UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended March 31, 2008

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 


 

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 incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

 

 

711 High Street, Des Moines, Iowa 50392

(Address of principal executive offices)

 

 

 

(515) 247-5111

(Registrant’s telephone number, including area code)

 


 

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 o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o   No x

 

The total number of shares of the registrant’s Common Stock, $0.01 par value, outstanding as of April 30, 2008 was 258,897,011.

 

 



 

PRINCIPAL FINANCIAL GROUP, INC.

 

TABLE OF CONTENTS

 

 

Page

Part I - FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Consolidated Statements of Financial Position at March 31, 2008 (Unaudited) and December 31, 2007

3

 

 

 

 

 

 

Unaudited Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007

4

 

 

 

 

 

 

Unaudited Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2008 and 2007

5

 

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007

6

 

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements — March 31, 2008

8

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

36

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

72

 

 

 

 

 

Item 4.

Controls and Procedures

78

 

 

 

Part II — OTHER INFORMATION

 

 

 

 

 

Item 1.

Legal Proceedings

78

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

79

 

 

 

 

 

Item 6.

Exhibits

79

 

 

 

Signature

80

 

2



 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Principal Financial Group, Inc.
Consolidated Statements of Financial Position

 

 

 

March 31,
2008

 

December 31,
2007

 

 

 

(Unaudited)

 

 

 

 

 

(in millions)

 

Assets

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

46,631.2

 

$

46,738.9

 

Fixed maturities, trading

 

534.6

 

529.3

 

Equity securities, available-for-sale

 

268.6

 

316.4

 

Equity securities, trading

 

250.1

 

269.8

 

Mortgage loans

 

12,876.7

 

12,659.6

 

Real estate

 

864.8

 

862.5

 

Policy loans

 

883.6

 

869.9

 

Other investments

 

2,589.8

 

2,118.6

 

Total investments

 

64,899.4

 

64,365.0

 

Cash and cash equivalents

 

1,120.7

 

1,344.4

 

Accrued investment income

 

796.8

 

774.1

 

Premiums due and other receivables

 

940.4

 

951.2

 

Deferred policy acquisition costs

 

3,076.3

 

2,810.1

 

Property and equipment

 

481.5

 

469.0

 

Goodwill

 

381.4

 

374.7

 

Other intangibles

 

998.1

 

1,006.9

 

Separate account assets

 

76,897.7

 

80,486.8

 

Other assets

 

2,408.9

 

1,938.0

 

Total assets

 

$

152,001.2

 

$

154,520.2

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Contractholder funds

 

$

40,994.6

 

$

40,288.9

 

Future policy benefits and claims

 

18,899.9

 

18,454.7

 

Other policyholder funds

 

550.1

 

540.5

 

Short-term debt

 

175.1

 

290.8

 

Long-term debt

 

1,406.6

 

1,398.8

 

Income taxes currently payable

 

45.5

 

41.6

 

Deferred income taxes

 

201.9

 

576.3

 

Separate account liabilities

 

76,897.7

 

80,486.8

 

Other liabilities

 

5,987.7

 

5,020.1

 

Total liabilities

 

145,159.1

 

147,098.5

 

Stockholders’ equity

 

 

 

 

 

Series A preferred stock, par value $.01 per share with liquidation preference of $100 per share - 3.0 million shares authorized, issued and outstanding in 2008 and 2007

 

 

 

Series B preferred stock, par value $.01 per share with liquidation preference of $25 per share - 10.0 million shares authorized, issued and outstanding in 2008 and 2007

 

0.1

 

0.1

 

Common stock, par value $.01 per share - 2,500.0 million shares authorized, 386.3 million and 385.8 million shares issued, and 258.6 million and 259.1 million shares outstanding in 2008 and 2007, respectively

 

3.9

 

3.9

 

Additional paid-in capital

 

8,326.1

 

8,295.4

 

Retained earnings

 

3,589.4

 

3,414.3

 

Accumulated other comprehensive income (loss)

 

(359.1

)

420.2

 

Treasury stock, at cost (127.7 million and 126.7 million shares in 2008 and 2007, respectively)

 

(4,718.3

)

(4,712.2

)

Total stockholders’ equity

 

6,842.1

 

7,421.7

 

Total liabilities and stockholders’ equity

 

$

152,001.2

 

$

154,520.2

 

 

See accompanying notes.

 

3



 

Principal Financial Group, Inc.
Consolidated Statements of Operations

(Unaudited)

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions, except per share data)

 

Revenues

 

 

 

 

 

Premiums and other considerations

 

$

1,053.0

 

$

1,107.7

 

Fees and other revenues

 

613.4

 

592.5

 

Net investment income

 

960.3

 

923.2

 

Net realized/unrealized capital gains (losses)

 

(126.0

)

37.6

 

Total revenues

 

2,500.7

 

2,661.0

 

Expenses

 

 

 

 

 

Benefits, claims and settlement expenses

 

1,472.0

 

1,498.0

 

Dividends to policyholders

 

70.8

 

74.0

 

Operating expenses

 

745.9

 

754.7

 

Total expenses

 

2,288.7

 

2,326.7

 

Income before income taxes

 

212.0

 

334.3

 

Income taxes

 

29.6

 

69.0

 

Net income

 

182.4

 

265.3

 

Preferred stock dividends

 

8.2

 

8.2

 

Net income available to common stockholders

 

$

174.2

 

$

257.1

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

Basic earnings per common share

 

$

0.67

 

$

0.96

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.67

 

$

0.95

 

 

See accompanying notes.

