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 June 30, 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 July 31, 2008 was 259,158,218.

 

 

 



 

PRINCIPAL FINANCIAL GROUP, INC.

 

TABLE OF CONTENTS

 

 

 

Page

Part I - FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements

3

 

 

 

 

 

 

Consolidated Statements of Financial Position at June 30, 2008 (Unaudited) and December 31, 2007

3

 

 

 

 

 

 

Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007

4

 

 

 

 

 

 

Unaudited Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2008 and 2007

5

 

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007

6

 

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements — June 30, 2008

8

 

 

 

 

Item 2.

 

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

38

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

81

 

 

 

 

Item 4.

 

Controls and Procedures

87

 

 

 

 

Part II — OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

88

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

88

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

89

 

 

 

 

Item 6.

 

Exhibits

89

 

 

 

 

Signature

90

 

2



 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Principal Financial Group, Inc.
Consolidated Statements of Financial Position

 

 

 

June 30,
2008

 

December 31,
2007

 

 

 

(Unaudited)

 

 

 

 

 

(in millions)

 

Assets

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

46,860.9

 

$

46,738.9

 

Fixed maturities, trading

 

907.4

 

529.3

 

Equity securities, available-for-sale

 

261.6

 

316.4

 

Equity securities, trading

 

265.5

 

269.8

 

Mortgage loans

 

12,773.1

 

12,659.6

 

Real estate

 

888.7

 

862.5

 

Policy loans

 

875.6

 

869.9

 

Other investments

 

2,296.1

 

2,118.6

 

Total investments

 

65,128.9

 

64,365.0

 

Cash and cash equivalents

 

1,524.5

 

1,344.4

 

Accrued investment income

 

744.0

 

774.1

 

Premiums due and other receivables

 

892.1

 

951.2

 

Deferred policy acquisition costs

 

3,344.1

 

2,810.1

 

Property and equipment

 

490.9

 

469.0

 

Goodwill

 

385.1

 

374.7

 

Other intangibles

 

995.7

 

1,006.9

 

Separate account assets

 

75,527.3

 

80,486.8

 

Other assets

 

2,494.3

 

1,938.0

 

Total assets

 

$

151,526.9

 

$

154,520.2

 

Liabilities

 

 

 

 

 

Contractholder funds

 

$

42,942.1

 

$

40,288.9

 

Future policy benefits and claims

 

18,690.5

 

18,454.7

 

Other policyholder funds

 

546.9

 

540.5

 

Short-term debt

 

215.1

 

290.8

 

Long-term debt

 

1,384.0

 

1,398.8

 

Income taxes currently payable

 

52.8

 

41.6

 

Deferred income taxes

 

165.0

 

576.3

 

Separate account liabilities

 

75,527.3

 

80,486.8

 

Other liabilities

 

5,383.3

 

5,020.1

 

Total liabilities

 

144,907.0

 

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, 386.7 million and 385.8 million shares issued, and 259.0 million and 259.1 million shares outstanding in 2008 and 2007, respectively

 

3.9

 

3.9

 

Additional paid-in capital

 

8,350.4

 

8,295.4

 

Retained earnings

 

3,757.7

 

3,414.3

 

Accumulated other comprehensive income (loss)

 

(773.9

)

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

 

6,619.9

 

7,421.7

 

Total liabilities and stockholders’ equity

 

$

151,526.9

 

$

154,520.2

 

 

See accompanying notes.

 

3



 

Principal Financial Group, Inc.
Consolidated Statements of Operations

(Unaudited)

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions, except per share data)

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums and other considerations

 

$

1,156.2

 

$

1,176.9

 

$

2,209.2

 

$

2,284.6

 

Fees and other revenues

 

622.5

 

622.9

 

1,235.9

 

1,215.4

 

Net investment income

 

991.0

 

976.6

 

1,951.3

 

1,899.8

 

Net realized/unrealized capital gains (losses)

 

(111.5

)

55.4

 

(237.5

)

93.0

 

Total revenues

 

2,658.2

 

2,831.8

 

5,158.9

 

5,492.8

 

Expenses

 

 

 

 

 

 

 

 

 

Benefits, claims and settlement expenses

 

1,634.0

 

1,584.7

 

3,106.0

 

3,082.7

 

Dividends to policyholders

 

69.0

 

74.0

 

139.8

 

148.0

 

