The following table sets forth certain selected historical consolidated financial information of Principal Financial Group, Inc., the successor to Principal Mutual Holding Company, following our demutualization effective October 26, 2001. We derived the consolidated financial information for each of the years ended December 31, 2001, 2000 and 1999 and as of December 31, 2001 and 2000 from our audited consolidated financial statements and notes to the financial statements included in this Form 10-K. We derived the consolidated financial information for the years ended December 31, 1998 and 1997 and as of December 31, 1999, 1998 and 1997 from our audited consolidated financial statements not included in this Form 10-K. The following summary consolidated financial information, other than the Principal Life statutory data, has been prepared in accordance with U.S. GAAP.
(9) We have provided statutory data from annual statements of Principal Life filed with insurance regulatory authorities. Certain financial information for periods beginning on or after January 1, 2001, is not comparable to information from earlier periods. We prepared statutory data as of or for the year ended December 31, 2001, in conformity with the NAIC Codification of Statutory Principles ("Codification"), adopted as prescribed and permitted by the Insurance Division, Department of Commerce of the State of Iowa, effective January 1, 2001. As allowed by Codification, we did not restate prior period information. We prepared statutory data as of or for the years ended December 31, 2000, 1999, 1998 and 1997 in conformity with accounting practices prescribed or permitted on the dates thereof by the Insurance Division, Department of Commerce of the State of Iowa.
(11)Codification, as adopted by Principal Life on January 1, 2001, has impacted the reporting of Principal Life's statutory net income for the year ended December 31, 2001. Under Codification our net income has been significantly impacted due to a change in the accounting for undistributed income (loss) from subsidiaries. We no longer report undistributed income (loss) from subsidiaries as part of net investment income, but rather report these amounts as unrealized gains and losses, which are excluded from the calculation of net income. This has the effect of decreasing reported total statutory revenues and net income, but has no effect on statutory surplus. Undistributed income from subsidiaries for the years ended December 31, 2000 and 1999 were $208.9 million and $159.9 million, respectively, and undistributed loss from subsidiaries for the years ended December 31, 1998 and 1997 were $0.4 million and $41.3 million respectively.
o Life and Health Insurance, which provides individual life and disability insurance as well as group life and health insurance throughout the U.S. Our individual insurance products include interest-sensitive life, traditional life and disability insurance. Our group insurance products include life, disability, medical, dental and vision insurance, and administrative services.
Our group life and health insurance premiums and premium equivalents for the years ended December 31, 2001, 2000 and 1999 were as follows:
Spectrum Asset Management. On October 1, 2001, Spectrum Asset Management became an affiliate of Principal Capital Management, LLC. The acquisition was accounted for using the purchase method and the results of operations of the acquired business have been included in our financial statements from the date of acquisition. We included revenues of $0.8 million in 2001 in our consolidated results of operations.
Costs relating to the demutualization, excluding costs relating to the IPO, incurred through December 31, 2001, were $18.6 million and $7.2 million, net of tax, in 2001 and 2000, respectively. Demutualization expenses consist primarily of printing and mailing costs and our aggregate cost of engaging independent accounting, actuarial, financial, investment banking, legal and other consultants to advise us on the demutualization. In addition, our costs include the costs of the advisors of the Insurance Commissioner of the State of Iowa and the New York State Insurance Department, other regulatory authorities and internal allocated costs for staff and related costs associated with the demutualization.
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, our 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. We have estimated the impairment amount that will result from the adoption of SFAS 142 on January 1, 2002, and expect an after-tax impairment of approximately $300.0 million. The impairment will be recognized in our first quarter 2002 consolidated financial statements as a cumulative effect of a change in accounting principle.
The following table presents summary consolidated financial information for the years indicated:
(2) For the year ended December 31, 2001, non-recurring interest income included the positive effect of investment income generated from the proceeds of our IPO.
Net investment income increased $14.2 million, or 1%, to $2,303.9 million for the year ended December 31, 2000, from $2,289.7 million for the year ended December 31, 1999. The increase was primarily due to a $1,561.6 million, or 5%, increase in average invested assets and cash for the segment. The yield on average invested assets and cash was 7.3% for the year ended December 31, 2000, compared to 7.6% 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.
