Principal Financial Group, Inc.

(515) 247-5111
711 High Street, 42-1520346
Des Moines, IA 50392

www.principal.com

Sales

$9.4 billion

Business Description 

The Principal Financial Group is a leading provider of retirement savings,
investment and insurance products and services with $144.9 billion in assets
under management and approximately fifteen million customers worldwide as of
December 31, 2003. We were organized as an individual life insurer in 1879,
formed a mutual insurance holding company in 1998, and Principal Financial
Group, Inc. was organized on April 18, 2001, as a Delaware business corporation.

We focus on providing retirement products and services to businesses and their
employees. We provided services to more 401(k) plans in the U.S. in 2002 than
any other bank, mutual fund or insurance company, according to surveys conducted
by CFO magazine. We also had the leading market share in 2002 within the 401(k)
market for businesses with less than 500 employees based on number of plans
according to the Spectrem Group.

We believe there are attractive growth opportunities in the 401(k) and other
defined contribution pension plan markets in the U.S. and internationally. We
believe our expertise and leadership in serving the U.S. pension plan market
give us a unique competitive advantage in the U.S., as well as in countries with
a trend toward private sector defined contribution pension systems.

OUR OPERATING SEGMENTS

We organize our businesses into the following operating segments:

o U.S. Asset Management and Accumulation;

o International Asset Management and Accumulation;

o Life and Health Insurance; and

o Mortgage Banking.

We also have a Corporate and Other segment which consists of the assets and
activities that have not been allocated to any other segment.

U.S. ASSET ACCUMULATION

Our asset accumulation activities in the U.S. date back to the 1940s when we
first began providing pension plan products and services. We now offer a
comprehensive portfolio of asset accumulation products and services for
retirement savings and investment:

o To businesses of all sizes with a concentration on small and medium-sized
businesses, which we define as businesses with fewer than 1,000 employees.
We offer products and services for defined contribution pension plans,
including 401(k) and 403(b) plans, defined benefit pension plans,
non-qualified executive benefit plans, and employee stock ownership plan
("ESOP") consulting services. For more basic investment needs, we offer
SIMPLE IRA and payroll deduction plans;

o To large institutional clients, we also offer investment-only products,
including guaranteed investment contracts and funding agreements; and

o To employees of businesses and other individuals, we offer the ability to
accumulate funds for retirement and savings through mutual funds,
individual annuities and bank products.

We organize our U.S. asset accumulation operations into four product and service
categories: pension, mutual funds, individual annuities and Principal Bank.

Our pension products and services are further grouped into three categories:
full-service accumulation, full-service payout and investment-only.

PENSION PRODUCTS

We offer a wide variety of investment and administrative products for defined
contribution pension plans, including 401(k) and 403(b) plans, defined benefit
pension plans, non-qualified executive benefit plans, and ESOPs. A 403(b) plan
is a plan described in section 403(b) of the Internal Revenue Code that provides
retirement benefits for employees of tax-exempt organizations and public
schools.

FULL-SERVICE ACCUMULATION. Full-service accumulation products respond to the
needs of plan sponsors seeking both administrative and investment services for
defined contribution plans or defined benefit plans. The investment component of
our defined contribution plans may be in the form of a group annuity contract or
a mutual fund. The investment component of our defined benefit plans is
available only in the form of a group annuity contract.

As of December 31, 2003, we provided full-service accumulation products to
32,139 defined contribution pension plans, of which 25,794 were 401(k) plans,
covering 2.3 million plan participants, and to 2,976 defined benefit pension
plans, covering 260,816 plan participants. As of December 31, 2003,
approximately 68% of our full-services accumulation account values were managed
by Principal Global Investors. Third-party asset managers provide asset
management services with respect to the remaining assets.

Prior to 2001, annuities were the only product through which we delivered both
administrative and investment services to our defined contribution plan and
defined benefit plan customers. Under U.S. federal securities laws, neither the
annuity nor the underlying investment options are required to be registered with
the SEC. Beginning January 2001, we began to offer administrative and investment
services to defined contribution plan customers through Principal Advantage, a
new qualified plan product based on our mutual fund, Principal Investors Fund.
We offer investments covering the full range of stable value, equity, fixed
income and international investment options managed by our affiliated asset
manager, Principal Global Investors, as well as third-party asset managers.

FULL-SERVICE PAYOUT. Full-service payout products respond to the needs of
pension plan participants who, upon retirement or termination of their
employment, leave their pension plans, and who seek both administrative and
investment services for distributions from the plans they are leaving. Plan
participants who seek these services include those departing pension plans we
service, as well as pension plans other providers service. We offer both
flexible income option products and single premium group annuities. Flexible
income option products allow the customer to control the rate of distribution,
or payout, and provide limited performance guarantees. Single premium group
annuities are immediate or deferred annuities that provide a current or future
specific income amount, fully guaranteed by us. Both products are available to
defined contribution and defined benefit plan participants. For both products,
we make regular payments to individuals, invest the underlying assets on their
behalf and provide tax reporting to them.

Single premium group annuities are traditionally used in conjunction with
defined benefit plans, particularly those where the plan is being terminated. In
such instances, the plan sponsor transfers all its obligations under the plan to
an insurer by paying a single premium. Increasingly, these products are
purchased by defined contribution plan participants who reach retirement age.
Generally, plan sponsors restrict their purchases to insurance companies with
superior or excellent financial quality ratings because the Department of Labor
has mandated that annuities be purchased only from the "safest available"
insurers.

