Principal Financial Group, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; balance-sheet comparisons are to December 31, 2014. Amounts are in millions of dollars unless noted. The company provides retirement and investment services, asset management, international retirement and insurance products, and U.S. insurance solutions.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total revenue | $2,657.3 | $2,478.6 |
| Income before income taxes | $458.1 | $376.4 |
| Net income | $429.1 | $324.1 |
| Net income attributable to PFG | $422.4 | $301.9 |
| Net income available to common stockholders | $414.2 | $293.7 |
| Diluted earnings per common share | $1.39 | $0.95 |
| Cash from operating activities | $630.9 | $591.3 |
- Revenue rose $178.7, led by higher premiums and fee revenue and a $65.6 increase in net realized capital gains. Net investment income fell $120.8 to $723.9, reflecting lower investment yields and prepayments in U.S. operations, lower inflation-related returns in Chile, and real estate sale gains in the prior-year quarter.
- Operating expenses increased $92.2 to $921.2; benefits, claims and settlement expenses increased $8.8 to $1,236.3. The effective income tax rate was 6%, versus 14% a year earlier.
- Management’s segment operating earnings were $326.4, compared with $317.1. This non-GAAP measure excludes adjusted realized capital gains and other after-tax adjustments.
- Operating cash flow increased to $630.9. Investing activities used $229.5, versus $835.3 in Q1 2014; financing activities used $813.3, versus $734.7. Cash and cash equivalents declined $411.9 during the quarter to $1,452.0.
Financial position, debt and liquidity
- Total assets were $222,494.9, up from $219,087.0 at year-end; total liabilities were $211,937.8, versus $208,797.0. Total stockholders’ equity was $10,492.1, up from $10,232.0.
- Invested assets totaled $68,862.5. Separate-account assets and matching liabilities were each $143,505.2; the filing says clients direct these investments and bear their investment risk.
- Total debt was $2,541.8 ($27.2 short-term and $2,514.6 long-term), down from $2,559.2. Debt to capitalization, excluding accumulated other comprehensive income, was 20%; debt to equity on the same basis was 24%.
- The holding companies reported $640.7 of cash and liquid assets. Credit facilities totaled $1,005.0, with $27.2 outstanding; $900.0 of revolving facilities were extended or renewed during the quarter. Management said available sources and liquidity stress testing were sufficient for current needs and reasonably foreseeable contingencies.
- Cash returned to common stockholders was $181.7: $106.3 in dividends and $75.4 in share repurchases. The declared common dividend was $0.36 per share, compared with $0.28 a year earlier.
Material changes and segment trends
- Retirement and Investor Services operating earnings declined to $210.9 from $216.5. Accumulation net revenue improved, but Guaranteed earnings were pressured by lower variable investment income and reduced loan prepayment activity.
- Principal Global Investors operating earnings rose to $30.7 from $26.9. AUM increased to $324.2 billion from $314.0 billion at the start of the quarter, supported by $5.3 billion of net cash flow and $6.0 billion of investment performance.
- Principal International operating earnings fell to $59.9 from $63.3. AUM ended at $110.9 billion, including a $9.8 billion adverse currency translation effect; management estimated foreign-exchange movements reduced segment operating earnings by $10.3.
- U.S. Insurance Solutions operating earnings rose to $55.1 from $43.4, with growth in specialty benefits and individual life, partly offset by higher sales, staff and pension-related expenses.
- Management announced planned organizational changes for 2015, expected not to materially affect consolidated financial statements. A proposed acquisition of AXA’s Hong Kong pension business for approximately $335 million was expected to close in the second half of 2015, subject to regulatory approvals.
Outlook, unusual items and risks
- The filing provides no specific consolidated earnings guidance. Management cautioned that quarterly results are not necessarily indicative of full-year results. It expects 2015 defined-benefit pension expense of $123.3 pre-tax, up from $85.0 in 2014, mainly due to a lower discount rate and revised mortality assumptions.
- Q1 earnings included a $105.2 benefit from deferred-tax balance changes following a merger of two Chilean legal entities. A court ruling concerning uncertain tax positions reduced net income by $30.3; management also reported $66.9 of other income on a tax indemnification. These items make headline earnings less representative of underlying operations.
- Market exposures include interest-rate, equity, credit and foreign-currency risks. A hypothetical 100-basis-point parallel rise in interest rates implied a $2,329.5 net fair-value loss at March 31. A hypothetical 10% equity decline would reduce the fair value of equity securities by $102.0; the filing estimates a specified equity-market stress could reduce annual operating earnings by approximately 4%–6%. These are sensitivities, not forecasts.
- Investment risks include credit impairment, spread and valuation changes, mortgage exposure, and potential losses if assumptions or expected cash flows change. Net realized capital gains can be volatile; Q1 gains included substantial derivative-related gains. Commercial mortgage loans were $10,820.8, and the mortgage valuation allowance was $56.9.
- Legal matters include an ERISA fee class action, an investment-company fee lawsuit, and Lehman bankruptcy litigation. No losses were accrued for the matters discussed because management did not consider losses probable and estimable; the Lehman estate’s disputed claim against Principal Life, including interest, was approximately $550.0.
- Other contingencies include approximately $237.0 of maximum exposure under certain guarantees, with management describing material payments as remote. The future maximum exposure under a Chilean minimum-return guarantee is indeterminable. The filing also identifies possible liquidity, rating-downgrade, policy surrender, regulatory, tax, cyber and catastrophe risks.
Most important facts for investors to verify
- Separate recurring segment performance from the Chilean deferred-tax benefit, uncertain-tax-position charge, tax indemnification income and volatile derivative gains.
- Review the drivers behind the decline in net investment income and the sustainability of fee, premium and AUM growth across segments.
- Monitor investment portfolio credit quality, unrealized losses, mortgage delinquencies and allowance adequacy, as well as the sensitivity of guarantees and reserves to market conditions.
- Assess cash depletion from financing outflows, contract withdrawals, debt and holding-company liquidity, including the limits on dividends from Principal Life.
- Track developments in tax litigation, the disclosed lawsuits and guarantees, and completion and integration risks for the proposed Hong Kong acquisition.