 

4



 

Principal Financial Group, Inc.
Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

 

 

Series A
preferred
stock

 

Series B
preferred
stock

 

Common
stock

 

Additional
paid-in
capital

 

Retained
earnings

 

Accumulated
other
comprehensive
income (loss)

 

Treasury
stock

 

Total
stockholders’
equity

 

 

 

(in millions)

 

Balances at January 1, 2007

 

$

 

$

0.1

 

$

3.8

 

$

8,141.8

 

$

2,824.1

 

$

846.9

 

$

(3,955.9

)

$

7,860.8

 

Common stock issued

 

 

 

 

18.0

 

 

 

 

18.0

 

Capital transactions of equity method investee, net of related income taxes

 

 

 

 

0.2

 

 

 

 

0.2

 

Stock-based compensation and additional related tax benefits

 

 

 

 

26.2

 

 

 

 

26.2

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(106.1

)

(106.1

)

Dividends to preferred stockholders

 

 

 

 

 

(8.2

)

 

 

(8.2

)

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

265.3

 

 

 

265.3

 

Net unrealized gains, net

 

 

 

 

 

 

50.7

 

 

50.7

 

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

0.6

 

 

0.6

 

Unrecognized post-retirement benefit obligation, net of related income taxes

 

 

 

 

 

 

(0.5

)

 

(0.5

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

316.1

 

Balances at March 31, 2007

 

$

 

$

0.1

 

$

3.8

 

$

8,186.2

 

$

3,081.2

 

$

897.7

 

$

(4,062.0

)

$

8,107.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2008

 

$

 

$

0.1

 

$

3.9

 

$

8,295.4

 

$

3,414.3

 

$

420.2

 

$

(4,712.2

)

$

7,421.7

 

Common stock issued

 

 

 

 

9.3

 

 

 

 

9.3

 

Capital transactions of equity method investee, net of related income taxes

 

 

 

 

0.1

 

 

 

 

0.1

 

Stock-based compensation and additional related tax benefits

 

 

 

 

21.3

 

 

 

 

21.3

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(6.1

)

(6.1

)

Dividends to preferred stockholders

 

 

 

 

 

(8.2

)

 

 

(8.2

)

Effects of changing post-retirement benefit plan measurement date, net of related income taxes

 

 

 

 

 

0.9

 

(2.0

)

 

(1.1

)

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

182.4

 

 

 

182.4

 

Net unrealized losses, net

 

 

 

 

 

 

(838.1

)

 

(838.1

)

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

62.8

 

 

62.8

 

Unrecognized post-retirement benefit obligation, net of related income taxes

 

 

 

 

 

 

(2.0

)

 

(2.0

)

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(594.9

)

Balances at March 31, 2008

 

$

 

$

0.1

 

$

3.9

 

$

8,326.1

 

$

3,589.4

 

$

(359.1

)

$

(4,718.3

)

$

6,842.1

 

 

See accompanying notes.

 

5



 

Principal Financial Group, Inc.
Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Operating activities

 

 

 

 

 

Net income

 

$

182.4

 

$

265.3

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Amortization of deferred policy acquisition costs

 

69.3

 

79.9

 

Additions to deferred policy acquisition costs

 

(168.7

)

(118.3

)

Accrued investment income

 

(22.7

)

(2.0

)

Net cash flows from trading securities

 

25.9

 

(51.5

)

Premiums due and other receivables

 

23.9

 

292.8

 

Contractholder and policyholder liabilities and dividends

 

507.3

 

433.0

 

Current and deferred income taxes

 

34.5

 

6.6

 

Net realized/unrealized capital (gains) losses

 

126.0

 

(37.6

)

Depreciation and amortization expense

 

33.8

 

32.5

 

Mortgage loans held for sale, acquired or originated

 

(14.0

)

(39.7

)

Mortgage loans held for sale, sold or repaid, net of gain

 

15.3

 

115.8

 

Real estate acquired through operating activities

 

(10.2

)

(6.8

)

Real estate sold through operating activities

 

7.2

 

30.4

 

Stock-based compensation

 

17.2

 

24.0

 

Other

 

170.6

 

200.5

 

Net adjustments

 

815.4

 

959.6

 

Net cash provided by operating activities

 

997.8

 

1,224.9

 

Investing activities

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

Purchases

 

(1,905.8

)

(2,358.5

)

Sales

 

120.8

 

797.7

 

Maturities

 

1,044.0

 

1,289.4

 

Mortgage loans acquired or originated

 

(431.9

)

(679.8

)

Mortgage loans sold or repaid

 

286.6

 

349.8

 

Real estate acquired

 

(6.2

)

(16.6

)

Real estate sold

 

17.2

 

0.5

 

Net purchases of property and equipment

 

(26.1

)

(13.4

)

Net change in other investments

 

(67.4

)

(67.6

)

Net cash used in investing activities

 

$

(968.8

)

$

(698.5

)

 

6



 

Principal Financial Group, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Financing activities

 

 

 

 

 

Issuance of common stock

 

$

9.3

 

$

18.0

 

Acquisition of treasury stock

 

(6.1

)

(106.1

)

Proceeds from financing element derivatives

 

43.0

 

60.7

 

Payments for financing element derivatives

 

(37.5

)

(54.6

)

Excess tax benefits from share-based payment arrangements

 

2.5

 

4.5

 

Dividends to preferred stockholders

 

(8.2

)

(16.5

)

Issuance of long-term debt

 

1.0

 

4.2

 

Principal repayments of long-term debt

 

(4.9

)

(10.0

)

Net repayments of short-term borrowings

 

(121.5

)

(25.0

)

Investment contract deposits

 

2,283.5

 

2,044.4

 

Investment contract withdrawals

 

(2,599.1

)

(2,605.3

)

Net increase in banking operation deposits

 

186.9

 

45.0

 

Other

 

(1.6

)

 

Net cash used in financing activities

 

(252.7

)

(640.7

)

Discontinued operations

 

 

 

 

 

Net cash provided by operating activities

 

 

0.6

 

Net cash used in investing activities

 

 

(0.5

)

Net cash used in financing activities

 

 

(0.1

)

Net cash provided by discontinued operations

 

 

 

Net decrease in cash and cash equivalents

 

(223.7

)

(114.3

)

Cash and cash equivalents at beginning of period

 

1,344.4

 

1,590.8

 

Cash and cash equivalents at end of period

 

$

1,120.7

 

$

1,476.5

 

Cash and cash equivalents of discontinued operations included above

 

 

 

 

 

At beginning of period

 

$

 

$

(0.7

)

At end of period

 

$

 

$

(0.7

)

 

See accompanying notes.

