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 September 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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1-16725
(Commission file number)
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 October 24, 2003 was 322,968,071.
PRINCIPAL FINANCIAL GROUP, INC.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Position at September 30,
2003 (Unaudited) and December 31, 2002.......................3
Unaudited Consolidated Statements of Operations for the three
months and nine months ended September 30, 2003 and 2002.....4
Unaudited Consolidated Statements of Stockholders' Equity for the
nine months ended September 30, 2003 and 2002................6
Unaudited Consolidated Statements of Cash Flows for the nine
months ended September 30, 2003 and 2002.....................7
Notes to Unaudited Consolidated Financial Statements - September
30, 2003.....................................................9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...........................................22
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......76
Item 4. Controls and Procedures..........................................83
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................84
Item 6. Exhibits and Reports on Form 8-K.................................85
Signature................................................................86
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------------ ------------------
(Unaudited) (Note 1)
(IN MILLIONS,
EXCEPT PER SHARE DATA)
ASSETS
Fixed maturities, available-for-sale....................................... $ 36,898.0 $34,185.7
Fixed maturities, trading.................................................. 103.5 101.7
Equity securities, available-for-sale...................................... 398.8 378.7
Mortgage loans............................................................. 15,385.7 11,081.9
Real estate................................................................ 1,515.5 1,229.0
Policy loans............................................................... 805.8 818.5
Other investments.......................................................... 1,218.6 1,200.1
------------------ ------------------
Total investments....................................................... 56,325.9 48,995.6
Cash and cash equivalents.................................................. 1,008.0 1,038.6
Accrued investment income.................................................. 631.9 646.3
Premiums due and other receivables......................................... 792.2 459.7
Deferred policy acquisition costs.......................................... 1,445.6 1,414.4
Property and equipment..................................................... 450.4 482.5
Goodwill................................................................... 154.3 106.5
Other intangibles.......................................................... 123.4 88.8
Mortgage loan servicing rights............................................. 1,892.4 1,518.6
Separate account assets.................................................... 39,443.5 33,501.4
Other assets............................................................... 1,501.9 1,608.9
------------------ ------------------
Total assets............................................................ $103,769.5 $89,861.3
================== ==================
LIABILITIES
Contractholder funds....................................................... $ 28,086.1 $26,315.0
Future policy benefits and claims.......................................... 15,159.9 14,736.4
Other policyholder funds................................................... 730.6 642.9
Short-term debt............................................................ 2,810.8 564.8
Long-term debt............................................................. 2,745.9 1,332.5
Income taxes payable....................................................... 25.3 -
Deferred income taxes...................................................... 1,710.9 1,177.7
Separate account liabilities............................................... 39,443.5 33,501.4
Other liabilities.......................................................... 5,588.4 4,933.4
------------------ ------------------
Total liabilities....................................................... 96,301.4 83,204.1
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share - 2,500.0 million shares
authorized, 377.3 million and 376.7 million shares issued, and 322.8
million and 334.4 million shares outstanding in 2003 and 2002,
respectively............................................................ 3.8 3.8
Additional paid-in capital................................................. 7,142.4 7,106.3
Retained earnings.......................................................... 603.6 29.4
Accumulated other comprehensive income..................................... 1,202.4 635.8
Treasury stock, at cost (54.5 million and 42.3 million shares in 2003 and
2002, respectively)..................................................... (1,484.1) (1,118.1)
------------------ ------------------
Total stockholders' equity.............................................. 7,468.1 6,657.2
------------------ ------------------
Total liabilities and stockholders' equity.............................. $ 103,769.5 $89,861.3
================== ==================
SEE ACCOMPANYING NOTES.
3
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- --------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
REVENUES
Premiums and other considerations.............. $ 868.8 $ 888.7 $2,650.9 $ 2,941.0
Fees and other revenues........................ 525.1 516.6 1,846.1 1,386.7
Net investment income.......................... 877.9 821.2 2,571.6 2,455.5
Net realized/unrealized capital losses......... (5.7) (230.6) (93.3) (224.0)
---------------- ---------------- --------------- ---------------
Total revenues.............................. 2,266.1 1,995.9 6,975.3 6,559.2
EXPENSES
Benefits, claims and settlement expenses....... 1,175.7 1,231.6 3,558.7 3,942.7
Dividends to policyholders..................... 78.7 79.1 232.7 241.0
Operating expenses............................. 727.5 640.2 2,392.4 1,832.2
---------------- ---------------- --------------- ---------------
Total expenses.............................. 1,981.9 1,950.9 6,183.8 6,015.9
---------------- ---------------- --------------- ---------------
Income from continuing operations before
income taxes................................ 284.2 45.0 791.5 543.3
Income taxes................................... 78.1 2.4 226.4 140.6
---------------- ---------------- --------------- ---------------
Income from continuing operations, net of
related income taxes........................ 206.1 42.6 565.1 402.7
Income (loss) from discontinued operations,
net of related income taxes................. 12.4 (201.0) 11.3 (194.9)
---------------- ---------------- --------------- ---------------
Income (loss) before cumulative effect of
accounting changes.......................... 218.5 (158.4) 576.4 207.8
Cumulative effect of accounting
changes, net of related income taxes (2.2) - (2.2) (280.9)
---------------- ---------------- --------------- ---------------
Net income (loss).............................. $ 216.3 $ (158.4) $ 574.2 $ (73.1)
================ ================ =============== ===============
4
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
---------------- -------------- --------------- ---------------
EARNINGS PER COMMON SHARE
Basic earnings per common share:
Income from continuing operations, net of related
income taxes.................................... $ 0.64 $ 0.12 $ 1.73 $ 1.13
Income (loss) from discontinued operations, net
of related income taxes......................... 0.04 (0.58) 0.03 (0.54)
---------------- -------------- --------------- ---------------
Income (loss) before cumulative effect of (0.46) 1.76 0.59
accounting changes.............................. 0.68
Cumulative effect of accounting changes, net of
related income taxes............................ (0.01) - (0.01) (0.80)
---------------- -------------- --------------- ---------------
Net income (loss)................................. $ 0.67 $(0.46) $ 1.75 $(0.21)
================ ============== =============== ===============
Diluted earnings per common share:
Income from continuing operations, net of related
income taxes.................................... $ 0.64 $ 0.12 $ 1.73 $ 1.13
Income (loss) from discontinued operations, net
of related income taxes......................... 0.04 (0.57) 0.03 (0.55)
---------------- -------------- --------------- ---------------
Income (loss) before cumulative effect of (0.45) 1.76 0.58
accounting changes.............................. 0.68
Cumulative effect of accounting changes, net of
related income taxes............................ (0.01) - (0.01) (0.79)
---------------- -------------- --------------- ---------------
Net income (loss)................................. $ 0.67 $(0.45) $ 1.75 $(0.21)
================ ============== =============== ===============
SEE ACCOMPANYING NOTES.
