PFG

Business Context and Reporting Period

Company: Principal Financial Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2006
Business Overview: Principal Financial Group provides financial products and services through four primary segments: U.S. Asset Management and Accumulation, International Asset Management and Accumulation, Life and Health Insurance, and Corporate and Other. The company operates as a large accelerated filer.

Key Financial Metrics (Six Months Ended June 30, 2006)

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 11% to $4,840.1 million, driven by a 14% increase in premiums and a 9% increase in fees. Net investment income rose 8% to $1,763.8 million due to higher yields and increased invested assets.
• Profitability: Net income increased 15% to $512.7 million. However, net income available to common stockholders decreased in the three-month period due to preferred stock dividends ($16.5 million for six months) and the absence of discontinued operations income present in 2005.
• Capital Gains/Losses: Net realized/unrealized capital gains were $29.8 million for the six months ended June 30, 2006, compared to $8.7 million in 2005. This included a $44.3 million gain on the sale of an equity method investment, partially offset by $16.0 million in impairment write-downs related to the intent to fund the WM Advisors acquisition.
• Equity Decline: Total stockholders' equity decreased by approximately $962.5 million to $6,844.7 million. This was primarily due to a $1,113.0 million net unrealized loss on available-for-sale securities recorded in Accumulated Other Comprehensive Income (AOCI), partially offset by net income and stock-based compensation.
• Cash Flow: Operating cash flow increased significantly to $1,104.8 million, largely due to the absence of a large IRS deficiency payment made in 2005. Investing cash outflows increased to $2,068.0 million due to higher acquisition activity and securities purchases.

Guidance, Outlook, and Risks

• Acquisition: On July 25, 2006, the company announced a definitive agreement to acquire WM Advisors, Inc. for $740.0 million in cash. The transaction is expected to close in Q4 2006 or early 2007.
• Share Repurchases: The company entered into an accelerated common stock repurchase agreement in May 2006 for $500.0 million. A previous $250.0 million program was completed in May 2006.
• Dividends: Principal Life Insurance Company declared an extraordinary dividend of up to $550.0 million to the parent company, which was approved by the Iowa Insurance Commissioner and paid in May 2006.
• Accounting Changes: The company adopted SFAS 123R (Share-Based Payment) effective January 1, 2006, using the modified-prospective method. The company does not expect FIN 48 (Accounting for Uncertainty in Income Taxes) to have a material impact upon adoption in 2007.
• Risks:
  • Market Risk: Exposure to interest rate, equity, and foreign currency fluctuations. A 100 basis point increase in interest rates is estimated to decrease net fair value by $68.1 million.
  • Credit Risk: Exposure to credit impairments in fixed maturity securities and commercial mortgage loans. The company recognized $16.0 million in impairments in 2006 due to the need to fund the WM Advisors acquisition.
  • Litigation: Ongoing inquiries from state attorneys general regarding compensation arrangements and a pending appeal regarding demutualization allocation. Management does not believe pending litigation will have a material adverse effect.

Investor Verification Checklist

• WM Advisors Acquisition: Verify the closing timeline and funding sources for the $740 million cash acquisition.
• Unrealized Losses: Review the $1,113 million decline in AOCI and the composition of gross unrealized losses ($755.1 million) in fixed maturity securities to assess potential future realized losses.
• Impairment Charges: Confirm the $16.0 million impairment write-downs related to the change in intent to hold securities for the WM Advisors deal and monitor for further credit impairments.
• Dividend Capacity: Monitor the $630.7 million statutory dividend limit for Principal Life and the impact of the recent $550 million extraordinary dividend on future capital availability.
• Segment Performance: Analyze the divergence between the strong growth in U.S. Asset Management operating earnings ($309.0 million) and the decline in Life and Health Insurance operating earnings ($135.6 million).