SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 1-16725
PRINCIPAL FINANCIAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 42-1520346
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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711 High Street, Des Moines, Iowa 50392
(Address of principal executive offices)
(515) 247-5111
(Registrant's telephone number, including area code)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding as of July 31, 2003 was 323,673,772.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at June 30, 2003
(Unaudited) and December 31, 2002.......................... 3
Unaudited Consolidated Statements of Operations for the three
months and six months ended June 30, 2003 and 2002......... 4
Unaudited Consolidated Statements of Stockholders' Equity for
the six months ended June 30, 2003 and 2002................ 5
Unaudited Consolidated Statements of Cash Flows for the six
months ended June 30, 2003 and 2002........................ 6
Notes to Unaudited Consolidated Financial Statements -
June 30, 2003.............................................. 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 59
Item 4. Controls and Procedures......................................... 65
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................... 66
Item 4. Submission of Matters to a Vote of Security Holders............. 67
Item 6. Exhibits and Reports on Form 8-K................................ 68
Signature............................................................... 69
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
JUNE 30, DECEMBER 31,
2003 2002
------------------ ------------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale....................................... $37,400.2 $34,185.7
Fixed maturities, trading.................................................. 104.3 101.7
Equity securities, available-for-sale...................................... 410.5 378.7
Mortgage loans............................................................. 11,730.5 11,081.9
Real estate................................................................ 1,412.2 1,229.0
Policy loans............................................................... 808.1 818.5
Other investments.......................................................... 1,278.1 1,200.1
------------------ ------------------
Total investments....................................................... 53,143.9 48,995.6
Cash and cash equivalents.................................................. 1,525.2 1,038.6
Accrued investment income.................................................. 644.5 646.3
Premiums due and other receivables......................................... 438.8 459.7
Deferred policy acquisition costs.......................................... 1,340.5 1,414.4
Property and equipment..................................................... 459.0 482.5
Goodwill................................................................... 157.5 106.5
Other intangibles.......................................................... 118.5 88.8
Mortgage loan servicing rights............................................. 1,434.2 1,518.6
Separate account assets.................................................... 37,495.8 33,501.4
Other assets............................................................... 1,863.8 1,608.9
------------------ ------------------
Total assets............................................................ $98,621.7 $89,861.3
================== ==================
LIABILITIES
Contractholder funds....................................................... $28,179.4 $26,315.0
Future policy benefits and claims.......................................... 15,009.1 14,736.4
Other policyholder funds................................................... 755.0 642.9
Short-term debt............................................................ 665.4 564.8
Long-term debt............................................................. 1,360.2 1,332.5
Income taxes payable....................................................... 178.2 -
Deferred income taxes...................................................... 1,644.0 1,177.7
Separate account liabilities............................................... 37,495.8 33,501.4
Other liabilities.......................................................... 5,795.6 4,933.4
------------------ ------------------
Total liabilities....................................................... 91,082.7 83,204.1
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500.0 million shares
authorized, 377.2 million and 376.7 million shares issued, and 325.1
million and 334.4 million shares outstanding in 2003 and 2002,
respectively............................................................ 3.8 3.8
Additional paid-in capital................................................. 7,133.4 7,106.3
Retained earnings.......................................................... 387.3 29.4
Accumulated other comprehensive income..................................... 1,420.6 635.8
Treasury stock, at cost (52.1 million and 42.3 million shares in 2003 and
2002, respectively)..................................................... (1,406.1) (1,118.1)
------------------ ------------------
Total stockholders' equity.............................................. 7,539.0 6,657.2
------------------ ------------------
Total liabilities and stockholders' equity.............................. $98,621.7 $89,861.3
================== ==================
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- -------------------------------
2003 2002 2003 2002
--------------- ----------------- ---------------- -------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
REVENUES
Premiums and other considerations.............. $ 876.6 $1,166.6 $1,782.1 $2,052.3
Fees and other revenues........................ 689.0 437.2 1,321.0 870.1
Net investment income.......................... 857.7 823.2 1,693.7 1,634.3
Net realized/unrealized capital gains (losses). (10.9) (91.5) (87.6) 6.6
--------------- ----------------- ---------------- -------------
Total revenues.............................. 2,412.4 2,335.5 4,709.2 4,563.3
EXPENSES
Benefits, claims and settlement expenses....... 1,187.8 1,507.9 2,383.0 2,711.1
Dividends to policyholders..................... 73.9 79.5 154.0 161.9
Operating expenses............................. 865.6 599.8 1,664.9 1,192.0
--------------- ----------------- ---------------- -------------
Total expenses.............................. 2,127.3 2,187.2 4,201.9 4,065.0
--------------- ----------------- ---------------- -------------
Income from continuing operations before income
taxes....................................... 285.1 148.3 507.3 498.3
Income taxes................................... 82.5 31.9 148.3 138.2
--------------- ----------------- ---------------- -------------
Income from continuing operations, net of
related income taxes........................ 202.6 116.4 359.0 360.1
Income (loss) from discontinued operations, net
of related income taxes..................... (0.4) 3.8 (1.1) 6.1
--------------- ----------------- ---------------- -------------
Income before cumulative effect of
accounting change........................... 202.2 120.2 357.9 366.2
Cumulative effect of accounting change,
net of related income taxes................. - - - (280.9)
--------------- ----------------- ---------------- -------------
Net income..................................... $ 202.2 $ 120.2 $ 357.9 $ 85.3
=============== ================= ================ =============
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- --------------------------------
2003 2002 2003 2002
--------------------------- ----------------- --------------
EARNINGS PER COMMON SHARE
Basic and diluted earnings per common share:
Income from continuing operations, net of related
income taxes.................................... $0.62 $0.33 $1.09 $ 1.00
Income (loss) from discontinued operations, net
of related income taxes......................... - 0.01 - 0.02
--------------------------- ---------------- --------------
Income before cumulative effect of 0.62 0.34 1.09 1.02
accounting change.........................
Cumulative effect of accounting change, net of
related income taxes............................ - - - (0.78)
--------------------------- ----------------- --------------
Net income........................................ $0.62 $0.34 $1.09 $ 0.24
=========================== ================= ==============
SEE ACCOMPANYING NOTES.
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED
ADDITIONAL RETAINED OTHER TOTAL
COMMON PAID-IN EARNINGS COMPREHENSIVE TREASURY STOCKHOLDERS' OUTSTANDING
STOCK CAPITAL (DEFICIT) INCOME STOCK EQUITY SHARES
------------- ------------ ------------ --------------- ------------ -------------- -------------
(IN MILLIONS) (IN THOUSANDS)
BALANCES AT JANUARY 1, 2002...... $3.8 $7,072.5 $ (29.1) $ 147.5 $ (374.4) $6,820.3 360,142.2
Shares issued, net of put
options........................ - 14.8 - - - 14.8 569.4
Treasury stock acquired and
sold, net...................... - 1.3 - - (267.1) (265.8) (9,305.9)
Comprehensive income:
Net income..................... - - 85.3 - - 85.3
Net unrealized gains........... - - - 12.8 - 12.8
Provision for deferred
income taxes................. - - - (3.1) - (3.1)
Foreign currency
translation adjustment....... - - - 5.8 - 5.8
--------------
Comprehensive income............. 100.8
-------------- ------------ ------------ --------------- ------------ -------------- -------------
BALANCES AT JUNE 30, 2002........ $3.8 $7,088.6 $ 56.2 $ 163.0 $ (641.5) $6,670.1 351,405.7
============== ============ ============ =============== ============ ============== =============
BALANCES AT JANUARY 1, 2003...... $3.8 $7,106.3 $ 29.4 $ 635.8 $(1,118.1) $6,657.2 334,419.3
Shares issued, net of call
options........................ - 11.7 - - - 11.7 441.7
Stock-based compensation......... - 12.2 - - - 12.2
Treasury stock acquired and
sold, net...................... - 3.2 - - (288.0) (284.8) (9,779.2)
Comprehensive income:
Net income..................... - - 357.9 - - 357.9
Net unrealized gains........... - - - 1,147.0 - 1,147.0
Provision for deferred
income taxes................. - - - (398.4) - (398.4)
Foreign currency
translation adjustment....... - - - 36.2 - 36.2
--------------
Comprehensive income............. 1,142.7
-------------- ------------ ------------ --------------- ------------ -------------- -------------
BALANCES AT JUNE 30, 2003........ $3.8 $7,133.4 $ 387.3 $1,420.6 $(1,406.1) $7,539.0 325,081.8
============== ============ ============ =============== ============ ============== =============
SEE ACCOMPANYING NOTES.
