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Principal Financial Group Inc – ‘10-Q’ for 9/30/01

On: Monday, 11/19/01 · For: 9/30/01 · Accession #: 1126328-1-500014 · File #: 1-16725

  As Of                Filer                Filing    For·On·As Docs:Size

11/19/01  Principal Financial Group Inc     10-Q        9/30/01    1:273K

Quarterly Report — Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Principal Financial Group 10-Q 3Q2001                 77    454K

Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Changes in Securities and Use of Proceeds Exhibits and Reports on Form 8-K Financial Statements Interest Rate Risk Legal Proceedings Management's Discussion and Analysis of Financial Condition and Results of Operations Mortgage loans Net income Other investments Principal Life Quantitative and Qualitative Disclosures about Market Risk Signature
1	1st Page - Filing Submission
3	Item 1. Financial Statements
14	Net income
22	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
47	Principal Life
58	Mortgage loans
64	Other investments
69	Item 3. Quantitative and Qualitative Disclosures about Market Risk
"	Interest Rate Risk
75	Item 1. -. Legal Proceedings
"	Item 2. -. Changes in Securities and Use of Proceeds
76	Item 6. -. Exhibits and Reports on Form 8-K
77	Signature

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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, 2001

OR

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

------------------

Commission file number 1-16725

 PRINCIPAL FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)

Delaware                                     42-1520346 
(State or other jurisdiction of                    (I.R.S. Employer       
incorporation or organization)                   Identification Number)     

------------------

 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 |_| No |X|                               

The total number of shares of the  registrant's  Common Stock,  $0.01 par value,
outstanding on November 15, 2001, was 375,314,377.                              

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                         PRINCIPAL FINANCIAL GROUP, INC.                                         
                 (SUCCESSOR TO PRINCIPAL MUTUAL HOLDING COMPANY)                                 
                                TABLE OF CONTENTS                                                

                                                                                             Page
                                                                                                 
Part I - FINANCIAL INFORMATION                                                                   
   Item 1. Financial Statements                                                                  
            Consolidated Statements of Financial Position at September 30, 2001 (Unaudited)      
                and December 31, 2000.......................................................  3  
            Unaudited Consolidated Statements of Operations for the three and nine months        
                ended September 30, 2001 and 2000...........................................  4  
            Unaudited Consolidated Statements of Equity for the nine months ended                
                September 30, 2001 and 2000.................................................  5  
            Unaudited Consolidated Statements of Cash Flows for the nine months ended            
                September 30, 2001 and 2000.................................................  6  
            Notes to Unaudited Consolidated Financial Statements............................  8  
   Item 2. Management's Discussion and Analysis of Financial Condition and Results of            
            Operations...................................................................... 22  
   Item 3. Quantitative and Qualitative Disclosures about Market Risk....................... 69  

Part II - OTHER INFORMATION                                                                      
   Item 1. Legal Proceedings................................................................ 75  
   Item 2. Changes in Securities and Use of Proceeds........................................ 75  
   Item 6. Exhibits and Reports on Form 8-K................................................. 76  
   Signature................................................................................ 77  

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PART I - FINANCIAL INFORMATION                                                  

Item 1.  Financial Statements                                                   

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                         Principal Financial Group, Inc.                                                        
                  Consolidated Statements of Financial Position                                                 

                                                                            September 30,        December 31,   
                                                                                 2001               2000        
                                                                          ------------------  ------------------
                                                                              (Unaudited)          (Note 1)     
                                                                                      (in millions)             
                                                                                                                
Assets                                                                                                          
Investments:                                                                                                    
  Fixed maturities, available-for-sale...................................     $30,402.1            $26,839.9    
  Equity securities, available-for-sale..................................         764.3                742.9    
  Mortgage loans.........................................................      11,409.8             11,492.7    
  Real estate............................................................       1,147.4              1,400.5    
  Policy loans...........................................................         826.0                803.6    
  Other investments......................................................         970.8                811.0    
                                                                          ------------------  ------------------
       Total investments.................................................      45,520.4             42,090.6    

Cash and cash equivalents................................................         231.1                926.6    
Accrued investment income................................................         585.5                530.8    
Premiums due and other receivables.......................................         553.8                505.7    
Deferred policy acquisition costs........................................       1,292.1              1,333.3    
Property and equipment...................................................         508.4                507.0    
Goodwill and other intangibles...........................................       1,200.8              1,375.9    
Mortgage loan servicing rights...........................................       1,481.8              1,084.4    
Separate account assets..................................................      31,286.4             34,916.2    
Other assets.............................................................       1,294.9              1,134.4    
                                                                          ------------------  ------------------
       Total assets......................................................     $83,955.2            $84,404.9    
                                                                          ==================  ==================

Liabilities                                                                                                     
Contractholder funds.....................................................     $25,009.6            $24,300.2    
Future policy benefits and claims........................................      13,930.8             13,346.0    
Other policyholder funds.................................................         609.0                597.4    
Short-term debt..........................................................         713.8                459.5    
Long-term debt...........................................................       1,383.5              1,336.5    
Income taxes currently payable...........................................           5.1                108.4    
Deferred income taxes....................................................         914.9                487.4    
Separate account liabilities.............................................      31,286.4             34,916.2    
Other liabilities........................................................       3,283.1              2,600.8    
                                                                          ------------------  ------------------
       Total liabilities.................................................      77,136.2             78,152.4    

Equity                                                                                                          
Retained earnings........................................................       6,652.7              6,312.5    
Accumulated other comprehensive income (loss):                                                                  
  Net unrealized gains (losses) on available-for-sale securities and                                            
     derivative instruments..............................................         472.5                129.9    
  Net foreign currency translation adjustment............................        (306.2)              (189.9)   
                                                                          ------------------  ------------------
       Total equity......................................................       6,819.0              6,252.5    
                                                                          ------------------  ------------------
       Total liabilities and equity......................................     $83,955.2            $84,404.9    
                                                                          ==================  ==================

See accompanying notes.                                                         

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                        Principal Financial Group, Inc.                                                            
                      Consolidated Statements of Operations                                                        
                                   (Unaudited)                                                                     

                                                For the three months ended            For the nine months ended    
                                                      September 30,                         September 30,          
                                             ---------------------------------    ---------------------------------
                                                  2001               2000              2001                2000    
                                             --------------     --------------    --------------     --------------
                                                             (in millions, except per share amounts)               
                                                                                                                   
Revenues                                                                                                           
Premiums and other considerations.......        $1,255.0           $  910.5          $3,210.3           $2,903.2   
Fees and other revenues.................           453.2              414.5           1,309.5            1,197.7   
Net investment income...................           829.1              777.9           2,515.1            2,336.0   
Net realized capital gains (losses).....           (80.8)              20.9            (257.7)              52.4   
                                             --------------     --------------    --------------     --------------
      Total revenues....................         2,456.5            2,123.8           6,777.2            6,489.3   

Expenses                                                                                                           
Benefits, claims and settlement                                                                                    
  expenses..............................         1,597.3            1,193.7           4,236.5            3,824.8   
Dividends to policyholders..............            79.1               75.8             241.2              231.6   
Operating expenses......................           631.5              625.2           1,859.7            1,853.2   
                                             --------------     --------------    --------------     --------------
      Total expenses....................         2,307.9            1,894.7           6,337.4            5,909.6   
                                             --------------     --------------    --------------     --------------

Income before income taxes and                                                                                     
  cumulative effect of accounting                                                                                  
  change................................           148.6              229.1             439.8              579.7   

Income taxes............................            32.8               55.2              88.9              160.5   
                                             --------------     --------------    --------------     --------------
Income before cumulative effect of                                                                                 
  accounting change.....................           115.8              173.9             350.9              419.2   
Cumulative effect of accounting change,                                                                            
  net of related income taxes...........             -                  -               (10.7)               -     
                                             --------------     --------------    --------------     --------------

Net income..............................        $  115.8           $  173.9          $  340.2           $  419.2   
                                             ==============     ==============    ==============     ==============

Pro forma Earnings Per Common Share:                                                                               
Basic earnings per common share:                                                                                   
  Income before cumulative effect                                                                                  
    of accounting change................        $    0.32                            $    0.97                     
  Cumulative effect of accounting                                                                                  
    change..............................             -                                   (0.03)                    
                                             --------------                       --------------                   
  Net income............................        $    0.32                            $    0.94                     
                                             ==============                       ==============                   

Diluted earnings per common share:                                                                                 
  Income before cumulative effect ......                                                                           
    of accounting change................        $    0.32                            $    0.97                     
  Cumulative effect of accounting                                                                                  
    change..............................             -                                   (0.03)                    
                                             --------------                       --------------                   
  Net income............................        $    0.32                            $    0.94                     
                                             ==============                       ==============                   

The pro forma  earnings per common share  information  above gives effect to the                                   
Demutualization and Initial Public Offering described in Note 7.                                                   

See accompanying notes.                                                         

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                        Principal Financial Group, Inc.                                                                     
                        Consolidated Statements of Equity                                                                   
                                   (Unaudited)                                                                              

                                                                          Net Unrealized                                    
                                                                         Gains (Losses) on                                  
                                                                        Available-for-Sale     Net Foreign                  
                                                                          Securities and        Currency                    
                                                           Retained         Derivative         Translation                  
                                                           Earnings         Instruments        Adjustment      Total Equity 
                                                        --------------  ------------------  ----------------  --------------
                                                                                   (in millions)                            
                                                                                                                            
Balances at January 1, 2000......................          $5,692.3          $(79.1)            $ (60.3)         $5,552.9   
Comprehensive income:                                                                                                       
  Net income.....................................             419.2             -                   -               419.2   
  Net change in unrealized gains and losses on fixed                                                                        
    maturities, available-for-sale...............               -             342.9                 -               342.9   
  Net change in unrealized gains and losses on equity                                                                       
    securities, available-for-sale, including seed                                                                          
    money in separate accounts...................               -            (180.0)                -              (180.0)  
  Adjustments for assumed changes in amortization                                                                           
    patterns:                                                                                                               
    Deferred policy acquisition costs............               -             (58.6)                -               (58.6)  
    Unearned revenue reserves....................               -               9.2                 -                 9.2   
  Net change in unrealized gains and losses on                                                                              
    derivative instruments.......................               -             (22.0)                -               (22.0)  
  Provision for deferred income taxes............               -             (41.5)                -               (41.5)  
  Change in net foreign currency translation                                                                                
    adjustment...................................               -               -                (129.5)           (129.5)  
                                                                                                              --------------
Comprehensive income.............................                                                                   339.7   
                                                        --------------  ------------------  ----------------  --------------
Balances at September 30, 2000...................          $6,111.5          $(29.1)            $(189.8)         $5,892.6   
                                                        ==============  ==================  ================  ==============

Balances at January 1, 2001......................          $6,312.5          $129.9             $(189.9)         $6,252.5   
Comprehensive income:                                                                                                       
  Net income.....................................             340.2             -                   -               340.2   
  Net change in unrealized gains and losses on fixed                                                                        
    maturities, available-for-sale...............               -             731.8                 -               731.8   
  Net change in unrealized gains and losses on equity                                                                       
    securities, available-for-sale, including seed                                                                          
    money in separate accounts...................               -             (34.9)                -               (34.9)  
  Adjustments for assumed changes in amortization                                                                           
    patterns:                                                                                                               
    Deferred policy acquisition costs............               -             (99.8)                -               (99.8)  
    Unearned revenue reserves....................               -               6.2                 -                 6.2   
  Net change in unrealized gains and losses on                                                                              
    derivative instruments.......................               -             (53.2)                -               (53.2)  
  Net change in unrealized gains and losses on                                                                              
    policyholder dividend obligation.............               -              (8.8)                -                (8.8)  
  Provision for deferred income taxes............               -            (195.6)                -              (195.6)  
  Change in net foreign currency translation                                                                                
    adjustment...................................               -               -                (105.2)           (105.2)  
  Cumulative effect of accounting change, net of                                                                            
    related income taxes.........................               -              (3.1)              (11.1)            (14.2)  
                                                                                                              --------------
Comprehensive income.............................                                                                   566.5   
                                                        --------------  ------------------  ----------------  --------------
Balances at September 30, 2001...................          $6,652.7          $472.5             $(306.2)         $6,819.0   
                                                        ==============  ==================  ================  ==============

See accompanying notes.                                                         

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

                                                                     For the nine months ended     
                                                                           September 30,           
                                                                -----------------------------------
                                                                      2001               2000      
                                                                ---------------     ---------------
                                                                            (in millions)          
                                                                                                   
Operating activities                                                                               
Net income.....................................................   $     340.2         $     419.2  
Adjustments to reconcile net income to net cash provided by                                        
   operating activities:                                                                           
   Cumulative effect of accounting change, net of related                                          
     income taxes..............................................          10.7                 -    
   Amortization of deferred policy acquisition costs...........         130.8               170.2  
   Additions to deferred policy acquisition costs..............        (191.4)             (202.9) 
   Accrued investment income...................................         (57.3)              (21.6) 
   Premiums due and other receivables..........................         (39.6)               (9.4) 
   Contractholder and policyholder liabilities and dividends...       1,614.6               750.3  
   Current and deferred income taxes...........................          20.9                 0.8  
   Net realized capital (gains) losses.........................         257.7               (52.4) 
   Depreciation and amortization expense.......................         110.1               113.5  
   Amortization and impairment/recovery of mortgage loan                                           
     servicing rights..........................................         232.8               118.1  
   Other.......................................................         378.5                36.6  
                                                                ---------------     ---------------
Net adjustments................................................       2,467.8               903.2  
                                                                ---------------     ---------------
Net cash provided by operating activities......................       2,808.0             1,322.4  

Investing activities                                                                               
Available-for-sale securities:                                                                     
   Purchases...................................................     (10,814.9)           (8,816.2) 
   Sales.......................................................       4,157.3             5,707.7  
   Maturities..................................................       3,457.2             2,056.0  
Mortgage loans acquired or originated..........................     (27,931.2)           (7,327.5) 
Mortgage loans sold or repaid..................................      28,011.9             7,997.9  
Net change in mortgage loan servicing rights...................        (621.4)              (89.4) 
Real estate acquired...........................................        (228.9)             (251.0) 
Real estate sold...............................................         535.9               422.1  
Net change in property and equipment...........................         (56.7)              (33.3) 
Net proceeds from sales of subsidiaries........................          (7.9)                -    
Purchases of interests in subsidiaries, net of cash acquired...          (4.2)              (37.4) 
Net change in other investments................................        (187.5)              108.0  
                                                                -----------------------------------
Net cash used in investing activities..........................      (3,690.4)             (263.1) 

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

                                                                       For the nine months ended      
                                                                             September 30,            
                                                                   -----------------------------------
                                                                        2001                2000      
                                                                   ---------------     ---------------
                                                                             (in millions)            
                                                                                                      
Financing activities                                                                                  
Issuance of debt............................................         $    157.0          $     78.8   
Principal repayments of debt................................             (110.0)              (59.1)  
Proceeds of short-term borrowings...........................            6,391.1             2,277.9   
Repayment of short-term borrowings..........................           (6,136.8)           (2,184.0)  
Investment contract deposits................................            4,192.8             2,832.3   
Investment contract withdrawals.............................           (4,307.2)           (3,726.4)  
                                                                   ---------------     ---------------
Net cash provided by (used in) financing activities.........              186.9              (780.5)  
                                                                   ---------------     ---------------

Net increase (decrease) in cash and cash equivalents........             (695.5)              278.8   

Cash and cash equivalents at beginning of period............              926.6               569.5   
                                                                   ---------------     ---------------
Cash and cash equivalents at end of period..................         $    231.1          $    848.3   
                                                                   ===============     ===============

See accompanying notes.                                                         

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 Principal Financial Group, Inc.
Notes to Consolidated Financial Statements
September 30, 2001
 (Unaudited)

1.   Nature of Operations and Summary of Significant Accounting Policies        

Description of Business                                                         

Principal   Financial  Group,  Inc.  and  its  consolidated   subsidiaries  (the
"Company"),  the successor to Principal Mutual Holding Company, is a diversified
financial  services   organization  engaged  in  promoting  retirement  savings,
investment  and  insurance  products  and  services in the United  States and in
selected  international  markets.  In addition,  the Company offers  residential
mortgage loan origination and servicing in the United States.                   

Effective  October 26, 2001, the Company  completed an initial  public  offering
("IPO") made in  connection  with the  conversion  of Principal  Mutual  Holding
Company from a mutual insurance holding company into a stock company. See Note 7
- Subsequent Events, for a description of the demutualization and the IPO.      

Basis of Presentation                                                           

The accompanying unaudited consolidated financial statements of the Company have
been prepared in accordance with generally accepted accounting principles in the
United States 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 month and
nine month periods ended September 30, 2001, are not  necessarily  indicative of
the results  that may be expected for the year ended  December  31, 2001.  These
interim  unaudited   consolidated   financial   statements  should  be  read  in
conjunction with the Company's  annual  financial  statements as of December 31,
2000,  included in the Company's Form S-1  Registration  Statement as filed with
the  United  States  Securities  and  Exchange   Commission.   The  accompanying
consolidated  statement  of financial  position at December  31, 2000,  has been
derived from the audited  consolidated  statement of financial position but does
not  include  all  of the  information  and  footnotes  required  by  accounting
principles  generally  accepted  in the  United  States for  complete  financial
statements.                                                                     

Reclassifications  have been made to the December 31, 2000,  and  September  30,
2000, financial statements to conform to the September 30, 2001, presentation.  

Accounting Changes                                                              

On July 20, 2001, the Financial  Accounting  Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 141, Business Combinations,  and
No. 142, Goodwill and Other Intangible Assets ("SFAS 142"),  which  dramatically
change the accounting for business  combinations,  goodwill and other intangible
assets.  These  Statements  were  effective  July  1,  2001,  for  any  business
combinations  entered into  subsequent  to June 30, 2001.  SFAS 142,  which will
become  effective  January  1, 2002,  for the  Company's  business  combinations
entered into prior to June 30, 2001, adopts a  nonamortization,  impairment-only
model for the Company's goodwill and  indefinite-lived  intangible assets.  This
includes a more  stringent  impairment  test  methodology  (fair  value based on
discounted cash flows) for measuring and recognizing impairment losses.         

The Company  continues to study the impact the new  Statements  will have on its
consolidated  financial  statements,  particularly  with  regard to  intangibles
resulting  from our 1999  acquisition of BT Financial  Group.  To determine fair
value at January  1, 2002 (date of  adoption),  the new  impairment  methodology
requires  consideration  of many variables that are difficult to predict at this
time. If it is determined that economic conditions and the business  environment
at  adoption  of the  new  standard  warrant  recognition  of  intangible  asset
impairment, it is possible the Company could recognize an impairment material to
net income.  Such impairment will be treated as a cumulative  effect of a change
in accounting principle.                                                        

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 Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

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

The Company's policy, under existing GAAP guidance,  for measuring impairment of
goodwill and other  intangibles is based on undiscounted  cash flows and has not
resulted in an indicated impairment.                                            

In June 1998,  the FASB issued  Statement  No. 133,  Accounting  for  Derivative
Instruments and Hedging  Activities  ("SFAS 133").  In June 1999,  Statement No.
137, Accounting for Derivative  Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No. 133 was issued  deferring the effective
date of SFAS 133 by one year. In June 2000,  the FASB issued  Statement No. 138,
Accounting for Certain Derivative  Instruments and Certain Hedging Activities an
amendment of FASB  Statement No. 133, which amended the accounting and reporting
standards of SFAS 133 for certain  derivative  instruments  and certain  hedging
activities.                                                                     

As amended,  SFAS 133 requires an entity to recognize all  derivatives as either
assets or liabilities  in the statement of financial  position and measure those
instruments  at fair value.  If certain  conditions are met, a derivative may be
specifically designated as one of the following:                                

(a)  a hedge of the exposure to changes in the fair value of a recognized  asset
or liability or an unrecognized firm commitment;                      
(b)  a hedge of the exposure to variable cash flows of a forecasted transaction;
or                                                                    
(c)  a hedge of the foreign  currency  exposure of a net investment in a foreign
     operation, an unrecognized firm commitment, an available-for-sale security,
or a foreign-currency- denominated forecasted transaction.            

The Company's  accounting for the ongoing  changes in fair value of a derivative
depends on the intended use of the derivative  and the  designation as described
above and is determined when the derivative contract is entered into.           

For  derivatives  hedging the  exposure to changes in fair value of a recognized
asset or liability,  the change in fair value of the derivative is recognized in
earnings in the period of change  together  with the  offsetting  change in fair
value on the hedged item  attributable  to the risk being hedged.  The effect of
such  accounting  is to reflect in earnings the extent to which the hedge is not
effective in achieving offsetting changes in fair value.                        

For  derivatives  hedging the  exposure to variable  cash flows,  the  effective
portion of the  derivative's  change in fair  value is  initially  deferred  and
reported  as  a  component  of  other  comprehensive   income  and  subsequently
reclassified  into  earnings  when  the  forecasted  transaction  occurs  and is
recognized in earnings.  The ineffective  portion of the change in fair value is
reported in earnings in the period of change.                                   

The  Company  currently  does not hedge the foreign  currency  exposure of a net
investment in a foreign operation.                                              

For derivatives  hedging the foreign currency  exposure of an unrecognized  firm
commitment or an  available-for-sale  security,  the change in fair value of the
derivative is  recognized in earnings in the period of change  together with the
offsetting  change in fair value on the  hedged  item  attributable  to the risk
being hedged. The effect of such accounting is to reflect in earnings the extent
to which the hedge is not  effective  in  achieving  offsetting  changes in fair
value.                                                                          

For derivatives  hedging the foreign  currency  exposure of a  foreign-currency-
denominated  forecasted  transaction,  the  change  in fair  value is  initially
deferred  and  reported  as  a  component  of  other  comprehensive  income  and
subsequently  reclassified into earnings when the forecasted  transaction occurs
and is recognized  in earnings.  The  ineffective  portion of the change in fair
value is reported in earnings in the period of change.                          

For derivatives not designated as a hedging instrument, the change in fair value
is recognized in earnings in the period of change.                              

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Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

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

At  January  1, 2001,  the  Company's  consolidated  financial  statements  were
adjusted  to record a  cumulative  effect of  adopting  SFAS 133, as follows (in
millions):                                                                      

                                                        [Enlarge/Download Table]


                                                                        Accumulated other 
                                                                          comprehensive   
                                                          Net income          income      
                                                         ------------  -------------------
                                                                                          
Adjustment to fair value of derivative contracts (1)....  $  (16.4)          $  (15.8)    
Income tax impact.......................................       5.7                1.6     
                                                         ------------  -------------------

Total...................................................  $  (10.7)          $  (14.2)    
                                                         ============  ===================

---------------------------------                                               

(1)  Amount presented is net of adjustment to hedged item.                      

Derivatives and Hedging Instruments                                             

Overview                                                                        

The Company's derivatives are generally held for purposes other than trading and
are  primarily  used to hedge or reduce  exposure to  interest  rate and foreign
currency risks  associated with assets held or expected to be purchased or sold,
and liabilities incurred or expected to be incurred.  Additionally,  derivatives
are used to change the  characteristics  of the  Company's  asset/liability  mix
consistent with the Company's risk management activities.                       

The  Company's  risk of loss is  typically  limited  to the  fair  value  of its
derivative  instruments and not to the notional or contractual  amounts of these
derivatives.  Risk  arises  from  changes  in the fair  value of the  underlying
instruments.  The  Company  is also  exposed  to  credit  losses in the event of
nonperformance of the  counterparties.  The Company's current credit exposure is
limited to the value of derivatives  that have become  favorable to the Company.
This credit risk is minimized  by  purchasing  such  agreements  from  financial
institutions  with  high  credit  ratings  and by  establishing  and  monitoring
exposure limits.                                                                

The net interest  effect of interest  rate and  currency  swap  transactions  is
recorded as an  adjustment  to net  investment  income or interest  expense,  as
appropriate,  over the periods covered by the agreements. The cost of derivative
instruments related to residential mortgage loan servicing rights is included in
the basis of the underlying  assets which are  marked-to-market  and reported in
fees and other revenue in the consolidated statement of operations.  The cost of
other  derivative  contracts is  amortized  over the life of the  contracts  and
classified with the results of the underlying hedged item.                      

Hedge  accounting is used for derivatives  that are  specifically  designated in
advance as hedges and that reduce the Company's exposure to an indicated risk by
having a high  correlation  between  changes in the value of the derivatives and
the item being  hedged at both the  inception  of the hedge and  throughout  the
hedge  period.  Should such criteria not be met or if the hedged items are sold,
terminated or matured,  the changes in value of the  derivatives are included in
net income.                                                                     

The fair value of derivative instruments, identified as hedges and classified as
assets at September 30, 2001, was $456.1 million. Of this amount, the fair value
of derivatives  related to investment  hedges was $82.3 million and was reported
with other invested assets on the consolidated  statement of financial position.
The fair value of  derivatives  related to  residential  mortgage loan servicing
rights and  residential  mortgage loans was $227.8 million and the fair value of

10

10-Q 11th Page of 77 TOC 1st Previous Next ↓Bottom Just 11th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

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

derivatives  related to debt serviced by Australian  dollars was $146.0 million.
Both are reported with other assets on the  consolidated  statement of financial
position.  The fair value of derivative instruments classified as liabilities at
September 30, 2001, was $542.7  million and was reported with other  liabilities
on the consolidated statement of financial position.                            

Fair Value Hedges                                                               

The Company  uses  fixed-to-floating  rate  interest  rate swaps to more closely
align the interest rate  characteristics  of certain assets and liabilities.  In
general,  these  swaps  are used in asset  and  liability  management  to modify
duration.                                                                       

The Company  also enters  into  currency  exchange  swap  agreements  to convert
certain   foreign   denominated   assets  and   liabilities   into  U.S.  dollar
floating-rate  denominated  instruments  to  eliminate  the  exposure  to future
currency volatility on those items.                                             

For the nine months ended  September 30, 2001, the Company  recognized a pre-tax
net gain of $40.6 million related to the  ineffective  portion of its fair value
hedges.  This net gain  includes  a net gain of $100.0  million  related  to the
ineffective portion of its fair value residential mortgage loan servicing hedges
and a net  loss of $47.1  million  related  to the  change  in the  value of the
residential mortgage loan servicing hedges that was excluded from the assessment
of hedge  effectiveness.  The net gain on  residential  mortgage loan  servicing
hedges was offset by amortization and an impairment of residential mortgage loan
servicing  rights.  The net gain,  amortization  and impairment of mortgage loan
servicing rights were reported with other expenses on the consolidated statement
of operations. The net gain also includes a net loss of $12.3 million related to
investment  hedges  and was  reported  with net  realized  capital  gains on the
consolidated statement of operations.                                           

Cash Flow Hedges                                                                

The Company also  utilizes  floating-to-fixed  rate interest rate swaps to match
cash flows.                                                                     

The Company  enters into  currency  exchange  swap  agreements  to convert  both
principal  and  interest  payments  of certain  foreign  denominated  assets and
liabilities into U.S. dollar denominated fixed-rate instruments to eliminate the
exposure to future currency volatility on those items.                          

For the nine months ended  September  30, 2001,  the Company  recognized a $34.6
million  after-tax  decrease in value related to cash flow hedges in accumulated
other comprehensive  income. During this time period, none of the Company's cash
flow hedges have been  discontinued  because it was  probable  that the original
forecasted  transaction  would not occur by the end of the originally  specified
time  period.  The  Company  has  not  reclassified   amounts  from  accumulated
comprehensive  income into earnings  over the past nine months,  and it does not
expect to reclassify any amounts in the next twelve months.                     

In most  cases,  zero  hedge  ineffectiveness  for cash flow  hedges is  assumed
because the  derivative  instrument was  constructed  such that all terms of the
derivative  match the hedged risk in the hedged item.  As a result,  the Company
has  recognized  an  immaterial  amount  in  earnings  due to  cash  flow  hedge
ineffectiveness.                                                                

The transition adjustment for the adoption of SFAS 133 resulted in a decrease to
other   comprehensive   income  of  $36.9  million  ($24.0  million  after  tax)
representing  the  accumulation in other  comprehensive  income of the effective
portion of the  Company's  cash flow hedges as of January 1, 2001.  For the nine
months ended September 30, 2001, $53.2 million ($34.6 million after-tax) of loss
representing  the  effective  portion of the change in fair value of  derivative
instruments  designated  as cash  flow  hedges  was added to  accumulated  other
comprehensive  income resulting in an ending balance of $(90.1) million ($(58.6)
million after-tax) at September 30, 2001.                                       

11

10-Q 12th Page of 77 TOC 1st Previous Next ↓Bottom Just 12th
 Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

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

Derivatives Not Designated as Hedging Instruments                               

The Company attempts to match the timing of when interest rates are committed on
insurance  products,  residential  mortgage  loans,  and other new  investments.
However,  timing differences may occur and can expose the Company to fluctuating
interest rates. To offset this risk, the Company uses mortgage-backed  forwards,
over-the-counter  options on mortgage-backed  securities,  U.S. Treasury futures
contracts,  options on Treasury futures, Treasury rate guarantees,  and interest
rate  floors  to  economically  hedge  anticipated  transactions  and to  manage
interest rate risk.  Futures  contracts are  marked-to-market  value and settled
daily,   which  minimizes  the   counterparty   risk.   Forward   contracts  are
marked-to-market no less than quarterly.                                        

Occasionally,  the Company will sell a callable investment-type contract and may
use interest  rate  swaptions or similar  instruments  to transform the callable
liability  into a fixed term  liability.  In  addition,  the Company may sell an
investment-type  contract with  attributes  tied to market indices in which case
the Company writes an equity call option to convert the overall  contract into a
fixed rate liability, essentially eliminating the equity component altogether.  

Although the above mentioned  derivatives are effective  hedges from an economic
standpoint,  they do not meet the requirements  for hedge  accounting  treatment
under  SFAS  133.  As  such,  periodic  changes  in the  market  value  of these
instruments flow directly into net income.  As of September 30, 2001, the impact
to net income as a result of derivatives not receiving hedge accounting was $2.4
million.                                                                        

2.   Segment Information                                                        

The Company  provides  financial  products  and services  through the  following
operating segments: U.S. Asset Management and Accumulation,  International Asset
Management and Accumulation,  Life and Health Insurance and Mortgage Banking. In
addition,  there is a Corporate and Other segment.  The segments are managed and
reported  separately because they provide different products and services,  have
different strategies or have different markets and distribution channels.       

The U.S.  Asset  Management and  Accumulation  segment  provides  retirement and
related financial products and services primarily to businesses, their employees
and other  individuals and provides asset  management  services to the Company's
asset  accumulation  business,  the life and  health  insurance  operations  and
third-party clients.                                                            

The  International  Asset  Management and  Accumulation  segment  provides asset
management   products   and  services  to  retail   clients  in  Australia   and
institutional  clients  throughout  the world and provides  life  insurance  and
retirement and related financial  products and services primarily to businesses,
their employees and other individuals  principally in Australia,  Chile, Brazil,
New Zealand, Mexico, India, Japan, Argentina and Hong Kong.                     

The Life and Health Insurance  segment  provides  individual life and disability
insurance to the owners and employees of businesses and other individuals in the
United States and provides group life and health  insurance to businesses in the
United States.                                                                  

The Mortgage Banking segment originates and services  residential  mortgage loan
products for customers primarily in 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 financing activities for the Company,  income on
capital  not  allocated  to  other  segments,   intercompany  eliminations,  and
non-recurring or other income or expenses not allocated to the segments based on
review of the nature of such items.                                             

12

10-Q 13th Page of 77 TOC 1st Previous Next ↓Bottom Just 13th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

The Company evaluates segment performance on segment operating  earnings,  which
excludes the effect of net realized capital gains and losses,  as adjusted,  and
non-recurring events and transactions.  Net realized capital gains, as adjusted,
are net of tax, related changes in the  amortization  pattern of deferred policy
acquisition  costs,  recognition  of front-end fee revenues for sales charges on
pension  products  and  services  and net  realized  capital  gains  credited to
customers.  Segment  operating  revenues  exclude net realized capital gains and
their  impact on  recognition  of  front-end  fee  revenues.  Segment  operating
earnings are  determined by adjusting  GAAP net income for net realized  capital
gains and losses, as adjusted, and non-recurring items which management believes
are not  indicative  of  overall  operating  trends.  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  the  Company's   results  of  operations  by
highlighting  earnings  attributable to the normal,  recurring operations of the
business.  However,  segment  operating  earnings are not a  substitute  for net
income determined in accordance with GAAP.                                      

For the three  months ended  September  30,  2001,  the Company  excluded a $4.1
million  non-recurring item, net of tax, from net income for the presentation of
operating  earnings.  The non-recurring  item represented the negative effect of
expenses related to our demutualization.                                        

For the three  months ended  September  30,  2000,  the Company  excluded a $1.9
million  non-recurring item, net of tax, from net income for the presentation of
operating  earnings.  The non-recurring  item represented the negative effect of
expenses related to our demutualization.                                        

For the nine months ended September 30, 2001, the Company excluded $35.5 million
of  non-recurring  items,  net of tax, from net income for the  presentation  of
operating  earnings.  The non-recurring  items included the negative effects of:
(a) expenses related to our  demutualization  ($18.9 million);  (b) a cumulative
effect of change in accounting  principle related to our  implementation of SFAS
133  ($10.7  million);  and (c) an  increase  to our  loss  contingency  reserve
established for sales practices litigation ($5.9 million).                      

