 million in credit facilities to finance a commercial mortgage-backed securities pipeline ("CMBS") and $45.0 million of unused lines of credit for short-term debt used for general corporate purposes.
Our primary uses of liquidity could include payment of dividends on our common stock, interest payments and any other payments related to debt servicing, payment of benefits, claims and settlement expenses and dividends to policyholders, payment of general operating expenses, contributions to subsidiaries, acquisitions and the repurchase of our common stock. Any such repurchases would occur after due consideration and approval by our board of directors. On February 26, 2002, the company's board of directors authorized the repurchase of up to $450.0 million of the company's common stock. The repurchases will be made in the open market or through privately negotiated transactions from time to time, depending upon market conditions.
Our fundamental business approach is to avoid guarantees or other commitments to or on behalf of affiliated companies of Principal Financial Group, Inc. Affiliates are encouraged to operate as autonomously as possible; however, there are instances where a rated entity within Principal Financial Group, Inc. provides a guarantee to or on behalf of an affiliate. The guarantees typically supplement a partially secured transaction, but require the additional enhancement provided by the guarantee to make the transaction more economical for our organization.
Net cash provided by operating activities was $3,944.8 million and $2,637.3 million for the years ended December 31, 2001 and 2000, respectively. The increase in net cash provided was due, in part, to: (1) a decrease in cash paid for operating expenses due to improved expense management and a decrease in commissions, a result of our decision to reinsure 100% of our group Medicare supplement insurance business effective July 1, 2000; (2) a decrease in cash paid for income taxes due to the change in pre-tax operating earnings; and (3) a decrease in cash paid for benefits, claims, and settlement expenses. The following also contributed to the increase: (1) an increase in fees and other revenues, reflecting the increase in mortgage loan production volume; (2) an increase in net investment income due to an increase in average invested assets and cash as well as investment yields; and (3) an increase in premiums and other considerations received primarily due to an increase in premiums from single premium group annuities with life contingencies. Continuation of the low interest rate environment and poor performance in the equity markets, could reduce customer demand for pension, individual annuity, variable investment or mutual fund products, resulting in reduced cash flows from our subsidiaries' operations. However, should interest rates rise, we may experience a decrease in cash flows from residential mortgage loan production.
Net cash used in financing activities was $549.2 million and $1,006.9 million for the years ended December 31, 2001 and 2000, respectively. The decrease in net cash used in financing activities was primarily due to the receipt of net proceeds from issuance of common stock in conjunction with our IPO and exercise of the underwriters' over-allotment options, and, to a lesser extent, due to net proceeds received from short-term borrowings. Partially offsetting the decreases, were payments made to eligible policyholders as part of our demutualization, the repurchase of shares of our common stock as approved by our board of directors, and, to a lesser extent, the repayment of long-term debt in 2001 compared to the issuance of long-term debt in 2000.
Given the historical cash flow of our subsidiaries and the financial results of these subsidiaries, we believe the cash flow from our consolidated operating activities over the next year will provide sufficient liquidity for our operations, as well as satisfy interest payments and any payments related to debt servicing.
Our privately placed fixed maturity securities, commercial mortgage loans and real estate investments are generally less liquid than our publicly traded fixed maturity securities. As of December 31, 2001 and 2000, these asset classes represented approximately 49% and 57%, respectively, of the value of our consolidated invested assets.
Life insurance companies generally produce a positive cash flow from operations, as measured by the amount by which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing and acquiring new business. It is important to match the investment portfolio maturities to the cash flow demands of the type of annuity, investment or insurance product being provided. Principal Life continuously monitors benefits, surrenders and maturities to provide projections of future cash requirements. As part of this monitoring process, Principal Life performs cash flow testing of many of its assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing its investment strategy, Principal Life establishes a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage-backed securities and commercial mortgage loans, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations. There can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since withdrawal and surrender levels are influenced by such factors as the interest rate environment and the claims paying ability and financial strength ratings of Principal Life.
Principal Life takes into account asset-liability management considerations in the product development and design process. Contract terms of 96% and 97% of Principal Life's interest-sensitive products as of December 31, 2001 and 2000, respectively, include surrender and withdrawal provisions which mitigate the risk of losses due to early withdrawals. These provisions generally do one or more of the following: limit the amount of penalty-free withdrawals; limit the circumstances under which withdrawals are permitted; or assess a surrender charge or market value adjustment relating to the underlying assets. The market value adjustment feature in Principal Life's fixed annuity products adjusts the surrender value of a contract in the event of surrender prior to the end of the contract period to protect Principal Life against losses due to higher interest rates at the time of surrender.
The following table presents U.S. GAAP reserves for guaranteed investment contracts and funding agreements by withdrawal provisions as of December 31, 2001 and 2000:
As of December 31, ------------------------- 2001 2000 ----------- ----------- (in millions)
Surrenderable: Book value out without surrender charge..... 22.9 45.2 Book value out with surrender charge........ 396.3 128.0 ----------- ----------- Total surrenderable...................... 419.2 173.2 ----------- ----------- Total book value out................. 474.3 804.6
(2) Contracts currently in initial lock-out period but which will become puttable with 90 days' notice at some time in the future.
BT Financial Group required infusions of capital of $1.7 million, $59.3 million and $1.6 million for the years ended December 31, 2001, 2000 and 1999, respectively. The 2001 infusion was provided to further develop our operations in the UK, the 2000 infusion was to service acquisition related debt funding expenses, and the 1999 infusion represented initial capital amounts for Europe and Ireland. Primary sources of cash inflows for BT Financial Group are fee revenues and interest spread earned on margin lending operations. Cash outflows consist primarily of operating expenses.
Principal International is in a development or entry stage in several countries. Historically, principal cash flow sources for Principal International have been pension and annuity deposits, asset management fee revenues, administrative services fee revenues, insurance premiums, income from investments, proceeds from the sales or maturity of investments and short-term borrowings. Cash outflows consist primarily of payment of benefits to policyholders and beneficiaries, income and other taxes, current operating expenses, payments in connection with investments acquired, and payments relating to policy and contract surrenders, withdrawals, policy loans, interest expense and repayment of short-term borrowings.
Principal International's operating companies monitor benefits, surrenders and maturities to provide projections of future cash requirements. There can be no assurance that future experience regarding benefits and surrenders will be similar to historic experience since withdrawal and surrender levels are influenced by factors such as the interest rate environment and local economic conditions in each country.
(3) Non-recourse medium term notes represent claims for principal and interest under international funding agreements issued to non-qualified institutional investors. These international funding agreements are afforded equal priority to claims of life insurance and annuity policyholders under insolvency provisions of Iowa Insurance Laws and, accordingly, are reported as contractholder funds liabilities.
The components of short-term debt as of December 31, 2001 and 2000, are as follows:
Short-term debt consists primarily of commercial paper and outstanding balances on revolving credit facilities with various financial institutions. As of December 31, 2001, we had credit facilities with various financial institutions in an aggregate amount of $1.4 billion. We may borrow up to $600.0 million on a back-stop facility to support our $1.0 billion commercial paper program. In addition, as of December 31, 2001, we have $780.0 million in credit facilities to finance a CMBS pipeline and $45.0 million of unused lines of credit for short-term debt used for general corporate purposes.
We have entered into certain contracts to: 1) fund residential mortgage loan production, 2) sell qualifying delinquent residential mortgage loans, and 3) securitize margin loans. As appropriate under U.S. GAAP, the contracts involve special purpose entities ("SPEs") or trusts that are not reported on our consolidated statement of financial position.
held for sale by PRMCR must meet portfolio criteria, eligibility representations, and portfolio aging limitations. Based on these eligibility representations, we are required to repurchase ineligible loans from PRMCR.
We paid a commitment fee to PRMCR based on the overall warehouse limit. PRMCR used a portion of the fee to fund a cash collateral account maintained at PRMCR. These funds are available as additional collateral to cover credit related losses on defaulted loans. The balance in the account was $24.0 million at December 31, 2001. Any remaining amounts in the cash collateral account will be returned to us upon the termination of PRMCR. This right to the return of the cash collateral amount is reflected in other assets on our consolidated statements of financial position.
In order to hedge interest rate risk and non-credit related market value risk associated with its inventory of mortgage loans held for sale, PRMCR entered into swaps with counterparties not affiliated with us or PRMCR. The swap counterparties are required to maintain certain minimum ratings as approved by the rating agencies. Through separate swap agreements with the swap counterparties that mirror the original swaps with PRMCR, the interest rate risk and non-credit related market value components are swapped back to us.
Delinquent Residential Mortgage Loan Funding. In October 2000, our mortgage banking segment created a wholly-owned, unconsolidated qualifying special purpose entity, Principal Residential Mortgage Funding, LLC ("PRMF"), to provide an off-balance sheet source of funding for up to $250.0 million of qualifying delinquent mortgage loans. The limit was increased to $357.0 million in December 2001. We sell qualifying delinquent loans to PRMF which then transfers the loans to Principal Residential Mortgage EBO Trust ("Trust"), an unaffiliated Delaware business trust. The Trust funds its acquisitions of mortgage loans by selling participation certificates, representing an undivided interest in the Trust, to commercial paper conduit purchasers, who are not affiliated with us or any of our affiliates, directors or officers. At December 31, 2001, PRMF held $273.5 million in mortgage loans and had outstanding participation certificates of $256.9 million.
Mortgage loans typically remain in the Trust until they are processed through the foreclosure claim process, are paid-off or reinstate. Loans that reinstate are no longer eligible to remain in the Trust and are required to be removed by us at fair market value at the monthly settlement date following reinstatement.