5
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........................ - 17.8 - - - 17.8 710.8
Stock-based compensation......... - 7.4 - - - 7.4
Treasury stock acquired and
sold, net...................... - 1.3 - - (500.1) (498.8) (17,624.8)
Comprehensive income:
Net loss....................... - - (73.1) - - (73.1)
Net unrealized gains........... - - - 411.2 - 411.2
Provision for deferred
income taxes................. - - - (146.5) - (146.5)
Foreign currency translation
adjustment................... - - - 95.7 - 95.7
-------------
Comprehensive income............. 287.3
-------------- ----------- ------------- ---------------- ----------- ------------- -------------
BALANCES AT SEPTEMBER 30, 2002... $3.8 $7,099.0 $(102.2) $ 507.9 $ (874.5) $6,634.0 343,228.2
============== =========== ============= ================ =========== ============= =============
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........................ - 14.9 - - - 14.9 578.0
Stock-based compensation......... - 18.0 - - - 18.0
Treasury stock acquired and
sold, net...................... - 3.2 - - (366.0) (362.8) (12,156.3)
Comprehensive income:
Net income..................... - - 574.2 - - 574.2
Net unrealized gains........... - - - 816.6 - 816.6
Provision for deferred
income taxes................. - - - (294.7) - (294.7)
Foreign currency
translation adjustment....... - - - 35.5 - 35.5
Cumulative effect of
accounting change, net of
related income taxes......... - - - 9.2 - 9.2
-------------
Comprehensive income............. 1,140.8
-------------- ----------- ------------- ---------------- ----------- ------------- -------------
BALANCES AT SEPTEMBER 30, 2003... $3.8 $7,142.4 $ 603.6 $1,202.4 $(1,484.1) $7,468.1 322,841.0
============== =========== ============= ================ =========== ============= =============
SEE ACCOMPANYING NOTES.
6
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2003 2002
----------------- ----------------
(IN MILLIONS)
OPERATING ACTIVITIES
Net income (loss)..................................... $ 574.2 $ (73.1)
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss (income) from discontinued operations, net
of related income taxes........................ (11.3) 194.9
Cumulative effect of accounting changes,
net of related income taxes.................... 2.2 280.9
Amortization of deferred policy acquisition costs. 142.3 109.6
Additions to deferred policy acquisition costs.... (253.1) (233.5)
Accrued investment income......................... 24.5 9.1
Premiums due and other receivables................ (0.8) (45.1)
Contractholder and policyholder liabilities
and dividends.................................. 1,473.3 1,545.5
Current and deferred income taxes................. 251.5 310.4
Net realized/unrealized capital losses............ 93.3 224.0
Depreciation and amortization expense............. 79.7 74.5
Amortization of mortgage servicing rights......... 336.8 223.9
Stock-based compensation.......................... 16.2 7.4
Mortgage servicing rights valuation adjustments... 367.1 800.5
Other............................................. (70.1) 91.1
----------------- ----------------
Net adjustments....................................... 2,451.6 3,593.2
----------------- ----------------
Net cash provided by operating activities............. 3,025.8 3,520.1
INVESTING ACTIVITIES
Available-for-sale securities:
Purchases......................................... (7,435.7) (11,882.9)
Sales............................................. 1,660.6 6,081.3
Maturities........................................ 4,007.7 3,109.1
Net cash flows from trading securities................ - (69.1)
Mortgage loans acquired or originated................. (54,000.8) (33,052.9)
Mortgage loans sold or repaid......................... 53,397.8 32,703.2
Purchase of mortgage servicing rights................. (930.1) (690.7)
Proceeds from sale of mortgage servicing rights....... 34.4 6.4
Real estate acquired.................................. (220.9) (143.3)
Real estate sold...................................... 76.0 198.2
Net change in property and equipment.................. (15.6) (41.8)
Net proceeds from sales of subsidiaries............... 33.6 1.4
Purchases of interest in subsidiaries, net of
cash acquired..................................... (95.4) (48.0)
Net change in other investments....................... 52.6 397.6
----------------- ----------------
Net cash used in investing activities................. $ (3,435.8) $ (3,431.5)
7
PRINCIPAL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2003 2002
----------------- ----------------
(IN MILLIONS)
FINANCING ACTIVITIES
Issuance of common stock, net of call and
put options....................................... $ 14.9 $ 17.8
Acquisition and sales of treasury stock, net......... (378.0) (498.8)
Issuance of long-term debt........................... 4.4 11.0
Principal repayments of long-term debt............... (84.4) (85.7)
Net proceeds of short-term borrowings................ 0.9 (37.3)
Investment contract deposits......................... 6,935.0 5,510.2
Investment contract withdrawals...................... (6,310.7) (5,072.1)
Net increase in Principal Bank deposits.............. 197.3 136.6
----------------- ----------------
Net cash provided by (used in) financing activities.. 379.4 (18.3)
----------------- ----------------
Net increase (decrease) in cash and cash equivalents. (30.6) 70.3
Cash and cash equivalents at beginning of period..... 1,038.6 561.2
----------------- ----------------
Cash and cash equivalents at end of period........... $ 1,008.0 $ 631.5
================= ================
SEE ACCOMPANYING NOTES.