For the nine months ended September 30, 2000, the Company excluded $77.7 million
of  non-recurring  items,  net of tax, from net income for the  presentation  of
operating  earnings.  The non-recurring  items included the negative effects of:
(a) an increase to our loss contingency  reserve established for sales practices
litigation  ($75.0  million),  and (b) expenses  related to our  demutualization
($2.7 million).                                                                 

The  accounting  policies of the  segments  are similar to those of the Company,
with the exception of capital  allocation.  The Company allocates capital to its
segments  based upon an internal  capital  model that allows  management to more
effectively manage the Company's capital.                                       

13

10-Q 14th Page of 77 TOC 1st Previous Next ↓Bottom Just 14th
 Principal Financial Group, Inc.
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

The following table summarizes  selected financial  information by segment as of
or for the three months  ended  September 30 and  reconciles  segment  totals to
those reported in the consolidated financial statements (in millions):          

                                                        [Enlarge/Download Table]


                                         International                                                       
                          U.S. Asset         Asset                                                           
                          Management      Management     Life and                                            
                              and             and         Health       Mortgage    Corporate                 
                         Accumulation    Accumulation    Insurance     Banking     and Other    Consolidated 
                        --------------  --------------  -----------  -----------  -----------  --------------
                                                                                                             
2001                                                                                                         
Revenues:                                                                                                    
  Operating revenues...   $ 1,065.5       $   276.6      $   970.3     $  207.7    $   16.4       $ 2,536.5  
  Net realized capital                                                                                       
    losses, including                                                                                        
    recognition of                                                                                           
    front-end fee                                                                                            
    revenues...........       (46.4)           (5.9)          (7.6)         -         (20.1)          (80.0) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Revenues...............   $ 1,019.1       $   270.7      $   962.7     $  207.7    $   (3.7)      $ 2,456.5  
                        ==============  ==============  ===========  ===========  ===========  ==============

Net income:                                                                                                  
  Operating earnings                                                                                         
    (loss).............   $    82.5       $    (2.0)     $    60.7     $   26.5    $   (2.6)      $   165.1  
  Net realized capital                                                                                       
    gains (losses), as                                                                                       
    adjusted...........       (28.6)            0.9           (4.3)         -         (13.2)          (45.2) 
  Non-recurring items..         -               -              -            -          (4.1)           (4.1) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Net income (loss)......   $    53.9       $    (1.1)     $    56.4     $   26.5    $  (19.9)      $   115.8  
                        ==============  ==============  ===========  ===========  ===========  ==============

Assets.................   $64,571.9       $ 4,995.2      $10,817.1     $2,339.8    $1,231.2       $83,955.2  
                        ==============  ==============  ===========  ===========  ===========  ==============
Other segment data:                                                                                          
  Revenues from                                                                                              
    external customers    $   996.4       $   270.4      $   963.5     $  207.7    $   18.5       $ 2,456.5  
  Intersegment                                                                                               
    revenues...........        22.7             0.3           (0.8)         -         (22.2)            -    
  Interest expense.....         0.7             -             (1.6)         -          18.6            17.7  
  Income tax expense                                                                                         
    (benefit)..........        (2.6)          (10.9)          28.1         20.4        (2.2)           32.8  
  Amortization of                                                                                            
    goodwill and                                                                                             
    other                                                                                                    
    intangibles........         0.4            10.8            1.1          0.2        (0.3)           12.2  

14

10-Q 15th Page of 77 TOC 1st Previous Next ↓Bottom Just 15th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

                                                        [Enlarge/Download Table]


                                         International                                                       
                          U.S. Asset         Asset                                                           
                          Management      Management     Life and                                            
                              and             and         Health      Mortgage     Corporate                 
                         Accumulation    Accumulation    Insurance     Banking     and Other    Consolidated 
                        --------------  --------------  -----------  -----------  -----------  --------------
                                                                                                             
2000                                                                                                         
Revenues:                                                                                                    
  Operating revenues...   $   830.5       $   163.6      $ 1,004.5     $   90.4    $   13.9       $ 2,102.9  
  Net realized capital                                                                                       
    gains (losses),                                                                                          
    including                                                                                                
    recognition of                                                                                           
    front-end fee                                                                                            
    revenues...........         4.4             1.4           (0.8)         -          15.9            20.9  
                        --------------  --------------  -----------  -----------  -----------  --------------
Revenues...............   $   834.9       $   165.0      $ 1,003.7     $   90.4    $   29.8       $ 2,123.8  
                        ==============  ==============  ===========  ===========  ===========  ==============

Net income:                                                                                                  
  Operating earnings                                                                                         
    (loss).............   $    89.0       $    (1.6)     $    53.6     $    7.2    $   15.1       $   163.3  
  Net realized capital                                                                                       
    gains (losses), as                                                                                       
    adjusted...........         3.0            (0.1)          (0.4)         -          10.0            12.5  
  Non-recurring items..         -               -              -            -          (1.9)           (1.9) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Net income (loss)......   $    92.0       $    (1.7)     $    53.2     $    7.2    $   23.2       $   173.9  
                        ==============  ==============  ===========  ===========  ===========  ==============
Assets.................   $66,037.0       $ 5,347.3      $10,578.0     $1,530.3    $1,106.5       $84,599.1  
                        ==============  ==============  ===========  ===========  ===========  ==============

Other segment data:                                                                                          
  Revenues from                                                                                              
    external customers    $   812.5       $   164.8      $ 1,004.5     $   90.4    $   51.6       $ 2,123.8  
  Intersegment                                                                                               
    revenues...........        22.4             0.2           (0.8)         -         (21.8)            -    
  Interest expense.....         1.3            (0.3)           0.7          -          17.1            18.8  
  Income tax expense                                                                                         
    (benefit)..........        30.4             1.9           27.0          3.8        (7.9)           55.2  
  Amortization of                                                                                            
    goodwill and other                                                                                       
    intangibles........         0.3            12.5            4.3          0.2        (0.3)           17.0  

15

10-Q 16th Page of 77 TOC 1st Previous Next ↓Bottom Just 16th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

The following table summarizes  selected financial  information by segment as of
or for the nine months ended September 30 and reconciles segment totals to those
reported in the consolidated financial statements (in millions):                

                                                        [Enlarge/Download Table]


                                         International                                                       
                          U.S. Asset         Asset                                                           
                          Management      Management     Life and                                            
                             and             and          Health       Mortgage    Corporate                 
                         Accumulation    Accumulation    Insurance     Banking     and Other    Consolidated 
                        --------------  --------------  -----------  -----------  -----------  --------------
                                                                                                             
2001                                                                                                         
Revenues:                                                                                                    
  Operating revenues...   $ 2,923.7       $   586.7      $ 2,948.5     $  500.8    $   73.9       $ 7,033.6  
  Net realized capital                                                                                       
    losses, including                                                                                        
    recognition of                                                                                           
    front-end fee                                                                                            
    revenues...........      (111.3)          (44.6)         (16.7)         -         (83.8)         (256.4) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Revenues...............   $ 2,812.4       $   542.1      $ 2,931.8     $  500.8    $   (9.9)      $ 6,777.2  
                        ==============  ==============  ===========  ===========  ===========  ==============

Net income:                                                                                                  
  Operating earnings                                                                                         
    (loss).............   $   259.4       $    (6.7)     $   151.6     $   95.3    $   29.5       $   529.1  
  Net realized capital                                                                                       
    losses, as                                                                                               
    adjusted...........       (69.4)          (20.3)          (9.0)         -         (54.7)         (153.4) 
  Non-recurring items..       (10.8)            -              0.1          -         (24.8)          (35.5) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Net income (loss)......   $   179.2       $   (27.0)     $   142.7     $   95.3    $  (50.0)      $   340.2  
                        ==============  ==============  ===========  ===========  ===========  ==============
Assets.................   $64,571.9       $ 4,995.2      $10,817.1     $2,339.8    $1,231.2       $83,955.2  
                        ==============  ==============  ===========  ===========  ===========  ==============

Other segment data:                                                                                          
  Revenues from                                                                                              
    external customers.   $ 2,740.9       $   541.3      $ 2,934.3     $  500.8    $   59.9       $ 6,777.2  
  Intersegment                                                                                               
    revenues...........        71.5             0.8           (2.5)         -         (69.8)            -    
  Interest expense.....         2.8             0.1            0.6          -          54.7            58.2  
  Income tax expense                                                                                         
    (benefit)..........        14.2           (30.7)          71.6         57.4       (23.6)           88.9  
  Amortization of                                                                                            
    goodwill and other                                                                                       
    intangibles........         0.9            36.9            3.0          0.6        (0.6)           40.8  


16

10-Q 17th Page of 77 TOC 1st Previous Next ↓Bottom Just 17th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

                                                        [Enlarge/Download Table]


                                         International                                                       
                          U.S. Asset         Asset                                                           
                          Management      Management     Life and                                            
                              and             and          Health      Mortgage    Corporate                 
                         Accumulation    Accumulation    Insurance     Banking     and Other    Consolidated 
                        --------------  --------------  -----------  -----------  -----------  --------------
                                                                                                             
2000                                                                                                         
Revenues:                                                                                                    
  Operating revenues...   $ 2,531.2       $   473.1      $ 3,105.2     $  271.1    $   54.4       $ 6,435.0  
  Net realized capital                                                                                       
    gains (losses),                                                                                          
    including                                                                                                
    recognition of                                                                                           
    front-end fee                                                                                            
    revenues...........       (45.1)            5.1           75.2          -          19.1            54.3  
                        --------------  --------------  -----------  -----------  -----------  --------------
Revenues...............   $ 2,486.1       $   478.2      $ 3,180.4     $  271.1    $   73.5       $ 6,489.3  
                        ==============  ==============  ===========  ===========  ===========  ==============

Net income:                                                                                                  
  Operating earnings                                                                                         
    (loss).............   $   266.3       $    (5.3)     $   139.6     $   41.6    $   19.1       $   461.3  
  Net realized capital                                                                                       
    gains (losses), as                                                                                       
    adjusted...........       (32.1)            3.4           49.7          -          14.6            35.6  
  Non-recurring items..         -               -              -            -         (77.7)          (77.7) 
                        --------------  --------------  -----------  -----------  -----------  --------------
Net income (loss)......   $   234.2       $    (1.9)     $   189.3     $   41.6    $  (44.0)      $   419.2  
                        ==============  ==============  ===========  ===========  ===========  ==============
Assets.................   $66,037.0       $ 5,347.3      $10,578.0     $1,530.3    $1,106.5       $84,599.1  
                        ==============  ==============  ===========  ===========  ===========  ==============

Other segment data:                                                                                          
  Revenues from                                                                                              
    external customers    $ 2,428.3       $   477.3      $ 3,182.8     $  271.1    $  129.8       $ 6,489.3  
  Intersegment                                                                                               
    revenues...........        57.8             0.9           (2.4)         -         (56.3)            -    
  Interest expense.....         6.4            (0.2)           2.0          -          59.4            67.6  
  Income tax expense                                                                                         
    (benefit)..........        82.7             4.3           94.0         22.4       (42.9)          160.5  
  Amortization of                                                                                            
    goodwill and other                                                                                       
    intangibles........         0.8            36.4            6.4          0.6        (0.9)           43.3  


17

10-Q 18th Page of 77 TOC 1st Previous Next ↓Bottom Just 18th
Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

2.   Segment Information (continued)                                            

The   Company   operates  in  the  United   States  and  in   selected   markets
internationally (including Australia, Chile, Brazil, New Zealand, Mexico, India,
Japan,  Argentina  and Hong  Kong).  The  following  table  summarizes  selected
financial  information by geographic  location as of or for the three months and
nine months ended September 30 (in millions):                                   

                                                        [Enlarge/Download Table]


                                                    For the three months          For the nine months     
                        As of September 30,         ended September 30,           ended September 30,     
                     --------------------------  ---------------------------  ----------------------------
                        Long-                                       Net                            Net    
                        Lived                                      Income                         Income  
                        Assets        Assets       Revenues        (Loss)       Revenues          (Loss)  
                     ------------  ------------  ------------   ------------  ------------    ------------
                                                                                                          
2001                                                                                                      
United States.......  $   543.2      $78,960.0     $ 2,185.8       $ 116.9      $ 6,235.1        $ 367.2  
International.......    1,166.0        4,995.2         270.7          (1.1)         542.1          (27.0) 
                     ------------  ------------  ------------   ------------  ------------    ------------
Total...............  $ 1,709.2      $83,955.2     $ 2,456.5       $ 115.8      $ 6,777.2        $ 340.2  
                     ============  ============  ============   ============  ============    ============

2000                                                                                                      
United States.......  $   502.1      $79,251.8     $ 1,958.8       $ 175.6      $ 6,011.1        $ 421.1  
International.......    1,317.4        5,347.3         165.0          (1.7)         478.2           (1.9) 
                     ------------  ------------  ------------   ------------  ------------    ------------
Total...............  $ 1,819.5      $84,599.1     $ 2,123.8       $ 173.9      $ 6,489.3        $ 419.2  
                     ============  ============  ============   ============  ============    ============

Long-lived  assets  include  property  and  equipment  and  goodwill  and  other
intangibles.                                                                    

The  Corporate  and Other  segment  includes  an equity  ownership  interest  in
Coventry Health Care, Inc. The Corporate and Other segment's  equity in earnings
of Coventry Health Care, Inc., which was included in net investment  income, was
$5.1 million for both the three months ended  September 30, 2001,  and 2000, and
$14.8  million and $15.9  million for the nine months ended  September 30, 2001,
and 2000, respectively.  The investment in Coventry Health Care, Inc. was $139.4
million and $122.9  million at  September  30,  2001,  and  December  31,  2000,
respectively.  The Corporate and Other segment also includes  consolidating  and
intersegment eliminations.                                                      

The Company's operations are not materially dependent on one or a few customers,
brokers or agents, and revenues,  assets and operating earnings are attributable
to geographic location based on the country of domicile sales originate from.   

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Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

3.   Comprehensive Income                                                       

Comprehensive  income for the three months and nine months ended September 30 is
as follows:                                                                     

                                                        [Enlarge/Download Table]


                                                                For the three                 For the nine        
                                                                months ended                  months ended        
                                                                September 30,                 September 30,       
                                                          --------------------------    --------------------------
                                                              2001           2000           2001           2000   
                                                          ------------  ------------    ------------  ------------
                                                                           (in millions)                          
                                                                                                                  
Comprehensive Income:                                                                                             
  Net income.............................................   $  115.8      $  173.9        $  340.2      $  419.2  
  Net change in unrealized gains and losses on fixed                                                              
     maturities, available-for-sale......................      550.4         286.7           731.8         342.9  
  Net change in unrealized gains and losses on equity                                                             
     securities, available-for-sale, including seed                                                               
     money in separate accounts..........................     (109.6)        (19.4)          (34.9)       (180.0) 
  Adjustments for assumed changes in amortization                                                                 
     patterns:                                                                                                    
     Deferred policy acquisition costs...................      (73.0)        (47.7)          (99.8)        (58.6) 
     Unearned revenue reserves...........................        5.6           4.0             6.2           9.2  
  Net change in unrealized gains and losses on                                                                    
     derivative Instruments..............................      (50.7)          5.1           (53.2)        (22.0) 
  Net change in unrealized gains and losses on                                                                    
     policyholder dividend obligation....................       (8.8)          -              (8.8)          -    
  Provision for deferred income taxes....................     (110.0)        (79.6)         (195.6)        (41.5) 
  Change in net foreign currency translation adjustment..      (29.1)        (64.2)         (105.2)       (129.5) 
  Cumulative effect of accounting change, net of related                                                          
     income taxes........................................        -             -             (14.2)          -    
                                                          ------------  ------------    ------------  ------------
  Comprehensive income...................................   $  290.6      $  258.8        $  566.5      $  339.7  
                                                          ============  ============    ============  ============

4.   Commitments and Contingencies                                              

The  Company  is a  plaintiff  or  defendant  in  actions  arising  out  of  its
operations.  The  Company  is,  from  time to time,  also  involved  in  various
governmental and administrative proceedings. While the outcome of any pending or
future  litigation  cannot be  predicted,  management  does not believe that any
pending  litigation  will  have a  material  adverse  effect  on  the  Company's
business,  financial condition or results of operations.  However, no assurances
can be given that such litigation  would not materially and adversely affect the
Company's business, financial condition or results of operations.               

Other companies in the life insurance industry have historically been subject to
substantial  litigation  resulting from claims disputes and other matters.  Most
recently,  such companies have faced extensive  claims,  including  class-action
lawsuits,   alleging   improper  life  insurance  sales  practices.   Negotiated
settlements of such class-action  lawsuits have had a material adverse effect on
the business,  financial condition and results of operations of certain of these
companies.  Principal Life is currently a defendant in two class-action lawsuits
which allege improper sales practices.                                          

In 2000,  the Company  reached an  agreement  in  principle  to settle these two
class-action  lawsuits  alleging  improper sales  practices.  In April 2001, the
proposed  settlement of the class-action  lawsuits  received court approval.  In
agreeing to the settlement,  the Company specifically denied any wrongdoing. The
Company has accrued a loss reserve for its best  estimate  based on  information
available.  As uncertainties  continue to exist in resolving this matter,  it is
reasonably  possible  that,  as  the  actual  cost  of  the  claims  subject  to
alternative  dispute resolution becomes available,  the final cost of settlement
could exceed the Company's estimate. The range of any additional cost related to

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Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

4.   Commitments and Contingencies (continued)                                  

the settlement cannot be presently  estimated,  however the Company believes the
settlement will not have a material impact on its business,  financial condition
or results of operations.  A number of persons and entities who were eligible to
be class members have excluded  themselves  from the class (or "opted out"),  as
the law permits them to do. The Company has been notified that some of those who
opted out from the class will file  lawsuits  and make  claims  similar to those
addressed by the settlement.                                                    

The Company is also subject to insurance guaranty laws in the states in which it
writes business.  These laws provide for assessments against insurance companies
for the benefit of  policyholders  and  claimants in the event of  insolvency of
other insurance companies.  The assessments may be partially recovered through a
reduction in future  premium  taxes in some states.  The Company  believes  such
assessments  in excess  of  amounts  accrued  would not  materially  affect  its
financial condition or results of operations.                                   

5.   Terrorist Attacks in the United States                                     

On  September  11,  2001,  terrorist  attacks in the United  States  resulted in
significant  loss of life and  property,  as well as  interruption  of  business
activities and an overall  disruption of the world economy.  The Company accrued
$6.5  million  (net of income tax and  reinsurance)  for  potential  losses from
individual and group life and disability insurance claims from these events. The
accrual reflects the Company's best estimate of anticipated losses.  Because the
Company  does not know the full extent of the impact of the events of  September
11,  2001,  it is  possible  that  the  Company  may  incur  additional  losses.
Management  has estimated no material  property or  investment  real estate loss
exposures  resulting  from  these  events.  However,  some of the  assets in the
Company's  investment portfolio may be adversely affected by the declines in the
securities  markets and  economic  activity  that were  caused by the  terrorist
attacks and military  action and heightened  security  measures.  In particular,
this may lead to possible write-downs,  loss of value or impairments with regard
to securities issued by companies affected by these events.                     

The  continuing  impacts  of these  events on the world  economy  and  financial
markets cannot presently be determined. This creates related uncertainties as to
the future  realization of and return on certain invested assets;  the impact on
the  Company's  assumptions  in assessing  the value of  intangibles  from prior
acquisitions  and the  amortization  patterns  for deferred  policy  acquisition
costs;  and the impact on future operating  results,  for which estimates cannot
presently be made.                                                              

6.   Plan of Demutualization                                                    

The board of directors of Principal Mutual Holding Company  unanimously  adopted
the plan of conversion on March 31, 2001.                                       

On  July  24,  2001,  policyholders  entitled  to  vote  approved  the  plan  of
conversion.  The public  hearing was held on July 25,  2001,  and the  Insurance
Commissioner  of the State of Iowa approved the plan of conversion on August 28,
2001.                                                                           

7.   Subsequent Events                                                          

Demutualization and Initial Public Offering                                     

Under the terms of the plan of conversion, effective October 26, 2001, Principal
Mutual Holding Company  converted from a mutual  insurance  holding company to a
stock company. All policyholder membership interests in Principal Mutual Holding
Company were extinguished on that date and eligible  policyholders of the mutual
insurance  holding company are expected to receive,  in aggregate,  an estimated
260.6 million shares of common stock, an estimated  $1,181.5 million of cash and
an estimated  $472.7 million of policy credits as  compensation.                

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Principal Financial Group, Inc. 
Notes to Consolidated Financial Statements (continued)
September 30, 2001
 (Unaudited)

7.   Subsequent Events (continued)                                              

In  connection  with the  restructuring  effective  October 26, 2001,  Principal
Mutual Holding Company merged with and into Principal Iowa Newco, Inc. Principal
Financial Group, Inc., an Iowa business  corporation and subsidiary of Principal
Mutual  Holding  Company,  merged  with  and into  Principal  Iowa  Newco,  Inc.
Principal Financial Services,  Inc., an Iowa business  corporation,  merged with
and into  Principal Iowa Newco,  Inc.  Principal  Iowa Newco,  Inc.,  which is a
subsidiary of Principal Financial Group, Inc., a Delaware business  corporation,
changed its name to Principal Financial Services, Inc.                          

In addition,  on October 26, 2001,  the Company  completed  its IPO in which the
Company  issued  100.0  million  shares of common stock at a price of $18.50 per
share.  Estimated net proceeds from the IPO were $1,753.3  million,  of which an
estimated $59.5 million was retained by Principal  Financial Group, Inc., and an
estimated  $1,693.8 million was contributed to Principal Life Insurance Company.
Net proceeds included offering costs of approximately $96.7 million.            

On November 9, 2001, the Company issued 15.0 million additional shares of common
stock,  at a  price  of  $18.50  per  share,  as a  result  of the  exercise  of
over-allotment options granted to underwriters in the IPO. Net proceeds from the
over-allotment were approximately $265.4 million.                               

Costs  relating to the  demutualization,  excluding  costs  relating to the IPO,
incurred  through  September 30, 2001,  were $26.1  million,  net of income tax.
Demutualization expenses consist primarily of printing and mailing costs and the
aggregate  cost  of  engaging  independent  accounting,   actuarial,  financial,
investment  banking,  legal and other  consultants  to advise the Company on the
demutualization.  In addition,  these costs include the costs of the advisors of
the Insurance Commissioner of the State of Iowa and the New York State Insurance
Department,  other regulatory authorities and internal allocated costs for staff
and related costs associated with the demutualization.                          

Adoption of Incentive Stock Plans                                               

On May 21,  2001,  the Company  approved and adopted the Stock  Incentive  Plan,
Board of  Directors'  Stock Plan  ("Directors'  Stock Plan") and Employee  Stock
Purchase Plan ("Stock  Purchase  Plan").  Under the terms of the Stock Incentive
Plan,  grants  may be  non-qualified  stock  options,  incentive  stock  options
qualifying  under Section 422 of the Internal  Revenue Code,  restricted  stock,
restricted  stock units and stock  appreciation  rights.  Under the terms of the
Directors'  Stock Plan,  grants may be non-qualified  stock options,  restricted
stock and restricted  stock units.  The maximum number of shares of common stock
that may be issued under the Stock Incentive Plan,  together with an excess plan
(the  Company's   non-qualified  defined  contribution   retirement  plan),  the
Directors' Stock Plan, the long-term  performance plan and any new plan awarding
the Company's  common stock,  in the five years  following the completion of the
IPO,  is 6% of the  number  of  shares  outstanding  immediately  following  the
completion of the IPO.                                                          

In addition,  the maximum number of shares of common stock  available  under the
Stock Purchase Plan is 2% of the total number of shares of common stock that are
outstanding following the IPO of the common stock.                              

Pro Forma Earnings Per Share                                                    

After the Company's IPO, SFAS No. 128, Earnings per Share, was adopted. SFAS No.
128 requires  disclosure of basic and diluted earnings per share. Basic earnings
per share  excludes  the  dilutive  effects of  options,  warrants,  convertible
securities,  etc. For purposes of the Company's  unaudited basic and diluted pro
forma earnings per share calculations,  the weighted average number of estimated
shares outstanding during the year was assumed to be 360.6 million shares. These
shares represent an estimated 260.6 million shares to be issued to policyholders
entitled to receive compensation in the demutualization and 100.0 million shares
sold to  investors  in the  IPO,  prior  to the  underwriters'  exercise  of the
over-allotment  options.  The  shares  issued to the  policyholders  include  an
estimated  56.2 million  shares to be issued as policy credits and to be held in
one of the Company's separate accounts.                                         

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Item 2. Management's  Discussion and Analysis of Financial Condition and Results
of Operations                                                   

The following  analysis  discusses  the financial  condition as of September 30,
2001,  compared  with  December  31,  2000,  and  our  consolidated  results  of
operations for the three and nine month periods ended  September 30, 2001,  and,
where  appropriate,  factors that may affect future financial  performance.  The
discussion  should be read in conjunction with our S-1  Registration  Statement,
filed  with  the  United  States  Securities  and  Exchange  Commission  and the
unaudited  consolidated  financial  statements  and  the  related  notes  to the
financial  statements and the other financial  information included elsewhere in
this Form 10-Q.                                                                 

Forward-Looking Information                                                     

Our  narrative  analysis  below  contains  forward-looking  statements  that are
intended  to  enhance  the  reader's  ability  to assess  our  future  financial
performance.  Forward-looking  statements  include,  but  are  not  limited  to,
statements that represent our beliefs concerning future operations,  strategies,
financial results or other  developments,  and contain words and phrases such as
"may," "expects," "should" or similar expressions. Because these forward-looking
statements  are  based  on  estimates  and  assumptions   that  are  subject  to
significant business, economic and competitive risks and uncertainties,  many of
which are beyond our control or are subject to change,  actual  results could be
materially different.                                                           

The risks,  uncertainties  and factors  that could cause or  contribute  to such
material  differences  are discussed in our  registration  statement on Form S-1
filed with the Securities and Exchange Commission. These risks and uncertainties
include,  without  limitation:  (1)  competition  from  companies  that may have
greater  financial  resources,  broader  arrays of products,  higher ratings and
stronger  financial  performance  may  impair  our  ability  to retain  existing
customers,  attract new customers and maintain our profitability;  (2) a decline
or increased  volatility  in the  securities  markets  could result in investors
withdrawing from the markets or decreasing their rates of investment,  either of
which could reduce our net income,  revenues and assets under management;  (3) a
downgrade in Principal Life Insurance  Company's  ("Principal  Life")  financial
strength  ratings may increase  policy  surrenders and  withdrawals,  reduce new
sales and terminate  relationships with distributors;  (4) our efforts to reduce
the impact of interest rate changes on our  profitability and surplus may not be
effective;  (5) if we are unable to attract and retain sales representatives and
develop new  distribution  sources,  sales of our  products  and services may be
reduced; (6) our international businesses face political, legal, operational and
other  risks  that could  reduce  our  profitability  in those  businesses;  (7)
fluctuations in foreign currency exchange rates could reduce our  profitability;
(8) a decline in  Australian  equity values may reduce the  profitability  of BT
Financial  Group's margin lending  business;  (9) our reserves  established  for
future policy benefits and claims may prove inadequate, requiring us to increase
liabilities; (10) our investment portfolio is subject to several risks which may
diminish  the value of our invested  assets and affect our sales,  profitability
and the investment  returns  credited to our customers;  (11) our ability to pay
dividends and meet our  obligations  may be  constrained  by the  limitations on
dividends Iowa insurance laws impose on Principal Life; (12) we may need to fund
deficiencies in our closed block;  assets  allocated to the closed block benefit
only the  holders of closed  block  policies;  (13)  changes in  regulations  or
accounting  standards  may reduce our  profitability;  (14) a  challenge  to the
Insurance Commissioner of the State of Iowa's approval of the plan of conversion
could put the terms of our  demutualization  in  question  and reduce the market
price of our common stock;  (15)  litigation and regulatory  investigations  may
harm our financial strength and reduce our  profitability;  (16) sales of shares
distributed  in the  demutualization  may reduce the market  price of our common
stock;  (17)  applicable laws and our  stockholder  rights plan,  certificate of
incorporation  and by-laws may  discourage  takeovers and business  combinations
that our  stockholders  might  consider  in their best  interests;  and (18) the
impact of recent terrorist  attacks and military and other actions may result in
decreases  in our net  income,  revenue  and  assets  under  management  and may
adversely affect our investment portfolio.                                      

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Transactions Affecting Comparability of Results of Operations                   

Dispositions                                                                    

We disposed  of the  following  businesses,  among  others,  during the past two
years:                                                                          

PT Asuransi Jiwa Principal Indonesia.  On September 25, 2001, we disposed of all
the stock of PT Asuransi Jiwa Principal Indonesia,  our subsidiary in Indonesia.
We  currently  have no business  operations  in  Indonesia.  Total assets of our
operations in Indonesia as of December 31, 2000, were $3.2 million.  We included
nominal  revenues  and  net  loss  from  our  operations  in  Indonesia  in  our
consolidated results of operations for the three and nine months ended September
30, 2001, and 2000.                                                             

Principal  International  Espana, S.A. de Seguros de Vida. On February 15, 2001,
we  disposed  of all of the stock of  Principal  International  Espana,  S.A. de
seguros de Vida, our subsidiary in Spain, for nominal  proceeds,  resulting in a
net realized capital loss of $38.4 million,  ceasing our business  operations in
Spain.  Total assets of our  operations  in Spain as of December 31, 2000,  were
$222.7 million.                                                                 

We included  revenues of $10.3 million and $43.4 million from our  operations in
Spain in our  consolidated  results of operations  for the three and nine months
ended  September  30, 2000,  respectively.  We included net loss of $2.1 million
from our operations in Spain for the three months ended  September 30, 2000. Our
operations  in Spain  contributed  nominal net income for the nine months  ended
September  30,  2000.  We did  not  include  revenues  or net  income  from  our
operations in Spain in our consolidated  results of operations for the three and
nine months ended September 30, 2001.                                           

Reinsurance Transactions                                                        

We are considering entering into a reinsurance agreement, to become effective at
the beginning of 2002, to reduce the  volatility of our group medical  insurance
earnings.                                                                       

Effective  July 1, 2000, we entered into a reinsurance  agreement with General &
Cologne Life Re of America to reinsure 100% of our Medicare supplement insurance
business.  Medicare  supplement  insurance  premiums were $0.6 million and $99.0
million for the three and nine months ended September 30, 2000, respectively.   

Operating Earnings and Non-Recurring Items                                      

For the three  months  ended  September  30,  2001,  we excluded a $4.1  million
non-recurring  item,  net of  tax,  from  net  income  for our  presentation  of
consolidated  operating earnings. The non-recurring item represents the negative
effect of expenses related to our demutualization.                              

