Business context and reporting period
Principal Financial Group, Inc. (Nasdaq: PFG) filed this Form 10-K for the fiscal year ended December 31, 2019. The company provides retirement and income solutions, global investment management, international savings and insurance products through four reportable business segments, plus Corporate. Reported assets under management (AUM) were $735.3 billion at year-end. The filing is an annual report, not a standalone quarterly filing; Q4 figures below are from its unaudited quarterly summary.
Financial performance and position
| Metric | FY 2019 | FY 2018 |
|---|---|---|
| Total revenue | $16.22 billion | $14.24 billion |
| Income before tax | $1.69 billion | $1.78 billion |
| Net income attributable to PFG | $1.39 billion | $1.55 billion |
| Diluted EPS | $4.96 | $5.36 |
| Operating cash flow | $5.49 billion | $5.16 billion |
| Total assets | $276.09 billion | $243.04 billion |
| Total stockholders’ equity | $14.69 billion | $11.46 billion |
Revenue rose about 14%, while net income attributable to PFG fell about 10%. Total expenses increased to $14.53 billion from $12.45 billion; benefits, claims and settlement expenses were $9.91 billion. Net realized capital losses were $52.8 million, versus $75.4 million of losses in 2018. The filing does not present a single company-wide operating margin as a key performance measure.
Fourth quarter: revenue was $4.05 billion, net income attributable to PFG was $300.9 million and diluted EPS was $1.07, compared with $3.77 billion, $236.5 million and $0.83, respectively, in Q4 2018.
Cash, investments and debt
Operating cash flow was $5.49 billion; investing activities used $7.69 billion and financing activities provided $1.73 billion. Cash and cash equivalents ended the year at $2.52 billion, down from $2.98 billion. The $1.21 billion net cash purchase of the Wells Fargo retirement business was a major investing outflow. Total invested assets were $96.35 billion, principally fixed maturities and commercial mortgage loans.
Total debt was $3.83 billion, including $93.4 million of short-term debt and $3.73 billion of long-term debt. Debt-to-equity was 26% and debt-to-capitalization 21%, versus 29% and 22% in 2018. PFG reported $1.75 billion of cash and liquid assets at its holding companies and other subsidiaries. Committed revolving credit facilities totaling $800 million were undrawn; commercial paper outstanding was zero. Insurance-company dividend capacity is subject to Iowa regulatory limits.
Material changes versus the prior comparable period
- Revenue increased primarily from higher single-premium pension risk-transfer annuity sales, increased investment income and the acquired Wells Fargo Institutional Retirement & Trust (IRT) business. Pension-risk-transfer premiums can vary substantially and are accompanied by related benefit reserves and expenses.
- Retirement and Income Solutions pre-tax operating earnings declined to $874.0 million from $922.2 million, despite $205.9 million of 2019 net revenue from the acquired business. Acquisition-related integration expenses included a $27.9 million pre-tax loss.
- Principal Global Investors pre-tax operating earnings fell to $483.3 million from $562.1 million, largely because 2018 included a $101.2 million net benefit from an accelerated real-estate performance fee and related expenses. Its AUM rose to $458.6 billion from $393.5 billion, primarily on positive investment performance.
- Principal International pre-tax operating earnings increased to $390.7 million from $272.6 million, including favorable market performance and actuarial assumption updates in Brazil; foreign-exchange movements were a headwind.
- U.S. Insurance Solutions pre-tax operating earnings increased to $521.6 million from $467.0 million, supported by business growth and more favorable specialty-benefits claims experience.
- Actuarial assumption updates and model refinements reduced 2019 net income by $36.5 million, compared with a $32.1 million increase in 2018. The 2018 and 2017 comparisons also include the prior-year real-estate fee and, in 2017, a $690.9 million pre-tax real-estate transaction gain and a substantial tax-reform benefit.
Outlook, commentary, risks and unusual items
The filing provides no specific forward earnings guidance. Management described positive market performance and net customer cash flow as supporting retirement account values and AUM in 2019. It also noted that low interest rates have compressed insurance spreads and increased reserves, with some mitigation from investment-strategy and product changes. Fitch revised its 2020 U.S. life-insurance sector outlook to negative over low-rate concerns; Principal Life and Principal National Life retained strong financial-strength ratings with stable company outlooks. U.S. life insurers’ statutory surplus exceeded minimum risk-based capital requirements at year-end.
- Acquisition and integration: PFG paid $1.2 billion for Wells Fargo’s IRT business on July 1, 2019, with up to $150 million additional earn-out tied to fee-revenue retention through December 31, 2020. Customer migration was expected to begin in late 2020 and continue into 2021; Wells Fargo was to continue servicing customers during the transition. Integration, consent and retention risks remain.
- Market and insurance risks: Low or changing interest rates, equity-market declines, credit-spread movements and policyholder behavior can affect investment spreads, guarantees, reserves, hedging costs, AUM and fee revenue. A hypothetical 10% equity-market decline followed by partial recovery was estimated to reduce annual segment pre-tax operating earnings by approximately 5%–7% over 12 months, excluding potential DAC unlocking.
- Investment and liquidity risks: Commercial mortgage loans were $15.0 billion; California represented 21% of the U.S. commercial mortgage portfolio. About 84% of U.S. commercial mortgage loans had balloon maturities. Privately placed fixed maturities, mortgage loans and real estate are less liquid than public securities.
- Legal contingency: In February 2020, the Eighth Circuit reversed a summary judgment for Principal Life in the Rozo ERISA class action and remanded the case. The company said it would defend the case; no loss was accrued because loss was not considered probable and could not be reasonably estimated.
- Accounting and controls: Long-duration insurance accounting changes are scheduled for 2022 and are expected to significantly change accounting for many products; the financial impact was not yet clear. Auditors gave unqualified opinions on the financial statements and internal control, but the acquired IRT business was excluded from the control assessment.
Important facts for investors to verify
- Progress on IRT customer retention, system integration, migration timing and the potential earn-out payment.
- Whether fee-based growth and AUM flows can offset spread pressure, higher expenses and volatile pension-risk-transfer volumes.
- Insurance-subsidiary statutory capital, dividend capacity and the sensitivity of guarantees, reserves and hedges to interest-rate and equity-market changes.
- Commercial mortgage performance, especially balloon maturities and California exposure, and the quality and liquidity of investment assets.
- Developments in the Rozo litigation and the eventual financial and reporting effects of the 2022 insurance-accounting standard.