Operating expenses

 

749.2

 

760.4

 

1,495.1

 

1,515.1

 

Total expenses

 

2,452.2

 

2,419.1

 

4,740.9

 

4,745.8

 

Income from continuing operations before income taxes

 

206.0

 

412.7

 

418.0

 

747.0

 

Income taxes

 

29.4

 

100.4

 

59.0

 

169.4

 

Income from continuing operations, net of related income taxes

 

176.6

 

312.3

 

359.0

 

577.6

 

Loss from discontinued operations, net of related income taxes

 

 

(0.2

)

 

(0.2

)

Net income

 

176.6

 

312.1

 

359.0

 

577.4

 

Preferred stock dividends

 

8.3

 

8.3

 

16.5

 

16.5

 

Net income available to common stockholders

 

$

168.3

 

$

303.8

 

$

342.5

 

$

560.9

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations, net of related income taxes

 

$

0.65

 

$

1.14

 

$

1.32

 

$

2.09

 

Loss from discontinued operations, net of related income taxes

 

 

 

¾

 

¾

 

Net income

 

$

0.65

 

$

1.14

 

$

1.32

 

$

2.09

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations, net of related income taxes

 

$

0.64

 

$

1.12

 

$

1.31

 

$

2.07

 

Loss from discontinued operations, net of related income taxes

 

 

 

¾

 

¾

 

Net income

 

$

0.64

 

$

1.12

 

$

1.31

 

$

2.07

 

 

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

 

 

 

 

38.5

 

 

 

 

38.5

 

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

 

 

 

 

0.2

 

 

 

 

0.2

 

Stock-based compensation and additional related tax benefits

 

 

 

 

43.2

 

 

 

 

43.2

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(224.0

)

(224.0

)

Dividends to preferred stockholders

 

 

 

 

 

(16.5

)

 

 

(16.5

)

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

577.4

 

 

 

577.4

 

Net unrealized losses, net

 

 

 

 

 

 

(328.5

)

 

(328.5

)

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

36.5

 

 

36.5

 

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

 

 

 

 

 

 

(0.9

)

 

(0.9

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

284.5

 

Balances at June 30, 2007

 

$

 

$

0.1

 

$

3.8

 

$

8,223.7

 

$

3,385.0

 

$

554.0

 

$

(4,179.9

)

$

7,986.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

23.6

 

 

 

 

23.6

 

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

 

 

 

 

0.2

 

 

 

 

0.2

 

Stock-based compensation and additional related tax benefits

 

 

 

 

31.2

 

 

 

 

31.2

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(6.1

)

(6.1

)

Dividends to preferred stockholders

 

 

 

 

 

(16.5

)

 

 

(16.5

)

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

 

 

 

 

 

0.9

 

(2.0

)

 

(1.1

)

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

359.0

 

 

 

359.0

 

Net unrealized losses, net

 

 

 

 

 

 

(1,220.9

)

 

(1,220.9

)

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

32.8

 

 

32.8

 

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

 

 

 

 

 

 

(4.0

)

 

(4.0

)

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(833.1

)

Balances at June 30, 2008

 

$

 

$

0.1

 

$

3.9

 

$

8,350.4

 

$

3,757.7

 

$

(773.9

)

$

(4,718.3

)

$

6,619.9

 

 

See accompanying notes.

 

5



 

Principal Financial Group, Inc.
Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Operating activities

 

 

 

 

 

Net income

 

$

359.0

 

$

577.4

 

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

 

 

 

 

 

Loss from discontinued operations, net of related income taxes

 

 

0.2

 

Amortization of deferred policy acquisition costs

 

126.4

 

150.5

 

Additions to deferred policy acquisition costs

 

(373.8

)

(252.8

)

Accrued investment income

 

30.1

 

21.3

 

Net cash flows from trading securities

 

(409.8

)

(157.8

)

Premiums due and other receivables

 

23.0

 

186.6

 

Contractholder and policyholder liabilities and dividends

 

1,083.9

 

983.7

 

Current and deferred income taxes

 

(20.1

)

26.7

 

Net realized/unrealized capital (gains) losses

 

237.5

 

(93.0

)

Depreciation and amortization expense

 

69.8

 

65.4

 

Mortgage loans held for sale, acquired or originated

 

(27.4

)

(52.5

)

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

 

28.8

 

128.4

 