8
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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., its majority-owned subsidiaries and, subsequent to June
30, 2003 its consolidated variable interest entities ("VIE"), 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 nine
months ended September 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 September 30, 2002 financial statements
to conform to the September 30, 2003 presentation.
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 applies to certain entities in which equity investors do not have the
characteristics of a controlling financial interest, or do not have sufficient
equity at risk for the entities to finance their activities without additional
subordinated financial support from other parties. FIN 46 requires the
consolidation of VIEs in which an enterprise, known as the primary beneficiary,
absorbs a majority of the entity's expected losses, receives a majority of the
entity's expected residual returns, or both, as a result of ownership,
contractual or other financial interests in the entity.
FIN 46 established new accounting guidance relating to the consolidation of
VIEs. The guidance was effective immediately for all VIEs created after January
31, 2003, and effective July 1, 2003, for all VIEs created before February 1,
2003. In October 2003, the FASB released Staff Position FIN 46-6, EFFECTIVE DATE
OF FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, that
allows the deferral of FIN 46 for all VIEs created or acquired prior to February
1, 2003, until the end of the first interim or annual period ending after
December 15, 2003, if certain conditions are met. Subsequent to February 1,
2003, we invested in one VIE, for which we are the primary beneficiary, and
consolidated in accordance with FIN 46. Effective July 1, 2003, we consolidated
all VIEs created or acquired prior to February 1, 2003, for which we are the
primary beneficiary.
As of September 30, 2003, our consolidated financial statements were adjusted to
record a cumulative effect of adopting FIN 46, as follows (in millions):
ACCUMULATED OTHER
COMPREHENSIVE
NET LOSS INCOME
------------------ ----------------------
Cumulative effect of accounting change....................... $(4.1) $14.1
Income tax impact............................................ 1.9 (4.9)
------------------ ----------------------
Total........................................................ $(2.2) $ 9.2
================== ======================
9
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
See Note 2 for the disclosures relating to VIEs and the impact of such adoption
on our consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("SFAS 150"). SFAS 150
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify certain financial instruments as liabilities that, under
previous guidance, issuers accounted for as equity. We adopted SFAS 150 on July
1, 2003, which did not have a material impact to our consolidated financial
statements.
On July 7, 2003, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 03-1, ACCOUNTING AND REPORTING BY INSURANCE
ENTERPRISES FOR CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE
ACCOUNTS. This SOP addresses an insurance enterprise's accounting for certain
fixed and variable contract features not covered by other authoritative
accounting guidance. This SOP is effective for financial statements for fiscal
years beginning after December 15, 2003. We are currently evaluating this SOP.
SEPARATE ACCOUNTS
At September 30, 2003 and December 31, 2002, the separate accounts included a
separate account valued at $834.3 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 September 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.
10
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 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 nine months ended September
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 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 ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
---------------- -------------- --------------- --------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Net income (loss), as reported................. $ 216.3 $ (158.4) $ 574.2 $ (73.1)
Add: Stock-based compensation expense
included in reported net income, net
of related tax effects....................... 5.1 6.2 14.2 10.5
Deduct: Total stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects.......................... 5.9 7.0 16.7 13.0
---------------- -------------- ---------------- --------------
Pro forma net income (loss).................... $ 215.5 $ (159.2) $ 571.7 $ (75.6)
================ ============== ================ ==============
Basic earnings per share:
As reported.................................. $ 0.67 $(0.46) $ 1.75 $ (0.21)
Pro forma.................................... 0.67 (0.46) 1.75 (0.21)
Diluted earnings per share:
As reported.................................. $ 0.67 $(0.45) $ 1.75 $ (0.21)
Pro forma.................................... 0.67 (0.45) 1.75 (0.21)
2. VARIABLE INTEREST ENTITIES
We have relationships with various types of special purpose entities and other
entities. Upon the review of the guidance and evaluation of these entities, we
determined that we have certain investments that meet the definition of a VIE
under FIN 46.
11
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
2. VARIABLE INTEREST ENTITIES (CONTINUED)
CONSOLIDATED VARIABLE INTEREST ENTITIES
As of September 30, 2003, we are consolidating a residential mortgage loan
production VIE, three grantor trusts and several other immaterial VIEs in which
we have determined we are the primary beneficiary. The following table presents
the net impact on certain financial data for these consolidated VIEs:
AS OF SEPTEMBER 30,
2003
-----------------------
(IN MILLIONS)
Total assets...................................... $ 3,709.5
=======================
Total short-term debt............................. $ 2,159.9
Total long-term debt.............................. 1,458.1
Total other liabilities........................... 90.4
-----------------------
Total liabilities................................. 3,708.4
Total equity...................................... 1.1
-----------------------
Total liabilities and equity.................... $ 3,709.5
=======================
The consolidation of these entities did not have a material impact to our income
(loss) before cumulative effect of accounting changes.
