Business context and reporting period
Principal Financial Group, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2014. Its businesses include retirement and investor services, global asset management, international operations, and U.S. insurance solutions. Amounts below are in millions of dollars unless stated otherwise.
Financial and operating performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenues | $2,484.3 | $2,239.6 | $7,569.6 | $6,616.9 |
| Income before income taxes | $393.8 | $320.3 | $1,177.7 | $814.1 |
| Net income | $252.8 | $259.1 | $896.1 | $685.7 |
| Net income available to common stockholders | $240.7 | $245.7 | $840.7 | $646.3 |
| Diluted EPS | $0.77 | $0.82 | $2.75 | $2.17 |
| Operating cash flow | Not presented quarterly | $2,197.6 | $1,397.9 |
- Quarterly revenue increased 11%; common-stockholder income declined 2%, chiefly as higher taxes offset segment earnings growth. Nine-month revenue rose 14% and common income rose 30%.
- For the first nine months, segment operating earnings were $993.9, up from $773.9. Q3 segment operating earnings were $353.7 versus $269.2. These are management’s non-GAAP segment measures; GAAP common income also reflects investment gains/losses and other adjustments.
- Q3 effective tax rate was 36% versus 19%; nine-month rate was 24% versus 16%. Net investment income was $770.4 in Q3, down from $784.5, and $2,444.1 for nine months, up from $2,323.5.
- At September 30, total assets were $216,422.8 and total stockholders’ equity was $10,369.0. Total investments were $68,094.9; separate-account assets and matching liabilities were $138,296.7 each, and the filing says clients bear the investment risk on those accounts.
- Cash and cash equivalents were $1,270.8, down from $2,371.8 at year-end. Nine-month investing cash use was $827.3 and financing cash use was $2,471.3.
- Short- and long-term debt totaled $2,655.5, compared with $2,752.0 at year-end. Debt to equity excluding AOCI was 27% versus 29%; debt to capitalization excluding AOCI was 21% versus 22%.
- PGI assets under management were $307.0 billion at quarter-end; Principal International AUM was $116.1 billion. Nine-month segment operating earnings increased across RIS ($632.9), PGI ($79.6), Principal International ($205.1), and U.S. Insurance Solutions ($175.7), compared with 2013.
Material changes and unusual items
- Q3 2014 actuarial assumption and model updates increased net income by $38.0 and individual-life operating earnings by $39.0. The filing reports offsetting changes across fees, benefits/claims, and operating expenses.
- Chile tax legislation enacted in September increased net deferred tax liabilities by $58.1 and reduced earnings. A separate court ruling on Principal Life’s tax treatment of principal-only certificates led to a $47.5 reduction in net income in Q2 2014.
- Nine-month realized capital gains were $41.0, compared with losses of $181.9 in 2013; management attributed the improvement mainly to derivative results and gains on real estate and fixed-maturity sales. Q3 realized capital losses were $46.4.
- Other comprehensive income was $190.1 for the first nine months, versus a loss of $668.3 in 2013. Q3 OCI was a loss of $225.9, including a $195.8 foreign-currency translation loss.
- On September 30, Principal acquired an additional 24.65% of Columbus Circle Investors, bringing ownership to 95%; it is contracted to purchase the remaining 5% in installments in 2015 and 2016.
- Common dividends declared were $0.34 per share for Q3 and $0.94 for the first nine months, versus $0.26 and $0.72 in 2013. Nine-month cash returned to common stockholders through dividends and repurchases totaled $499.2.
Outlook, risks, and contingencies
- No quantified company-wide earnings or revenue guidance is provided in the filing text. Management states that operating results for the interim periods are not necessarily indicative of full-year results and says existing liquidity sources are expected to meet current requirements, including reasonably foreseeable contingencies.
- Principal identifies exposure to interest rates, credit and equity markets, foreign exchange, investment valuation and impairments, policyholder behavior, guarantees, competition, regulation, taxes, cyber and vendor risks, litigation, and international operations. A modeled immediate 100-basis-point rate increase produced an estimated net fair-value loss of $2,265.1, compared with $1,847.1 at year-end 2013; this is a hypothetical sensitivity, not a forecast.
- Management estimates a 10% equity-market decline followed by 2% quarterly increases could reduce annual operating earnings by approximately 4%–6%. A 10% unfavorable currency move was estimated to reduce international operating earnings by $6.5 for Q3 and $21.1 for the first nine months.
- At September 30, domestic investment-type insurance contracts included $7,125.4 subject to discretionary withdrawal without adjustments; other balances had surrender charges, market-value adjustments, or were not subject to discretionary withdrawal. Approximately 99% of institutional GICs and funding agreements reportedly could not be redeemed before maturity.
- Material legal matters include an ERISA putative class action, mutual-fund fee litigation, and Lehman bankruptcy claims against Principal Life of approximately $532.0, including disputed interest. No losses were accrued for the matters discussed because management considered loss not probable and not reasonably estimable. Management cautions that outcomes remain uncertain.
- Other exposures include guarantees to third parties with maximum exposure of approximately $254.0 and an uncapped, indeterminable minimum-return guarantee for Chilean pension funds. Management considers material payments under these guarantees remote.
- Fitch affirmed ratings and revised its outlook to stable; S&P affirmed Principal Life’s A+ financial-strength rating with a stable outlook. Management reports effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much of the nine-month earnings improvement reflects recurring segment performance versus realized investment results, actuarial unlocking, and tax items.
- The sustainability of insurance and retirement earnings given payout-annuity reserve growth, claim experience, persistently low rates, and policyholder withdrawal behavior.
- Investment portfolio credit quality, unrealized losses, mortgage-loan performance, and assumptions used in impairment and fair-value estimates.
- The effects of Chilean tax changes, the unresolved U.S. tax-law extender issue, and the $47.5 tax-court-related charge on future tax expense and cash flows.
- Liquidity and parent-company capital access, including the decline in cash, debt maturities, insurance-subsidiary dividend restrictions, and the availability of committed facilities.
- Developments in the disclosed litigation and guarantees, particularly the Lehman claim and the Chilean pension-fund guarantee.