Premium received from full-service payout products are generally in the form of
single payments. As a result, the level of new premiums can fluctuate depending
on the number of retirements and large-scale annuity sales in a particular
fiscal quarter. Assets under management relating to single premium group
annuities generate a spread between the investment income earned by us and the
amount credited to the customer. Assets under management relating to flexible
income option products may generate either spread or fee revenue depending on
the investment options elected by the customer. Our affiliated asset manager,
Principal Global Investors, manages full-service payout account values.

INVESTMENT-ONLY. The three primary products for which we provide investment-only
services are: guaranteed investment contracts ("GICs"); funding agreements; and
other investment-only products.

GICs and funding agreements pay a specified rate of return. The rate of return
can be a floating rate based on an external market index or a fixed rate. Our
investment-only products contain provisions disallowing or limiting early
surrenders, including penalties for early surrenders and minimum notice
requirements. Put provisions give customers the option to terminate a contract
prior to maturity, provided they give us a minimum notice period. We no longer
issue puttable GICs.

Deposits to investment-only products are predominantly in the form of single
payments. As a result, the level of new deposits can fluctuate from one fiscal
quarter to another. Assets invested in GICs and funding agreements generate a
spread between the investment income earned by us and the amount credited to the
customer. Our other investment-only products consist of separate accounts
invested in either equities or fixed income instruments. Our affiliated asset
manager, Principal Global Investors, manages investment-only account values.

PENSION MARKETS AND DISTRIBUTION

We offer our pension products and services to employer-sponsored pension plans,
including qualified and non-qualified defined contribution plans, qualified
defined benefit plans and institutional investors. Our primary target market is
pension plans sponsored by small and medium-sized businesses, which we believe
remains under-penetrated. Only 16% of businesses with less than 100 employees,
and 47% of businesses with between 100 and 500 employees, offered a 401(k) plan
in 2002, according to the Spectrem Group. The same study indicates that 83% of
employers with between 500 and 1000 employees and 93% of employers with 1000 or
more employees offered a 401(k) plan in 2002.

FULL-SERVICE ACCUMULATION. We sell our full-service accumulation products and
services nationally, primarily through a captive retirement services sales
force. As of December 31, 2003, over 100 retirement services sales
representatives in over 40 offices, operating as a wholesale distribution
network, maintained relationships with over 11,000 independent brokers,
consultants and agents. Retirement services sales representatives are an
integral part of the sales process alongside the referring consultant or
independent broker. We compensate retirement services sales representatives
through a blend of salary and production-based incentives, while we pay
independent brokers, consultants and agents a commission or fee.

As of December 31, 2003, we had a separate staff of over 140 service
representatives located in our local offices who play a key role in the ongoing
servicing of pension plans by: providing local services to our customers, such
as renewing contracts, revising plans and solving any administration problems;
communicating the customers' needs and feedback to us; and helping employees
understand the benefits of their pension plans.

We believe that our approach to pension plan services distribution gives us a
local sales and service presence that differentiates us from many of our
competitors. We have also recently established a number of marketing and
distribution relationships to increase the sales of our accumulation products
with firms such as Frank Russell Investment Management Company, A.G. Edwards and
AON.

We sell our annuity-based products through sales representatives, agents and
brokers who are not required to register with the SEC.

Principal Advantage, our mutual fund-based product, is targeted at defined
contribution plans through broker/dealer distribution channels. Principal
Advantage gives us access to National Association of Securities
Dealers-registered distributors who are not traditional sellers of annuity-based
products and opens new opportunities for us in the investment advisor and
broker-dealer distribution channels.

Impact401k.com is our self-service Internet site, through which plan sponsors
can handle the purchase, enrollment and administration of a 401(k) pension plan
entirely through the Internet. Impact401k.com allows plan participants to gain
on-line access to their accounts, transfer funds between accounts and review
customized investment options. Accordingly, our employees do not have to perform
any administrative activities. Impact401k.com is targeted at smaller businesses
that seek a low cost product, as well as businesses of any size that prefer to
handle administrative activities through the Internet.

FULL-SERVICE PAYOUT AND INVESTMENT-ONLY. Our primary distribution channel for
full-service payout and investment-only products was comprised of approximately
10 specialized home office sales consultants as of December 31, 2003, working
through consultants and brokers that specialize in this type of business. Our
home office sales consultants also make sales directly to institutions. Our
nationally dispersed retirement services sales representatives act as a
secondary distribution channel for these products. Principal Connection also
distributes full-service payout products to participants in plans we service who
are terminating employment or retiring. Principal Connection is our direct
response distribution channel for retail financial services products to
individuals. Principal Connection's services are available over the phone, on
the Internet or by mail.

We market GICs and funding agreements primarily to pension plan sponsors and
other institutions. We also offer them as part of our full-service accumulation
products. We sell our GICs primarily to plan sponsors for funding of
tax-qualified retirement plans. We sell our funding agreements to institutions
that may or may not be pension funds. Our primary market for funding agreements
is institutional investors in the U.S. and around the world. These investors
purchase debt obligations from a special purpose vehicle which, in turn,
purchases a funding agreement from us with terms similar to those of the debt
obligations. The strength of this market is dependent on debt capital market
conditions. As a result, our sales through this channel can vary widely from one
quarter to another.

MUTUAL FUNDS

We have been providing mutual funds to customers since 1969. We offer mutual
funds to individuals and businesses, for use within variable life and variable
annuity contracts and for use in employer-sponsored pension plans and as a
rollover investment option.