RESIDENTIAL MORTGAGE LOAN PRODUCTION VIE. Principal Residential Mortgage Capital
Resources, LLC ("PRMCR") provides a source of funding for our residential
mortgage loan production. We sold approximately $51.1 billion in mortgage loans
to PRMCR during the nine months ended September 30, 2003. The maximum amount of
mortgage loans, which can be warehoused in PRMCR, was $4.0 billion as of
September 30, 2003. PRMCR held $3.5 billion in mortgage loans held-for-sale as
of September 30, 2003. The portfolio of loans held-for-sale by PRMCR must meet
portfolio criteria, eligibility representations, and portfolio aging
limitations. Based on these eligibility representations, we are required to
repurchase ineligible loans from PRMCR. During the first nine months of 2003, we
repurchased $109.4 million of ineligible loans from PRMCR.
PRMCR had the following debt components:
AS OF SEPTEMBER 30,
2003
-----------------------
(IN MILLIONS)
SHORT-TERM DEBT:
Secured liquidity notes........................... $ 1,759.9
Three-year fixed term notes....................... 400.0
-----------------------
Total short-term debt........................... $ 2,159.9
=======================
LONG-TERM DEBT:
Three-year fixed term notes....................... $ 400.0
Five-year variable term notes..................... 800.0
Outstanding equity certificates................... 193.0
-----------------------
Total long-term debt............................ $ 1,393.0
=======================
12
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
2. VARIABLE INTEREST ENTITIES (CONTINUED)
As of September 30, 2003, future annual maturities of the long-term debt were as
follows (in millions):
2004.................................................. $ 400.0
2005.................................................. 44.0
2006.................................................. 949.0
----------------------
Total future maturities of the long-term debt.. $ 1,393.0
======================
All borrowings are collateralized by the assets of PRMCR, which are reported
primarily as mortgage loans held-for-sale on the consolidated statement of
financial position. The creditors of PRMCR have no recourse to other assets of
our company.
CERTAIN GRANTOR TRUSTS. We contributed undated subordinated floating rate notes
to three grantor trusts. The trusts separated the cash flows of the underlying
notes by issuing an interest-only certificate and a residual certificate related
to each note contributed. Each interest-only certificate entitles the holder to
interest on the stated note for a specified term while the residual certificate
entitles the holder to interest payments subsequent to the term of the
interest-only certificate and to all principal payments. We retained the
interest-only certificate and the residual certificates were subsequently sold
to a third party.
Upon adoption of FIN 46, we have deemed these grantor trusts to be variable
interest entities. In the event of a default or prepayment on the underlying
notes, which is the main risk of loss, our interest-only certificates are
exposed to the majority of the risk of loss. The restricted interest period ends
between 2016 and 2020 and, at that time, the residual certificate holder's
certificate is redeemed by the trust in return for the note. It will be
necessary to consolidate these entities until the expiration of the
interest-only period. As of September 30, 2003, we recorded $328.2 million in
undated subordinated floating rate notes that represent collateral for the
trusts' obligations. These notes are classified as available-for-sale fixed
maturity securities in the consolidated financial statements. The obligation to
deliver the underlying securities to the residual certificate holders is
classified as an other liability and contains an embedded derivative of the
forecasted transaction to deliver the underlying securities. The creditors of
the grantor trusts do not have recourse to our general credit.
OTHER. In addition to the entities above, we have a number of relationships with
a disparate group of entities, which result from our direct investment in the
equity and/or debt of certain VIEs. These entities include a financial services
company, a private investment trust, and a real estate limited partnership.
Based upon our relationship with such entities, the individual consolidation of
these VIEs did not have a material effect on our consolidated financial
position. For these entities, as of September 30, 2003, we reflect $81.4 million
in consolidated assets that are collateral for the VIEs' obligations and
classified as fixed maturity securities, available-for-sale ($12.9 million),
equity securities, available-for-sale ($13.9 million), real estate ($54.3
million) and cash and other assets ($0.3 million). For the majority of these
entities, the creditors have no recourse to the assets of our company.
SIGNIFICANT UNCONSOLIDATED VARIABLE INTEREST ENTITIES
We hold a significant variable interest in a number of VIEs where we are not the
primary beneficiary. These entities include private investment trusts and
custodial relationships that have issued trust certificates or custodial
receipts that are recorded as available-for-sale fixed maturity securities in
the consolidated financial statements.
13
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
2. VARIABLE INTEREST ENTITIES (CONTINUED)
Between October 3, 1996 and September 21, 2001, we entered into seven separate
but similar transactions where various third parties transferred funds to either
a custodial account or a trust. The custodians or trusts purchased shares of
specific money market funds and then separated the cash flows of the money
market shares into share receipts and dividend receipts. The dividend receipts
entitle the holder to dividends paid for a specified term while the share
receipts purchased at a discount entitle the holder to dividend payments
subsequent to the term of the dividend receipts and the rights to the underlying
shares. We have purchased the share receipts. After the restricted dividend
period ends between 2017 and 2021, we, as the share receipt holder, have the
right to terminate the custodial account or trust agreement and will receive the
underlying money market fund shares. The primary beneficiary is the dividend
receipt holder, which has the majority of the risk of loss. Our maximum exposure
to loss as a result of our involvement with these entities is our recorded
investment of $181.7 million as of September 30, 2003.
On June 20, 1997, we entered into a transaction in which we purchased a residual
trust certificate. The trust separated the cash flows of an underlying security
into an interest-only certificate that entitles the third party certificate
holder to the stated interest on the underlying security through May 15, 2017,
and into a residual certificate entitling the holder to interest payments
subsequent to the term of the interest-only certificates and any principal
payments. Subsequent to the restricted interest period, we, as the residual
certificate holder, have the right to terminate the trust agreement and will
receive the underlying security. The primary beneficiary is the interest-only
certificate holder, which has the majority of the risk of loss. Our maximum
exposure to loss as a result of our involvement with this entity is our recorded
investment of $56.3 million as of September 30, 2003.
