Table of Contents

 

 

 

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 September 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, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” 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 October 29, 2008, was 259,339,895.

 

 

 



Table of Contents

 

PRINCIPAL FINANCIAL GROUP, INC.

 

TABLE OF CONTENTS

 

 

Page

Part I - FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

3

 

 

 

 

 

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

 

3

 

 

 

 

 

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007

 

4

 

 

 

 

 

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

 

5

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007

 

6

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements — September 30, 2008

 

8

 

 

 

 

Item 2.

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

 

40

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

88

 

 

 

 

Item 4.

Controls and Procedures

 

93

 

 

 

 

Part II — OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

94

 

 

 

 

Item 1A.

Risk Factors

 

94

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

108

 

 

 

 

Item 6.

Exhibits

 

109

 

 

 

 

Signature

 

 

110

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Principal Financial Group, Inc.
Consolidated Statements of Financial Position

 

 

 

September 30,
2008

 

December 31,
2007

 

 

 

(Unaudited)

 

 

 

 

 

(in millions)

 

Assets

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

44,622.1

 

$

46,738.9

 

Fixed maturities, trading

 

982.2

 

529.3

 

Equity securities, available-for-sale

 

246.2

 

316.4

 

Equity securities, trading

 

204.8

 

269.8

 

Mortgage loans

 

13,268.8

 

12,659.6

 

Real estate

 

891.5

 

862.5

 

Policy loans

 

883.7

 

869.9

 

Other investments

 

1,981.4

 

2,118.6

 

Total investments

 

63,080.7

 

64,365.0

 

Cash and cash equivalents

 

2,269.0

 

1,344.4

 

Accrued investment income

 

806.9

 

774.1

 

Premiums due and other receivables

 

1,598.4

 

951.2

 

Deferred policy acquisition costs

 

3,727.1

 

2,810.1

 

Property and equipment

 

510.8

 

469.0

 

Goodwill

 

382.3

 

374.7

 

Other intangibles

 

976.1

 

1,006.9

 

Separate account assets

 

67,087.6

 

80,486.8

 

Other assets

 

2,970.8

 

1,938.0

 

Total assets

 

$

143,409.7

 

$

154,520.2

 

Liabilities

 

 

 

 

 

Contractholder funds

 

$

44,238.4

 

$

40,288.9

 

Future policy benefits and claims

 

18,770.0

 

18,454.7

 

Other policyholder funds

 

559.2

 

540.5

 

Short-term debt

 

350.1

 

290.8

 

Long-term debt

 

1,378.6

 

1,398.8

 

Income taxes currently payable

 

43.6

 

41.6

 

Deferred income taxes

 

148.5

 

576.3

 

Separate account liabilities

 

67,087.6

 

80,486.8

 

Other liabilities

 

5,221.1

 

5,020.1

 

Total liabilities

 

137,797.1

 

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, 386.9 million and 385.8 million shares issued, and 259.2 million and 259.1 million shares outstanding in 2008 and 2007, respectively

 

3.9

 

3.9

 

Additional paid-in capital

 

8,366.7

 

8,295.4

 

Retained earnings

 

3,847.8

 

3,414.3

 

Accumulated other comprehensive income (loss)

 

(1,887.3

)

420.2

 

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

 

(4,718.6

)

(4,712.2

)

Total stockholders’ equity

 

5,612.6

 

7,421.7

 

Total liabilities and stockholders’ equity

 

$

143,409.7

 

$

154,520.2

 

 

See accompanying notes.

 

3



Table of Contents

 

Principal Financial Group, Inc.
Consolidated Statements of Operations

(Unaudited)

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions, except per share data)

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums and other considerations

 

$

1,049.7

 

$

1,171.4

 

$

3,258.9

 

$

3,456.0

 

Fees and other revenues

 

599.0

 

738.5

 

1,834.9

 

1,953.9

 

Net investment income

 

1,079.7

 

1,029.0

 

3,031.0

 

2,928.8

 

Net realized/unrealized capital gains (losses)

 

(230.6

)

(89.3

)

(468.1

)

3.7

 

Total revenues

 

2,497.8

 

2,849.6

 

7,656.7

 

8,342.4

 

Expenses

 

 

 

 

 

 

 

 

 

Benefits, claims and settlement expenses

 

1,597.2

 

1,643.2

 

4,703.2

 

4,725.9

 

Dividends to policyholders

 