We and the Trust are parties to a cost of funds hedge agreement. We pay the weighted average cost of funds on the participation certificates plus fees and expenses and receive the indicated swap bid rate, subject to a cap.
Margin Loan Securitizations. We sell loans under a margin loan securitization program and retain primary servicing responsibilities and subordinated interests. We receive servicing distributions approximating 0.3 percent of the outstanding balance and rights to future cash flows through an excess distribution from the trust, representing the balance remaining after all interest and fees of the trust have been accounted for. Our retained interests are subordinated to investors' interests. Retained interests equate to 7% of the outstanding loan balances, of which we earn a return of 2.0% over the Australian 30 day Bank Bill swap rate. The investors and the securitization trusts have no recourse to our other assets for failure of debtors to pay when due. The value of our retained interests is subject to market risk and all positions are primarily hedged. No gains or losses on the transaction have been realized to date.
The fair values of the retained interests, $37.8 million at December 31, 2001, are based upon our relative ownership percentage of the outstanding loan balances. At December 31, 2001, we utilized the present value of expected future cash flows as a valuation technique to assess the sensitivity of the fair values of retained interests. Key economic assumptions used in measuring the retained interests included interest margin, credit losses, terminations and discount rates, and the resulting changes to the fair values were not significant.
Proceeds from advances on margin loans previously securitized were $86.4 million and $16.1 million for the years ended December 31, 2001 and 2000, respectively.
o credit risk, relating to the uncertainty associated with the continued ability of a given obligor to make timely payments of principal and interest;
Our Fixed Income Securities Committee, consisting of fixed income securities senior management members, approves the credit rating for the fixed maturity securities we purchase. Teams of security analysts organized by industry focus either on the public or private markets and analyze and monitor these investments. In addition, we have teams who specialize in residential mortgage-backed securities, commercial mortgage-backed securities and public below investment grade securities. We establish a credit reviewed list of approved public issuers to provide an efficient way for our portfolio managers to purchase liquid bonds for which credit review has already been completed. Issuers remain on the list for six months unless removed by our analyst. Our analysts monitor issuers on the list on a continuous basis with a formal review
The qualitative analysis includes an assessment of both accounting and management aggressiveness. In addition, technical indicators such as stock price volatility and credit default swap levels are monitored.
Our Fixed Income Securities Committee also reviews private transactions on a continuous basis to assess the quality ratings of our privately placed investments. We regularly review our investments to determine whether we should re-rate them, employing the following criteria:
o debt service coverage or cash flow ratios that fall below industry-specific thresholds;
We have limited exposure to equity risk in our common stock portfolio. Equity securities accounted for only 2% of our U.S. invested assets as of December 31, 2001.
The yield on U.S. invested assets and on cash and cash equivalents, excluding net realized gains and losses, was 7.6%, 7.5% and 7.4% for the years ended December 31, 2001, 2000 and 1999, respectively.
- -------------------- (1) Yields are based on annual average asset carrying values for the years ended December 31, 2001, 2000, and 1999.
We have classified the majority of our fixed maturity securities as available-for-sale. Accordingly, we mark such securities to market, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income, net of deferred income taxes and an adjustment for the effect on deferred policy acquisition costs that would have occurred had such gains and losses been realized. We write down to fair value securities whose value is deemed other than temporarily impaired. We record writedowns as realized losses included in earnings and adjust the cost basis of such securities to fair value. The new cost basis is not changed for subsequent recoveries in value.
Fixed maturity securities consist of short-term investments, publicly traded debt securities, privately placed debt securities and small amounts of redeemable preferred stock, and represented 67% of total U.S. invested assets as of December 31, 2001, and 63% as of December 31, 2000. The fixed maturity securities portfolio was comprised, based on carrying amount, of 63% in publicly traded fixed maturity securities and 37% in privately placed fixed maturity securities as of December 31, 2001, and 55% in publicly traded fixed maturity securities and 45% in privately placed fixed maturity securities as of December 31, 2000. Included in the privately placed category as of December 31, 2001, were $3.5 billion of securities eligible for resale to qualified institutional buyers under Rule 144A under the Securities Act of 1933. Fixed maturity securities were diversified by category of issuer as of December 31, 2001, and December 31, 2000, as shown in the following table:
The Securities Valuation Office of the NAIC evaluates most of the fixed maturity securities that we and other U.S. insurance companies hold. The Securities Valuation Office evaluates the bond investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories. The NAIC Designations closely mirror the nationally recognized securities rating organizations' credit ratings for marketable bonds. NAIC Designations 1 and 2 include bonds considered investment grade by such rating organizations. Bonds are considered investment grade when rated "Baa3" or higher by Moody's, or "BBB-" or higher by Standard & Poor's. NAIC Designations 3 through 6 are referred to as below investment grade. Bonds are considered below investment grade when rated "Ba1" or lower by Moody's, or "BB+" or lower by Standard & Poor's.
The following tables present our publicly traded, privately placed and total fixed maturity securities by NAIC Designation and the equivalent ratings of the nationally recognized securities rating organizations as of December 31, 2001, and December 31, 2000, as well as the percentage, based on estimated fair value, that each designation comprises:
We invest in privately placed fixed maturity securities to enhance the overall value of the portfolio, increase diversification and obtain higher yields than are possible with comparable quality public market securities. Generally, private placements provide broader access to management information, strengthened negotiated protective covenants, call protection features and, where applicable, a higher level of collateral. They are, however, generally not freely tradable because of restrictions imposed by federal and state securities laws and illiquid trading markets. As of December 31, 2001, the percentage, based on estimated fair value, of total publicly traded and privately placed fixed maturity securities that were investment grade with an NAIC Designation 1 or 2 was 93%.
As of December 31, 2001, our largest unaffiliated single concentration of fixed maturity securities consisted of $315.3 million of corporate bonds by Ford Motor Company and its affiliates. This represented approximately 1% of our total U.S. invested assets as of December 31, 2001. No other individual non-government issuer represented more than 1% of U.S. invested assets.
Residential pass-through securities......... $ 2,855.5 $ 3,426.5 Commercial MBS.............................. 1,874.1 1,403.4 Asset-backed securities..................... 1,152.2 1,586.4 ---------- ---------- Total MBSs and asset-backed securities... $ 5,881.8 $ 6,416.3 ========== ==========
Commercial mortgage-backed securities provide high levels of credit protection, diversification, reduced event risk and enhanced liquidity. Commercial mortgage-backed securities are predominantly comprised of rated large pool securitizations that are individually and collectively diverse by property type, borrower and geographic dispersion.
We purchase asset-backed securities, ("ABS"), to diversify the overall credit risks of the fixed maturity securities portfolio and to provide attractive returns. The principal risks in holding asset-backed securities are structural and credit risks. Structural risks include the security's priority in the issuer's capital structure, the adequacy of and ability to realize proceeds from the collateral and the potential for prepayments. Credit risks involve issuer/servicer risk where collateral values can become impaired in the event of servicer credit deterioration.
Our ABS portfolio is diversified both by type of asset and by issuer. We actively monitor holdings of asset-backed securities to ensure that the risk profile of each security improves or remains consistent. If we are not receiving an adequate yield for the risk, relative to other investment opportunities, we will attempt to sell the security. Prepayments in the ABS portfolio are, in general, insensitive to changes in interest rates or are insulated to such changes by call protection features. In the event that we are subject to prepayment risk, we monitor the factors that impact the level of prepayment and prepayment speed for those asset-backed securities. To the extent we believe that prepayment risk increases, we may attempt to sell the security and reinvest in another security that offers better yield relative to the risk. In addition, we diversify the risks of asset-backed securities by holding a diverse class of securities, which limits our exposure to any one security.
Carrying Amount As of December 31, ------------------------ 2001 2000 ---------- ---------- (in millions)
Credit cards................................ $ 131.2 $ 220.0 Automobile receivables...................... 49.7 72.2 Collateralized debt obligations............. 468.6 579.1 Lease receivables........................... 101.5 198.9 Consumer loans.............................. 126.5 145.0 Other....................................... 274.7 371.2 ---------- ---------- Total asset-backed securities............ $ 1,152.2 $ 1,586.4 ========== ==========
In accordance with our asset liability risk management techniques, we manage the expected lives of U.S. invested assets to be similar to the lives of our liabilities. Significant amounts of our liabilities have an expected life of six years or less. Therefore, comparable amounts of assets have a similar expected life. The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity dates, excluding scheduled sinking funds, as of December 31, 2001, and December 31, 2000, as follows:
We monitor any decline in the credit quality of fixed maturity securities through the designation of "problem securities", "potential problem securities" and "restructured securities". We define problem securities in our fixed maturity portfolio as securities: (i) as to which principal and/or interest payments are in default or (ii) issued by a company that went into bankruptcy subsequent to the acquisition of such securities. We define potential problem securities in our fixed maturity portfolio as securities included on an internal "watch list" for which management has concerns as to the ability of the issuer to comply with the present debt payment terms and which may result in the security becoming a problem or being restructured. The decision whether to classify a performing fixed maturity security as a potential problem involves significant subjective judgments by our management as to the likely future industry conditions and developments with respect to the issuer. We define
In December 2001, Enron Corp., along with certain of its subsidiaries, filed voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy Court. We recognized realized losses in 2001 for other than temporary impairments and have classified our remaining investment in Enron Corp. and Enron related entities of $45.5 million in our problem fixed maturity securities.
As a result, we have focused on constructing a solid, high quality portfolio of mortgages. Our portfolio is generally comprised of mortgages with conservative loan-to-value ratios, high debt service coverages and general purpose property types with a strong credit tenancy.