 

7



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

March 31, 2008
(Unaudited)

 

1. Nature of Operations and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Principal Financial Group, Inc. (“PFG”), its majority-owned subsidiaries and its consolidated variable interest entities (“VIEs”), 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 ended March 31, 2008, are not necessarily indicative of the results that may be expected for the year ended December 31, 2008. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2007, included in our Form 10-K for the year ended December 31, 2007, filed with the United States Securities and Exchange Commission (“SEC”). The accompanying consolidated statement of financial position as of December 31, 2007, 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 March 31, 2007, financial statements to conform to the March 31, 2008, presentation.

 

Recent Accounting Pronouncements

 

On March 19, 2008, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS 161”).  This Statement requires (1) qualitative disclosures about objectives and strategies for using derivatives, (2) quantitative disclosures about fair value amounts of gains and losses on derivative instruments and related hedged items and (3) disclosures about credit-risk-related contingent features in derivative instruments.  The disclosures are intended to provide users of financial statements with an enhanced understanding of how and why derivative instruments are used, how they are accounted for and the financial statement impacts.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  We are currently evaluating the impact this guidance will have on our disclosures.

 

On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115 (“SFAS 159”).  SFAS 159 permits entities to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be reported at fair value.  Unrealized gains and losses on items for which the fair value option is elected shall be reported in net income.  The decision about whether to elect the fair value option (1) is applied instrument by instrument, with certain exceptions; (2) is irrevocable and (3) is applied to an entire instrument and not only to specified risks, specific cash flows or portions of that instrument.  SFAS 159 also requires additional disclosures that are intended to facilitate comparisons between entities that choose different measurement attributes for similar assets and liabilities and between assets and liabilities in the financial statements of an entity that selects different measurement attributes for similar assets and liabilities.  At the effective date, the fair value option may be elected for eligible items that exist at that date and the effect of the first remeasurement to fair value for those items should be reported as a cumulative effect adjustment to retained earnings.  We adopted SFAS 159 on January 1, 2008, and the cumulative effect of the change in accounting principle as a result of adopting SFAS 159 was immaterial.  Therefore, the pre-tax cumulative effect of the change in accounting principle is reflected in net realized/unrealized capital gains (losses).  Future election of this option could introduce period to period volatility in net income.

 

8



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

1. Nature of Operations and Significant Accounting Policies (continued)

 

On September 29, 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132R (“SFAS 158”).  The requirement to recognize the funded status of a defined benefit postretirement plan and the disclosure requirements were effective for fiscal years ending after December 15, 2006, and did not have a material impact on our consolidated financial statements.  Effective for fiscal years ending after December 15, 2008, SFAS 158 also eliminates the ability to choose a measurement date, by requiring that plan assets and benefit obligations be measured as of the annual balance sheet date.  For 2007, we used a measurement date of October 1 for the measurement of plan assets and benefit obligations.  Two transition methods are available when implementing the change in measurement date for 2008.  We chose the alternative that allowed us to use the October 1, 2007, measurement date as a basis for determining the 2008 expense and transition adjustment.  The effect of changing the measurement date resulted in a $0.9 million increase to retained earnings and a $2.0 million decrease to accumulated other comprehensive income in the first quarter of 2008.

 

On September 15, 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). This standard, which provides guidance for using fair value to measure assets and liabilities, applies whenever other standards require or permit assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. SFAS 157 establishes a fair value hierarchy that gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, and requires fair value measurements to be separately disclosed by level within the hierarchy. On February 12, 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, Effective Date of Statement No. 157,  to defer the effective date of the standard for one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value on a nonrecurring basis. On February 14, 2008, the FASB issued FSP FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13, which amends SFAS 157 to exclude instruments covered by SFAS No. 13, Accounting for Leases, and its related interpretive guidance from the scope of SFAS 157.  Our adoption of SFAS 157 on January 1, 2008, did not have a material impact on our consolidated financial statements. See Note 6, Fair Value Measurement, for further details.

 

Separate Accounts

 

As of March 31, 2008, and December 31, 2007, the separate accounts include a separate account valued at $581.0 million and $748.5 million, 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 our 2001 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 statements of financial position. Changes in fair value of the separate account shares are reflected in both the separate account assets and separate account liabilities and do not impact our results of operations.

 

2. Federal Income Taxes

 

The effective income tax rate for the three months ended March 31, 2008, was lower than the corporate income tax rate of 35% primarily due to income tax deductions allowed for corporate dividends received and the release of state deferred income tax liabilities associated with a reorganization of certain subsidiaries.  The effective income tax rate for the three months ended March 31, 2007, was lower than the corporate income tax rate of 35% primarily due to income tax deductions allowed for corporate dividends received, tax credits received on our investment in a synthetic fuel production facility and interest exclusion from taxable income.

 

The Internal Revenue Service is currently auditing our federal income tax returns for the years 2004 and 2005. We do not expect the results of these audits or developments in other tax areas to significantly increase or decrease the total amount of unrecognized tax benefits in the next twelve months, but the outcome of tax reviews is uncertain and unforeseen results can occur.

 

9



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

3. Employee and Agent Benefits

 

Components of net periodic benefit cost (income):

 

 

 

Pension benefits

 

Other postretirement
benefits

 

 

 

For the three months ended
March 31,

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Service cost

 

$

12.4

 

$

11.8

 

$

2.1

 

$

2.0

 

Interest cost

 

24.9

 

22.4

 

4.2

 

3.9

 

Expected return on plan assets

 

(32.6

)

(28.6

)

(9.4

)

(8.4

)

Amortization of prior service benefit

 

(1.9

)

(2.1

)

(0.6

)

(0.7

)

Recognized net actuarial loss (gain)

 

0.3

 

2.5

 

(0.8

)

(0.5

)

Net periodic benefit cost (income)

 

$

3.1

 

$

6.0

 

$

(4.5

)

$

(3.7

)

 

Contributions

 

Our funding policy for our qualified pension plan is to fund the plan annually in an amount at least equal to the minimum annual contribution required under the Employee Retirement Income Security Act (“ERISA”) and, generally, not greater than the maximum amount that can be deducted for federal income tax purposes. The minimum annual contribution for 2008 will be zero so we will not be required to fund our qualified pension plan during 2008. However, it is possible that we may fund the qualified and nonqualified pension plans in 2008 in the range of $20.0 million to $50.0 million, in total. During the three months ended March 31, 2008, no contributions were made to these plans.