70.4

 

73.9

 

210.2

 

221.9

 

Operating expenses

 

734.1

 

800.9

 

2,229.2

 

2,316.0

 

Total expenses

 

2,401.7

 

2,518.0

 

7,142.6

 

7,263.8

 

Income from continuing operations before income taxes

 

96.1

 

331.6

 

514.1

 

1,078.6

 

Income taxes (benefits)

 

(2.2

)

90.9

 

56.8

 

260.3

 

Income from continuing operations, net of related income taxes

 

98.3

 

240.7

 

457.3

 

818.3

 

Loss from discontinued operations, net of related income taxes

 

 

(0.2

)

 

(0.4

)

Net income

 

98.3

 

240.5

 

457.3

 

817.9

 

Preferred stock dividends

 

8.2

 

8.2

 

24.7

 

24.7

 

Net income available to common stockholders

 

$

90.1

 

$

232.3

 

$

432.6

 

$

793.2

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations, net of related income taxes

 

$

0.35

 

$

0.88

 

$

1.67

 

$

2.97

 

Loss from discontinued operations, net of related income taxes

 

 

 

¾

 

¾

 

Net income

 

$

0.35

 

$

0.88

 

$

1.67

 

$

2.97

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income from continuing operations, net of related income taxes

 

$

0.35

 

$

0.87

 

$

1.66

 

$

2.94

 

Loss from discontinued operations, net of related income taxes

 

 

 

¾

 

¾

 

Net income

 

$

0.35

 

$

0.87

 

$

1.66

 

$

2.94

 

 

See accompanying notes.

 

4



Table of Contents

 

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

 

 

 

 

49.5

 

 

 

 

49.5

 

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

 

 

 

 

0.8

 

 

 

 

0.8

 

Stock-based compensation and additional related tax benefits

 

 

 

 

58.7

 

 

 

 

58.7

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(436.2

)

(436.2

)

Dividends to preferred stockholders

 

 

 

 

 

(24.7

)

 

 

(24.7

)

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

817.9

 

 

 

817.9

 

Net unrealized losses, net

 

 

 

 

 

 

(492.3

)

 

(492.3

)

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

35.2

 

 

35.2

 

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

 

 

 

 

 

 

(1.4

)

 

(1.4

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

359.4

 

Balances at September 30, 2007

 

$

 

$

0.1

 

$

3.8

 

$

8,250.8

 

$

3,617.3

 

$

388.4

 

$

(4,392.1

)

$

7,868.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

31.5

 

 

 

 

31.5

 

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

 

 

 

 

0.3

 

 

 

 

0.3

 

Stock-based compensation and additional related tax benefits

 

 

 

 

39.5

 

 

 

 

39.5

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(6.4

)

(6.4

)

Dividends to preferred stockholders

 

 

 

 

 

(24.7

)

 

 

(24.7

)

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

 

 

 

 

 

0.9

 

(2.0

)

 

(1.1

)

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

457.3

 

 

 

457.3

 

Net unrealized losses, net

 

 

 

 

 

 

(2,282.8

)

 

(2,282.8

)

Foreign currency translation adjustment, net of related income taxes

 

 

 

 

 

 

(16.7

)

 

(16.7

)

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

 

 

 

 

 

 

(6.0

)

 

(6.0

)

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,848.2

)

Balances at September 30, 2008

 

$

 

$

0.1

 

$

3.9

 

$

8,366.7

 

$

3,847.8

 

$

(1,887.3

)

$

(4,718.6

)

$

5,612.6

 

 

See accompanying notes.

 

5



Table of Contents

 

Principal Financial Group, Inc.
Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Operating activities

 

 

 

 

 

Net income

 

$

457.3

 

$

817.9

 

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

 

 

 

 

 

Loss from discontinued operations, net of related income taxes

 

 

0.4

 

Amortization of deferred policy acquisition costs

 

212.6

 

292.2

 

Additions to deferred policy acquisition costs

 

(540.1

)

(416.6

)

Accrued investment income

 

(32.8

)

(38.1

)

Net cash flows from trading securities

 

(451.9

)

(196.6

)

Premiums due and other receivables

 

10.0

 

234.4

 

Contractholder and policyholder liabilities and dividends

 

1,747.0

 

1,593.4

 

Current and deferred income taxes (benefits)

 

(93.5

)

96.0

 

Net realized/unrealized capital (gains) losses

 