PRODUCTS

We were ranked in the top quartile among U.S. mutual fund managers in terms of
total mutual fund assets under management as of November 30, 2003, according to
the Investment Company Institute. The value of our mutual fund assets we managed
was $12.1 billion as of December 31, 2003. We provide accounting, compliance,
corporate governance, product development and transfer agency functions for all
mutual funds we organize. As of November 30, 2003, our mutual fund operations
served approximately 782,800 mutual fund shareholder accounts.

PRINCIPAL MUTUAL FUNDS. Principal Mutual Funds is a family of mutual funds
offered to individuals and businesses, with 22 mutual funds and $3.5 billion in
assets under management as of December 31, 2003. We report the results for these
funds in this segment under "Mutual Funds".

PRINCIPAL VARIABLE CONTRACTS FUND. Principal Variable Contracts Fund is a series
mutual fund which, as of December 31, 2003, provided 24 investment options for
use as funding choices in variable annuity and variable life insurance contracts
issued by Principal Life. As of December 31, 2003, this fund had $3.0 billion in
assets under management. We report the results for the funds backing variable
annuity contracts in this segment under "Individual Annuities." We report the
results for the funds backing variable life insurance contracts in the Life and
Health Insurance segment.

PRINCIPAL INVESTORS FUND. Principal Investors Fund is a series mutual fund,
which as of December 31, 2003, offered 46 investment options. This fund acts as
the funding vehicle for Principal Advantage, the defined contribution product
described above under "U.S. Asset Management and Accumulation Segment-U.S. Asset
Accumulation-Pension Services and Products-Pension Products-Full-service
Accumulation." This fund also offers a retail class of shares to individuals
primarily for IRA rollovers. As of December 31, 2003, this retail class of
shares had $1.3 billion in assets under management; $0.2 billion of this retail
class invests in other share classes of Principal Investors Funds. All other
share classes of Principal Investors Funds, including seed money, had $4.5
billion of assets under management. We report the results for this fund,
excluding the retail class of shares, under "Pension". We report the results of
the retail class of shares in this segment under "Mutual Funds."

MUTUAL FUND MARKETS AND DISTRIBUTION

Our markets for retail mutual funds are individuals seeking to accumulate
savings for retirement and other purposes and small businesses seeking to use
mutual funds as the funding vehicle for pension plans, as well as non-qualified
individual savings plans utilizing payroll deductions. We also market our retail
mutual funds to participants in pension plans who are departing their plans and
reinvesting their retirement assets into individual retirement accounts.

Our retail mutual funds are sold primarily through our affiliated financial
representatives, independent brokers registered with our securities
broker-dealer Princor Financial Services Corporation, ("Princor"), registered
representatives from other broker-dealers, direct deposits from our employees
and others and Principal Connection. Princor, as the marketing arm of our mutual
fund business, recruits, trains and supervises registered representatives
selling our products.

INDIVIDUAL ANNUITIES

Individual annuities offer a tax-deferred means of accumulating retirement
savings and provide a tax-efficient source of income during the payout period.

PRODUCTS

We offer both fixed and variable annuities to individuals and pension plans.
Individual annuities may be deferred, in which case assets accumulate until the
contract is surrendered, the customer dies or the customer begins receiving
benefits under an annuity payout option, or immediate, in which case payments
begin within one year of issue and continue for a fixed period of time or for
life.

FIXED ANNUITIES. Our individual fixed annuities are predominantly single premium
deferred annuity contracts. These contracts are savings vehicles through which
the customer makes a single deposit with us. For most contracts, the principal
amount is guaranteed and for a specified time period, typically one year, we
credit the customer's account at a fixed interest rate. Thereafter, we reset,
typically annually, the interest rate credited to the contract based upon market
and other conditions. Our major source of income from fixed annuities is the
spread between the investment income we earn on the underlying general account
assets and the interest rate we credit to customers' accounts. We bear the
investment risk because, while we credit customers' accounts with a stated
interest rate, we cannot be certain the investment income we earn on our general
account assets will exceed that rate. Our affiliated asset manager, Principal
Global Investors, manages fixed annuity account values.

VARIABLE ANNUITIES. Our individual variable annuity products consist almost
entirely of flexible premium deferred variable annuity contracts. These
contracts are savings vehicles through which the customer makes a single deposit
or a series of deposits of varying amounts and intervals. Customers have the
flexibility to allocate their deposits to investment sub-accounts managed by
Principal Global Investors, or leading third-party asset managers. As of
December 31, 2003, 71% of our $3.0 billion in variable annuity account balances
was allocated to investment sub-accounts and our general account, which are
managed by Principal Global Investors and 29% to investment sub-accounts managed
by third-party asset managers. The customers bear the investment risk and have
the right to allocate their assets among various separate investment
sub-accounts. The value of the annuity fluctuates in accordance with the
experience of the investment sub-accounts chosen by the customer. Customers have
the option to allocate all or a portion of their account to our general account,
in which case we credit interest at rates we determine, subject to contractual
minimums. Customers may also elect death benefit guarantees. Our major source of
revenue from variable annuities is mortality and expense fees we charge to the
customer, generally determined as a percentage of the market value of the assets
held in a separate investment sub-account.

INDIVIDUAL ANNUITY MARKETS AND DISTRIBUTION

Our target markets for individual annuities include owners, executives and
employees of small and medium-sized businesses, and individuals seeking to
accumulate and/or eventually receive distributions of assets for retirement. We
market both fixed and variable annuities to both qualified and non-qualified
pension plans.