For the nine months ended  September  30,  2001,  we excluded  $35.5  million of
non-recurring  items,  net of tax,  from  net  income  for our  presentation  of
consolidated  operating earnings.  The non-recurring items included the negative
effects of: (1) expenses related to our demutualization  ($18.9 million);  (2) a
cumulative  effect of change in  accounting  related  to our  implementation  of
Statement No. 133, Accounting for Derivative  Instruments and Hedging Activities
("SFAS 133")  ($10.7  million),  as  discussed in Note 1 to Principal  Financial
Group, Inc.'s unaudited consolidated  financial statements;  and (3) an increase
to our loss contingency reserve established for sales practices litigation ($5.9
million).                                                                       

For the three  months  ended  September  30,  2000,  we excluded a $1.9  million
non-recurring  item,  net of  tax,  from  net  income  for our  presentation  of
consolidated  operating earnings. The non-recurring item represents the negative
effect of expenses related to our demutualization.                              

For the nine months ended  September  30,  2000,  we excluded  $77.7  million of
non-recurring  items,  net of tax,  from  net  income  for our  presentation  of
consolidated  operating earnings.  The non-recurring items included the negative
effects of: (1) an  increase to our loss  contingency  reserve  established  for
sales practices  litigation  ($75.0  million);  and (2) expenses  related to our
demutualization ($2.7 million).                                                 

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Fluctuations in Foreign Currency to U.S. Dollar Exchange Rates                  

Fluctuations in foreign  currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported  financial  results.  In years when
foreign  currencies  weaken  against  the  U.S.  dollar,   translating   foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported.  When
foreign currencies strengthen,  translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.                                    

Foreign currency  exchange rate  fluctuations  create variances in our financial
statement  line  items but do not have a  material  impact  on our  consolidated
operating  earnings and net income.  Our  consolidated  operating  earnings were
negatively  impacted $0.3 million and  positively  impacted $0.3 million for the
three months ended  September 30, 2001, and 2000,  respectively,  as a result of
fluctuations in foreign currency to U.S. dollar exchange rates. Our consolidated
operating earnings were negatively impacted $1.1 million and positively impacted
$0.1  million  for  the  nine  months  ended   September  30,  2001,  and  2000,
respectively,  as a result of  fluctuations  in foreign  currency to U.S. dollar
exchange rates. For a discussion of our approaches to foreign currency  exchange
rate risk, see "Quantitative and Qualitative Disclosures about Market Risk."    

The Demutualization and Initial Public Offering                                 

The board of directors of Principal Mutual Holding Company  unanimously  adopted
the plan of conversion on March 31, 2001.                                       

On  July  24,  2001,  policyholders  entitled  to  vote  approved  the  plan  of
conversion.  The public  hearing was held on July 25,  2001,  and the  Insurance
Commissioner  of the State of Iowa approved the plan of conversion on August 28,
2001.                                                                           

Under the terms of the plan of conversion, effective October 26, 2001, Principal
Mutual Holding Company  converted from a mutual  insurance  holding company to a
stock company. All policyholder membership interests in Principal Mutual Holding
Company were extinguished on that date and eligible  policyholders of the mutual
insurance  holding company are expected to receive,  in aggregate,  an estimated
260.6 million shares of common stock, an estimated  $1,181.5 million of cash and
an estimated $472.7 million of policy credits as compensation.                  

In  connection  with the  restructuring  effective  October 26, 2001,  Principal
Mutual Holding Company merged with and into Principal Iowa Newco, Inc. Principal
Financial Group, Inc., an Iowa business  corporation and subsidiary of Principal
Mutual  Holding  Company,  merged  with  and into  Principal  Iowa  Newco,  Inc.
Principal Financial Services,  Inc., an Iowa business  corporation,  merged with
and into  Principal Iowa Newco,  Inc.  Principal  Iowa Newco,  Inc.,  which is a
subsidiary of Principal Financial Group, Inc., a Delaware business  corporation,
changed its name to Principal Financial Services, Inc.                          

In addition,  on October 26, 2001, we completed our IPO in which we issued 100.0
million  shares of common  stock at a price of $18.50 per share.  Estimated  net
proceeds from the IPO were $1,753.3 million, of which an estimated $59.5 million
was retained by  Principal  Financial  Group,  Inc.,  and an estimated  $1,693.8
million was contributed to Principal Life. Net proceeds  included offering costs
of approximately $96.7 million.                                                 

On November 9, 2001, the Company issued 15.0 million additional shares of common
stock,  at a  price  of  $18.50  per  share,  as a  result  of the  exercise  of
over-allotment options granted to underwriters in the IPO. Net proceeds from the
over-allotment were approximately $265.4 million.                               

Costs  relating to the  demutualization,  excluding  costs  relating to the IPO,
incurred  through  September 30, 2001,  were $26.1  million,  net of income tax.
Demutualization expenses consist primarily of printing and mailing costs and our
aggregate  cost  of  engaging  independent  accounting,   actuarial,  financial,
investment   banking,   legal  and  other   consultants  to  advise  us  on  the
demutualization. In addition, our costs include the costs of the advisors of the
Insurance  Commissioner  of the State of Iowa and the New York  State  Insurance
Department,  other regulatory authorities and internal allocated costs for staff
and related costs associated with the demutualization.                          

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Recent Developments                                                             

Terrorist Attacks in the United States                                          

On September 11, 2001,  terrorist  attacks in the U.S.  resulted in  significant
loss of life and property, as well as interruption of business activities and an
overall disruption of the world economy.  The Company accrued $6.5 million,  net
of income tax and  reinsurance,  in our Life and Health  Insurance  segment  for
potential losses from individual and group life and disability  insurance claims
from these events. The accrual reflects our best estimate of anticipated losses.
Because we do not know the full extent of the impact of the events of  September
11, 2001, it is possible that we may incur additional losses.                   

We do not engage in any  property  and  casualty  insurance  or any  reinsurance
businesses.  Additionally,  we do not have  significant  insurance  exposures to
businesses in the affected areas and did not  experience a material  increase in
claims related to our group life, health or disability policies.                

The impact of the events of  September  11,  2001,  has reduced our assets under
management as a result of the declines in the U.S.,  Australian  and other stock
markets.  These  declines in the securities  markets and reduced  commercial and
economic  activity may also  decrease  our net income and  revenue.  Some of the
assets  in our  investment  portfolio  may  also be  adversely  affected  by the
declines in the securities markets and economic activity caused by the terrorist
attacks and military  action and heightened  security  measures.  In particular,
this may lead to possible write-downs,  loss of value or impairments with regard
to  securities  issued by  companies  affected by these  events.  Credit  rating
agencies  have  downgraded,  and may in the  future  downgrade,  some  of  these
companies, as a result of the impacts of the terrorist attacks. In addition, the
recent  declines in the securities  markets and reduced  commercial and economic
activity may impact our  assumptions in assessing the value of intangibles  from
prior acquisitions and the amortization patterns for deferred policy acquisition
costs.                                                                          

Adoption of Incentive Stock Plans                                               

On May 21,  2001,  the Company  approved and adopted the Stock  Incentive  Plan,
Board of  Directors'  Stock Plan  ("Directors'  Stock Plan") and Employee  Stock
Purchase Plan ("Stock  Purchase  Plan").  Under the terms of the Stock Incentive
Plan,  grants  may be  non-qualified  stock  options,  incentive  stock  options
qualifying  under Section 422 of the Internal  Revenue Code,  restricted  stock,
restricted  stock units and stock  appreciation  rights.  Under the terms of the
Directors'  Stock Plan,  grants may be non-qualified  stock options,  restricted
stock and restricted  stock units.  The maximum number of shares of common stock
that may be issued under the Stock Incentive Plan,  together with an excess plan
(our non-qualified  defined contribution  retirement plan), the Directors' Stock
Plan, the long-term performance plan and any new plan awarding our common stock,
in the five years  following  the  completion of the IPO, is 6% of the number of
shares outstanding immediately following the completion of the IPO.             

In addition,  the maximum number of shares of common stock  available  under the
Stock Purchase Plan is 2% of the total number of shares of common stock that are
outstanding following the IPO of the common stock.                              

Statement of Financial Accounting Standards No. 141 and No. 142                 

On July 20, 2001, the Financial  Accounting  Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 141, Business Combinations,  and
No. 142, Goodwill and Other Intangible Assets ("SFAS 142"),  which  dramatically
change the accounting for business  combinations,  goodwill and other intangible
assets.  These  Statements  were  effective  July  1,  2001,  for  any  business
combinations  entered into  subsequent  to June 30, 2001.  SFAS 142,  which will
become  effective  January  1, 2002,  for the  Company's  business  combinations
entered into prior to June 30, 2001, adopts a  nonamortization,  impairment-only
model for the Company's goodwill and  indefinite-lived  intangible assets.  This
includes a more  stringent  impairment  test  methodology  (fair  value based on
discounted cash flows) for measuring and recognizing impairment losses.         

The Company  continues to study the impact the new  Statements  will have on its
consolidated  financial  statements,  particularly  with  regard to  intangibles
resulting  from our 1999  acquisition of BT Financial  Group.  To determine fair

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value at January  1, 2002 (date of  adoption),  the new  impairment  methodology
requires  consideration  of many  variables  that are  difficult  to  accurately
predict at this time.  If it is  determined  that  economic  conditions  and the
business  environment  at adoption of the new standard  warrant  recognition  of
intangible  asset  impairment,  it is possible  the Company  could  recognize an
impairment  material  to net  income.  Such  impairment  will  be  treated  as a
cumulative effect of a change in accounting principle.                          

The Company's policy, under current GAAP principles, for measuring impairment of
goodwill and other  intangibles is on an  undiscounted  cash flow basis and that
methodology has not resulted in an indicated impairment.                        

Results of Operations                                                           

The table below presents  summary  consolidated  financial  information  for the
periods indicated.                                                              

                                                        [Enlarge/Download Table]


                                                           For the three                  For the nine        
                                                           months ended                   months ended        
                                                           September 30,                 September 30,        
                                                     --------------------------     --------------------------
                                                         2001           2000            2001          2000    
                                                     ------------   -----------     ------------  ------------
                                                                           (in millions)                      
                                                                                                              
Income Statement Data:                                                                                        
Revenues:                                                                                                     
  Premiums and other considerations................. $  1,255.0     $    910.5      $  3,210.3    $  2,903.2  
  Fees and other revenues...........................      453.2          414.5         1,309.5       1,197.7  
  Net investment income.............................      829.1          777.9         2,515.1       2,336.0  
  Net realized capital gains (losses)...............      (80.8)          20.9          (257.7)         52.4  
                                                     ------------   -----------     ------------  ------------
      Total revenues................................    2,456.5        2,123.8         6,777.2       6,489.3  

Expenses:                                                                                                     
  Benefits, claims and settlement expenses..........    1,597.3        1,193.7         4,236.5       3,824.8  
  Dividends to policyholders........................       79.1           75.8           241.2         231.6  
  Operating expenses................................      631.5          625.2         1,859.7       1,853.2  
                                                     ------------   -----------     ------------  ------------
      Total expenses................................    2,307.9        1,894.7         6,337.4       5,909.6  
                                                     ------------   -----------     ------------  ------------

Income before income taxes and cumulative effect                                                              
  of accounting change..............................      148.6          229.1           439.8         579.7  
Income taxes........................................       32.8           55.2            88.9         160.5  
                                                     ------------   -----------     ------------  ------------
Income before cumulative effect of accounting                                                                 
  change............................................      115.8          173.9           350.9         419.2  

Cumulative effect of accounting change, net of                                                                
  related income taxes..............................        -              -             (10.7)          -    
                                                     ------------   -----------     ------------  ------------
      Net income.................................... $    115.8     $    173.9      $    340.2    $    419.2  
                                                     ============   ===========     ============  ============

Other Data:                                                                                                   
Net income.......................................... $    115.8     $    173.9      $    340.2    $    419.2  
Less:                                                                                                         
  Net realized capital gains (losses), as adjusted..      (45.2)          12.5          (153.4)         35.6  
  Non-recurring items...............................       (4.1)          (1.9)          (35.5)        (77.7) 
                                                     ------------   -----------     ------------  ------------
Operating earnings.................................. $    165.1     $    163.3      $    529.1    $    461.3  
                                                     ============   ===========     ============  ============

Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Premiums and other considerations  increased $344.5 million, or 38%, to $1,255.0
million for the three months ended  September 30, 2001,  from $910.5 million for
the three  months ended  September  30,  2000.  The increase  reflected a $258.7
million  increase  from the U.S.  Asset  Management  and  Accumulation  segment,
primarily  a result  of an  increase  in  premiums  from  single  premium  group
annuities  with life  contingencies,  which are  typically  used to fund defined
benefit  pension  plan  terminations.  The premium  income we receive from these
contracts  fluctuates  due to the  variability in the number and size of pension
plan  terminations  in the market  and our  ability  to  attract  new sales.  In

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addition,  a $124.9 million increase from the International Asset Management and
Accumulation segment, primarily resulting from the sale of a large group annuity
contract with life  contingencies  in Mexico.  These  increases  were  partially
offset by a $39.1 million,  or 5%,  decrease from the Life and Health  Insurance
segment,  primarily  due to large premium rate  increases in 2000,  which led to
increased lapses and lower sales of group medical insurance in 2001.            

Fees and other revenues  increased  $38.7 million,  or 9%, to $453.2 million for
the three months ended  September  30, 2001,  from $414.5  million for the three
months ended  September  30, 2000.  The increase was  primarily  due to a $105.6
million increase from the Mortgage Banking segment,  primarily resulting from an
increase in mortgage  loan  production  fee  revenues  and, to a lesser  extent,
growth in the mortgage  loan  servicing  portfolio,  reflecting  the increase in
mortgage loan production volume. The increase was also due to a $1.8 million, or
14%, increase from the Corporate and Other segment. The increases were partially
offset by a $49.8 million,  or 26%,  decrease from the U.S. Asset Management and
Accumulation  segment  primarily  related to a decrease  in the  recognition  of
front-end  fee  revenues,  a result of changes in  assumptions  consistent  with
unlocking of deferred  policy  acquisition  costs,  and, to a lesser  extent,  a
decrease in surrender charge and market value  adjustment  revenues from pension
products due to a decline in the interest rate  environment.  The increases were
also  partially  offset  by  an  $18.1  million,   or  23%,  decrease  from  the
International Asset Management and Accumulation  segment,  primarily as a result
of  declining  assets  under  management  for BT  Financial  Group  and from the
weakening of the Australian  dollar versus the U.S.  dollar.  The increases were
also  partially  offset by a $0.8  million,  or 1%,  decrease  from the Life and
Health Insurance segment.                                                       

Net investment income increased $51.2 million,  or 7%, to $829.1 million for the
three months ended  September 30, 2001, from $777.9 million for the three months
ended September 30, 2000. The increase  resulted mainly from a $3,234.2 million,
or 8%, increase in average  invested assets and cash, which was partially offset
by lower yields.  The yield on average invested assets and cash was 7.3% for the
three months  ended  September  30, 2001,  compared to 7.4% for the three months
ended September 30, 2000.                                                       

Net realized capital gains (losses) decreased $101.7 million to $80.8 million of
net realized  capital losses for the three months ended September 30, 2001, from
$20.9 million of net realized capital gains for the three months ended September
30, 2000. The decrease related to realized  capital losses on equity  securities
and real estate  recognized  during the three months ended  September  30, 2001,
compared  to  realized  capital  gains on  equity  securities  and  real  estate
recognized  during  the  three  months  ended  September  30,  2000.   Permanent
impairments of certain fixed maturity  securities  during the three months ended
September 30, 2001, also contributed to the decrease.                           

Benefits,  claims and settlement  expenses increased $403.6 million,  or 34%, to
$1,597.3  million for the three months ended  September 30, 2001,  from $1,193.7
million  for the three  months  ended  September  30,  2000.  The  increase  was
primarily  due to a  $284.6  million,  or 55%,  increase  from  the  U.S.  Asset
Management  and  Accumulation  segment,  primarily  reflecting  the  increase in
reserves  resulting from an increase in sales of single premium group  annuities
with life contingencies.  The increase was also due to a $129.7 million increase
from the International Asset Management and Accumulation segment,  primarily due
to an  increase  in the  change in  reserves  and policy  and  contract  benefit
payments,  primarily  the result of the sale of a large group  annuity  contract
with life  contingencies in Mexico.  The increase was also due to a $0.2 million
increase from the  Corporate and Other  segment.  The increases  were  partially
offset by a $10.9 million,  or 2%,  decrease from the Life and Health  Insurance
segment.                                                                        

Dividends to policyholders  increased $3.3 million,  or 4%, to $79.1 million for
the three months ended  September  30,  2001,  from $75.8  million for the three
months ended  September 30, 2000. The increase  resulted from an increase in the
Life and Health  Insurance  segment due to increased  dividends  on  traditional
individual life insurance products, a result of a maturing in-force block.      

Operating  expenses  increased  $6.3 million,  or 1%, to $631.5  million for the
three months ended  September 30, 2001, from $625.2 million for the three months
ended September 30, 2000. The increase was primarily due to an $81.4 million, or
103%,  increase in the Mortgage  Banking  segment  primarily  resulting  from an
impairment  of  capitalized  mortgage  loan  servicing  rights  and, to a lesser
extent,  due to growth in the mortgage loan servicing  portfolio and an increase
in mortgage loan production volume. The increase was also due to a $3.7 million,
or 25%,  increase  from the Corporate and Other  segment,  primarily  related to
non-recurring  expenses  related  to our  demutualization.  The  increases  were
partially offset by a $37.7 million,  or 16%,  decrease from the Life and Health
Insurance  segment,  resulting  from our decision to reinsure  100% of our group
Medicare  supplement  insurance  business  effective  July 1,  2000,  and due to

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expense  management  in response to an overall  decline in group life and health
insurance business. The increases were also partially offset by a $29.3 million,
or 15%,  decrease  from the U.S.  Asset  Management  and  Accumulation  segment,
primarily  reflecting a decrease in amortization of deferred policy  acquisition
costs in our pension business, a result of unlocking deferred policy acquisition
costs for changes in assumptions,  which was partially  offset by an increase in
Principal Bank operating  expenses  related to growth in bank  operations and an
increase in  expenses  from  Principal  Capital  Management.  In  addition,  the
increases were partially  offset by a $11.8 million,  or 12%,  decrease from the
International Asset Management and Accumulation  segment,  primarily a result of
the weakening of the Australian dollar versus the U.S. dollar.                  

Income taxes  decreased  $22.4  million,  or 41%, to $32.8 million for the three
months ended  September 30, 2001,  from $55.2 million for the three months ended
September 30, 2000.  The effective  income tax rate was 22% for the three months
ended September 30, 2001, and 24% for the three months ended September 30, 2000.
The  effective  income tax rates for the three months ended  September 30, 2001,
and 2000 were lower than the corporate income tax rate of 35%,  primarily due to
income tax deductions allowed for corporate  dividends  received,  for which the
estimated  benefit  recognition  rate  increased  during the three  months ended
September 30, 2001, compared to the three months ended September 30, 2000.      

As a result of the foregoing  factors,  net income  decreased $58.1 million,  or
33%, to $115.8  million for the three months  ended  September  30,  2001,  from
$173.9 million for the three months ended September 30, 2000.                   

During the three months ended September 30, 2001 and 2000, a non-recurring  item
of $4.1  million,  net of  tax,  and  $1.9  million,  net of tax,  respectively,
represented the negative effect of expenses related to our demutualization.     

As a result of the foregoing  factors and the exclusion of net realized  capital
gains (losses), as adjusted and nonrecurring items, operating earnings increased
$1.8 million,  or 1%, to $165.1 million for the three months ended September 30,
2001,  from $163.3  million for the three months ended  September 30, 2000.  The
increase  resulted  from a $19.3  million  increase  from the  Mortgage  Banking
segment,  primarily due to an increase in mortgage loan production  volume.  The
increase  was also due to a $7.1  million,  or 13%,  increase  from the Life and
Health Insurance segment,  primarily a result of individual disability insurance
reserve  strengthening  during the three months ended  September  30, 2000.  The
increases were partially  offset by a $17.7 million  decrease from the Corporate
and Other segment,  due to an increase in income tax expense,  primarily related
to a favorable  IRS tax audit matter that  resulted in an income tax benefit for
the three months ended  September 30, 2000.  The increases  were also  partially
offset by a $6.5 million,  or 7%,  decrease from the U.S.  Asset  Management and
Accumulation  segment,  primarily  due to a  decrease  in  individual  annuities
operating earnings due mainly to deferred policy acquisition costs unlocking; an
increase in Principal Bank operating  expenses,  primarily a result of growth in
bank operations; an increase in Principal Capital Management operating expenses,
which were partially  offset by a net gain on a  mortgage-backed  securitization
transaction;  and a decrease in Princor operating earnings, primarily the result
of lower fees generated from declining assets under management. In addition, the
increases were  partially  offset by a $0.4 million,  or 25%,  decrease from the
International Asset Management and Accumulation segment.                        

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Premiums and other considerations  increased $307.1 million, or 11%, to $3,210.3
million for the nine months ended September 30, 2001, from $2,903.2  million for
the nine months  ended  September  30,  2000.  The  increase  reflected a $387.9
million  increase  from the U.S.  Asset  Management  and  Accumulation  segment,
primarily  a result  of an  increase  in  premiums  from  single  premium  group
annuities  with life  contingencies,  which are  typically  used to fund defined
benefit  pension  plan  terminations.  The premium  income we receive from these
contracts  fluctuates  due to the  variability in the number and size of pension
plan  terminations  in the market  and our  ability  to  attract  new sales.  In
addition,  a $126.0  million,  or 75%,  increase  from the  International  Asset
Management  and  Accumulation  segment,  primarily  resulting from the sale of a
large group annuity contract with life contingencies in Mexico. The increase was
partially  offset by a $206.8 million,  or 8%, decrease from the Life and Health
Insurance  segment,  related  to our  decision  to  reinsure  100% of our  group
Medicare  supplement  insurance business effective July 1, 2000. Life and Health
Insurance segment premiums also decreased due to large premium rate increases in
2000, which led to increased  lapses and lower sales of group medical  insurance
in 2001.                                                                        

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Fees and other revenues increased $111.8 million, or 9%, to $1,309.5 million for
the nine months ended  September 30, 2001,  from  $1,197.7  million for the nine
months ended  September  30, 2000.  The increase was  primarily  due to a $210.7
million,  or 76%, increase from the Mortgage Banking segment primarily resulting
from mortgage loan production fee revenues,  reflecting the increase in mortgage
loan production  volume.  The increase was also due to a $23.1 million,  or 14%,
increase from the Life and Health  Insurance  segment,  primarily  related to an
increase in group  fee-for-service fee revenues,  a result of fee rate increases
and  growth  in  that  business,  and an  increase  in  interest-sensitive  life
insurance  fee  revenues,  a result  of growth in that  block of  business.  The
increases were partially offset by an $81.1 million,  or 15%,  decrease from the
U.S. Asset Management and Accumulation  segment  primarily related to a decrease
in the recognition of front-end fee revenues, a result of changes in assumptions
consistent  with  unlocking of deferred  policy  acquisition  costs in the three
months  ended  September  30,  2001,  and,  to a lesser  extent,  a decrease  in
surrender  charge and market value  adjustment  revenues from pension  products,
primarily due to a declining interest rate environment.  The increases were also
partially  offset by a $31.6 million,  or 14%,  decrease from the  International
Asset  Management  and  Accumulation  segment,  primarily  as a  result  of  the
weakening  of the  Australian  dollar  versus the U.S.  dollar and  declining BT
Financial  Group assets under  management.  The  increases  were also  partially
offset  by an $9.3  million,  or 37%,  decrease  from the  Corporate  and  Other
segment.                                                                        

Net investment  income increased $179.1 million,  or 8%, to $2,515.1 million for
the nine months ended  September 30, 2001,  from  $2,336.0  million for the nine
months ended  September 30, 2000. The increase  resulted  mainly from a $2,304.2
million,  or 5%,  increase in average  invested assets and cash and also from an
increase in investment  yields,  primarily  resulting from our investment policy
during 2000 to  reposition  the  investment  portfolio  to  maximize  investment
returns  by  selling  lower  yielding  fixed  income  securities  to  allow  for
reinvestment  in higher yielding fixed income  securities.  The yield on average
invested  assets and cash was 7.6% for the nine months ended September 30, 2001,
compared to 7.4% for the nine months ended September 30, 2000.                  

Net realized  capital gains (losses)  decreased $310.1 million to $257.7 million
of net realized  capital  losses for the nine months ended  September  30, 2001,
from $52.4  million of net  realized  capital  gains for the nine  months  ended
September 30, 2000.  The decrease  related to realized  capital losses on equity
securities  recognized during the nine months ended September 30, 2001, compared
to realized capital gains on equity securities recognized during the nine months
ended  September 30, 2000. In addition,  we sold our investment in United Payors
and United Providers,  and realized a capital gain of $90.6 million,  during the
nine months ended  September 30, 2000.  Permanent  impairments  of certain fixed
maturity  securities,  during the nine months ended  September  30, 2001,  and a
realized  capital loss of $38.4 million on the sale of our  operations in Spain,
also contributed to the decrease.                                               

Benefits,  claims and settlement  expenses increased $411.7 million,  or 11%, to
$4,236.5  million for the nine months ended  September  30, 2001,  from $3,824.8
million for the nine months ended September 30, 2000. The increase was primarily
due to a $432.8  million,  or 27%,  increase from the U.S. Asset  Management and
Accumulation  segment,  primarily  reflecting the increase in reserves resulting
from  an  increase  in  sales  of  single  premium  group  annuities  with  life
contingencies.  The increase was also due to a $142.4 million,  or 73%, increase
from the International Asset Management and Accumulation segment,  primarily due
to an  increase  in the  change in  reserves  and policy  and  contract  benefit
payments,  primarily  the result of the sale of a large group  annuity  contract
with life  contingencies  in Mexico.  The increases were  partially  offset by a
$130.5  million,  or 7%,  decrease from the Life and Health  Insurance  segment,
related  to our  decision  to  reinsure  100% of our group  Medicare  supplement
insurance  business  effective  July 1, 2000.  The increases were also partially
offset  by a $33.0  million,  or 99%,  decrease  from the  Corporate  and  Other
segment,   primarily  related  to  a  non-recurring  loss  contingency   reserve
established during the nine months ended September 30, 2000, for sales practices
litigation.                                                                     

Dividends to policyholders  increased $9.6 million, or 4%, to $241.2 million for
the nine months  ended  September  30,  2001,  from $231.6  million for the nine
months ended  September  30,  2000.  The  increase  was  attributable  to a $7.7
million,  or 3%,  increase  from the Life and Health  Insurance  segment  due to
increased dividends on traditional  individual life insurance products, a result
of a maturing  in-force  block.  The  increase was also  attributable  to a $1.9
million,  or 63%,  increase  from the U.S.  Asset  Management  and  Accumulation
segment.                                                                        

Operating  expenses  increased  $6.5  million to  $1,859.7  million for the nine
months ended September 30, 2001, from $1,853.2 million for the nine months ended
September 30, 2000. The increase was primarily due to a $141.0 million,  or 68%,
increase  from  the  Mortgage  Banking  segment  primarily   resulting  from  an

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impairment of mortgage loan  servicing  rights and, to a lesser  extent,  due to
growth in the mortgage loan servicing  portfolio and an increase in the mortgage
loan  production  volume.  The increase also  reflected a $4.3  million,  or 1%,
increase from the U.S. Asset  Management  and  Accumulation  segment,  primarily
reflecting an increase in Principal Bank operating expenses related to growth in
bank  operations  and an increase in Principal  Capital  Management's  operating
expenses  related to an increase in compensation  and recruiting costs resulting
from growth in operations,  which were partially  offset by decreases in pension
and mutual fund operating expenses and a decrease in intra-segment eliminations.
The increases were partially  offset by a $63.7 million,  or 50%,  decrease from
the Corporate  and Other  segment,  primarily  related to a  non-recurring  loss
contingency reserve established during the nine months ended September 30, 2000,
for sales practices  litigation.  The increases were also partially  offset by a
$56.7  million,  or 8%,  decrease  from the Life and  Health  Insurance  segment
commissions  resulting  from our decision to reinsure 100% of our group Medicare
supplement insurance business effective July 1, 2000. In addition, the increases
were  partially   offset  by  an  $18.4  million,   or  7%,  decrease  from  the
International Asset Management and Accumulation  segment,  primarily as a result
of the weakening of the Australian dollar versus the U.S. dollar.               

Income taxes  decreased  $71.6  million,  or 45%, to $88.9  million for the nine
months ended  September 30, 2001,  from $160.5 million for the nine months ended
September 30, 2000.  The  effective  income tax rate was 20% for the nine months
ended  September 30, 2001, and 28% for the nine months ended September 30, 2000.
The effective  income tax rates for the nine months ended September 30, 2001 and
2000,  were lower than the  corporate  income tax rate of 35%,  primarily due to
income tax deductions allowed for corporate  dividends  received,  for which the
estimated  benefit  recognition  rate  increased  during the nine  months  ended
September 30, 2001,  compared to the nine months ended  September 30, 2000.  The
effective  income tax rate for the nine months ended  September  30,  2001,  was
further  reduced  by  additional  tax  benefits  related to excess tax over book
capital losses realized from the sale of our operations in Spain.               

As a result of the foregoing  factors and the inclusion of the cumulative effect
of accounting  change,  net of related income taxes,  net income decreased $79.0
million, or 19%, to $340.2 million for the nine months ended September 30, 2001,
from $419.2 million for the nine months ended September 30, 2000. The cumulative
effect of accounting change was related to our implementation of SFAS 133.      

During the nine months ended  September 30, 2001,  non-recurring  items of $35.5
million,  net of tax,  included the negative effects of: (1) expenses related to
our  demutualization  ($18.9  million);  (2) a  cumulative  effect  of change in
accounting related to our implementation of SFAS 133 ($10.7 million); and (3) an
increase  to our  loss  contingency  reserve  established  for  sales  practices
litigation  ($5.9  million).  During the nine months ended  September  30, 2000,
non-recurring items of $77.7 million,  net of tax, included the negative effects
of (1) an  increase  to our  loss  contingency  reserve  established  for  sales
practices   litigation  ($75.0  million);   and  (2)  expenses  related  to  our
demutualization ($2.7 million).                                                 

As a result of the foregoing  factors and the exclusion of net realized  capital
gains (losses), as adjusted and nonrecurring items, operating earnings increased
$67.8 million, or 15%, to $529.1 million for the nine months ended September 30,
2001,  from $461.3  million for the nine months ended  September  30, 2000.  The
increase  resulted  from a $53.7  million  increase  from the  Mortgage  Banking
segment,  primarily due to an increase in mortgage loan production  volume.  The
increase was also due to a $12.0  million,  or 9 %,  increase  from the Life and
Health Insurance segment,  primarily a result of individual disability insurance
reserve  strengthening  during the three months ended  September  30, 2000,  and
improved  margins on individual  life insurance  business  resulting from higher
investment yields. In addition, the increase was due to a $10.4 million, or 54%,
increase  from the  Corporate  and  Other  segment,  primarily  due to  improved
investment yields. The increases were partially offset by a $6.9 million, or 3%,
decrease from the U.S.  Asset  Management  and  Accumulation  segment and a $1.4
million,   or  26%,  decrease  from  the  International   Asset  Management  and
Accumulation segment.                                                           

Results of Operations by Segment                                                

We evaluate segment  performance by segment operating  earnings,  which excludes
the  effect  of  net  realized  capital  gains  and  losses,  as  adjusted,  and
non-recurring events and transactions. Segment operating earnings are determined
by  adjusting  GAAP net income for net  realized  capital  gains and losses,  as
adjusted,  and non-recurring items that we believe are not indicative of overall
operating   trends.   While  these  items  may  be  significant   components  in

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10-Q 31st Page of 77 TOC 1st Previous Next ↓Bottom Just 31st
understanding and assessing our consolidated financial  performance,  we believe
the presentation of segment operating earnings enhances the understanding of our
results of  operations  by  highlighting  earnings  attributable  to the normal,
recurring operations of our businesses.  However, segment operating earnings are
not a substitute for net income determined in accordance with GAAP.             