468.1

 

(3.7

)

Depreciation and amortization expense

 

105.4

 

86.2

 

Mortgage loans held for sale, acquired or originated

 

(56.4

)

(67.6

)

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

 

52.1

 

142.7

 

Real estate acquired through operating activities

 

(50.7

)

(36.7

)

Real estate sold through operating activities

 

14.6

 

49.6

 

Stock-based compensation

 

32.8

 

52.5

 

Other

 

(7.3

)

437.1

 

Net adjustments

 

1,409.9

 

2,225.2

 

Net cash provided by operating activities

 

1,867.2

 

3,043.1

 

Investing activities

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

Purchases

 

(6,205.6

)

(8,024.7

)

Sales

 

524.5

 

2,727.2

 

Maturities

 

2,483.7

 

3,430.1

 

Mortgage loans acquired or originated

 

(1,682.3

)

(2,119.3

)

Mortgage loans sold or repaid

 

1,041.8

 

1,476.3

 

Real estate acquired

 

(20.6

)

(87.8

)

Real estate sold

 

68.7

 

6.2

 

Net purchases of property and equipment

 

(83.3

)

(64.2

)

Purchases of interest in subsidiaries, net of cash acquired

 

(20.3

)

(69.1

)

Net change in other investments

 

(124.9

)

(106.6

)

Net cash used in investing activities

 

$

(4,018.3

)

$

(2,831.9

)

 

6



Table of Contents

 

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

 

 

 

For the nine months ended,
September 30,

 

 

 

2008

 

2007

 

 

 

(in millions)

 

Financing activities

 

 

 

 

 

Issuance of common stock

 

$

31.5

 

$

49.5

 

Acquisition of treasury stock

 

(6.4

)

(436.2

)

Proceeds from financing element derivatives

 

130.6

 

122.7

 

Payments for financing element derivatives

 

(91.3

)

(107.0

)

Excess tax benefits from share-based payment arrangements

 

2.8

 

6.6

 

Dividends to preferred stockholders

 

(24.7

)

(24.7

)

Issuance of long-term debt

 

6.4

 

8.5

 

Principal repayments of long-term debt

 

(17.3

)

(42.3

)

Net proceeds (repayments) of short-term borrowings

 

63.9

 

(29.4

)

Investment contract deposits

 

9,852.4

 

6,824.8

 

Investment contract withdrawals

 

(7,160.6

)

(6,427.5

)

Net increase in banking operation deposits

 

293.0

 

811.2

 

Other

 

(4.6

)

 

Net cash provided by financing activities

 

3,075.7

 

756.2

 

Discontinued operations

 

 

 

 

 

Net cash provided by operating activities

 

 

2.2

 

Net cash used in investing activities

 

 

(1.3

)

Net cash used in financing activities

 

 

(0.4

)

Net cash provided by discontinued operations

 

 

0.5

 

Net increase in cash and cash equivalents

 

924.6

 

967.9

 

Cash and cash equivalents at beginning of period

 

1,344.4

 

1,590.8

 

Cash and cash equivalents at end of period

 

$

2,269.0

 

$

2,558.7

 

Cash and cash equivalents of discontinued operations included above

 

 

 

 

 

At beginning of period

 

$

 

$

(0.7

)

At end of period

 

$

 

$

(0.2

)

 

See accompanying notes.

 

7



Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements
September 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 nine months ended September 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 September 30, 2007, financial statements to conform to the September 30, 2008, presentation.

 

Recent Accounting Pronouncements

 

On September 12, 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. FAS 133-1 and FASB Interpretation 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (“FSP FAS 133-1 and FIN 45-4”). FSP FAS 133-1 and FIN 45-4 (1) amends Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument;(2) amends FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, to require an additional disclosure about the current status of the payment/performance risk of a guarantee and (3) clarifies the FASB’s intent about the effective date of SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS 161”). FSP FAS 133-1 and FIN 45-4 is effective for reporting periods ending after November 15, 2008. We are currently evaluating the impact this guidance will have on our disclosures.

 

On March 19, 2008, the FASB issued 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.

 

8



Table of Contents

 

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

 

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

 

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.