We sell our individual annuity products largely through our affiliated financial
representatives, who accounted for 50%, 63%, and 74% of annuity sales for the
years ended December 31, 2003, 2002 and 2001, respectively. The remaining sales
were made through brokerage general agencies, banks, Principal Connection and
unaffiliated broker-dealer firms. Although our percentage of sales from
affiliated financial representatives has declined, they continued to be strong
in 2003. The decline is a result of focused efforts to increase sales through
non-affiliated distribution channels.

PRINCIPAL BANK

Principal Bank, our electronic banking operation, is a federal savings bank that
began its activities in February 1998. It offers traditional retail banking
products and services via the telephone, Internet, ATM or by mail. Our current
products and services include checking and savings accounts, money market
accounts, certificates of deposit, consumer loans, first mortgage loans, home
equity loans, credit cards, debit cards, and a college savings program. As of
December 31, 2003, Principal Bank had 107,731 customers and $2,012.3 million in
assets, primarily generated by checking account, money market accounts and
certificates of deposit.

We market our Principal Bank products and services to our existing customers and
external prospects, through Principal Connection and other means such as the
Internet, direct mail, and targeted advertising. Through Principal Bank, we also
pursue asset retention strategies with our customers who seek to transfer assets
from our other asset accumulation products by offering them our banking products
and services.

U.S. ASSET MANAGEMENT

PRINCIPAL GLOBAL INVESTORS

In 1999, we established Principal Global Investors to consolidate our extensive
investment management expertise and to focus on marketing our asset management
services to third-party institutional clients. Principal Global Investors
provides asset management services to our U.S. and international asset
accumulation businesses and third-party institutional clients, as well as our
other U.S.-based segments. Principal Global Investors provides a full range of
asset management services with emphasis on three primary asset classes: (1)
equity investments; (2) fixed income investments; and (3) real estate
investments.

As of December 31, 2003, Principal Global Investors, together with its
affiliates, Principal Real Estate Investors, Spectrum Asset Management and Post
Advisory Group, managed $113.3 billion in assets. Our third-party institutional
assets were $24.7 billion as of December 31, 2003, compared to $3.5 billion on
January 1, 1999, the date Principal Global Investors was established.

PRODUCTS

Principal Global Investors provides a full range of asset management services,
with emphasis on three asset classes through a range of investment vehicles
including separate accounts, mutual funds, institutional accounts,
collateralized debt securities and Principal Life's general account:

EQUITY INVESTMENTS. Principal Global Investors manages equity portfolios, which
represented $20.8 billion in assets as of December 31, 2003. Principal Global
Investors provides our clients with access to a broad array of domestic,
international and emerging markets equity capabilities. The domestic equity
products are organized across growth and value styles, with portfolios targeted
to distinct capitalization ranges. As of December 31, 2003, 75% of Principal
Global Investors equity assets under management were derived from our pension
products, 19% from other products of the Principal Financial Group, and the
remaining 6% from third-party institutional clients.

FIXED INCOME INVESTMENTS. Principal Global Investors, along with Spectrum Asset
Management and Post Advisory Group, manages $66.1 billion in fixed income assets
as of December 31, 2003. Principal Global Investors, Spectrum Asset Management
and Post Advisory Group provide our clients with access to investment-grade
corporate debt, mortgage-backed, asset-backed and commercial mortgage-backed
securities, high yield and municipal bonds, private and syndicated debt
instruments and preferred securities. As of December 31, 2003, 50% of these
assets were derived from our pension products, 22% from other products of the
Principal Financial Group, and the remaining 28% from third-party institutional
clients.

REAL ESTATE INVESTMENTS. Principal Global Investors, through its affiliate
Principal Real Estate Investors, manages a commercial real estate portfolio of
$24.4 billion of assets as of December 31, 2003. Principal Real Estate Investors
provides our clients with a broad range of real estate investment options,
including private real estate equity, commercial mortgages, credit tenant debt,
construction-permanent financing, bridge/mezzanine loans, commercial
mortgage-backed securities and real estate investment trusts. Principal Global
Investors had $0.4 billion of assets under management as of December 31, 2003,
from bridge/mezzanine loans and commercial mortgages which appear on its balance
sheet. The commercial mortgages represent the source of mortgages for our
commercial mortgage-backed securitization program. As of December 31, 2003, 50%
of the commercial real estate portfolio was derived from our pension products,
30% from other products of the Principal Financial Group, and the remaining 20%
from third-party institutional clients.

U.S. ASSET MANAGEMENT MARKETS AND DISTRIBUTION

Principal Global Investors employed over 60 institutional sales, relationship
management and client service professionals as of December 31, 2003, who worked
with consultants and directly with large investors to acquire and retain
third-party institutional clients. For the year ended December 31, 2003,
approximately 60% of new institutional clients were originated through direct
client contact by Principal Global Investors representatives, with the balance
derived from contact with consultants or other intermediaries.

INTERNATIONAL ASSET MANAGEMENT AND ACCUMULATION SEGMENT

Our International Asset Management and Accumulation segment consists of
Principal International and the discontinued operations of BT Financial Group.
Principal International has subsidiaries in Argentina, Chile, Mexico, Hong Kong
and India and joint ventures in Brazil, Japan and Malaysia. We focus on
countries with favorable demographics and a trend toward private sector defined
contribution pension systems. We entered these countries through acquisitions,
start-up operations and joint ventures.