Our commercial loan portfolio consists of primarily non-recourse, fixed rate mortgages on fully or near fully leased properties. The mortgage portfolio is comprised of general-purpose industrial properties, manufacturing office properties and credit oriented retail properties.
California accounted for 21% of our commercial mortgage loan portfolio as of December 31, 2001. We are, therefore, exposed to potential losses resulting from the risk of catastrophes, such as earthquakes, that may affect the region. Like other lenders, we generally do not require earthquake insurance for properties on which we make commercial mortgage loans. With respect to California properties, however, we obtain an engineering report specific to each property. The report assesses the building's design specifications, whether it has been upgraded to meet seismic building codes and the maximum loss that is likely to result from a variety of different seismic events. We also obtain a report that assesses by building and geographic fault lines the amount of loss our commercial mortgage loan portfolio might suffer under a variety of seismic events.
Pacific................. $ 2,421.3 25% $ 2,774.8 26% South Atlantic.......... 2,403.0 25 2,630.5 24 Middle Atlantic......... 1,606.3 16 1,664.9 15 East North Central...... 930.1 10 1,006.2 9 West South Central...... 769.0 8 886.4 8 Mountain................ 637.7 7 600.2 6 West North Central...... 397.8 4 439.9 4 East South Central...... 338.5 3 384.5 4 New England............. 327.4 3 495.9 5 Valuation allowance..... (90.7) (1) (108.0) (1) ---------- ----- ---------- ----- Total................ $ 9,740.4 100% $10,775.3 100% ========== ===== ========== =====
Our commercial loan portfolio is highly diversified by borrower. As of December 31, 2001, 43% of the U.S. commercial mortgage loan portfolio was comprised of mortgage loans with principal balances of less than $10.0 million. The following table shows our U.S. commercial mortgage loan portfolio by loan size, for the years indicated:
The total number of commercial mortgage loans outstanding as of December 31, 2001 and December 31, 2000 was 1,646 and 1,838, respectively. The average loan size of our commercial mortgage portfolio was $6.0 million as of December 31, 2001. The largest loan on any single property at such dates aggregated $100.0 million for December 31, 2001 and 2000, respectively, and represented 0.2% of U.S. invested assets on these dates. Total mortgage loans to the 10 largest borrowers accounted in the aggregate for approximately 7.1% of the total carrying amount of the commercial mortgage loan portfolio as of December 31, 2001, and 7.0% as of December 31, 2000, and 2% of total U.S. invested assets as of December 31, 2001 and 2000, respectively. As of such dates, all such loans were performing.
The following table presents the disposition of maturities as of December 31, 2001, and December 31, 2000:
U.S. Invested Assets Dispositions of Scheduled Maturities of Commercial Mortgage Loans
Amortized Cost As of December 31, ------------------- 2001 2000 ------- ------- (in millions)
Paid as scheduled........... $ 434.7 $ 395.0 Extended.................... 138.1 174.8 Refinanced.................. 75.7 82.7 Foreclosed.................. 5.4 - Expired maturities.......... 10.6 59.1 ------- ------- Total.................... $ 664.5 $ 711.6 ======= =======
The amortized cost of commercial mortgage loans by contractual maturity dates, excluding scheduled sinking funds as of December 31, 2001, and December 31, 2000, are as follows:
As of December 31, ------------------------------------- 2001 2000 ----------------- ---------------- Amortized % of Amortized % of Cost Total Cost Total ---------- ----- ---------- ----- ($ in millions)
We state commercial mortgage loans at their unpaid principal balances, net of discount accrual and premium amortization, valuation allowances and writedowns for impairment. We provide a valuation allowance for commercial mortgage loans based on past loan loss experience and for specific loans considered to be impaired. Mortgage loans are considered impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement may not be collected. When we determine that a loan is impaired, we establish a valuation allowance for loss for the excess of the carrying value of the mortgage loan over its estimated fair value. Estimated fair value is based on either the present value of expected future cash flows discounted at the loan's original effective interest rate, the loan's observable market price or the fair value of the collateral. We record increases in such valuation allowances as realized investment losses and, accordingly, we reflect such losses in our consolidated results of operations. Such increases (decreases) in valuation allowances aggregated $(17.3) million for the year ended December 31, 2001, and $(9.8) million for the year ended December 31, 2000.
We charge mortgage loans deemed to be uncollectible against the allowance for losses and credit subsequent recoveries to the allowance for losses. We maintain the allowance for losses at a level management believes to be adequate to absorb estimated probable credit losses. Management bases its periodic evaluation of the adequacy of the allowance for losses on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. The evaluation is inherently subjective as it requires estimating the amounts and timing of future cash flows expected to be received on impaired loans that may change.
The following table represents our commercial mortgage valuation allowance for the years indicated:
The carrying amount of real estate held for sale as of December 31, 2001, and December 31, 2000, was $390.7 million and $695.4 million, net of valuation allowances of $19.8 million and $40.8 million, respectively. Once we identify a real estate property to be sold and commence a plan for marketing the property, we classify the property as held for sale. We establish a valuation allowance subject to periodical revisions, if necessary, to adjust the carrying value of the property to reflect the lower of its current carrying value or the fair value, less associated selling costs.
We use research, both internal and external, to recommend appropriate product and geographic allocations and changes to the equity real estate portfolio. We monitor product, geographic and industry diversification separately and together to determine the most appropriate mix.
We use various derivative financial instruments to manage our exposure to fluctuations in interest rates, including interest rate futures and interest rate swaps and swaptions. We use interest rate futures contracts to hedge changes in interest rates subsequent to the issuance of an insurance liability, such as a guaranteed investment contract, but prior to the purchase of a supporting asset, or during periods of holding assets in anticipation of near term liability sales. We use interest rate swaps primarily to more closely match the interest rate characteristics of assets and liabilities. They can be used to change the interest rate characteristics of specific assets and liabilities as well as an entire portfolio. Occasionally, we will sell a callable liability or a liability with attributes similar to a call option. In these cases, we will use interest rate swaptions or similar products to hedge the risk of early liability payment, thereby transforming the callable liability into a fixed term liability.
We also seek to reduce call or prepayment risk arising from changes in interest rates in individual investments. We limit our exposure to investments that are prepayable without penalty prior to maturity at the option of the issuer, and we require additional yield on these investments to compensate for the risk that the issuer will exercise such option. An example of an investment we limit because of the option risk is residential mortgage-backed securities. We assess option risk in all investments we make and, when we take that risk, we price for it accordingly.
o performing similar credit analysis prior to approval on each derivatives counterparty that we do when lending money on a long-term basis;
o conducting stress-test analysis to determine the maximum exposure created during the life of a prospective transaction; and
All new derivative counterparties are approved by the investment committee. We believe the risk of incurring losses due to nonperformance by our counterparties is remote and that such losses, if any, would not be material. Futures contracts trade on organized exchanges and, therefore, effectively have no credit risk.
The notional amounts used to express the extent of our involvement in swap transactions represent a standard measurement of the volume of our swap business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual flows to be exchanged and are not paid or received, except for contracts such as currency swaps. Actual credit exposure represents the amount owed to us under derivative contracts as of the valuation date. The following tables present our position in, and credit exposure to, derivative financial instruments as of December 31, 2001, and December 31, 2000:
As of December 31, -------------------------------------- 2001 2000 ----------------- ----------------- Credit % of Credit % of Exposure Total Exposure Total -------- ----- -------- ----- ($ in millions)
The terms of our securities lending program, approved in 1999, allow us to lend our securities to major brokerage firms. Our policy requires an initial minimum of 102% of the fair value of the loaned securities as collateral. Our securities on loan as of December 31, 2001, had a fair value of $0.5 million.
As of December 31, 2001, our international investment operations consist of the investments of Principal International and BT Financial Group and comprise $1.4 billion in invested assets, which primarily represent the assets of Principal International. Principal Capital Management works with each Principal International affiliate to develop investment policies and strategies that are consistent with the products they offer. Due to the regulatory constraints in each country, each company maintains its own investment policies which are approved by Principal Capital Management. Each international affiliate is required to submit a compliance report relative to its strategy to Principal Capital Management. A credit committee comprised of Principal Capital Management employees and international affiliate company chief investment officers review each corporate credit annually. In addition, employees from our U.S. operations who serve on the credit committee currently hold investment positions in two of our international affiliates. Principal Capital Management provides credit analysis training to Principal International personnel.
As shown in the following table, the major categories of international invested assets as of December 31, 2001, and December 31, 2000, were fixed maturity securities and residential mortgage loans:
The yield on international invested assets and on cash and cash equivalents, excluding net realized gains and losses, was 8.5%, 7.1% and 7.5% for the years ended December 31, 2001, 2000 and 1999, respectively.
The issuers of the majority of our fixed maturity corporate securities are mainly banks and are categorized in the finance, insurance and real estate category as shown in the following tables:
The international operations held $254.6 million of residential pass-through securities as of December 31, 2001, and $256.7 million as of December 31, 2000.
The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity dates excluding scheduled sinking funds, as of December 31, 2001, and December 31, 2000, were as follows:
Our equity securities represented 2% of international invested assets as of December 31, 2001, and 6% as of December 31, 2000. Our equity securities consisted of $8.2 million in mutual funds and $16.7 million in common stock as of December 31, 2001.