 

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 FSP FAS 157-2, Effective Date of Statement No. 157 (“FSP FAS 157-2”), 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.  On October 10, 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset in a Market That Is Not Active (“FSP FAS 157-3”), which clarifies the application of SFAS 157 in an inactive market and provides an illustrative example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. Our adoption of SFAS 157 on January 1, 2008, for assets and liabilities measured at fair value on a recurring basis and financial assets and liabilities measured at fair value on a nonrecurring basis did not have a material impact on our consolidated financial statements. We are deferring the adoption of SFAS 157 for nonfinancial assets and liabilities measured at fair value on a nonrecurring basis until January 1, 2009, in accordance with FSP FAS 157-2. FSP FAS 157-3 is effective upon issuance and is not expected to have a material impact on our consolidated financial statements.  See Note 7, Fair Value Measurement, for further details.

 

9



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

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

 

Separate Accounts

 

As of September 30, 2008, and December 31, 2007, the separate accounts include a separate account valued at $408.0 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. Variable Interest Entities

 

On June 21, 2006, and June 14, 2007, we invested $285.0 million and $100.0 million, respectively, in secured limited recourse notes issued by private investment vehicles. The notes represented Class B notes. Class A notes were senior and Class C notes and below were subordinated to Class B notes. The entities entered into credit default swaps with a third party providing credit protection in exchange for a fee.  Defaults in the underlying reference portfolios would only affect the notes if cumulative losses of the synthetic reference portfolios exceeded the loss attachment points on the portfolios. We determined we were not the primary beneficiary of these entities, as we did not hold the majority of the risk of losses. As of September 19, 2008, these fixed maturity securities were unwound due to the default of the credit default swap counterparty. As of September 30, 2008, the invested amounts of $285.0 million and $100.0 million, respectively, were reflected as a receivable on the statement of financial position. Subsequent to period end, our invested amounts have been returned in cash.

 

3. Federal Income Taxes

 

The effective income tax rate for the three months ended September 30, 2008, was lower than the U.S. corporate income tax rate of 35% (“U.S. statutory rate”) primarily due to a current quarter adjustment needed to reflect a decrease in the annual estimated effective income tax rate. The change resulted from an increase in our annual estimate of net realized capital losses from the second quarter estimate. Income tax deductions allowed for corporate dividends received and taxes on our share of earnings generated from equity method investments being reflected in net investment income also contributed to a lower than U.S. statutory rate. The effective income tax rate for the nine months ended September 30, 2008, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, interest exclusion from taxable income 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, but the benefit from additional U.S. foreign tax credits is reflected in income tax expense. The effective income tax rates for the three and nine months ended September 30, 2007, were lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received.

 

We believe it is reasonably possible that the amount of our unrecognized tax benefits could decrease by $0.0 million to $45.0 million within the next twelve months due to the potential resolution of an uncertain tax position related to the disposition of foreign subsidiaries in a prior year. Any foreign taxes paid upon resolution of this uncertain tax position should result in offsetting credits against U.S. income tax. Therefore, the outcome of this uncertain tax position will not result in a material change to our consolidated financial statements.

 

10



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

4. Employee and Agent Benefits

 

Components of net periodic benefit cost (income):

 

 

 

Pension benefits

 

Other postretirement
benefits

 

 

 

For the three months ended
September 30,

 

For the three months ended
September 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 nine months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Service cost

 

$

37.2

 

$

35.3

 

$

6.3

 

$

6.0

 

Interest cost

 

74.6

 

67.1

 

12.6

 

11.6

 

Expected return on plan assets

 

(97.7

)

(85.6

)

(28.2

)

(25.2

)

Amortization of prior service benefit

 

(5.8

)

(6.3

)

(1.9

)

(2.0

)

Recognized net actuarial loss (gain)

 

0.9

 

7.5

 

(2.4

)

(1.4

)

Net periodic benefit cost (income)

 

$

9.2

 

$

18.0

 

$

(13.6

)

$

(11.0

)

 

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 $37.0 million to $50.0 million. During both the three and nine months ended September 30, 2008, we contributed $37.0 million to these plans.

 

5. 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.

 

11



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

5. Contingencies, Guarantees and Indemnifications (continued)

 

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. On August 27, 2008, the Plaintiff’s Motion for Class Certification was denied. The Plaintiff filed a petition seeking permission to appeal that ruling. The petition was denied on October 28, 2008.

 

            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.