On October 31, 2002, we sold substantially all of BT Financial Group to Westpac
Banking Corporation ("Westpac"). As of December 31, 2003, we have received
proceeds of A$958.9 million Australian dollars ("A$") (U.S. $537.4 million )
from Westpac, with future contingent proceeds in 2004 of up to A$150.0 million
(approximately U.S. $115.0 million ). The contingent proceeds will be based on
Westpac's future success in growing retail funds under management. We do not
anticipate receiving the contingent proceeds.

LIFE AND HEALTH INSURANCE SEGMENT

Our Life and Health Insurance segment offers (1) individual and group life
insurance (2) group health insurance and (3) individual and group disability
insurance throughout the U.S.

For financial results for the Life and Health Insurance segment see Item 8.
"Financial Statements and Supplementary Data, Notes to Consolidated Financial
Statements, Note 19 Segment Information".

INDIVIDUAL AND GROUP LIFE INSURANCE

We began as an individual life insurer in 1879. We began as a group life insurer
in 1941. Our U.S. operations served approximately 654,000 individual life
policyholders with $89.9 billion of individual life insurance in force as of
December 31, 2003. Group life operations provided products and services to 2.5
million covered lives with $73.7 billion of group life insurance in force as of
December 31, 2003.
 
We offer a wide array of individual and group life insurance products aimed at
serving our customers' financial needs throughout their lives.

PRODUCTS AND SERVICES

Our individual and group life insurance products include: universal and variable
universal life insurance, traditional life insurance and group life insurance.

UNIVERSAL AND VARIABLE UNIVERSAL LIFE INSURANCE. Universal and variable
universal life insurance products offer life insurance protection for which both
the premium and the death benefit may be adjusted by the policyholder. For the
year ended December 31, 2003, 74% of individual life insurance annualized first
year sales have come from universal and variable universal life insurance
products. Universal and variable universal life insurance represents 32% of
individual life insurance premium and deposits for the year ended December 31,
2003 and 27% of individual life insurance in force as of December 31, 2003.
Variable universal life insurance products represented 55% of our universal and
variable universal life insurance deposits for the year ended December 31, 2003.
We credit deposits, net of specified expenses, to an account maintained for the
policyholder. Specific charges are made against the account for the cost of
insurance protection and expenses. For universal life contracts, the entire
account balance is invested in our general account. Interest is credited to the
policyholder's account based on the earnings on general account investments. For
variable universal life contracts, the policyholder may allocate the account
balance among our general account and a variety of separate account choices.
Interest is credited on amounts allocated to the general account in the same
manner as for universal life. Net investment performance on separate account
investments is allocated directly to the policyholder accounts; the policyholder
bears the investment risk. Some of our universal life and variable universal
life insurance contracts contain what are commonly referred to as "no-lapse
guarantee provisions". A no-lapse guarantee keeps the contract in force, even if
the contractholder's account balance is insufficient to cover all the contract
charges, provided that the contractholder has continually paid a specified
minimum premium. Our profitability is based on charging sufficient asset-based,
premium-based and risk-based fees to cover the cost of insurance and expenses.

TRADITIONAL LIFE INSURANCE. Traditional life insurance includes participating
whole life, adjustable life products and term life insurance products.
Participating products and term life insurance products represented 17% and 9%,
respectively, of our individual life insurance annualized first year sales for
the year ended December 31, 2003 and 50% and 23% of individual life insurance in
force as of December 31, 2003. Adjustable life insurance products provide a
guaranteed benefit in return for the payment of a fixed premium and allow the
policyholder to change the premium and face amount combination. Sales of
participating products consist primarily of premium increase adjustments on our
adjustable life products. Participating policyholders may receive policy
dividends as declared by the board of directors of Principal Life if the
combined result of experience factors, including interest earnings, mortality
experience and expenses is better than the assumptions used in setting the
premium. Our profitability is based on keeping a portion of the favorable
experience before crediting the remainder to policyholders. Term insurance
products provide a guaranteed benefit for a specified period of time in return
for the payment of a fixed premium. Policy dividends are not paid on term
insurance. Our profitability is based on charging a premium that is sufficient
to cover the cost of insurance and expenses while providing us with an
appropriate return.

GROUP LIFE INSURANCE. Group life insurance provides coverage to employees and
their dependents for a specified period. As of December 31, 2003, we had $73.7
billion of group life insurance in force covering 2.5 million lives. We carry
both traditional group life insurance that does not provide for accumulation of
cash values and group universal life, which does provide for accumulation of
cash values. Our group life insurance business remains focused on the
traditional annually renewable term product. Group term life and group universal
life accounted for 91% and 9%, respectively, of our total group life insurance
in force as of December 31, 2003. As of January 1, 2004, we no longer market
group universal life insurance to new employer groups. According to the 2002
LIMRA International, Inc. Sales and In Force Reports, we were ranked first in
the U.S. in terms of the number of life insurance contracts in force and second
in terms of the number of contracts sold.

GROUP HEALTH INSURANCE

We began offering group health insurance in 1941. We offer a wide array of group
health insurance products including medical, dental and vision insurance. In
addition, we offer administrative services on a fee-for-service basis to large
employers in the U.S. As of December 31, 2003, we provided products and services
to over 596,000 medical covered members, 1,348,000 dental/vision members and
1,663,000 administrative services only members on a duplicated basis. Members
may be counted multiple times if they have more than one product.