 

4. Contingencies, Guarantees and Indemnifications

 

Litigation and Regulatory Contingencies

 

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. 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 Financial Industry Regulatory Authority, 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. We receive requests from regulators and other governmental authorities relating to other industry issues and may receive additional requests, including subpoenas and interrogatories, in the future.

 

On November 8, 2006, a trustee of Fairmount Park Inc. Retirement Savings Plan filed a putative class action lawsuit in the United States District Court for the Southern District of Illinois against Principal Life Insurance Company (“Principal Life”). Principal Life’s Motion to Transfer Venue was granted and the case is now pending in the Southern District of Iowa. The complaint alleges, among other things, that Principal Life breached its alleged fiduciary duties while performing services to 401(k) plans by failing to disclose, or adequately disclose, to employers or plan participants the fact that Principal Life receives “revenue sharing fees from mutual funds that are included in its pre-packaged 401(k) plans” and allegedly failed to use the revenue to defray the expenses of the services provided to the plans.  Plaintiff further alleges that these acts constitute prohibited transactions under ERISA. Plaintiff seeks to certify a class of all retirement plans to which Principal Life was a service provider and for which Principal Life received and retained “revenue sharing” fees from mutual funds. Plaintiff seeks declaratory, injunctive and monetary relief. Principal Life is aggressively defending the lawsuit.

 

10



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

4. Contingencies, Guarantees and Indemnifications (continued)

 

On August 28, 2007, two plaintiffs filed two putative class action lawsuits in the United States District Court for the Southern District of Iowa against us and Princor Financial Services Corporation (the “Principal Defendants”). One of the lawsuits alleges that the Principal Defendants breached alleged fiduciary duties to participants in employer-sponsored 401(k) plans who were retiring or leaving their respective plans, including providing misleading information and failing to act solely in the interests of the participants, resulting in alleged violations of ERISA. The Plaintiffs dismissed the second suit, which was based upon the same facts and alleged violations of the Securities Exchange Act of 1934 and the Securities Act of 1933. The Principal Defendants are aggressively defending the first lawsuit.

 

While the outcome of any pending or future litigation or regulatory matter cannot be predicted, management does not believe that any pending litigation or regulatory matter will have a material adverse effect on our business or financial position. The outcome of such matters 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 through 2019. The maximum exposure under these agreements as of March 31, 2008, was approximately $206.0 million; however, we believe the likelihood is remote that material payments will be required and therefore any liability accrued within our consolidated statements of financial position is insignificant. 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; therefore, such guarantees would not result in a material adverse effect on our business or financial position. It is possible that such outcomes could materially affect net income in a particular quarter or annual period. The fair value of such guarantees is not material.

 

We are also subject to various other indemnification obligations issued in conjunction with certain transactions, primarily the sale of Principal Residential Mortgage, Inc. and other divestitures, 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; 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 or financial position. It is possible that such outcomes could materially affect net income in a particular quarter or annual period. The fair value of such indemnifications was determined to be insignificant.

 

11



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

5. Stockholders’ Equity

 

Reconciliation of Outstanding Shares

 

 

 

Series A
preferred
stock

 

Series B

preferred
stock

 

Common
stock

 

 

 

(in millions)

 

Outstanding shares at January 1, 2007

 

3.0

 

10.0

 

268.4

 

Shares issued

 

 

 

0.7

 

Treasury stock acquired

 

 

 

(1.7

)

Outstanding shares at March 31, 2007

 

3.0

 

10.0

 

267.4

 

 

 

 

 

 

 

 

 

Outstanding shares at January 1, 2008

 

3.0

 

10.0

 

259.1

 

Shares issued

 

 

 

0.5

 

Treasury stock acquired

 

 

 

(1.0

)

Outstanding shares at March 31, 2008

 

3.0

 

10.0

 

258.6

 

 

Comprehensive income (loss)

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Net income

 

$

182.4

 

$

265.3

 

Net change in unrealized gains (losses) on fixed maturities, available-for-sale

 

(1,455.2

)

43.2

 

Net change in unrealized losses on equity securities, available-for-sale

 

(8.9

)

(0.5

)

Net change in unrealized gains on equity method subsidiaries and minority interest adjustments

 

0.6

 

13.1

 

Adjustments for assumed changes in amortization patterns

 

171.0

 

5.4

 

Adjustment for assumed changes in liability for policyholder benefits and claims

 

(7.7

)

 

Net change in unrealized gains (losses) on derivative instruments

 

(36.7

)

6.9

 

Change in net foreign currency translation adjustment

 

70.4

 

(0.5

)

Change in unrecognized post-retirement benefit obligation

 

(3.1

)

(0.7

)

Provision for deferred income tax benefits (taxes)

 

492.3

 

(16.1

)

Comprehensive income (loss)

 

$

(594.9

)

$

316.1

 

 

6. Fair Value Measurement

 

Valuation hierarchy

 

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).  For disclosures, SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels.

 

·                  Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities.

·                  Level 2 – Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly.

·                  Level 3 – Unobservable inputs for the asset or liability.

 

12



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

6. Fair Value Measurement (continued)

 

Determination of fair value

 

The following discussion describes the valuation methodologies used for assets and liabilities measured at fair value.  The techniques utilized in estimating the fair values of financial instruments are affected by the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

 

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument.

 

Fixed Maturities and Equity Securities

 

Fair values of equity securities have been determined by us from public quotations, when available. Fair values of public bonds and those private securities that are actively traded in the secondary market have been determined through the use of independent pricing services using market observable inputs. Private placement securities and other corporate security fixed maturities where we do not receive a public quotation are valued by discounting the expected total cash flows. Market rates used are applicable to the yield, credit quality and average maturity of each security.  Private equity securities may also utilize internal valuation methodologies appropriate for the specific asset.  Fair values might also be determined using broker quotes or through the use of internal models or analysis.

 

Derivatives

 

Fair values of derivative instruments are determined using either pricing valuation models that utilize market data inputs or broker quotes.  The valuation models consider projected discounted cash flows, relevant swap curves and appropriate implied volatilities.