 

On February 28, 2007, Luz Zapien (“Zapien”) filed a securities class action against Washington Mutual, Inc. (“WaMu”), us and certain mutual fund-related entities.  The Complaint alleged that WaMu had inadequately disclosed an alleged shelf-space arrangement that misled fund investors during the putative class period.  We were named in the Complaint based on our December 2006 purchase of the distributor, investment advisor and assets of the relevant WaMu mutual funds (“the acquired business”). This action was dismissed with prejudice on June 17, 2008.  The Plaintiffs filed an appeal to the Ninth Circuit Court of Appeals on September 11, 2008. In addition, on August 20, 2008, counsel for the Plaintiffs filed a new class action, Robinson v. WM Trust I, et al., (“Robinson Plaintiffs”), in the United States District Court for the Western District of Washington, making the same allegations that were contained in Zapien.  On September 26, 2008, the Robinson Plaintiffs filed a First Amended Complaint which dropped the WaMu defendants, added four directors of the Principal Mutual Funds entity in their individual capacity, and amended the putative class to include “all persons or entities that purchased or otherwise acquired shares, units or like interests in any of the WM Funds (including through the reinvestment of Fund dividends) between March 1, 2002, and December 31, 2006, inclusive”. The Purchase Agreement of the acquired business contained an indemnification provision from WaMu that we believed would have significantly limited our exposure in these lawsuits. The bankruptcy filing by WaMu raises concerns as to the availability of any indemnification protection for us. We are aggressively defending both lawsuits.

 

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.

 

12



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

5. Contingencies, Guarantees and Indemnifications (continued)

 

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 September 30, 2008, was approximately $198.0 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.

 

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 $683.8 million in fixed maturities, available-for-sale securities at September 30, 2008, to satisfy collateral requirements primarily associated with our derivative credit support annex (collateral) agreements and a reinsurance arrangement. In addition, we posted $1,376.2 million in commercial and residential mortgage-backed securities and commercial mortgage loans as of September 30, 2008, to satisfy collateral requirements associated with our obligation under funding agreements with the Federal Home Loan Bank of Des Moines (“FHLB of Des Moines”).

 

Cash Posted as Collateral

 

As of September 30, 2008, we had received $273.8 million of cash collateral associated with our derivative credit support annex (collateral) agreements. The cash collateral is included in other assets with a corresponding liability reflecting our obligation to return the collateral recorded in other liabilities.  We did not post any cash collateral associated with these agreements.  We do not offset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparties under master netting agreements.

 

As of September 30, 2008, we had also received $398.8 million of cash collateral on securities lending. The cash collateral is included in other assets with a corresponding liability reflecting our obligation to return the collateral recorded in other liabilities.

 

13



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

6. 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

 

 

 

1.6

 

Treasury stock acquired

 

 

 

(7.5

)

Outstanding shares at September 30, 2007

 

3.0

 

10.0

 

262.5

 

 

 

 

 

 

 

 

 

Outstanding shares at January 1, 2008

 

3.0

 

10.0

 

259.1

 

Shares issued

 

 

 

1.1

 

Treasury stock acquired

 

 

 

(1.0

)

Outstanding shares at September 30, 2008

 

3.0

 

10.0

 

259.2

 

 

Comprehensive income (loss) is as follows:

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Net income

 

$

98.3

 

$

240.5

 

$

457.3

 

$

817.9

 

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

 

(2,001.6

)

(209.8

)

(4,173.6

)

(923.4

)

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

 

(31.3

)

(2.8

)

(33.6

)

(8.2

)

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

 

39.2

 

(43.4

)

45.3

 

53.2

 

Adjustments for assumed changes in amortization patterns

 

338.8

 

11.3

 

632.5

 

129.8

 

Adjustment for assumed changes in liability for policyholder benefits and claims

 

0.4

 

 

(11.0

)

 

Net change in unrealized gains (losses) on derivative instruments

 

16.1

 

(20.2

)

28.0

 

8.6

 

Change in net foreign currency translation adjustment

 

(59.9

)

(2.2

)

(18.8

)

36.1

 

Change in unrecognized post-retirement benefit obligation

 

(3.1

)

(0.8

)

(9.2

)

(2.2

)

Provision for deferred income tax benefits

 

588.0

 

102.3

 

1,234.9

 

247.6

 

Comprehensive income (loss)

 

$

(1,015.1

)

$

74.9

 

$

(1,848.2

)

$

359.4

 

 

7. 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.

 

14



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

7. Fair Value Measurement (continued)

 

·                  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 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 – Significant unobservable inputs for the asset or liability. Our Level 3 assets and liabilities include certain fixed maturity securities, private equity securities, complex derivatives and embedded derivatives that must be priced using broker quotes or other valuation methods that utilize significant 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.