PRODUCTS AND SERVICES

Our U.S. group health insurance products and services include: medical
insurance, dental and vision insurance and fee-for-service.

GROUP MEDICAL INSURANCE. Group medical insurance provides partial reimbursement
of medical expenses for insured employees and their dependents. Employees are
responsible for deductibles, co-payments and co-insurance. We believe our
products are well-positioned to address our customers' preference for a variety
of provider choices and preferred provider discounts. We do not offer
unrestricted indemnity and no longer offer the pure HMO model. Through our
wholly-owned subsidiary, HealthRisk Resource Group, Inc., we also negotiate
discounts with providers on claims for which we have no other pre-arranged
discount.

GROUP DENTAL AND VISION INSURANCE. Group dental and vision insurance plans
provide partial reimbursement for dental and vision expenses. As of December 31,
2003, we had over 33,000 group dental and vision insurance policies in force.
According to the 2002 LIMRA International, Inc. Sales and Inforce Reports, we
were the sixth largest group dental insurer in terms of in force premium based
on total indemnity and PPO plans and third in terms of number of
contracts/employer groups in force based on total indemnity and PPO plans. In
addition to indemnity and PPO dental, we offer a prepaid dental plan in Arizona
through our Dental-Net, Inc. subsidiary.

FEE-FOR-SERVICE. We offer administration of group disability, medical, dental
and vision services on a fee-for-service basis to larger self-insured employers.

INDIVIDUAL AND GROUP DISABILITY INSURANCE

We began as an individual disability insurer in 1952. We began as a group
disability insurer in 1941. Our U.S. operations served approximately 82,000
individual disability policyholders as of December 31, 2003. Group disability
provided products and services to approximately 800,000 covered members as of
December 31, 2003.

We offer a wide array of individual and group disability insurance products
aimed at serving our customers' financial needs throughout their lives.

PRODUCTS AND SERVICES

INDIVIDUAL DISABILITY INSURANCE. Individual disability insurance products
provide a benefit in the event of the disability of the insured. In most
instances, this benefit is in the form of a monthly income. Individual
disability income represents 42% of total disability premium. In addition to
income replacement, we offer products to pay business overhead expenses for a
disabled business owner, and for the purchase by the other business owners of
the disabled business owner's interests in the business. Our profitability is
based on charging a premium that is sufficient to cover claims and expenses
while providing us with an appropriate return. Our individual disability
business was ranked seventh in the U.S. as of December 31, 2002, in terms of
premium in force, according to the 2002 LIMRA International, Inc. In Force
Report.

GROUP DISABILITY INSURANCE. Group disability insurance provides a benefit to
insured employees who become disabled. Our group disability products include
both short-term and long-term disability. Long-term disability represents 34% of
total disability premium while short-term disability represents 24% of total
disability premium. In addition, we provide disability management services, or
rehabilitation services, to assist individuals in returning to work as quickly
as possible following disability. We also work with disability claimants to
improve the approval rate of Social Security benefits, thereby reducing payment
of benefits by the amount of Social Security payments received. Our group
disability business was ranked seventh in the U.S. as of December 31, 2002, in
terms of number of contracts/employer groups in force, according to the 2002
LIMRA International, Inc. In Force Reports.

LIFE AND HEALTH MARKETS AND DISTRIBUTION

We sell our individual life and individual disability income products in all 50
states and the District of Columbia. Our target market is owners and executives
of small and medium-sized businesses, as well as other individuals. Cash value
life insurance provides valuable benefits at death and funding for needs prior
to death, including funding employee benefit liabilities, estate planning,
business continuation or buy-out. We design, market and administer our products
to meet these needs. We have also recently established a number of marketing and
distribution alliances to increase the sales of individual insurance products
with firms such as: AXA, Highland Capital, AG Edwards, Wells Fargo, Piper
Jaffrey, and BISYS. Variable universal life insurance is popular for many
reasons, including higher historical performance of equity investments resulting
in a lower cost of insurance and an increase in values available while still
alive. We also offer products specifically designed to meet the estate planning
needs of business executives. Our individual disability products are also
tailored to the needs of this market. A single large individual life insurance
case of approximately $10.0 million was sold in 2002. No comparable case was
sold in 2001 nor in 2003. Small and medium-sized business sales represented 64%
of individual life sales and 49% of individual disability sales for the year
ended December 31, 2003, based on first year annualized premium.

We distribute our individual insurance products primarily through our affiliated
financial representatives and secondarily through independent brokers.
Affiliated financial representatives were responsible for 72% of individual life
insurance sales based on first year annualized premium for the year ended
December 31, 2003. We had 926 affiliated financial representatives in 30 offices
as of December 31, 2003. Although they are independent contractors, we have a
close tie with affiliated financial representatives and offer them benefits,
training and access to tools and expertise. Non-affiliated financial
representatives comprised 80% of individual disability sales for the year ended
December 31, 2003.

We market our group life, disability, medical, dental and vision insurance
products to small and medium-sized businesses to complement our retirement
services products. We market our fee-for-service administration capabilities to
larger employers that self-insure their employees' health insurance benefits.

We sell our group life, disability, dental and fee-for-service products in all
50 states and the District of Columbia. We sell vision coverage in 49 states
plus the District of Columbia. We have chosen to market our group medical
insurance in 35 states and the District of Columbia, which we believe have
attractive market conditions. We consider a market to be attractive if there is
a lack of deep penetration by HMOs and a favorable regulatory environment. We
continually adapt our products and pricing to meet local market conditions.