 

Other Investments

 

Other investments reported at fair value primarily include seed money investments, for which the fair value is determined using the net asset value of the fund.

 

Cash Equivalents

 

Because of the nature of these assets, carrying amounts approximate fair values.  Fair values of cash equivalents may also be determined by us from public quotations, when available.

 

Separate Account Assets

 

Separate account assets include public equity, public and private debt securities and derivative instruments, for which fair values are determined as previously described.  Separate account assets also include commercial mortgage loans, for which the fair value is estimated by discounting the expected total cash flows using market rates that are applicable to the yield, credit quality and maturity of the loans.  Finally, separate account assets include real estate, for which the fair value is estimated using discounted cash flow valuation models that utilize public real estate market data inputs such as transaction prices, market rents, vacancy levels, leasing absorption, market cap rates and discount rates.  In addition, each property is appraised annually by an independent appraiser.

 

Investment-Type Insurance Contracts

 

Certain annuity contracts and other investment-type insurance contracts include embedded derivatives that have been bifurcated from the host contract.  The fair value of embedded derivatives is calculated based on actuarial and capital market assumptions, including non-performance risk, related to the projected cash flows over the life of the contract, incorporating expected policyholder behavior.

 

13



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

6. Fair Value Measurement (continued)

 

Assets and liabilities measured at fair value on a recurring basis

 

Assets and liabilities measured at fair value on a recurring basis are summarized below.

 

 

 

As of March 31, 2008

 

 

 

Assets/liabilities
measured at fair

 

Fair value hierarchy level

 

 

 

value

 

Level 1

 

Level 2

 

Level 3

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

46,631.2

 

$

161.6

 

$

44,658.8

 

$

1,810.8

 

Fixed maturities, trading

 

534.6

 

15.0

 

413.1

 

106.5

 

Equity securities, available-for-sale

 

268.6

 

224.3

 

5.4

 

38.9

 

Equity securities, trading

 

250.1

 

123.1

 

127.0

 

 

Net derivative assets and liabilities (1)

 

351.4

 

 

399.5

 

(48.1

)

Other investments (2)

 

113.9

 

16.8

 

97.1

 

 

Cash equivalents (3)

 

674.5

 

254.4

 

420.1

 

 

Separate account assets

 

76,897.7

 

52,377.5

 

17,132.0

 

7,388.2

 

Total assets

 

$

125,722.0

 

$

53,172.7

 

$

63,253.0

 

$

9,296.3

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts (4)

 

$

(4.0

)

$

 

$

 

$

(4.0

)

Total liabilities

 

$

(4.0

)

$

 

$

 

$

(4.0

)


(1)          The fair value of our derivative instruments classified as assets and liabilities at March 31, 2008, was $1,499.5 million and $1,148.1 million, respectively.  Within the consolidated statements of financial position, derivative assets are reported with other investments and derivative liabilities are reported with other liabilities.

(2)          Primarily includes seed money investments reported at fair value.

(3)          Includes short-term investments with a maturity date of three months or less when purchased.

(4)          Includes bifurcated embedded derivatives that are reported at fair value.

 

14



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

6. Fair Value Measurement (continued)

 

Changes in Level 3 fair value measurements

 

The reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2008, is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

 

 

 

Total realized/unrealized

 

 

 

 

 

 

 

gains (losses)

 

 

 

 

 

gains (losses)

 

 

 

 

 

Ending

 

included in net

 

 

 

Beginning
balance as of
January 1,
2008

 

Included in
net income
(1)

 

Included in
other
comprehensive
income

 

Purchases,
sales,
issuances and
settlements

 

Transfers
in (out) of
Level 3

 

balance
as of
March 31,
2008

 

income
relating to
positions still
held (1)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

2,201.3

 

$

(41.8

)

$

(349.0

)

$

(78.7

)

$

79.0

 

$

1,810.8

 

$

(39.6

)

Fixed maturities, trading

 

92.3

 

(0.6

)

 

14.8

 

 

106.5

 

(0.6

)

Equity securities, available-for-sale

 

51.1

 

(23.3

)

(10.1

)

(1.8

)

23.0

 

38.9

 

(23.7

)

Net derivative assets and liabilities

 

(8.0

)

(45.9

)

5.2

 

0.6

 

 

(48.1

)

(45.3

)

Separate account assets

 

7,313.2

 

17.4

 

 

131.4

 

(73.8

)

7,388.2

 

17.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts

 

(49.3

)

8.7

 

 

36.6

 

 

(4.0

)

8.8

 


(1)   Both realized and unrealized gains and losses for the three months ended March 31, 2008, are generally reported in net realized/unrealized capital gains (losses) within the consolidated statements of operations.  Gains and losses for separate account assets are not reflected in the consolidated statements of operations.

 

Assets and liabilities measured at fair value on a nonrecurring basis

 

Certain assets are measured at fair value on a nonrecurring basis.  As of March 31, 2008, mortgage servicing rights with an aggregate cost of $9.0 million had been written down to fair value of $7.9 million, resulting in a charge of $1.1 million that was recorded in operating expenses.  These mortgage servicing rights are a Level 3 fair value measurement, as fair value is determined by calculating the present value of the future servicing cash flows from the underlying mortgage loans.

 

Transition

 

In connection with our adoption of SFAS 157 on January 1, 2008, we recorded a $13.0 million pre-tax increase to net realized/unrealized capital gains (losses) resulting from the incorporation of our own creditworthiness and additional risk margins in the valuation of certain embedded derivatives recorded at fair value.

 

15



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)

March 31, 2008
(Unaudited)

 

7. Segment Information

 

We provide financial products and services through the following segments: U.S. Asset Accumulation, Global Asset Management, International Asset Management and Accumulation and Life and Health Insurance. 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.

 

Prior to December 31, 2007, amounts now reported in the U.S. Asset Accumulation segment and the Global Asset Management segment were reported together in the U.S. Asset Management and Accumulation segment. This change was made due to continued growth in our Global Asset Management business and has no impact on our consolidated financial statements for any period presented. Our segment results for the three months ended March 31, 2007, have been restated to conform to the current segment presentation.

