Principal Financial Group, Inc. — Q3 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2013, compared with the same 2012 periods; balance-sheet figures are compared with December 31, 2012. Principal provides retirement and investment products, asset management, international financial services, and U.S. insurance. Its reportable segments are Retirement and Investor Services, Principal Global Investors, Principal International, U.S. Insurance Solutions, and Corporate.
Financial results and key metrics
- Third quarter: Revenue was $2.240 billion, down from $2.705 billion. Net income attributable to Principal was $253.9 million versus $195.4 million; income available to common stockholders was $245.7 million versus $187.2 million. Diluted EPS rose to $0.82 from $0.63.
- First nine months: Revenue was $6.617 billion versus $6.919 billion. Net income attributable to Principal was $671.0 million versus $583.4 million; income available to common stockholders was $646.3 million versus $558.7 million. Diluted EPS was $2.17 versus $1.85.
- Operating earnings: Management’s non-GAAP segment operating earnings totaled $269.2 million in Q3 versus $142.3 million, and $773.9 million for nine months versus $568.5 million. Common-stockholder GAAP net margin, calculated as income available to common stockholders divided by revenue, was approximately 11.0% in Q3 versus 6.9%, and 9.8% for nine months versus 8.1%.
- Revenue and expenses: Q3 fees and other revenues increased to $803.0 million from $675.0 million, while premiums and other considerations fell to $703.0 million from $1.158 billion. Nine-month operating expenses increased to $2.372 billion from $2.101 billion. Nine-month net investment income declined to $2.324 billion from $2.410 billion.
- Cash flow: Nine-month operating cash flow was $1.398 billion, down from $2.374 billion; investing cash outflow was $1.433 billion versus $1.719 billion; financing cash outflow was $2.435 billion versus $1.209 billion. Cash and cash equivalents fell to $1.707 billion from $4.177 billion at year-end.
- Balance sheet and debt: Total assets were $201.687 billion, including $123.801 billion of separate-account assets matched by liabilities; total liabilities were $192.080 billion and stockholders’ equity $9.373 billion. Short- and long-term debt totaled $2.769 billion, compared with $2.712 billion at year-end. Debt-to-equity and debt-to-capitalization, each excluding AOCI, were 30% and 23%, respectively, unchanged from year-end.
- Liquidity: The company reported $216.5 million of excess capital at the holding companies. Committed short-term credit facilities totaled $1.105 billion, with $175.5 million outstanding. Management said available sources and liquid assets were sufficient for current and reasonably foreseeable needs.
Material changes versus comparable periods
- Q3 and nine-month common earnings increased despite lower reported revenue. Management attributed the improvement primarily to the absence of adverse 2012 actuarial assumption and model-refinement adjustments, stronger Retirement and Investor Services results from equity-market performance and business growth, and improved U.S. Insurance Solutions results. Higher net realized capital losses partly offset these gains.
- Net realized capital results shifted from gains of $87.7 million in Q3 2012 and $81.2 million in the first nine months of 2012 to losses of $50.9 million and $181.9 million, respectively, in 2013. Comparisons were affected by the 2012 Catalyst Health Solutions transaction gain of $184.3 million in Q3 and by derivative losses in 2013.
- Cuprum, acquired in February for approximately $1.3 billion, added scale to Principal International. International AUM rose to $102.9 billion from $66.2 billion year over year, with the acquisition contributing $34.3 billion to nine-month AUM. Cuprum contributed $120.8 million of revenue and $52.7 million of net income from acquisition through September 30.
- Total assets increased from $161.830 billion at year-end, substantially reflecting Cuprum and consolidation of its retirement savings funds. Separate-account assets and liabilities increased in tandem; clients bear the investment risk for these segregated funds.
- Other comprehensive income swung to a loss of $668.3 million for the first nine months of 2013 from income of $618.1 million in 2012, principally reflecting unrealized investment losses and foreign-currency translation. AOCI moved from positive $640.3 million to negative $17.7 million.
- Management revised accounting for Mexico’s AFORE retirement accumulation product to service-contract accounting and revised prior-period statements; it said the changes were not material to prior periods. A third-quarter classification correction increased redeemable noncontrolling interest by $173.9 million and reduced equity by the same amount; management said the EPS effect was not material.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific company earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results. It expects 2013 pre-tax pension expense of $143.3 million, up $21.0 million from 2012; the qualified pension plan has no required minimum contribution for 2013, although combined qualified and nonqualified plan contributions could be $81 million to $110 million. The company had contributed $81 million through September.
- Interest rates and markets: Management identified sustained low rates, rising rates, equity-market declines, credit spreads, investment impairments, valuation assumptions, and policyholder surrenders as important risks. A hypothetical immediate 100-basis-point rate increase produced an estimated $1.858 billion net fair-value loss at September 30, 2013; this is a sensitivity scenario, not a forecast. A hypothetical 10% S&P decline followed by 2% quarterly gains was estimated to reduce annual operating earnings by approximately 4%–6%.
- Currency and Cuprum: A hypothetical 10% unfavorable currency move was estimated to reduce international operations’ nine-month operating earnings by $17.3 million. Fitch affirmed ratings but retained a negative outlook, citing Cuprum integration execution risk and leverage at the high end of rating expectations; S&P revised the outlook on Principal Life and Principal National Life to stable.
- Regulatory capital: The filing highlights Regulation XXX and Actuarial Guideline 38 reserve requirements. New York’s September 2013 withdrawal of prior guidance and stated intention to apply a more conservative interpretation of Regulation 147 could increase reported reserves. The company said the potential amount was not yet clear; inability to mitigate the requirements could require additional capital or higher prices and reduced term and universal life sales.
- Investments and contingencies: Gross unrealized losses on available-for-sale fixed maturities were $883.7 million at September 30. Management attributed their increase during 2013 primarily to higher interest rates and said it expected recovery of amortized cost. Litigation includes an excessive-fees claim filed in August 2013 and a stayed Lehman-related matter seeking an unspecified amount, possibly up to approximately $440 million plus interest. No losses were accrued for the discussed legal matters because management did not consider loss probable and estimable; possible losses could not be reasonably estimated.
- Other unusual items: 2012 comparisons include a $61.2 million charitable contribution of appreciated stock and substantial actuarial assumption/model changes. Principal returned $365.1 million to common stockholders through dividends and repurchases in the first nine months of 2013. The board authorized a $150 million repurchase program in February; $55.0 million remained available at September 30.
Important facts for investors to verify
- How much of the increase in earnings and assets reflects underlying business performance versus the Cuprum acquisition, accounting changes, and unusually weak 2012 comparisons?
- Whether Cuprum integration, foreign-exchange movements, and Chilean regulatory requirements affect future earnings, capital, or ratings.
- How interest-rate changes, unrealized investment losses, credit impairments, and GMWB hedging results could affect earnings, AOCI, and liquidity.
- The eventual reserve and capital impact of New York’s interpretation of Regulation 147 and the continuing applicability of affiliated reinsurance used for Regulation XXX and AG38.
- Developments in the ACE and Lehman matters, other litigation and regulatory reviews, and any exposure beyond amounts currently accrued.
- Cash-flow trends, the decline in cash balances, debt and facility usage, and the availability of subsidiary dividends to the holding company.