We distribute our group insurance and fee-for-service products through
independent benefit brokers, consultants, financial planners and the same
channels that sell our U.S. asset accumulation products. To reach these
independent benefit brokers, consultants and financial planners, we employ three
types of wholesale distributors: our medical sales representatives, our
non-medical sales representatives and two independent wholesale organizations,
Rogers Benefit Group and Excelsior Benefits, dedicated to marketing group life,
health and disability insurance products. We have also formed a number of
strategic distribution alliances with national brokerages and regional brokerage
agencies.

As of December 31, 2003, we had 96 medical and non-medical sales representatives
and 62 service representatives in 53 offices. Our medical and non-medical sales
representatives accounted for 67%, 61%, and 64% of our group insurance sales for
the years ended December 31, 2003, 2002 and 2001, respectively. These
representatives act as a unique combination of wholesalers and brokers. They are
an integral part of the sales process alongside the agent or independent broker.
In addition to a high level of involvement in the sales process, the group sales

force plays a key role in the ongoing servicing of the case by: providing local,
responsive services to our customers, such as renewing contracts, revising plans
and solving any administrative issues; communicating the customers' needs and
feedback to us; and helping employees understand the benefits of their plan.
Compensation for the group sales force is a blend of salary and production-based
incentives.

Rogers Benefit Group is a marketing and service organization that represents
major high quality insurance carriers specializing in individual and group
medical programs, and group life, disability and dental plans. Our relationship
with Rogers Benefit Group dates back to its creation in 1970. It accounted for
33%, 39%, and 36% of our group insurance sales for the years ended December 31,
2003, 2002 and 2001, respectively.

Excelsior Benefits is a relatively new marketing organization specializing in
group medical programs, and group life, disability, and dental plans. We entered
into our relationship with Excelsior Benefits beginning in November 2003. As
such, they accounted for less than 1% of sales in 2003.

MORTGAGE BANKING SEGMENT

We began our residential lending activities in 1936. Our Mortgage Banking
segment is primarily engaged in residential loan production and loan servicing
in the U.S. Through our wholly-owned subsidiary, Principal Residential Mortgage,
Inc., ("Principal Residential Mortgage"), we originate, purchase, sell and
service mortgage loans. We principally originate "A" quality home mortgages and
do not originate subprime mortgages to any material degree, nor do we service or
purchase any subprime mortgage loans. "A" quality loans are generally defined as
loans eligible for sale to the Federal National Mortgage Association, ("Fannie
Mae"), Federal Home Loan Mortgage Corporation, ("Freddie Mac") and using the
Government National Mortgage Association, ("Ginnie Mae") Program. According to
INSIDE MORTGAGE FINANCE, based on the unpaid principal balance of $118.7 billion
in mortgage loans in its servicing portfolio, Principal Residential Mortgage was
ranked as the eleventh largest mortgage servicer in the U.S. as of December 31,
2003, and was ranked twelfth in production with $58.7 billion of new loans for
the year ended December 31, 2003.

For financial results for Mortgage Banking see Item 8. "Financial Statements and
Supplementary Data, Notes to Consolidated Financial Statements, Note 19 Segment
Information".

LOAN PRODUCTION

Our loan production strategy is to manage our three distribution channels:
correspondent lending, wholesale lending and Principal Residential Mortgage
Direct, in a manner that is consistent with our loan servicing strategy. We
obtain new customers through each of our three distribution channels, with the
majority being obtained through our correspondent lending and wholesale lending
operations.

We originate and purchase conventional mortgage loans, mortgage loans insured by
the Federal Housing Administration, ("FHA"), and mortgage loans partially
guaranteed by the Department of Veterans Affairs, ("VA"). A majority of our
conventional loans are conforming loans that qualify for inclusion in guarantee
programs sponsored by Fannie Mae or Freddie Mac. The remainder of the
conventional loans are non-conforming loans, such as jumbo loans with an
original balance in excess of $322,700 for loans delivered before January 1,
2004, and $333,700 for loans delivered after January 1, 2004, or other loans
that do not meet Fannie Mae or Freddie Mac guidelines. We neither originate nor
purchase "B" or "C" mortgages, defined as lower credit quality loans. However,
we are beginning to originate or purchase "A-" quality residential loans that
are eligible for sale to Fannie Mae or Freddie Mac. We believe this segment
presents opportunities to further penetrate the expanding U.S. housing market
without presenting the types of risks inherent in the subprime sector.

Our guidelines for underwriting conventional conforming loans comply with the
underwriting criteria employed by Fannie Mae and Freddie Mac. Our guidelines for
underwriting FHA-insured and VA-guaranteed loans comply with the criteria
established by those government entities. Our underwriting guidelines and
property standards for conventional non-conforming loans are based on the
underwriting standards employed by private investors for such loans. In
addition, conventional loans having a loan-to-value ratio greater than 80% at

origination, which are originated or purchased by us, are required to have
private mortgage insurance. Insurance premium is paid either by the borrower or
the lender. Our underwriting standards generally allow loan-to-value at
origination of up to 97% for mortgage loans with an original principal balance
of up to $322,700 for loans delivered before January 1, 2004 and $333,700 for
loans delivered after January 1, 2004. We generally use the guidelines,
techniques and technology tools provided by our investors to determine whether a
prospective borrower has sufficient monthly income available to meet: (1) the
borrower's monthly obligation on the proposed mortgage loan and (2) monthly
housing expenses and other financial obligations.