 

The U.S. Asset Accumulation segment provides retirement and related financial products and services primarily to businesses, their employees and other individuals.

 

The Global Asset Management segment provides asset management services to our asset accumulation businesses, our life and health insurance operations, the Corporate and Other segment and third-party clients.

 

The International Asset Management and Accumulation segment consists of Principal International, which has operations in Brazil, Chile, China, Hong Kong, India, Malaysia and Mexico. We focus on countries with favorable demographics and growing long-term savings and defined contribution markets. We entered these countries through acquisitions, start-up operations and joint ventures.

 

The Life and Health Insurance segment provides individual life insurance, group health insurance and specialty benefits, which consists of group dental and vision insurance, individual and group disability insurance and group life insurance, within the United States.

 

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 (including interest expense), income on capital not allocated to other segments, inter-segment eliminations, income tax risks and certain income, expenses and other after-tax adjustments not allocated to the segments based on the nature of such items.

 

Management uses segment operating earnings in goal setting, as a basis in determining employee compensation and in evaluating performance on a basis comparable to that used by securities analysts. We determine segment operating earnings by adjusting U.S. GAAP net income available to common stockholders 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 (“DPAC”) and sales inducements, recognition of deferred front-end fee revenues for sales charges on retirement products and services, net realized capital gains and losses distributed, minority interest capital gains and losses and certain market value adjustments to fee revenues. Net realized/unrealized capital gains (losses), as adjusted, exclude periodic settlements and accruals on non-hedge derivative instruments. Segment operating revenues exclude net realized/unrealized capital gains (except periodic settlements and accruals on non-hedge derivatives) and their impact on recognition of front-end fee revenues and certain market value adjustments to fee revenues and include operating revenues from real estate properties that qualify for discontinued operations. 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 income tax allocation. 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 tax returns. The Corporate and Other segment results reflect any differences between the tax returns and the estimated resolution of any disputes.

 

16



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

7. Segment Information (continued)

 

The following tables summarize selected financial information by segment and reconcile segment totals to those reported in the consolidated financial statements:

 

 

 

March 31,
2008

 

December 31,
2007

 

 

 

(in millions)

 

Assets:

 

 

 

 

 

U.S. Asset Accumulation

 

$

123,027.6

 

$

126,131.1

 

Global Asset Management

 

1,320.1

 

1,438.9

 

International Asset Management and Accumulation

 

10,029.6

 

9,350.5

 

Life and Health Insurance

 

14,873.9

 

14,816.6

 

Corporate and Other

 

2,750.0

 

2,783.1

 

Total consolidated assets

 

$

152,001.2

 

$

154,520.2

 

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Operating revenues by segment:

 

 

 

 

 

U.S. Asset Accumulation

 

$

1,204.7

 

$

1,179.1

 

Global Asset Management

 

118.3

 

134.8

 

International Asset Management and Accumulation

 

183.7

 

141.3

 

Life and Health Insurance

 

1,187.6

 

1,212.4

 

Corporate and Other

 

(55.3

)

(43.9

)

Total segment operating revenues

 

2,639.0

 

2,623.7

 

Add:

 

 

 

 

 

Net realized/unrealized capital gains (losses) (except periodic settlements and accruals on non-hedge derivatives), including recognition of front-end fee revenues and certain market value adjustments to fee revenues

 

(138.3

)

37.2

 

Subtract:

 

 

 

 

 

Operating revenues from a discontinued real estate investment

 

 

(0.1

)

Total revenues per consolidated statements of operations

 

$

2,500.7

 

$

2,661.0

 

Operating earnings (loss) by segment, net of related income taxes:

 

 

 

 

 

U.S. Asset Accumulation

 

$

139.1

 

$

154.7

 

Global Asset Management

 

2.7

 

23.7

 

International Asset Management and Accumulation

 

31.7

 

19.3

 

Life and Health Insurance

 

79.2

 

45.5

 

Corporate and Other

 

(11.4

)

(6.4

)

Total segment operating earnings, net of related income taxes

 

241.3

 

236.8

 

Net realized/unrealized capital gains (losses), as adjusted (1)

 

(74.7

)

20.3

 

Other after-tax adjustments (2)

 

7.6

 

 

Net income available to common stockholders per consolidated statements of operations

 

$

174.2

 

$

257.1

 

 

17



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

7. Segment Information (continued)

 


(1)                                  Net realized/unrealized capital gains (losses), as adjusted, is derived as follows:

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

 

 

 

 

 

 

Net realized/unrealized capital gains (losses)

 

$

(126.0

)

$

37.6

 

Periodic settlements and accruals on non-hedge derivatives

 

(8.8

)

 

Certain market value adjustments to fee revenues

 

(3.5

)

(0.8

)

Recognition of front-end fee revenues

 

 

0.4

 

Net realized/unrealized capital gains (losses), net of related revenue adjustments

 

(138.3

)

37.2

 

Amortization of deferred policy acquisition and sales inducement costs related to net realized capital gains (losses)

 

13.5

 

(0.7

)

Capital (gains) losses distributed

 

9.3

 

(2.0

)

Minority interest capital (gains) losses

 

6.7

 

(1.3

)

Net realized/unrealized capital gains (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 and sales inducement costs, capital (gains) losses distributed and minority interest capital (gains) losses

 

(108.8

)

33.2

 

Income tax effect

 

34.1

 

(12.9

)

Net realized/unrealized capital gains (losses), as adjusted

 

$

(74.7

)

$

20.3

 

 

(2)

 

For the three months ended March 31, 2008, other after-tax adjustments included the positive effect of $7.6 million, resulting from a change in estimated loss related to a prior year legal contingency.