5
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
------------------------------------
2003 2002
----------------- ------------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income............................................ $ 357.9 $ 85.3
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss (income) from discontinued operations, net
of related income taxes........................... 1.1 (6.1)
Cumulative effect of accounting change,
net of related income taxes....................... - 280.9
Amortization of deferred policy acquisition costs... 101.8 67.0
Additions to deferred policy acquisition costs...... (166.5) (160.0)
Accrued investment income........................... 1.8 (12.4)
Premiums due and other receivables.................. 23.7 65.2
Contractholder and policyholder liabilities
and dividends..................................... 1,064.0 1,029.9
Current and deferred income taxes................... 264.4 339.2
Net realized/unrealized capital (gains) losses...... 87.6 (6.6)
Depreciation and amortization expense............... 52.0 50.0
Amortization of mortgage servicing rights........... 221.1 140.9
Stock-based compensation............................ 10.5 -
Mortgage servicing rights valuation adjustments..... 562.9 163.5
Other............................................... 242.1 (99.1)
----------------- ------------------
Net adjustments....................................... 2,466.5 1,852.4
----------------- ------------------
Net cash provided by operating activities............. 2,824.4 1,937.7
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases........................................... (5,371.0) (7,347.0)
Sales............................................... 1,798.5 3,712.2
Maturities.......................................... 1,921.6 2,107.4
Net cash flows from trading securities................ - (41.2)
Mortgage loans acquired or originated................. (34,743.3) (20,757.9)
Mortgage loans sold or repaid......................... 34,185.0 20,985.0
Purchase of mortgage servicing rights................. (643.6) (466.5)
Proceeds from sale of mortgage servicing rights....... 34.4 3.9
Real estate acquired.................................. (161.7) (126.5)
Real estate sold...................................... 45.6 157.7
Net change in property and equipment.................. (8.4) (32.4)
Net proceeds from sales of subsidiaries............... 2.1 1.4
Purchases of interest in subsidiaries, net of cash
acquired............................................ (88.1) (49.0)
Net change in other investments....................... (92.5) 490.8
----------------- -----------------
Net cash used in investing activities................. $ (3,121.4) $ (1,362.1)
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
------------------------------------
2003 2002
----------------- ------------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock, net of call and put
options............................................ $ 11.7 $ 14.8
Acquisition and sales of treasury stock, net......... (300.0) (265.8)
Issuance of long-term debt........................... 1.9 10.7
Principal repayments of long-term debt............... (8.4) (46.9)
Net proceeds of short-term borrowings................ 107.8 (111.4)
Investment contract deposits......................... 5,052.1 4,088.7
Investment contract withdrawals...................... (4,081.5) (3,660.8)
----------------- ------------------
Net cash provided by financing activities............ 783.6 29.3
----------------- ------------------
Net increase in cash and cash equivalents............ 486.6 604.9
Cash and cash equivalents at beginning of period..... 1,038.6 561.2
----------------- ------------------
Cash and cash equivalents at end of period........... $ 1,525.2 $ 1,166.1
================= ==================
SEE ACCOMPANYING NOTES.
7
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Principal
Financial Group, Inc. and its majority-owned subsidiaries have been prepared in
conformity with accounting principles generally accepted in the U.S. ("U.S.
GAAP") for interim financial statements and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three months and six
months ended June 30, 2003, are not necessarily indicative of the results that
may be expected for the year ended December 31, 2003. These interim unaudited
consolidated financial statements should be read in conjunction with our annual
audited financial statements as of December 31, 2002, included in our Form 10-K
for the year ended December 31, 2002, filed with the United States Securities
and Exchange Commission ("SEC"). The accompanying consolidated statement of
financial position at December 31, 2002, has been derived from the audited
consolidated statement of financial position but does not include all of the
information and footnotes required by U.S. GAAP for complete financial
statements.
Reclassifications have been made to the June 30, 2002, financial statements to
conform to the June 30, 2003, presentation.
SEPARATE ACCOUNTS
At June 30, 2003 and December 31, 2002, the separate accounts included a
separate account valued at $927.8 million and $1.0 billion, respectively, which
primarily includes shares of our stock that were allocated and issued to
eligible participants of qualified employee benefit plans administered by us as
part of the policy credits issued under the demutualization. These shares are
included in both basic and diluted earnings per share calculations. The separate
account shares are recorded at fair value and are reported as separate account
assets and separate account liabilities in the consolidated statement of
financial position. Activity of the separate account shares is reflected in both
the separate account assets and separate account liabilities and does not impact
net income.
STOCK-BASED COMPENSATION
At June 30, 2003, we have four stock-based compensation plans. We applied the
fair value method to all stock-based awards granted subsequent to January 1,
2002. For stock-based awards granted prior to this date, we used the intrinsic
value method.
8
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Awards under our plans vest over periods ranging from three months to three
years. Therefore, the cost related to stock-based compensation included in the
determination of net income for the three months and six months ended June 30,
2003 and 2002, is less than that which would have been recognized if the fair
value based method had been applied to all awards since the inception of our
stock-based compensation plans. Had compensation expense for our stock option
awards and employees' purchase rights been determined based upon fair values at
the grant dates for awards under the plans in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, our net income and earnings per share would have been reduced to
the pro forma amounts indicated below. For the purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period.
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ -------------------------------
2003 2002 2003 2002
---------------- ------------- --------------- --------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Net income, as reported........................ $ 202.2 $ 120.2 $ 357.9 $ 85.3
Add: Stock-based compensation expense
included in reported net income, net
of related tax effects....................... 6.1 1.9 9.1 4.3
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects.......................... 6.9 3.7 10.8 7.7
---------------- -------------- ---------------- --------------
Pro forma net income........................... $ 201.4 $ 118.4 $ 356.2 $ 81.9
================ ============== ================ ==============
Basic and diluted earnings per share:
As reported.................................. $ 0.62 $ 0.34 $ 1.09 $ 0.24
Pro forma.................................... 0.62 0.33 1.08 0.23
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (the "FASB") issued Interpretation No.
46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("FIN 46"), in January 2003. FIN
46 provides guidance related to identifying variable interest entities and
determining whether such entities should be consolidated. In addition, FIN 46
also provides guidance related to the initial and subsequent measurement of
assets, liabilities and noncontrolling interests of newly consolidated variable
interest entities and requires disclosures for both the primary beneficiary of a
variable interest entity and other beneficiaries of the entity. FIN 46 is
effective immediately for variable interest entities created, or interests in
variable interest entities obtained, after January 31, 2003. For those variable
interest entities created, or interests in variable interest entities obtained,
on or before January 31, 2003, the guidance in FIN 46 must be applied in the
first fiscal year or interim period beginning after June 15, 2003. We have
initiated an assessment and are currently evaluating interests in entities that
may be considered variable interest entities. While the ultimate impact of
adopting FIN 46 on the consolidated financial statements is still being
reviewed, we anticipate consolidation of Principal Residential Mortgage Capital
Resources, LLC ("PRMCR"), which currently provides an off-balance sheet source
of funding for our residential mortgage loan production, by September 30, 2003.
If FIN 46 was effective as of June 30, 2003, the impact would be the
consolidation of approximately $3.7 billion in assets and liabilities related to
PRMCR.
9
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
2. FEDERAL INCOME TAXES
The effective income tax rate on net income for the three months and six months
ended June 30, 2003 and 2002, is lower than the prevailing corporate federal
income tax rate primarily due to income tax deductions allowed for corporate
dividends received and interest exclusion from taxable income, partially offset
by state income taxes.
3. COMPREHENSIVE INCOME
Comprehensive income is as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2003 2002 2003 2002
---------------- ------------- --------------- --------------
(IN MILLIONS)
COMPREHENSIVE INCOME:
Net income.............................. $ 202.2 $ 120.2 $ 357.9 $ 85.3
Net change in unrealized gains and
losses on fixed maturities,
available-for-sale.................... 978.4 406.5 1,385.2 46.9
Net change in unrealized gains and
losses on equity securities,
available-for-sale.................... 16.6 (14.4) 14.0 7.5
Adjustments for assumed changes in
amortization patterns:
Deferred policy acquisition costs..... (90.8) (66.6) (138.9) (25.1)
Unearned revenue reserves............. 4.0 3.4 6.1 0.6
Net change in unrealized gains and
losses on derivative instruments...... 3.7 (26.6) 18.1 (14.0)
Adjustments to unrealized gains for
Closed Block policyholder dividend
obligation............................ (94.0) - (132.2) -
Provision for deferred income tax
expense (281.4) (105.4) (398.4) (3.1)
Net change in unrealized gains and
losses on equity method subsidiaries.. (2.8) (0.6) (5.3) (3.1)
Change in net foreign currency
translation adjustment................ 45.4 (5.7) 36.2 5.8
---------------- ------------- --------------- --------------
Comprehensive income.................... $ 781.3 $ 310.8 $ 1,142.7 $100.8
================ ============= =============== ==============
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS
LITIGATION
We are regularly involved in litigation, both as a defendant and as a plaintiff
but primarily as a defendant. Litigation naming us as a defendant ordinarily
arises out of our business operations as a provider of asset management and
accumulation products and services, life, health and disability insurance, and
mortgage banking. Some of the lawsuits are class actions, or purport to be, and
some include claims for punitive damages. In addition, regulatory bodies, such
as state insurance departments, the SEC, the National Association of Securities
Dealers, Inc., the Department of Labor and other regulatory bodies regularly
10
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
make inquiries and conduct examinations or investigations concerning our
compliance with, among other things, insurance laws, securities laws, ERISA and
laws governing the activities of broker-dealers.