We entered into various separate but similar transactions between August 15,
2000 and February 15, 2001, in which we contributed cash to trusts in return for
a trust note. The trusts executed swaps in which the trust delivered cash to the
counterparty in return for convertible, puttable fixed maturity securities. On
the various dates in 2004 and 2005 that the trust notes are due, the underlying
securities are returned to the swap counterparty and the trust notes are
redeemed with the proceeds. The trust also swaps the equity option value
embedded in the convertible security and the coupon on the security to the swap
counterparty in return for a variable interest rate which the trust remits to
the trust note holder. The swap counterparty has the right to instruct the trust
to call the trust note and return the underlying security in order to utilize
the convertible features of the security. We are not the primary beneficiary but
we hold a significant variable interest in each of the trusts in which our notes
have not yet been called by the swap counterparties. Our maximum exposure to
loss as a result of our involvement with these entities is our recorded
investment of $73.0 million as of September 30, 2003.
3. FEDERAL INCOME TAXES
The effective income tax rate on income from continuing operations for the three
months and nine months ended September 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.
14
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
4. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ------------------------------
2003 2002 2003 2002
-------------- ------------- ------------- -------------
(IN MILLIONS)
COMPREHENSIVE INCOME (LOSS):
Net income (loss)........................ $ 216.3 $(158.4) $ 574.2 $(73.1)
Net change in unrealized gains and
losses on fixed maturities,
available-for-sale..................... (464.9) 557.0 920.3 603.9
Net change in unrealized gains and
losses on equity securities,
available-for-sale..................... (6.1) 35.2 7.9 42.7
Adjustments for assumed changes in
amortization patterns:
Deferred policy acquisition costs...... 60.2 (56.9) (78.7) (82.0)
Unearned revenue reserves.............. (6.5) 4.3 (0.4) 4.9
Net change in unrealized gains and
losses on derivative instruments....... 36.8 (124.9) 54.9 (138.9)
Adjustments to unrealized gains for
Closed Block policyholder dividend
obligation............................. 38.2 (16.1) (94.0) (16.1)
Provision for deferred income tax
benefit (expense)...................... 103.7 (143.4) (294.7) (146.5)
Net change in unrealized gains and
losses on equity method subsidiaries
and minority interest adjustments...... 11.9 (0.2) 6.6 (3.3)
Change in net foreign currency
translation adjustment................. (0.7) 89.9 35.5 95.7
Cumulative effect of accounting change,
net of related income taxes............ 9.2 - 9.2 -
-------------- ------------- ------------- -------------
Comprehensive income (loss).............. $ (1.9) $ 186.5 $ 1,140.8 $287.3
============== ============= ============= =============
5. 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
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.
15
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
5. CONTINGENCIES, GUARANTEES AND INDEMNIFICATIONS (CONTINUED)
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 maximum
exposure under these agreements as of September 30, 2003, was $160.2 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. The fair value of such
guarantees issued after January 1, 2003, was insignificant.
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 September 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.
16
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
5. 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 September 30, 2003, $5.1 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.
6. 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.
17
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
6. 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 losses 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 SEPTEMBER 30, AS OF DECEMBER 31,
2003 2002
---------------------- ---------------------
(IN MILLIONS)
ASSETS:
U.S. Asset Management and Accumulation ............... $ 79,307.0 $ 70,371.9
International Asset Management and Accumulation....... 2,724.0 2,202.5
Life and Health Insurance............................. 11,903.1 11,356.3
Mortgage Banking...................................... 7,865.3 3,740.1
Corporate and Other .................................. 1,970.1 2,190.5
---------------------- ---------------------
Total consolidated assets........................... $ 103,769.5 $ 89,861.3
====================== =====================
18
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
6. SEGMENT INFORMATION (CONTINUED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(IN MILLIONS)
OPERATING REVENUES BY SEGMENT:
U.S. Asset Management and Accumulation.... $ 871.9 $ 865.9 $ 2,626.9 $2,863.7
International Asset Management and
Accumulation............................ 99.9 82.8 289.7 252.3
Life and Health Insurance................. 995.7 987.7 3,009.8 2,950.7
Mortgage Banking.......................... 288.1 312.9 1,145.1 731.3
Corporate and Other....................... 15.4 (15.8) 8.5 1.4
-------------- -------------- -------------- --------------
Total segment operating revenues........ 2,271.0 2,233.5 7,080.0 6,799.4
Net realized/unrealized capital losses,
including recognition of front-end fee
revenues and certain market value
adjustments to fee revenues............. (4.9) (237.6) (104.7) (240.2)
-------------- -------------- -------------- --------------
Total revenue per consolidated $ 2,266.1 $1,995.9 $ 6,975.3 $6,559.2
statements of operations.............. ============== ============== ============== ==============
REVENUES FROM EXTERNAL CUSTOMERS:
U.S. Asset Management and Accumulation.... $ 828.3 $ 763.1 $ 2,461.6 $2,560.8
International Asset Management and
Accumulation........................... 103.3 83.3 285.8 289.4
Life and Health Insurance................. 995.3 972.8 2,994.5 2,888.5
Mortgage Banking.......................... 285.4 303.0 1,137.2 721.4
Corporate and Other....................... 53.8 (126.3) 96.2 99.1
-------------- -------------- -------------- --------------
Total external revenues................. $ 2,266.1 $1,995.9 $ 6,975.3 $6,559.2
============== ============== ============== ==============
INTERSEGMENT REVENUES:
U.S. Asset Management and Accumulation.... $ 14.0 $ 12.7 $ 40.2 $ 40.7
International Asset Management and
Accumulation........................... - - - -
Life and Health Insurance................. (1.5) (1.1) (4.3) (4.2)
Mortgage Banking.......................... 2.7 9.9 7.9 9.9
Corporate and Other....................... (15.2) (21.5) (43.8) (46.4)
-------------- -------------- -------------- --------------
Total.................................. $ - $ - $ - $ -
============== ============== ============== ==============
19
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003
(UNAUDITED)
6. SEGMENT INFORMATION (CONTINUED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(IN MILLIONS)
OPERATING EARNINGS (LOSS) BY SEGMENT:
U.S. Asset Management and Accumulation .... $ 110.5 $ 84.9 $316.2 $ 287.2
International Asset Management and
Accumulation............................ 8.0 5.0 26.7 10.1
Life and Health Insurance.................. 52.8 55.7 174.8 171.7
Mortgage Banking........................... 29.2 62.5 126.6 113.8
Corporate and Other ....................... 3.8 (5.6) (11.6) (11.3)
-------------- -------------- -------------- --------------
Total segment operating earnings........ 204.3 202.5 632.7 571.5
Net realized/unrealized capital gains
(losses), as adjusted................... 1.8 (146.9) (67.6) (153.8)
Other after-tax adjustments (1)............ 10.2 (214.0) 9.1 (490.8)
-------------- -------------- -------------- --------------
Net income (loss) per consolidated
statements of operations.............. $ 216.3 $(158.4) $574.2 $ (73.1)
============== ============== ============== ==============
- --------------------
(1) For the three months ended September 30, 2003, other after-tax adjustments
of $10.2 million included (1) the positive effect of a change in the
estimated loss on disposal of BT Financial Group ($12.4 million) and (2) the
negative effect of a cumulative effect of accounting change related to the
implementation of FIN 46 ($2.2 million).
For the three months ended September 30, 2002, other after-tax adjustments
of ($214.0) million included the negative effects of: (1) a loss from the
discontinued operations of BT Financial Group ($201.0 million) and (2) an
increase to the loss contingency reserve established for sales practice
litigation ($13.0 million).
For the nine months ended September 30, 2003, other after-tax adjustments of
$9.1 million included (1) the positive effect of a change in the estimated
loss on disposal of BT Financial Group ($11.3 million) and (2) the negative
effect of a cumulative effect of accounting change related to the
implementation of FIN 46 ($2.2 million).
For the nine months ended September 30, 2002, other after-tax adjustments of
($490.8) million included 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); (b) a loss from the discontinued
operations of BT Financial Group ($194.9 million); (c) an increase to a loss
contingency reserve established for sales practice litigation ($13.0
million); and (d) expenses related to the demutualization ($2.0 million).
20
PRINCIPAL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ----------------------------------
2003 2002 2003 2002
----------------- ---------------- ----------------- ----------------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Income from continuing
operations................... $206.1 $42.6 $565.1 $402.7
================= ================ ================= ================
Weighted-average shares
outstanding:
Basic........................ 323.5 347.2 327.2 354.8
Dilutive effect:
Stock options.............. 0.6 0.4 0.5 0.4
Long-term performance
plan..................... - 0.6 - 0.1
Restricted stock units (1). - - - -
----------------- ---------------- ----------------- ----------------
Diluted...................... 324.1 348.2 327.7 355.3
================= ================ ================= ================
Income from continuing
operations per share:
Basic........................ $ 0.64 $ 0.12 $ 1.73 $ 1.13
================= ================ ================= ================
Diluted...................... $ 0.64 $ 0.12 $ 1.73 $ 1.13
================= ================ ================= ================
- --------------------
(1) The dilutive effect was less than 0.1 million shares.
The calculation of diluted earnings per share for the three months and nine
months ended September 30, 2003 and 2002, excludes the incremental effect
related to certain stock-based compensation grants due to their anti-dilutive
effect.
8. SUBSEQUENT EVENT
On October 24, 2003, our Board of Directors declared an annual dividend of
approximately $145.3 million, equal to $0.45 per share, payable on December 8,
2003, to shareholders of record as of November 7, 2003.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis discusses our financial condition as of September 30,
2003, compared with December 31, 2002, and our consolidated results of
operations for the three months and nine months ended September 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.
22
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.
RECENT EVENTS
STOCKHOLDER DIVIDENDS
On October 24, 2003, our Board of Directors declared an annual dividend of
approximately $145.3 million, equal to $0.45 per share, payable on December 8,
2003, to shareholders of record as of November 7, 2003.
RATINGS
On September 30, 2003, the rating agency Standard and Poor's affirmed Principal
Life's financial strength and counterparty ratings of AA. In addition, Standard
and Poor's revised the outlook on Principal Life's ratings to stable from
negative.
23
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
ACQUISITIONS
We acquired the following businesses, among others, during 2003 and 2002:
MW POST ADVISORY GROUP. On August 21, 2003, we agreed to purchase approximately
68% of MW Post Advisory Group ("Post Advisory") for approximately $101.6
million. Effective October 15, 2003, we own 23% of Post Advisory and have agreed
to purchase an additional 45% on or around, January 5, 2004. As part of our U.S.
Asset Management and Accumulation segment, we will account for Post Advisory
using the full consolidation method of accounting since, although we are only a
minority owner from a voting share perspective prior to January 5, 2004, the
terms of the acquisition provide us with control of Post Advisory effective
October 15, 2003. Our assets under management will increase approximately $3.6
billion as a result of the acquisition.