The following table presents segment information as of or for the three and nine
months ended September 30, 2001 and 2000:                                       

                                                        [Enlarge/Download Table]


                                                    As of or for the three             As of or for the nine      
                                                         months ended                      months ended           
                                                        September 30,                      September 30,          
                                                -------------------------------    -------------------------------
                                                     2001             2000              2001             2000     
                                                --------------   --------------    --------------   --------------
                                                                         (in millions)                            
                                                                                                                  
Operating revenues by segment:                                                                                    
U.S. Asset Management and Accumulation.........   $  1,065.5       $    830.5        $  2,923.7       $  2,531.2  
International Asset Management and                                                                                
   Accumulation................................        276.6            163.6             586.7            473.1  
Life and Health Insurance......................        970.3          1,004.5           2,948.5          3,105.2  
Mortgage Banking...............................        207.7             90.4             500.8            271.1  
Corporate and Other (1)........................         16.4             13.9              73.9             54.4  
                                                --------------    -------------    -------------    --------------
   Total operating revenues....................      2,536.5          2,102.9           7,033.6          6,435.0  
Net realized capital gains (losses), including                                                                    
   recognition of front-end fee revenues (2)...        (80.0)            20.9            (256.4)            54.3  
                                                --------------    -------------    -------------    --------------
   Total consolidated revenues.................   $  2,456.5       $  2,123.8        $  6,777.2       $  6,489.3  
                                                ==============    =============    =============    ==============

Operating earnings (loss) by segment:                                                                             
U.S. Asset Management and Accumulation ........   $     82.5       $     89.0        $    259.4       $    266.3  
International Asset Management and                                                                                
   Accumulation................................         (2.0)            (1.6)             (6.7)            (5.3) 
Life and Health Insurance......................         60.7             53.6             151.6            139.6  
Mortgage Banking...............................         26.5              7.2              95.3             41.6  
Corporate and Other ...........................         (2.6)            15.1              29.5             19.1  
                                                --------------    -------------    -------------    --------------
   Total operating earnings....................        165.1            163.3             529.1            461.3  
Net realized capital gains (losses), as                                                                           
   adjusted (2)................................        (45.2)            12.5            (153.4)            35.6  
Non-recurring items (3)........................         (4.1)            (1.9)            (35.5)           (77.7) 
                                                --------------    -------------    -------------    --------------
GAAP Reported:                                                                                                    
Net income.....................................   $    115.8       $    173.9        $    340.2       $    419.2  
                                                ==============    =============    =============    ==============

Total assets by segment:                                                                                          
U.S. Asset Management and Accumulation ........   $ 64,571.9       $ 66,037.0        $ 64,571.9       $ 66,037.0  
International Asset Management and                                                                                
   Accumulation................................      4,995.2          5,347.3           4,995.2          5,347.3  
Life and Health Insurance......................     10,817.1         10,578.0          10,817.1         10,578.0  
Mortgage Banking...............................      2,339.8          1,530.3           2,339.8          1,530.3  
Corporate and Other (4)........................      1,231.2          1,106.5           1,231.2          1,106.5  
                                                --------------    -------------    -------------    --------------
   Total assets................................   $ 83,955.2       $ 84,599.1        $ 83,955.2       $ 84,599.1  
                                                ==============    =============    =============    ==============

(1)  Includes   inter-segment   eliminations   primarily   related  to  internal
     investment  management  fee revenues,  commission fee revenues paid to U.S.
     Asset  Management  and  Accumulation  agents  for  selling  Life and Health
     Insurance segment insurance products,  and real estate joint venture rental
     income.  The Corporate and Other segment  reported  rental income from real
estate joint ventures for office space used by other segments.        

(2)  Net realized capital gains (losses),  as adjusted,  are net of tax, related
     changes in the amortization  pattern of deferred policy  acquisition costs,
     recognition of front-end fee revenues for sales charges on pension products
     and services and net realized  capital gains  credited to  customers.  This
     presentation  may  not  be  comparable  to  presentations   made  by  other
companies.                                                            

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                                                         [Enlarge/Download Table]
                                                                                                                    

                                                           For the three                      For the nine           
                                                           months ended                       months ended           
                                                           September 30,                      September 30,          
                                                   -------------------------------    -------------------------------
                                                        2001              2000             2001             2000     
                                                   --------------   --------------    --------------   --------------
                                                                         (in millions)                               
                                                                                                                     
Net realized capital gains (losses)...............   $    (80.8)      $     20.9        $   (257.7)     $     52.4   
Recognition of front-end fee revenues.............          0.8              -                 1.3             1.9   
                                                   --------------   --------------    --------------   --------------
  Net realized capital gains (losses), including                                                                     
    recognition of front-end fee revenues.........        (80.0)            20.9            (256.4)           54.3   
Amortization of deferred policy acquisition                                                                          
  costs related to net realized capital gains                                                                        
  (losses)........................................          3.4              0.4               7.3            (3.0)  
Amounts credited to contractholder accounts.......          -                -                 -               -     
 Non-recurring net realized capital losses........          -                -                 -               -     
                                                   --------------   --------------    --------------   --------------
  Net realized capital gains (losses),                                                                               
    including recognition of front-end fee                                                                           
    revenues, net of related amortization of                                                                         
    deferred policy acquisition costs and                                                                            
    amounts credited to contractholders...........        (76.6)            21.3            (249.1)           51.3   
Income tax effect ................................         31.4             (8.8)             95.7           (15.7)  
                                                   --------------   --------------    --------------   --------------
  Net realized capital gains (losses), as                                                                            
    adjusted......................................   $    (45.2)      $     12.5        $   (153.4)     $     35.6   
                                                   ==============   ==============    ==============   ==============


(3)  For the three months ended September 30, 2001, a non-recurring item of $4.1
     million, net of tax, represented the negative effect of expenses related to
     our  demutualization.  For the three  months  ended  September  30, 2000, a
     non-recurring  item of $1.9 million,  net of tax,  represented the negative
     effect of  expenses  related to our  demutualization.  For the nine  months
     ended September 30, 2001, non-recurring items of $35.5 million, net of tax,
     included   the   negative   effects  of:  (a)   expenses   related  to  our
     demutualization  ($18.9  million);  (b) a  cumulative  effect  of change in
     accounting  principle  related  to our  implementation  of SFAS 133  ($10.7
     million);  and (c) an increase to our loss contingency  reserve established
     for sales practices  litigation  ($5.9 million).  For the nine months ended
     September  30,  2000,  non-recurring  items of $77.7  million,  net of tax,
     included the negative  effects of: (a) an increase to our loss  contingency
     reserve established for sales practices litigation ($75.0 million), and (b)
expenses related to our demutualization ($2.7 million).               

(4)  Includes inter-segment  elimination amounts related to internally generated
     mortgage loans and an internal line of credit.  The U.S.  Asset  Management
     and  Accumulation  segment and Life and Health  Insurance  segment reported
     mortgage loan assets issued for real estate joint ventures.  These mortgage
     loans were reported as liabilities  in the Corporate and Other segment.  In
     addition,  the  Corporate  and Other  segment  managed a revolving  line of
credit used by other segments.                                        

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10-Q 33rd Page of 77 TOC 1st Previous Next ↓Bottom Just 33rd
U.S. Asset Management and Accumulation Segment                                  

The table below  presents  certain  summary  financial data relating to the U.S.
Asset Management and Accumulation segment for the periods indicated:            

                                                        [Enlarge/Download Table]


                                                 For the three                      For the nine            
                                                  months ended                      months ended            
                                                 September 30,                      September 30,           
                                         -------------------------------    --------------------------------
                                              2001              2000              2001             2000     
                                         --------------  ---------------    ---------------  ---------------
                                                                  (in millions)                             
                                                                                                            
Operating Earnings Data:                                                                                    
Operating revenues(1):                                                                                      
  Premiums and other considerations.....   $    330.8       $     72.1         $    660.8       $    272.9  
  Fees and other revenues...............        140.9            191.5              461.7            542.2  
  Net investment income.................        593.8            566.9            1,801.2          1,716.1  
                                         --------------  ---------------    ---------------  ---------------
    Total operating revenues............      1,065.5            830.5            2,923.7          2,531.2  

Expenses:                                                                                                   
  Benefits, claims and settlement                                                                           
    expenses, including dividends to                                                                        
    policyholders.......................        802.8            518.2            2,045.7          1,611.0  
  Operating expenses....................        167.4            194.5              566.9            553.9  
                                         --------------  ---------------    ---------------  ---------------
    Total expenses......................        970.2            712.7            2,612.6          2,164.9  
                                         --------------  ---------------    ---------------  ---------------
Pre-tax operating earnings..............         95.3            117.8              311.1            366.3  
Income taxes............................         12.8             28.8               51.7            100.0  
                                         --------------  ---------------    ---------------  ---------------
Operating earnings......................         82.5             89.0              259.4            266.3  

Net realized capital gains (losses), as                                                                     
  adjusted..............................        (28.6)             3.0              (69.4)           (32.1) 
Non-recurring items.....................          -                -                (10.8)             -    
                                         --------------  ---------------    ---------------  ---------------
GAAP Reported:                                                                                              
Net income..............................   $     53.9       $     92.0         $    179.2       $    234.2  
                                         ==============  ===============    ===============  ===============

--------------------                                                            
(1)  Excludes  net  realized   capital  gains   (losses)  and  their  impact  on
recognition of front-end fee revenues.                                

Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Premiums and other considerations increased $258.7 million to $330.8 million for
the three months ended  September  30,  2001,  from $72.1  million for the three
months ended September 30, 2000. The increase  primarily  resulted from a $257.8
million  increase in premiums  from single  premium  group  annuities  with life
contingencies,  which are typically  used to fund defined  benefit  pension plan
terminations.  The premium income we receive from these contracts fluctuates due
to the  variability in the number and size of pension plan  terminations  in the
market and our ability to attract new sales.                                    

Fees and other revenues  decreased $50.6 million,  or 26%, to $140.9 million for
the three months ended  September  30, 2001,  from $191.5  million for the three
months  ended  September  30,  2000.  A decrease of $49.4  million  related to a
decrease in the  recognition  of front-end fee revenues,  a result of changes in
assumptions  consistent with unlocking of deferred policy acquisition costs and,
to a lesser extent,  a decrease in surrender  charge and market value adjustment
revenues  from  pension   products  due  to  a  decline  in  the  interest  rate
environment. In addition, a $4.8 million decrease reflected lower commission fee
revenues  from sales of variable life  insurance  products and lower mutual fund
fee  revenues,  a result of a decrease in mutual fund assets  under  management.
These  decreases  were  partially  offset by an  increase of $3.9  million  from
Principal Capital  Management,  a result of revenues  attributable to commercial
mortgage-backed securitizations.                                                

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Net investment income increased $26.9 million,  or 5%, to $593.8 million for the
three months ended  September 30, 2001, from $566.9 million for the three months
ended  September 30, 2000.  The increase  reflects a $3,310.1  million,  or 11%,
increase  in  average  invested  assets  and cash  for the  segment,  which  was
partially offset by lower yields.  The yield on average invested assets and cash
was 7.0% for the three months ended September 30, 2001, compared to 7.4% for the
three months ended  September 30, 2000,  reflecting an increase in cash and cash
equivalents  balances  during the period,  which earn lower yields than invested
assets.                                                                         

Benefits, claims and settlement expenses,  including dividends to policyholders,
increased  $284.6 million,  or 55%, to $802.8 million for the three months ended
September 30, 2001, from $518.2 million for the three months ended September 30,
2000. An increase of $270.2 million in our pension  full-service payout business
primarily reflected the increase in reserves resulting from an increase in sales
of single premium group annuities with life  contingencies.  An additional $20.7
million  increase  from  our  pension  investment-only  business  related  to an
increase in interest  credited  due to growth in our  investment-only  business.
Partially  offsetting these increases was a $7.0 million decrease in our pension
full-service  accumulation  business reflecting a decrease in interest credited,
primarily a result of a decline in the interest rate environment.               

Operating  expenses  decreased $27.1 million,  or 14%, to $167.4 million for the
three months ended  September 30, 2001, from $194.5 million for the three months
ended  September 30, 2000. A decrease of $43.6  million in our pension  business
related to a decrease in amortization of deferred  policy  acquisition  costs, a
result  of  unlocking   deferred  policy   acquisition   costs  for  changes  in
assumptions.  The decrease was partially  offset by an increase of $11.3 million
for Principal Bank resulting  from growth in bank  operations.  The decrease was
also  partially  offset by an increase of $6.8  million from  Principal  Capital
Management,  reflecting an increase in compensation  costs resulting from growth
in operations.                                                                  

Income taxes  decreased  $16.0  million,  or 56%, to $12.8 million for the three
months ended  September 30, 2001,  from $28.8 million for the three months ended
September 30, 2000.  The effective  income tax rate for this segment was 13% for
the three months ended  September  30, 2001,  and 24% for the three months ended
September 30, 2000.  The  effective  income tax rates for the three months ended
September 30, 2001 and 2000,  were lower than the  corporate  income tax rate of
35% as a result  of  income  tax  deductions  allowed  for  corporate  dividends
received,  for which an estimated benefit  recognition rate increased during the
three  months  ended  September  30,  2001,  compared to the three  months ended
September 30, 2000, and other tax exempt income.  The effective  income tax rate
for the three months ended  September 30, 2001,  was also reduced due to foreign
tax benefits previously included in net investment income.                      

As a result of the foregoing factors, operating earnings decreased $6.5 million,
or 7%, to $82.5  million for the three months  ended  September  30, 2001,  from
$89.0 million for the three months ended September 30, 2000.                    

Net realized  capital gains  (losses),  as adjusted,  decreased $31.6 million to
$28.6  million  of net  realized  capital  losses  for the  three  months  ended
September 30, 2001, from $3.0 million of net realized gains for the three months
ended  September 30, 2000.  The decrease  reflects the current  period impact of
SFAS 133 for  derivatives,  losses  resulting  from the permanent  impairment of
certain fixed  maturity  securities and losses on real estate sales in the three
months ended  September 30, 2001,  compared to the three months ended  September
30, 2000. The decreases  were partially  offset by lower losses related to sales
of fixed  maturity  securities,  reflecting a decrease in portfolio  activity in
2001.                                                                           

As a result of the foregoing  factors,  net income  decreased $38.1 million,  or
41%, to $53.9 million for the three months ended  September 30, 2001, from $92.0
million for the three months ended September 30, 2000.                          

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Premiums and other considerations increased $387.9 million to $660.8 million for
the nine months  ended  September  30,  2001,  from $272.9  million for the nine
months ended September 30, 2000. The increase  primarily  resulted from a $386.8
million  increase in premiums  from single  premium  group  annuities  with life
contingencies,  which are typically  used to fund defined  benefit  pension plan
terminations.  The premium income we receive from these contracts fluctuates due
to the  variability in the number and size of pension plan  terminations  in the
market and our ability to attract new sales.                                    

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Fees and other revenues  decreased $80.5 million,  or 15%, to $461.7 million for
the nine months  ended  September  30,  2001,  from $542.2  million for the nine
months  ended  September  30,  2000.  A decrease of $81.6  million  related to a
decrease  in  recognition  of  front-end  fee  revenues,  a result of changes in
assumptions  consistent  with  unlocking of deferred  policy  acquisition  costs
during the three months ended  September 30, 2001,  and, to a lesser  extent,  a
decrease in surrender charge and market value  adjustment  revenues from pension
products,  primarily due to a declining interest rate environment. A decrease of
$9.3 million  resulted  from  intra-segment  eliminations.  In addition,  a $7.4
million decrease reflected lower commission fee revenues primarily from sales of
variable life insurance  products and third-party  mutual funds and lower mutual
fund  fee  revenues,  a  result  of a  decrease  in  mutual  fund  assets  under
management.  The decreases were partially offset by an increase of $18.2 million
from   Principal   Capital   Management   due  to   commercial   mortgage-backed
securitizations.                                                                

Net investment  income  increased $85.1 million,  or 5%, to $1,801.2 million for
the nine months ended  September 30, 2001,  from  $1,716.1  million for the nine
months ended September 30, 2000. The increase  reflects a $2,139.8  million,  or
7%,  increase in average  invested  assets and cash for the  segment,  which was
partially  offset by lower  investment  yields.  The yield on  average  invested
assets and cash was 7.2% for the nine months ended  September 30, 2001, and 7.3%
for the nine months ended September 30, 2000, reflecting an increase in cash and
cash equivalents balances, which earn lower yields than invested assets.        

Benefits, claims and settlement expenses,  including dividends to policyholders,
increased $434.7 million,  or 27%, to $2,045.7 million for the nine months ended
September 30, 2001,  from $1,611.0  million for the nine months ended  September
30,  2000.  An increase of $413.3  million in our  pension  full-service  payout
business  reflected the increase in reserves resulting from an increase in sales
of single premium group annuities with life  contingencies.  An additional $62.3
million  increase  from  our  pension  investment-only  business  related  to an
increase in interest  credited  due to growth in our  investment-only  business.
Partially  offsetting the increases was a $45.7 million  decrease in our pension
full-service  accumulation  business reflecting a decrease in interest credited,
primarily a result of a declining interest rate environment.                    

Operating  expenses  increased  $13.0 million,  or 2%, to $566.9 million for the
nine months ended  September 30, 2001,  from $553.9  million for the nine months
ended  September  30, 2000.  An increase of $26.5  million from  Principal  Bank
resulted  from  growth in bank  operations.  Additionally,  an increase of $20.6
million from Principal Capital Management  reflected an increase in compensation
and recruiting  costs  resulting  from growth in operations.  The increases were
partially  offset by a $19.6 million  decrease from our pension business related
to a decrease in the amortization of deferred policy acquisition costs, a result
of unlocking deferred policy  acquisition costs for changes in assumptions.  The
pension expense decrease was partially offset by increases in expenses resulting
from initiatives to create growth in operations and a decrease in capitalization
of deferred policy  acquisition  costs. The increases were also partially offset
by a $9.3 million decrease resulting from intra-segment  eliminations and a $6.0
million  decrease  primarily in variable life insurance  product and mutual fund
commissions.                                                                    

Income taxes  decreased  $48.3  million,  or 48%, to $51.7  million for the nine
months ended  September 30, 2001,  from $100.0 million for the nine months ended
September 30, 2000.  The effective  income tax rate for this segment was 17% for
the nine months  ended  September  30,  2001,  and 27% for the nine months ended
September  30, 2000.  The  effective  income tax rates for the nine months ended
September 30, 2001 and 2000,  were lower than the  corporate  income tax rate of
35%,  as a result of income  tax  deductions  allowed  for  corporate  dividends
received,  for which an estimated benefit  recognition rate increased during the
nine  months  ended  September  30,  2001,  compared  to the nine  months  ended
September 30, 2000, and other tax-exempt  income.  The effective income tax rate
for the nine months ended September 30, 2001 was also reduced due to foreign tax
benefits previously included in net investment income.                          

As a result of the foregoing factors, operating earnings decreased $6.9 million,
or 3%, to $259.4  million for the nine months ended  September  30,  2001,  from
$266.3 million for the nine months ended September 30, 2000.                    

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Net realized  capital  losses,  as adjusted,  increased  $37.3  million to $69.4
million for the nine months ended September 30, 2001, from $32.1 million for the
nine months ended  September 30, 2000. The increase  reflects the current period
impact  of  SFAS  133 for  derivatives,  losses  resulting  from  the  permanent
impairment of certain equity and fixed maturity securities and fewer real estate
sales in the nine months ended  September 30, 2001,  compared to the nine months
ended  September 30, 2000. The increases  were partially  offset by the positive
effects  of a  change  in  the  mortgage  loan  valuation  allowance,  primarily
reflecting the decrease in the amount invested in commercial  mortgage loans. In
addition,  there was a decrease  in losses  related  to sales of fixed  maturity
securities, reflecting a decrease in portfolio activity in 2001.                

As a result of the foregoing  factors and the inclusion of  non-recurring  items
for the nine  months  ended  September  30,  2001,  net income  decreased  $55.0
million, or 23%, to $179.2 million for the nine months ended September 30, 2001,
from $234.2 million for the nine months ended September 30, 2000.  Non-recurring
items for the nine months ended September 30, 2001, had a negative impact on net
income of $10.8 million,  net of tax, due to the cumulative effect of accounting
change, net of income taxes, related to our implementation of SFAS 133.         

International Asset Management and Accumulation Segment                         

The  table  below  presents  certain  summary  financial  data  relating  to the
International  Asset  Management  and  Accumulation   segment  for  the  periods
indicated:                                                                      

                                                        [Enlarge/Download Table]


                                               For the three                      For the nine            
                                               months ended                       months ended            
                                               September 30,                      September 30,           
                                      --------------------------------    --------------------------------
                                           2001              2000              2001              2000     
                                      --------------    --------------    --------------    --------------
                                                                (in millions)                             
                                                                                                          
Operating Earnings Data:                                                                                  
Operating revenues (1):                                                                                   
  Premiums and other considerations..    $  184.1          $   59.2          $  294.1         $ 168.1     
  Fees and other revenues............        61.8              79.9             201.3           232.9     
  Net investment income..............        30.7              24.5              91.3            72.1     
                                      --------------    --------------    --------------    --------------
    Total operating revenues.........       276.6             163.6             586.7           473.1     

Expenses:                                                                                                 
  Benefits, claims and settlement                                                                         
    expenses.........................       198.8              69.1             338.4           196.0     
  Operating expenses.................        83.9              95.7             261.4           279.8     
                                      --------------    --------------    --------------    --------------
    Total expenses...................       282.7             164.8             599.8           475.8     
                                      --------------    --------------    --------------    --------------
Pre-tax operating loss...............        (6.1)             (1.2)            (13.1)           (2.7)    
Income taxes (benefits)..............        (4.1)              0.4              (6.4)            2.6     
                                      --------------    --------------    --------------    --------------
Operating loss.......................        (2.0)             (1.6)             (6.7)           (5.3)    

Net realized capital gains (losses),                                                                      
  as adjusted........................         0.9              (0.1)            (20.3)            3.4     
Non-recurring items..................         -                 -                 -               -       
                                      --------------    --------------    --------------    --------------
GAAP Reported:                                                                                            
Net loss.............................    $   (1.1)         $   (1.7)         $  (27.0)        $  (1.9)    
                                      ==============    ==============    ==============    ==============

--------------------                                                            
(1)  Excludes  net  realized   capital  gains   (losses)  and  their  impact  on
recognition of front-end fee revenues.                                

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Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Premiums and other considerations increased $124.9 million to $184.1 million for
the three months ended  September  30,  2001,  from $59.2  million for the three
months ended September 30, 2000. An increase of $137.2 million in Mexico was the
result of increased sales of single premium  annuities with life  contingencies,
primarily  resulting  from  the  sale of a large  group  annuity  contract.  The
increase was partially  offset by the loss of $8.1 million of premiums and other
considerations due to the February 2001 divestiture of our operations in Spain. 

Fees and other revenues  decreased  $18.1 million,  or 23%, to $61.8 million for
the three months ended  September  30,  2001,  from $79.9  million for the three
months ended  September  30,  2000. A decrease of $22.9  million of fee revenues
contributed by BT Financial Group primarily resulted from declining assets under
management  for the three months  ended  September  30,  2001,  and, to a lesser
extent,  the  weakening of the  Australian  dollar versus the U.S.  dollar.  The
decrease  was  partially  offset by a $3.3  million  increase in fee revenues in
Mexico,  primarily  a result of an  increase  in the number of  retirement  plan
participants.                                                                   

Net investment  income increased $6.2 million,  or 25%, to $30.7 million for the
three months ended  September 30, 2001,  from $24.5 million for the three months
ended   September  30,  2000.  An  increase  of  $8.3  million  from   Principal
International  related to a 15% increase in average invested assets and cash and
an increase in investment  yields. The yield on average invested assets and cash
was 9.2% for the three months ended September 30, 2001, compared to 7.3% for the
three months ended September 30, 2000. The increase in net investment income was
partially  offset by the $2.2 million loss of net  investment  income  resulting
from the divestiture of our operations in Spain.                                

Benefits,  claims and  settlement  expenses  increased  $129.7 million to $198.8
million for the three months ended  September  30, 2001,  from $69.1 million for
the three months ended  September 30, 2000.  An increase in reserve  changes and
policy and contract  benefit  payments of $137.9 million in Mexico was primarily
the  result  of  the  sale  of  a  large  group   annuity   contract  with  life
contingencies. The increase was partially offset by the loss of $10.3 million of
benefits,  claims and settlement  expenses resulting from the divestiture of our
operations in Spain.                                                            

Operating  expenses  decreased  $11.8 million,  or 12%, to $83.9 million for the
three months ended  September 30, 2001,  from $95.7 million for the three months
ended  September 30, 2000.  Operating  expenses  incurred by BT Financial  Group
decreased  $10.9  million,   primarily  resulting  from  the  weakening  of  the
Australian dollar versus the U.S. dollar. Ongoing operating expenses incurred by
BT Financial  Group also  decreased.  This decrease was offset by an increase in
costs associated with staff  restructuring  efforts undertaken to reduce ongoing
operating expenses.                                                             

Income tax expense  (benefits)  decreased  $4.5 million to a $4.1 million income
tax benefit for the three months ended  September 30, 2001, from $0.4 million of
income tax expense for the three months ended  September 30, 2000.  The decrease
was primarily due to a decrease in pre-tax operating  earnings from BT Financial
Group.                                                                          

As a result of the foregoing factors,  operating loss increased $0.4 million, or
25%, to $2.0 million for the three months ended  September  30, 2001,  from $1.6
million for the three months ended September 30, 2000.                          

Net realized capital gains (losses), as adjusted, increased $1.0 million to $0.9
million of net realized  capital gains for the three months ended  September 30,
2001,  from $0.1  million of net  realized  capital  losses for the three months
ended  September 30, 2000.  The increase was  primarily  related to net realized
capital losses from our operations in Spain for the three months ended September
30, 2000.                                                                       

As a result of the foregoing factors,  net loss decreased $0.6 million,  or 35%,
to $1.1 million for the three months ended September 30, 2001, from $1.7 million
for the three months ended September 30, 2000.                                  

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Premiums and other  considerations  increased $126.0 million,  or 75%, to $294.1
million for the nine months ended  September 30, 2001,  from $168.1  million for
the nine months  ended  September  30,  2000.  An increase of $160.7  million in

37

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Mexico was the result of increased  sales of single premium  annuities with life
contingencies,  primarily  resulting  from  the  sale of a large  group  annuity
contract.  The increase  was  partially  offset by the loss of $32.7  million of
premiums and other  considerations  due to the February 2001  divestiture of our
operations in Spain.                                                            

Fees and other revenues  decreased $31.6 million,  or 14%, to $201.3 million for
the nine months  ended  September  30,  2001,  from $232.9  million for the nine
months ended  September  30,  2000. A decrease of $44.7  million of fee revenues
contributed by BT Financial  Group resulted from the weakening of the Australian
dollar versus the U.S. dollar and from declining assets under management for the
nine months ended  September 30, 2001.  The decrease was  partially  offset by a
$13.1 million increase in Principal  International fee revenues,  a result of an
increase in the number of retirement plan  participants in Mexico,  assets under
management  growth in Argentina and deposits  growth in Hong Kong resulting from
sales to plans established under the new Mandatory Provident Fund, which started
in December 2000.                                                               

Net investment income increased $19.2 million,  or 27%, to $91.3 million for the
nine months ended  September  30, 2001,  from $72.1  million for the nine months
ended   September  30,  2000.  An  increase  of  $28.3  million  from  Principal
International  related to a 19% increase in average invested assets and cash and
an increase in investment  yields. The yield on average invested assets and cash
was 9.4% for the nine months ended September 30, 2001,  compared to 7.2% for the
nine months ended  September  30, 2000.  The increase in  investment  yields was
partially due to the impact of inflation  adjustments in Chile, which was offset
by a corresponding  increase in reserve changes.  The increase in net investment
income was partially  offset by the $6.5 million loss of net  investment  income
resulting  from the  divestiture  of our  operations  in Spain.  In addition,  a
decrease of $1.6 million of equity method net  investment  income was related to
our pro rata share of net loss of  ING/Principal  Pensions Co.,  Ltd., a pension
company in Japan in which we acquired a minority interest in January 2000.      

Benefits,  claims and settlement  expenses increased $142.4 million,  or 73%, to
$338.4 million for the nine months ended September 30, 2001, from $196.0 million
for the nine months ended September 30, 2000. An increase in reserve changes and
policy and contract  benefit  payments of $161.9 million in Mexico was primarily
the  result  of  the  sale  of  a  large  group   annuity   contract  with  life
contingencies.  An increase of $13.3  million in Chile  primarily  related to an
increase in reserve changes to reflect the impact of inflation adjustments.  The
increases were partially offset by the loss of $38.0 million of benefits, claims
and  settlement  expenses  resulting  from the  divestiture of our operations in
Spain.                                                                          

Operating  expenses  decreased  $18.4 million,  or 7%, to $261.4 million for the
nine months ended  September 30, 2001,  from $279.8  million for the nine months
ended  September 30, 2000.  Operating  expenses  incurred by BT Financial  Group
decreased  $15.9  million,   primarily  resulting  from  the  weakening  of  the
Australian  dollar versus the U.S. dollar.  The decrease was partially offset by
an increase in costs associated with staff  restructuring  efforts undertaken to
reduce ongoing  operating  expenses and an increase in  amortization of goodwill
and other  intangibles.  Operating  expenses  also  decreased  $5.4 million as a
result of the  divestiture  of our  operations  in Spain.  In  addition,  a $3.3
million decrease in Chile was primarily due to the weakening of the Chilean peso
versus  the U.S.  dollar and was also due to a  commission  rate  decrease.  The
decreases were partially offset by an $8.5 million increase in Mexico, primarily
attributable to commissions and compensation resulting from increased sales.    

Income tax expense  (benefits)  decreased  $9.0 million to a $6.4 million income
tax benefit for the nine months ended  September 30, 2001,  from $2.6 million of
income tax expense for the nine months ended  September  30, 2000.  The decrease
was primarily due to a decrease in pre-tax operating  earnings from BT Financial
Group.                                                                          

As a result of the foregoing factors,  operating loss increased $1.4 million, or
26%, to $6.7 million for the nine months  ended  September  30, 2001,  from $5.3
million for the nine months ended September 30, 2000.                           

Net realized  capital gains  (losses),  as adjusted,  decreased $23.7 million to
$20.3 million of net realized capital losses for the nine months ended September
30, 2001,  from $3.4 million of net realized  capital  gains for the nine months
ended  September  30, 2000.  The decrease was  primarily  due to a $21.0 million
after-tax net realized  capital loss on the February 2001 sale of our operations
in Spain. In addition,  a $2.6 million  decrease related to net realized capital
gains from our operations in Spain for the nine months ended September 30, 2000.

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As a result of the foregoing factors,  net loss increased $25.1 million to $27.0
million for the nine months ended  September 30, 2001, from $1.9 million for the
nine months ended September 30, 2000.                                           

Life and Health Insurance Segment                                               

The table below presents certain summary financial data relating to the Life and
Health Insurance segment for the periods indicated:                             

                                                        [Enlarge/Download Table]


                                                    For the three                     For the nine          
                                                    months ended                      months ended          
                                                    September 30,                    September 30,          
                                            ------------------------------    ------------------------------
                                                 2001            2000              2001             2000    
                                            --------------  --------------    -------------    -------------
                                                                    (in millions)                           
                                                                                                            
Operating Earnings Data:                                                                                    
Operating Revenues(1):                                                                                      
  Premiums and other considerations........    $  740.1        $  779.2         $ 2,255.4       $ 2,462.2   
  Fees and other revenues..................        62.1            62.9             191.0           167.9   
  Net investment income....................       168.1           162.4             502.1           475.1   
                                            --------------  --------------    -------------    -------------
     Total operating revenues..............       970.3         1,004.5           2,948.5         3,105.2   

Expenses:                                                                                                   
  Benefits, claims and settlement expenses.       596.7           607.6           1,857.1         1,987.6   
  Dividends to policyholders...............        78.0            74.7             236.3           228.6   
  Operating expenses.......................       204.5           241.4             627.1           682.2   
                                            --------------  --------------    -------------    -------------
     Total expenses........................       879.2           923.7           2,720.5         2,898.4   
                                            --------------  --------------    -------------    -------------
Pre-tax operating earnings.................        91.1            80.8             228.0           206.8   
Income taxes...............................        30.4            27.2              76.4            67.2   
                                            --------------  --------------    -------------    -------------
Operating earnings.........................        60.7            53.6             151.6           139.6   

Net realized capital gains (losses), as                                                                     
  adjusted.................................        (4.3)           (0.4)             (9.0)           49.7   
Non-recurring items........................         -               -                 0.1             -     
                                            --------------  --------------    -------------    -------------
GAAP Reported:                                                                                              
Net income.................................    $   56.4        $   53.2         $   142.7       $   189.3   
                                            ==============  ==============    =============    =============

--------------------                                                            
(1)  Excludes  net  realized   capital  gains   (losses)  and  their  impact  on
recognition of front-end fee revenues.                                

Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Premiums and other  considerations  decreased  $39.1  million,  or 5%, to $740.1
million for the three months ended  September 30, 2001,  from $779.2 million for
the three months ended September 30, 2000. Premium rate increases in 2000 led to
increased lapses and lower sales of group medical insurance, which resulted in a
$20.7 million decrease in premiums. Group life insurance premium decreased $16.0
million,  primarily  due to the loss of two  large  customers  and,  to a lesser
extent,  a result of declines in sales during 2001 as we transitioned to a newly
established dedicated non-medical sales force.                                  

Fees and other revenues decreased $0.8 million,  or 1%, to $62.1 million for the
three months ended  September 30, 2001,  from $62.9 million for the three months
ended September 30, 2000.  Individual life insurance fee revenues decreased $6.2
million,  primarily  related  to  classifying  fees from  reinsurance  ceded for
traditional  life insurance as operating  expenses.  These fees were  previously
reported as fee revenues. The decrease was partially offset by fee revenues from
our group fee-for-service business, which increased $5.9 million,  primarily due
to increases in fee rates and growth in that business.                          

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Net investment  income increased $5.7 million,  or 4%, to $168.1 million for the
three months ended  September 30, 2001, from $162.4 million for the three months
ended September 30, 2000. The increase was primarily due to a $307.7 million, or
4%, increase in average  invested assets and cash for the segment.  The yield on
average  invested  assets  and cash was 7.5%  for both the  three  months  ended
September 30, 2001, and the three months ended September 30, 2000.              

Benefits,  claims and settlement  expenses  decreased  $10.9 million,  or 2%, to
$596.7  million for the three  months  ended  September  30,  2001,  from $607.6
million for the three months ended September 30, 2000.  Group medical  insurance
benefits,  claims and  settlement  expenses  decreased  $25.7  million  due to a
reduction in business and improved claim experience, partially offset by reserve
releases during the three months ended September 30, 2000.  Group life insurance
benefits, claims and settlement expenses decreased $13.9 million due to the loss
of two large customers and an overall decline in business. Individual disability
benefits,  claims and settlement  expenses decreased $12.6 million,  primarily a
result of claim reserve  strengthening  during the three months ended  September
30, 2000. The decreases  were partially  offset by a release of $38.2 million of
group  Medicare  supplement  insurance  reserves  during the three  months ended
September  30,  2000,  resulting  from our  decision  to  reinsure  100% of this
business effective July 1, 2000.                                                

Dividends to policyholders  increased $3.3 million,  or 4%, to $78.0 million for
the three months ended  September  30,  2001,  from $74.7  million for the three
months ended September 30, 2000. The increase was due to increased  dividends on
traditional  individual life insurance products, a result of a maturing in-force
block.                                                                          

Operating  expenses  decreased $36.9 million,  or 15%, to $204.5 million for the
three months ended  September 30, 2001, from $241.4 million for the three months
ended September 30, 2000.  Group life and health  insurance  operating  expenses
decreased $35.8 million,  primarily resulting from our decision to reinsure 100%
of our group Medicare supplement  insurance business effective July 1, 2000, and
due to expense  management  in response to an overall  decline in group life and
health insurance business.                                                      

Income taxes  increased  $3.2  million,  or 12%, to $30.4  million for the three
months ended  September 30, 2001,  from $27.2 million for the three months ended
September 30, 2000.  The  effective  income tax rate for the segment was 33% for
the three months ended  September  30, 2001,  and 34% for the three months ended
September 30, 2000.  The  effective  income tax rates for the three months ended
September 30, 2001, and 2000,  were lower than the corporate  income tax rate of
35%, primarily due to tax-exempt income.                                        

As a result of the foregoing factors, operating earnings increased $7.1 million,
or 13%, to $60.7  million for the three months ended  September  30, 2001,  from
$53.6 million for the three months ended September 30, 2000.                    

Net realized capital losses, as adjusted, increased $3.9 million to $4.3 million
for the three months ended  September 30, 2001,  from $0.4 million for the three
months ended September 30, 2000. The increase in net realized capital losses was
primarily due to losses from permanent  impairments of fixed maturity securities
during the three months ended September 30, 2001.                               

As a result of the foregoing factors,  net income increased $3.2 million, or 6%,
to $56.4  million for the three months  ended  September  30,  2001,  from $53.2
million for the three months ended September 30, 2000.                          

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Premiums and other  considerations  decreased $206.8 million, or 8%, to $2,255.4
million for the nine months ended September 30, 2001, from $2,462.2  million for
the nine months ended September 30, 2000.  Group Medicare  supplement  insurance
premium decreased $99.0 million, resulting from our decision to reinsure 100% of
this  business  effective  July 1, 2000.  Premium rate  increases in 2000 led to
increased lapses and lower sales of group medical  insurance,  which resulted in
an $80.2 million decrease in premiums.  Group life insurance  premium  decreased
$42.4 million, primarily due to the loss of two large customers and, to a lesser
extent,  a result of declines in sales during 2001 as we transitioned to a newly
established  dedicated  non-medical  sales force.  The decreases  were partially
offset by a $15.2 million increase in group dental insurance  premium  primarily
due to increases in dental premium rates.                                       

40

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Fees and other revenues  increased $23.1 million,  or 14%, to $191.0 million for
the nine months  ended  September  30,  2001,  from $167.9  million for the nine
months ended  September 30, 2000.  Fee revenues  from our group  fee-for-service
business  increased  $17.7 million,  primarily due to increases in fee rates and
growth in that business.  Fee revenues from individual  interest-sensitive  life
insurance  products increased $9.5 million, a result of continued growth in that
business.  The growth  reflected a continued  shift in customer  preference from
individual  traditional life insurance products to individual universal life and
individual variable universal life insurance products.                          

Net investment income increased $27.0 million,  or 6%, to $502.1 million for the
nine months ended  September 30, 2001,  from $475.1  million for the nine months
ended September 30, 2000. The increase was primarily due to a $342.1 million, or
4%, increase in average invested assets and cash for the segment. Net investment
income also  increased due to an increase in average  investment  yields for the
segment.  The yield on  average  invested  assets and cash was 7.5% for the nine
months  ended  September  30,  2001,  compared to 7.3% for the nine months ended
September 30, 2000, reflecting higher interest yields on fixed income securities
backing product liabilities.                                                    

Benefits,  claims and settlement  expenses  decreased $130.5 million,  or 7%, to
$1,857.1  million for the nine months ended  September  30, 2001,  from $1,987.6
million for the nine months ended September 30, 2000. Group Medicare  supplement
insurance  benefits,  claims and settlement  expenses  decreased  $58.9 million,
resulting from our decision to reinsure 100% of this business  effective July 1,
2000. Group life insurance  benefits,  claims and settlement  expenses decreased
$37.2 million due to the loss of two large  customers and an overall  decline in
business.  Group medical  insurance  benefits,  claims and  settlement  expenses
decreased  $35.4  million,  due to a reduction in business and to improved claim
experience,  partially  offset by reserve  releases during the nine months ended
September 30, 2000.                                                             

Dividends to policyholders  increased $7.7 million, or 3%, to $236.3 million for
the nine months  ended  September  30,  2001,  from $228.6  million for the nine
months ended September 30, 2000. The increase was due to increased  dividends on
traditional  individual life insurance products, a result of a maturing in-force
block.                                                                          

Operating  expenses  decreased  $55.1 million,  or 8%, to $627.1 million for the
nine months ended  September 30, 2001,  from $682.2  million for the nine months
ended September 30, 2000.  Group life and health  insurance  operating  expenses
decreased  $63.1 million,  primarily due to a decrease in commissions  resulting
from our decision to reinsure 100% of our group  Medicare  supplement  insurance
business effective July 1, 2000, and due to expense management in response to an
overall decline in group life and health  insurance  business.  The decrease was
offset by an $8.0  million  increase  in  individual  life and health  insurance
operating  expenses,   primarily   attributable  to  growth  in  our  individual
disability  insurance business and due to higher amortization of deferred policy
acquisition   costs  related  to  individual  life  and  individual   disability
insurance.                                                                      

Income  taxes  increased  $9.2  million,  or 14%, to $76.4  million for the nine
months ended  September  30, 2001,  from $67.2 million for the nine months ended
September 30, 2000.  The  effective  income tax rate for the segment was 34% for
the nine months  ended  September  30,  2001,  and 32% for the nine months ended
September  30,  2000.  The  effective  income tax rate for the nine months ended
September  30,  2001,  was  lower  than  the  corporate  income  tax rate of 35%
primarily due to tax-exempt  income.  The effective tax rate for the nine months
ended  September 30, 2000, was lower than the corporate  income tax rate of 35%,
primarily  due to tax exempt income and a reduction in a tax reserve as a result
of a favorable IRS audit event.                                                 

As a  result  of the  foregoing  factors,  operating  earnings  increased  $12.0
million,  or 9%, to $151.6 million for the nine months ended September 30, 2001,
from $139.6 million for the nine months ended September 30, 2000.               

Net realized  capital gains  (losses),  as adjusted,  decreased $58.7 million to
$9.0 million of net realized  capital losses for the nine months ended September
30, 2001,  from $49.7 million of net realized  capital gains for the nine months
ended  September  30, 2000.  The decrease  primarily  related to the sale of our
investment in United Payors and United Providers. In 2000, we sold our remaining
investment and realized an after-tax capital gain of $58.9 million.             

As a result of the foregoing  factors and the inclusion of  non-recurring  items
for the nine  months  ended  September  30,  2001,  net income  decreased  $46.6
million, or 25%, to $142.7 million for the nine months ended September 30, 2001,

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from $189.3 million for the nine months ended September 30, 2000.  Non-recurring
items for the nine months ended September 30, 2001, had a positive impact on net
income of $0.1 million,  net of tax, due to the cumulative  effect of accounting
change, net of income taxes, related to our implementation of SFAS 133.         

Mortgage Banking Segment                                                        

The table below presents certain summary financial data relating to the Mortgage
Banking segment for the periods indicated:                                      

                                                        [Enlarge/Download Table]


                                                For the three                       For the nine          
                                                 months ended                        months ended         
                                                September 30,                       September 30,         
                                          ------------------------------    ------------------------------
                                              2001              2000            2001             2000     
                                          ------------      ------------    ------------      ------------
                                                                 (in millions)                            
                                                                                                          
Operating Earnings Data:                                                                                  
Operating Revenues(1):                                                                                    
  Loan servicing.........................   $  101.5          $   77.0        $  282.5          $  232.2  
  Loan production........................      106.2              13.4           218.3              38.9  
                                          ------------      ------------    ------------     ------------ 
    Total operating revenues.............      207.7              90.4           500.8             271.1  
Expenses:                                                                                                 
  Loan servicing.........................      124.8              62.2           254.3             159.8  
  Loan production........................       36.0              17.2            93.8              47.3  
                                          ------------      ------------    ------------     ------------ 
    Total expenses.......................      160.8              79.4           348.1             207.1  
                                          ------------      ------------    ------------     ------------ 
Pre-tax operating earnings...............       46.9              11.0           152.7              64.0  
Income taxes.............................       20.4               3.8            57.4              22.4  
                                          ------------      ------------    ------------     ------------ 
Operating earnings.......................       26.5               7.2                                    
                                                                                  95.3              41.6  

Net realized capital gains (losses), as                                                                   
  adjusted...............................        -                 -               -                 -    
Non-recurring items......................        -                 -               -                 -    
                                          ------------      ------------    ------------     ------------ 
GAAP Reported:                                                                                            
Net income...............................   $   26.5          $    7.2        $   95.3          $   41.6  
                                          ============      ============    ============     ============ 

--------------------                                                            
(1)  Excludes  net  realized   capital  gains   (losses)  and  their  impact  on
recognition of front-end fee revenues.                                

Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Total  operating  revenues  increased  $117.3  million to $207.7 million for the
three months ended  September 30, 2001,  from $90.4 million for the three months
ended  September  30,  2000.  An  increase  of $92.8  million in  mortgage  loan
production revenues was the result of increased mortgage loan production volumes
during the three months ended  September  30,  2001,  due to declining  interest
rates. In addition,  mortgage loan servicing  revenues  increased $24.5 million,
reflecting  the growth in the mortgage loan servicing  portfolio.  Mortgage loan
production  was $10.5  billion for the three  months ended  September  30, 2001,
compared to $2.4  billion for the three  months ended  September  30, 2000.  The
average balance of the servicing  portfolio for the three months ended September
30, 2001, was $68.5 billion compared to $52.1 billion for the three months ended
September 30, 2000.                                                             

Total  expenses  increased  $81.4 million to $160.8 million for the three months
ended  September  30,  2001,  from  $79.4  million  for the three  months  ended
September  30, 2000.  An increase of $62.6  million in mortgage  loan  servicing
expenses was primarily a result of an impairment  of  capitalized  mortgage loan
servicing  rights and, to a lesser  extent,  due to growth in the mortgage  loan
servicing portfolio.  Mortgage loan production expenses increased $18.8 million,
reflecting the increase in mortgage loan production volume.                     

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Income taxes increased $16.6 million to $20.4 million for the three months ended
September 30, 2001,  from $3.8 million for the three months ended  September 30,
2000, due to an increase in pre-tax operating earnings. The effective income tax
rate for this segment was 43% for the three months ended September 30, 2001, and
35% for the three months ended  September 30, 2000. The increase in the tax rate
was due to the  allocation of deferred  state taxes relating to both current and
prior  years,  recorded in the three  months  ended  September  30,  2001.  This
allocation  will  increase  the  effective  tax rate for this segment to 36% for
future reporting periods.                                                       

As a  result  of the  foregoing  factors,  operating  earnings  and  net  income
increased  $19.3 million to $26.5  million for the three months ended  September
30, 2001, from $7.2 million for the three months ended September 30, 2000.      

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Total operating revenues increased $229.7 million, or 85%, to $500.8 million for
the nine months  ended  September  30,  2001,  from $271.1  million for the nine
months ended  September  30, 2000. A $179.4  million  increase in mortgage  loan
production  revenues  reflects the increase in mortgage loan  production  volume
during the nine months ended  September  30, 2001.  In addition,  an increase of
$50.3 million in mortgage  loan  servicing  revenues  reflects the growth in the
mortgage  loan  servicing  portfolio.  The  decline  in  interest  rates in 2001
resulted in mortgage loan  production of $25.9 billion for the nine months ended
September 30, 2001, compared to $5.7 billion for the same period a year ago. The
average balance of the servicing portfolio was $62.1 billion for the nine months
ended  September 30, 2001,  compared to $51.8 billion for the same period a year
ago.                                                                            

Total expenses increased $141.0 million,  or 68%, to $348.1 million for the nine
months ended  September 30, 2001,  from $207.1 million for the nine months ended
September 30, 2000. A $94.5 million increase in mortgage loan servicing expenses
was primarily a result of an impairment of  capitalized  mortgage loan servicing
rights and, to a lesser  extent,  due to growth in the mortgage  loan  servicing
portfolio.  The impairment  was partially  offset by an increase in net gains on
servicing hedge activity recognized in the nine months ended September 30, 2001,
compared to the nine months ended  September 30, 2000.  Mortgage loan production
expenses  increased  $46.5  million,  reflecting  the increase in mortgage  loan
production volume.                                                              

Income taxes  increased $35.0 million to $57.4 million for the nine months ended
September 30, 2001,  from $22.4 million for the nine months ended  September 30,
2000. The effective income tax rate for this segment was 38% for the nine months
ended  September 30, 2001, and 35% for the nine months ended September 30, 2000.
The increase in the tax rate was due to the  allocation of deferred state taxes,
relating to both  current and prior  years,  recorded in the three  months ended
September  30, 2001.  This  allocation  will increase the effective tax rate for
this segment to 36% for future reporting periods.                               

As a  result  of the  foregoing  factors,  operating  earnings  and  net  income
increased $53.7 million to $95.3 million for the nine months ended September 30,
2001, from $41.6 million for the nine months ended September 30, 2000.          

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Corporate and Other Segment                                                     

The table below presents certain summary financial data relating to the         
Corporate and Other segment for the periods indicated:                          

                                                        [Enlarge/Download Table]


                                                         For the three                    For the nine        
                                                          months ended                    months ended        
                                                         September 30,                    September 30,       
                                                   ---------------------------     ---------------------------
                                                       2001           2000             2001            2000   
                                                   ------------   ------------     ------------   ------------
                                                                          (in millions)                       
                                                                                                              
Operating Earnings Data:                                                                                      
Operating Revenues (1):                                                                                       
     Total operating revenues.....................   $   16.4       $   13.9         $   73.9        $  54.4  

Expenses:                                                                                                     
     Total expenses...............................       12.0           11.6             25.5           40.9  
                                                   ------------   ------------     ------------   ------------
Pre-tax operating earnings........................        4.4            2.3             48.4           13.5  
Income taxes (benefits)...........................        7.0          (12.8)            18.9           (5.6) 
                                                   ------------   ------------     ------------   ------------
Operating earnings (loss).........................       (2.6)          15.1             29.5           19.1  

Net realized capital gains (losses), as adjusted..      (13.2)          10.0            (54.7)          14.6  
Non-recurring items...............................       (4.1)          (1.9)           (24.8)         (77.7) 
                                                   ------------   ------------     ------------   ------------
GAAP Reported:                                                                                                
Net income (loss).................................   $  (19.9)      $   23.2         $  (50.0)       $ (44.0) 
                                                   ============   ============     ============   ============

--------------------                                                            
(1)  Excludes  net  realized   capital  gains   (losses)  and  their  impact  on
recognition of front-end fee revenues.                                

Three Months Ended  September 30, 2001 Compared to Three Months Ended  September
30, 2000                                                                        

Total operating  revenues  increased $2.5 million,  or 18%, to $16.4 million for
the three months ended  September  30,  2001,  from $13.9  million for the three
months  ended   September  30,  2000.  A  $3.2  million   increase   related  to
inter-segment  eliminations  included  in this  segment,  which was  offset by a
corresponding  change in total expenses.  The increase was partially offset by a
$0.9 million decrease in net investment income.                                 

Total  expenses  increased  $0.4 million,  or 3%, to $12.0 million for the three
months ended  September 30, 2001,  from $11.6 million for the three months ended
September  30,  2000.  A  $3.2  million   increase   related  to   inter-segment
eliminations  included in this segment.  The increase was partially  offset by a
$2.8  million  decrease in  interest  expense as a result of  extinguishment  of
commercial real estate debt on home office properties.                          

Income tax expense (benefits)  increased $19.8 million to $7.0 million of income
tax expense for the three months ended  September 30, 2001, from a $12.8 million
income tax benefit for the three months ended  September 30, 2000.  The increase
was  primarily  related to a favorable  IRS tax audit matter that resulted in an
income tax benefit for the three months ended  September  30, 2000. In addition,
the income tax expense for the three months ended September 30, 2001,  increased
as a result of foreign tax expense previously included in net investment income.

As a result of the foregoing factors, operating earnings decreased $17.7 million
to a $2.6 million  operating loss for the three months ended September 30, 2001,
from $15.1 million  operating  earnings for the three months ended September 30,
2000.                                                                           

Net realized  capital gains  (losses),  as adjusted,  decreased $23.2 million to
$13.2  million  of net  realized  capital  losses  for the  three  months  ended
September  30, 2001,  from $10.0  million of net realized  capital gains for the
three  months ended  September  30, 2000.  The  decrease  was  primarily  due to
decreased sales of invested assets, primarily equity securities and real estate,
for the three months ended September 30, 2001.                                  

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As a result of the foregoing  factors and the inclusion of non-recurring  items,
net income  decreased  $43.1  million to a $19.9  million net loss for the three
months ended  September  30, 2001,  from $23.2  million net income for the three
months ended  September 30, 2000. Net income  included the negative  effect of a
non-recurring  item, net of tax, related to expenses of our  demutualization  of
$4.1 million and $1.9 million for the three months ended September 30, 2001, and
2000, respectively.                                                             

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000                                                                            

Total operating revenues  increased $19.5 million,  or 36%, to $73.9 million for
the nine months ended September 30, 2001, from $54.4 million for the nine months
ended September 30, 2000. Operating revenues increased $21.7 million,  primarily
as a result of improved  investment  yields for the  segment.  The  increase was
partially   offset  by  a  $2.5  million   decrease   related  to  inter-segment
eliminations  included  in this  segment,  which was  offset by a  corresponding
change in total expenses.                                                       

Total expenses  decreased  $15.4 million,  or 38%, to $25.5 million for the nine
months ended  September  30, 2001,  from $40.9 million for the nine months ended
September  30,  2000.  Interest  expense  decreased  $7.0 million as a result of
extinguishment  of  commercial  real  estate  debt  on home  office  properties.
Interest  expense on private  debt  securities  and  commercial  paper issued in
connection with the acquisition of BT Financial Group decreased $5.7 million,  a
result of the impact of the weakening of the  Australian  dollar versus the U.S.
dollar and repayment of the commercial paper. A $2.5 million decrease related to
inter-segment  eliminations  included in this  segment.  Interest  expense  also
decreased  $2.2 million,  primarily due to an accrual of interest to be received
as a result of the  resolution of a favorable  IRS tax audit event in 2000.  The
decreases were partially  offset by a $3.2 million  increase related to interest
expense on short-term borrowings.                                               

Income tax expense  (benefits)  increased  $24.5 million to $18.9 million income
tax expense for the nine months ended  September  30, 2001,  from a $5.6 million
income tax benefit for the nine months ended  September 30, 2000. As a result of
an increase in pre-tax  operating  earnings,  income tax expense increased $12.3
million.  The  remaining  $12.2  million  increase  was  primarily  related to a
favorable  IRS tax audit  matter that  resulted in an income tax benefit for the
nine months ended  September 30, 2000.  In addition,  the income tax expense for
the nine months ended  September 30, 2001,  increased as a result of foreign tax
expense previously included in net investment income.                           

As a  result  of the  foregoing  factors,  operating  earnings  increased  $10.4
million,  or 54%, to $29.5 million for the nine months ended September 30, 2001,
from $19.1 million for the nine months ended September 30, 2000.                

Net realized  capital gains  (losses),  as adjusted,  decreased $69.3 million to
$54.7 million of net realized capital losses for the nine months ended September
30, 2001,  from $14.6 million of net realized  capital gains for the nine months
ended  September 30, 2000.  The decrease was primarily due to an increase in net
realized  capital losses for the nine months ended  September 30, 2001, on sales
of equity securities.                                                           

As a result of the foregoing  factors and the inclusion of non-recurring  items,
net loss  increased  $6.0 million,  or 14%, to $50.0 million for the nine months
ended September 30, 2001, from $44.0 million for the nine months ended September
30, 2000. For the nine months ended  September 30, 2001, net income included the
negative  effect of  non-recurring  items totaling  $24.8  million,  net of tax,
related to: (1) expenses of our  demutualization  ($18.9 million) and (2) a loss
contingency reserve  established for sales practices  litigation ($5.9 million).
For the nine months ended  September 30, 2000, net income  included the negative
effect of  non-recurring  items totaling $77.7 million,  net of tax, related to:
(1) a loss contingency reserve established for sales practices litigation ($75.0
million) and (2) expenses of our demutualization ($2.7 million).                

Liquidity and Capital Resources                                                 

Liquidity  describes the ability of a company to generate  sufficient cash flows
to meet the cash requirements of business operations.  The primary source of our
liquidity is dividends we receive  from  Principal  Life.  We could also receive
dividends from our other  subsidiaries,  including  Princor  Financial  Services
Corporation,   Principal   Financial   Services   (Australia)  Inc.,   Principal
International  de  Chile,  S.A.  and PFG do  Brasil  Ltda.  However,  given  the
historical  cash  flows  of  the  operations  and  financial  results  of  these
subsidiaries,  it is unlikely  that we may rely upon them for  significant  cash

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flow in the next twelve  months.  In  addition,  estimated  net  proceeds to the
Company from the IPO, including the underwriters' exercise of the over-allotment
options,  totaled  $2,018.7  million,  of which an estimated  $324.9 million was
retained by Principal  Financial  Group,  Inc. for working  capital,  payment of
dividends,  and other general corporate purposes.  An estimated $1,693.8 million
was  contributed  to  Principal  Life  Insurance  Company  principally  to  fund
demutualization  compensation to policyholders in the form of policy credits and
cash, and to cover certain expenses related to the demutualization.             

The payment of dividends by Principal Life to us is limited by Iowa laws.  Under
Iowa laws, Principal Life may pay dividends only from the earned profits arising
from  its  business  and  must  receive  the  prior  approval  of the  Insurance
Commissioner  of the  State  of Iowa  to pay  any  dividend  that  would  exceed
statutory limitations. The current statutory limitation is the greater of:      

o    10% of  Principal  Life's  statutory  surplus as of the  previous  calendar
year-end; or                                                          
o    the net gain from  operations of Principal  Life  determined on a statutory
basis for the previous calendar year.                                 

Iowa law gives the  Insurance  Commissioner  of the State of Iowa  discretion to
disapprove requests for dividends in excess of these limits.  Principal Life was
able to pay approximately $760.9 million in statutory dividends in 2001 based on
its 2000 statutory  financial  results without being subject to the restrictions
on payment of extraordinary stockholder dividends, all of which as of August 24,
2001, has been declared and paid. The ability to make dividends or distributions
in the future will depend on the amounts of statutory  surplus and net gain from
operations determined on a statutory basis for the previous year.               

Our primary uses of liquidity  could include  payment of dividends on our common
stock,  interest  payments  and any other  payments  related to debt  servicing,
payment  of  general   operating   expenses,   contributions   to  subsidiaries,
acquisitions and the repurchase of our common stock. Any such repurchases  would
occur after due consideration and approval by our board of directors.           

Sources and Uses of Cash of Consolidated Operations                             

Net cash  provided by operating  activities  was  $2,808.0  million and $1,322.4
million for the nine months ended September 30, 2001 and 2000, respectively. The
increase  was  primarily  due to a decrease in cash paid for  benefits,  claims,
settlement expenses and operating expenses and an increase in premiums and other
considerations  received  primarily  due to an increase in premiums  from single
premium group annuities with life contingencies.                                

Net cash used in investing  activities  was $3,690.4  million and $263.1 million
for the nine  months  ended  September  30,  2001 and  2000,  respectively.  The
increase in cash used was  primarily  due to an increase in net cash invested in
available-for-sale  securities  during the nine months ended September 30, 2001,
compared to the nine months ended September 30, 2000, and, to a lesser extent, a
decrease  in net  mortgage  loans  sold or repaid due to a  commercial  mortgage
securitization  that occurred during 2000. Also  contributing to the increase in
net  cash  used in  investing  activities  was the  increase  in  mortgage  loan
servicing  rights due to the increase in mortgage loan production  volume during
2001.                                                                           

Net cash provided by financing activities was $186.9 million for the nine months
ended  September 30, 2001, and net cash used in financing  activities was $780.5
million for the nine months  ended  September  30,  2000.  Net cash  provided by
financing  activities increased primarily as a result of a decline in investment
contract net  withdrawals.  Also  contributing  to the increase was net proceeds
received from short-term borrowings.                                            

Cash flow  requirements are also supported by committed lines of credit totaling
$600.0 million, of which there were no outstanding  balances as of September 30,
2001.  The lines of credit are  available  to provide  backup of the  commercial
paper programs.                                                                 

Given the historical cash flow of our subsidiaries and the financial  results of
these  subsidiaries,  we believe the cash flow from our  consolidated  operating
activities  over  the  next  year  will  provide  sufficient  liquidity  for our
operations,  as well as to satisfy interest payments and any payments related to
debt servicing.                                                                 

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Principal Life                                                                  

Historically,  the  principal  cash flow  sources for  Principal  Life have been
premiums from life and health insurance products,  pension and annuity deposits,
asset management fee revenues, administrative services fee revenues, income from
investments,  proceeds from the sales or maturity of investments  and short-term
borrowings.   Cash  outflows  consist   primarily  of  payment  of  benefits  to
policyholders  and  beneficiaries,  income and other  taxes,  current  operating
expenses,  payment of dividends to  policyholders,  payments in connection  with
investments  acquired,  payments  made  to  acquire  subsidiaries,   payment  of
dividends to parent,  and payments  relating to policy and contract  surrenders,
withdrawals,   policy  loans,  interest  expense  and  repayment  of  short-term
borrowings.                                                                     

Principal Life maintains  investment  strategies  generally  intended to provide
adequate  funds to pay benefits  without forced sales of  investments.  Products
having  liabilities  with longer lives,  such as life insurance and full-service
payout pension products,  are matched with assets having similar estimated lives
such  as  mortgage  loans,   long-term  bonds  and  private   placement   bonds.
Shorter-term  liabilities  are  matched  with  investments  such  as  short  and
medium-term  fixed  maturities.   In  addition,   highly  liquid,  high  quality
short-term  U.S.  Treasury  securities and other liquid  investment  grade fixed
maturities  are  held  to  fund  anticipated  operating  expenses,   surrenders,
withdrawals  and  development  and  maintenance  expenses  associated  with  new
products and technologies.  See "Quantitative and Qualitative  Disclosures about
Market Risk--Interest Rate Risk" for a discussion of duration matching.         

Our privately placed fixed maturity  securities,  commercial  mortgage loans and
real estate investments are generally less liquid than our publicly traded fixed
maturity  securities.  As of September 30, 2001, these asset classes represented
approximately 51% of the value of our consolidated invested assets.             

Life insurance companies generally produce a positive cash flow from operations,
as measured by the amount by which cash  inflows  are  adequate to meet  benefit
obligations to policyholders and normal operating expenses as they are incurred.
The remaining  cash flow is generally used to increase the asset base to provide
funds to meet the need for future  policy  benefit  payments and for writing and
acquiring  new  business.  It is  important  to match the  investment  portfolio
maturities  to the cash  flow  demands  of the type of  annuity,  investment  or
insurance product being provided. Principal Life continuously monitors benefits,
surrenders and maturities to provide projections of future cash requirements. As
part of this  monitoring  process,  Principal Life performs cash flow testing of
many of its assets and  liabilities  under  various  scenarios  to evaluate  the
adequacy of reserves.  In developing  its  investment  strategy,  Principal Life
establishes  a level of cash and  securities  which,  combined with expected net
cash inflows from  operations,  maturities  of fixed  maturity  investments  and
principal payments on mortgage-backed  securities, are believed adequate to meet
anticipated  short-term and long-term  benefit and expense payment  obligations.
There  can  be no  assurance  that  future  experience  regarding  benefits  and
surrenders will be similar to historic experience since withdrawal and surrender
levels are influenced by such factors as the interest rate  environment  and the
claims paying ability and financial strength ratings of Principal Life.         