A lawsuit was filed on September 27, 2001, in the United States District Court
for the Northern District of Illinois, seeking damages and other relief on
behalf of a putative class of policyholders based on allegations that the plan
of conversion of Principal Mutual Holding Company from a mutual insurance
holding company into a stock company violates the United States Constitution.
The action is captioned ESTHER L. GAYMAN V. PRINCIPAL MUTUAL HOLDING COMPANY, ET
AL. On April 16, 2002, the Court granted our Motion to Dismiss and ordered the
lawsuit be dismissed in its entirety. On April 17, 2002, a Judgment was entered
to that effect. The Plaintiffs filed an appeal on May 15, 2002, with the 7th
Circuit Court of Appeals. On November 22, 2002, the 7th Circuit Court of Appeals
affirmed the District Court's decision. The Plaintiffs filed a Petition for a
Writ of Certiorari on April 21, 2003, requesting the United States Supreme Court
to review the decision of the 7th Circuit Court of Appeals. The Petition for a
Writ of Certiorari was denied by the United States Supreme Court on June 23,
2003.
While the outcome of any pending or future litigation cannot be predicted,
management does not believe that any pending litigation will have a material
adverse effect on our business, financial position or net income. The outcome of
litigation is always uncertain, and unforeseen results can occur. It is possible
that such outcomes could materially affect net income in a particular quarter or
annual period.
GUARANTEES AND INDEMNIFICATIONS
In the normal course of business, we have provided guarantees to third parties
primarily related to a former subsidiary, joint ventures and industrial revenue
bonds. These agreements generally expire from 2003 through 2019. The estimated
maximum exposure under these agreements as of June 30, 2003, was $171.0 million;
however, we believe the likelihood is remote that material payments will be
required and therefore have not accrued for a liability on our consolidated
statements of financial position. Should we be required to perform under these
guarantees, we generally could recover a portion of the loss from third parties
through recourse provisions included in agreements with such parties, the sale
of assets held as collateral that can be liquidated in the event that
performance is required under the guarantees or other recourse generally
available to us, minimizing the impact to net income.
In connection with the 2002 sale of BT Financial Group, we agreed to indemnify
the purchaser, Westpac Banking Corporation ("Westpac") for, among other things,
the costs associated with potential late filings made by BT Financial Group in
New Zealand prior to Westpac's ownership, up to a maximum of A$250.0 million
Australian dollars (approximately U.S. $170.0 million as of June 30, 2003). New
Zealand securities regulations allow Australian issuers to issue their
securities in New Zealand provided that certain documents are appropriately
filed with the New Zealand Registrar of Companies. Specifically, the regulations
require that any amendments to constitutions and compliance plans be filed in
New Zealand. In April 2003, the New Zealand Securities Commission ("the
Commission") opined that such late filings would result in certain New Zealand
investors having a right to return of their investment plus interest at 10% per
annum from the date of investment. Consequently, the Commission has advised that
it has initiated an inquiry into the matter, both with regard to BT Financial
Group and other similar issuers. We view these potential late filings as a
technical matter as we believe investors received the information that is
required to be provided directly to them. In addition, we believe this technical
issue may affect many in the industry and result in a favorable legislative or
judicial solution. Finally, we are reviewing the applicability of the
indemnification regarding this matter. Although we cannot predict the outcome of
this matter or reasonably estimate losses, we do not believe that it would
result in a material adverse effect on our business or financial position. It is
possible, however, that it could have a material adverse effect on net income in
a particular quarter or annual period.
11
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
4. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
In the normal course of business, we are subject to indemnification obligations
related to the sale of residential mortgage loans. Under these indemnifications,
we are required to repurchase certain mortgage loans that fail to meet the
standard representations and warranties included in the sales contracts. The
amount of our exposure is based on the potential loss that may be incurred if
the repurchased mortgage loans are processed through the foreclosure process.
Based on historical experience, total mortgage loans repurchased pursuant to
these indemnification obligations are estimated to be approximately 0.04% of
annual mortgage loan production levels. Total losses on the mortgage loans
repurchased are estimated to approximate 25% of the unpaid principal balance of
the related mortgage loans. As of June 30, 2003, $3.3 million has been accrued
for representing the fair value of such indemnifications issued after January 1,
2003, in accordance with FASB's Interpretation No. 45, GUARANTOR'S ACCOUNTING
AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF
INDEBTEDNESS OF OTHERS.
We are also subject to various other indemnification obligations issued in
conjunction with certain transactions, primarily the sale of BT Financial Group
and other divestitures, the sale of servicing rights in our mortgage banking
business, acquisitions, and financing transactions whose terms range in duration
and often are not explicitly defined. Certain portions of these indemnifications
may be capped, while other portions are not subject to such limitations.
Generally, a maximum obligation is not explicitly stated; therefore, the overall
maximum amount of the obligation under the indemnifications cannot be reasonably
estimated. While we are unable to estimate with certainty the ultimate legal and
financial liability with respect to these indemnifications, we believe the
likelihood is remote that material payments would be required under such
indemnifications and therefore such indemnifications would not result in a
material adverse effect on our business, financial position or net income. The
fair value of such indemnifications issued after January 1, 2003, was
insignificant.
5. SEGMENT INFORMATION
We provide financial products and services through the following segments: U.S.
Asset Management and Accumulation, International Asset Management and
Accumulation, Life and Health Insurance and Mortgage Banking. In addition, there
is a Corporate and Other segment. The segments are managed and reported
separately because they provide different products and services, have different
strategies or have different markets and distribution channels.
The U.S. Asset Management and Accumulation segment provides retirement and
related financial products and services primarily to businesses, their employees
and other individuals and provides asset management services to our asset
accumulation business, the life and health insurance operations, the Corporate
and Other segment and third-party clients.
The International Asset Management and Accumulation segment offers retirement
products and services, annuities, long-term mutual funds and life insurance
through subsidiaries in Argentina, Chile, Mexico, Hong Kong and India and joint
ventures in Brazil, Japan and Malaysia. Prior to October 31, 2002, the operating
segment included BT Financial Group, an Australia based asset manager. We sold
substantially all of BT Financial Group, effective October 31, 2002. As a
result, the results of operations (excluding corporate overhead) for BT
Financial Group are reported as other after-tax adjustments for all periods
presented.
The Life and Health insurance segment provides individual and group life
insurance, group health insurance and individual and group disability insurance
throughout the U.S.
The Mortgage Banking segment originates and services residential mortgage loan
products for customers in the U.S.
12
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
5. SEGMENT INFORMATION (CONTINUED)
The Corporate and Other segment manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate and
Other segment primarily reflect our financing activities, income on capital not
allocated to other segments, intersegment eliminations, income tax risk
assumptions and certain income, expenses and other after-tax adjustments not
allocated to the segments based on review of the nature of such items.
Management uses segment operating earnings for goal setting, determining
employee compensation, and evaluating performance on a basis comparable to that
used by securities analysts. We determine segment operating earnings by
adjusting U.S. GAAP net income for net realized/unrealized capital gains and
losses, as adjusted, and other after-tax adjustments which management believes
are not indicative of overall operating trends. Net realized/unrealized capital
gains and losses, as adjusted, are net of income taxes, related changes in the
amortization pattern of deferred policy acquisition costs, recognition of
front-end fee revenues for sales charges on pension products and services, net
realized capital gains and losses distributed, minority interest capital gains
and certain market value adjustments to fee revenues. Segment operating revenues
exclude net realized/unrealized capital gains and their impact on recognition of
front-end fee revenues and certain market value adjustments to fee revenues.
While these items may be significant components in understanding and assessing
the consolidated financial performance, management believes the presentation of
segment operating earnings enhances the understanding of our results of
operations by highlighting earnings attributable to the normal, ongoing
operations of the business.
