Business context and reporting period
Principal Financial Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It provides retirement, asset management and insurance products through Retirement and Income Solutions, Principal Global Investors, Principal International and U.S. Insurance Solutions, with a Corporate segment. The company reported $591.6 billion in assets under management (AUM) and approximately 22.1 million customers worldwide at year-end.
Financial performance and position
Unless noted otherwise, amounts are U.S. dollars. Annual results are for 2016 compared with 2015.
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenue | $12.394 billion | $11.964 billion | +$429.7 million (+3.6%) |
| Income before income taxes | $1.592 billion | $1.431 billion | +$160.9 million |
| Net income | $1.362 billion | $1.253 billion | +$108.6 million (+8.7%) |
| Net income available to common stockholders | $1.317 billion | $1.209 billion | +$107.2 million (+8.9%) |
| Diluted EPS | $4.50 | $4.06 | +$0.44 (+10.8%) |
| Net investment income | $3.297 billion | $3.052 billion | +$244.4 million |
| Net realized capital gains (losses) | $171.1 million | $(51.1) million | +$222.2 million |
| Operating cash flow | $3.858 billion | $4.377 billion | Down $519.3 million |
| Total assets | $228.014 billion | $218.660 billion | +$9.354 billion |
| Stockholders’ equity | $10.294 billion | $9.377 billion | +$916.4 million |
| Total debt | $3.177 billion | $3.446 billion | Down $269.2 million |
| AUM | $591.6 billion | $527.4 billion | +$64.2 billion (+12.2%) |
Calculated from reported figures, pretax income was about 12.8% of revenue and net income about 11.0%, versus approximately 12.0% and 10.5%, respectively, in 2015. These are simple consolidated ratios, not company-reported operating margins. The effective tax rate was 14%, compared with 12% in 2015.
Net cash used in investing activities was $5.154 billion, principally reflecting increased purchases of available-for-sale securities. Financing activities provided $1.451 billion, compared with $508.6 million used in 2015, largely due to net investment-contract deposits. Year-end cash and cash equivalents were $2.720 billion. Debt-to-equity excluding AOCI improved to 29% from 34%; debt-to-capitalization excluding AOCI improved to 23% from 25%.
Fourth-quarter 2016 revenue was $3.514 billion, net income was $338.2 million and diluted EPS was $1.09; fourth-quarter 2015 figures were $2.807 billion, $258.3 million and $0.86, respectively.
Material changes versus the prior comparable period
- Net income benefited from the shift to realized gains in 2016 from realized losses in 2015, including gains on derivatives not designated as hedges; higher average invested assets and variable investment income also contributed. Lower investment yields and the absence of a $105.2 million deferred-tax benefit recognized in 2015 partly offset the improvement.
- 2016 included a $68.8 million after-tax unfavorable impact from actuarial assumption updates and model refinements; 2015 updates had increased net income by $26.2 million. The 2015 Chilean legal-entity merger generated a separate $105.2 million net-income benefit.
- Net investment income increased, but its reported yield rose only to 4.5% from 4.4%; the company attributed the increase mainly to higher average U.S. invested assets and variable investment income, partly offset by lower U.S. investment yields.
- Pre-tax operating earnings by segment: Retirement and Income Solutions $794.5 million (up $54.4 million); Principal Global Investors $443.8 million (up $55.3 million); Principal International $288.1 million (up $16.8 million); U.S. Insurance Solutions $361.2 million (down $68.3 million); Corporate loss $218.9 million (wider by $26.6 million).
- Principal Global Investors AUM increased to $390.5 billion from $360.8 billion, including $9.0 billion of net cash flow and $21.7 billion of investment performance. Principal International AUM rose to $137.1 billion from $109.9 billion, including positive net flows, investment performance and a favorable currency-translation effect.
- Company-wide cash returned to common stockholders was $742.2 million in 2016: $464.9 million in dividends and $277.3 million in share repurchases. The declared dividend per share increased to $1.61 from $1.50.