As a mortgage banker, substantially all loans we originate or purchase are sold
without recourse, subject in the case of VA loans to the limits of the VA's
guaranty. Conforming conventional loans are generally pooled by us and exchanged
for securities guaranteed by Fannie Mae or Freddie Mac. These securities are
then sold to national or regional broker-dealers. Substantially all conventional
loans securitized through Fannie Mae or Freddie Mac are sold, subject to
representations and warranties made by us on a non-recourse basis, whereby
foreclosure losses are generally a liability of Fannie Mae or Freddie Mac.
Substantially all of our FHA-insured and VA-guaranteed mortgage loans sold are
securitized through the Ginnie Mae program. The FHA insures us against
foreclosure loss and the VA provides partial guarantees against foreclosure
loss. To guarantee timely and full payment of principal and interest on Fannie
Mae, Freddie Mac and Ginnie Mae securities, we pay guarantee fees to these
agencies.

CORRESPONDENT LENDING. As of December 31, 2003, we had contracts with 702
lending institutions across the U.S. to purchase prime credit quality loans on
an ongoing basis. According to INSIDE MORTGAGE FINANCE, as of December 31, 2003,
we were the eighth largest correspondent lender in the U.S. High quality
financial institutions are approved to do business with us only after we review
their reputation, financial strength and lending expertise. Our "Correspondent
Lending Service Center" on our Internet website currently offers online access
to loan registration, an interactive sellers' procedure manual, seller-specific
rate/price quotations and simplified contact information. We are developing
online technologies to offer automated underwriting systems, pipeline reporting
and account management tools and electronic business-to-business capabilities
for our correspondent sellers. Additionally, we are entering into numerous
alliances with third-party service providers to further streamline processes,
improve productivity and provide outstanding customer service.

WHOLESALE. Our wholesale channel originates or purchases prime credit quality
loans through 14 regional offices that worked directly with 4,432 participating
mortgage loan brokers across the U.S. as of December 31, 2003. Mortgage loan
brokers are approved only after a review of their reputation and mortgage
lending expertise and financial condition. Through the "Wholesale Lending
Service Center" on our Internet website, wholesale lenders can retrieve contact
information and seller specific interest rate quotations. We have developed
plans and are working to provide online registration, automated underwriting
systems, pipeline reporting and account management services to our brokers. We
are also developing electronic document delivery and execution capabilities for
wholesale sellers to exchange secure documents with wholesale purchasers.

PRINCIPAL RESIDENTIAL MORTGAGE DIRECT. Our Mortgage Direct channel originates
prime credit quality mortgage loans through direct contact with current and new
customers via telephone and the Internet. The goal of our Internet channel is to
give our current customers access to a customer-focused website, allowing them
to obtain home financing quickly, confidently and at an attractive value, while
preserving acceptable profit margins for us. We believe that providing current
customers with choice, ease of access, convenient processes and simplified
procedures will encourage a growing percentage of our customers to choose us for
all of their home financing needs.

RETAIL ORIGINATION. On February 4, 2003, Principal Residential Mortgage signed a
definitive agreement to sell the assets of the retail field mortgage lending
branches to American Home Mortgage, Inc. ("American Home Mortgage"), an
independent retail mortgage banking company. American Home Mortgage paid
Principal Residential Mortgage a guaranteed profit margin on its application
pipeline that existed on February 4, 2003 and purchased the assets of the branch
network and assumed related liabilities.

LOAN SERVICING

We service residential mortgages in return for a servicing fee. Our servicing
division receives and processes mortgage payments for home owners, remits
payments to investors and others, holds escrow funds, contacts delinquent
borrowers, supervises foreclosures and property dispositions and performs other
miscellaneous duties related to loan administration. We acquire only "A" or "A-"
quality home mortgages for servicing. This practice simplifies the systems
necessary for servicing and reduces the amount of time and money spent on
collections and foreclosure administration activities. Our goal is to service,
on a non-recourse basis, a majority of the loans that we originate. In addition,
we periodically purchase servicing rights, also on a non-recourse basis to us,
on prime quality mortgage loans originated by other lenders. Our purchases focus
primarily on the acquisition of Fannie Mae, Freddie Mac and Ginnie Mae servicing
rights packages. Factors which influence the management of the servicing
portfolio include the expected long-term and short-term profitability of the
servicing rights, customer retention objectives and the potential cross-selling
of retirement investments and insurance and other products to home owners.
Servicing contracts acquired accounted for 19% of our mortgage servicing
portfolio as of December 31, 2003.

The weighted-average interest rate in our servicing portfolio as of December 31,
2003 was 5.95%. As of December 31, 2003, fixed rate loans comprised 95% of the
servicing portfolio and the weighted-average interest rate of the fixed-rate
loans was 6.01%.

In November 1999, we established a wholly-owned reinsurance subsidiary,
Principal Mortgage Reinsurance Company ("PMRC"), which reinsures a portion of
the primary mortgage insurance on loans that we originate or purchase. In return
for our participation in the mortgage insurance risk, we receive a portion of
the mortgage insurance premium.

In July 2002, we established a wholly-owned subsidiary, Principal Residential
Mortgage Servicing, LLC ("PRMS") to provide a source of financing from
third-party entities which is collateralized by mortgage servicing rights held
by PRMS. In 2003, PRMS entered into a borrowing arrangement with an unaffiliated
entity. As of December 31, 2003, $300.0 million was outstanding under the
borrowing arrangement.

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