The accounting policies of the segments are consistent with the accounting
policies for the consolidated financial statements, with the exception of
capital allocation and income tax allocation. We allocate capital to our
segments based upon an internal capital model that allows management to more
effectively manage our capital. The Corporate and Other segment functions to
absorb the risk inherent in interpreting and applying tax law. The segments are
allocated tax adjustments consistent with the positions we took on our tax
returns. The Corporate and Other segment results reflect any differences between
the tax returns and the estimated resolution of any disputes.
The following tables summarize selected financial information on a continuing
basis by segment and reconcile segment totals to those reported in the
consolidated financial statements:
AS OF JUNE 30, AS OF DECEMBER 31,
2003 2002
---------------------- ---------------------
(IN MILLIONS)
ASSETS:
U.S. Asset Management and Accumulation ............... $ 77,647.6 $ 70,371.9
International Asset Management and Accumulation....... 2,531.3 2,202.5
Life and Health Insurance............................. 11,857.0 11,356.3
Mortgage Banking...................................... 4,119.5 3,740.1
Corporate and Other .................................. 2,466.3 2,190.5
---------------------- ---------------------
Total consolidated assets.................... $ 98,621.7 $ 89,861.3
====================== =====================
13
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
5. SEGMENT INFORMATION (CONTINUED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation.... $ 869.0 $1,135.7 $ 1,755.0 $1,997.8
International Asset Management and
Accumulation............................ 113.0 93.6 189.8 169.5
Life and Health Insurance................. 1,001.8 984.5 2,014.1 1,963.0
Mortgage Banking.......................... 452.5 209.7 857.0 418.4
Corporate and Other....................... (6.2) 6.7 (6.9) 17.2
-------------- -------------- -------------- --------------
Total segment operating revenues........ 2,430.1 2,430.2 4,809.0 4,565.9
Net realized/unrealized capital losses,
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues............. (17.7) (94.7) (99.8) (2.6)
-------------- -------------- -------------- --------------
Total revenue per consolidated $ 2,412.4 $2,335.5 $ 4,709.2 $4,563.3
statements of operations.............. ============== ============== ============== ==============
REVENUES FROM EXTERNAL CUSTOMERS:
U.S. Asset Management and Accumulation.... $ 811.5 $1,029.4 $ 1,633.3 $1,797.7
International Asset Management and
Accumulation............................ 111.3 122.9 182.5 206.1
Life and Health Insurance................. 1,000.7 952.5 1,999.2 1,915.7
Mortgage Banking.......................... 449.7 209.7 851.8 418.4
Corporate and Other....................... 39.2 21.0 42.4 225.4
-------------- -------------- -------------- --------------
Total external revenues................. $ 2,412.4 $2,335.5 $ 4,709.2 $4,563.3
============== ============== ============== ==============
INTERSEGMENT REVENUES:
U.S. Asset Management and Accumulation.... $ 12.9 $ 13.4 $ 26.2 $ 28.0
International Asset Management and
Accumulation............................ - - - -
Life and Health Insurance................. (1.5) (1.6) (2.8) (3.1)
Mortgage Banking.......................... 2.8 - 5.2 -
Corporate and Other....................... (14.2) (11.8) (28.6) (24.9)
-------------- -------------- -------------- --------------
Total................................... $ - $ - $ - $ -
============== ============== ============== ==============
14
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
5. SEGMENT INFORMATION (CONTINUED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(IN MILLIONS)
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ... $ 108.2 $ 102.1 $ 205.7 $ 202.3
International Asset Management and
Accumulation............................ 12.1 3.9 18.7 5.1
Life and Health Insurance................. 62.9 61.7 122.0 116.0
Mortgage Banking.......................... 45.1 24.8 97.4 51.3
Corporate and Other ...................... (10.4) (6.0) (15.4) (5.7)
-------------- -------------- -------------- --------------
Total segment operating earnings........ 217.9 186.5 428.4 369.0
Net realized/unrealized capital losses,
as adjusted............................. (15.3) (70.1) (69.4) (6.9)
Other after-tax adjustments (1)........... (0.4) 3.8 (1.1) (276.8)
-------------- -------------- -------------- --------------
Net income per consolidated $ 202.2 $ 120.2 $ 357.9 $ 85.3
statements of operations.............. ============== ============== ============== ==============
- --------------------
(1) For the three months ended June 30, 2003, other after-tax adjustments of
($0.4) million included the negative effect of a change in the estimated
loss on disposal of BT Financial Group.
For the three months ended June 30, 2002, other after-tax adjustments of
$3.8 million included the positive effect of the income from discontinued
operations of BT Financial Group.
For the six months ended June 30, 2003, other after-tax adjustments of
($1.1) million included the negative effect of a change in the estimated
loss on disposal of BT Financial Group.
For the six months ended June 30, 2002, other after-tax adjustments of
($276.8) million included (1) the negative effects of (a) a cumulative
effect of accounting change related to the implementation of SFAS 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, ($280.9 million) and (b) expenses
related to the demutualization ($2.0 million); and (2) the positive effect
of the income from discontinued operations of BT Financial Group ($6.1
million).
6. STOCKHOLDERS' EQUITY
In May 2003, our board of directors authorized the repurchase of up to $300.0
million of our outstanding common stock. The repurchases will be made in the
open market or through privately negotiated transactions, from time to time,
depending on market conditions.
15
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2003
(UNAUDITED)
7. EARNINGS PER SHARE
The computations of the basic and diluted per share amounts for our continuing
operations were as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------- ----------------------------------
2003 2002 2003 2002
----------------- ---------------- ----------------- ----------------
(IN MILLIONS)
Income from continuing
operations................. $202.6 $116.4 $359.0 $360.1
================= ================ ================= ================
Weighted-average shares
outstanding:
Basic...................... 326.9 356.8 329.1 358.6
Dilutive effect:
Stock options............ 0.5 0.5 0.5 0.4
Restricted stock units (1) - - - -
----------------- ---------------- ----------------- ----------------
Diluted.................... 327.4 357.3 329.6 359.0
================= ================ ================= ================
Income from continuing
operations per share:
Basic...................... $ 0.62 $ 0.33 $ 1.09 $ 1.00
================= ================ ================= ================
Diluted.................... $ 0.62 $ 0.33 $ 1.09 $ 1.00
================= ================ ================= ================
- -----------------
(1) The dilutive effect was less than 0.1 million shares.
The calculation of diluted earnings per share for the three months and six
months ended June 30, 2003 and 2002, excludes the incremental effect related to
certain stock-based compensation grants due to their anti-dilutive effect.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis discusses our financial condition as of June 30, 2003,
compared with December 31, 2002, and our consolidated results of operations for
the three months and six months ended June 30, 2003 and 2002, prepared in
conformity with accounting principles generally accepted in the U.S. ("U.S.
GAAP"). The discussion and analysis includes, where appropriate, factors that
may affect our future financial performance. The discussion should be read in
conjunction with our Form 10-K, for the year ended December 31, 2002, filed with
the United States Securities and Exchange Commission and the unaudited
consolidated financial statements and the related notes to the financial
statements and the other financial information included elsewhere in this Form
10-Q.
FORWARD-LOOKING INFORMATION
Our narrative analysis below contains forward-looking statements intended to
enhance the reader's ability to assess our future financial performance.
Forward-looking statements include, but are not limited to, statements that
represent our beliefs concerning future operations, strategies, financial
results or other developments, and contain words and phrases such as
"anticipate," "believe," "plan," "estimate," "expect," "intend," and similar
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects on us. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to
the following: (1) a decline or increased volatility in the securities markets
could result in investors withdrawing from the markets or decreasing their rates
of investment, either of which could reduce our net income, revenues and assets
under management; (2) our investment portfolio is subject to several risks which
may diminish the value of our invested assets and affect our sales,
profitability and the investment returns credited to our customers; (3)
competition from companies that may have greater financial resources, broader
arrays of products, higher ratings and stronger financial performance may impair
our ability to retain existing customers, attract new customers and maintain our
profitability; (4) a downgrade in Principal Life Insurance Company's ("Principal
Life") financial strength ratings may increase policy surrenders and
withdrawals, reduce new sales and terminate relationships with distributors and
cause some of our existing liabilities to be subject to acceleration, additional
collateral support, changes in terms, or creation of additional financial
obligations; (5) our efforts to reduce the impact of interest rate changes on
our profitability and surplus may not be effective; (6) if we are unable to
attract and retain sales representatives and develop new distribution sources,
sales of our products and services may be reduced; (7) our international
businesses face political, legal, operational and other risks that could reduce
our profitability in those businesses; (8) our reserves established for future
policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (9) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends Iowa insurance
laws impose on Principal Life; (10) we may need to fund deficiencies in our
closed block ("Closed Block") assets which benefit only the holders of Closed
Block policies; (11) changes in laws, regulations or accounting standards may
reduce our profitability; (12) litigation and regulatory investigations may harm
our financial strength and reduce our profitability; (13) fluctuations in
foreign currency exchange rates could reduce our profitability; (14) applicable
laws and our stockholder rights plan, certificate of incorporation and by-laws
may discourage takeovers and business combinations that our stockholders might
consider in their best interests; and (15) a downgrade in our debt ratings may
adversely affect our ability to secure funds and cause some of our existing
liabilities to be subject to acceleration, additional collateral support,
changes in terms, or creation of additional financial obligations.