Operating expenses increased $114.6 million, or 18%, to $740.9 million for the year ended December 31, 2000, from $626.3 million for the year ended December 31, 1999. An increase of $57.3 million was primarily due to a change in our assumptions related to amortization of deferred policy acquisition costs attributable to pension products. An additional $28.7 million increase was primarily related to an increase in pension salary and incentive compensation costs and other pension administrative costs. Operating expenses also increased $9.7 million for our mutual fund business, primarily the result of increased sales of third-party mutual funds and also due to other mutual fund operating expenses. An $8.3 million increase in operating expenses related to our individual annuity business was primarily due to an increase in amortization of deferred policy acquisition costs. Additionally, a $6.5 million increase in operating expenses for Principal Capital Management was primarily related to an increase in incentive compensation costs.
Net investment income increased $24.0 million, or 23%, to $129.0 million for the year ended December 31, 2001, from $105.0 million for the year ended December 31, 2000. An increase of $36.1 million from Principal International related to a 21% increase in average invested assets and cash and an increase in investment yields. The yield on average invested assets and cash was 9.6% for the year ended December 31, 2001, compared to 8.0% for the year ended December 31, 2000. The increase in investment yields was partially due to the impact of inflation on nominal yields in Chile, which was offset by a corresponding increase in reserve changes. The increase in net investment income was partially offset by the $8.7 million loss of net investment income resulting from the divestiture of our operations in Spain and a $2.7 million decrease related to BT Financial Group.
Expenses: Benefits, claims and settlement expenses.... 2,491.0 2,659.4 2,714.9 Dividends to policyholders.................. 307.0 308.1 295.6 Operating expenses.......................... 842.7 913.6 872.0 -------- -------- -------- Total expenses............................ 3,640.7 3,881.1 3,882.5 -------- -------- -------- Pre-tax operating earnings.................... 305.7 241.5 103.0 Income taxes.................................. 104.5 79.2 12.3 -------- -------- -------- Operating earnings............................ 201.2 162.3 90.7
Total operating revenues increased $397.6 million to $757.4 million for the year ended December 31, 2001, from $359.8 million for the year ended December 31, 2000. A $308.4 million increase in mortgage loan production revenues reflects the increase in mortgage loan production volume during the year ended December 31, 2001. In addition, an increase of $89.2 million in mortgage loan servicing revenues reflects the growth in the mortgage loan servicing portfolio. The decline in interest rates in 2001 resulted in mortgage loan production of $37.8 billion for the year ended December 31, 2001, compared to $8.3 billion for the same period a year ago. The average balance of the servicing portfolio was $65.8 billion for the year ended December 31, 2001, compared to $52.6 billion for the same period a year ago.
Expenses: Total expenses................................ 43.3 14.4 54.1 ------- ------- ------- Pre-tax operating earnings......................... 57.5 82.7 7.8 Income taxes (benefits)............................ 19.4 15.0 (1.7) ------- ------- ------- Operating earnings................................. 38.1 67.7 9.5 Net realized capital gains (losses), as adjusted... (93.3) 80.3 284.5 Non-recurring items................................ (20.4) (101.0) - ------- ------- ------- U.S. GAAP Reported: Net income (loss).................................. $ (75.6) $ 47.0 $ 294.0 ======= ======= ======= - -------------------- (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.
As a result of the foregoing factors and the inclusion of non-recurring items for the year ended December 31, 2000, net income decreased $247.0 million, or 84%, to $47.0 million for the year ended December 31, 2000, from $294.0 million for the year ended December 31, 1999. 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).
