PRINCIPAL FINANCIAL GROUP INC quarterly report, Q3 FY2018

Principal Financial Group, Inc. — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Comparisons are with the corresponding 2017 periods unless otherwise noted. Principal operates retirement and income solutions, asset management, international financial services, and U.S. insurance businesses.

Financial performance and position

MetricQ3 2018Q3 2017Nine months 2018Nine months 2017
Total revenue$4.348B$4.628B$10.467B$10.856B
Income before tax$569.1M$1.158B$1.542B$1.937B
Net income attributable to Principal$456.3M$810.2M$1.310B$1.469B
Diluted earnings per share$1.59$2.76$4.52$5.02
Segment pre-tax operating earnings$593.4M$452.9M$1.576B$1.420B

Revenue and GAAP earnings declined year over year, while segment pre-tax operating earnings increased. The filing does not provide a directly comparable consolidated operating margin; reported GAAP results include significant investment gains and losses.

Cash flow, nine months: Operating cash flow was $3.714B, investing cash flow was $(4.409)B, and financing cash flow was $1.151B. Cash and cash equivalents rose to $2.927B from $2.471B at year-end 2017.

Balance sheet at September 30: Total assets were $258.758B and total liabilities $246.841B. Total debt was $3.282B ($36.1M short-term; $3.246B long-term). Debt was 25% of equity excluding AOCI and 20% of capitalization excluding AOCI, both unchanged from year-end. Stockholders’ equity was $11.769B, down from $12.922B; AOCI moved from positive $165.5M to negative $1.348B, primarily reflecting unrealized investment losses and foreign currency translation. Cash and separate-account assets are not equivalent to unrestricted parent-company liquidity.

Changes and significant drivers

  • Q3 revenue included a $253.1M accelerated performance fee following a real estate investment-team realignment; $151.9M of related revenue-sharing expenses left a $101.2M increase in Principal Global Investors’ pre-tax operating earnings. The firm no longer manages $9.2B of the client’s assets, and management did not expect material ongoing earnings effects.
  • Q3 actuarial assumption updates and model refinements increased consolidated net income by $32.1M. The comparable 2017 updates decreased net income by $26.6M.
  • The prior-year comparison includes a $690.9M pre-tax ($410.8M after-tax) gain from 2017 real estate transactions. This was the principal reason net realized capital gains and consolidated net income were much lower in 2018; Q3 2018 had a $5.5M net realized capital loss versus a $676.6M gain in Q3 2017.
  • Nine-month operating revenue in Retirement and Income Solutions fell, mainly on lower single-premium group and individual annuity sales. Principal Global Investors’ AUM ended at $426.5B, including a $9.2B outflow related to the team realignment; the $3.5B INTERNOS acquisition added AUM. Principal International AUM ended at $156.6B, affected by foreign exchange movements.
  • U.S. tax reform lowered the statutory federal corporate tax rate to 21%; effective tax rates were 19% for Q3 and 14% for nine months, versus 30% and 24% in 2017.

Liquidity, outlook, risks, and unusual items

  • Management said cash flows and available funding were adequate for current and reasonably foreseeable liquidity needs. Holding companies and other subsidiaries held $2.034B of cash and liquid assets available for corporate purposes. Credit facilities totaled approximately $996M, with $36.1M drawn at quarter-end.
  • Management reported no material change in contractual obligations or guarantees since year-end 2017 and gave no specific earnings or revenue guidance in the provided filing text. It noted that results are not necessarily indicative of full-year results.
  • In March 2018, the company entered contingent funding agreements that can provide access to $400M of 2028 notes and $350M of 2048 notes. The notes are not issued unless the put options are exercised; specified events can require exercise. The company also may have to purchase up to $750M of Treasury securities from the trusts if due and unpaid.
  • Interest-rate, credit, equity, foreign-exchange, investment valuation, policyholder behavior, and asset-liability risks are significant. A hypothetical 100-basis-point rate decrease was estimated to reduce segment pre-tax operating earnings by less than 1% over the next 12 months, excluding possible DAC and actuarial-balance unlocking; management said adverse effects may grow as assets mature. A modeled 10% equity-market decline followed by 2% quarterly increases would reduce annual segment pre-tax operating earnings by approximately 4%–6%.
  • Gross unrealized losses on available-for-sale fixed maturities increased to $1.140B from $267M at year-end, primarily due to higher interest rates. The company said it did not intend, and was not more likely than not required, to sell these securities before recovering amortized cost; 97% of Principal Life’s securities in unrealized-loss positions were investment grade.
  • The Chilean mandatory retirement fund relative-return guarantee has no stated cap on duration or amount, so maximum future exposure is indeterminable. Other disclosed guarantees had approximately $131M maximum exposure; management considered material payments remote. The filing reported no litigation or regulatory contingencies for which disclosure was considered appropriate.
  • Acquisitions during 2018 included RobustWealth, INTERNOS, and MetLife Afore’s Mexican pension business. The company is evaluating a new long-duration insurance accounting standard expected to be adopted in 2021 and anticipates significant changes to accounting for many insurance and annuity products.

Important facts for investors to verify

  • How much of current earnings and fee growth is recurring after the $253.1M accelerated performance fee and the $32.1M actuarial-update benefit?
  • Whether asset flows, market performance, and foreign exchange movements support future AUM and fee revenue, particularly after the $9.2B real-estate mandate departure.
  • How rising rates, unrealized fixed-maturity losses, credit spreads, and policyholder withdrawals affect statutory capital, liquidity, and realized results.
  • The availability and restrictions on subsidiary dividends and holding-company liquidity, and the triggers and costs associated with the $750M contingent funding arrangements.
  • Developments in the uncapped Chilean fund guarantee, insurance-reserve assumptions, and implementation of the long-duration insurance accounting standard.