17
OVERVIEW
We provide financial products and services through the following segments:
o U.S. Asset Management and Accumulation, which consists of our asset
accumulation operations, which provide products and services, including
retirement savings and related investment products and services, and our
asset management operations conducted through Principal Global Investors.
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
Principal International, offers retirement products and services,
annuities, long-term mutual funds and life insurance through subsidiaries
in Argentina, Chile, Mexico, Hong Kong and India and joint ventures in
Brazil, Japan, and Malaysia. Prior to October 31, 2002, the segment
included BT Financial Group, an Australia based asset manager. We sold
substantially all of BT Financial Group, effective October 31, 2002. See
"Transactions Affecting Comparability of Results of Operations."
o Life and Health Insurance, which provides life insurance, health insurance
as well as disability insurance throughout the U.S. Our life insurance
products include universal and variable universal life, traditional life,
and group life. Our health insurance products include medical insurance,
dental and vision insurance, and administrative services. Our disability
insurance products include individual and group disability insurance.
o Mortgage Banking, which engages in originating, purchasing, selling and
servicing residential mortgage loans in the U.S.
o Corporate and Other, which manages the assets representing capital that has
not been allocated to any other segment. Financial results of the Corporate
and Other segment primarily reflect our financing activities, income on
capital not allocated to other segments, intersegment eliminations, income
tax risk assumptions and certain income, expenses and other after-tax
adjustments not allocated to the segments based on review of the nature of
such items.
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during 2003 and 2002:
IDBI - PRINCIPAL ASSET MANAGEMENT COMPANY. On June 24, 2003, our wholly-owned
subsidiary, Principal Financial Group (Mauritius) Ltd. finalized a buy-sale
agreement to purchase an additional 50% ownership of IDBI - Principal Asset
Management Company in India from Industrial Development Bank of India ("IDBI")
for 940 million Indian Rupees ("INR") (approximately U.S. $20.3 million). This
transaction gives Principal Financial Group (Mauritius) Ltd. 100% ownership of
IDBI - Principal Asset Management Company. Upon completion of the transaction,
IDBI - Principal Asset Management Company was renamed to Principal Asset
Management Company.
Principal Financial Group (Mauritius) Ltd. is also in negotiations to sell
minority ownership of Principal Asset Management Company to Punjab National Bank
and Vijaya Bank, two large Indian commercial banks. Subsequent to the close of
these transactions, Principal Financial Group (Mauritius) Ltd. will retain
18
majority ownership of Principal Asset Management Company. We expect to close
negotiations in the second half of 2003.
As part of our International Asset Management and Accumulation segment, we
account for Principal Asset Management Company's statements of financial
position using the full consolidation method of accounting. Activity that
affected our statements of operations before our acquisition of majority
ownership of the subsidiary is accounted for using the equity method of
accounting. Activity that will affect our statements of operations in future
periods will be accounted for using the full consolidation method of accounting.
AFORE TEPEYAC S.A. DE C.V. On February 28, 2003, we purchased a 100% ownership
of AFORE Tepeyac S.A. de C.V. ("AFORE Tepeyac") in Mexico from Mapfre American
Vida, Caja Madrid and Mapfre Tepeyac for MX$590.0 million Mexican Pesos ("MX$")
(approximately U.S. $53.5 million). The operations of AFORE Tepeyac have been
integrated into Principal International, Inc., as a part of our International
Asset Management and Accumulation segment.
BENEFIT CONSULTANTS, INC. On January 1, 2003, we acquired Benefit Consultants,
Inc. ("BCI Group") headquartered in Appleton, Wisconsin. BCI Group is a
full-service consulting, actuarial and administration firm that specializes in
administering qualified and nonqualified retirement benefit plans with a primary
focus on employee stock ownership plans. Effective, January 1, 2003, the
operations of BCI Group are reported in our U.S. Asset Management and
Accumulation segment. We are in the process of integrating BCI Group operations
into Principal Life.
ZURICH AFORE S.A. DE C.V. On May 31, 2002, we purchased a 100% ownership of
Zurich AFORE S.A. de C.V. ("Zurich AFORE") in Mexico from Zurich Financial
Services for MX$468.4 million (approximately U.S. $49.0 million). The operations
of Zurich AFORE have been integrated into Principal International, Inc., as a
part of our International Asset Management and Accumulation segment.
DISPOSITIONS
We entered into disposition agreements or disposed of the following businesses,
among others, during 2003 and 2002:
BT FINANCIAL GROUP. On October 31, 2002, we sold substantially all of BT
Financial Group to Westpac Banking Corporation ("Westpac"). As of June 30, 2003,
we have received proceeds of A$950.0 million Australian dollars ("A$") (U.S.
$530.9 million) from Westpac, with future contingent proceeds in 2004 of up to
A$150.0 million (approximately U.S. $80.0 million). The contingent proceeds will
be based on Westpac's future success in growing retail funds under management.
Excluding contingent proceeds, our total estimated after-tax proceeds from the
sale are expected to be approximately U.S. $875.0 million. This amount includes
cash proceeds from Westpac, expected tax benefits, and gain from unwinding the
hedged asset associated with our investment in BT Financial Group. As of June
30, 2003, we have received $699.1 million of the expected total proceeds.
As of December 31, 2002, we accrued for an estimated after-tax loss on disposal
of $208.7 million. During the three months ended and six months ended June 30,
2003, we incurred an additional after-tax loss of $0.4 million and $1.1 million,
respectively. These losses are recorded in the loss from discontinued operations
in the consolidated statements of operations. Although we are unable to estimate
the impacts at this time, we expect a reduction in the after-tax loss on sale of
BT Financial Group to be recorded in the third quarter of 2003.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, ACCOUNTING FOR THE
19
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, and therefore is still included in
our results of continuing operations. The results of operations (excluding
corporate overhead) for BT Financial Group are reported as other after-tax
adjustments in our International Asset Management and Accumulation segment.
Selected financial information for the discontinued operations is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------------- --------------------------
2003 2002 2003 2002
------------ ----------- ------------ ------------
(IN MILLIONS, EXCEPT AS INDICATED)
Total assets under management ($ in
billions).................................. $ - $18.6 $ - $ 18.6
============ =========== ============ ============
Total revenues............................... $ - $44.1 $ - $ 88.9
============ =========== ============ ===========
Loss from continuing operations
(corporate overhead)....................... $ - $(0.7) $ - $ (1.5)
Income (loss) from discontinued operations:
Income (loss) before income taxes............ - 5.7 - 12.3
Income taxes................................. - 1.9 - 6.2
------------ ----------- ------------ ------------
Income from discontinued operations.......... - 3.8 - 6.1
Loss on disposal, net of related income
taxes...................................... (0.4) - (1.1) -
------------ ----------- ------------ ------------
Income (loss) from discontinued operations,
net of related income taxes................ (0.4) 3.8 (1.1) 6.1
Cumulative effect of accounting change, net
of related income taxes.................... - - - (255.4)
------------ ----------- ------------ ------------
Net income (loss)............................ $(0.4) $ 3.1 $ (1.1) $(250.8)
============ =========== ============ ============
In connection with the 2002 sale of BT Financial Group, we agreed to indemnify
the purchaser, Westpac for, among other things, the costs associated with
potential late filings made by BT Financial Group in New Zealand prior to
Westpac's ownership, up to a maximum of A$250.0 million Australian dollars
(approximately U.S. $170.0 million as of June 30, 2003). New Zealand securities
regulations allow Australian issuers to issue their securities in New Zealand
provided that certain documents are appropriately filed with the New Zealand
Registrar of Companies. Specifically, the regulations require that any
amendments to constitutions and compliance plans be filed in New Zealand. In
April 2003, the New Zealand Securities Commission ("the Commission") opined that
such late filings would result in certain New Zealand investors having a right
to return of their investment plus interest at 10% per annum from the date of
investment. Consequently, the Commission has advised that it has initiated an
inquiry into the matter, both with regard to BT Financial Group and other
similar issuers. We view these potential late filings as a technical matter as
we believe investors received the information that is required to be provided
directly to them. In addition, we believe this technical issue may affect many
in the industry and result in a favorable legislative or judicial solution.