Principal Life takes into account asset-liability  management  considerations in
the product  development and design process.  Contract terms of 97% of Principal
Life's  interest-sensitive  products as of December 31, 2000,  include surrender
and  withdrawal  provisions  which  mitigate  the  risk of  losses  due to early
withdrawals.  These provisions generally do one or more of the following:  limit
the amount of  penalty-free  withdrawals;  limit the  circumstances  under which
withdrawals  are  permitted;  or  assess a  surrender  charge  or  market  value
adjustment  relating  to the  underlying  assets.  The market  value  adjustment
feature in Principal  Life's fixed annuity  products adjusts the surrender value
of a contract in the event of surrender  prior to the end of the contract period
to protect  Principal  Life against  losses due to higher  interest rates at the
time of surrender.                                                              

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The following  table  summarizes  Principal  Life's  statutory  liabilities  for
annuities and deposit funds by their contractual withdrawal provisions:         

                                                        [Enlarge/Download Table]


                                                                                             As of       
                                                                                         December 31,    
                                                                                             2000        
                                                                                      -------------------
                                                                                         (in millions)   
                                                                                                         
Statutory Liabilities for Annuities and Deposit Funds:                                                   
  Not subject to discretionary withdrawal............................................    $   17,813.8    
  Subject to discretionary withdrawal with adjustments:                                                  
  Specified surrender charges at book value less surrender charge of 5% or more......           670.9    
  Market value adjustments...........................................................        40,535.0    
                                                                                      -------------------
     Subtotal........................................................................        59,019.7    
  Subject to discretionary withdrawal without adjustments............................         2,138.1    
                                                                                      -------------------
     Total...........................................................................    $   61,157.8    
                                                                                      ===================

International Operations                                                        

BT  Financial  Group  required no infusions of capital for the nine months ended
September 30, 2001,  and $59.3  million for the nine months ended  September 30,
2000, to meet cash flow requirements. We do not anticipate making future capital
contributions.  Primary  sources of cash inflows for BT Financial  Group are fee
revenues and interest spread earned on margin lending operations.  Cash outflows
consist primarily of operating expenses.                                        

Principal International is in a development or entry stage in several countries.
Historically,  principal cash flow sources for Principal International have been
pension and annuity  deposits,  asset  management  fee revenues,  administrative
services fee revenues,  insurance  premiums,  income from investments,  proceeds
from the sales or  maturity  of  investments  and  short-term  borrowings.  Cash
outflows  consist   primarily  of  payment  of  benefits  to  policyholders  and
beneficiaries,  income and other taxes, current operating expenses,  payments in
connection  with  investments  acquired,  and  payments  relating  to policy and
contract surrenders,  withdrawals,  policy loans, interest expense and repayment
of short-term borrowings.                                                       

Principal  International  maintains investment  strategies generally intended to
provide  adequate  funds to pay benefits  without  forced sales of  investments.
Highly liquid,  high quality short-term  government  securities and other liquid
investment grade fixed  maturities are held to fund  anticipated  operating cash
outflows and development and maintenance  expenses  associated with new products
and technologies.                                                               

Principal International's  operating companies monitor benefits,  surrenders and
maturities to provide  projections of future cash requirements.  There can be no
assurance  that future  experience  regarding  benefits and  surrenders  will be
similar  to  historic  experience  since  withdrawal  and  surrender  levels are
influenced by factors such as the interest rate environment.                    

Our  Brazilian  and  Chilean  operations  produced  a  positive  cash  flow from
operations  in the first nine months of 2001 and in 2000.  These cash flows have
been historically  maintained at the local country level for strategic expansion
purposes. Our other international  operations have required infusions of capital
of $29.7 million for the nine months ended  September 30, 2001, to meet the cash
outflow  requirements of those operations or to fund  acquisitions.  These other
operations  are  primarily in the start-up  stage or are  expanding in the short
term. Our capital  funding of these  operations is consistent with our long term
strategy to  establish  viable  companies  that can sustain  future  growth from
internally generated sources.                                                   

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Investments                                                                     

We had total consolidated  assets as of September 30, 2001, of $84.0 billion, of
which $45.5 billion were  invested  assets.  The rest of our total  consolidated
assets are comprised  primarily of separate  account  assets for which we do not
bear  investment  risk.  Because we generally do not bear any investment risk on
assets held in separate accounts, the discussion and financial information below
does not include such assets. Of our invested assets, $44.3 billion were held by
our  U.S.   operations   and  the  remaining  $1.2  billion  were  held  by  our
International Asset Management and Accumulation segment.                        

U.S Investment Operations                                                       

Our U.S.  invested  assets  are  managed  by  Principal  Capital  Management,  a
subsidiary of Principal  Life. Our primary  investment  objective is to maximize
after-tax returns consistent with acceptable risk parameters. We seek to protect
policyholders' benefits by optimizing the risk/return relationship on an ongoing
basis, through asset/liability matching, reducing the credit risk, avoiding high
levels  of  investments  that  may  be  redeemed  by  the  issuer,   maintaining
sufficiently liquid investments and avoiding undue asset concentrations  through
diversification. We are exposed to three primary sources of investment risk:    

o    credit risk,  relating to the  uncertainty  associated  with the  continued
     ability  of a given  obligor  to make  timely  payments  of  principal  and
interest;                                                             
o    interest  rate  risk,  relating  to  the  market  price  and/or  cash  flow
variability associated with changes in market yield curves; and       
o    equity risk, relating to adverse fluctuations in a particular common stock.

Our  ability  to  manage  credit  risk  is  essential  to our  business  and our
profitability.  We devote considerable  resources to the credit analysis of each
new investment.  We manage credit risk through industry,  issuer and asset class
diversification.  Our Investment Committee, appointed by our board of directors,
establishes  all investment  policies and reviews and approves all  investments.
There are nine members on the Investment  Committee,  two of whom are members of
our board of  directors.  The  remaining  seven  members  are senior  management
members representing various areas of our company.                              

Our Fixed Income  Securities  Committee,  consisting of fixed income  securities
senior  management  members,  approves the credit rating for the fixed  maturity
securities  we  purchase.  Teams  specializing  in  residential  mortgage-backed
securities,  commercial  mortgage-backed  securities and public below investment
grade securities monitor these investments. We establish a credit review list of
approved  public issuers to provide an efficient way for our portfolio  managers
to purchase  liquid  bonds for which credit  review has already been  completed.
Issuers  remain on the list for 6 months  unless  removed  by our  analyst.  The
analyst  monitors issuers on the list on a continuous basis with a formal review
documented every six months.                                                    

Our Fixed Income  Securities  Committee also reviews  private  transactions on a
continuous  basis  to  assess  the  quality  ratings  of  our  privately  placed
investments.  We regularly review our investments to determine whether we should
re-rate them, employing the following criteria:                                 

o    material declines in the issuer's revenues or margins;                     
o    significant management or organizational changes;                          
o    significant uncertainty regarding the issuer's industry;                   
o    debt service coverage or cash flow ratios that fall below industry-specific
thresholds;                                                           
o    violation of financial covenants; and                                      
o    other business factors that relate to the issuer.                          

A dedicated risk management  team is responsible  for centralized  monitoring of
the commercial mortgage portfolio.  We apply a variety of strategies to minimize
credit risk in our commercial  mortgage loan  portfolio.  When  considering  the
origination  of  new  commercial   mortgage  loans,  we  review  the  cash  flow

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fundamentals  of the  property,  make a physical  assessment  of the  underlying
security,  conduct a comprehensive  market analysis and compare against industry
lending  practices.  We use a proprietary  risk rating model to evaluate all new
and a majority of existing  loans within the  portfolio.  The  proprietary  risk
model is designed to stress  projected cash flows under  simulated  economic and
market downturns.  Our lending  guidelines are designed to encourage 75% or less
loan-to-value ratios and a debt service coverage ratio of at least 1.2 times. We
analyze  investments  outside of these  guidelines  based on cash flow  quality,
tenancy and other  factors.  From 1998 through  September 30, 2001, the weighted
average  loan-to-value  ratio at  origination  for brick and  mortar  commercial
mortgages in our portfolio  was in the 65%-68%  range and debt service  coverage
ratios at loan inception in the 1.6-1.7 times range.                            

We have limited  exposure to equity risk in our common stock  portfolio.  Equity
securities accounted for only 2% of our U.S. invested assets as of September 30,
2001.                                                                           

Our investment  decisions and objectives are a function of the underlying  risks
and  product  profiles of each  primary  business  operation.  In  addition,  we
diversify  our product  portfolio  offerings  to include  products  that contain
features  that will protect us against  fluctuations  in interest  rates.  Those
features include adjustable crediting rates, policy surrender charges and market
value adjustments on liquidations.  For further information on our management of
interest rate risk, see "Quantitative  and Qualitative  Disclosures about Market
Risk".                                                                          

Overall Composition of U.S. Invested Assets                                     

U.S.  invested  assets as of September  30,  2001,  were  predominantly  of high
quality and broadly diversified across asset class,  individual credit, industry
and geographic  location.  As shown in the following table, the major categories
of U.S. invested assets are fixed maturity securities and commercial  mortgages.
The remainder is invested in real estate, equity securities and other assets. In
addition,  policy  loans are included in our  invested  assets.  We combined our
invested  assets in the closed  block with  invested  assets  outside the closed
block  in  view  of  the  similar  asset  quality  characteristics  of  the  two
portfolios.  The following  discussion analyzes the composition of U.S. invested
assets,  which includes  $4,169.5 million in invested assets of the closed block
as of September  30, 2001,  but excludes  invested  assets of the  participating
separate accounts.                                                              

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                       
                                                      As of September 30,           As of December 31,   
                                                    ------------------------     ------------------------
                                                             2001                          2000          
                                                    ------------------------     ------------------------
                                                      Carrying       % of          Carrying       % of   
                                                       Amount        Total          Amount        Total  
                                                    ------------    --------     ------------    --------
                                                                    ($ in millions)                      
                                                                                                         
Fixed maturity securities, available-for-sale                                                            
  Public..........................................  $  17,861.1        40%       $  14,263.6        35%  
  Private.........................................     11,643.5        26           11,611.4        28   
Equity securities, available-for-sale.............        720.5         2              666.0         2   
Mortgage loans                                                                                           
  Commercial .....................................     10,255.9        23           10,775.3        26   
  Residential.....................................        988.0         2              550.5         1   
Real estate held for sale ........................        611.7         2              695.4         2   
Real estate held for investment...................        528.4         1              696.4         2   
Policy loans......................................        826.0         2              803.6         2   
Other investments ................................        842.4         2              681.2         2   
                                                    ------------     -----       ------------     -----  
Total invested assets.............................  $  44,277.5       100%       $  40,743.4       100%  
                                                                     =====                        =====  

Cash and cash equivalents.........................         47.9                        750.1             
                                                    ------------                 ------------            

Total invested assets and cash ...................  $  44,325.4                  $  41,493.5             
                                                    ============                 ============            

We actively manage public fixed maturity securities,  including our portfolio of
residential  mortgage-backed  securities,  in order  to  provide  liquidity  and
enhance yield and total return. Our residential  mortgage-backed  securities are

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managed to ensure  that the  securities  we hold trade  close to or below par in
order to manage  prepayment  risk.  This active  management  has resulted in the
realization of capital gains and losses with respect to such investments.       

U.S. Investment Results                                                         

The yield on U.S.  invested assets and on cash and cash  equivalents,  excluding
net  realized  gains and losses,  was 7.3% and 7.4% for the three  months  ended
September  30,  2001,  and  2000,  respectively,  and 7.5% and 7.4% for the nine
months ended September 30, 2001, and 2000, respectively.                        

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The table  below  illustrates  the  yields  on  average  assets  for each of the
components  of our  investment  portfolio  for the three and nine  months  ended
September 30, 2001, and 2000:                                                   

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                                        
                              Yields by Asset Type                                                                        

                                             As of or for the three months              As of or for the nine months      
                                                  ended September 30,                        ended September 30,          
                                         -------------------------------------     -------------------------------------- 
                                                2001                 2000                 2001                 2000       
                                         -----------------   -----------------     -----------------    ----------------- 
                                         Yield     Amount    Yield     Amount      Yield     Amount     Yield     Amount  
                                         -----   ---------   -----   ---------     -----   ---------    -----   --------- 
                                                                        ($ in millions)                                   
                                                                                                                          
Fixed maturity securities,                                                                                                
  available-for-sale                                                                                                      
    Gross investment income (1)...        7.5%   $   540.4    7.8%   $   457.1      7.6%   $ 1,585.4     7.6%   $ 1,332.5 
    Net realized capital losses...       (0.4)       (27.0)  (0.1)        (2.9)    (0.5)      (104.5)   (0.6)      (105.8)
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $   513.4           $   454.2             $ 1,480.9            $ 1,226.7 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $29,504.6           $23,989.8             $29,504.6            $23,989.8 
Equity securities,                                                                                                        
  available-for-sale                                                                                                      
    Gross investment income (1)...        4.6%   $     7.2    1.3%   $     2.1      2.7%   $    14.1     5.3%   $    27.9 
    Net realized capital gains                                                                                            
      (losses)....................       (2.5)        (3.9)   7.5         12.0    (11.8)       (61.5)   10.1         52.8 
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $     3.3           $    14.1             $   (47.4)           $    80.7 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $   720.5           $   630.7             $   720.5            $   630.7 
Mortgage loans - Commercial                                                                                               
    Gross investment income (1)...        7.4%   $   189.3    8.0%   $   239.8      7.8%   $   611.4     7.9%   $   728.3 
    Net realized capital gains                                                                                            
      (losses)....................       (0.2)        (4.2)   0.1          2.3      0.1         10.7     -            2.7 
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $   185.1           $   242.1             $   622.1            $   731.0 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $10,255.9           $11,745.2             $10,255.9            $11,745.2 
Mortgage loans - Residential                                                                                              
    Gross investment income (1)...        7.8%   $    19.7    7.1%   $     9.1      8.4%   $    48.4    10.9%   $    46.5 
    Net realized capital gains                                                                                            
      (losses)....................        -            -      -            -        -            -       -            -   
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $    19.7           $     9.1             $    48.4            $    46.5 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $   988.0           $   487.9             $   988.0            $   487.9 
Real estate                                                                                                               
    Gross investment income (1)...        8.8%   $    26.0    8.4%   $    43.8     13.3%   $   126.0     7.9%   $   129.1 
    Net realized capital gains                                                                                            
      (losses)....................       (0.4)        (1.1)   3.2         16.5     (0.1)        (1.4)    1.2         19.9 
                                                 ----------          ---------             ---------            --------- 
      Total.......................               $    24.9           $    60.3             $   124.6            $   149.0 
                                                 ==========          =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $ 1,140.1           $ 2,019.7             $ 1,140.1            $ 2,019.7 
Policy loans                                                                                                              
    Gross investment income (1)...        6.4%   $    13.2    6.7%   $    13.4      7.0%   $    42.6     6.8%   $    40.2 
    Net realized capital gains                                                                                            
      (losses)....................        -            -      -            -        -            -       -            -   
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $    13.2           $    13.4             $    42.6            $    40.2 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $   826.0           $   798.2             $   826.0            $   798.2 
Cash and cash equivalents                                                                                                 
    Gross investment income (1)...        9.0%   $     3.2    0.6%   $     0.8      6.2%   $    18.6     3.7%   $    14.4 
    Net realized capital gains                                                                                            
      (losses)....................        -            -      -            -        -            -       -            -   
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $     3.2           $     0.8             $    18.6            $    14.4 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $    47.9           $   661.0             $    47.9            $   661.0 
Other investments                                                                                                         
    Gross investment income (1)...       13.6%   $    27.6   17.9%   $    21.8     10.2%   $    58.5    11.6%   $    42.0 
    Net realized capital gains                                                                                            
      (losses)....................      (19.0)       (38.7)  (6.9)        (8.4)    (9.9)       (56.4)   21.5         77.7 
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $   (11.1)          $    13.4             $     2.1            $   119.7 
                                                 =========           =========             =========            ========= 
    Ending assets (at carrying                                                                                            
      value)......................               $   842.4           $   448.4             $   842.4            $   448.4 
Total before investment expenses                                                                                          
    Gross investment income.......        7.5%   $   826.6    7.8%   $   787.9      7.8%   $ 2,505.0     7.7%   $ 2,360.9 
    Net realized capital gains                                                                                            
      (losses)....................       (0.7)       (74.9)   0.2         19.5     (0.7)      (213.1)    0.2         47.3 
                                                 ---------           ---------             ---------            --------- 
    Total.........................               $   751.7           $   807.4             $ 2,291.9            $ 2,408.2 
                                                 =========           =========             =========            ========= 

Investment expenses...............        0.3%   $    28.2    0.3%   $    34.5      0.3%   $    81.2     0.3%   $    97.0 
Net investment income.............        7.3%   $   798.4    7.4%   $   753.4      7.5%   $ 2,423.8     7.4%   $ 2,263.9 

--------------------                                                            
(1)  Yields,  which are annualized for interim  periods,  are based on quarterly
     average  asset  carrying  values for the three months and nine months ended
September 30, 2001, and 2000.                                         

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Fixed Maturity Securities                                                       

We  have  classified  all  of  our  fixed  maturity  and  equity  securities  as
available-for-sale.  Accordingly,  we  mark  such  securities  to  market,  with
unrealized  gains and losses  excluded  from earnings and reported as a separate
component  of  other  comprehensive   income,  net  of  deferred  income  taxes,
policyholder  dividend  obligation  and an adjustment for the effect on deferred
policy acquisition costs that would have occurred had such gains and losses been
realized.  We write down to fair value  securities  whose value is deemed  other
than temporarily  impaired.  We record writedowns as realized losses included in
earnings  and adjust the cost basis of such  securities  to fair value.  The new
cost basis is not changed for subsequent recoveries in value.                   

Fixed maturity  securities  consist of short-term  investments,  publicly traded
debt  securities,   privately  placed  debt  securities  and  small  amounts  of
redeemable preferred stock, and represented 66% of total U.S. invested assets as
of September  30, 2001,  and 63% as of December  31,  2000.  The fixed  maturity
securities portfolio was comprised, based on carrying amount, of 61% in publicly
traded fixed  maturity  securities  and 39% in privately  placed fixed  maturity
securities as of September 30, 2001,  and 55% in publicly  traded fixed maturity
securities and 45% in privately placed fixed maturity  securities as of December
31, 2000.  Included in the privately  placed  category as of September 30, 2001,
were $3.8 billion of securities  eligible for resale to qualified  institutional
buyers  under  Rule  144A  under  the  Securities  Act of 1933.  Fixed  maturity
securities were  diversified by category of issuer as of September 30, 2001, and
December 31, 2000, as shown in the table below:                                 

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                               
                   Fixed Maturity Securities by Type of Issuer                                                   

                                                              As of September 30,          As of December 31,    
                                                                     2001                        2000            
                                                            -------------------------   -------------------------
                                                             Carrying         % of       Carrying          % of  
                                                              Amount          Total       Amount           Total 
                                                            ----------       --------   ----------       --------
                                                                               ($ in millions)                   
                                                                                                                 
U.S. Treasury securities and obligations of U.S.                                                                 
  Government corporations and agencies...............       $     9.9           -%      $    21.3            -%  
States and political subdivisions....................           310.5           1           295.7            1   
Non-U.S. governments.................................           637.9           2           604.3            2   
Corporate - public...................................        12,372.2          42         8,740.8           34   
Corporate - private..................................         9,811.8          33         9,796.6           38   
Mortgage-backed securities and other asset                                                                       
  backed securities..................................         6,362.3          22         6,416.3           25   
                                                            ----------       --------   ----------       --------
 Total fixed maturities..............................       $29,504.6         100%      $25,875.0          100%  
                                                            ==========       ========   ==========       ========

The international exposure in our U.S. invested assets totaled $3,955.3 million,
or 13%, of total fixed maturity securities,  as of September 30, 2001, comprised
of corporate and foreign government fixed maturity  securities.  Of the $3,955.3
million as of September 30, 2001,  investments  totaled  $1,050.0 million in the
United Kingdom, $731.2 million in the continental European Union, $520.4 million
in Asia, $426.1 million in South America,  $340.6 million in Australia and $26.2
million  in  Japan.  The  remaining  $860.8  million  was  invested  in 15 other
countries.  All  international  fixed  maturity  securities  held  by  our  U.S.
operations are either denominated in U.S. dollars or have been swapped into U.S.
dollar  equivalents.  Our international  investments are analyzed  internally by
country and industry credit investment professionals.  We control concentrations
using  issuer and  country  level  exposure  benchmarks,  which are based on the
credit quality of the issuer and the country. Our investment policy limits total
international  fixed maturity  securities  investments to 15% of total statutory
general account assets with a 4% limit in emerging  markets.  Exposure to Canada
is not included in our international  exposure due to its treatment by the NAIC.
As of September 30, 2001, our investments in Canada totaled $714.1 million.     

The Securities Valuation Office of the NAIC evaluates most of the fixed maturity
securities  that we and other U.S.  insurance  companies  hold.  The  Securities
Valuation  Office  evaluates  the bond  investments  of insurers for  regulatory
reporting purposes and assigns securities to one of six investment categories.  

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The NAIC Designations closely mirror the nationally recognized securities rating
organizations'  credit ratings for marketable  bonds.  NAIC Designations 1 and 2
include bonds considered  investment grade by such rating  organizations.  Bonds
are  considered  investment  grade when rated  "Baa3" or higher by  Moody's,  or
"BBB-"  or higher  by  Standard  &  Poor's.  NAIC  Designations  3 through 6 are
referred to as below  investment  grade.  Bonds are considered  below investment
grade  when rated  "Ba1" or lower by  Moody's,  or "BB+" or lower by  Standard &
Poor's.                                                                         

The table below presents our total fixed maturity securities by NAIC Designation
and the  equivalent  ratings  of the  nationally  recognized  securities  rating
organizations  as of September  30, 2001,  and December 31, 2000, as well as the
percentage, based on estimated fair value, that each designation comprises:     

                                                        [Enlarge/Download Table]


                             U.S. Invested Assets                                                                    
               Total Fixed Maturity Securities by Credit Quality                                                     

                                           As of September 30, 2001                     As of December 31, 2000      
                                   -------------------------------------        -------------------------------------
                                                                  % of                                         % of  
                 Rating                                           Total                                        Total 
 NAIC            Agency             Amortized      Carrying     Carrying         Amortized     Carrying      Carrying
Rating         Equivalent              Cost          Amount      Amount             Cost         Amount       Amount 
------  ------------------------   ------------   -----------   --------        ------------   -----------   --------
                                                                    ($ in millions)                                  
                                                                                                                     
1       Aaa/Aa/A................   $  14,837.4    $  15,574.6       53%         $  14,185.3    $  14,496.9       56% 
2       Baa.....................      11,095.6       11,527.9       39              9,181.5        9,314.8       36  
3       Ba......................       1,793.1        1,746.8        6              1,603.0        1,560.6        6  
4       B.......................         444.0          425.7        1                393.9          357.3        2  
5       Caa and lower...........          85.1           56.9        -                101.0           68.0        -  
6       In or near default......         198.7          172.7        1                125.9           77.4        -  
                                   ------------   -----------   --------        -----------    -----------   --------
        Total public                                                                                                 
        fixed maturities........   $  28,453.9    $  29,504.6      100%         $  25,590.6    $  25,875.0      100% 
                                   ============   ===========   ========        ===========    ===========   ========

We believe  that our  long-term  fixed  maturity  securities  portfolio  is well
diversified  among  industry  types and between  publicly  traded and  privately
placed securities. Each year we direct the majority of our net cash inflows into
investment  grade fixed  maturity  securities.  We typically  invest up to 7% of
general account cash flow in below  investment  grade assets.  While the general
account investment returns have improved due to the below investment grade asset
class,  we manage its growth  strategically  by  limiting it to 10% of the total
fixed maturity securities portfolio.                                            

We invest in privately  placed fixed maturity  securities to enhance the overall
value of the portfolio,  increase  diversification and obtain higher yields than
are possible  with  comparable  quality  public  market  securities.  Generally,
private   placements   provide   broader   access  to  management   information,
strengthened  negotiated  protective  covenants,  call protection  features and,
where applicable, a higher level of collateral. They are, however, generally not
freely tradable because of restrictions  imposed by federal and state securities
laws and illiquid  trading  markets.  As of September 30, 2001, the  percentage,
based on estimated  fair value,  of total publicly  traded and privately  placed
fixed maturity  securities that were investment grade with an NAIC Designation 1
or 2 was 92%.                                                                   

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The table  below  shows the  carrying  amount of our  corporate  fixed  maturity
securities  by  industry  category,  as  well  as the  percentage  of the  total
corporate  portfolio that each industry  category  comprises as of September 30,
2001,  and December 31, 2000.                                                   

                                                        [Enlarge/Download Table]

                              U.S. Invested Assets                                                          
           Corporate Fixed Maturity Securities Portfolio by Industry                                        

                                                          As of September 30,           As of December 31,  
                                                                  2001                         2000         
                                                       -------------------------     -----------------------
                                                        Carrying          % of        Carrying        % of  
                                                         Amount           Total        Amount         Total 
                                                       -----------      --------     -----------    --------
                                                                          ($ in millions)                   
                                                                                                            
Industry Class                                                                                              
Transportation and Public Utilities............        $   7,339.9         33%       $   5,155.0       28%  
Finance, Insurance and Real Estate.............            5,519.3         25            4,958.0       27   
Manufacturing..................................            4,989.1         23            4,524.8       24   
Mining.........................................            1,648.0          7            1,432.9        8   
Retail.........................................            1,205.6          5            1,091.1        6   
Services.......................................            1,130.5          5            1,037.8        5   
Public Administration..........................              150.6          1              131.7        1   
Construction...................................              116.1          1              130.2        1   
Agriculture, Forestry and Fishing..............               84.9          -               75.9        -   
                                                       -----------      --------     -----------     -------
Total..........................................        $  22,184.0        100%       $  18,537.4      100%  
                                                       ===========      ========     ===========     =======

We held $6,362.3 million of  mortgage-backed  and asset-backed  securities as of
September  30,  2001,  and $6,416.3  million as of December 31, 2000.  The table
below  presents the types of  mortgage-backed  securities  ("MBSs"),  as well as
other asset-backed securities, held as of the dates indicated.                  

U.S. Invested Assets
Mortgage and Asset-Backed Securities

                                        Carrying Amount      Carrying Amount
                                       As of September 30,  As of December 31,
                                        2001                  2000
                                       -------------------  ------------------
                                             (in millions)

Residential pass-through securities....    $     3,245.8        $    3,426.5    
Commercial MBS.........................          1,743.2             1,403.4    
Asset-backed securities................          1,373.3             1,586.4    
                                          ----------------    ----------------
Total MBSs and asset-backed securities.    $     6,362.3        $    6,416.3    
                                          ================    ================

We believe that it is desirable to hold residential  mortgage-backed  securities
due to their credit  quality and liquidity as well as portfolio  diversification
characteristics. Our portfolio is comprised of GNMA, FNMA and FHLMC pass-through
securities  and is  actively  managed  to ensure  that the  securities  held are
trading  close to or below par,  in order to reduce risk of  prepayments.  As of
September 30, 2001, we held no collateralized  mortgage  obligations in our U.S.
invested asset portfolio.                                                       

Commercial  mortgage-backed securities provide high levels of credit protection,
diversification,   reduced  event  risk  and  enhanced   liquidity.   Commercial
mortgage-backed  securities  are  predominantly  comprised  of rated  large pool
securitizations that are individually and collectively diverse by property type,
borrower and geographic dispersion.                                             

We purchase  asset-backed  securities,  or ABS, to diversify the overall  credit
risks of the fixed  maturity  securities  portfolio  and to  provide  attractive
returns. The principal risks in holding  asset-backed  securities are structural

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and credit  risks.  Structural  risks  include  the  security's  priority in the
issuer's capital structure, the adequacy of and ability to realize proceeds from
the  collateral  and  the  potential  for  prepayments.   Credit  risks  involve
issuer/servicer risk where collateral values can become impaired in the event of
servicer credit deterioration.                                                  

Our ABS  portfolio  is  diversified  both by type of  asset  and by  issuer.  We
actively  monitor  holdings of  asset-backed  securities to ensure that the risk
profile of each security improves or remains consistent. If we are not receiving
an adequate yield for the risk, relative to other investment  opportunities,  we
will attempt to sell the  security.  Prepayments  in the ABS  portfolio  are, in
general,  insensitive  to changes in  interest  rates or are  insulated  to such
changes  by call  protection  features.  In the  event  that we are  subject  to
prepayment  risk, we monitor the factors that impact the level of prepayment and
prepayment  speed for those  asset-backed  securities.  To the extent we believe
that prepayment risk increases, we may attempt to sell the security and reinvest
in another  security that offers better yield relative to the risk. In addition,
we diversify the risks of asset-backed  securities by holding a diverse class of
securities, which limits our exposure to any one security.                      

U.S. Invested Assets
 Asset-Backed Securities by Type

                                   Carrying Amount         Carrying Amount
                                  As of September 30,     As of December 31,
                                 2001                   2000
                                   -------------------    --------------------
                                     (in millions)

Credit Cards......................     $       134.2          $        220.0    
Automobile receivables............              56.9                    72.2    
Collateralized debt obligations...             536.6                   579.1    
Lease receivables.................             124.3                   198.9    
Consumer loans....................             131.7                   145.0    
Other.............................             389.6                   371.2    
                                   -------------          --------------
Total asset-backed securities.....     $     1,373.3          $      1,586.4    
                                   =============          ==============

In accordance with our asset liability risk management techniques, we manage the
expected  lives  of U.S.  invested  assets  to be  similar  to the  lives of our
liabilities. Significant amounts of our liabilities have an expected life of six
years or less.  Therefore,  comparable amounts of assets have a similar expected
life. The amortized cost and estimated fair value of fixed maturity  securities,
by  contractual  maturity  dates,  excluding  scheduled  sinking  funds,  as  of
September 30, 2001, and December 31, 2000, as follows:                          

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                               
             Fixed Maturity Securities by Contractual Maturity Dates                                             

                                                               As of September 30,           As of December 31,  
                                                                      2001                           2000        
                                                            ------------------------      -----------------------
                                                            Amortized       Carrying       Amortized     Carrying
                                                               Cost          Amount          Cost         Amount 
                                                            ----------   -----------      ----------   ----------
                                                                                 (in millions)                   

                                                                                                                 
Due in one year or less..............................       $  1,249.4    $  1,257.2      $  1,093.6   $  1,083.8
Due after one year through five years................         11,159.5      11,541.8         9,691.0      9,687.7
Due after five years through ten years...............          5,557.1       5,764.5         5,058.0      5,135.6
Due after ten years..................................          4,448.1       4,578.8         3,505.4      3,551.6
                                                            ----------   -----------      ----------   ----------
   Subtotal..........................................         22,414.1      23,142.3        19,348.0     19,458.7
Mortgage-backed and other securities without a single                                                            
   maturity date.....................................          6,039.8       6,362.3         6,242.6      6,416.3
                                                            ----------   -----------      ----------   ----------
   Total.............................................       $ 28,453.9    $ 29,504.6      $ 25,590.6   $ 25,875.0
                                                            ==========   ===========      ==========   ==========

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We  monitor  any  decline in the credit  quality  of fixed  maturity  securities
through the designation of "problem securities",  "potential problem securities"
and  "restructured  securities".  We  define  problem  securities  in our  fixed
maturity  portfolio as securities:  (i) as to which  principal  and/or  interest
payments  are in default or (ii) issued by a company  that went into  bankruptcy
subsequent to the acquisition of such securities.  We define  potential  problem
securities in our fixed maturity portfolio as securities included on an internal
"watch list" for which  management  has concerns as to the ability of the issuer
to comply  with the  present  debt  payment  terms  and which may  result in the
security  becoming  a problem or being  restructured.  The  decision  whether to
classify a performing  fixed maturity  security as a potential  problem involves
significant  subjective judgments by management as to the likely future industry
conditions and developments with respect to the issuer.  We define  restructured
securities in our fixed maturity  portfolio as securities where a concession has
been granted to the borrower  related to the borrower's  financial  difficulties
that would not have otherwise been  considered.  We determine that  restructures
should occur in those  instances  where greater  economic value will be realized
under  the new terms  than  through  liquidation  or other  disposition  and may
involve a change in contractual cash flows.                                     

The table  below  presents  the  total  carrying  amount  of our fixed  maturity
portfolio,  as well as its problem,  potential  problem and  restructured  fixed
maturities:                                                                     

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                               
 Problem, Potential Problem and Restructured Fixed Maturities at Carrying Amount                                 

                                                                      As of September 30,      As of December 31,
                                                                              2001                    2000       
                                                                      -------------------      ------------------
                                                                                     ($ in millions)             

                                                                                                                 
Total fixed maturity securities (public and private)............         $   29,504.6             $  25,875.0    
                                                                         ============             ===========    

Problem fixed maturity securities...............................         $      177.6             $      79.0    
Potential problem fixed maturity securities.....................                179.1                   132.5    
Restructured fixed maturity securities..........................                103.1                    48.6    
                                                                         ------------             -----------    

Total problem, potential problem and restructured fixed maturity                                                 
securities......................................................         $      459.8             $     260.1    
                                                                         ============             ===========    
Total problem, potential problem and restructured fixed maturity                                                 
securities as a percent of total fixed maturity securities......                  2%                      1%     

Equity Securities                                                               

Our equity  securities  consist  primarily of investments  in common stocks.  We
classify our  investment  in common stocks as available for sale and report them
at estimated fair value. We report  unrealized gains and losses on common stocks
as a separate  component of other  comprehensive  income, net of deferred income
taxes and an adjustment for the effect on deferred  acquisition costs that would
have occurred if such gains and losses had been realized.                       