Real estate acquired through operating activities

 

(29.9

)

(28.2

)

Real estate sold through operating activities

 

7.2

 

46.8

 

Stock-based compensation

 

26.4

 

37.3

 

Other

 

(58.0

)

280.5

 

Net adjustments

 

714.1

 

1,343.1

 

Net cash provided by operating activities

 

1,073.1

 

1,920.5

 

Investing activities

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

Purchases

 

(4,360.4

)

(5,067.2

)

Sales

 

434.2

 

2,265.5

 

Maturities

 

1,799.4

 

2,356.7

 

Mortgage loans acquired or originated

 

(753.4

)

(1,336.8

)

Mortgage loans sold or repaid

 

613.8

 

862.4

 

Real estate acquired

 

(11.2

)

(60.8

)

Real estate sold

 

46.0

 

5.7

 

Net purchases of property and equipment

 

(49.5

)

(46.1

)

Purchases of interest in subsidiaries, net of cash acquired

 

(20.3

)

 

Net change in other investments

 

(25.3

)

(16.9

)

Net cash used in investing activities

 

$

(2,326.7

)

$

(1,037.5

)

 

6



 

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

 

 

 

For the six months ended,
June 30,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Financing activities

 

 

 

 

 

Issuance of common stock

 

$

23.6

 

$

38.5

 

Acquisition of treasury stock

 

(6.1

)

(224.0

)

Proceeds from financing element derivatives

 

83.3

 

76.2

 

Payments for financing element derivatives

 

(61.1

)

(69.1

)

Excess tax benefits from share-based payment arrangements

 

2.8

 

6.1

 

Dividends to preferred stockholders

 

(16.5

)

(16.5

)

Issuance of long-term debt

 

3.1

 

8.3

 

Principal repayments of long-term debt

 

(12.7

)

(22.3

)

Net repayments of short-term borrowings

 

(72.7

)

(26.1

)

Investment contract deposits

 

6,792.5

 

4,015.3

 

Investment contract withdrawals

 

(5,531.7

)

(4,510.4

)

Net increase in banking operation deposits

 

232.3

 

108.2

 

Other

 

(3.1

)

 

Net cash provided by (used in) financing activities

 

1,433.7

 

(615.8

)

Discontinued operations

 

 

 

 

 

Net cash provided by operating activities

 

 

1.4

 

Net cash used in investing activities

 

 

(1.1

)

Net cash used in financing activities

 

 

(0.3

)

Net cash provided by discontinued operations

 

 

 

Net increase in cash and cash equivalents

 

180.1

 

267.2

 

Cash and cash equivalents at beginning of period

 

1,344.4

 

1,590.8

 

Cash and cash equivalents at end of period

 

$

1,524.5

 

$

1,858.0

 

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

June 30, 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 and six months ended June 30, 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 June 30, 2007, financial statements to conform to the June 30, 2008, presentation.

 

Recent Accounting Pronouncements

 

On March 19, 2008, the Financial Accounting Standards Board (“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). Election of this option upon acquisition or assumption of eligible items could introduce period to period volatility in net income.

 

8



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 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 June 30, 2008, and December 31, 2007, the separate accounts include a separate account valued at $418.4 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 rates for the three and six months ended June 30, 2008, were lower than the corporate income tax rate of 35% primarily due to income tax deductions allowed for corporate dividends received and additional U.S. foreign tax credits resulting from the enactment of legislation to increase the Brazilian tax rate in the second quarter of 2008.  As we apply the equity method of accounting to our Brazilian operations, the net increase in deferred tax liabilities associated with the newly enacted rate is reflected in net investment income.  The effective income tax rate for the six months ended June 30, 2008, is also lower than the prevailing corporate federal income tax rate due to the release of state deferred income tax liabilities associated with a reorganization of certain subsidiaries. The effective income tax rates for the three and six months ended June 30, 2007, were lower than the corporate income tax rate of 35% primarily due to income tax deductions allowed for corporate dividends received and interest exclusion from taxable income. The effective income tax rate for the six months ended June 30, 2007, is also lower than the prevailing corporate federal income tax rate due to tax credits received on our investment in a synthetic fuel production facility.

 

9



 

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

June 30, 2008
(Unaudited)

 

2. Federal Income Taxes (continued)

 

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.