Finally, we are reviewing the applicability of the indemnification regarding
this matter. Although we cannot predict the outcome of this matter or reasonably
estimate losses, we do not believe that it would result in a material adverse
effect on our business or financial position. It is possible, however, that it
could have a material adverse effect on net income in a particular quarter or
annual period.
COVENTRY HEALTH CARE. On February 1, 2002, we sold our remaining stake of 15.1
million shares of Coventry Health Care, Inc. ("Coventry") common stock and a
warrant, exercisable for 3.1 million shares of Coventry common stock. We
20
received proceeds of $325.4 million, resulting in a net realized capital gain of
$183.0 million, or $114.5 million net of income taxes.
We reported our investment in Coventry in our Corporate and Other segment and
accounted for it using the equity method prior to its sale. Our share of
Coventry's net income was $2.1 million for the six months ended June 30, 2002.
OTHER TRANSACTIONS
SALE OF RETAIL FIELD MORTGAGE LENDING BRANCH OFFICES. On February 5, 2003,
Principal Residential Mortgage signed a definitive agreement to sell the retail
field mortgage lending branches to American Home Mortgage, Inc. ("American Home
Mortgage"), an independent retail mortgage banking company. American Home
Mortgage has paid Principal Residential Mortgage a guaranteed profit margin on
its application pipeline that existed as of February 4, 2003 and has purchased
the assets of the branch network and assumed related liabilities.
REINSURANCE TRANSACTION. Effective January 1, 2002, we entered into a
reinsurance agreement to reinsure group medical insurance contracts. We have
amended the contract. Effective January 1, 2003, the reinsurance contract will
be reported under the deposit method of accounting. Prospectively, this will
reduce ceded premiums and claims and increase operating expenses with no impact
to net income.
FLUCTUATIONS IN FOREIGN CURRENCY TO U.S. DOLLAR EXCHANGE RATES
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
In January 2002, the Argentine government ended its tie of the Argentine peso to
the U.S. dollar, creating a dual currency system with an official fixed exchange
rate of 1.4 pesos to 1.0 U.S. dollar for import and export transactions and a
"free" floating exchange rate for other transactions, subsequently floating the
Argentine peso in February 2002. The devaluation did not materially impact our
consolidated results of operations.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
operating earnings and net income. Our consolidated net income was negatively
impacted $3.2 million and $8.1 million for the three months ended June 30, 2003
and 2002 and negatively impacted $5.0 million and $6.8 million for the six
months ended June 30, 2003 and 2002, respectively, as a result of fluctuations
in foreign currency to U.S. dollar exchange rates. For a discussion of our
approaches to foreign currency exchange rate risk, see Item 3. "Quantitative and
Qualitative Disclosures about Market Risk."
PENSION AND OTHER POST-RETIREMENT BENEFIT EXPENSE
The 2003 annual pension benefit expense for substantially all of our employees
and certain agents is expected to be approximately $60.2 million pre-tax, $39.1
million after-tax. This is an annual pre-tax increase of $53.7 million over the
2002 pre-tax pension expense of $6.5 million. Our consolidated net income
reflected approximately $15.0 million and $30.1 million of pre-tax pension
expense for the three months ended June 30, 2003 and six months ended June 30,
2003, respectively. In addition, approximately $15.0 million of pre-tax pension
expense will be reflected in each of the remaining two quarters of 2003. This
increase in expense over 2002 is primarily due to the impact of low interest
rates and the equity market downturn. The discount rate used to value the
liabilities was lowered to 6.5% from the 2002 discount rate of 7.5% and the
return on assets assumption was lowered to 8.5% from the 2002 return on assets
21
assumption of 9.0%. To a lesser extent, the expense for other post-retirement
benefits expense increased as well.
PERMANENT IMPAIRMENT OF MORTGAGE SERVICING RIGHTS
During the second quarter of 2003, we established a policy of evaluating
permanent impairment of our mortgage servicing rights. Each quarter we will
evaluate permanent impairment of our mortgage servicing rights and will
recognize a direct write-down when the gross carrying value is not expected to
be recovered in the foreseeable future. We estimate the amount of permanent
impairment based on an analysis of the mortgage servicing rights valuation
allowance related to loans that have prepaid. During the three months ending
June 30, 2003, we recorded a permanent impairment of our mortgage servicing
rights of approximately $500.2 million, which reduced the gross carrying value
and the valuation allowance of the mortgage servicing rights, thereby precluding
subsequent reversals. This write-down had no impact on our net income or
financial position in the current quarter but may result in a reduction of
amortization expense in future periods.
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
periods indicated:
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ---------------------------
2003 2002 2003 2002
------------ ----------- ------------ -----------
(IN MILLIONS)
INCOME STATEMENT DATA:
Revenues:
Premiums and other considerations............... $ 876.6 $ 1,166.6 $ 1,782.1 $ 2,052.3
Fees and other revenues......................... 689.0 437.2 1,321.0 870.1
Net investment income........................... 857.7 823.2 1,693.7 1,634.3
Net realized/unrealized capital gains (losses).. (10.9) (91.5) (87.6) 6.6
------------ ----------- ------------ -----------
Total revenues................................ 2,412.4 2,335.5 4,709.2 4,563.3
Expenses:
Benefits, claims and settlement expenses........ 1,187.8 1,507.9 2,383.0 2,711.1
Dividends to policyholders...................... 73.9 79.5 154.0 161.9
Operating expenses.............................. 865.6 599.8 1,664.9 1,192.0
------------ ----------- ------------ -----------
Total expenses................................ 2,127.3 2,187.2 4,201.9 4,065.0
------------ ----------- ------------ -----------
Income from continuing operations before
income taxes.................................... 285.1 148.3 507.3 498.3
Income taxes...................................... 82.5 31.9 148.3 138.2
------------ ----------- ---------- -----------
Income from continuing operations, net of
related income taxes........................ 202.6 116.4 359.0 360.1
Income (loss) from discontinued operations, net of
related income taxes............................ (0.4) 3.8 (1.1) 6.1
------------ ----------- ------------ -----------
Income before cumulative effect of accounting
changes......................................... 202.2 120.2 357.9 366.2
Cumulative effect of accounting changes, net of
related income taxes............................ - - - (280.9)
------------ ----------- ------------ -----------
Net income.................................... $ 202.2 $ 120.2 $ 357.9 $ 85.3
============ =========== ============ ===========
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Premiums and other considerations decreased $290.0 million, or 25%, to $876.6
million for the three months ended June 30, 2003, from $1,166.6 million for the
three months ended June 30, 2002. The decrease reflected a $304.9 million
22
decrease from the U.S. Asset Management and Accumulation segment, primarily a
result of a decrease in pension full-service payout sales of single premium
group annuities with life contingencies, which are typically used to fund
defined benefit plan terminations. The premium income received from these
contracts fluctuates due to the variability in the number and size of pension
plan terminations, the interest rate environment and the ability to attract new
sales.
Fees and other revenues increased $251.8 million, or 58%, to $689.0 million for
the three months ended June 30, 2003, from $437.2 million for the three months
ended June 30, 2002. The increase was primarily due to a $221.5 million increase
from the Mortgage Banking segment resulting from an increase in mortgage loan
production fee revenues, reflecting the increase in mortgage loan production
volume. The increase also related to an $18.5 million increase from the U.S.
Asset Management and Accumulation segment primarily related to increased
revenues from Spectrum (our asset manager of investment-grade preferred
securities portfolios), the acquisition of BCI Group and improvements in the
equity markets and net cash flow, which have led to higher account values.
Net investment income increased $34.5 million, or 4%, to $857.7 million for the
three months ended June 30, 2003, from $823.2 million for the three months ended
June 30, 2002. The increase was primarily a result of a $6,507.0 million, or
14%, increase in average invested assets and cash. Partially offsetting the
increase was a decrease in annualized investment yields. The annualized yield on
average invested assets and cash was 6.5% for the three months ended June 30,
2003, compared to 7.1% for the three months ended June 30, 2002. This reflects
lower yields on fixed maturity securities and commercial mortgages due in part
to a lower interest rate environment.
Net realized/unrealized capital losses decreased $80.6 million, or 88%, to $10.9
million for the three months ended June 30, 2003, from $91.5 million for the
three months ended June 30, 2002. The decrease was primarily due to a $99.0
million reduction in write downs of other than temporary declines in the value
of certain fixed maturity securities.
Benefits, claims and settlement expenses decreased $320.1 million, or 21%, to
$1,187.8 million for the three months ended June 30, 2003, from $1,507.9 million
for the three months ended June 30, 2002. The decrease was primarily due to a
$310.6 million decrease from the U.S. Asset Management and Accumulation segment,
reflecting a decrease in pension full-service payout sales of single premium
group annuities with life contingencies.