As of December 31, -------------------------------------- 2001 2000 ----------------- ----------------- Notional % of Notional % of Amount Total Amount Total -------- ----- -------- ----- ($ in millions)
Foreign currency swaps....... $ 13.4 100% $ 665.0 39% Interest rate swaps.......... - - 665.0 39 Currency forwards............ - - 380.0 22 -------- ----- -------- ----- Total..................... $ 13.4 100% $1,710.0 100% ======== ===== ======== =====
Interest rate swaps.......... $ - -% $ 39.1 42% Foreign currency swaps....... - - 28.4 30 Currency forwards............ - - 26.2 28 -------- ----- -------- ----- Total..................... - -% $ 93.7 100% ======== ===== ======== =====
Our other investments totaled $151.4 million as of December 31, 2001, compared to $129.8 million as of December 31, 2000. Of the $151.4 million, $37.8 million is related to subordinated notes in BT Financial Group's margin lending program, $68.2 million represents our investments in unconsolidated subsidiaries in Brazil, Japan, India and Mexico, $25.5 million represents BT Financial Group's investment in unit trusts, $19.5 million represents other invested assets from our Chilean operations and $0.4 million represents other invested assets from our Mexican operations.
The management of Principal Financial Group, Inc. is responsible for the preparation and integrity of the consolidated financial statements and related financial information included in the annual report. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States and include amounts based on management's best estimates and informed judgements. Management believes the statements fairly present Principal Financial Group, Inc.'s financial position and results of operation, and that other information contained in this Form 10-K is consistent with the financial statements.
Ernst & Young LLP, independent auditors, has audited the consolidated financial statements of Principal Financial Group, Inc. The audit was conducted in accordance with auditing standards generally accepted in the United States. Those standards require that the independent auditor plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. The independent auditors have discussed with the audit committee accounting principles, estimates and judgments used by management in the preparation of the consolidated financial statements.
The board of directors is responsible for engaging the independent auditors, evaluating the independent auditors' independence, overseeing the independent audit, and assuring management fulfills its responsibilities in the preparation of the financial statements and for maintaining the system of internal controls. The audit committee of the board meets quarterly with management, the internal auditors and the independent auditors to enable the board to fulfill these responsibilities.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for derivative instruments and hedging activities in response to a new accounting standard that became effective January 1, 2001.
December 31, 2001 2000 ---------- ---------- (in millions, except per share data) Assets Fixed maturities, available-for-sale........... $30,012.3 $26,839.9 Fixed maturities, trading...................... 17.8 - Equity securities, available-for-sale.......... 833.6 742.9 Mortgage loans................................. 11,065.7 11,492.7 Real estate.................................... 1,181.8 1,400.5 Policy loans................................... 831.9 803.6 Other investments.............................. 829.8 811.0 ---------- ---------- Total investments........................... 44,772.9 42,090.6
Cash and cash equivalents...................... 623.8 926.6 Accrued investment income...................... 594.3 530.8 Premiums due and other receivables............. 531.3 505.7 Deferred policy acquisition costs.............. 1,372.5 1,333.3 Property and equipment......................... 518.2 507.0 Goodwill and other intangibles................. 1,228.4 1,375.9 Mortgage loan servicing rights................. 1,779.2 1,084.4 Separate account assets........................ 35,864.8 34,916.2 Other assets................................... 1,065.1 1,134.4 ---------- ---------- Total assets................................ $88,350.5 $84,404.9 ========== ==========
Stockholders' equity Common stock, par value $.01 per share - 2,500 million shares authorized, 375.8 million shares issued, 360.1 million shares outstanding.......................... 3.8 - Additional paid-in capital..................... 7,072.5 - Retained earnings (deficit).................... (29.1) 6,312.5 Accumulated other comprehensive income (loss).. 147.5 (60.0) Treasury stock, at cost (15.7 million shares).. (374.4) - ---------- ---------- Total stockholders' equity.................. 6,820.3 6,252.5 ---------- ---------- Total liabilities and stockholders' equity.. $88,350.5 $84,404.9 ========== ==========
The unaudited pro forma earnings per common share information above gives effect to the Demutualization and Initial Public Offering completed on October 26, 2001 (see Note 18 to the consolidated financial statements).
Principal Financial Group, Inc. Notes to Consolidated Financial Statements December 31, 2001
Principal Financial Group, Inc. and its consolidated subsidiaries ("the Company"), the successor to Principal Mutual Holding Company, is a diversified financial services organization engaged in promoting retirement savings and investment and insurance products and services in the U.S. and selected international markets. In addition, the Company offers residential mortgage loan origination and servicing in the U.S.
Costs relating to the demutualization, excluding costs relating to the IPO, were $18.6 million and $7.2 million, net of income taxes, in 2001 and 2000, respectively. Demutualization expenses consist primarily of printing and mailing costs and the aggregate cost of engaging independent accounting, actuarial, financial, investment banking, legal and other consultants to advise the Company on the demutualization. In addition, these costs include the costs of the advisors of the Insurance Commissioner of the State of Iowa and the New York State Insurance Department, other regulatory authorities and internal allocated costs for staff and related costs associated with the demutualization.
At the time the MIHC structure was created in 1998, Principal Life Insurance Company ("Principal Life") formed and began operating a closed block ("Closed Block") for the benefit of individual participating dividend-paying policies in force on that date. See Note 6 for further details regarding the Closed Block.
In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). In June 1999, SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 was issued deferring the effective date of SFAS 133 by one year, to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133, which amended the accounting and reporting standards of SFAS 133 for certain derivative instruments and certain hedging activities.
At January 1, 2001, the Company's consolidated financial statements were adjusted to record a cumulative effect of adopting SFAS 133, as follows (in millions):
In accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company is required to classify its investments into one of three categories: held-to-maturity, available-for-sale or trading. The Company determines the appropriate classification of fixed maturity securities at the time of purchase. Fixed maturity securities include bonds, mortgage-backed securities, and redeemable preferred stock. The Company classifies its fixed maturity securities as either available-for-sale or trading and, accordingly, carries them 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. Unrealized gains and losses related to trading securities are reflected in net realized capital gains and losses.
Real estate investments are reported at cost less accumulated depreciation. The initial cost bases of properties acquired through loan foreclosures is 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. The Company recognizes impairment losses for its 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
Commercial and residential mortgage loans are generally reported at cost adjusted for amortization of premiums and accrual of discounts, computed using the interest method, and net of valuation allowances. Any changes in the valuation allowances are reported as net realized capital gains (losses). The Company measures impairment based upon the present value of expected cash flows discounted at the loan's effective interest rate or the loan's observable market price. If foreclosure is probable, the measurement of any valuation allowance is based upon the fair value of the collateral. The Company has residential mortgage loans held for sale in the amount of $476.1 million and $251.7 million and commercial mortgage loans held for sale in the amount of $493.5 million and $520.9 million at December 31, 2001 and 2000, respectively, which are carried at lower of cost or fair value, less cost to sell, and reported as mortgage loans in the statements of financial position.
Net realized capital gains and losses on sales of investments are determined on the basis of specific identification. In general, in addition to realized capital gains and losses on investment sales, unrealized gains and losses related to other than temporary impairments, trading securities, fair value hedge ineffectiveness, derivatives not designated as hedges and changes in the mortgage loan allowance are reported as net realized capital gains and losses. Unrealized gains and losses on derivatives within the Company's mortgage banking segment are reported as either operating expenses or fees and other revenues depending on the nature of the hedge and are excluded from net realized capital gains and losses. Investment gains and losses on sales of certain real estate held-for-sale are reported as net investment income and are also excluded from net realized capital gains and losses.
As a result of SFAS 133, all derivatives are recognized as either assets or liabilities in the statement of financial position and measured at fair value. If certain conditions are met, a derivative may be specifically designated as one of the following:
(b) a hedge of the exposure to variable cash flows of a forecasted transaction; or
(c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security or a foreign-currency-denominated forecasted transaction.
For derivatives hedging the exposure to variable cash flows, the effective portion of the derivative's change in fair value is initially deferred and reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction occurs and is recognized in earnings. The ineffective portion of the change in fair value is reported in earnings in the period of change. In addition, if the hedged items are sold, terminated or matured, the changes in value of the derivatives are also included in net income.
The Company's risk management policy regarding net investment hedges is to hedge currency fluctuations between foreign currencies and the U.S. dollar. At December 31, 2001, the Company was hedging a portion ($665.0 million) of its net investment in Australia.
Prior to the January 1, 2001, adoption of FAS 133, the Company used futures contracts, mortgage-backed securities forwards, interest rate and principal only swap and floor agreements, options on futures contracts and currency rate swap agreements to hedge and manage its exposure to changes in interest rate levels and foreign exchange rate fluctuations, and to manage duration mismatch of assets and liabilities. Futures contracts were marked-to-market and settled daily with the net gain or loss at expiration or termination of the contracts recorded in realized capital gains and losses. Outstanding mortgage-backed forwards were reported as commitments and upon settlement, the net gain or loss was reported in realized capital gains and losses. For interest rate and currency swaps held by Principal Life, the net amounts paid or received and net amounts accrued through the end of the accounting period were included in net investment income. Any discounts or premiums related to these instruments were amortized to net investment income over the life of the contract. Gains or losses on contracts terminated early were recognized immediately in realized capital gains and losses. Unrealized gains or losses on interest rate swap contracts and currency swaps were not recognized in income. The Company primarily utilized interest rate floors, futures and options on futures contracts, and interest rate and principal only swaps in hedging its portfolio of mortgage servicing rights. The realized and unrealized gains and losses on servicing derivatives accounted for as effective hedges were considered in the periodic assessment of mortgage servicing rights impairment. The realized and unrealized gains and losses on servicing derivatives not considered effective hedges were recorded in the Company's results of operations. The Company managed interest rate risk on its mortgage loan pipeline by buying and selling mortgage-backed securities in the forward markets, over the counter options on mortgage-backed securities, futures contracts and options on treasury futures contracts. The unrealized gains and losses on these derivatives were included in the lower of cost or market calculation of mortgage loans held for sale.
