Principal Financial Group, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing is an annual report, not a standalone fourth-quarter filing; selected Q4 results are included. Amounts are in U.S. dollars unless noted.
Business context
Principal provides retirement, asset management and insurance products through Retirement and Income Solutions, Principal Global Investors, Principal International, U.S. Insurance Solutions and Corporate. At year-end, it reported $668.6 billion in assets under management (AUM) and approximately 22.8 million customers worldwide.
Financial performance and position
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Total revenue | $14.093 billion | $12.394 billion |
| Income before income taxes | $2.252 billion | $1.592 billion |
| Net income | $2.325 billion | $1.362 billion |
| Net income attributable to PFG | $2.310 billion | $1.317 billion |
| Diluted EPS | $7.88 | $4.50 |
| Net cash from operating activities | $4.188 billion | $3.858 billion |
| Net cash used in investing activities | $4.053 billion | $5.154 billion |
| Net cash from (used in) financing activities | $(384) million | $1.451 billion |
| Total assets | $253.941 billion | $228.014 billion |
| Total stockholders’ equity | $12.922 billion | $10.294 billion |
| Total debt | $3.218 billion | $3.177 billion |
| Cash and cash equivalents | $2.471 billion | $2.720 billion |
| AUM | $668.6 billion | $591.6 billion |
Net investment income was $3.459 billion, up from $3.297 billion; the reported net investment yield was 4.4%, versus 4.5%. Net realized capital gains were $524.2 million, compared with $171.1 million. The filing does not present a single consolidated operating margin; reported segment pre-tax operating earnings totaled $1.874 billion, up from $1.669 billion.
Segment pre-tax operating earnings: Retirement and Income Solutions $899.8 million (2016: $794.5 million); Principal Global Investors $469.7 million ($443.8 million); Principal International $330.0 million ($288.1 million); U.S. Insurance Solutions $384.7 million ($361.2 million); and Corporate loss $210.5 million ($218.9 million).
Q4 snapshot: Revenue was $3.238 billion versus $3.514 billion in Q4 2016; net income was $842.9 million versus $338.2 million; diluted EPS was $2.87 versus $1.09.
At year-end, debt-to-equity excluding AOCI was 25% (2016: 29%) and debt-to-capitalization excluding AOCI was 20% (23%). The company reported $2.171 billion in cash and liquid assets at holding companies and other subsidiaries. Short-term credit facilities totaled $905 million, with $39.5 million outstanding. Common dividends paid were $540 million and share repurchases were $220.4 million; dividends declared per share were $1.87.
Material changes and unusual items
- Net income attributable to PFG rose by $993.9 million year over year, with $568.3 million attributed to U.S. tax reform and $410.8 million after tax from real estate transactions. These are significant non-recurring contributors to reported earnings.
- U.S. tax reform lowered the federal statutory rate from 35% to 21% and produced a reported 2017 effective tax benefit of $72.3 million, versus tax expense of $229.9 million in 2016. The company described some tax accounting amounts as provisional and subject to finalization.
- September 2017 real estate joint-venture exchanges and sales generated a $690.9 million pre-tax realized gain. Management said the transactions aimed to adjust property concentration, improve liquidity and gain control of certain properties.
- Actuarial assumption updates and model refinements reduced 2017 net income by $26.6 million, compared with a $68.8 million reduction in 2016.
- PGI AUM increased to $430.9 billion, but it recorded $2.7 billion of net outflows, primarily from several large, low-fee mandates. Principal International AUM increased to $160.7 billion, supported by net flows, markets and currency translation.
- Shareholder returns totaled $760.4 million, compared with $742.2 million in 2016. Cash operating activities increased, while financing cash flow turned negative, primarily reflecting lower net investment-contract deposits.
Outlook, risks and contingencies
The filing provides no specific consolidated earnings or revenue guidance. Management cited positive market performance and customer flows as supporting accumulation and asset-management account values and fees. It also noted that U.S. Insurance Solutions continued to face spread compression and higher reserves associated with low interest rates; actions included investment-strategy and product changes.
- Market and investment exposure: Earnings and AUM are sensitive to equity, fixed-income and real-estate markets, interest rates, credit spreads and foreign exchange. A hypothetical 100-basis-point rise in rates would reduce the reported fair value of financial assets and derivatives by an estimated $3.832 billion; the analysis excludes potentially offsetting liabilities.
- Insurance guarantees and reserves: Variable-annuity guarantees, including GMWB riders, create market and hedging risks. Actual mortality, morbidity, lapse, investment and expense experience can differ from assumptions and affect reserves, DAC and earnings.
- Credit and liquidity: U.S. commercial mortgage loans totaled $12.9 billion; 18% of the U.S. commercial mortgage portfolio was in California. The company also disclosed that approximately 42% of invested assets were in comparatively less-liquid asset classes. It reported no commercial mortgage loans in foreclosure and no problem, potential problem or restructured commercial mortgages at year-end.
- Capital and distributions: Principal Life’s dividends to its parent are subject to Iowa insurance-law limits and regulatory approval in some cases. Based on 2017 statutory results, approximately $1.122 billion could be paid as ordinary dividends in 2018 without prior approval, subject to timing and statutory rules. Principal Life’s 2017 statutory capital and surplus was $4.947 billion; it met minimum RBC requirements.
- Legal and other contingencies: The company said it had no estimated losses accrued for the discussed litigation because losses were not considered probable and estimable. A Lehman bankruptcy estate claim against Principal Life, stated at approximately $600 million including interest, was dismissed with prejudice following a January 2018 voluntary dismissal. Other legal outcomes remain uncertain, and some possible losses cannot be estimated. Guarantees to third parties had maximum exposure of approximately $147 million, with management viewing material payment as remote.
- Strategic transactions: Acquisitions of Mexico’s MetLife Afore and European real-estate manager INTERNOS were expected to close in the first half of 2018, subject to approvals. Agreements to increase ownership in Southeast Asian joint ventures and the Indian asset-management venture were also pending approvals.
- Reporting and controls: Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management concluded controls were effective. No material change in internal controls was reported for the final quarter.
Most important facts for investors to verify
- How much of 2017’s earnings and EPS growth is repeatable after excluding the $568.3 million tax-reform benefit and $410.8 million after-tax real-estate gain.
- Underlying segment earnings, especially the durability of growth in Retirement and Income Solutions and Principal International, and the effect of PGI’s net mandate outflows on fee revenue.
- Interest-rate and spread sensitivity, GMWB hedge effectiveness and the potential for reserve, DAC or capital changes under different market conditions.
- Holding-company liquidity, access to subsidiary dividends, debt maturities and the cash available for dividends, repurchases and pending acquisitions.
- Final tax-reform accounting, pending transactions and regulatory approvals, and developments in litigation, tax audits and other contingencies.