 

3. Employee and Agent Benefits

 

Components of net periodic benefit cost (income):

 

 

 

Pension benefits

 

Other postretirement
benefits

 

 

 

For the three months ended
June 30,

 

For the three months ended
June 30,

 

 

 

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

)

 

 

 

Pension benefits

 

Other postretirement
benefits

 

 

 

For the six months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Service cost

 

$

24.8

 

$

23.5

 

$

4.2

 

$

4.0

 

Interest cost

 

49.8

 

44.8

 

8.4

 

7.7

 

Expected return on plan assets

 

(65.2

)

(57.1

)

(18.8

)

(16.8

)

Amortization of prior service benefit

 

(3.8

)

(4.2

)

(1.2

)

(1.3

)

Recognized net actuarial loss (gain)

 

0.6

 

5.0

 

(1.6

)

(0.9

)

Net periodic benefit cost (income)

 

$

6.2

 

$

12.0

 

$

(9.0

)

$

(7.3

)

 

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. During the three and six months ended June 30, 2008, no contributions were made to these plans.

 

10



 

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

June 30, 2008
(Unaudited)

 

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.

 

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 Principal Life 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 June 30, 2008, was approximately $206.0 million. At inception, the fair value of such guarantees was insignificant. In addition, we believe the likelihood is remote that material payments will be required. 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 performance under these guarantees could materially affect net income in a particular quarter or annual period.

 

11



 

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

June 30, 2008
(Unaudited)

 

4. Contingencies, Guarantees and Indemnifications (continued)

 

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. At inception, the fair value of such indemnifications was insignificant. In addition, we believe the likelihood is remote that material payments will be required. Therefore, any liability accrued within our consolidated statements of financial position is insignificant. While we are unable to estimate with certainty the ultimate legal and financial liability with respect to these indemnifications, we believe that performance under these indemnifications would not result in a material adverse effect on our business or financial position. It is possible that performance under these indemnifications could materially affect net income in a particular quarter or annual period.

 

Securities Posted as Collateral

 

We posted $865.0 million in fixed maturities, available-for-sale securities at June 30, 2008, to satisfy collateral requirements primarily associated with our derivatives credit support annex agreements and a reinsurance arrangement. In addition, we posted $295.2 million in commercial and residential mortgage-backed securities as of June 30, 2008, to satisfy collateral requirements associated with our obligation under a funding agreement with the Federal Home Loan Bank of Des Moines (“FHLB of Des Moines”).

 

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

 

 

 

1.3

 

Treasury stock acquired

 

 

 

(3.7

)

Outstanding shares at June 30, 2007

 

3.0

 

10.0

 

266.0

 

 

 

 

 

 

 

 

 

Outstanding shares at January 1, 2008

 

3.0

 

10.0

 

259.1

 

Shares issued

 

 

 

0.9

 

Treasury stock acquired

 

 

 

(1.0

)

Outstanding shares at June 30, 2008

 

3.0

 

10.0

 

259.0

 

 

12



 

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

June 30, 2008
(Unaudited)

 

5. Stockholders’ Equity (continued)

 

Comprehensive income (loss) is as follows:

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Net income

 

$

176.6

 

$

312.1

 

$

359.0

 

$

577.4

 

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

 

(716.8

)

(756.8

)

(2,172.0

)

(713.6

)

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

 

6.6

 

(4.9

)

(2.3

)

(5.4

)

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

 

5.5

 

83.5

 

6.1

 

96.6

 

Adjustments for assumed changes in amortization patterns

 

122.7

 

113.1

 

293.7

 

118.5

 

Adjustment for assumed changes in liability for policyholder benefits and claims

 

(3.7

)

 

(11.4

)

 

Net change in unrealized gains on derivative instruments

 

48.6

 

21.9

 

11.9

 

28.8

 

Change in net foreign currency translation adjustment

 

(29.3

)

38.8

 

41.1

 

38.3

 

Change in unrecognized post-retirement benefit obligation

 

(3.0

)

(0.7

)

(6.1

)

(1.4

)

Provision for deferred income tax benefits

 

154.6

 

161.4

 

646.9

 

145.3

 

Comprehensive income (loss)

 

$

(238.2

)

$

(31.6

)

$

(833.1

)

$

284.5

 

 

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. Our Level 1 assets and liabilities primarily include exchange traded equity securities, mutual funds and highly liquid U.S. Treasury bonds.

