Principal Financial Group, Inc. — Q1 2012 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2012, with balance-sheet comparisons to December 31, 2011. Principal provides retirement and investment services, asset management, international financial products, and U.S. insurance. Results are unaudited; management cautions that quarterly results are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 or prior date |
|---|---|---|
| Total revenue | $2,095.9 million | $2,221.9 million |
| Income before tax | $277.1 million | $261.5 million |
| Net income | $218.9 million | $208.8 million |
| Net income attributable to Principal | $209.7 million | $190.2 million |
| Net income available to common stockholders | $201.5 million | $182.0 million |
| Diluted earnings per share | $0.66 | $0.56 |
| Operating cash flow | $901.7 million | $1,195.5 million |
| Cash and cash equivalents | $1,651.9 million | $2,833.9 million at Dec. 31, 2011 |
| Total assets / total equity | $153.7 billion / $9.8 billion | $147.4 billion / $9.4 billion at Dec. 31, 2011 |
| Total debt | $1,672.0 million | $1,670.0 million at Dec. 31, 2011 |
| Debt to capitalization, excluding AOCI | 16% | 16% at Dec. 31, 2011 |
Pre-tax income as a share of total revenue was approximately 13.2%, compared with 11.8% in Q1 2011. Net cash used in investing activities was $690.5 million, versus $715.9 million provided in the prior-year quarter; net cash used in financing was $1,393.2 million, versus $1,804.6 million. The filing does not present a single consolidated operating-margin measure. Separate-account assets and liabilities were each $77.6 billion and largely pass through to policyholders; they should not be treated as assets available to meet general obligations.
Material changes versus the prior comparable period
- Revenue fell $126.0 million, while common-stockholder income rose $19.5 million and diluted EPS increased from $0.56 to $0.66. The improvement in common income was primarily attributable to a $34.3 million after-tax reduction in net realized capital losses.
- Premiums and other considerations declined $117.3 million and fees declined $25.0 million. A large part of the premium decline reflected the wind-down of exited group medical insurance: related revenue was $18.9 million versus $254.9 million in Q1 2011.
- Net investment income decreased $35.0 million, mainly from lower reinvestment yields and no repeat of a prior-year development-real-estate sale gain. Net realized capital losses narrowed to $6.7 million from $58.0 million; net impairment losses on available-for-sale securities were $28.8 million versus $52.4 million.
- Operating expenses declined $161.9 million, but benefits and claims increased $23.6 million. Both comparisons were materially affected by the exited medical business and changes in life-insurance accounting estimates.
- Segment operating earnings were $213.0 million, down from $219.8 million. Principal International earnings increased to $41.8 million from $27.8 million; Retirement and Investor Services fell to $143.6 million from $154.1 million; U.S. Insurance Solutions fell to $50.2 million from $53.4 million; and Principal Global Investors was $16.2 million versus $16.6 million.
- Assets under management rose to $242.2 billion at Principal Global Investors and $59.2 billion at Principal International, aided by investment performance and net flows; the international total also reflected exchange rates and the HSBC AFORE acquisition.
Outlook, management commentary, risks and unusual items
- Outlook and liquidity: No specific earnings or revenue guidance is provided. Management stated that operating cash flows, borrowing capacity and other funding sources were adequate for current needs and reasonably foreseeable contingencies. It reported $633.2 million of excess holding-company capital and an $800 million commercial-paper backstop facility effective March 30, 2012.
- Accounting changes: The company retrospectively adopted revised deferred policy acquisition cost guidance and a voluntary reinsurance accounting change. The 2011 comparative figures were adjusted. The reinsurance change recognizes differences between actual and expected reinsurance cash flows in earnings immediately; the company said it better aligns claims and recoveries. Separately, an individual-life amortization-basis change caused substantial shifts among revenue and expense lines but a stated net after-tax gain of only $3.3 million in Q1 2012.
- Investments and valuation: Available-for-sale fixed maturities had $1.275 billion of gross unrealized losses at March 31, including $550 million on commercial mortgage-backed securities. Management said it expected recovery of amortized cost and did not intend, nor expect to be required, to sell the affected securities before recovery. Such losses may become realized or lead to future impairments. Most fixed maturities were investment grade; the filing reports 93% in NAIC categories 1 and 2.
- Market and insurance risks: Management highlights low interest rates, credit-spread and equity volatility, investment impairment and valuation judgments, policyholder behavior, claims differing from actuarial assumptions, reinsurer performance, foreign-exchange movements, and potential rating downgrades. A 10% equity-market decline was estimated to reduce annual operating earnings by approximately 4%–6%, under the filing’s stated hypothetical scenario.
- Debt and derivative contingencies: Certain derivatives require investment-grade debt ratings. If triggered at quarter-end, the company estimated it would need to post an additional $56.4 million of collateral. Net derivative credit exposure after collateral received was $894.9 million on a gross measure; management also reported $37.2 million after counterparty netting and pledged collateral.
- Legal, tax and other contingencies: The company reported several ERISA and investment-fund lawsuits, with no related losses accrued because management considered loss not probable or not reasonably estimable. It said outcomes could nevertheless require unestimated payments. Guarantees related primarily to a former subsidiary had maximum exposure of approximately $141 million, with management assessing material payment as remote. Tax audits and litigation remain uncertain. The 2012 qualified pension plan minimum contribution was zero, although combined qualified and nonqualified plan contributions could reach $60 million–$110 million; $23 million had been contributed through Q1.
- Corporate actions: Q1 included $64.2 million of common-share repurchases and $54.3 million of common dividends ($0.18 per share). The Claritas acquisition agreement was announced in March and closed April 2, 2012, after the reporting date.
Most important facts for investors to verify
- How much of the year-over-year revenue and expense movement reflects the exited group medical business and accounting changes, versus underlying business trends.
- Whether earnings growth persists after the unusually favorable comparison in realized investment losses and the effects of life-insurance assumption and amortization changes.
- Credit quality, impairment trends and recoverability of the sizeable unrealized losses, particularly in commercial mortgage-backed and other structured securities.
- Cash-flow sustainability, liquidity at the holding company and regulated insurance subsidiaries, and the effect of investment-contract withdrawals and policyholder behavior.
- Potential effects of interest rates, equity markets, credit ratings and derivative collateral requirements on earnings, capital and liquidity.
- Developments in disclosed litigation and tax matters, pension funding, and the post-quarter Claritas acquisition.