Investments in equity  securities,  totaled  $720.5 million and $666.0  million,
which  represented  2% of U.S.  invested  assets as of September  30, 2001,  and
December 31, 2000, respectively.  Investments in company-sponsored funds totaled
$438.2 million,  or 61%, of our U.S. equity securities as of September 30, 2001.
These  sponsored  funds are  intended  to be  marketed  to our asset  management
clients.  Of  company-sponsored  funds,  $293.0 million  represented  underlying
investments in publicly-traded  equities, $139.7 million represented investments
in  publicly-traded  fixed income  securities and $5.5 million in balanced funds
which represented investments in both publicly-traded  equities and fixed income
securities as of September 30, 2001. The remaining  balance of equity securities
is a mixture of public and private securities  acquired for investment  purposes
or which were acquired through equity participation features of below investment
grade bonds or through recoveries of defaulted securities.                      

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Mortgage Loans                                                                  

Mortgage loans  comprised 25% of total U.S.  invested assets as of September 30,
2001, and 27% as of December 31, 2000.  Mortgage loans consist of commercial and
residential loans.  Commercial  mortgage loans comprised $10,255.9 million as of
September 30, 2001,  and  $10,775.3  million as of December 31, 2000, or 91% and
95%, of total mortgage loan  investments,  respectively.  Residential  mortgages
comprised  $988.0  million and $550.5  million,  or 9% and 5%, of total mortgage
loan investments as of September 30, 2001, and December 31, 2000,  respectively.
Principal  Residential  Mortgage,  Inc. and Principal  Bank hold the majority of
residential loans. Principal Residential Mortgage,  Inc. holds residential loans
as part of its  securitization  inventory and Principal  Bank holds  residential
loans to comply with federal thrift charter requirements.                       

On  September  30,  2000,  we completed a  securitization  of $598.0  million of
general account  commercial loans comprised of 102 loans. We sold $578.4 million
of  investment  grade  bonds into the market and we  retained  $28.7  million of
interest only bonds.                                                            

Commercial  Mortgage Loans.  Commercial  mortgages play an important role in our
investment strategy by:                                                         

o    providing  strong  risk  adjusted  relative  value in  comparison  to other
investment alternatives;                                              
o    enhancing total returns; and                                               
o    providing strategic portfolio diversification.                             

As a result,  we have focused on constructing a solid, high quality portfolio of
mortgages.  Our portfolio is generally  comprised of mortgages with conservative
loan-to-value  ratios,  high debt service coverages and general purpose property
types with a strong credit tenancy.                                             

Our commercial  loan portfolio  consists of primarily  non-recourse,  fixed rate
mortgages on fully or near fully leased  properties.  The mortgage  portfolio is
comprised  of  general-purpose   industrial  properties,   manufacturing  office
properties and credit oriented retail properties.                               

California  accounted for 22% of our  commercial  mortgage loan  portfolio as of
September 30, 2001. We are,  therefore,  exposed to potential  losses  resulting
from the risk of catastrophes,  such as earthquakes, that may affect the region.
Like other  lenders,  we  generally  do not  require  earthquake  insurance  for
properties  on  which  we  make  commercial  mortgage  loans.  With  respect  to
California properties, however, we obtain an engineering report specific to each
property. The report assesses the building's design  specifications,  whether it
has been  upgraded to meet seismic  building  codes and the maximum loss that is
likely to result from a variety of different  seismic  events.  We also obtain a
report that assesses by building and  geographic  fault lines the amount of loss
our commercial  mortgage loan portfolio  might suffer under a variety of seismic
events.                                                                         

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The following is a summary of our commercial mortgage loans by property type and
geographic area as of September 30, 2001, and December 31, 2000.                

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                         
                  Commercial Mortgage Loan Distribution by Type                            

                                            As of September 30,         As of December 31, 
                                                    2001                       2000        
                                           ---------------------      ---------------------
                                            Carrying       % of        Carrying        % of
                                             Amount        Total        Amount        Total
                                           ----------      -----      ----------      -----
                                                           ($ in millions)                 
                                                                                           
Office........................             $  3,352.3        32%      $  3,273.5        30%
Retail........................                3,249.7        32          3,612.7        34 
Industrial....................                3,155.1        31          3,381.6        31 
Apartments....................                  409.2         4            419.7         4 
Mixed use/other...............                  115.0         1            130.2         1 
Hotel.........................                   63.6         1             65.6         1 
Valuation allowance...........                  (89.0)       (1)          (108.0)       (1)
                                           ----------      -----      ----------      -----
   Total......................             $ 10,255.9       100%      $ 10,775.3       100%
                                           ==========      =====      ==========      =====

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                         
                 Commercial Mortgage Loan Distribution by Region                           

                                            As of September 30,        As of December 31,  
                                                    2001                      2000         
                                           ---------------------      ---------------------
                                            Carrying       % of        Carrying       % of 
                                             Amount        Total        Amount        Total
                                           ----------      -----      ----------      -----
                                                           ($ in millions)                 
                                                                                           
Region:                                                                                    
Pacific.........................           $  2,648.1        26%      $  2,774.8        26%
South Atlantic..................              2,389.6        23          2,630.5        24 
Middle Atlantic.................              1,720.6        17          1,664.9        15 
East North Central..............                987.5        10          1,006.2         9 
West South Central..............                801.3         8            886.4         8 
Mountain........................                643.3         6            600.2         6 
West North Central..............                417.8         4            439.9         4 
New England.....................                376.9         4            495.9         5 
East South Central..............                359.8         3            384.5         4 
Valuation allowance.............                (89.0)       (1)          (108.0)       (1)
                                           ----------      -----      ----------      -----
   Total........................           $ 10,255.9       100%      $ 10,775.3       100%
                                           ==========      =====      ==========      =====

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The amortized cost of commercial  mortgage loans by contractual  maturity dates,
excluding  scheduled  sinking funds as of September  30, 2001,  and December 31,
2000, are as follows:                                                           

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                              
               Commercial Mortgage Loan Portfolio Maturity Profile                              

                                            As of September 30,           As of December 31,    
                                                    2001                          2000          
                                          ------------------------      ------------------------
                                           Amortized        % of         Amortized        % of  
                                             Cost           Total          Cost           Total 
                                          -----------     --------      -----------     --------
                                                                  ($ in millions)               
                                                                                                
Due in one year or less..............     $     882.5          9%       $     675.8          6% 
Due after one year through five years         3,156.0         30            3,033.4         28  
Due after five years through ten years        3,225.6         31            3,900.7         36  
Due after ten years..................         3,080.8         30            3,273.4         30  
                                          -----------     --------      -----------     --------
   Total.............................     $  10,344.9        100%       $  10,883.3        100% 
                                          ===========     ========      ===========     ========

We  actively  monitor  and  manage  our  commercial   mortgage  loan  portfolio.
Substantially all loans within the portfolio are analyzed regularly,  based on a
proprietary  risk  rating cash flow  model,  in order to monitor  the  financial
quality of these assets and are internally rated.  Based on ongoing  monitoring,
mortgage  loans with a likelihood  of becoming  delinquent  are  identified  and
placed on an internal  "watch  list".  Among  criteria  which  would  indicate a
potential  problem are:  imbalances in ratios of loan to value or contract rents
to debt service,  major tenant vacancies or bankruptcies,  borrower  sponsorship
problems,  late  payments,   delinquent  taxes  and  loan   relief/restructuring
requests.                                                                       

We state commercial  mortgage loans at their unpaid principal  balances,  net of
discount accrual and premium  amortization,  valuation allowances and writedowns
for impairment.  We provide a valuation  allowance for commercial mortgage loans
based on past loan loss  experience  and for  specific  loans  considered  to be
impaired.  Mortgage  loans  are  considered  impaired  when,  based  on  current
information  and events,  it is probable  that all amounts due  according to the
contractual terms of the loan agreement may not be collected.  When we determine
that a loan is  impaired,  we establish a valuation  allowance  for loss for the
excess of the carrying value of the mortgage loan over its estimated fair value.
Estimated  fair value is based on either the present  value of  expected  future
cash flows discounted at the loan's original effective interest rate, the loan's
observable market price or the fair value of the collateral. We record increases
in such valuation allowances as realized investment losses and, accordingly,  we
reflect such losses in our  consolidated  results of operations.  Such increases
(decreases)  in valuation  allowances  aggregated  $(19.0)  million for the nine
months ended  September 30, 2001, and $(9.8) million for the year ended December
31, 2000.                                                                       

We review our  mortgage  loan  portfolio  and  analyze  the need for a valuation
allowance  for any loan which is  delinquent  for 60 days or more, in process of
foreclosure,  restructured,  on the  "watch  list",  or  which  currently  has a
valuation allowance. We categorize loans which are delinquent,  loans in process
of  foreclosure  and  loans to  borrowers  in  bankruptcy  as  "problem"  loans.
Potential  problem loans are loans placed on an internal  "watch list" for which
management  has  concerns as to the  ability of the  borrower to comply with the
present loan payment  terms and which may result in the loan  becoming a problem
or being  restructured.  The decision whether to classify a performing loan as a
potential problem involves significant  subjective judgments by management as to
the likely  future  economic  conditions  and  developments  with respect to the
borrower. We categorize loans for which the original terms of the mortgages have
been modified or for which interest or principal  payments have been deferred as
"restructured"  loans.  We also consider  matured  loans that are  refinanced at
below market rates as restructured.                                             

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We charge  mortgage loans deemed to be  uncollectible  against the allowance for
losses and credit subsequent recoveries to the allowance for losses. We maintain
the allowance for losses at a level management believes to be adequate to absorb
estimated  probable credit losses.  Management bases its periodic  evaluation of
the adequacy of the allowance for losses on our past loan loss experience, known
and inherent  risks in the  portfolio,  adverse  situations  that may affect the
borrower's  ability to repay, the estimated value of the underlying  collateral,
composition  of the  loan  portfolio,  current  economic  conditions  and  other
relevant  factors.  The  evaluation  is  inherently  subjective  as it  requires
estimating  the amounts and timing of future cash flows  expected to be received
on impaired loans that may change.                                              

The table below represents our commercial  mortgage valuation  allowance for the
periods indicated:                                                              

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                         
                     Commercial Mortgage Valuation Allowance                                               

                                                              As of September 30,        As of December 31,
                                                                      2001                     2000        
                                                              -------------------      --------------------
                                                                             ($ in millions)               
                                                                                                           
Beginning balance.........................................       $     108.0              $     117.8      
Provision.................................................              10.5                      3.0      
Release due to writedowns, sales and foreclosures.........             (29.5)                   (12.8)     
                                                                 -----------              -----------      
Ending balance............................................       $      89.0              $     108.0      
                                                                 ===========              ===========      
Valuation allowance as % of carrying value before reserves               1%                       1%       

The following table presents the carrying amounts of problem,  potential problem
and  restructured  commercial  mortgages  relative to the carrying amount of all
commercial mortgages as of the dates indicated:                                 

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                             
 Problem, Potential Problem and Restructured Commercial Mortgages at Carrying Amount                           

                                                                   As of September 30,      As of December 31, 
                                                                          2001                      2000       
                                                                   -------------------      -------------------
                                                                                 ($ in millions)               
                                                                                                               
Total commercial mortgages ...................................        $    10,255.9            $    10,775.3   
                                                                      =============            =============   

Problem commercial mortgages(1)...............................        $        21.0            $         8.9   
Potential problem commercial mortgages .......................                 67.1                     58.9   
Restructured commercial mortgages ............................                 40.8                     92.6   
                                                                      -------------            -------------   
Total problem, potential problem and restructured                                                              
     commercial mortgages ....................................        $       128.9            $       160.4   
                                                                      =============            =============   
 Total problem, potential problem and restructured commercial                                                  
     mortgages as a percent of total commercial mortgages.....                  1%                       1%    


(1)  Problem commercial mortgages included mortgage loans in foreclosure of $6.0
     million  as  of  December  31,  2000.  There  were  no  mortgage  loans  in
foreclosure as of September 30, 2001.                                 

Equity Real Estate                                                              

We hold commercial equity real estate as part of our investment portfolio. As of
September 30, 2001,  and December 31, 2000,  the carrying  amount of equity real
estate  investment was $1,140.1  million and $1,391.8  million,  or 3% and 4% of
U.S.  invested assets,  respectively.  We own real estate,  real estate acquired
upon foreclosure of commercial mortgage loans and interests, both majority owned
and non-majority owned, in real estate joint ventures. We continue to focus on a
long-term strategy of reducing our real estate equity portfolio.                

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Equity real estate is categorized as either "real estate held for investment" or
"real  estate held for sale".  Real estate held for  investment  totaled  $528.4
million as of September  30, 2001,  and $696.4  million as of December 31, 2000.
The carrying value of real estate held for investment is generally  adjusted for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying amount of the asset may not be recoverable. Such impairment adjustments
are recorded as realized investment losses and accordingly, are reflected in our
consolidated  results of  operations.  For the nine months ended  September  30,
2001,  and the year ended  December  31,  2000,  there  were no such  impairment
adjustments.                                                                    

The carrying  amount of real estate held for sale as of September 30, 2001,  and
December  31,  2000,  was $611.7  million and $695.4  million,  net of valuation
allowances of $17.4 million and $40.8 million, respectively.  Once we identify a
real estate  property to be sold and commence a plan for marketing the property,
we classify  the property as held for sale.  We establish a valuation  allowance
subject to periodical revisions,  if necessary,  to adjust the carrying value of
the  property  to reflect the lower of its  current  carrying  value or the fair
value, less associated selling costs.                                           

We use research,  both internal and external,  to recommend  appropriate product
and geographic  allocations and changes to the equity real estate portfolio.  We
monitor product, geographic and industry diversification separately and together
to determine the most appropriate mix.                                          

Derivatives                                                                     

We use  various  derivative  financial  instruments  to manage our  exposure  to
fluctuations  in interest  rates,  including  interest rate futures and interest
rate swaps and  swaptions.  We use  interest  rate  futures  contracts  to hedge
changes in interest rates subsequent to the issuance of an insurance  liability,
such as a  guaranteed  investment  contract,  but  prior  to the  purchase  of a
supporting  asset,  or during periods of holding assets in  anticipation of near
term liability sales. We use interest rate swaps primarily to more closely match
the interest rate characteristics of assets and liabilities. They can be used to
change the interest rate  characteristics  of specific assets and liabilities as
well as an entire portfolio.  Occasionally, we will sell a callable liability or
a liability with  attributes  similar to a call option.  In these cases, we will
use  interest  rate  swaptions  or similar  products  to hedge the risk of early
liability payment, thereby transforming the callable liability into a fixed term
liability.                                                                      

We also seek to reduce call or prepayment  risk arising from changes in interest
rates in individual  investments.  We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require  additional  yield on these  investments to compensate for the risk that
the issuer will  exercise  such  option.  An example of an  investment  we limit
because of the option risk is residential  mortgage-backed securities. We assess
option risk in all investments we make and, when we take that risk, we price for
it accordingly.                                                                 

Foreign  currency  risk is the risk that we will  incur  economic  losses due to
adverse  fluctuations in foreign currency  exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional   amount   of   our   currency   swap   agreements    associated   with
foreign-denominated  liabilities as of September 30, 2001, was $3,099.7 million.
We  also  have  fixed  maturity  securities  that  are  denominated  in  foreign
currencies.  However,  we use derivatives to hedge the foreign  currency risk of
these funding  agreements  and  securities.  As of September 30, 2001,  the fair
value of our foreign currency  denominated fixed maturity  securities was $334.5
million.  We use  currency  swap  agreements  of the same  currency to hedge the
foreign currency exchange risk related to these investments. The notional amount
of our  currency  swap  agreements  associated  with  foreign-denominated  fixed
maturity securities as of September 30, 2001, was $379.0 million.               

In conjunction  with the interest rate swaps,  interest rate swaptions and other
derivatives,  we are exposed to counterparty risk, or the risk that counterparty
fails to perform the terms of the derivative  contract.  We actively manage this
risk by:                                                                        

o    establishing  exposure  limits  which  take  into  account   non-derivative
exposure we have with the counterparty as well as derivative exposure;

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o    performing  similar credit  analysis prior to approval on each  derivatives
counterparty that we do when lending money on a long-term basis;      
o    limiting exposure to AA- credit or better;                                 
o    conducting  stress-test  analysis to determine the maximum exposure created
during the life of a  prospective  transaction; and                   
o    daily monitoring of counterparty credit ratings.                           

All new derivative  counterparties are approved by the investment committee.  We
believe the risk of incurring losses due to nonperformance by our counterparties
is remote and that such losses, if any, would not be material. Futures contracts
trade on organized exchanges and, therefore, effectively have no credit risk.   

The  notional  amounts  used to express  the extent of our  involvement  in swap
transactions  represent  a  standard  measurement  of the  volume  of  our  swap
business.  Notional amount is not a quantification of market risk or credit risk
and it may not  necessarily be recorded on the balance sheet.  Notional  amounts
represent those amounts used to calculate  contractual flows to be exchanged and
are not paid or received,  except for contracts such as currency  swaps.  Actual
credit exposure  represents the amount owed to us under derivative  contracts as
of the valuation date. The following  tables present our position in, and credit
exposure to,  derivative  financial  instruments  as of September 30, 2001,  and
December 31, 2000:                                                              

                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                                  
                        Derivative Financial Instruments                                            

                                                     As of September 30,         As of December 31, 
                                                              2001                      2000        
                                                     -------------------      ----------------------
                                                     Notional     % of        Notional        % of  
                                                      Amount      Total        Amount         Total 
                                                     ---------    ------      ---------       ------
                                                                       ($ in millions)              

                                                                                                    
Foreign currency swaps..........................     $ 3,478.7      17%       $ 2,745.0         26% 
Interest rate floors............................       2,550.0      12          2,450.0         23  
Interest rate swaps.............................       3,188.6      15          2,391.5         23  
Mortgage-backed forwards and options............       8,312.5      40          1,898.3         18  
Swaptions ......................................       2,735.0      13            697.7          7  
Call options....................................          30.0       -             30.0          -  
US treasury futures.............................          75.9       -            183.2          2  
Currency forwards...............................          39.4       -             39.4          -  
Forwards........................................         153.1       1              -            -  
Principal Only swaps............................         250.0       1              -            -  
Treasury rate guarantees........................         191.0       1             60.0          1  
                                                     ---------    ------        ---------     ------
   Total........................................     $21,004.2     100%       $10,495.1        100% 
                                                     =========    ======      =========       ======

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                                                        [Enlarge/Download Table]


                              U.S. Invested Assets                                              
                        Derivative Financial Instruments                                        

                                                      As of September 30,     As of December 31,
                                                              2001                    2000      
                                                     -------------------      ------------------
                                                       Credit     % of          Credit     % of 
                                                      Exposure    Total        Exposure    Total
                                                     ---------    ------      ---------    -----
                                                                      ($ in millions)           
                                                                                                
Foreign currency swaps..........................     $    40.2      10%       $    45.3     42% 
Interest rate floors............................           4.3       1             20.0     18  
Interest rate swaps.............................          34.2       9             14.1     13  
Call options....................................           9.5       2             12.3     11  
Swaptions ......................................           8.0       2             11.8     11  
Currency forwards...............................           9.9       3              5.5      5  
Principal Only swaps............................           0.7       -              -        -  
Mortgage-backed forwards and options............         284.2      73              -        -  
                                                     ---------    ------      ---------    -----
   Total........................................     $   391.0     100%       $   109.0    100% 
                                                     =========    ======      =========    =====

Other Investments                                                               

Our other investments  totaled $842.4 million as of September 30, 2001, compared
to $681.2  million as of  December  31,  2000.  Our  investment  in  Coventry is
included in other investments as we accounted for it using the equity method. As
of September 30, 2001, our carrying value in Coventry was $139.4  million.  Also
included in other  investments is a $131.3  million  investment in an Australian
hotel  trust,  which  we  acquired  in  connection  with our  acquisition  of BT
Financial Group.  With the adoption of SFAS 133 on January 1, 2001,  derivatives
were  reflected on our balance sheet and  accounted for $152.1  million in other
investments  as of September 30, 2001. The remaining  investment  assets include
leases and other private equity investments.                                    

Securities Lending                                                              

The terms of our securities lending program,  approved in 1999, allow us to lend
our securities to major brokerage  firms. Our policy requires an initial minimum
of 102% of the fair value of the loaned  securities as  collateral.  Although we
lend  from time to time  during  the  financial  reporting  quarters,  we had no
securities  on  loan as of  December  31,  2000.  Our  securities  on loan as of
September 30, 2001, had a fair value of $347.1 million.                         

International Investment Operations                                             

As of September 30, 2001, our international investment operations consist of the
investments of Principal  International and BT Financial Group and comprise $1.2
billion in invested  assets,  which primarily  represent the assets of Principal
International.   Principal   Capital   Management   works  with  each  Principal
International  affiliate to develop investment  policies and strategies that are
consistent  with the products they offer.  Due to the regulatory  constraints in
each country,  each company  maintains  its own  investment  policies  which are
approved by  Principal  Capital  Management.  Each  international  affiliate  is
required to submit a  compliance  report  relative to its  strategy to Principal
Capital Management. A credit committee comprised of Principal Capital Management
employees and international  affiliate company chief investment officer's review
each corporate credit annually. In addition,  employees from our U.S. operations
who serve on the credit committee currently hold investment  positions in two of
our  international  affiliates.  Principal  Capital  Management  provides annual
credit approval training to Principal International personnel.                  

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Overall Composition of International Invested Assets                            

As shown in the table below,  the major  categories  of  international  invested
assets as of September  30, 2001,  and  December 31, 2000,  were fixed  maturity
securities and residential mortgage loans:                                      

                                                        [Enlarge/Download Table]


                          International Invested Assets                                             

                                                          As of September 30,     As of December 31,
                                                                  2001                    2000      
                                                         -------------------      ------------------
                                                          Carrying      % of       Carrying     % of
                                                           Amount      Total       Amount      Total
                                                         -----------   -----      ----------   -----
                                                                        ($ in millions)             
                                                                                                    
Fixed maturity securities, available-for-sale                                                       
   Public.........................................       $    844.9      68%      $    948.6     70%
   Private........................................             52.6        4            16.3      1 
Equity securities, available-for-sale.............             43.8        4            76.9      6 
Mortgage loans                                                                                      
   Residential....................................            165.9       13           166.9     12 
Real estate held for investment...................              7.3        1             8.7      1 
Other investments ................................            128.4       10           129.8     10 
                                                         ----------    -----       ---------   -----
Total invested assets.............................       $  1,242.9     100%      $  1,347.2    100%
                                                         ==========    =====      ==========   =====

Cash and cash equivalents.........................            183.2                    176.5        
                                                         -----------              ----------        

Total invested assets and cash ...................       $   1,426.1              $  1,523.7        
                                                         ===========              ==========        

International Investment Results                                                

The yield on  international  invested  assets and on cash and cash  equivalents,
excluding net realized gains and losses,  was 9.0% and 6.6% for the three months
ended September 30, 2001, and 2000, respectively, and 8.3% and 6.6% for the nine
months ended September 30, 2001, and 2000, respectively.                        

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The table below illustrates the yields on average assets for each of the        
components of our investment portfolio for the three and nine months ended      
September 30, 2001, and 2000:                                                   

                                                        [Enlarge/Download Table]


                          International Invested Assets                                                                
                              Yields by Asset Type                                                                     

                                            As of or for the three months              As of or for the nine months    
                                                  ended September 30,                        ended September 30,       
                                         ------------------------------------      ------------------------------------
                                                2001                 2000                2001                  2000    
                                         ----------------    ----------------      ----------------    ----------------
                                         Yield   Amount      Yield   Amount        Yield    Amount     Yield   Amount  
                                         -----  ---------    -----  ---------      -----  ---------    -----  ---------
                                                                        ($ in millions)                                
                                                                                                                       
Fixed maturity securities,                                                                                             
  available-for-sale                                                                                                   
    Gross investment income (1)...       10.1%   $   21.8     6.7%   $   15.3       9.2%   $   64.2     7.2%   $   47.8
    Net realized capital gains                                                                                         
      (losses)....................       (1.1)       (2.3)    -          (0.1)     (0.5)       (3.4)    0.5         3.7
                                                ---------           ---------             ---------           ---------
    Total.........................               $   19.5            $   15.2              $   60.8            $   51.5
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $  897.5            $  913.3              $  897.5            $  913.3
Equity securities,                                                                                                     
  available-for-sale                                                                                                   
    Gross investment income (1)...        1.9%   $    0.2     0.5%   $    0.1       0.4%   $    0.2     0.7%   $    0.5
    Net realized capital gains....        1.9         0.2     8.6         1.9       2.0         0.9     1.9         1.3
                                                ---------           ---------             ---------           ---------
    Total.........................               $    0.4            $    2.0              $    1.1            $    1.8
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $   43.8            $   85.0              $   43.8            $   85.0
Mortgage loans - Residential                                                                                           
    Gross investment income (1)...        8.7%   $    3.7     8.7%   $    3.1      10.3%   $   12.9     8.8%   $    8.0
    Net realized capital gains                                                                                         
      (losses)....................        -           -       -           -         -           -       -           -  
                                                ---------           ---------             ---------           ---------
    Total.........................               $    3.7            $    3.1              $   12.9            $    8.0
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $  165.9            $  150.6              $  165.9            $  150.6
Real estate                                                                                                            
    Gross investment income (1)...        5.2%   $    0.1     3.9%   $    0.1       8.3%   $    0.5     5.4%   $    0.4
    Net realized capital gains                                                                                         
      (losses)....................        -           -       -           -         -           -       -           -  
                                                ---------           ---------             ---------           ---------
    Total.........................               $    0.1            $    0.1              $    0.5            $    0.4
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $    7.3            $   10.0              $    7.3            $   10.0
Cash and cash equivalents                                                                                              
    Gross investment income (1)...        3.8%   $    1.5     4.3%   $    2.2       3.7%   $    5.0     3.9%   $    5.7
    Net realized capital gains                                                                                         
      (losses)....................        -           -       -           -         -           -       -           -  
                                                ---------           ---------             ---------           ---------
    Total.........................               $    1.5            $    2.2              $    5.0            $    5.7
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $  183.2            $  187.3              $  183.2            $  187.3
Other investments                                                                                                      
    Gross investment income (1)...       12.0%   $    3.6    13.7%   $    4.2       9.7%   $    9.4     9.4%   $   11.2
    Net realized capital gains                                                                                         
      (losses)....................      (12.7)       (3.8)   (1.3)       (0.4)    (43.5)      (42.1)    0.1         0.1
                                                ---------           ---------             ---------           ---------
    Total.........................               $   (0.2)           $    3.8              $  (32.7)           $   11.3
                                                =========           =========             =========           =========
    Ending assets (at carrying                                                                                         
      value)......................               $  128.4            $  120.5              $  128.4            $  120.5
Total before investment expenses                                                                                       
    Gross investment income.......        9.1%   $   30.9     6.8%   $   25.0       8.3%   $   92.2     6.7%   $   73.6
    Net realized capital gains                                                                                         
      (losses)....................       (1.7)       (5.9)    0.4         1.4      (4.0)      (44.6)    0.5         5.1
                                                ---------           ---------             ---------           ---------
    Total.........................               $   25.0            $   26.4              $   47.6            $   78.7
                                                =========           =========             =========           =========

Investment expenses...............        0.1%   $    0.2     0.1%   $    0.5       0.1%   $    0.9     0.1%   $    1.5
Net investment income.............        9.0%   $   30.7     6.6%   $   24.5       8.3%   $   91.3     6.6%   $   72.1

--------------------                                                            
(1)  Yields,  which are annualized for interim  periods,  are based on quarterly
     average  asset  carrying  values for the three months and nine months ended
September 30, 2001, and 2000.                                         

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Fixed Maturity Securities                                                       

Fixed maturity  securities  consist primarily of publicly traded debt securities
and represented 72% of total  international  invested assets as of September 30,
2001,  and  71%  as  of  December  31,  2000.  Fixed  maturity  securities  were
diversified  by type of issuer as of September 30, 2001,  and for the year ended
December 31, 2000, as shown in the following table:                             

                                                        [Enlarge/Download Table]


                          International Invested Assets                                                  
                   Fixed Maturity Securities by Type of Issuer                                           

                                                            As of September 30,       As of December 31, 
                                                                    2001                      2000       
                                                            --------------------      -------------------
                                                            Carrying       % of       Carrying      % of 
                                                             Amount        Total       Amount       Total
                                                            --------       -----      --------      -----
                                                                          ($ in millions)                
                                                                                                         
U.S. Treasury securities and obligations of U.S.                                                         
   Government corporations and agencies..............       $   0.5          -%       $   1.8         -% 
Non-U.S. governments.................................         317.0         35          313.6        32  
Corporate - public...................................         304.3         34          376.5        39  
Corporate - private..................................          52.6          6           16.3         2  
Mortgage-backed securities and other asset                                                               
   backed securities.................................         223.1         25          256.7        27  
                                                            --------       -----      --------      -----
Total fixed maturities...............................       $ 897.5        100%       $ 964.9       100% 
                                                            ========       =====      ========      =====

The fixed maturity securities held by the international operations have not been
rated by external agencies and cannot be presented in a comparable rating agency
equivalent.                                                                     

The  issuers of the  majority of our fixed  maturity  corporate  securities  are
mainly  banks and are  categorized  in the  finance,  insurance  and real estate
category as shown in the table below:                                           

                                                        [Enlarge/Download Table]


                          International Invested Assets                               
                Corporate Fixed Maturities Portfolio by Industry                      

                                            As of September 30,     As of December 31,
                                                    2001                    2000      
                                            -------------------     ------------------
                                            Carrying      % of      Carrying      % of
                                             Amount       Total      Amount      Total
                                            --------      -----     --------     -----
                                                            ($ in millions)           
                                                                                      
Industry Class                                                                        
Transportation and public utilities.....    $  41.4        12%      $ 100.6       26% 
Finance, insurance and real estate......      175.1        49         240.3       61  
Manufacturing...........................       15.8         4          13.6        3  
Mining..................................        -           -           -          -  
Services................................       49.7        14          11.8        3  
Retail..................................       30.7         9          26.2        7  
Public administration...................        0.1         -           -          -  
Construction............................       44.1        12           0.3        -  
                                            -------       -----     -------      -----
Total...................................    $ 356.9       100%      $ 392.8      100% 
                                            =======       =====     =======      =====

The  international  operations  held $223.1 million of residential  pass-through
securities as of September 30, 2001, and $256.7 million as of December 31, 2000.