IDBI - PRINCIPAL ASSET MANAGEMENT COMPANY. On August 31, 2003, we announced that
our wholly-owned subsidiary, Principal Financial Group (Mauritius) Ltd., had
entered into a joint venture agreement with Punjab National Bank ("PNB") and
Vijaya Bank, two large Indian commercial banks, to sell long-term mutual funds
and related financial services in India. The new company will be called
Principal PNB Asset Management Company. As part of this transaction, we will
roll our existing fund management company, Principal Asset Management Company,
into the joint venture. We will retain 65% of the new company, selling 30% to
PNB, who will merge its own PNB funds into the new company, and 5% to Vijaya
Bank. We expect to close the transaction in the fourth quarter of 2003.
On June 24, 2003, 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 gave 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.
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 have integrated BCI Group operations into Principal
Life.
24
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 September 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 after-tax proceeds from the sale were
approximately U.S. $885.0 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 December 31, 2002, we accrued for an estimated after-tax loss on disposal
of $208.7 million. During the three months ended and nine months ended September
30, 2003, we incurred an after-tax gain of $12.4 million and $11.3 million,
respectively. These gains are recorded in the income (loss) from discontinued
operations in the consolidated statements of operations.
BT Financial Group is accounted for as a discontinued operation and therefore,
the results of operations (excluding corporate overhead) and cash flows have
been removed from our results of continuing operations for all periods
presented. Corporate overhead allocated to BT Financial Group does not qualify
for discontinued operations treatment under SFAS 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, and therefore is still included in
our results of continuing operations. The results of operations (excluding
corporate overhead) for BT Financial Group are reported as other after-tax
adjustments in our International Asset Management and Accumulation segment.
Selected financial information for the discontinued operations is as follows:
25
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ----------------------------
2003 2002 2003 2002
------------ ----------- ---------- ------------
(IN MILLIONS, EXCEPT AS INDICATED)
Total assets under management ($ in
billions).................................... $ - $ 15.6 $ - $ 15.6
============ =========== ============ ============
Total revenues................................. $ - $ 39.2 $ - $ 128.1
============ =========== ============ ============
Loss from continuing operations
(corporate overhead)......................... $ - $ (0.8) $ - $ (2.3)
Income (loss) from discontinued operations:
Income before income taxes..................... - 3.9 - 16.3
Income taxes (benefits)........................ - (1.7) - 4.6
------------ ----------- ------------ ------------
Income from discontinued operations............ - 5.6 - 11.7
Income (loss) on disposal, net of related
income taxes................................ 12.4 (206.6) 11.3 (206.6)
------------ ----------- ------------ ------------
Income (loss) from discontinued operations, net
of related income taxes..................... 12.4 (201.0) 11.3 (194.9)
Cumulative effect of accounting change, net of
related income taxes........................ - - - (255.4)
------------ ----------- ------------ ------------
Net income (loss).............................. $12.4 $(201.8) $ 11.3 $(452.6)
============ =========== ============ ============
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 September 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
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 nine months ended September 30,
2002.
26
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 is
reported under the deposit method of accounting. This reduces ceded premiums and
claims and increases 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
income from continuing operations. Our consolidated income from continuing
operations was negatively impacted $0.3 million and $2.5 million for the three
months ended September 30, 2003 and 2002 and negatively impacted $5.3 million
and $9.3 million for the nine months ended September 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 $45.1 million of pre-tax pension
expense for the three months ended September 30, 2003 and nine months ended
September 30, 2003, respectively. In addition, approximately $15.0 million of
pre-tax pension expense will be reflected in the remaining quarter 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
assumption of 9.0%. To a lesser extent, the expense for other post-retirement
benefits expense increased as well.
27
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 and nine
months ended September 30, 2003, we recorded a permanent impairment of our
mortgage servicing rights of $81.7 million and $581.9 million, respectively,
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 period
of adjustment but may result in a reduction of amortization expense and reduced
recovery of impairments in periods subsequent to adjustment.
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 applies to certain entities in which equity investors do not have the
characteristics of a controlling financial interest, or do not have sufficient
equity at risk for the entities to finance their activities without additional
subordinated financial support from other parties. FIN 46 requires the
consolidation of variable interest entities ("VIE") in which an enterprise,
known as the primary beneficiary, absorbs a majority of the entity's expected
losses, receives a majority of the entity's expected residual returns, or both,
as a result of ownership, contractual or other financial interests in the
entity.
FIN 46 established new accounting guidance relating to the consolidation of
VIEs. The guidance was effective immediately for all VIEs created after January
31, 2003, and effective July 1, 2003, for all VIEs created before February 1,
2003. In October 2003, the FASB released Staff Position FIN 46-6, EFFECTIVE DATE
OF FASB INTERPRETATION NO. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, that
allows the deferral of FIN 46 for all VIEs created or acquired prior to February
1, 2003, until the end of the first interim or annual period ending after
December 15, 2003, if certain conditions are met. Subsequent to February 1,
2003, we invested in one VIE, for which we are the primary beneficiary, and
consolidated in accordance with FIN 46. Effective July 1, 2003, we consolidated
all VIEs created or acquired prior to February 1, 2003, for which we are the
primary beneficiary.
As of September 30, 2003, our consolidated financial statements were adjusted to
record a cumulative effect of adopting FIN 46, as follows (in millions):
ACCUMULATED OTHER
COMPREHENSIVE
NET LOSS INCOME
------------------ ----------------------
Cumulative effect of accounting change....................... $(4.1) $14.1
Income tax impact............................................ 1.9 (4.9)
------------------ ----------------------
Total........................................................ $(2.2) $ 9.2
================== ======================
28
As of September 30, 2003, we are consolidating a residential mortgage loan
production VIE, three grantor trusts and several other immaterial VIEs in which
we have determined we are the primary beneficiary. The following table presents
the net impact on certain financial data for these consolidated VIEs:
AS OF SEPTEMBER 30,
2003
-----------------------
(IN MILLIONS)
Total assets...................................... $ 3,709.5
=======================
Total short-term debt............................. $ 2,159.9
Total long-term debt.............................. 1,458.1
Total other liabilities........................... 90.4
-----------------------
Total liabilities................................. 3,708.4
Total equity...................................... 1.1
-----------------------
Total liabilities and equity.................. $ 3,709.5
=======================
The consolidation of these entities did not have a material impact to our income
(loss) before cumulative effect of accounting changes.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH
CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("SFAS 150"). SFAS 150
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify certain financial instruments as liabilities that, under
previous guidance, issuers accounted for as equity. We adopted SFAS 150 on July
1, 2003, which did not have a material impact to our consolidated financial
statements.