 

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.

 

15



Table of Contents

 

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

September 30,  2008
(Unaudited)

 

7. Fair Value Measurement (continued)

 

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.

 

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 September 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

 

$

44,622.1

 

$

132.1

 

$

43,043.2

 

$

1,446.8

 

Fixed maturities, trading

 

982.2

 

 

911.0

 

71.2

 

Equity securities, available-for-sale

 

246.2

 

197.4

 

2.0

 

46.8

 

Equity securities, trading

 

204.8

 

77.4

 

127.4

 

 

Net derivative assets and liabilities (1)

 

208.9

 

 

284.8

 

(75.9

)

Other investments (2)

 

103.5

 

15.7

 

87.8

 

 

Cash equivalents (3)

 

1,818.8

 

231.7

 

1,587.1

 

 

Sub-total excluding separate account assets

 

48,186.5

 

654.3

 

46,043.3

 

1,488.9

 

 

 

 

 

 

 

 

 

 

 

Separate account assets

 

67,087.6

 

38,610.0

 

21,666.4

 

6,811.2

 

Total assets

 

$

115,274.1

 

$

39,264.3

 

$

67,709.7

 

$

8,300.1

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts (4)

 

$

7.0

 

$

 

$

 

$

7.0

 

Total liabilities

 

$

7.0

 

$

 

$

 

$

7.0

 

 


(1)          The fair value of our derivative instruments classified as assets and liabilities at September 30, 2008, was $895.0 million and $686.1 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 within the same line item in the consolidated statements of financial position that the host contract is reported in.

 

16



Table of Contents

 

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

September 30,  2008
(Unaudited)

 

7. 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 nine months ended September 30, 2008, is as follows:

 

 

 

For the three months ended September 30, 2008

 

Changes in
unrealized

 

 

 

 

 

Total realized/unrealized
gains (losses)

 

Purchases,

 

 

 

Ending

 

gains (losses)
included in

 

 

 

Beginning
balance as
of June 30,
2008

 

Included
in net
income
(1)

 

Included in
other
comprehensive
income

 

sales,
issuances
and
settlements

 

Transfers
in (out) of
Level 3

 

balance
as of
September
30, 2008

 

net income
relating to
positions
still held (1)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

1,851.5

 

$

(37.0

)

$

40.7

 

$

(487.4

)

$

79.0

 

$

1,446.8

 

$

(37.3

)

Fixed maturities, trading

 

65.4

 

(7.0

)

 

3.7

 

9.1

 

71.2

 

(7.0

)

Equity securities, available-for-sale

 

53.2

 

(10.1

)

(23.3

)

27.0

 

 

46.8

 

(10.1

)

Net derivative assets and liabilities

 

(35.8

)

(29.7

)

(10.4

)

 

 

(75.9

)

(44.7

)

Separate account assets

 

7,097.1

 

(84.7

)

 

(199.4

)

(1.8

)

6,811.2

 

(101.2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts

 

(2.4

)

6.0

 

 

3.4

 

 

7.0

 

6.1

 

 

 

 

For the nine months ended September 30, 2008

 

Changes in
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
September
30, 2008

 

net income
relating to
positions
still held (1)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

2,201.3

 

$

(87.4

)

$

(321.6

)

$

(562.1

)

$

216.6

 

$

1,446.8

 

$

(53.5

)

Fixed maturities, trading

 

92.3

 

(8.6

)

 

(11.4

)

(1.1

)

71.2

 

(8.6

)

Equity securities, available-for-sale

 

51.1

 

(44.4

)

(23.1

)

25.3

 

37.9

 

46.8

 

(44.9

)

Net derivative assets and liabilities

 

(8.0

)

(65.6

)

(3.3

)

1.0

 

 

(75.9

)

(67.2

)

Separate account assets

 

7,313.2

 

(368.5

)

 

(59.3

)

(74.2

)

6,811.2

 

(371.9

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment-type insurance contracts

 

(49.3

)

13.3

 

 

43.0

 

 

7.0

 

13.5

 

 


(1)   Both realized and unrealized gains and losses for the three and nine months ended September 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.

 

17



Table of Contents

 

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

September 30, 2008
(Unaudited)

 

7. 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.

 

8. 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 nine months ended September 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.