·                  Level 2 – Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. Our Level 2 assets and liabilities primarily include fixed maturity securities (including public and private bonds), equity securities, over-the-counter derivatives and other investments for which public quotations are not available but that are priced by third-party pricing services or internal models using observable inputs.

·                  Level 3 – Unobservable inputs for the asset or liability. Our Level 3 assets and liabilities include fixed maturity securities (including private, structured transactions), private equity securities, complex derivatives and embedded derivatives that must be priced using broker quotes or other valuation methods that utilize substantial unobservable inputs.

 

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 reliant on 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.

 

13



 

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

June 30, 2008
(Unaudited)

 

6. Fair Value Measurement (continued)

 

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 are determined using 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 third-party pricing services using market observable inputs. Private placement securities and other corporate fixed maturities where we do not receive a public quotation are valued by discounting the expected 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 observable 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 be determined using 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, reflecting the projected cash flows over the life of the contract, incorporating expected policyholder behavior.

 

14



 

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

June 30, 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 June 30, 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

 

$

46,860.9

 

$

147.2

 

$

44,862.2

 

$

1,851.5

 

Fixed maturities, trading

 

907.4

 

 

842.0

 

65.4

 

Equity securities, available-for-sale

 

261.6

 

206.4

 

2.0

 

53.2

 

Equity securities, trading

 

265.5

 

127.2

 

138.3

 

 

Net derivative assets and liabilities (1)

 

486.6

 

 

522.4

 

(35.8

)

Other investments (2)

 

125.6

 

16.7

 

108.9

 

 

Cash equivalents (3)

 

1,419.4

 

693.3

 

726.1

 

 

Sub-total excluding separate account assets

 

50,327.0

 

1,190.8

 

47,201.9

 

1,934.3

 

 

 

 

 

 

 

 

 

 

 

Separate account assets

 

75,527.3

 

49,216.4

 

19,213.8

 

7,097.1

 

Total assets

 

$

125,854.3

 

$

50,407.2

 

$

66,415.7

 

$

9,031.4

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts (4)

 

$

(2.4

)

$

 

$

 

$

(2.4

)

Total liabilities

 

$

(2.4

)

$

 

$

 

$

(2.4

)

 


(1)

 

The fair value of our derivative instruments classified as assets and liabilities at June 30, 2008, was $1,227.0 million and $740.4 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.

 

15



 

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

June 30, 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 and six months ended June 30, 2008, is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

For the three months ended June 30, 2008

 

unrealized

 

 

 

 

 

Total realized/unrealized
gains (losses)

 

Purchases,

 

 

 

Ending

 

gains (losses)
included in

 

 

 

Beginning
balance as
of March
31, 2008

 

Included
in net
income
(1)

 

Included in
other
comprehensive
income

 

sales,
issuances
and
settlements

 

Transfers
in (out) of
Level 3

 

balance
as of
June 30,
2008

 

net income
relating to
positions
still held (1)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

1,810.8

 

$

(8.6

)

$

(13.3

)

$

4.0

 

$

58.6

 

$

1,851.5

 

$

(9.4

)

Fixed maturities, trading

 

106.5

 

(1.0

)

 

(30.0

)

(10.1

)

65.4

 

(1.0

)

Equity securities, available-for-sale

 

38.9

 

(11.0

)

10.3

 

 

15.0

 

53.2

 

(11.0

)

Net derivative assets and liabilities

 

(48.1

)

10.0

 

1.8

 

0.5

 

 

(35.8

)

8.0

 

Separate account assets

 

7,388.2

 

(301.2

)

 

8.7

 

1.4

 

7,097.1

 

(289.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts

 

(4.0

)

(1.4

)

 

3.0

 

 

(2.4

)

1.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

For the six months ended June 30, 2008

 

unrealized

 

 

 

 

 

Total realized/unrealized
gains (losses)

 

Purchases,

 

 

 

Ending

 

gains (losses)
included in

 

 

 

Beginning
balance as
of January
1, 2008

 

Included
in net
income
(1)

 

Included in
other
comprehensive
income

 

sales,
issuances
and
settlements

 

Transfers
in (out) of
Level 3

 

balance
as of
June 30,
2008

 

net income
relating to
positions still
held (1)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

2,201.3

 

$

(50.4

)

$

(362.2

)

$

(74.8

)

$

137.6

 

$

1,851.5

 

