6. Closed Block

In connection with the 1998 MIHC formation, Principal Life formed a Closed Block to provide reasonable assurance to policyholders included therein that, after the formation of the MIHC, assets would be available to maintain dividends in aggregate in accordance with the 1997 policy dividend scales, if the experience underlying such scales continued. Assets of Principal Life were allocated to the Closed Block in an amount that produces cash flows which, together with anticipated revenue from policies and contracts included in the Closed Block, were expected to be sufficient to support the Closed Block policies. This includes, but is not limited to, provisions for payment of claims, certain expenses, charges and taxes, and to provide for continuation of policy and contract dividends in aggregate in accordance with the 1997 dividend scales, if the experience underlying such scales continues, and to allow for appropriate adjustments in such scales, if such experience changes. Due to adjustable life policies being included in the Closed Block, the Closed Block is charged with amounts necessary to properly fund for certain adjustments, such as face amount and premium increases, that are made to these policies after the Closed Block inception date. These amounts are referred to as Funding Adjustment Charges and are treated as capital transfers from the Closed Block.

Assets allocated to the Closed Block inure solely to the benefit of the holders of policies included in the Closed Block. Closed Block assets and liabilities are carried on the same basis as other similar assets and liabilities. Principal Life will continue to pay guaranteed benefits under all policies, including the policies within the Closed Block, in accordance with their terms. If the assets allocated to the Closed Block, the investment cash flows from those assets and the revenues from the policies included in the Closed Block, including investment income thereon, prove to be insufficient to pay the benefits guaranteed under the policies included in the Closed Block, Principal Life will be required to make such payments from its general funds. No additional policies were added to the Closed Block, nor was the Closed Block affected in any other way, as a result of the demutualization.

A policyholder dividend obligation (“PDO”) is required to be established for earnings in the Closed Block that are not available to stockholders. A model of the Closed Block was established to produce the pattern of expected earnings, assets and liabilities in the Closed Block, adjusted to eliminate the impact of related amounts in AOCI. These projections are utilized to determine ratios that will allow us to compare actual cumulative earnings to expected cumulative earnings.

If actual cumulative earnings of the Closed Block are greater than the expected cumulative earnings of the Closed Block, only the expected cumulative earnings will be recognized in income with the excess recorded as a PDO. This PDO represents undistributed accumulated earnings that will be paid to Closed Block policyholders as dividends unless offset by future performance of the Closed Block that is less favorable than originally expected. If actual cumulative performance is less favorable than expected, only actual earnings will be recognized in income. As of both December 31, 2018 and 2017, cumulative actual earnings were less than cumulative expected earnings. As of December 31, 2018 and 2017, cumulative net unrealized gains were greater than expected, resulting in the recognition of a PDO of $36.6 million and $161.7 million, respectively.

Closed Block liabilities and assets designated to the Closed Block were as follows:


	December 31, 2018		December 31, 2017
	(in millions)
Closed Block liabilities
Future policy benefits and claims	$	3,732.5	$	3,899.7
Other policyholder funds		6.5		7.0
Policyholder dividends payable		211.3		219.6
Policyholder dividends obligation		36.6		161.7
Other liabilities		9.5		6.9
Total Closed Block liabilities		3,996.4		4,294.9

Assets designated to the Closed Block
Fixed maturities, available-for-sale		2,176.4		2,304.4
Fixed maturities, trading		2.5		2.9
Equity securities		1.0		1.3
Mortgage loans		678.5		766.3
Policy loans		510.5		537.1
Other investments		33.8		49.4
Total investments		3,402.7		3,661.4
Cash and cash equivalents		42.1		13.2
Accrued investment income		39.5		41.1
Premiums due and other receivables		10.0		14.4
Deferred tax asset		30.5		34.6
Total assets designated to the Closed Block		3,524.8		3,764.7
Excess of Closed Block liabilities over assets designated to the Closed Block		471.6		530.2
Amounts included in accumulated other comprehensive income		5.2		1.9
Maximum future earnings to be recognized from Closed Block assets and liabilities	$	476.8	$	532.1

Closed Block revenues and expenses were as follows:


	For the year ended December 31,
	2018		2017		2016
	(in millions)
Revenues
Premiums and other considerations	$	244.2	$	275.6	$	298.0
Net investment income		160.5		169.4		181.6
Net realized capital losses		(3.4)		(5.8)		(1.0)
Total revenues		401.3		439.2		478.6
Expenses
Benefits, claims and settlement expenses		211.5		245.6		267.1
Dividends to policyholders		120.9		122.0		153.5
Operating expenses		3.3		3.5		3.6
Total expenses		335.7		371.1		424.2
Closed Block revenues, net of Closed Block expenses, before income taxes		65.6		68.1		54.4
Income taxes		11.1		46.0		17.1
Closed Block revenues, net of Closed Block expenses and income taxes		54.5		22.1		37.3
Funding adjustments		(0.5)		(4.4)		9.3
Closed Block revenues, net of Closed Block expenses, income taxes and funding adjustments	$	54.0	$	17.7	$	46.6

The change in maximum future earnings of the Closed Block was as follows:


	For the year ended December 31,
	2018		2017		2016
	(in millions)
Beginning of year	$	532.1	$	549.8	$	596.4
Effects of implementation of accounting changes (1)		1.3		—		—
End of year		476.8		532.1		549.8
Change in maximum future earnings	$	(54.0)	$	(17.7)	$	(46.6)

(1)

Includes the effects of implementation of accounting changes related to equity investments and the reclassification of certain tax effects.

Principal Life charges the Closed Block with U.S. federal income taxes, payroll taxes, state and local premium taxes and other state or local taxes, licenses and fees as provided in the plan of reorganization.