 

18



Table of Contents

 

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

 

8. 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 (losses), as adjusted, and other after-tax adjustments which management believes are not indicative of overall operating trends. Net realized/unrealized capital gains (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 and exclude certain market value adjustments of embedded derivatives. Segment operating revenues exclude net realized/unrealized capital gains (losses) (except periodic settlements and accruals on non-hedge derivatives), including their impact on recognition of front-end fee revenues and certain market value adjustments to fee revenues and revenue from our terminated commercial mortgage securities issuance operation. Segment operating revenues 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:

 

 

 

September 30,
2008

 

December 31,
2007

 

 

 

(in millions)

 

Assets:

 

 

 

 

 

U.S. Asset Accumulation

 

$

114,790.5

 

$

126,131.1

 

Global Asset Management

 

1,276.6

 

1,438.9

 

International Asset Management and Accumulation

 

9,365.6

 

9,350.5

 

Life and Health Insurance

 

14,664.5

 

14,816.6

 

Corporate and Other

 

3,312.5

 

2,783.1

 

Total consolidated assets

 

$

143,409.7

 

$

154,520.2

 

 

19



Table of Contents

 

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

 

8. Segment Information (continued)

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

Operating revenues by segment:

 

 

 

 

 

 

 

 

 

U.S. Asset Accumulation

 

$

1,237.5

 

$

1,404.9

 

$

3,697.9

 

$

3,849.9

 

Global Asset Management

 

141.7

 

138.9

 

425.0

 

401.5

 

International Asset Management and Accumulation

 

265.5

 

224.6

 

700.4

 

540.9

 

Life and Health Insurance

 

1,158.9

 

1,211.6

 

3,527.1

 

3,635.5

 

Corporate and Other

 

(52.4

)

(41.9

)

(152.2

)

(107.2

)

Total segment operating revenues

 

2,751.2

 

2,938.1

 

8,198.2

 

8,320.6

 

Add:

 

 

 

 

 

 

 

 

 

Net realized/unrealized capital 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

 

(248.3

)

(89.3

)

(517.5

)

(6.0

)

Terminated commercial mortgage securities issuance operation

 

(5.1

)

0.7

 

(24.0

)

27.4

 

Subtract:

 

 

 

 

 

 

 

 

 

Operating revenues from a discontinued real estate investment

 

 

(0.1

)

 

(0.4

)

Total revenues per consolidated statements of operations

 

$

2,497.8

 

$

2,849.6

 

$

7,656.7

 

$

8,342.4

 

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

 

 

 

 

 

 

 

 

 

U.S. Asset Accumulation

 

$

136.5

 

$

186.7

 

$

428.5

 

$

505.9

 

Global Asset Management

 

23.5

 

28.3

 

67.4

 

73.0

 

International Asset Management and Accumulation

 

44.4

 

39.3

 

107.9

 

85.3

 

Life and Health Insurance

 

73.9

 

73.4

 

219.8

 

179.0

 

Corporate and Other

 

(27.1

)

(11.7

)

(59.9

)

(18.7

)

Total segment operating earnings, net of related income taxes

 

251.2

 

316.0

 

763.7

 

824.5

 

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

 

(156.3

)

(59.4

)

(316.4

)

(18.2

)

Other after-tax adjustments (2)

 

(4.8

)

(24.3

)

(14.7

)

(13.1

)

Net income available to common stockholders per consolidated statements of operations

 

$

90.1

 

$

232.3

 

$

432.6

 

$

793.2

 

 

20



Table of Contents

 

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

 

8. Segment Information (continued)

 


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

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Net realized/unrealized capital gains (losses)

 

$

(230.6

)

$

(89.3

)

$

(468.1

)

$

3.7

 

Periodic settlements and accruals on non-hedge derivatives

 

(17.6

)

(5.4

)

(45.8

)

(14.9

)

Certain market value adjustments to fee revenues

 

(0.1

)

(2.5

)

(3.6

)

(3.5

)

Recognition of front-end fee revenues

 

 

7.9

 

 

8.7

 

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

 

(248.3

)

(89.3

)

(517.5

)

(6.0

)

Amortization of deferred policy acquisition and sales inducement costs

 

16.2

 

(6.0

)

46.1

 

(4.9

)

Capital (gains) losses distributed

 

11.8

 

2.9

 

14.2

 

(7.7

)

Certain market value adjustments of embedded derivatives

 

(3.3

)

 

(6.5

)

 

Minority interest capital (gains) losses

 

(8.1

)

0.2

 

(4.4

)

(6.7

)

Income tax effect

 

75.4

 

32.8

 

151.7

 

7.1

 

Net realized/unrealized capital losses, as adjusted

 

$

(156.3

)

$

(59.4

)

$

(316.4

)

$

(18.2

)

 

(2)          For the three months ended September 30, 2008, other after-tax adjustments of $4.8 million included the negative effect of losses associated with our terminated commercial mortgage securities issuance operation that will be exited but does not qualify for discontinued operations accounting treatment under U.S. GAAP.