$

(49.0

)

Fixed maturities, trading

 

92.3

 

(1.6

)

 

(15.2

)

(10.1

)

65.4

 

(1.6

)

Equity securities, available-for-sale

 

51.1

 

(34.3

)

0.2

 

(1.8

)

38.0

 

53.2

 

(34.7

)

Net derivative assets and liabilities

 

(8.0

)

(35.9

)

7.0

 

1.1

 

 

(35.8

)

(37.3

)

Separate account assets

 

7,313.2

 

(283.8

)

 

140.1

 

(72.4

)

7,097.1

 

(272.7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts

 

(49.3

)

7.3

 

 

39.6

 

 

(2.4

)

7.6

 

 


(1)

 

Both realized and unrealized gains and losses for the three and six months ended June 30, 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.

 

16



 

Principal Financial Group, Inc.

Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

6. Fair Value Measurement (continued)

 

Assets and liabilities measured at fair value on a nonrecurring basis

 

Certain assets are measured at fair value on a nonrecurring basis.  During the first quarter of 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 gain in 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.

 

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 and six months ended June 30, 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.

 

17



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

7. Segment Information (continued)

 

Management uses segment operating earnings in goal setting, as a basis for 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.

 

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

 

 

 

June 30,
2008

 

December 31,
2007

 

 

 

(in millions)

 

Assets:

 

 

 

 

 

U.S. Asset Accumulation

 

$

123,028.0

 

$

126,131.1

 

Global Asset Management

 

1,343.3

 

1,438.9

 

International Asset Management and Accumulation

 

9,571.1

 

9,350.5

 

Life and Health Insurance

 

14,949.8

 

14,816.6

 

Corporate and Other

 

2,634.7

 

2,783.1

 

Total consolidated assets

 

$

151,526.9

 

$

154,520.2

 

 

18



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

7. Segment Information (continued)

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Operating revenues by segment:

 

 

 

 

 

 

 

 

 

U.S. Asset Accumulation

 

$

1,255.7

 

$

1,265.9

 

$

2,460.4

 

$

2,445.0

 

Global Asset Management

 

146.1

 

154.5

 

264.4

 

289.3

 

International Asset Management and Accumulation

 

251.2

 

175.0

 

434.9

 

316.3

 

Life and Health Insurance

 

1,180.6

 

1,211.5

 

2,368.2

 

2,423.9

 

Corporate and Other

 

(44.5

)

(21.4

)

(99.8

)

(65.3

)

Total segment operating revenues

 

2,789.1

 

2,785.5

 

5,428.1

 

5,409.2

 

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

 

(130.9

)

46.1

 

(269.2

)

83.3

 

Subtract:

 

 

 

 

 

 

 

 

 

Operating revenues from a discontinued real estate investment

 

 

(0.2

)

 

(0.3

)

Total revenues per consolidated statements of operations

 

$

2,658.2

 

$

2,831.8

 

$

5,158.9

 

$

5,492.8

 

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

 

 

 

 

 

 

 

 

 

U.S. Asset Accumulation

 

$

152.9

 

$

164.5

 

$

292.0

 

$

319.2

 

Global Asset Management

 

23.7

 

32.2

 

26.4

 

55.9

 

International Asset Management and Accumulation

 

31.8

 

26.7

 

63.5

 

46.0

 

Life and Health Insurance

 

66.7

 

60.1

 

145.9

 

105.6

 

Corporate and Other

 

(21.4

)

(0.6

)

(32.8

)

(7.0

)

Total segment operating earnings, net of related income taxes

 

253.7

 

282.9

 

495.0

 

519.7

 

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

 

(85.4

)

20.9

 

(160.1

)

41.2

 

Other after-tax adjustments (2)

 

 

 

7.6

 

 

Net income available to common stockholders per consolidated statements of operations

 

$

168.3

 

$

303.8

 

$

342.5

 

$

560.9

 

 

19



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

7. Segment Information (continued)

 


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

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Net realized/unrealized capital gains (losses)

 

$

(111.5

)

$

55.4

 

$

(237.5

)

$

93.0

 

Periodic settlements and accruals on non-hedge derivatives

 

(19.4

)

(9.5

)

(28.2

)

(9.5

)

Certain market value adjustments to fee revenues

 

 

(0.2

)

(3.5

)

(1.0

)

Recognition of front-end fee revenues

 