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. The primary source of our liquidity is dividends we receive from Principal Life. We could also receive dividends from our other subsidiaries, including Princor Financial Services Corporation, Principal Financial Services (Australia) Inc., Principal International de Chile, S.A. and PFG do Brasil Ltda; however, given the historical cash flows of the operations and financial results of these subsidiaries, it is unlikely we may rely upon them for significant cash flow in the next year. The payment of dividends by Principal Life to us is limited by Iowa laws. Under Iowa laws, Principal Life may pay dividends only from the earned surplus arising from its business and must receive the prior approval of the Insurance Commissioner of the State of Iowa ("the Commissioner") to pay a stockholder dividend if such a stockholder dividend would exceed certain statutory limitations. The current statutory limitation is the greater of:
Principal Life maintains investment strategies generally intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with longer lives, such as life insurance and full-service payout pension products, are matched with assets having similar estimated lives such as mortgage loans, long-term bonds and private placement bonds. Shorter-term liabilities are matched with investments such as short and medium-term fixed maturities. In addition, highly liquid, high quality short-term U.S. Treasury securities and other liquid investment grade fixed maturities are held to fund anticipated operating expenses, surrenders, withdrawals and development and maintenance expenses associated with new
(3) Market Value Out: The amount equal to the book value out plus a market value adjustment to adjust for changes in interest rates.
On March 10, 1994, Principal Life issued $300.0 million of surplus notes, including $200.0 million due March 1, 2024, at a 7.875% annual interest rate and the remaining $100.0 million due March 1, 2044, at an 8% annual interest rate. No affiliates of ours hold any portion of the notes. Each payment of interest and principal on the notes, however, may be made only with the prior approval of the Commissioner and only to the extent that Principal Life has sufficient surplus earnings to make such payments. For each of the years ended December 31, 2001, 2000 and 1999, interest of $23.8 million was approved by the Commissioner, paid and charged to expense.
We had total consolidated assets as of December 31, 2001, of $88.4 billion, of which $44.8 billion were invested assets. The rest of our total consolidated assets are comprised primarily of separate account assets for which we do not bear investment risk. Because we generally do not bear any investment risk on assets held in separate accounts, the discussion and financial information below does not include such assets. Of our invested assets, $43.4 billion were held by our U.S. operations and the remaining $1.4 billion were held by our International Asset Management and Accumulation segment.
Guaranty-fund assessments are accrued for anticipated assessments, which are estimated using data available from various industry sources that monitor the current status of open and closed insolvencies. The Company has also established an other asset for assessments expected to be recovered through future premium tax offsets.
On November 24, 1999, the Company purchased all of the outstanding units of BT Hotels in response to a hostile buyout offer. At that time, the intent of the Company's management was to immediately resyndicate the trust or resell the trust properties, therefore, the Company recorded 100% ownership of BT Hotels under the cost method. As of December 31, 2001, all due diligence and active bids to sell were ceased and BT Hotels was fully consolidated into the Company's financial statements, which did not have a material impact on total assets and revenue.
The Company is retained as the servicer of the mortgage loans and also performs accounting and various administrative functions on behalf of PRMF, in its capacity as the managing member of PRMF. As the servicer, the Company receives a servicing fee pursuant to the pooling and servicing agreement. The Company may also receive a successful servicing fee only after all other conditions in the monthly cash flow distribution are met. At December 31, 2001, the Company's residual interest in such cash flows was $21.5 million and was recorded in other investments on the Company's consolidated statements of financial position. The value of the residual interest was based on the net present value of expected cash flows from PRMF, as well as estimates of foreclosure losses associated with the related loans. The Company is required to advance funds for payment of interest on the participation certificates and other carrying costs, if sufficient cash is not available in the collection account to meet this obligation.
The Company and the Trust are parties to a cost of funds hedge agreement. The Company pays the weighted average cost of funds on the participation certificates plus fees and expenses and receives the indicated swap bid rate, subject to a cap.
In 2001, the Company recognized a pre-tax net gain of $95.5 million relating to its fair value hedges. This includes a net gain of $151.7 million related to the ineffective portion of its fair value hedges of residential mortgage loan servicing rights and a net loss of $43.6 million related to the change in the value of the servicing hedges that was excluded from the assessment of hedge effectiveness. The net gain on servicing hedges was reported with operating expenses on the consolidated statement of operations. The net gain of $95.5 million also includes a net loss of $12.6 million related to the ineffective portion of the Company's investment hedges, which was reported with net realized capital gains (losses) on the consolidated statement of operations.
