Principal Financial Group, Inc. — 2015 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2015, with comparable annual results for 2014 and 2013. Principal provides retirement, asset management, and insurance products through four operating segments—Retirement and Income Solutions, Principal Global Investors, Principal International, and U.S. Insurance Solutions—plus Corporate. At year-end, the company reported $527.4 billion in assets under management (AUM) and approximately 19.1 million customers worldwide.
Financial performance and position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total revenue | $11,964.4 million | $10,477.6 million | +14.2% |
| Income before tax | $1,430.8 million | $1,494.9 million | -4.3% |
| Net income | $1,253.2 million | $1,176.4 million | +6.5% |
| Net income available to common stockholders | $1,209.3 million | $1,111.1 million | +8.8% |
| Diluted EPS | $4.06 | $3.65 | +11.2% |
| Net cash from operating activities | $4,377.1 million | $3,102.9 million | +$1,274.2 million |
| Total assets | $218,685.9 million | $219,087.0 million | -0.2% |
| Total stockholders’ equity | $9,377.4 million | $10,232.0 million | -8.4% |
- Revenue mix and earnings quality: Premiums and other considerations rose to $5,310.3 million from $3,722.9 million, primarily reflecting higher single-premium group and individual annuity sales. Fees and other revenues increased to $3,653.1 million. Net investment income fell to $3,052.1 million from $3,257.9 million; net realized capital results shifted to a $51.1 million loss from a $14.7 million gain. Net income was approximately 10.5% of revenue, versus 11.2% in 2014.
- Cash flow: Investing activities used $3,167.6 million, including increased fixed-maturity purchases and the Hong Kong pension-business acquisition. Financing activities used $508.6 million. Cash and cash equivalents increased to $2,564.8 million from $1,863.9 million.
- Debt and liquidity: Total debt was $3,471.9 million, comprising $181.1 million short-term and $3,290.8 million long-term debt, up from $2,559.2 million in 2014. Debt to capitalization, excluding AOCI, increased to 25% from 20%; debt to equity, excluding AOCI, rose to 34% from 25%. Management said cash, securities, operating inflows and credit facilities were adequate for anticipated needs. Holding companies and other subsidiaries held $930 million in cash and liquid assets.
- Investments and credit: Invested assets totaled $69,820.5 million; fixed maturities were $47.1 billion and commercial mortgage loans were $11.2 billion. About 92% of fixed maturities were investment grade by the filing’s rating presentation. Problem, potential-problem and restructured fixed maturities were $243.8 million, or 0.52% of the portfolio, down from 0.97% in 2014. Gross unrealized losses on available-for-sale fixed maturities increased to $823.2 million from $338.8 million.
- Segment pre-tax operating earnings: Retirement and Income Solutions: $740.1 million, down from $851.2 million; Principal Global Investors: $388.5 million, up from $350.1 million; Principal International: $271.3 million, down from $352.7 million; U.S. Insurance Solutions: $429.5 million, up from $344.1 million; Corporate: a $192.3 million loss, versus a $175.0 million loss. Total segment operating earnings declined to $1,637.1 million from $1,723.1 million.
Material changes versus prior periods
- Annual net income increased, but income before tax and aggregate segment pre-tax operating earnings declined. Lower income taxes were a major contributor to the increase in reported net income.
- The 2015 effective tax rate was 12%, versus 21% in 2014. A $105.2 million net-income benefit from a Chilean legal-entity merger was a notable one-time item; the filing also reports a $30.3 million first-quarter reduction in net income tied to a tax-court development.
- Foreign-exchange movements reduced Principal International pre-tax operating earnings by $69.3 million. The segment’s reported AUM decreased to $109.9 billion from $114.6 billion, despite positive net cash flow and investment performance, principally because of currency translation.
- Principal Global Investors AUM rose to $360.8 billion from $342.7 billion, including $15.5 billion of net cash inflows and $0.6 billion of investment performance. Total company AUM was $527.4 billion, versus $519.3 billion.