 

0.4

 

 

0.8

 

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

 

(130.9

)

46.1

 

(269.2

)

83.3

 

Amortization of deferred policy acquisition and sales inducement costs

 

16.4

 

1.8

 

29.9

 

1.1

 

Capital (gains) losses distributed

 

(6.9

)

(8.6

)

2.4

 

(10.6

)

Certain market value adjustments of embedded derivatives

 

(3.2

)

 

(3.2

)

 

Minority interest capital (gains) losses

 

(3.0

)

(5.6

)

3.7

 

(6.9

)

Income tax effect

 

42.2

 

(12.8

)

76.3

 

(25.7

)

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

 

$

(85.4

)

$

20.9

 

$

(160.1

)

$

41.2

 

 

(2)                                  For the six months ended June 30, 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.

 

20



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

7. Segment Information (continued)

 

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

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

U.S. Asset Accumulation:

 

 

 

 

 

 

 

 

 

Full service accumulation

 

$

368.1

 

$

370.4

 

$

730.8

 

$

736.9

 

Principal Funds

 

168.8

 

179.0

 

342.1

 

336.4

 

Individual annuities

 

271.9

 

187.7

 

491.8

 

334.7

 

Bank and trust services

 

16.6

 

14.7

 

36.7

 

29.6

 

Eliminations

 

(44.9

)

(43.5

)

(94.2

)

(72.2

)

Total Accumulation

 

780.5

 

708.3

 

1,507.2

 

1,365.4

 

Investment only

 

274.4

 

295.5

 

562.1

 

577.9

 

Full service payout

 

200.8

 

262.1

 

391.1

 

501.7

 

Total Guaranteed

 

475.2

 

557.6

 

953.2

 

1,079.6

 

Total U.S. Asset Accumulation

 

1,255.7

 

1,265.9

 

2,460.4

 

2,445.0

 

Global Asset Management (1)

 

146.1

 

154.5

 

264.4

 

289.3

 

International Asset Management and Accumulation

 

251.2

 

175.0

 

434.9

 

316.3

 

Life and Health Insurance:

 

 

 

 

 

 

 

 

 

Individual life insurance

 

350.7

 

337.4

 

699.7

 

675.2

 

Health insurance

 

452.0

 

510.8

 

917.4

 

1,030.0

 

Specialty benefits insurance

 

378.4

 

363.9

 

752.2

 

720.0

 

Eliminations

 

(0.5

)

(0.6

)

(1.1

)

(1.3

)

Total Life and Health Insurance

 

1,180.6

 

1,211.5

 

2,368.2

 

2,423.9

 

Corporate and Other

 

(44.5

)

(21.4

)

(99.8

)

(65.3

)

Total operating revenues

 

$

2,789.1

 

$

2,785.5

 

$

5,428.1

 

$

5,409.2

 

Total operating revenues

 

$

2,789.1

 

$

2,785.5

 

$

5,428.1

 

$

5,409.2

 

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

 

(130.9

)

46.1

 

(269.2

)

83.3

 

Operating revenues from a discontinued real estate investment

 

 

0.2

 

 

0.3

 

Total revenues per consolidated statements of operations

 

$

2,658.2

 

$

2,831.8

 

$

5,158.9

 

$

5,492.8

 

 


(1)                                 Reflects inter-segment revenues of $59.1 million and $57.1 million and $117.9 million and $111.9 million for the three and six months ended June 30, 2008 and 2007, respectively.  These revenues are eliminated within the Corporate and Other segment.

 

21



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

8. Stock-Based Compensation Plans

 

As of June 30, 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 June 30, 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 six months ended
June 30,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Compensation cost

 

$

27.4

 

$

34.0

 

Related income tax benefit

 

9.0

 

11.0

 

Capitalized as part of an asset

 

2.6

 

2.1

 

 

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 six months ended June 30, 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 six months ended June 30, 2008, was $15.47 per share.

 

As of June 30, 2008, there were $21.6 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 2.0 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 six months ended June 30, 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 $59.99 per common share.

 

As of June 30, 2008, there were $9.2 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 1.2 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 0.8 million for the six months ended June 30, 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 $59.79 per common share.

 

As of June 30, 2008, there were $41.9 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 2.4 years.

 

22



 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
June 30, 2008
(Unaudited)

 

8. Stock-Based Compensation Plans (continued)