 

18



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

7. Segment Information (continued)

 

The following table summarizes operating revenues for our products and services:

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

U.S. Asset Accumulation:

 

 

 

 

 

Full service accumulation

 

$

362.7

 

$

366.5

 

Principal Funds

 

173.3

 

157.4

 

Individual annuities

 

219.9

 

147.0

 

Bank and trust services

 

20.1

 

14.9

 

Eliminations

 

(49.3

)

(28.7

)

Total Accumulation

 

726.7

 

657.1

 

Investment only

 

287.7

 

282.4

 

Full service payout

 

190.3

 

239.6

 

Total Guaranteed

 

478.0

 

522.0

 

Total U.S. Asset Accumulation

 

1,204.7

 

1,179.1

 

Global Asset Management (1)

 

118.3

 

134.8

 

International Asset Management and Accumulation

 

183.7

 

141.3

 

Life and Health Insurance:

 

 

 

 

 

Individual life insurance

 

349.0

 

337.8

 

Health insurance

 

465.4

 

519.2

 

Specialty benefits insurance

 

373.8

 

356.1

 

Eliminations

 

(0.6

)

(0.7

)

Total Life and Health Insurance

 

1,187.6

 

1,212.4

 

Corporate and Other

 

(55.3

)

(43.9

)

Total operating revenues

 

$

2,639.0

 

$

2,623.7

 

Total operating revenues

 

$

2,639.0

 

$

2,623.7

 

Net realized/unrealized capital gains (losses) (except periodic settlements and accruals on non-hedge derivatives), including recognition of front-end fee revenues and certain market value adjustments to fee revenues

 

(138.3

)

37.2

 

Operating revenues from discontinued real estate investment

 

 

0.1

 

Total revenues per consolidated statements of operations

 

$

2,500.7

 

$

2,661.0

 


(1)                                  Reflects inter-segment revenues of $58.8 million and $54.9 million for the three months ended March 31, 2008 and 2007, respectively.  These revenues are eliminated within the Corporate and Other segment.

 

19



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

8. Stock-Based Compensation Plans

 

As of March 31, 2008, we have the 2005 Stock Incentive Plan, the Employee Stock Purchase Plan, the 2005 Directors Stock Plan, the Stock Incentive Plan, the Directors Stock Plan and the Long-Term Performance Plan (“Stock-Based Compensation Plans”). As of May 17, 2005, no new grants will be made under the Stock Incentive Plan, the Directors Stock Plan or the Long-Term Performance Plan.

 

As of March 31, 2008, the maximum number of new shares of common stock that were available for grant under the 2005 Stock Incentive Plan and the 2005 Directors Stock Plan was 16.5 million.

 

The compensation cost that was charged against income for the Stock-Based Compensation Plans is as follows:

 

 

 

For the three months ended
March 31,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Compensation cost

 

$

18.6

 

$

22.4

 

Related income tax benefit

 

6.0

 

7.2

 

Capitalized as part of an asset

 

1.6

 

1.2

 

 

Nonqualified Stock Options

 

Nonqualified stock options were granted to certain employees under the 2005 Stock Incentive Plan. Total options granted were 1.6 million for the three months ended March 31, 2008. The fair value of these options was determined using the Black-Scholes option valuation model assuming a weighted-average dividend yield of 1.5 percent, a weighted-average expected volatility of 25.3 percent, a weighted-average risk-free interest rate of 3.1 percent and a weighted-average expected term of 6 years. The weighted-average estimated fair value of stock options granted during the three months ended March 31, 2008, was $15.49 per share.

 

As of March 31, 2008, there were $26.2 million of total unrecognized compensation costs related to nonvested stock options. The costs are expected to be recognized over a weighted-average service period of approximately 2.2 years.

 

Performance Share Awards

 

Performance share awards were granted to certain employees under the 2005 Stock Incentive Plan. Total performance share awards granted were 0.3 million for the three months ended March 31, 2008. The performance share awards granted represent initial target awards and do not reflect potential increases or decreases resulting from the final performance objectives to be determined at the end of the respective performance period. The actual number of shares to be awarded at the end of each performance period will range between 0% and 200% of the initial target awards. The fair value of performance share awards is determined based on the closing stock price of our common shares on the grant date. The weighted-average grant date fair value of these performance share awards granted was $60.10 per common share.

 

As of March 31, 2008, there were $20.3 million of total unrecognized compensation costs related to nonvested performance share awards granted. The costs are expected to be recognized over a weighted-average service period of approximately 1.3 years.

 

Restricted Stock Units

 

Restricted stock units were issued to certain employees and agents pursuant to the 2005 Stock Incentive Plan. Total restricted stock units granted were 0.7 million for the three months ended March 31, 2008. The fair value of restricted stock units is determined based on the closing stock price of our common shares on the grant date. The weighted-average grant date fair value of these restricted stock units granted was $60.14 per common share.

 

As of March 31, 2008, there were $46.2 million of total unrecognized compensation costs related to nonvested restricted stock unit awards granted. The costs are expected to be recognized over a weighted-average period of approximately 2.7 years.

 

20



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

8. Stock-Based Compensation Plans (continued)

 

 Employee Stock Purchase Plan

 

Under the Employee Stock Purchase Plan, employees purchased 0.2 million shares for the three months ended March 31, 2008. The weighted-average fair value of the discount on the stock purchased was $8.36 per share.

 

The maximum number of shares of common stock that we may issue under the Employee Stock Purchase Plan is 2% of the number of shares outstanding immediately following the completion of the Initial Public Offering. As of March 31, 2008, a total of 2.5 million of new shares are available to be made issuable by us for this plan.

 

9. Earnings Per Common Share

 

The computations of the basic and diluted per share amounts for our continuing operations were as follows:

 

 

 

For the three months ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(in millions,
except per share data)

 

Net income

 

$

182.4

 

$

265.3

 

Subtract:

 

 

 

 

 

Preferred stock dividends

 

8.2

 

8.2

 

Net income available to common stockholders

 

$

174.2

 

$

257.1

 

Weighted-average shares outstanding

 

 

 

 

 

Basic

 

258.9

 

268.1

 

Dilutive effects:

 

 

 

 

 

Stock options

 

1.9

 

2.3

 

Restricted stock units

 

0.5

 

0.5

 

Diluted

 

261.3

 

270.9

 

Net income per common share:

 

 

 

 

 

Basic

 

$

0.67

 

$

0.96

 

Diluted

 

$

0.67

 

$

0.95

 

 

21



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

10. Condensed Consolidating Financial Information

 

Principal Life has established special purpose entities to issue secured medium-term notes. Under the program, the payment obligations of principal and interest on the notes are secured by funding agreements issued by Principal Life. Principal Life’s payment obligations on the funding agreements are fully and unconditionally guaranteed by PFG. All of the outstanding stock of Principal Life is indirectly owned by PFG and PFG is the only guarantor of the payment obligations of the funding agreements.