December 31, 2001 2000 -------- -------- (in millions) Closed Block liabilities Future policy benefits and claims................. $5,248.7 $5,051.5 Other policyholder funds.......................... 20.3 4.8 Policyholder dividends payable.................... 376.6 402.2 Other liabilities................................. 11.8 22.6 -------- -------- Total Closed Block liabilities.................. 5,657.4 5,481.1
On August 25, 1999, Principal Financial Group (Australia) Holdings Pty Limited, a wholly-owned indirect subsidiary of the Company, issued $665.0 million of unsecured redeemable long-term debt ($200.0 million of 7.95% notes due August 15, 2004, and $465.0 million in 8.2% notes due August 15, 2009). Interest on the notes is payable semiannually on February 15 and August 15 of each year, commencing February 15, 2000. Principal Financial Group (Australia) Holdings Pty Limited used the net proceeds from the notes to partially fund the purchase of the outstanding stock of several companies affiliated with Bankers Trust Australia Group (see Note 2). On December 28, 2001, all of the long-term debt obligations of Principal Financial Group (Australia) Holdings Pty Limited were assumed by its parent, PFSI.
The Company has defined benefit pension plans covering substantially all of its employees and certain agents. Some of these plans provide supplemental pension benefits to employees with salaries and/or pension benefits in excess of the qualified plan limits imposed by federal tax law. The employees and agents are generally first eligible for the pension plans when they reach age 21. For plan participants employed prior to January 1, 2002, the pension benefits are based on the greater of a final average pay benefit or a cash balance benefit. The final average pay benefit is based on the years of service and generally the employee's or agent's average annual compensation during the last five years of employment. Partial benefit accrual of final average pay benefits is recognized from first eligibility until retirement based on attained service divided by potential service to age 65 with a minimum of 35 years of potential service. The cash balance portion of the plan will start on January 1, 2002. An employee's account will be credited with an amount based on the employee's salary, age and service. These credits will accrue with interest. For plan participants hired on and after January 1, 2002, only the cash balance plan applies. The Company's policy is to fund the cost of providing pension benefits in the years that the employees and agents are providing service to the Company. The Company's funding policy for all plans is to deposit the U.S. GAAP-related net periodic pension cost using long-term assumptions, unless the U.S. GAAP funded status is positive, in which case no deposit is made. Prior to 2001, the Company's funding policy was to deposit an amount within the range of U.S. GAAP net periodic pension 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.
Less future sublease rental income on these noncancelable leases.. 2.8 ------ Total future minimum lease payments............................... $213.8 ======
Under Iowa law, Principal Life may pay stockholder dividends only from the earned surplus arising from its business and must receive the prior approval of the Commissioner to pay a stockholder dividend if such a stockholder dividend would exceed certain statutory limitations. The current statutory limitation is the greater of 10% of Principal Life's policyholder surplus as of the preceding year-end or the net gain from operations from the previous calendar year. Based on this limitation and 2001 statutory results, Principal Life could pay approximately $640.3 million in stockholder dividends in 2002 without exceeding the statutory limitation.
Fair values of public debt and equity securities have been determined by the Company from public quotations, when available. Private placement securities and other fixed maturities and equity securities are valued by discounting the expected total cash flows. Market rates used are applicable to the yield, credit quality and average maturity of each security.
The carrying amounts and estimated fair values of the Company's financial instruments at December 31, 2001 and 2000, are as follows (in millions):
Reconciliations of weighted-average shares outstanding and net income (loss) for basic and diluted net income per share for the year ended December 31, 2001, and for the period October 26, 2001 through December 31, 2001, are presented below:
- -------------------- (1) Fourth quarter 2001 earnings per share are on a pro forma basis as the Company's IPO did not close until October 26, 2001. See Note 1. Actual net income per common share for the period from October 26, 2001 through December 31, 2001, was $(0.08) for basic and diluted computations.