Outlook, commentary, risks and unusual items
The filing provides no specific numerical earnings or revenue guidance. Management cited positive market performance and net customer cash flows as contributors to growth in retirement account values and asset-management AUM. It also described ongoing international growth and expense management. The company cautioned that lower interest rates had compressed spreads and increased reserves in U.S. Insurance Solutions, prompting product changes.
- Market and investment exposure: Sustained low rates may depress investment spreads, increase reserves and hedging costs, and affect statutory capital. Rising rates could prompt surrenders and asset sales at losses. A hypothetical immediate 100-basis-point rate decline was estimated to reduce segment pretax operating earnings by less than 1% over 12 months, excluding potential DAC and actuarial-balance unlocking; a 10% equity-market decline followed by a 2% quarterly recovery was estimated to reduce annual segment pretax operating earnings by 4%–6%.
- Credit, real estate and liquidity risks: U.S. fixed maturities totaled $51.6 billion, with about 7% below investment grade. Commercial mortgage loans totaled $12.0 billion; 18% of that portfolio was in California and approximately 82% had balloon maturities. Around 40% of invested assets were in asset classes management described as less liquid. The company reported $0.6 billion of gross unrealized losses on U.S. available-for-sale fixed maturities, while concluding it did not expect to be forced to sell the securities before recovery.
- Guarantees and reserves: Variable-annuity living-benefit guarantees expose the company to equity, interest-rate, volatility, policyholder-behavior and hedge-performance risk. The Closed Block had $3.894 billion of designated assets against $4.443 billion of liabilities; Principal Life may have to fund any shortfall, and excess Closed Block earnings benefit policyholders rather than shareholders.
- Regulatory, legal and tax matters: The filing discusses evolving insurance capital and reserving rules, the Department of Labor fiduciary rule, and uncertainty around other financial-services regulation. Management said its preliminary assessment was that the fiduciary rule would not significantly affect financial condition or results, while noting implementation impacts remained to be assessed. The company disclosed investment-fee litigation and other legal matters; no loss was accrued for the described matters because management did not consider losses probable and could not reasonably estimate them. A tax refund dispute concerning 1995–2003 tax years remained pending; the company reported $242.9 million of tax receivables associated with outstanding audit issues.
- Other unusual items and events: 2016 operating expenses included $86.4 million of one-time costs to extinguish debt early. The company issued $650 million of senior notes and used the proceeds to redeem notes due in 2017 and 2019. It also repurchased about $94.4 million principal amount of 2036 notes. The 2016 AFS impairment charge was $98.8 million, compared with $0.8 million in 2015, net of recoveries and related reclassifications.
- Liquidity and capital: Management stated that available cash, investment cash flows, operations and committed credit facilities were adequate for anticipated needs. Principal Life’s 2017 ordinary dividend limit without exceeding statutory limits was approximately $1.143 billion; its 2016 dividends to its parent totaled $1.175 billion, including $650 million approved as extraordinary dividends. Principal Life met minimum RBC requirements, and insurer financial-strength ratings were affirmed at A+ by A.M. Best and S&P, AA- by Fitch and A1 by Moody’s, all with stable outlooks in the ratings disclosed.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management also concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2016.
Important facts for investors to verify
- How much of the 2016 earnings improvement came from recurring operating performance versus derivative-related realized gains, variable investment income and other market-sensitive items?
- What assumptions drove the $68.8 million after-tax unfavorable actuarial/DAC update, and could further unlocking or reserve changes materially affect future earnings?
- How are low-rate spread compression, reinvestment yields and hedging costs affecting insurance profitability and statutory capital?
- What is the credit and refinancing outlook for the commercial mortgage portfolio, including balloon maturities and California concentration, and for the fixed-maturity portfolio?
- How much parent-company liquidity is available independently of regulated-subsidiary dividends, given statutory dividend limits and the company’s capital-return plans?
- What developments could change estimated exposure from litigation, tax disputes, reinsurance recoverables, guarantees or regulatory changes?