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The amortized  cost and estimated fair value of fixed  maturity  securities,  by
contractual  maturity dates excluding  scheduled  sinking funds, as of September
30, 2001, and December 31, 2000, were as follows:                               

                                                        [Enlarge/Download Table]


                          International Invested Assets                                                           
             Fixed Maturity Securities by Contractual Maturity Dates                                              

                                                               As of September 30,           As of December 31,   
                                                                      2001                           2000         
                                                            ------------------------     -------------------------
                                                            Amortized       Carrying     Amortized        Carrying
                                                               Cost          Amount         Cost           Amount 
                                                            ---------       --------     ---------        --------
                                                                                 (in millions)                    
                                                                                                                  
Due in one year or less..............................       $    82.0       $   82.0     $    31.6        $   29.2
Due after one year through five years................            91.7           93.5          91.8            95.3
Due after five years through ten years...............           193.9          196.7         215.6           217.2
Due after ten years..................................           311.5          302.2         356.4           366.5
                                                            ---------       --------     ---------        --------
   Subtotal..........................................           679.1          674.4         695.4           708.2
Mortgage-backed and other securities without a single                                                             
   maturity date.....................................           218.4          223.1         253.5           256.7
                                                            ---------       --------     ---------        --------
   Total.............................................       $   897.5       $  897.5     $   948.9        $  964.9
                                                            =========       ========     =========        ========

Equity Securities                                                               

Our equity  securities  represented 4% of  international  invested  assets as of
September  30,  2001,  and 6% as of December  31,  2000.  Our equity  securities
consisted of $30.6  million in mutual funds and $13.2 million in common stock as
of September 30, 2001.                                                          

Residential Mortgage Loans                                                      

Our  Chilean  operations  originate  residential  mortgage  loans.   Residential
mortgage loans  comprised  $165.9  million,  or 13%, of  international  invested
assets as of September 30, 2001, and $166.9 million,  or 12%, as of December 31,
2000.                                                                           

Derivatives                                                                     

Our use of derivative instruments includes foreign currency swaps, interest rate
swaps and currency  forwards.  The following tables present our position in, and
credit exposure to, derivative  financial  instruments as of September 30, 2001,
and December 31, 2000.                                                          

 International Invested Assets
Derivative Financial Instruments

                              As of September 30,         As of December 31,
                             2001                     2000
                             --------------------      ---------------------
                            Notional       % of       Notional        % of
                              Amount        Total       Amount         Total
                             --------       -----      --------        -----
                           ($ in millions)

Foreign currency swaps...      $  693.6        40%       $  665.0         39%   
Interest rate swaps......         665.0        38           665.0         39    
Currency forwards........         380.0        22           380.0         22    
                             --------       -----      --------        -----
Total.................      $1,738.6       100%       $1,710.0        100%
                             ========       =====      ========        =====

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 International Invested Assets
Derivative Financial Instruments

                        As of September 30,       As of December 31,
                      2001                      2000
                       --------------------      -------------------
                       Credit        % of       Credit        % of
                       Exposure       Total      Exposure      Total
                       --------       -----      --------      -----
                           ($ in millions)

Interest rate swaps......    $   72.7         37%      $   39.1        42%      
Foreign currency swaps...        57.2         29           28.4        30       
Currency forwards........        67.4         34           26.2        28       
                       --------       -----      --------      -----
Total.................    $  197.3        100%      $   93.7       100%   
                       ========       =====      ========      =====

Other Investments                                                               

Our other investments  totaled $128.4 million as of September 30, 2001, compared
to $129.8 million as of December 31, 2000. Of the $128.4 million,  $35.5 million
is related to subordinated notes in BT Financial Group's margin lending program,
$37.7 million  represents our  investments  in  unconsolidated  subsidiaries  in
Brazil,   Japan  and  India,  $19.5  million  represents  BT  Financial  Group's
investment in unit trusts,  $35.3 million  represents other invested assets from
our Chilean  operations and $0.4 million  represents  other invested assets from
our Mexican operations.                                                         

Item 3. Quantitative and Qualitative Disclosures About Market Risk              

Market Risk Exposures and Risk Management                                       

Market risk is the risk that we will incur losses due to adverse fluctuations in
market  rates and  prices.  Our primary  market  risk  exposure is to changes in
interest rates,  although we also have exposures to changes in equity prices and
foreign currency exchange rates.                                                

The active  management of market risk is an integral part of our operations.  We
manage our overall market risk exposure within established risk tolerance ranges
by using the following approaches:                                              

o    rebalance our existing asset or liability portfolios;                      
o    control the risk structure of newly acquired assets and liabilities; or    
o    use  derivative  instruments to modify the market risk  characteristics  of
existing assets or liabilities or assets expected to be purchased.    

Interest Rate Risk                                                              

Interest rate risk is the risk that we will incur economic losses due to adverse
changes in interest rates. Our exposure to interest rate risk stems largely from
our substantial  holdings of guaranteed fixed rate liabilities in our U.S. Asset
Management and Accumulation segment.                                            

We seek to earn  returns  on  investments  that  enhance  our  ability  to offer
competitive  rates and prices to customers while  contributing to attractive and
stable  profits  and  long-term  capital  growth.  Accordingly,  our  investment
decisions  and  objectives  are a function of the  underlying  risks and product
profiles of each  primary  business  operation.  In addition,  we diversify  our
product portfolio  offerings to include products that contain features that will
protect us against  fluctuations  in  interest  rates.  Those  features  include
adjustable   crediting  rates,   policy  surrender   charges  and  market  value
adjustments on liquidations.                                                    

We manage the interest rate risk inherent in our assets relative to the interest
rate risk  inherent in our  liabilities.  One of the measures we use to quantify

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this  exposure is  duration.  Duration  measures the change in the fair value of
assets and  liabilities  for given changes in interest  rates.  For example,  if
interest rates increase by a hypothetical 100 basis points, the fair value of an
asset  with  a  duration  of 5  years  is  expected  to  decrease  in  value  by
approximately 5%.                                                               

To calculate duration, we project asset and liability cashflows. These cashflows
are discounted to a net present value basis using a spot yield curve, which is a
blend of the spot  yield  curves for each of the asset  types in the  portfolio.
Duration is calculated by  re-calculating  these cashflows and redetermining the
net  present  value  based upon an  alternative  level of  interest  rates,  and
determining the percentage change in fair value.                                

As of  September  30,  2001,  the  difference  between  the asset and  liability
durations  on our primary  duration  managed  portfolio  was -0.12  years.  This
duration gap indicates that as of this date the sensitivity of the fair value of
our assets to interest rate movements is less than that of the fair value of our
liabilities. Our goal is to minimize the duration gap. Currently, our guidelines
dictate that total duration gaps between the asset and liability portfolios must
be within 0.25 years.  The value of the assets in this  portfolio  was $24,691.7
million as of September 30, 2001.                                               

We also manage interest rate risk by employing a partial duration analysis. With
this technique,  the yield curve is dissected into various term components and a
partial  duration is calculated for each. Each partial  duration  represents the
potential  change in fair value of the asset or liability to interest rate shift
in rates in the applicable  component of the yield curve. We minimize  potential
volatility in the fair value of surplus of Principal Life as a result of changes
in the yield curve by managing each partial  duration gap between the assets and
liabilities within established guidelines.                                      

With respect to our primary duration managed  portfolio,  we use several methods
to correct any potential total or partial  duration gaps that are outside of our
established  risk  tolerance  ranges.  We can  rebalance  the existing  asset or
liability  portfolios  or we can  redirect new asset  purchases  until the asset
portfolio is better aligned with the  liabilities and our duration gaps are back
within their limits. If a more expedient  correction is desired,  another method
we use is forward interest rate swaps. These swaps are designed to move duration
exposure  from one  specific  point on the yield  curve to  another,  and are an
efficient  way to quickly  shift the partial and total  duration  profile of the
asset portfolio so that duration gaps and hence interest rate risk is minimized.

For  products  such as whole  life  insurance,  term life  insurance  and single
premium deferred  annuities,  the liability cashflow is less predictable,  and a
duration-matching  strategy is less reliable and manageable. We do, however, try
to manage  the  duration  of these  portfolios.  For these  products,  we manage
interest rate risk based on a modeling process that considers the target average
life,  maturities,  crediting rates and assumptions of policyholder behavior. As
of September 30, 2001,  the  weighted-average  difference  between the asset and
liability  durations  on these  portfolios  was 1.2  years.  This  duration  gap
indicates  that as of this date the  sensitivity of the fair value of our assets
to  interest  rate  movements  is  greater  than  that of the fair  value of our
liabilities. We attempt to monitor this duration gap consistent with our overall
risk/reward  tolerances.  The  value  of the  assets  in  these  portfolios  was
$12,470.8 million as of September 30, 2001.                                     

We also have a block of  participating  general  account  pension  business that
passes the actual  investment  performance  of the assets to the  customer.  The
investment  strategy  of this  block is to  maximize  investment  return  to the
customer on a "best efforts" basis,  and there is little or no attempt to manage
the duration of this  portfolio  since there is little or no interest rate risk.
The value of the assets in these portfolios was $2,463.4 million as of September
30, 2001.                                                                       

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Using the  assumptions  and data in effect as of September 30, 2001, we estimate
that a 100 basis point immediate,  parallel increase in interest rates decreases
the net fair value of our  portfolio  by $120.1  million.  The  following  table
details the estimated changes by risk management strategy:                      

     As of
  Risk Management         September 30, 2001      Net Fair Value
 Strategy            Value of Total Assets        Change
------------------------------   ----------------------   --------------        
                         (in millions)

Primary duration-managed......        $   24,691.7          $     28.6          
Duration-monitored............            12,470.8              (148.7)         
Non duration-managed..........             2,463.4                 -            
                         ----------------------   --------------
Total......................        $   39,625.9          $   (120.1)      
                         ======================   ==============

Our selection of a 100 basis point immediate,  parallel  increase or decrease in
interest rates is a hypothetical  rate scenario we use to demonstrate  potential
risk.  While a 100 basis point immediate,  parallel  increase does not represent
our  view of  future  market  changes,  it is a near  term  reasonably  possible
hypothetical change that illustrates the potential impact of such events.  While
these  fair  value  measurements  provide  a  representation  of  interest  rate
sensitivity,  they are based on our  portfolio  exposures at a point in time and
may not be representative of future market results.  These exposures will change
as a result of ongoing  portfolio  transactions  in  response  to new  business,
management's  assessment of changing market conditions and available  investment
opportunities.                                                                  

We are also exposed to interest rate risk in our Mortgage  Banking  segment.  We
manage this risk by striving to balance our loan  origination and loan servicing
operations, the two of which are generally counter-cyclical. In addition, we use
various financial instruments,  including derivatives  contracts,  to manage the
interest rate risk  specifically  related to committed loans in the pipeline and
mortgage  servicing  rights.  The overall  objective of our  interest  rate risk
management  policies is to offset changes in the values of these items resulting
from changes in interest rates. We do not speculate on the direction of interest
rates in our management of interest rate risk.                                  

We manage interest rate risk on our mortgage loan pipeline by buying and selling
mortgage-backed  securities in the forward markets,  over-the-counter options on
mortgage-backed  securities,  U.S.  Treasury  futures  contacts  and  options on
futures contracts. We also use interest rate floors, futures contracts,  options
on futures contracts,  swaps and swaptions in hedging a portion of our portfolio
of mortgage  servicing  rights from  prepayment  risk associated with changes in
interest rates.                                                                 

We measure  pipeline  interest  rate risk  exposure  by  adjusting  the  at-risk
pipeline in light of the theoretical  optionality of each applicant's rate/price
commitment. The at-risk pipeline, which consists of closed loans and rate locks,
is then refined at the product type level to express each product's  sensitivity
to  changes in market  interest  rates in terms of a single  current  coupon MBS
duration. Suitable hedges are selected and a similar methodology applied to this
hedge  position.  We limit our risk exposure by requiring  that the net position
value not change by more than $10.0 million given an instantaneous change in the
benchmark MBS price of +/- 2.5%. This price sensitivity analysis is performed at
least once daily.  The value of the loans in the  pipeline as of  September  30,
2001, was $6.8 billion. Due to the impact of our hedging activities, we estimate
that a 100  basis  point  immediate  parallel  increase  in the  interest  rates
decreases the September 30, 2001, net position value by $36.0 million.          

The financial risk associated with our mortgage servicing operations is the risk
that the market value of the servicing asset falls below its GAAP book value. To
measure this risk, we analyze each  servicing  risk tranche's GAAP book value in
relation to the then  current  market  value for similar  servicing  rights.  We
perform this valuation using option-adjusted spread valuation techniques applied
to each risk tranche. We produce tranche market values at least monthly.        

The market value of the servicing  asset declines as interest rates decrease due
to possible  mortgage  loan  servicing  rights  impairment  that may result from
increased current and projected future prepayment activity.  The change in value

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of the servicing  asset due to interest rate  movements is reduced by the use of
financial  instruments,   including  derivative  contracts,   that  increase  in
aggregate value when interest rates decline.  We recently  shifted our servicing
hedge  portfolio from U.S.  Treasury  related  instruments to London  Inter-Bank
Offer  Rate  hedges,  including  swaps  and  swaptions.  Based on  values  as of
September  30,  2001,  a 100 basis point  parallel  decrease  in interest  rates
produces  a  $162.0  million  decline  in value  of the  servicing  asset of our
Mortgage  Banking  segment,  due to the impact of these hedging vehicles and the
current differences between current market values and GAAP book values.         

Cash Flow  Volatility.  Cash  flow  volatility  arises  as a result  of  several
factors.  One is the inherent difficulty in perfectly matching the cash flows of
new asset purchases with that of new liabilities. Another factor is the inherent
cash flow  volatility  of some  classes of assets and  liabilities.  In order to
minimize cash flow volatility,  we manage differences between expected asset and
liability cash flows within pre-established guidelines.                         

We also seek to minimize  cash flow  volatility  by  restricting  the portion of
securities with redemption features held in our invested asset portfolio.  These
asset  securities  include  redeemable  corporate  securities,   mortgage-backed
securities  or other assets with options  that,  if  exercised,  could alter the
expected  future cash  inflows.  In addition,  we limit sales  liabilities  with
features  such as puts or other options that may change the cash flow profile of
the liability portfolio.                                                        

Derivatives.  We use  various  derivative  financial  instruments  to manage our
exposure to  fluctuations  in interest  rates,  including  interest  rate swaps,
Principal Only swaps,  interest rate floors,  swaptions,  U.S. Treasury futures,
Treasury  rate  guarantees  and  mortgage-backed  forwards and  options.  We use
interest rate futures contracts and mortgage-backed forwards to hedge changes in
interest rates subsequent to the issuance of an insurance  liability,  such as a
guaranteed investment contract, but prior to the purchase of a supporting asset,
or during  periods  of holding  assets in  anticipation  of near term  liability
sales.  We use interest  rate swaps and Principal  Only swaps  primarily to more
closely match the interest rate characteristics of assets and liabilities.  They
can be used to change the interest rate  characteristics  of specific assets and
liabilities  as well  as an  entire  portfolio.  Occasionally,  we  will  sell a
callable  liability or a liability with attributes  similar to a call option. In
these cases,  we will use interest rate  swaptions or similar  products to hedge
the risk of early liability payment thereby  transforming the callable liability
into a fixed term liability.                                                    

We also seek to reduce call or prepayment  risk arising from changes in interest
rates in individual  investments.  We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer, and we
require  additional  yield on these  investments to compensate for the risk that
the issuer will  exercise  such  option.  An example of an  investment  we limit
because of the option risk is residential  mortgage-backed securities. We assess
option risk in all investments we make and, when we assume such risk, we seek to
price for it accordingly to achieve an appropriate return on our investments.   

In conjunction  with the interest rate swaps,  interest rate swaptions and other
derivatives,  we are exposed to counterparty risk, or the risk that counterparty
fails to perform the terms of the derivative  contract.  We actively manage this
risk by:                                                                        

o    establishing  exposure  limits  which  take  into  account   non-derivative
exposure we have with the counterparty as well as derivative exposure;
o    performing  similar credit  analysis prior to approval on each  derivatives
counterparty that we do when lending money on a long-term basis;      
o    limiting exposure to AA- credit or better;                                 
o    conducting  stress-test  analysis to determine the maximum exposure created
during the life of a  prospective  transaction; and                   
o    daily monitoring of counterparty credit ratings.                           

All new derivative  counterparties are approved by the investment committee.  We
believe the risk of incurring losses due to nonperformance by our counterparties
is remote and that such losses, if any, would not be material. Futures contracts
trade on organized exchanges and, therefore, effectively have no credit risk.   

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The table below shows the interest rate sensitivity of our derivatives  measured
in terms of fair  value.  These  exposures  will  change as a result of  ongoing
portfolio and risk management activities.                                       

                                                        [Enlarge/Download Table]


                                                                 As of September 30, 2001                     
                                      ------------------------------------------------------------------------
                                                                          Fair Value (no accrued interest)    
                                                                    ------------------------------------------
                                                      Weighted                                                
                                       Notional     Average Term     -100 Basis                    +100 Basis 
                                       Amount         (Years)       Point Change    No Change     Point Change
                                      ----------    ------------    ------------    ----------    ------------
                                                                     ($ in millions)                          

                                                                                                              
Interest rate swaps................   $  3,853.6       5.70(1)      $   (131.1)     $   (49.6)     $   (14.2) 
Principal Only swaps...............        250.0       2.31(1)            21.5            0.1          (20.7) 
Interest rate floors...............      2,550.0       4.75(2)            77.6           80.8          (43.0) 
U.S. Treasury futures..............         75.9       0.25(3)            (0.3)           -              0.2  
Swaptions..........................      2,735.0       1.88(4)           123.2          106.3          (75.2) 
Treasury rate guarantees...........        191.0       0.10(5)           (14.4)          (4.6)           5.2  
Forwards...........................        153.1       1.94(5)             7.2           (1.5)          (8.7) 
Mortgage-backed forwards and options     8,312.5       0.17(5)           (98.1)         938.1          127.2  
                                      ----------                    ------------    ----------    ------------
   Total...........................   $ 18,121.1                    $    (14.4)     $ 1,069.6      $   (29.2) 
                                      ==========                    ============    ==========    ============

(1) Based on maturity date of swap.                                             
(2) Based on maturity date of floor.                                            
(3) Based on maturity date.                                                     
(4) Based on option date of swaption.                                           
(5) Based on settlement date.                                                   

We use U.S. treasury features to manage our over/under commitment position,  and
our position in these contracts changes daily.                                  

Debt Issued and Outstanding.  As of September 30, 2001, the aggregate fair value
of debt was $1,434.5 million. A 100 basis point, immediate, parallel decrease in
interest  rates would  increase  the fair value of debt by  approximately  $71.3
million.                                                                        

                                                        [Enlarge/Download Table]


                                                          As of September 30, 2001            
                                               -----------------------------------------------
                                                       Fair Value (no accrued interest)       
                                               -----------------------------------------------
                                                -100 Basis                         +100 Basis 
                                               Point Change       No Change       Point Change
                                               ------------      -----------      ------------
                                                                    (in millions)             

                                                                                              
7.95% notes payable, due 2004................. $      223.3      $     217.7      $      212.2
8.2% notes payable, due 2009..................        544.1            512.5             483.3
7.875% surplus notes payable, due 2024........        213.1            198.3             182.7
8% surplus notes payable, due 2044............        108.7             97.6              87.9
Non-recourse mortgages and notes payable......        146.3            138.1             130.5
Other mortgages and notes payable.............        270.3            270.3             270.3
                                               ------------      -----------      ------------
   Total long-term debt....................... $    1,505.8      $   1,434.5      $    1,366.9
                                               ============      ===========      ============

Equity Risk                                                                     

Equity  risk is the risk  that we will  incur  economic  losses  due to  adverse
fluctuations  in a particular  common stock.  As of September 30, 2001, the fair
value of our equity securities was $764.3 million. A 10% decline in the value of
the equity securities would result in an unrealized loss of $76.4 million.      

We also have indirect  equity risk  exposure with respect to BT Financial  Group
margin lending  operations.  Under the terms of this financing  arrangement,  BT

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Financial Group margin lending  operations  allow retail clients and independent
financial  advisors  on behalf of  clients,  within  limits  approved  by senior
management,  to borrow  funds from BT  Financial  Group to invest in an approved
list of securities and mutual fund  investments  which serve as security for the
loan.  The  risk  of loan  default  increases  as the  value  of the  underlying
securities  declines.  This risk is actively  managed  through the use of margin
calls on loans when the underlying  securities  fall below  established  levels.
Overall, the margin lending portfolio is limited to a ratio of borrowed funds to
market value of  securities  of 60%. On November 30,  1999,  BT Financial  Group
margin lending operations  securitized its margin lending portfolio with Westpac
Banking Corporation,  an Australian bank. Under the terms of this financing,  BT
Financial Group margin lending operations are required to allocate capital equal
to  approximately 8% of the outstanding  borrowed amount,  as a cushion for loan
defaults.  As of September  30, 2001,  the margin  lending  portfolio was $507.3
million, or A$1,027.7 million, while the ratio of borrowed funds to market value
of securities was 48%, below that of the maximum allowed.                       

Foreign Currency Risk                                                           

Foreign  currency  risk is the risk that we will  incur  economic  losses due to
adverse  fluctuations in foreign currency  exchange rates. This risk arises from
our international operations and foreign currency-denominated funding agreements
issued to non-qualified institutional investors in the international market. The
notional   amount   of   our   currency   swap   agreements    associated   with
foreign-denominated  liabilities as of September 30, 2001, was $3,099.7 million.
We  also  have  fixed  maturity  securities  that  are  denominated  in  foreign
currencies. However, we use derivatives to hedge the foreign currency risk, both
interest  payments and the final maturity payment,  of these funding  agreements
and securities. As of September 30, 2001, the fair value of our foreign currency
denominated fixed maturity  securities was $334.5 million.  We use currency swap
agreements  of the same  currency to hedge the foreign  currency  exchange  risk
related  to  these  investments.  The  notional  amount  of  our  currency  swap
agreements associated with  foreign-denominated  fixed maturity securities as of
September  30,  2001,  was  $379.0  million.  With  regard to our  international
operations,  we  attempt  to do as  much  of our  business  as  possible  in the
functional  currency  of the country of  operation.  At times,  however,  we are
unable to do so, and in these  cases,  we use foreign  exchange  derivatives  to
hedge the resulting risks.                                                      

Additionally,  we utilize  foreign  currency  swaps related to $665.0 million of
private notes issued in connection with our  acquisition of BT Financial  Group.
Currently  the interest  payments  related to these notes are  serviced  through
operating  cash flows of our  Australian  operations.  By utilizing  the foreign
currency and  interest  rate swaps,  the impact of  Australian  and U.S.  dollar
exchange rate  fluctuations  have a minimal effect on our ability to rely on the
cash flows of our  Australian  operations  to service the interest and principal
payments related to the notes.                                                  

We estimate that as of September 30, 2001, a 10% immediate unfavorable change in
each of the foreign currency exchange rates to which we are exposed would result
in no  change  to the  net  fair  value  of  our  foreign  currency  denominated
instruments  identified  above,  including  the currency  swap  agreements.  The
selection of a 10% immediate  unfavorable  change in all currency exchange rates
should not be construed  as a  prediction  by us of future  market  events,  but
rather as an illustration of the potential  impact of such an event. Our largest
individual  currency  exposure is to fluctuations  between the Australian dollar
and the U.S. dollar.                                                            

Effects of Inflation                                                            

We do not believe that inflation, in the United States or in the other countries
in which we operate,  has had a material effect on our  consolidated  operations
over  the past  five  years.  In the  future,  however,  we may be  affected  by
inflation to the extent it causes interest rates to rise.                       

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PART II - OTHER INFORMATION                                                     

Item 1. - Legal Proceedings                                                     

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 medical insurance,  life
insurance,  annuities and residential mortgages.  In addition,  state regulatory
bodies, such as state insurance  departments,  the SEC, the National Association
of Securities Dealers, Inc., the Department of Labor and other regulatory bodies
regularly make inquiries and conduct  examinations or investigations  concerning
our compliance with, among other things,  insurance laws, securities laws, ERISA
and laws governing the activities of broker-dealers.  Recently, companies in the
life insurance  business have faced  extensive  claims,  including  class-action
lawsuits,  alleging  improper life insurance sales practices.  Principal Life is
currently a defendant in two purported  class-action  lawsuits alleging improper
sales  practices.  We have  reached an  agreement in principle to settle both of
those lawsuits.  The settlement has received court approval. We have established
reserves at a level we believe sufficient to cover the cost of the settlement. A
number of persons  and  entities  who were  eligible  to be class  members  have
excluded  themselves from the class (or "opted out"), as the law permits them to
do. We have been  notified  that some of those who opted out from the class will
file  lawsuits and make claims  similar to those  addressed  by the  settlement.
Similar  opt-out  lawsuits  have  been  brought  against  other  life  insurance
companies as a result of settlement of similar class-action lawsuits. Defense of
these lawsuits may cause us to incur significant costs. At this time, we are not
able to estimate  the number of such  lawsuits  that may be filed,  the costs of
defending the lawsuits or whether our defense will be successful.               

A lawsuit was filed on September 27, 2001, in the United States  District  Court
for the  Northern  District of  Illinois,  seeking  damages and other  relief on
behalf of a putative class of  policyholders  based on allegations that the plan
of  conversion  of Principal  Mutual  Holding  Company  from a mutual  insurance
holding  company into a stock company  violates the United States  Constitution.
The action is captioned Esther L. Gayman v. Principal Mutual Holding Company, et
al. We believe that there are meritorious defenses to the plaintiff's claims and
we  intend to  vigorously  contest  all of the  plaintiff's  claims.  We are not
presently aware of any other lawsuits challenging the plan of conversion.  There
can be no assurance, however, that additional lawsuits will not be commenced.   

While we cannot  predict  the  outcome  of any  pending  or  future  litigation,
examination  or  investigation,  we do not believe that any pending  matter will
have a material adverse effect on our business,  financial  condition or results
of operations.                                                                  

Item 2. - Changes in Securities and Use of Proceeds                             

The effective date of our  registration  statement on Form S-1, as amended (File
No. 333-62558),  relating to the IPO of our common stock was October 22, 2001. A
total of 100.0 million  shares of our common stock were sold to an  underwriting
syndicate on October 23, 2001. In addition,  the  underwriters  exercised  their
over-allotment options to purchase an additional 15.0 million shares,  effective
November 9, 2001.  The lead  managing  underwriters  for the U.S.  offering were
Goldman,  Sachs & Co.,  Credit Suisse First Boston  Corporation,  Merrill Lynch,
Pierce, Fenner & Smith Incorporated,  Salomon Smith Barney Inc., Banc of America
Securities LLC, Bear,  Stearns & Co. Inc., A.G. Edwards & Sons, Inc.,  Fox-Pitt,
Kelton Inc.,  J.P.  Morgan  Securities  Inc.,  Lehman  Brothers Inc.,  Samuel A.
Ramirez & Company, Inc., and UBS Warburg LLC. ABN AMRO Rothschild,  BNP Paribas,
Commerzbank  Aktiengesellschaft  and Credit Lyonnais also served as underwriters
for the international offering.                                                 

The IPO  commenced  on  October  23,  2001,  at a price of $18.50  per share and
terminated upon the sale of all of the 115.0 million shares of common stock that
were   registered   (including   15.0  million   shares  sold  pursuant  to  the
underwriters'  over-allotment  options).  The IPO resulted in gross  proceeds of
$2,127.5 million, including $277.5 million of gross proceeds attributable to the
underwriters'  exercise  of  the  over-allotment   options.  We  incurred  total
estimated  offering  expenses  of $108.8  million,  including  $92.6  million of
underwriting discounts and commissions,  and an estimated $16.2 million of other
expenses.  Estimated net proceeds to the Company equaled  $2,018.7  million,  of
which an estimated  $324.9  million was retained by Principal  Financial  Group,
Inc. for working  capital,  payment of dividends,  and other  general  corporate
purposes.  An estimated  $1,693.8  million was  contributed  to  Principal  Life
Insurance   Company   principally  to  fund   demutualization   compensation  to

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policyholders  in the form of  policy  credits  and cash,  and to cover  certain
expenses related to the demutualization. In connection with the IPO, the Company
did not make any payments, directly or indirectly, to any director or officer of
the Company, or, to the Company's knowledge, any of their associates, other than
as demutualization compensation payable to policyholders pursuant to the plan of
conversion,  or to any  person  owning  ten  percent or more of any class of our
equity  securities,  or (except as set forth in the  preceding  sentence) to any
affiliates of the Company.                                                      

In  addition  to the shares of our common  stock  distributed  in the IPO,  many
policyholders  entitled  to receive  compensation  in the  demutualization  will
receive  shares  of  our  common  stock   distributed  in  connection  with  the
demutualization,  as  well  as  cash  or  policy  credits  as  compensation  for
extinguishment  of  their  membership  interests  in  Principal  Mutual  Holding
Company.  Shares received by policyholders as  demutualization  compensation are
exempt from  registration  pursuant to Section 3(a)(10) of the Securities Act of
1933, as amended.  None of Principal Financial Group, Inc.,  Principal Financial
Services,  Inc. or Principal Life will receive any proceeds from the issuance of
our  common  stock to  policyholders  entitled  to receive  compensation  in the
demutualization  for  the  extinguishment  of  their  membership   interests  in
Principal Mutual Holding Company or to the policy credits separate account.     

Item 6. - Exhibits and Reports on Form 8-K                                      

a.  Exhibits                                                                    

Exhibit                                                                         
Number                            Description                                 
2.1     Plan of Conversion*                                                 
3.1     Form of Amended and  Restated  Certificate  of  Incorporation  of   
    Principal Financial Group, Inc. (included in Exhibit 2.1)*
3.2     Form of By-Laws of Principal Financial Group, Inc. (included in     
Exhibit 2.1)*                                         
  4.1     Form of Certificate for the Common Stock of Principal Financial Group,
Inc., par value $0.01 per share*                      
4.2     Form of Stockholder Rights Agreement*                               
10.1     Principal Financial Group, Inc. Stock Incentive Plan*                
10.2     Principal Financial Group Long-Term Performance Plan*                
10.3     Principal Financial Group Incentive Pay Plan (PrinPay), amended and  
restated effective January 1, 2001*                   
10.4     Principal Financial Group, Inc. Directors Stock Plan*                
10.5     Principal Select Savings Excess Plan*                                
10.6     Supplemental Executive Retirement Plan for Employees*                
10.7     Employment  Agreement,  dated as of May 19, 2000,  among  Principal  
     Mutual  Holding  Company,  Principal Financial Group, Inc.,
       Principal Financial Services,  Inc., Principal Life Insurance
Company and J. Barry Griswell*                        
10.8     Change-of-Control  Supplement and Amendment to Employment Agreement, 
      dated as of October 19, 2000, among Principal Mutual Holding
         Company,  Principal Financial Group, Inc.,  Principal Financial
        Services,  Inc., Principal Life Insurance Company and J. Barry
Griswell*                                             
10.9     Form of  Principal  Mutual  Holding  Company  and  Principal  Life   
           Insurance  Company  Change of Control Employment  Agreement (Tier
           One Executives) among Principal Mutual Holding Company, Principal
    Financial Group, Inc., Principal Financial Services, Inc.,
Principal Life Insurance Company and an Executive*    
10.10    Fiscal  Agency  Agreement,  dated as of August 25, 1999,  among      
        Principal  Financial  Group  (Australia) Holdings Pty Limited,
         Principal Financial Services, Inc. and U.S. Bank Trust National
Association*                                          

*    Previously  filed  as an  exhibit  to  Principal  Financial  Group,  Inc.'s
     Registration  Statement  on Form  S-1,  as  amended  (Commission  File  No.
333-62558).                                                           

b.  Reports on Form 8-K                                                   

None                                                              

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 SIGNATURE

Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.                                          

           PRINCIPAL FINANCIAL GROUP, INC.

Dated:  November 19, 2001     By   /s/ Michael H. Gersie                        
                                  --------------------------------------------

       Michael H. Gersie
                  Executive Vice President and
             Chief Financial Officer

                                  Duly Authorized Officer, Principal Financial
                           Officer, and Chief Accounting Officer

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Dates Referenced Herein and Documents Incorporated by Reference

		Referenced-On Page
This ‘10-Q’ Filing	Date	First	Last	Other Filings

	1/1/02	8	26
	12/31/01	8		10-K, 13F-HR, 13F-NT
Filed on:	11/19/01	77
	11/15/01	1
	11/9/01	21	75
	10/26/01	8	24
	10/23/01	75		424B1
	10/22/01	75		S-1/A, S-8
For Period End:	9/30/01	1	74
	9/27/01	75
	9/25/01	23
	9/11/01	20	25
	8/28/01	20	24
	8/24/01	46
	7/25/01	20	24
	7/24/01	20	24
	7/20/01	8	25
	7/1/01	8	25
	6/30/01	8	25
	5/21/01	21	25
	3/31/01	20	24
	2/15/01	23
	1/1/01	5	76
	12/31/00	2	69
	10/19/00	76
	9/30/00	2	66
	7/1/00	23	41
	5/19/00	76
	1/1/00	5
	11/30/99	74
	8/25/99	76
				List all Filings

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Filing Submission 0001126328-01-500014 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

Principal Financial Group Inc – ‘10-Q’ for 9/30/01

On: Monday, 11/19/01 · For: 9/30/01 · Accession #: 1126328-1-500014 · File #: 1-16725

Previous ‘10-Q’: None · Next: ‘10-Q’ on 5/10/02 for 3/31/02 · Latest: ‘10-Q’ on 5/1/24 for 3/31/24

Quarterly Report — Form 10-QFiling Table of Contents

Document Table of Contents

Dates Referenced Herein and Documents Incorporated by Reference

Quarterly Report — Form 10-Q
Filing Table of Contents