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 the Company's experience. Mortality, morbidity and withdrawal rate assumptions are based on experience of the Company and are periodically reviewed against both industry standards and experience.
Traditional individual life and health insurance products include those products with fixed and guaranteed premiums and benefits, and consist principally of whole life and term life insurance policies. Premiums from these products are recognized as premium revenue when due.
Immediate annuities with life contingencies include products with fixed and guaranteed annuity considerations and benefits, and consist principally of group and individual single premium annuities with life contingencies. Annuity considerations from these products are recognized as revenue when due.
Group life and health insurance premiums are generally recorded as premium revenue over the term of the coverage. Some group contracts allow for premiums to be adjusted to reflect emerging experience. Such adjusted premiums are recognized in the period that the related experience emerges. Fees for contracts providing claim processing or other administrative services are recorded over the period the service is provided.
Investment contracts do not subject the Company to risks arising from policyholder mortality or morbidity, and consist primarily of Guaranteed Investment Contracts ("GICs"), funding agreements and certain deferred annuities. Amounts received as payments for investment contracts are established as investment contract liability balances and are not reported as premium revenues. Revenues for investment contracts consist of investment income and policy administration charges. Investment contract benefits that are charged to expense include benefit claims incurred in the period in excess of related investment contract liability balances and interest credited to investment contract liability balances.
recordkeeping and reporting services for retirement savings plans. Fees and other revenues received for performance of asset management and administrative services are recognized as revenue when the service is performed.
The effect of reinsurance on premiums and other considerations and policy and contract benefits and changes in reserves is as follows (in millions):
Assets and liabilities of the Company's foreign subsidiaries and affiliates denominated in non-U.S. dollars are translated into U.S. dollar equivalents at the year-end spot foreign exchange rates. Resulting translation adjustments are reported as a component of stockholders' equity, along with any related hedge effects. Revenues and expenses for these entities are translated at the weighted average exchange rates for the year. Revenue, expense and other translation adjustments for foreign subsidiaries and affiliates with the U.S. dollar as the functional currency and foreign currency transactions that affect cash flows are reported in current operations, along with related hedge effects.
The Company accounts for its pension benefits and postretirement benefits other than pension (medical, life insurance and long-term care) using the full accrual method.
Property and equipment................ $932.0 $924.6 Accumulated depreciation.............. (413.8) (417.6) --------- ---------- Property and equipment, net........... $518.2 $507.0 ========= ==========
Goodwill and other intangibles, and related accumulated amortization, are as follows (in millions):
Goodwill..................................... $ 516.2 $ 648.2 Other intangibles............................ 852.7 818.8 ----------- ----------- 1,368.9 1,467.0 Accumulated amortization..................... (140.5) (91.1) ----------- ----------- Total goodwill and other intangibles, net.... $ 1,228.4 $ 1,375.9 =========== ===========
Effective January 1, 2002, the Company will adopt a non-amortization, impairment-only approach for goodwill and indefinite-lived intangible assets based on new accounting guidance issued in 2001 described later in Note 1.
Mortgage loan servicing rights represent the cost of purchasing or originating the right to service mortgage loans. These costs are capitalized and amortized to operations over the estimated remaining lives of the underlying loans using the interest method and taking into account appropriate prepayment assumptions. Capitalized mortgage loan servicing rights are periodically assessed for impairment, which is recognized in the consolidated statements of operations during the period in which impairment occurs by establishing a corresponding valuation allowance. For purposes of performing its impairment evaluation, the Company stratifies the servicing portfolio on the basis of specified predominant risk characteristics, including loan type and note rate. A valuation model is used to determine the fair value of each stratum. Cash flows are calculated using an internal prepayment model and discounted at a spread to London Inter-Bank Offer Rates. External valuations are obtained for comparison purposes.
Activity in the valuation allowance for mortgage loan servicing rights is summarized as follows (in millions):
Balance at beginning of year... $ 2.3 $ 2.9 $ 56.1 Impairments.................... 196.0 1.1 1.7 Recoveries..................... (0.2) (1.7) (54.9) ---------- ---------- ---------- Balance at end of year......... $ 198.1 $ 2.3 $ 2.9 ========== ========== ==========
Included in other assets are certain assets pending transfer or novation that are carried at fair value (see Note 2). The remainder of other assets are reported primarily at cost.
In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS 141"), and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. SFAS 142, effective January 1, 2002, prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Intangible assets with finite useful lives will continue to be amortized over their estimated useful lives. In 2001, the Company's amortization expense for goodwill and intangible assets was $54.7 million, of which $48.5 million will not continue after January 1, 2002. Additionally, SFAS 142 requires that goodwill and indefinite-lived intangible assets be reviewed for impairment at least annually. This includes a more stringent impairment test methodology (fair value based on discounted cash flows) for measuring and recognizing impairment losses. The Company has estimated the impairment amount that will result from the adoption of SFAS 142 on January 1, 2002, and expects an after-tax impairment of approximately $300 million. The impairment will be recognized in the Company's first quarter 2002 consolidated financial statements as a cumulative effect of a change in accounting principle.
Completion of the sale of the investment banking operations required the transfer or novation to Macquarie Bank Limited of the investment banking assets and liabilities of the Acquired Companies. The bulk of these were statutorily transferred on August 3, 1999, pursuant to the procedures laid down in the Financial Sector (Transfers of Business) Act ("the Act") of the Commonwealth of Australia. Certain assets and liabilities which are governed by a law other than that of Australia, or which the Act does not address, were excluded from the statutory transfer. For these assets and liabilities it has been necessary to effect individual transfers or novations, in some cases with the agreement of the relevant customers or counterparties. Pending such transfers or novations, the Company agreed, as part of the sale of the investment banking operations, that these assets and liabilities will remain in the name of one of the Acquired Companies, but all economic risks and benefits associated with them will be assumed and a related indemnification provided by Macquarie Bank Limited. In addition, the Company may rely upon Deutsche Bank AG to ensure that the Company does not suffer any claim or loss related to the investment banking operations sold, including the assets and liabilities, respectively, that will remain in the name of the Acquired Companies pending transfer or novation. These assets and liabilities which remain in the name of one of the Acquired Companies and aggregated $148.3 million and $53.8 million, respectively, at December 31, 2001, are reported at fair value and included in other assets and other liabilities in the Company's consolidated statement of financial position, with a net payable to Deutsche Bank AG of $94.5 million. At December 31, 2000, these assets and liabilities aggregated $424.1 million and $122.8 million, respectively, with a net payable to Macquarie Bank Limited of $204.5 million and a net payable to Deutsche Bank AG of $96.8 million.
Beginning January 1, 2000, the Company ceased new sales of Medicare supplement insurance and effective July 1, 2000, the Company entered into a reinsurance agreement to reinsure 100% of the Medicare supplement insurance block of business. Medicare supplement insurance premiums were $98.4 million for the six months ended June 30, 2000, and $164.6 million for the year ended December 31, 1999.
The cost, gross unrealized gains and losses and fair value of fixed maturities and equity securities available-for-sale as of December 31, 2001 and 2000, are summarized as follows (in millions):
The cost and fair value of fixed maturities available-for-sale at December 31, 2001, by expected maturity, were as follows (in millions):
Cost Fair value ---------- ----------- Due in one year or less............................ $ 1,393.7 $ 1,403.3 Due after one year through five years.............. 10,646.0 10,977.3 Due after five years through ten years............. 5,748.4 5,933.8 Due after ten years................................ 5,485.9 5,579.3 ---------- ----------- 23,274.0 23,893.7 Mortgage-backed and other asset-backed securities.. 5,891.3 6,118.6 ---------- ----------- Total.............................................. $29,165.3 $ 30,012.3 ========== ===========
The above summarized activity is based on expected maturities. Actual maturities may differ because borrowers may have the right to call or pre-pay obligations.
Corporate private placement bonds represent a primary area of credit risk exposure. The corporate private placement bond portfolio is diversified by issuer and industry. The Company monitors the restrictive bond covenants which are intended to regulate the activities of issuers and control their leveraging capabilities.
Major categories of net investment income are summarized as follows (in millions):
Less investment expenses................ (103.5) (138.7) (116.6) --------- --------- --------- Net investment income................... $3,394.5 $3,172.3 $3,072.0 ========= ========= =========
Fixed maturities, available-for-sale: Gross gains........................... $ 75.8 $ 29.1 $ 31.2 Gross losses.......................... (408.8) (155.0) (128.1) Fixed maturities, trading: Gross gains........................... 0.9 - - Gross losses.......................... (0.1) - - Equity securities, available-for-sale: Gross gains........................... 9.4 84.2 408.7 Gross losses.......................... (76.9) (5.0) (25.7) Mortgage loans.......................... 10.7 8.6 (8.4) Real estate............................. (19.0) 82.3 56.4 Other, including unrealized derivative gains (losses)........................ (106.0) 95.7 70.4 -------- -------- -------- Net realized capital gains (losses)..... $(514.0) $ 139.9 $ 404.5 ======== ======== ========
Proceeds from sales of investments (excluding call and maturity proceeds) in fixed maturities were $5.7 billion, $5.7 billion and $5.5 billion in 2001, 2000 and 1999, respectively. Of the 2001, 2000 and 1999 proceeds, $1.6 billion, $2.6 billion and $3.8 billion, respectively, relates to sales of mortgage-backed securities. The Company actively manages its mortgage-backed securities portfolio to control prepayment risk. Gross gains of $22.5 million, $2.0 million and $2.1 million and gross losses of $5.0 million, $40.1 million and $60.3 million in 2001, 2000 and 1999, respectively, were realized on sales of mortgage-backed securities.
