PRINCIPAL FINANCIAL GROUP INC annual report, FY2010

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Principal Financial Group, Inc. — 2010 Form 10-K

Reporting period: Fiscal year ended December 31, 2010. Comparisons are primarily with 2009. This is an annual filing, not a quarterly-only report.

Business context

Principal is a diversified retirement, investment-management and insurance company, reporting five segments: Retirement and Investor Services, Principal Global Investors, Principal International, U.S. Insurance Solutions and Corporate. At year-end, it reported $318.8 billion of assets under management and approximately 19.1 million customers worldwide.

Financial performance and position

  • Revenue: $9.16 billion, up 3.5% from $8.85 billion. Premiums and other considerations declined to $3.56 billion from $3.75 billion; fees rose to $2.30 billion from $2.10 billion; net investment income increased to $3.50 billion from $3.40 billion.
  • Profit and EPS: Net income was $717.2 million versus $645.7 million. Net income available to common stockholders was $666.3 million versus $589.7 million. Diluted EPS was $2.06 versus $1.97. The approximate GAAP net margin was 7.8% of total revenue.
  • Segment operating earnings: Retirement and Investor Services $584.4 million (up from $510.4 million); Principal Global Investors $58.5 million (up from $38.2 million); Principal International $136.9 million (up from $118.9 million); U.S. Insurance Solutions $193.7 million (down from $204.1 million); Corporate operating loss $128.7 million, improved from $138.3 million.
  • Cash flow and liquidity: Operating cash flow was $2.79 billion, compared with $2.24 billion. Investing activities provided $27.5 million, down from $1.03 billion; financing activities used $3.18 billion. Cash and cash equivalents fell to $1.88 billion from $2.24 billion. Management said available cash, securities and expected inflows were adequate for anticipated obligations. Holding companies had $821.6 million of excess capital.
  • Debt and capital: Total debt was $1.69 billion ($107.9 million short-term; $1.58 billion long-term), versus $1.69 billion a year earlier. Debt-to-equity excluding accumulated other comprehensive income was 18%, down from 19%; debt-to-capitalization was 15%, down from 16%. Total stockholders’ equity increased to $9.89 billion from $8.02 billion.
  • Investments and assets: Total assets were $145.63 billion, up from $137.76 billion; invested assets were $66.0 billion. Net realized capital losses improved to $191.5 million from $398.3 million. The U.S. available-for-sale fixed-maturity portfolio had $1.49 billion of gross unrealized losses, but the portfolio was in a $695.8 million net unrealized gain position at year-end.
  • Shareholder distributions: Common dividends were $0.55 per share, up from $0.50. The company returned $178.8 million to common stockholders through dividends and repurchases; the repurchase program remained suspended.

Material changes versus 2009

  • Profit rose as recovering equity markets lifted average account values and AUM, boosting retirement and asset-management fees. Lower investment impairments also reduced realized losses.
  • Retirement and Investor Services account values rose to $178.3 billion from $163.9 billion, although net cash flow remained negative at $2.1 billion. Principal Global Investors AUM increased to $220.1 billion from $205.3 billion, while net cash flow was negative $7.0 billion.
  • Principal International AUM rose to $45.8 billion from $34.6 billion, supported by positive net flows, investment performance and currency appreciation. Segment results also benefited from Chilean inflation-linked returns.
  • U.S. Insurance Solutions operating earnings declined, primarily because lower long-term interest-rate assumptions affected reserves and deferred acquisition costs, and because claims increased. Specialty-benefits premiums and fees weakened in group lines.
  • Net unrealized gains improved substantially, and the pension and other postretirement plans’ combined net underfunded status improved by $278.7 million to $207.0 million pre-tax.

Outlook, management commentary and risks

  • Business changes: The company announced it would exit group medical insurance and arranged for UnitedHealthcare to renew coverage during the transition. The business remained in continuing operations for GAAP reporting. A $43.6 million pre-tax goodwill impairment and severance costs were recorded in connection with the exit.
  • International: A 2010 agreement with Banco do Brasil extended Brasilprev’s exclusive distribution access for 23 years, while reducing PFG’s economic interest from 46% to 25%. PFG recorded a $72.1 million after-tax gain and expects lower near-term earnings from the venture.
  • Guidance: No consolidated earnings or revenue guidance is provided in the supplied filing text. Management estimated 2011 pension expense of $90.9 million pre-tax and said 2011 pension-plan funding could be $60–$90 million; both estimates may change.
  • Principal risks: Market and interest-rate volatility, credit losses and impairments, commercial and residential mortgage exposure, investment valuation uncertainty, policy surrenders, liquidity and rating downgrades, foreign-exchange movements, insurance pricing/reserving assumptions, regulatory changes and competition. California represented 22% of commercial mortgage loans. Commercial mortgage loans identified as problem, potential problem or restructured were 3.76% of that portfolio, down from 6.20%.
  • Contingencies and controls: Management did not expect pending litigation or regulatory matters to materially affect the business or financial position, while noting outcomes remain uncertain. Guarantees had a maximum exposure of approximately $218 million; management considered material payment unlikely. The filing reports unqualified audit opinions and effective internal control over financial reporting.
  • Unusual comparability items: A second-quarter 2010 residential mortgage loan provision included $21.4 million after-tax attributed to 2009; a third-quarter 2009 DPAC correction increased that quarter’s net income by $18.9 million. The filing says neither adjustment was material to the respective annual results.

Investor verification priorities

  • Review the quality and durability of the earnings increase, including market-driven fees, lower impairments, currency effects and the Brasilprev gain.
  • Track AUM and account-value growth against continuing net outflows in Retirement and Investor Services and Principal Global Investors.
  • Assess credit performance, valuation assumptions and potential impairment exposure in fixed maturities, CMBS and mortgage loans, including the home-equity portfolio.
  • Verify the group medical exit’s transition costs, remaining liabilities and effects on reported and segment results.
  • Monitor holding-company liquidity, statutory limits on Principal Life dividends, debt maturities and the basis for the stated $821.6 million of excess capital.
  • Compare 2011 pension expense and funding outcomes with management’s estimates, and review developments in litigation, tax audits and regulatory implementation.