Principal Financial Group, Inc. — Q3 2011 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010. Principal provides retirement and investment services, asset management, international financial products, and U.S. insurance. Results include the ongoing exit from group medical insurance.
Key financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $2,088.8 million | $2,288.5 million | $6,650.6 million | $6,786.1 million |
| Income before taxes | $138.2 million | $163.5 million | $794.0 million | $577.6 million |
| Net income attributable to Principal | $71.9 million | $150.4 million | $542.7 million | $491.7 million |
| Net income available to common stockholders | $63.7 million | $142.2 million | $518.0 million | $467.0 million |
| Diluted EPS | $0.20 | $0.44 | $1.61 | $1.45 |
| Segment operating earnings, after tax | $191.9 million | $218.9 million | $661.0 million | $630.7 million |
Cash flow (nine months): Operating cash flow was $1,885.4 million, versus $1,929.5 million. Investing activities used $89.1 million, compared with providing $305.9 million; financing activities used $2,239.5 million, versus $2,207.0 million. Cash and cash equivalents ended at $1,434.2 million, down from $1,877.4 million at year-end 2010.
Balance sheet and capital: Total assets were $143.3 billion, including $66.8 billion of investments and $67.1 billion of separate-account assets; total liabilities were $133.0 billion and total equity $10.3 billion. Short- and long-term debt totaled $1.64 billion, down from $1.69 billion. Debt to equity excluding AOCI was 17%, compared with 18% at year-end. The holding companies reported $683.8 million of excess capital. Available short-term credit facilities totaled $745 million, of which $73.8 million was drawn; most facilities were not committed.
Investment and credit indicators: Nine-month net investment income was $2,549.0 million, down $71.3 million year over year. Net realized capital losses were $51.0 million, compared with $132.6 million. Net impairment losses on available-for-sale securities were $150.6 million, versus $183.3 million. Gross unrealized losses on available-for-sale fixed maturities reached $1,497.7 million, up from $1,445.5 million at year-end; management attributed the increase to wider credit spreads, particularly in corporate and commercial mortgage-backed securities. Management stated it did not intend, and was not more likely than not required, to sell the identified loss-position securities before recovery of amortized cost.
Material changes versus prior comparable periods
- Q3 common earnings and diluted EPS fell sharply year over year, primarily from a $68.9 million reduction to net income following a court ruling on uncertain tax positions and higher deferred policy acquisition cost (DPAC) amortization amid falling equity markets.
- Nine-month common earnings and EPS rose despite lower total revenue. Lower benefit and claim expenses—especially as the group medical business winds down—and reduced investment impairment losses helped; a $70.9 million after-tax? No: the filing reports a $70.9 million realized capital gain before tax from the partial Catalyst Health Solutions sale, while a separate approximately $46.0 million after-tax gain is described in the MD&A.
- Fees and other revenues increased, reflecting growth in universal and variable universal life, higher average account values, and acquisitions; premiums declined substantially as covered membership fell in the exited group medical business.
- Equity markets and credit spreads affected earnings and balance-sheet marks. Net unrealized gains on available-for-sale securities and derivatives were $811.6 million, versus $432.7 million at year-end, while third-quarter comprehensive income was a loss of $223.6 million, largely reflecting foreign currency translation and postretirement benefit remeasurement.
- Share repurchases totaled $456.4 million in the first nine months. The company repurchased about 16.8 million shares under announced programs; outstanding common shares declined to 305.1 million from 320.4 million at year-end.
Outlook, management commentary, risks, and unusual items
- Outlook: The filing provides no general earnings guidance. Management said operating results for the quarter and nine-month period are not necessarily indicative of full-year results. A $0.70 per-share annual common dividend, approximately $213.6 million in total, was declared October 26, payable December 2, 2011.
- Accounting change: Retrospective adoption of the new insurance acquisition-cost guidance is expected January 1, 2012. Management estimated a $550–$750 million reduction to opening retained earnings and a $35–$45 million decrease in 2012 net income available to common stockholders and operating earnings; estimates remain subject to change.
- Tax and legal items: The September 30 court ruling on foreign tax credits reduced Q3 net income by $68.9 million. The company had paid approximately $101.5 million of IRS deficiencies for prior tax years and plans to file refund claims on disputed adjustments. Litigation outcomes remain uncertain; no accrual was recorded for the matters discussed because losses were not considered probable and estimable. An estimated $10.5 million obligation related to Executive Life of New York’s liquidation petition was also included among Q3 after-tax adjustments.
- Business changes and acquisitions: Principal completed the $206.1 million HSBC AFORE acquisition in Mexico and acquired a 51% interest in Finisterre Capital for $84.6 million, with up to $30 million contingent consideration. The Origin Asset Management purchase closed October 3, after quarter-end, for an initial $60.4 million payment.
- Key risks: Management highlighted sensitivity to interest rates, credit spreads, equity markets, investment valuations and impairments, policyholder behavior, ratings downgrades, international currency and operating exposures, litigation, taxes, and regulation. A 10% equity-market decline followed by 2% quarterly recovery was estimated to reduce annual operating earnings by 4–6%. The investment portfolio also includes significant commercial real estate and structured-security exposures.
- Controls: Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether recurring operating performance supports the nine-month increase in segment operating earnings, given the pronounced Q3 GAAP earnings decline and tax charge.
- The resolution, appeal prospects, and potential cash and earnings effects of the tax ruling, IRS disputes, and Executive Life of New York matter.
- Credit quality, impairment assumptions, and potential realized losses in fixed maturities, CMBS, mortgage loans, and other structured investments, especially if spreads widen or asset values weaken.
- Actual effects of the 2012 acquisition-cost accounting change, including the eventual retained-earnings and earnings impacts.
- Liquidity and capital at the holding-company and insurance-subsidiary levels, including limits on subsidiary distributions, credit-facility availability, and the planned dividend and completed repurchases.