The Company recognizes impairment losses for fixed maturities and equity securities when declines in value are other than temporary. Realized losses related to other than temporary impairments were $227.4 million and $6.1 million in 2001 and 2000, respectively. There were no other than temporary impairments in 1999.
In December 2001, Enron Corp., along with certain of its subsidiaries, filed voluntary petitions for Chapter 11 reorganization with the U.S. Bankruptcy Court. Included in the $227.4 million of realized losses in 2001 for other than temporary impairments, $71.9 million related to the Company's exposure to Enron Corp. and Enron related entities. Also included in net realized capital gains and losses in 2001 was $65.8 million related to the sale of Enron investments. As of December 31, 2001, the remaining carrying amount of the Company's investment in Enron Corp. and Enron related entities was $45.5 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. Some of the assets in the Company's investment portfolio may be adversely affected by further declines in the securities markets and economic activity caused by the terrorist attacks and heightened security measures.
On December 31, 2001, the Company held corporate fixed maturity securities in the following sectors impacted most significantly by the September 11, 2001 terrorist attacks (carrying amounts noted in parenthesis): airlines ($245.9 million in public debt and $208.3 million in private debt), comprised mostly of equipment trust certificate transactions secured by aircraft; airline manufacturers and equipment providers ($239.0 million), comprised of public and private unsecured debt; property and casualty insurance companies ($28.9 million), comprised of public unsecured debt; and hotels and gaming companies ($168.9 million), comprised of public and private debt secured by hotel properties. As of December 31, 2001, the Company has not recognized any related other-than-temporary impairment of these assets.
The net unrealized gains and losses on investments in fixed maturities and equity securities available-for-sale are reported as a separate component of equity, reduced by adjustments to deferred policy acquisition costs and unearned revenue reserves that would have been required as a charge or credit to operations had such amounts been realized and a provision for deferred income taxes.
The cumulative amount of net unrealized gains and losses on available-for-sale securities is as follows (in millions):
The Company was servicing approximately 741,000 and 582,000 residential mortgage loans with aggregate principal balances of approximately $80,530.5 million and $55,987.4 million at December 31, 2001 and 2000, respectively. In connection with these mortgage servicing activities, the Company held funds in trust for others totaling approximately $508.9 million and $343.8 million at December 31, 2001 and 2000, respectively. As of December 31, 2001, $457.1 million of the funds held in trust were held in the Company's banking subsidiary. In connection with its loan administration activities, the Company advances payments of property taxes and insurance premiums and also advances principal and interest payments to investors in advance of collecting funds from specific mortgagors. In addition, the Company makes certain payments of attorney fees and other costs related to loans in foreclosure. These amounts receivable are recorded, at cost, as advances on serviced loans. Amounts advanced are considered in management's evaluation of the adequacy of the mortgage loan allowance for losses.
In June 2000, the Company, through its 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 the Company's residential mortgage loan production. The Company sells eligible residential mortgage loans to PRMCR, where they are warehoused until sold to the final investor. The Company sold $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 held for sale by PRMCR must meet portfolio criteria, eligibility representations, and portfolio aging limitations. Based on these eligibility representations, the Company is required to repurchase ineligible loans from PRMCR.
Mortgage loans typically remain in the Trust until they are processed through the foreclosure claim process, are paid-off or reinstate. Loans that reinstate are no longer eligible to remain in the Trust and are required to be removed by the Company at fair market value at the monthly settlement date following reinstatement.
December 31, 2001 2000 ------------------- ------------------ Investment real estate....... $ 905.1 $ 822.2 Accumulated depreciation..... (114.1) (117.1) ------------------- ------------------ 791.0 705.1 Properties held for sale..... 390.8 695.4 ------------------- ------------------ Real estate, net............. $1,181.8 $1,400.5 =================== ==================
Other investments include minority interests in unconsolidated entities and properties owned jointly with venture partners and operated by the partners. Joint ventures in which the Company has an interest have mortgage loans with the Company of $347.7 million and $612.1 million at December 31, 2001 and 2000, respectively. The Company is committed to providing additional mortgage financing for such joint ventures aggregating $171.8 million and $71.5 million at December 31, 2001 and 2000, respectively.
The Company sells commercial mortgage loans in securitization transactions and retains primary servicing responsibilities and other interests. The Company receives annual servicing fees approximating 0.01 percent, which approximates cost. 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 primarily to credit risk.
Key economic assumptions used in measuring the retained interests at the date of securitization resulting from transactions completed included a cumulative default rate between four and eight percent during 2001 and between five and eight percent during 2000. The assumed range of the loss severity, as a percentage of defaulted loans, was between 12 and 25 percent during 2001 and between 13 and 25 percent during 2000. The low end of the loss severity range relates to a portfolio of seasoned loans. The high end of the loss severity range relates to a portfolio of newly issued loans.
At December 31, 2001, the fair values of retained interests related to the securitizations of commercial mortgage loans were $170.5 million. Key economic assumptions and the sensitivity of the current fair values of residual cash flows were tested to one and two standard deviations from the expected rates. The changes in the fair values at December 31, 2001, as a result of these assumptions were not significant.
In 2001 and 2000, the Company recognized gains of $218.8 million and $9.4 million, respectively, on the sales of residential mortgage loans.
2001 2000 ------------------------------------ Weighted average life (years)........ 7.84 6.87 Weighted average prepayment speed.... 9.48% 11.81% Yield to maturity discount rate...... 7.45% 10.74%
value of expected future cash flows as a valuation technique to assess the sensitivity of the fair values of retained interests. Key economic assumptions used in measuring the retained interests included interest margin, credit losses, terminations and discount rates, and the resulting changes to the fair values were not significant.
The table below summarizes cash flows for securitization transactions and cash flows received from and paid to securitization trusts (in millions):
Derivatives are generally held for purposes other than trading and are primarily used to hedge or reduce exposure to interest rate and foreign currency risks associated with assets held or expected to be purchased or sold, and liabilities incurred or expected to be incurred. Additionally, derivatives are used to change the characteristics of the Company's asset/liability mix consistent with the Company's risk management activities.
The Company's derivative transactions are generally documented under International Swaps and Derivatives Association, Inc. Master Agreements. Management believes that such agreements provide for legally enforceable set-off and close out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, the Company is permitted to set off its receivable from a counterparty against its payables to the same counterparty arising out of all included transactions.
December 31, 2001 2000 ---------- ---------- Notional amounts of derivative instruments with regard to U.S. operations Foreign currency swaps............................ $ 4,091.9 $ 2,745.0 Interest rate floors.............................. 3,400.0 2,450.0 Interest rate swaps............................... 3,522.5 2,391.5 Mortgage-backed forwards and options.............. 9,250.7 1,898.3 Swaptions......................................... 3,570.0 697.7 Bond forwards..................................... 357.4 - Interest rate lock commitments.................... 2,565.9 - Call options...................................... 30.0 30.0 U.S. Treasury futures............................. 186.6 183.2 Currency forwards................................. 380.0 39.4 Treasury rate guarantees.......................... 88.0 60.0 Other............................................. 25.0 - ---------- --------- 27,468.0 10,495.1
Credit exposure of derivative instruments with regard to international operations Foreign currency swaps............................ - 28.4 Interest rate swaps............................... - 39.1 Currency forwards................................. - 26.2 ---------- ---------- - 93.7 ---------- ---------- Total credit exposure at end of year............. $ 307.4 $ 202.7 ========== ==========
The net interest effect of interest rate and currency swap transactions is recorded as an adjustment to net investment income or interest expense, as appropriate, over the periods covered by the agreements. The cost of derivative instruments related to residential mortgage loan servicing rights is included in the basis of the derivatives. These derivatives are marked-to-market with the changes in market value reported in operating expenses on the consolidated statements of operations.
The fair value of the Company's derivative instruments, identified as hedges and classified as assets at December 31, 2001, was $409.9 million. Of this amount, the fair value of derivatives related to investment hedges was $100.8 million and was reported with other invested assets on the consolidated statement of financial position. The fair value of derivatives related to residential mortgage loan servicing rights and residential mortgage loans was $182.3 million and the fair value of derivatives related to debt serviced by Australian dollars was $126.8 million. Both are reported with other assets on the consolidated statement of financial position. The fair value of derivative instruments classified as liabilities at December 31, 2001, was $449.7 million and was reported with other liabilities on the consolidated statement of financial position.
The Company enters into currency exchange swap agreements to convert both principal and interest payments of certain foreign denominated assets and liabilities into U.S. dollar denominated fixed-rate instruments to eliminate the exposure to future currency volatility on those items.
In most cases, zero hedge ineffectiveness for cash flow hedges is assumed because the derivative instrument was constructed such that all terms of the derivative match the hedged risk in the hedged item. As a result, the Company has recognized an immaterial amount in earnings due to cash flow hedge ineffectiveness.
The Company attempts to match the timing of when interest rates are committed on insurance products, residential mortgage loans and other new investments. However, timing differences may occur and can expose the Company to fluctuating interest rates. To offset this risk, the Company uses mortgage-backed forwards, over-the-counter options on mortgage-backed securities, U.S. Treasury futures contracts, options on Treasury futures, Treasury rate guarantees and interest rate floors to economically hedge anticipated transactions and to manage interest rate risk. Futures contracts are marked-to-market and settled daily, which minimizes the counterparty risk. Forward contracts are marked-to-market no less than quarterly. The Company's interest rate lock commitments on residential mortgage loans are also accounted for as derivatives.