Dividends to policyholders decreased $5.6 million, or 7%, to $73.9 million for
the three months ended June 30, 2003, from $79.5 million for the three months
ended June 30, 2002. The decrease was primarily attributable to a $3.3 million
decrease from the Life and Health Insurance segment, resulting from changes in
the individual life insurance dividend scale and a decrease in the dividend
interest crediting rates. In addition, the decrease resulted from a $2.3 million
decrease from the U.S. Asset Management and Accumulation segment resulting from
a decrease in dividends for our pension full-service accumulation products.
Operating expenses increased $265.8 million, or 44%, to $865.6 million for the
three months ended June 30, 2003, from $599.8 million for the three months ended
June 30, 2002. The increase was largely due to a $209.7 million increase from
the Mortgage Banking segment primarily resulting from growth in the mortgage
loan servicing portfolio, an increase in impairment of capitalized mortgage
servicing rights net of servicing hedge activity and an increase in the mortgage
loan production volume. The increase was also due to a $37.3 million increase in
the U.S Asset Management and Accumulation segment due to higher compensation
related costs including incentive compensation accruals and increases in
employee benefit costs, expenses from BCI Group, resetting the mean reversion
period for deferred policy acquisition cost ("DPAC") amortization, and the
expansion of our asset management offshore operations.
Income taxes increased $50.6 million to $82.5 million for the three months ended
June 30, 2003 from $31.9 million for the three months ended June 30, 2002. The
effective income tax rate was 29% for the three months ended June 30, 2003 and
23
22% for the three months ended June 30, 2002. The effective income tax rates for
the three months ended June 30, 2003 and 2002 were lower than the corporate
income tax rate of 35% primarily due to income tax deductions allowed for
corporate dividends received and interest exclusion from taxable income,
partially offset by state income taxes. The increase in the effective tax rate
to 29% for the three months ended June 30, 2003, from 22% for the three months
ended June 30, 2002, was primarily due to the increase in net income before
taxes, as the amount of permanent tax differences changed very little.
As a result of the foregoing factors and the inclusion of income (loss) from
discontinued operations, net of related income taxes, net income increased $82.0
million, or 68%, to $202.2 million for the three months ended June 30, 2003,
from $120.2 million for the three months ended June 30, 2002. The income (loss)
from discontinued operations was related to our sale of BT Financial Group.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
Premiums and other considerations decreased $270.2 million, or 13%, to $1,782.1
million for the six months ended June 30, 2003, from $2,052.3 million for the
six months ended June 30, 2002. The decrease reflected a $300.7 million decrease
from the U.S. Asset Management and Accumulation segment, primarily a result of a
decrease in pension full-service payout sales of single premium group annuities
with life contingencies, which are typically used to fund defined benefit plan
terminations. The premium income received from these contracts fluctuates due to
the variability in the number and size of pension plan terminations, the
interest rate environment and the ability to attract new sales. The decrease was
partially offset by a $34.1 million increase from the Life and Health Insurance
segment, primarily related to health premium rate increases, a reduction in
ceded premiums resulting from a change in the accounting treatment of a group
medical reinsurance contract, and increased group disability sales.
Fees and other revenues increased $450.9 million, or 52%, to $1,321.0 million
for the six months ended June 30, 2003, from $870.1 million for the six months
ended June 30, 2002. The increase was primarily due to a $400.4 million increase
from the Mortgage Banking segment resulting from an increase in mortgage loan
production fee revenues, reflecting the increase in mortgage loan production
volume. The increase also related to a $30.2 million increase from the U.S.
Asset Management and Accumulation segment primarily related to increased
revenues from Spectrum, improvements in the equity markets and net cash flow,
which have led to higher account values and the acquisition of BCI Group.
Net investment income increased $59.4 million, or 4%, to $1,693.7 million for
the six months ended June 30, 2003, from $1,634.3 million for the six months
ended June 30, 2002. The increase was primarily a result of a $6,020.7 million,
or 13%, increase in average invested assets and cash. Partially offsetting the
increase was a decrease in annualized investment yields. The annualized yield on
average invested assets and cash was 6.5% for the six months ended June 30,
2003, compared to 7.1% for the six months ended June 30, 2002. This reflects
lower yields on fixed maturity securities and commercial mortgages due in part
to a lower interest rate environment.
Net realized/unrealized capital losses increased $94.2 million to $87.6 million
of net realized/unrealized capital losses for the six months ended June 30,
2003, from $6.6 million of net realized/unrealized capital gains for the six
months ended June 30, 2002. The increase was primarily due to a $183.0 million
capital gain realized as the result of the sale of our remaining investment in
Coventry in February 2002 with no corresponding activity in 2003. This was
partially offset by a $79.2 million decrease in other than temporary impairments
of fixed maturity securities.
Benefits, claims and settlement expenses decreased $328.1 million, or 12%, to
$2,383.0 million for the six months ended June 30, 2003, from $2,711.1 million
for the six months ended June 30, 2002. The decrease was due to a $322.8 million
decrease from the U.S. Asset Management and Accumulation segment, primarily
24
reflecting a decrease in pension full-service payout sales of single premium
group annuities with life contingencies
Dividends to policyholders decreased $7.9 million, or 5%, to $154.0 million for
the six months ended June 30, 2003, from $161.9 million for the six months ended
June 30, 2002. The decrease was primarily attributable to a $5.8 million
decrease from the Life and Health Insurance segment, resulting from changes in
the individual life insurance dividend scale and a decrease in the dividend
interest crediting rates. In addition, the decrease resulted from a $2.1 million
decrease from the U.S. Asset Management and Accumulation segment resulting from
a decrease in dividends for our pension full-service accumulation products.
Operating expenses increased $472.9 million, or 40%, to $1,664.9 million for the
six months ended June 30, 2003, from $1,192.0 million for the six months ended
June 30, 2002. The increase was largely due to a $363.5 million increase from
the Mortgage Banking segment primarily resulting from growth in the mortgage
loan servicing portfolio, an increase in impairment of capitalized mortgage
servicing rights net of servicing hedge activity and an increase in the mortgage
loan production volume. The increase was also due to a $82.6 million increase in
the U.S Asset Management and Accumulation segment due to higher compensation
related costs including incentive compensation accruals and increases in
employee benefit costs, expenses from BCI Group, resetting the mean reversion
period for DPAC amortization, and the expansion of our asset management offshore
operations.
Income taxes increased $10.1 million, or 7%, to $148.3 million for the six
months ended June 30, 2003 from $138.2 million for the six months ended June 30,
2002. The effective income tax rate was 29% for the six months ended June 30,
2003 and 28% for the six months ended June 30, 2002. The effective income tax
rates for the six months ended June 30, 2003 and 2002 were lower than the
corporate income tax rate of 35% primarily due to income tax deductions allowed
for corporate dividends received and interest exclusion from taxable income,
partially offset by state income taxes.
As a result of the foregoing factors and the inclusion of income (loss) from
discontinued operations and the cumulative effect of accounting change, net of
related income taxes, net income increased $272.6 million to $357.9 million for
the six months ended June 30, 2003, from $85.3 million for the six months ended
June 30, 2002. The income (loss) from discontinued operations was related to our
sale of BT Financial Group. The cumulative effect of accounting change was
related to our implementation of SFAS No. 142, GOODWILL AND OTHER INTANGIBLE
ASSETS ("SFAS 142") in 2002.
RESULTS OF OPERATIONS BY SEGMENT
We use operating earnings, which excludes the effect of net realized/unrealized
capital gains and losses, as adjusted, and other after-tax adjustments, for goal
setting, determining employee compensation, and evaluating performance on a
basis comparable to that used by securities analysts. Segment operating earnings
are determined by adjusting U.S. GAAP net income for net realized/unrealized
capital gains and losses, as adjusted, and other after-tax adjustments we
believe are not indicative of overall operating trends. Note that after-tax
adjustments have occurred in the past and could recur in future reporting
periods. 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, ongoing
operations of our businesses.
