PRINCIPAL FINANCIAL GROUP INC quarterly report, Q1 FY2018

Principal Financial Group, Inc. — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Unaudited results are not necessarily indicative of full-year performance. Principal provides retirement and income products, asset management, international savings and insurance solutions.

Financial performance

Metric	Q1 2018	Q1 2017	Change
Total revenue	$2,883.6 million	$3,049.4 million	Down $165.8 million
Income before income taxes	$457.0 million	$414.0 million	Up $43.0 million
Net income attributable to Principal	$397.1 million	$348.9 million	Up $48.2 million
Diluted EPS	$1.36	$1.19	Up $0.17
Operating cash flow	$746.5 million	$522.9 million	Up $223.6 million

• Revenue included premiums and other considerations of $995.2 million (down $252.8 million), fees and other revenues of $1,011.3 million (up $70.7 million), and net investment income of $902.2 million (up $24.8 million). Net realized capital losses were $25.1 million.
• Total expenses fell to $2,426.6 million from $2,635.4 million. Benefits, claims and settlement expenses declined $246.2 million, principally alongside lower single-premium annuity sales; operating expenses rose $41.8 million.
• The effective tax rate was 12%, versus 15%, reflecting the effects of U.S. tax reform. The statutory corporate rate fell to 21% from 35% in 2018.
• Comprehensive income attributable to Principal was a loss of $339.9 million, versus income of $569.0 million a year earlier. Other comprehensive loss was $736.1 million, primarily reflecting unrealized losses on available-for-sale securities.
• Q1 segment pre-tax operating earnings, a non-GAAP measure, were $496.5 million versus $472.8 million. Global Investors and U.S. Insurance Solutions improved; Retirement and Income Solutions and Principal International declined.

Financial position, capital and liquidity

• Total assets were $253.6 billion at March 31, broadly unchanged from year-end. Total investments were $82.0 billion; cash and cash equivalents were $2.34 billion.
• Total stockholders’ equity was $12.26 billion, down from $12.92 billion at year-end. Accumulated other comprehensive income moved from $165.5 million to a loss of $469.3 million, largely due to the market-value decline in available-for-sale securities.
• Total debt was $3.27 billion, comprising $78.1 million short-term and $3.20 billion long-term debt. Debt to capitalization excluding AOCI was 21%, versus 20% at year-end.
• Management reported $2.03 billion of cash and liquid assets held in holding companies and other subsidiaries. Short-term credit facilities totaled $1.04 billion, with $78.1 million borrowed at quarter-end. Management said available sources and liquidity stress testing were adequate for current and reasonably foreseeable needs.
• Operating cash flow was $746.5 million; investing activities used $979.9 million and financing activities provided $98.3 million. Cash decreased $135.1 million during the quarter.
• Principal returned $346.9 million to common shareholders through $147.3 million of dividends and $199.6 million of share repurchases. The quarterly dividend declared was $0.51 per share, up from $0.45.

Comparability, outlook and risks

• The main revenue comparison was the decline in Retirement and Income Solutions premiums, largely from lower single-premium group and individual annuity sales. Related benefit expenses also fell. Fee growth reflected higher account values and asset-management revenue; U.S. Insurance Solutions benefited from business growth and favorable specialty-benefits claims.
• Principal Global Investors’ AUM ended at $423.8 billion, up from $403.0 billion a year earlier, but quarterly net cash flow was negative $6.2 billion and investment performance reduced AUM by $1.2 billion. Principal International AUM was $171.1 billion, including $3.8 billion from the Mexico acquisition.
• Interest-rate increases and wider credit spreads reduced the net unrealized gain position on available-for-sale securities by $1.29 billion during the quarter. Gross unrealized losses on these fixed maturities rose to $672.3 million from $267.0 million at year-end; management attributed the movement primarily to rates and spreads and said it did not intend, and was not more likely than not to be required, to sell the securities before recovery.
• Management provided no specific earnings guidance. It said a hypothetical immediate 100-basis-point rate decline would reduce segment pre-tax operating earnings by less than 1% over the next 12 months, excluding potential DAC and actuarial-balance unlocking; the adverse effect could grow over time as assets mature. A hypothetical 10% S&P 500 decline followed by 2% quarterly increases was estimated to reduce annual segment pre-tax operating earnings by approximately 4%–6%, excluding potential unlocking.
• Risks include market and credit conditions, interest-rate and spread movements, investment valuation and impairments, policyholder behavior and guarantees, asset-management withdrawals, foreign exchange, regulation, tax matters, litigation, ratings downgrades, operational and cyber disruptions, and reinsurer or joint-venture risks.
• On March 8, Principal established contingent funding agreements permitting issuance, if exercised, of up to $400 million of 2028 senior notes and $350 million of 2048 senior notes. The associated P-Caps provide a potential liquidity source but include mandatory exercise triggers and premiums.
• Principal completed the MetLife Afore Mexico acquisition in February, adding $3.8 billion of AUM. It finalized the INTERNOS European real-estate manager acquisition on April 16. A planned increase to 60% ownership of two CIMB joint ventures was expected to close in Q2, subject to regulatory approvals.
• In April, S&P affirmed Principal Life and PNLIC financial-strength ratings at A+ and upgraded PFG senior unsecured debt to A-, with stable outlooks. The filing reported no litigation or regulatory contingencies for which disclosure was considered appropriate, and no material changes to the risk factors in the 2017 Form 10-K.

Investor verification points

• Assess whether lower single-premium annuity sales and volatile group-annuity flows persist, and compare underlying segment operating earnings with GAAP results.
• Monitor unrealized investment losses, interest rates and credit spreads, impairment recognition, and the liquidity implications of any need to sell securities.
• Track Global Investors’ institutional withdrawals and AUM flows, plus international earnings exposure to Latin American investment performance and currency movements.
• Verify the completed integration and financial contribution of the Mexico and INTERNOS acquisitions, and the status and terms of the CIMB ownership realignment.
• Review holding-company liquidity, regulated-subsidiary dividend capacity, the P-Caps triggers and costs, and the effects of share repurchases and dividends on capital.