Although the above-mentioned derivatives are effective hedges from an economic standpoint, they do not meet the requirements for hedge accounting treatment under SFAS 133. As such, periodic changes in the market value of these instruments flow directly into net income. In 2001, gains of $68.3 million were recognized in income from market value changes of derivatives not receiving hedge accounting treatment.
In connection with its 1998 MIHC formation, Principal Life formed a Closed Block to provide reasonable assurance to policyholders included therein that, after the formation of the MIHC, assets would be available to maintain dividends in aggregate in accordance with the 1997 policy dividend scales, if the experience underlying such scales continued. Assets of Principal Life were allocated to the Closed Block in an amount that produces cash flows which, together with anticipated revenue from policies and contracts included in the Closed Block, were expected to be sufficient to support the Closed Block policies, including but not limited to, provisions for payment of claims, certain expenses, charges and taxes, and to provide for continuation of policy and contract dividends in aggregate in accordance with the 1997 dividend scales, if the experience underlying such scales continues, and to allow for appropriate adjustments in such scales, if such experience changes. Due to adjustable life policies being included in the Closed Block, the Closed Block is charged with amounts necessary to properly fund for certain adjustments, such as face amount and premium increases, that are made to these policies after the Closed Block inception date. These amounts are referred to as Funding Adjustment Charges and are treated as capital transfers from the Closed Block.
Excess of Closed Block liabilities over assets designated to the Closed Block.................. 1,305.0 1,381.6
Expenses Benefits, claims, and settlement expenses.............................. 614.4 601.2 614.6 Dividends to policyholders.............. 305.8 307.7 295.9 Operating expenses...................... 12.7 13.6 13.2 ---------- ---------- ---------- Total expenses 932.9 922.5 923.7 ---------- ---------- ----------
Major components of contractholder funds in the consolidated statements of financial position, are summarized as follows (in millions):
The Company's guaranteed investment contracts and funding agreements contain provisions limiting early surrenders, including penalties for early surrenders and minimum notice requirements. Put provisions give customers the option to terminate a contract prior to maturity, provided they give a minimum notice period.
The following table presents U.S. GAAP reserves for guaranteed investment contracts and funding agreements by withdrawal provisions (in millions):
December 31, 2001 ----------------- Book Value Out(1) Puttable: Less than 30 days' put......................... $ - 30 to 89 days' put............................. - 90 to 180 days' put............................ - More than 180 days' put........................ 55.1 No active put provision(2)..................... - ----------------- Total puttable................................... 55.1
Market Value Out(3) Less than 30 days' notice........................ 26.9 30 to 89 days' notice............................ 281.9 90 to 180 days' notice........................... 1,133.6 More than 180 days' notice....................... 4,795.6 No active surrender provision.................... 238.5 ----------------- Total market value out........................... 6,476.5
Not puttable or surrenderable.................... 11,502.1 ----------------- Total GICs and funding agreements................ $18,452.9 ================= - ------------------ (1) Book Value Out: The amount equal to the sum of deposits less withdrawals with interest accrued at the contractual interest rate.
Funding agreements are issued to non-qualified institutional investors both in domestic and international markets. The Company has a $4.0 billion international program, under which a consolidated offshore special purpose entity was created to issue nonrecourse medium-term notes. Under the program, the proceeds of each note series issuance are used to purchase a funding agreement from the Company, which is used to secure that particular series of notes. The payment terms of any particular series of notes match the payment terms of the funding agreement that secures that series. Claims for principal and interest under those international funding agreements are afforded equal priority to claims of life insurance and annuity policyholders under insolvency provisions of Iowa Insurance Laws and, accordingly, are reported as contractholder funds liabilities in the Company's consolidated statement of financial position. In general, the medium-term note funding agreements do not give the contractholder the right to terminate prior to contractually stated maturity dates, absent the
Balance at beginning of year..... $ 705.0 $ 721.7 $ 641.4
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, the Company recognized $6.7 million (net of income tax and reinsurance) in losses from individual and group life and disability insurance claims as a result of these events.
Short-term debt consists primarily of commercial paper and outstanding balances on revolving credit facilities with various financial institutions. At December 31, 2001, the Company and certain subsidiaries had credit facilities with various financial institutions in an aggregate amount of $1.4 billion. These credit facilities include $600.0 million on a back-stop facility to support the Company's $1 billion commercial paper program, $780.0 million in credit facilities to finance a CMBS pipeline and $45.0 million of unused lines of credit for short-term debt used for general corporate purposes.
The weighted average interest rates on short-term borrowings as of December 31, 2001 and 2000, were 2.30% and 7.17%, respectively.
The components of short-term debt as of December 31, 2001 and 2000 are as follows (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 ======= =======
7.95% notes payable, due 2004.............. $ 199.1 $ 199.3 8.2% notes payable, due 2009............... 464.6 464.9 7.875% surplus notes payable, due 2024. 199.0 198.9 8% surplus notes payable, due 2044......... 99.1 99.1 Non-recourse mortgages and notes payable... 247.5 149.8 Other mortgages and notes payable.......... 169.1 224.5 -------- -------- Total long-term debt....................... $1,378.4 $1,336.5 ======== ========
On March 10, 1994, Principal Life issued $300.0 million of surplus notes, including $200.0 million due March 1, 2024, at a 7.875% annual interest rate and the remaining $100.0 million due March 1, 2044, at an 8% annual interest rate. No affiliates of the Company hold any portion of the notes. Each payment of interest and principal on the notes, however, may be made only with the prior approval of the Commissioner of Insurance of the State of Iowa (the "Commissioner") and only to the extent that Principal Life has sufficient surplus earnings to make such payments. For each of the years ended December 31, 2001, 2000 and 1999, interest of $23.8 million was approved by the Commissioner, paid and charged to expense.
Subject to Commissioner approval, the surplus notes due March 1, 2024, may be redeemed at Principal Life's election on or after March 1, 2004, in whole or in part at a redemption price of approximately 103.6% of par. The approximate 3.6% premium is scheduled to gradually diminish over the following ten years. These surplus notes may then be redeemed on or after March 1, 2014, at a redemption price of 100% of the principal amount plus interest accrued to the date of redemption.
The mortgages and other notes payable are financings for real estate developments. The Company has 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%.
2002............................................ $ 165.1 2003............................................ 5.6 2004............................................ 283.2 2005............................................ 2.6 2006............................................ 2.8 Thereafter...................................... 919.1 --------- Total future maturities of the long-term debt... $ 1,378.4 =========
The Company's income tax expense (benefit) is as follows (in millions):
For the year ended December 31, 2001 2000 1999 -------- -------- -------- Current income taxes: Federal................................. $ 18.7 $ 167.7 $ 74.9 State and foreign....................... 36.9 37.3 23.2 Net realized capital gains (losses)..... (214.1) 29.6 162.8 -------- -------- -------- Total current income taxes (benefit)...... (158.5) 234.6 260.9 Deferred income taxes..................... 237.5 5.7 62.6 -------- -------- -------- Total income taxes........................ $ 79.0 $ 240.3 $ 323.5 ======== ======== ========
For the year ended December 31, 2001 2000 1999 -------- -------- -------- Statutory corporate tax rate.............. 35% 35% 35% Dividends received deduction.............. (14) (5) (3) Interest exclusion from taxable income.... (3) (1) - Other..................................... - (1) (2) -------- -------- -------- Effective tax rate........................ 18% 28% 30% ======== ======== ========
At December 31, 2001 and 2000, respectively, the Company's net deferred tax liability is comprised of international net deferred tax assets of $48.4 million and $36.4 million which have been included in other assets, and $894.6 million and $487.4 million of U.S. net deferred tax liabilities which have been included in deferred income taxes in the consolidated statements of financial position.
The Internal Revenue Service (the "Service") has completed examination of the U.S. consolidated federal income tax returns for 1996 and prior years. The Service has also begun to examine returns for 1997 and 1998. The Company believes that there are adequate defenses against or sufficient provisions for any challenges.
Cash paid for income taxes was $90.3 million in 2001, $279.3 million in 2000 and $251.5 million in 1999.
The Company also provides certain health care, life insurance and long-term care benefits for retired employees. Retiree health benefits are provided for employees hired prior to January 1, 2002, while retiree long-term care benefits are provided for employees whose retirement was effective prior to July 1, 2000. Covered employees are first eligible for these postretirement benefits when they reach age 57 and have completed ten years of service with the Company. Partial benefit accrual of these health, life and long-term care benefits is recognized from the employee's date of hire until retirement based on attained service divided by potential service to age 65 with a minimum of 35 years of potential service. The Company's policy is to fund the cost of providing retiree benefits in the years that the employees are providing service to the Company. The Company's funding policy for all plans is to deposit the U.S. GAAP-related net periodic postretirement benefit cost using long-term assumptions unless the U.S. GAAP funded status is positive, in which case no deposit is made. Prior to 2001, the Company's funding policy was to deposit an amount within the range of U.S. GAAP net periodic postretirement cost and the sum of the actuarial normal cost and any change in the unfunded accrued liability over a 30-year period as a percentage of compensation.
As a result of the Company's demutualization, the postretirement benefit plans received $11.3 million in compensation, which will be used to pay benefit claims and participant contributions, with the remainder to be amortized over the remaining service period of plan participants.
Effective January 1, 2000, the Company amended the method of determining postretirement health benefit plan contributions and terminated long-term care coverage for participants retiring on and subsequent to July 1, 2000. The result of these amendments decreased the postretirement benefit obligation by $31.8 million and was partially offset by the remaining portion of the original transition obligation. During 2001, the Company reclassified assets supporting non-qualified pension plan liabilities through a reduction in contractholder funds and an increase in invested assets.
