Principal Financial Group, Inc. — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. The filing is an annual report, not a standalone fourth-quarter report; it includes audited results for 2010–2012 and year-end balance sheets for 2012 and 2011. Amounts below are U.S. dollars unless noted.
Business context
Principal is a diversified financial services company focused on retirement services, investment management, international savings and insurance. Its reportable segments are Retirement and Investor Services, Principal Global Investors, Principal International, and U.S. Insurance Solutions, plus Corporate. At year-end, the company reported $403.0 billion of assets under management and approximately 18.3 million customers worldwide.
Financial performance and position
| Metric | 2012 | 2011 | Change / context |
|---|---|---|---|
| Total revenue | $9.215 billion | $8.671 billion | Up 6.3% |
| Net income | $824.7 million | $688.9 million | Up 19.7% |
| Net income available to common stockholders | $772.9 million | $619.7 million | Up $153.2 million |
| Diluted EPS | $2.57 | $1.95 | Up $0.62 |
| Income before tax / total revenue | About 10.4% | About 10.3% | Calculated from reported figures |
| Net investment income | $3.255 billion | $3.375 billion | Down $120.4 million; reported yield fell to 4.8% from 5.0% |
| Net realized capital gains (losses) | $114.1 million | $(122.3) million | Improved by $236.4 million |
| Operating cash flow | $3.081 billion | $2.713 billion | Up $367.6 million |
| Total assets | $161.927 billion | $147.362 billion | Up $14.565 billion |
| Long-term debt | $2.671 billion | $1.565 billion | Up $1.107 billion |
| Debt / capitalization, excluding AOCI | 23% | 16% | Leverage increased |
Net cash used in investing activities was $1.611 billion, mainly reflecting increased net investment purchases. Net cash used in financing activities was $126.2 million, versus $1.555 billion in 2011; 2012 included $1.493 billion of long-term debt issuance. Cash and cash equivalents ended the year at $4.177 billion. Management said liquidity was adequate for anticipated obligations; it also reported $270.3 million of excess holding-company capital, excluding capital earmarked for the Cuprum acquisition.
Segment operating earnings were $808.0 million, down from $843.8 million, despite growth at Retirement and Investor Services ($575.1 million versus $562.9 million), Principal Global Investors ($81.2 million versus $74.0 million), and Principal International ($153.3 million versus $149.5 million). U.S. Insurance Solutions fell to $138.2 million from $204.3 million. These segment figures are management’s non-GAAP measure and should not be confused with consolidated net income.
Material changes and unusual items
- Common-stockholder income rose largely because of the Catalyst Health Solutions merger and disposition: the company reported a $141.2 million after-tax net realized gain in 2012. It also reported a $39.8 million after-tax foundation contribution as an adjustment.
- Updated actuarial assumptions and model refinements reduced 2012 net income by $96.7 million. Lower long-term interest-rate assumptions drove much of the negative effect; the filing identifies a $66.3 million net negative operating-earnings effect from interest-rate updates and a further $24.4 million negative effect from other assumption changes and refinements.
- Single-premium group annuity sales increased substantially, lifting Retirement and Investor Services premiums by $772.2 million, but also raising related benefits and reserve expenses. Such sales can vary considerably between periods.
- Reported revenue and expenses were affected by the continuing run-off of the exited group medical business: its operating revenue was $25.0 million in 2012, compared with $606.3 million in 2011. It remains in continuing operations under GAAP.
- Effective January 1, 2012, the company retrospectively adopted revised accounting for deferred policy acquisition costs and changed its accounting for certain long-duration reinsurance contracts. The filing says these changes affected prior-period presentation; adjusted comparative figures are used.
- After year-end, on February 4, 2013, Principal completed its acquisition of approximately 90% of Chilean pension manager Cuprum for about $1.4 billion. The company issued $1.5 billion of senior notes in 2012, in part to fund the transaction; acquisition accounting was incomplete when the filing was issued.
Outlook, risks and contingencies
- Management said sustained low interest rates could continue to compress investment spreads, increase reserves and actuarial costs, and constrain net-income growth. It reported a $96.7 million adverse 2012 actuarial unlocking and said prolonged low rates could further affect earnings.
- Key exposures include market and interest-rate movements, credit defaults and impairments, policy surrenders, equity-linked variable-annuity guarantees, and the valuation and liquidity of investments. At year-end, U.S. fixed maturities included approximately 7% below investment grade; $605.6 million were classified as problem, potential problem or restructured. Gross unrealized losses on available-for-sale fixed maturities were $871.1 million.
- Commercial mortgage loans totaled about $10.2 billion; 20% of the portfolio was in California. Problem, potential problem and restructured commercial mortgages declined to $217.7 million, or 2.14% of the portfolio, from $273.0 million, or 2.91%, in 2011. Residential mortgage loan valuation allowances increased to $45.6 million from $37.3 million.
- Cuprum adds integration, execution, Chilean economic, regulatory and currency risks. Rating agencies affirmed insurer ratings around the acquisition but cited pressure on cash coverage and debt metrics and integration risk; Fitch moved its outlook to negative after closing. Principal Life’s reported insurer ratings were A+ from A.M. Best, AA- from Fitch, A+ from S&P and Aa3 from Moody’s.
- Parent-company dividends depend significantly on subsidiary distributions and are subject to Iowa regulatory limits. Principal Life paid $700 million in dividends to its parent in 2012 with regulatory approval; its stated 2013 ordinary dividend limit was approximately $472 million.
- The filing describes ongoing litigation and regulatory inquiries, including matters involving retirement-plan fees, the Principal U.S. Property Account and Lehman-related transactions. No losses were accrued for the named litigation matters because management considered losses not probable and not reasonably estimable. The company also noted inquiries concerning unclaimed property and death-record matching.
- Other stated risks include regulatory and accounting changes, reinsurance-counterparty failure, foreign-market exposure, cybersecurity and vendor disruption, and pension obligations. The pension plans’ net underfunded status was $584.0 million pre-tax at year-end, versus $427.9 million in 2011; 2013 pension expense was forecast at $143.3 million, versus $122.3 million in 2012.
Important facts for investors to verify
- Reconcile the reported net-income increase with the Catalyst gain, actuarial unlocking, tax-rate changes and other adjustments; assess recurring earnings using both GAAP and segment operating earnings.
- Review the Cuprum purchase price, funding, post-close debt and ratings outlook, integration costs, and the acquisition’s contribution to Principal International results.
- Monitor spread compression, credited-rate guarantees, annuity guarantee exposure and future actuarial reserve or deferred-acquisition-cost adjustments.
- Assess fixed-maturity unrealized losses, below-investment-grade and structured-security exposures, mortgage-loan delinquencies and allowances, and the sensitivity of fair-value estimates.
- Confirm holding-company liquidity and subsidiary dividend capacity after the acquisition, including debt maturities and capital returned through dividends and share repurchases.
- Track legal, regulatory and tax matters whose outcomes or potential losses were not clearly quantifiable in the filing.
Audit and controls: Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.