 

The following tables set forth condensed consolidating financial information of Principal Life and PFG as of March 31, 2008, and December 31, 2007, and for the three months ended March 31, 2008 and 2007.

 

22



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

10. Condensed Consolidating Financial Information (continued)

 

Condensed Consolidating Statements of Financial Position
March 31, 2008

 

 

 

Principal
Financial
Group, Inc.
Parent Only

 

Principal Life
Insurance
Company
Only

 

Principal Financial
Services, Inc. and
Other Subsidiaries
Combined

 

Eliminations

 

Principal
Financial
Group, Inc.
Consolidated

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

 

$

41,716.2

 

$

5,570.1

 

$

(655.1

)

$

46,631.2

 

Fixed maturities, trading

 

 

277.8

 

256.8

 

¾

 

534.6

 

Equity securities, available-for-sale

 

 

260.3

 

8.3

 

¾

 

268.6

 

Equity securities, trading

 

 

 

250.1

 

¾

 

250.1

 

Mortgage loans

 

 

10,464.5

 

2,739.8

 

(327.6

)

12,876.7

 

Real estate

 

 

10.8

 

854.0

 

 

864.8

 

Policy loans

 

 

864.3

 

19.3

 

 

883.6

 

Investment in unconsolidated entities

 

7,468.7

 

832.8

 

3,010.7

 

(10,801.1

)

511.1

 

Other investments

 

 

3,921.7

 

581.9

 

(2,424.9

)

2,078.7

 

Cash and cash equivalents

 

(9.7

)

525.0

 

708.6

 

(103.2

)

1,120.7

 

Accrued investment income

 

 

741.3

 

62.9

 

(7.4

)

796.8

 

Premiums due and other receivables

 

¾

 

729.4

 

215.2

 

(4.2

)

940.4

 

Deferred policy acquisition costs

 

 

2,880.0

 

196.3

 

 

3,076.3

 

Property and equipment

 

 

420.0

 

61.5

 

 

481.5

 

Goodwill

 

 

96.6

 

284.8

 

 

381.4

 

Other intangibles

 

 

37.6

 

960.5

 

 

998.1

 

Separate account assets

 

 

71,971.9

 

4,925.8

 

 

76,897.7

 

Other assets

 

6.4

 

1,746.5

 

415.5

 

240.5

 

2,408.9

 

Total assets

 

$

7,465.4

 

$

137,496.7

 

$

21,122.1

 

$

(14,083.0

)

$

152,001.2

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds

 

$

 

$

41,211.2

 

$

24.9

 

$

(241.5

)

$

40,994.6

 

Future policy benefits and claims

 

 

15,681.5

 

3,225.5

 

(7.1

)

18,899.9

 

Other policyholder funds

 

 

533.2

 

16.9

 

 

550.1

 

Short-term debt

 

 

 

175.1

 

 

175.1

 

Long-term debt

 

601.8

 

99.5

 

1,337.0

 

(631.7

)

1,406.6

 

Income taxes currently payable (receivable)

 

(8.0

)

(254.0

)

17.5

 

290.0

 

45.5

 

Deferred income taxes

 

(14.1

)

(154.2

)

314.3

 

55.9

 

201.9

 

Separate account liabilities

 

 

71,971.9

 

4,925.8

 

¾

 

76,897.7

 

Other liabilities

 

43.6

 

2,627.3

 

3,616.4

 

(299.6

)

5,987.7

 

Total liabilities

 

623.3

 

131,716.4

 

13,653.4

 

(834.0

)

145,159.1

 

Stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

Series A preferred stock

 

 

 

 

 

 

Series B preferred stock

 

0.1

 

 

 

 

0.1

 

Common stock

 

3.9

 

2.5

 

 

(2.5

)

3.9

 

Additional paid-in capital

 

8,326.1

 

5,608.9

 

7,775.7

 

(13,384.6

)

8,326.1

 

Retained earnings

 

3,589.4

 

903.4

 

33.4

 

(936.8

)

3,589.4

 

Accumulated other comprehensive loss

 

(359.1

)

(734.5

)

(340.4

)

1,074.9

 

(359.1

)

Treasury stock, at cost

 

(4,718.3

)

 

 

 

(4,718.3

)

Total stockholders’ equity

 

6,842.1

 

5,780.3

 

7,468.7

 

(13,249.0

)

6,842.1

 

Total liabilities and stockholders’ equity

 

$

7,465.4

 

$

137,496.7

 

$

21,122.1

 

$

(14,083.0

)

$

152,001.2

 

 

23



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
March 31, 2008
(Unaudited)

 

10. Condensed Consolidating Financial Information (continued)

 

Condensed Consolidating Statements of Financial Position
December 31, 2007

 

 

 

Principal
Financial
Group, Inc.
Parent Only

 

Principal Life
Insurance
Company
Only

 

Principal Financial
Services, Inc. and
Other Subsidiaries
Combined

 

Eliminations

 

Principal
Financial
Group, Inc.
Consolidated

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

 

$

42,178.6

 

$

5,288.6

 

$

(728.3

)

$

46,738.9

 

Fixed maturities, trading

 

 

267.4

 

261.9

 

 

529.3

 

Equity securities, available-for-sale

 

 

305.0

 

11.4

 

 

316.4

 

Equity securities, trading

 

 

 

269.8

 

 

269.8

 

Mortgage loans

 

 

10,284.2

 

2,693.1

 

(317.7

)

12,659.6

 

Real estate

 

 

10.9

 

851.6

 

 

862.5

 

Policy loans

 

 

853.7

 

16.2

 

 

869.9

 

Investment in unconsolidated entities

 

8,031.2

 

703.1

 

3,861.1

 

(12,104.7

)

490.7

 

Other investments

 

 

3,559.5

 

464.7

 

(2,396.3

)

1,627.9

 

Cash and cash equivalents

 

(3.2

)

927.8

 

536.4

 

(116.6

)

1,344.4

 

Accrued investment income