 

For the three months ended September 30, 2007, other after-tax adjustments of $24.3 million included the negative effect of (1) tax refinements related to prior years ($21.2 million) and (2) losses associated with our terminated commercial mortgage securities issuance operation that will be exited but does not qualify for discontinued operations accounting treatment under U.S. GAAP ($3.1 million).

 

For the nine months ended September 30, 2008, other after-tax adjustments of $14.7 million included (1) the negative effect of losses associated with our terminated commercial mortgage securities issuance operation that will be exited but does not qualify for discontinued operations accounting treatment under U.S. GAAP ($22.3 million) and (2) the positive effect of a change in estimated loss related to a prior year legal contingency ($7.6 million).

 

For the nine months ended September 30, 2007, other after-tax adjustments of $13.1 million included (1) the negative effect of tax refinements related to prior years ($21.2 million) and (2) the positive effect of earnings associated with our terminated commercial mortgage securities issuance operation that will be exited but does not qualify for discontinued operations accounting treatment under U.S. GAAP ($8.1 million).

 

21



Table of Contents

 

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

 

8. Segment Information (continued)

 

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

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(in millions)

 

U.S. Asset Accumulation:

 

 

 

 

 

 

 

 

 

Full service accumulation

 

$

360.7

 

$

478.5

 

$

1,091.5

 

$

1,215.4

 

Principal Funds

 

159.3

 

171.9

 

501.4

 

508.3

 

Individual annuities

 

278.1

 

232.6

 

769.9

 

567.3

 

Bank and trust services

 

18.9

 

18.1

 

55.6

 

47.7

 

Eliminations

 

(44.2

)

(44.2

)

(138.4

)

(116.4

)

Total Accumulation

 

772.8

 

856.9

 

2,280.0

 

2,222.3

 

Investment only

 

283.0

 

298.7

 

845.1

 

876.6

 

Full service payout

 

181.7

 

249.3

 

572.8

 

751.0

 

Total Guaranteed

 

464.7

 

548.0

 

1,417.9

 

1,627.6

 

Total U.S. Asset Accumulation

 

1,237.5

 

1,404.9

 

3,697.9

 

3,849.9

 

Global Asset Management (1)

 

141.7

 

138.9

 

425.0

 

401.5

 

International Asset Management and Accumulation

 

265.5

 

224.6

 

700.4

 

540.9

 

Life and Health Insurance:

 

 

 

 

 

 

 

 

 

Individual life insurance

 

346.1

 

341.1

 

1,045.8

 

1,016.3

 

Health insurance

 

438.6

 

497.5

 

1,356.0

 

1,527.5

 

Specialty benefits insurance

 

374.8

 

373.7

 

1,127.0

 

1,093.7

 

Eliminations

 

(0.6

)

(0.7

)

(1.7

)

(2.0

)

Total Life and Health Insurance

 

1,158.9

 

1,211.6

 

3,527.1

 

3,635.5

 

Corporate and Other

 

(52.4

)

(41.9

)

(152.2

)

(107.2

)

Total operating revenues

 

$

2,751.2

 

$

2,938.1

 

$

8,198.2

 

$

8,320.6

 

Total operating revenues

 

$

2,751.2

 

$

2,938.1

 

$

8,198.2

 

$

8,320.6

 

Add:

 

 

 

 

 

 

 

 

 

Net realized/unrealized capital 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

 

(248.3

)

(89.3

)

(517.5

)

(6.0

)

Terminated commercial mortgage securities issuance operation

 

(5.1

)

0.7

 

(24.0

)

27.4

 

Subtract:

 

 

 

 

 

 

 

 

 

Operating revenues from a discontinued real estate investment

 

 

(0.1

)

 

(0.4

)

Total revenues per consolidated statements of operations

 

$