For 2001 and 2000, the expected long-term rates of return on plan assets for pension benefits were 9.0% and 8.1%, respectively, on a pre-tax basis. The assumed rate of increase in future compensation levels varies by age for both the qualified and non-qualified pension plans.
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligations starts at 9% in 2001 and declines to an ultimate rate of 6% in 2011. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans.
The Company, as a lessor, leases industrial, office, retail and other investment real estate properties under various operating leases. Rental income for all operating leases totaled $178.4 million in 2001, $292.5 million in 2000 and $356.8 million in 1999.
The Company, as a lessee, leases office space, data processing equipment, corporate aircraft and office furniture and equipment under various operating leases. Rental expense for all operating leases totaled $58.8 million in 2001, $66.3 million in 2000 and $78.5 million in 1999. At December 31, 2001, future minimum annual rental commitments under these noncancelable operating leases are as follows (in millions):
The Company is also subject to insurance guaranty laws in the states in which it writes business. These laws provide for assessments against life and health insurance companies for the benefit of policyholders and claimants in the event of insolvency of other life and health insurance companies. The assessments may be partially recovered through a reduction in future premium taxes in some states. The Company believes such assessments in excess of amounts accrued would not materially affect its financial condition or results of operations.
On November 9, 2001, the Company 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 November 27, 2001, the Company announced that its board of directors authorized a repurchase program beginning in the fourth quarter of 2001, to be completed in the three to six months following the announcement, depending on market conditions, under which the Company would purchase up to 15.3 million shares of its outstanding common stock. Stock repurchased under the program is accounted for as treasury stock, carried at cost and reflected as a reduction to stockholders' equity. Through December 31, 2001, the Company purchased the 15.3 million shares, primarily through an accelerated share repurchase program (13.0 million shares), as well as in the open market and through privately negotiated transactions, at an aggregate cost of $367.7 million. The 13.0 million shares purchased under the accelerated share repurchase program are subject to a future contingent purchase price adjustment. The adjustment will be based upon the difference between the market price of the Company's common stock as of December 14, 2001, and its volume weighted average price over an extended trading period as outlined in the forward stock purchase contract and, at the Company's determination, can be settled in either cash or shares of common stock. Settlement of this contract will occur at contract completion.
December 31, 2001 2000 1999 -------- -------- ---------- Unrealized gains (losses) on available- for-sale securities arising during the year............................... $537.7 $261.8 $(1,036.1) Adjustment for realized gains (losses) on available-for-sale securities included in net income................. (247.3) (29.9) 188.2 -------- -------- ---------- Unrealized gains (losses) on available- for-sale securities, as adjusted....... $290.4 $231.9 $ (847.9) ======== ======== ==========
The above table is presented net of tax, related changes in the amortization patterns of deferred policy acquisition costs and unearned revenue reserves.
In 2001 and 2000, Principal Life notified the Commissioner in advance of all stockholder dividend payments. Total stockholder dividends paid to its parent company in 2001 and 2000 were $734.7 million and $538.8 million, respectively.
The following discussion describes the methods and assumptions utilized by the Company in estimating its fair value disclosures for financial instruments. Certain financial instruments, particularly policyholder liabilities other than investment-type contracts, are excluded from these fair value disclosure requirements. The techniques utilized in estimating the fair values of financial instruments are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about the Company's business, its value or financial position based on the fair value information of financial instruments presented below. The estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of the Company's financial instruments.
The Company defines fair value as the quoted market prices for those instruments that are actively traded in financial markets. In cases where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. The fair value estimates are made at a specific point in time, based on available market information and judgments about the financial
instrument, including estimates of timing, amount of expected future cash flows and the credit standing of counterparties. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument.
The NAIC revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual was effective January 1, 2001. The State of Iowa adopted the provisions of the revised manual without modification. The revised manual has changed, to some extent, prescribed statutory accounting practices and has resulted in changes to the accounting practices that Principal Life uses to prepare its statutory-basis financial statements.
Statutory net income and statutory surplus of Principal Life are as follows (in millions):
As of or for the year ended December 31, 2001 2000 1999 --------- --------- ---------
Life and health insurance companies are subject to certain risk-based capital ("RBC") requirements as specified by the NAIC. Under those requirements, the amount of capital and surplus maintained by a life and health insurance company is to be determined based on the various risk factors related to it. At December 31, 2001, Principal Life meets the RBC requirements.
The International Asset Management and Accumulation segment provides asset management products and services to retail clients in Australia and institutional clients throughout the world and provides life insurance and retirement and related financial products and services primarily to businesses, their employees and other individuals principally in Australia, Chile, Brazil, New Zealand, Mexico, India, Japan, Argentina and Hong Kong.
The Corporate and Other segment includes an equity ownership interest in Coventry Health Care, Inc. The ownership interest was initiated through a transaction in 1998, described further in Note 2. The Corporate and Other segment's equity in earnings of Coventry Health Care, Inc., which was included in net investment income, was $19.8 million and $20.0 million for the years ended December 31, 2001 and 2000, respectively.
In 2001, the Company excluded $31.1 million of non-recurring items, net of tax, from net income for the presentation of operating earnings. The non-recurring items included (1) the negative effects of (a) expenses related to the demutualization; (b) a cumulative effect of change in accounting principle related to the implementation of SFAS 133; and (c) an increase to a loss contingency reserve for sales practices litigation; and (2) the positive effect of investment income generated from the proceeds of the IPO.
In 2000, the Company excluded $101.0 million of non-recurring items, net of tax, from net income for the presentation of operating earnings. The non-recurring items included the negative effects of (a) a loss contingency reserve established for sales practices litigation; and (b) expenses related to the development of a plan of demutualization.
The Company operates in the U.S. and in selected markets internationally (including Australia, Chile, Brazil, New Zealand, Mexico, India, Japan, Argentina and Hong Kong). The following table summarizes selected financial information by geographic location as of or for the year ended December 31 (in millions):
Long-lived Net income Revenues assets Assets (loss) -------- ---------- --------- ---------- U.S............... $8,143.5 $ 554.3 $83,393.6 $ 396.9 International..... 674.0 1,192.3 4,956.9 (38.1) -------- ---------- --------- ---------- Total............. $8,817.5 $ 1,746.6 $88,350.5 $ 358.8 ======== ========== ========= ========== U.S............... $8,251.4 $ 517.7 $78,879.0 $ 627.3 International..... 633.5 1,365.2 5,525.9 (7.1) -------- ---------- --------- ---------- Total............. $8,884.9 $ 1,882.9 $84,404.9 $ 620.2 ======== ========== ========= ========== U.S............... $8,313.1 $ 505.0 $78,026.4 $ 772.8 International..... 388.3 1,474.2 5,926.8 (30.7) -------- ---------- --------- ---------- Total............. $8,701.4 $ 1,979.2 $83,953.2 $ 742.1 ======== ========== ========= ==========
The Company's operations are not materially dependent on one or a few customers, brokers or agents, and revenues, assets and operating earnings are attributed to geographic location based on the country of domicile the sales originate from.
Under the terms of the Stock Incentive Plan, grants may be non-qualified stock options, incentive stock options qualifying under Section 422 of the Internal Revenue Code, restricted stock, restricted stock units and stock appreciation rights. On November 26, 2001, a one-time, grant of non-qualified stock options was made under the Stock Incentive Plan to essentially all employees, including career agents who are statutory employees.
The Stock Incentive Plan has options exercisable at November 26, 2004. Total options granted under this plan amounted to 3.7 million options in 2001. Options outstanding under the Stock Incentive Plan were granted at a price equal to the market value of the Company's common stock on the date of grant, cliff-vest after a three-year period for employees still employed or under contract and expire ten years after the grant date.
Pursuant to SFAS No. 123, Accounting for Stock-Based Compensation, the Company has elected to account for its stock option and stock purchase plans under the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees and, accordingly, employee options and stock purchases were excluded from compensation expense. However, compensation expense has been recognized for stock option awards issued to career agents using the fair value method as prescribed in FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation - An Interpretation of APB Opinion No. 25. Total compensation expense recognized in income was $13,570 for the period ended December 31, 2001.
Diluted: As reported............. $(0.08) $ 0.99 Pro forma (unaudited)... (0.08) 0.99 - -------------------- (1) Calculation of weighted-average shares included in the December 31, 2001 pro forma disclosures are described in Note 18.
The fair value per share of stock options granted during 2001 using the Black-Scholes option valuation model was $6.07. The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model and the following assumptions:
Risk-free interest rate...................... 3.7% Expected volatility of common stock.......... 37.5% Dividend yield............................... 1.12% Expected life of options..................... 3 years
17. Stock Compensation Plans (continued) The following is a summary of the status of all of the Company's stock option plans as of December 31, 2001, and related changes during the year then ended:
At December 31, 2001, the Company had 3.6 million stock options outstanding with a weighted-average remaining contractual life of 9.9 years and a weighted-average exercise price of $22.33.
For purposes of the Company's unaudited basic and diluted pro forma earnings per share calculations for the period January 1, 2001 through October 25, 2001, the weighted-average number of shares outstanding was assumed to be 360.8 million shares. These shares represent 260.8 million shares issued to policyholders entitled to receive compensation in the demutualization and 100.0 million shares sold to investors in the IPO, prior to the underwriters' exercise of the over-allotment option. The shares issued to the policyholders include 56.2 million shares issued as policy credits and held in one of the Company's separate accounts.
On February 1, 2002, the Company sold its 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 the Company will recognize an estimated net realized capital gain of $183.1 million during the first quarter of 2002.