The following table presents segment information as of or for the periods
indicated:
25
AS OF OR FOR THE THREE AS OF OR FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- ------------- -------------- -------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation........ $ 869.0 $ 1,135.7 $ 1,755.0 $ 1,997.8
International Asset Management and
Accumulation................................ 113.0 93.6 189.8 169.5
Life and Health Insurance..................... 1,001.8 984.5 2,014.1 1,963.0
Mortgage Banking.............................. 452.5 209.7 857.0 418.4
Corporate and Other (1)....................... (6.2) 6.7 (6.9) 17.2
-------------- ------------- -------------- -------------
Total segment operating revenues............ 2,430.1 2,430.2 4,809.0 4,565.9
Net realized/unrealized capital losses,
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues(2).............. (17.7) (94.7) (99.8) (2.6)
-------------- ------------- -------------- -------------
Total revenue per consolidated statements $ 2,412.4 $ 2,335.5 $ 4,709.2 $ 4,563.3
of operations............................. ============== ============= ============== =============
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation ....... $ 108.2 $ 102.1 $ 205.7 $ 202.3
International Asset Management and
Accumulation................................ 12.1 3.9 18.7 5.1
Life and Health Insurance..................... 62.9 61.7 122.0 116.0
Mortgage Banking.............................. 45.1 24.8 97.4 51.3
Corporate and Other .......................... (10.4) (6.0) (15.4) (5.7)
-------------- ------------- -------------- -------------
Total segment operating earnings............ 217.9 186.5 428.4 369.0
Net realized/unrealized capital losses, as
adjusted(2)................................. (15.3) (70.1) (69.4) (6.9)
Other after-tax adjustments(3)................ (0.4) 3.8 (1.1) (276.8)
-------------- ------------- -------------- -------------
Net income per consolidated statements of $ 202.2 $ 120.2 $ 357.9 $ 85.3
operations................................ ============== ============= ============== =============
TOTAL ASSETS BY SEGMENT:
U.S. Asset Management and Accumulation (4).... $ 77,647.6 $ 69,752.1 $ 77,647.6 $ 69,752.1
International Asset Management and
Accumulation................................ 2,531.3 4,794.6 2,531.3 4,794.6
Life and Health Insurance..................... 11,857.0 11,132.5 11,857.0 11,132.5
Mortgage Banking.............................. 4,119.5 2,965.3 4,119.5 2,965.3
Corporate and Other (5)....................... 2,466.3 1,548.9 2,466.3 1,548.9
-------------- ------------- -------------- -------------
Total assets................................ $ 98,621.7 $ 90,193.4 $ 98,621.7 $ 90,193.4
============== ============= ============== =============
- -----------------------
(1)Includes inter-segment eliminations primarily related to internal investment
management fee revenues, commission fee revenues paid to U.S. Asset
Management and Accumulation agents for selling Life and Health Insurance
segment insurance products, internal interest paid to our Mortgage Banking
segment for escrow accounts deposited with our U.S. Asset Management and
Accumulation segment.
(2)In addition to sales activity and other than temporary impairments, net
realized/unrealized capital gains (losses) include unrealized gains (losses)
on mark to market changes of certain seed money investments and investments
classified as trading securities, as well as unrealized gains (losses) on
certain derivatives. Net realized/unrealized capital gains (losses), as
adjusted, are net of income taxes, net realized capital gains and losses
distributed, minority interest capital gains, 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.
26
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
-------------- --------------- -------------- ---------------
(IN MILLIONS)
Net realized/unrealized capital gains
(losses)..................................... $ (10.9) $ (91.5) $ (87.6) $ 6.6
Certain market value adjustments to fee
revenues..................................... (6.7) (4.6) (16.5) (13.2)
Recognition of front-end fee revenues.......... (0.1) 1.4 4.3 4.0
-------------- --------------- -------------- ---------------
Net realized/unrealized capital losses,
revenues and certain market value
adjustments to fee revenues ............... (17.7) (94.7) (99.8) (2.6)
Amortization of deferred policy acquisition
costs related to net realized/unrealized
capital gains (losses)....................... (0.4) 1.4 3.3 12.3
Capital gains distributed...................... (3.5) (21.8) (1.9) (21.8)
Minority interest capital losses............... 0.4 - 0.3 -
-------------- --------------- -------------- ---------------
Net realized/unrealized capital losses,
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues, net of related
amortization of deferred policy acquisition
costs, capital losses distributed and
minority capital gains..................... (21.2) (115.1) (98.1) (12.1)
Income tax effect ............................. 5.9 45.0 28.7 5.2
-------------- --------------- -------------- ---------------
Net realized/unrealized capital losses, as $ (15.3) $ (70.1) $ (69.4) $ (6.9)
adjusted..................................... ============== =============== ============== ===============
(3)For the three months ended June 30, 2003, other after-tax adjustments of
$0.4 million included the negative effect of a change in the estimated loss
on disposal of BT Financial Group. For the three months ended June 30, 2002,
other after-tax adjustments of $3.8 million included the positive effect of
income from discontinued operations of BT Financial Group. For the six months
ended June 30, 2003, other after-tax adjustments of $1.1 million included the
negative effect of a change in the estimated loss on disposal of BT Financial
Group. For the six months ended June 30, 2002, other after-tax adjustments of
$276.8 million included (1) the negative effects of: (a) a cumulative effect
of accounting change related to our implementation of SFAS 142 ($280.9
million) and (b) expenses related to our demutualization ($2.0 million) and
(2) the positive effect of income from discontinued operations of BT
Financial Group ($6.1 million).
(4)U.S. Asset Management and Accumulation separate account assets include
shares of Principal Financial Group stock allocated to a separate account, a
result of our demutualization. The value of the separate account was $927.8
million at June 30, 2003, and $1.2 billion at June 30, 2002. Activity of the
separate account was reflected in both separate account assets and separate
account liabilities and did not impact our results of operations.
(5)Includes inter-segment elimination amounts related to internally generated
mortgage loans and an internal line of credit. The U.S. Asset Management and
Accumulation segment and Life and Health Insurance segment reported mortgage
loan assets issued for real estate joint ventures. These mortgage loans were
reported as liabilities in the Corporate and Other segment. In addition, the
Corporate and Other segment managed a revolving line of credit used by other
segments.
27
U.S. ASSET MANAGEMENT AND ACCUMULATION SEGMENT
The following table presents certain summary financial data relating to the U.S.
Asset Management and Accumulation segment for the periods indicated:
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- -------------------------------
2003 2002 2003 2002
---------------- ------------- ------------- --------------
(IN MILLIONS)
OPERATING EARNINGS DATA:
Operating revenues(1):
Premiums and other considerations..... $ 74.4 $ 379.3 $ 188.2 $ 488.9
Fees and other revenues............... 193.5 171.4 378.3 345.1
Net investment income................. 601.1 585.0 1,188.5 1,163.8
---------------- ------------- ------------- --------------
Total operating revenues............ 869.0 1,135.7 1,755.0 1,997.8
Expenses:
Benefits, claims and settlement
expenses including dividends to
policyholders 508.6 821.5 1,044.2 1,369.1
Operating expenses.................... 219.9 183.5 445.3 371.0
---------------- ------------- ------------- --------------
Total expenses...................... 728.5 1,005.0 1,489.5 1,740.1
---------------- ------------- ------------- --------------
Pre-tax operating earnings.............. 140.5 130.7 265.5 257.7
Income taxes............................ 32.3 28.6 59.8 55.4
---------------- ------------- ------------- --------------
Operating earnings...................... 108.2 102.1 205.7 202.3
Net realized/unrealized capital losses,
as adjusted .......................... (29.0) (60.4) (60.1) (105.2)
Other after-tax adjustments............. - - - -
---------------- ------------- ------------- --------------
U. S. GAAP REPORTED:
Net income.............................. $ 79.2 $ 41.7 $ 145.6 $ 97.1
================ ============= ============= ==============
- --------------------
(1) Excludes net realized/unrealized capital losses and their impact on
recognition of front-end fee revenues and certain market value adjustments
to fee revenues.
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Premiums and other considerations decreased $304.9 million, or 80%, to $74.4
million for the three months ended June 30, 2003, from $379.3 million for the
three months ended June 30, 2002. The decrease primarily resulted from a $317.9
million decrease in pension full-service payout sales of single premium group
annuities with life contingencies, which are typically used to fund defined
benefit plan terminations. The premium income received from these contracts
fluctuates due to the variability in the number and size of pension plan
terminations, the interest rate environment and the ability to attract new
sales. The decrease was slightly offset by an increase of $13.0 million
primarily resulting from increased individual payout annuity sales due to an
expanding distribution presence.
Fees and other revenues increased $22.1 million, or 13%, to $193.5 million for
the three months ended June 30, 2003, from $171.4 million for the three months
ended June 30, 2002. Pension full-service accumulation fees and other revenue
increased $14.2 million primarily due to an increase in revenue from
improvements in the equity markets and net cash flow, which have led to higher
account values and the acquisition of BCI Group. In addition, Principal Global
Investors fees and other revenues increased $4.8 million primarily due to
increased revenues from Spectrum.
28
Net investment income increased $16.1 million, or 3%, to $601.1 million for the
three months ended June 30, 2003, from $585.0 million for the three months ended
June 30, 2002. The increase primarily resulted from a $4,367.0 million, or 13%,
increase in average invested assets and cash. The increase was offset by a
decrease in the average annualized yield on invested assets and cash, which was
6.1% for the three months ended June 30, 2003, compared to 6.7% for the three
months ended June 30, 2002. This reflects lower yields on fixed matu