- In September, Principal acquired AXA’s Hong Kong MPF and ORSO pension business for $335.5 million, more than doubling its Hong Kong pension AUM to $5.9 billion. An exclusive 15-year distribution agreement accompanied the acquisition.
- The company issued $400 million of 3.4% senior notes due 2025 and $400 million of 4.7% junior subordinated notes due 2055. It redeemed $550 million of preferred stock. Common dividends and share repurchases totaled $741.6 million, up from $599.3 million in 2014.
- Fourth-quarter net income was $258.3 million and diluted EPS was $0.86, compared with $280.3 million and $0.91 in fourth-quarter 2014. Segment reporting and organizational assignments changed in Q4 2015; prior segment results were retrospectively adjusted, with no impact on consolidated financial statements.
Outlook, commentary, risks and unusual items
- Outlook: Management stated that a sustained low-interest-rate environment would reduce net income growth, pressure investment spreads and could lead to higher reserves or DAC and other actuarial-balance adjustments. The filing does not provide quantified company-wide earnings guidance.
- Operating drivers: Positive markets and net customer cash flows supported retirement account values and asset-management AUM. U.S. Insurance Solutions continued to face spread compression and reserve/DAC pressure from low rates and lower long-term rate assumptions. Management cited growth opportunities in small and midsize businesses, voluntary benefits, international retirement markets, and fee-based asset management.
- Actuarial estimates: 2015 assumption updates and model refinements increased total company net income by $26.2 million; the related net segment pre-tax operating earnings impact was positive $48.1 million. Brazilian mutual-fund-business intangible impairments totaled $23.0 million pre-tax. Goodwill was not impaired in the annual test.
- Market and investment risks: The company highlighted sensitivity to interest rates, credit spreads, equity and real-estate markets, defaults, prepayments, currency movements and valuation assumptions. A hypothetical 100-basis-point rate increase produced an estimated $2.48 billion net fair-value loss; this is a scenario, not a forecast. Management also cited the risk of ineffective hedging of variable-annuity guarantees, counterparty exposure, and the illiquidity of some investments.
- Liquidity, capital and regulation: Insurance-subsidiary dividends are restricted by Iowa law; Principal Life’s 2016 dividend limit was approximately $937 million, subject to regulatory requirements. Potential regulatory changes include principles-based reserves and risk-based-capital revisions. The filing also identifies potential effects from fiduciary-rule changes, tax and accounting changes, and international regulatory or political developments.
- Legal and contingent matters: The filing describes a December 2015 investment-company excessive-fee lawsuit, an ERISA case whose dismissal was affirmed on appeal in January 2016, and litigation involving Lehman Brothers’ bankruptcy estate, whose disputed claim against Principal Life was approximately $550 million including interest through November 2014. No losses were accrued for the cited matters because management considered losses not probable and not reasonably estimable. Maximum exposure under certain third-party guarantees was approximately $200 million; management considered material payment remote.
- Audit and controls: Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls were effective as of December 31, 2015.
Most important facts for investors to verify
- How much of 2015 earnings growth came from the Chilean merger tax benefit and the lower effective tax rate, and how results trend excluding unusual tax items.
- Whether spread earnings and insurance profitability stabilize if low interest rates persist, and how actuarial assumptions and guarantee costs affect future earnings.
- Whether elevated unrealized fixed-maturity losses remain market-driven or lead to credit impairments, and how concentrated commercial mortgage and less-liquid exposures perform.
- Whether Principal International earnings and AUM recover from currency pressure, and whether the AXA Hong Kong acquisition delivers expected growth and distribution benefits.
- How debt growth, share repurchases, dividends and insurance-subsidiary dividend restrictions affect holding-company liquidity and capital flexibility.
- Developments and potential financial exposure in the disclosed tax litigation, excessive-fee litigation and Lehman-related dispute.