On July 7, 2003, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 03-1, ACCOUNTING AND REPORTING BY INSURANCE
ENTERPRISES FOR CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE
ACCOUNTS. This SOP addresses an insurance enterprise's accounting for certain
fixed and variable contract features not covered by other authoritative
accounting guidance. This SOP is effective for financial statements for fiscal
years beginning after December 15, 2003. We are currently evaluating this SOP.
29
RESULTS OF OPERATIONS
The following table presents summary consolidated financial information for the
periods indicated:
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- --------------------------
2003 2002 2003 2002
----------- ------------ ----------- ------------
(IN MILLIONS)
INCOME STATEMENT DATA:
Revenues:
Premiums and other considerations............... $ 868.8 $ 888.7 $2,650.9 $ 2,941.0
Fees and other revenues......................... 525.1 516.6 1,846.1 1,386.7
Net investment income........................... 877.9 821.2 2,571.6 2,455.5
Net realized/unrealized capital losses.......... (5.7) (230.6) (93.3) (224.0)
----------- ------------ ----------- ------------
Total revenues................................ 2,266.1 1,995.9 6,975.3 6,559.2
Expenses:
Benefits, claims and settlement expenses........ 1,175.7 1,231.6 3,558.7 3,942.7
Dividends to policyholders...................... 78.7 79.1 232.7 241.0
Operating expenses.............................. 727.5 640.2 2,392.4 1,832.2
----------- ------------ ----------- ------------
Total expenses................................ 1,981.9 1,950.9 6,183.8 6,015.9
----------- ------------ ----------- ------------
Income from continuing operations before income
taxes........................................... 284.2 45.0 791.5 543.3
Income taxes...................................... 78.1 2.4 226.4 140.6
----------- ------------ ----------- ------------
Income from continuing operations, net of
related income taxes........................ 206.1 42.6 565.1 402.7
Income (loss) from discontinued operations, net
of related income taxes......................... 12.4 (201.0) 11.3 (194.9)
----------- ------------ ----------- ------------
Income (loss) before cumulative effect of
accounting Changes.............................. 218.5 (158.4) 576.4 207.8
Cumulative effect of accounting changes, net of
related income taxes............................ (2.2) - (2.2) (280.9)
----------- ------------ ----------- ------------
Net income (loss) ............................ $ 216.3 $ (158.4) $ 574.2 $ (73.1)
=========== ============ =========== ============
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2002
Premiums and other considerations decreased $19.9 million, or 2%, to $868.8
million for the three months ended September 30, 2003, from $888.7 million for
the three months ended September 30, 2002. The decrease reflected a $35.0
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 $12.7 million increase from the
International Asset Management and Accumulation segment, primarily related to
record sales of single premium annuities with life contingencies in Chile in
2003 following a year of decreased sales due to market contraction.
Fees and other revenues increased $8.5 million, or 2%, to $525.1 million for the
three months ended September 30, 2003, from $516.6 million for the three months
ended September 30, 2002. The increase was largely due to a $37.9 million
increase from the U.S. Asset Management and Accumulation segment primarily
related to improvements in the equity markets and net cash flow, which have led
to higher account values, increased proceeds from a commercial mortgage-backed
securitization, and increased revenues from Spectrum (our asset manager of
investment-grade preferred securities portfolios). In addition, the increase was
30
due to a $9.5 million increase in the Corporate and Other segment primarily due
to a decrease in inter-segment eliminations. The increase was also related to
$6.5 million increase in the Life and Health Insurance segment primarily due to
growth in the universal life and variable universal life insurance business and
growth and fee rate increases in the fee-for-service business. The fees and
other revenues increased $4.4 million for the International Asset Management and
Accumulation segment primarily a result of an increase in the number of
retirement plan participants in Mexico due to the acquisition of AFORE Tepeyac
in 2003. These increases were partially offset by a $49.8 million decrease from
the Mortgage Banking segment resulting from a decrease in gains on the sales of
mortgage loans in the third quarter of 2003.
Net investment income increased $56.7 million, or 7%, to $877.9 million for the
three months ended September 30, 2003, from $821.2 million for the three months
ended September 30, 2002. The increase was primarily a result of a $6,208.4
million, or 13%, increase in average invested assets and cash, excluding the
impact of the implementation of FIN 46. Partially offsetting the increase was a
decrease in annualized investment yields. The annualized yield on average
invested assets and cash was 6.3% for the three months ended September 30, 2003,
compared to 6.9% for the three months ended September 30, 2002. This reflects
lower yields on invested assets due in part to a lower interest rate
environment.
Net realized/unrealized capital losses decreased $224.9 million, or 98%, to $5.7
million for the three months ended September 30, 2003, from $230.6 million for
the three months ended September 30, 2002. The decrease included gains related
to mark to market of our investment in company sponsored mutual funds compared
to losses in 2002, a reduction in write downs of other than temporary declines
in the value of certain fixed maturity securities, and lower losses related to
hedging activities.
The following table highlights the contributors to net realized/unrealized
capital gains and losses for the three months ended September 30, 2003.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
----------------------------------------------------------------