Principal Financial Group, Inc. — Q1 2011 Form 10-Q
Business context and reporting period. The filing covers the unaudited three months ended March 31, 2011, with balance-sheet comparisons to December 31, 2010 and year-over-year operating comparisons to Q1 2010. Principal reports Retirement and Investor Services, Principal Global Investors, Principal International, U.S. Insurance Solutions and Corporate. Results include the group medical insurance business being exited; its results remain in GAAP continuing operations.
Financial performance and position
- Revenue: $2.220 billion, down $44.2 million (2.0%) from $2.264 billion. Premiums and other considerations fell $81.8 million to $797.1 million; fees and other revenues rose $53.2 million to $620.8 million; net investment income was $859.9 million, nearly flat year over year.
- Profit and EPS: Net income was $223.1 million versus $203.6 million. Net income attributable to Principal was $204.5 million versus $199.0 million; income available to common shareholders was $196.3 million versus $190.8 million. Diluted EPS rose to $0.60 from $0.59. Management’s non-GAAP segment operating earnings were $231.8 million, up from $221.4 million.
- Margins: Income before taxes was $283.5 million (12.8% of revenue) versus $256.3 million (11.3%). These simple ratios are not presented as a company-defined operating margin.
- Cash flow: Operating cash flow was $1.196 billion, up from $653.2 million; investing activities provided $715.9 million, compared with $462.0 million used in Q1 2010. Financing activities used $1.805 billion, mainly reflecting $2.674 billion of investment-contract withdrawals. Cash and equivalents increased $106.8 million to $1.984 billion.
- Balance sheet and debt: Total assets were $147.550 billion and total equity $10.373 billion at March 31. Assets included $71.725 billion of separate-account assets, generally not bearing investment risk for the company. Short- and long-term debt totaled $1.687 billion. Debt-to-capitalization, excluding AOCI, was 15%; debt-to-equity on the same basis was 17%.
- Liquidity: Management said available cash flows and resources were sufficient for current and reasonably foreseeable needs. The holding companies reported $1.040 billion of excess capital in cash and highly liquid assets. The company had $737.8 million of short-term credit facilities, including a $579 million commercial-paper program; $106.8 million was borrowed under credit facilities. Principal Life’s potential 2011 dividend capacity was approximately $509.7 million; it had paid no dividends by quarter-end, but distributed $200 million of contributed surplus to its parent.
Changes versus the prior comparable period
- Common-shareholder income rose $5.5 million despite lower total revenue. Management attributed the improvement principally to better claims experience in U.S. Insurance Solutions; lower earnings in Principal International partly offset it.
- U.S. Insurance Solutions operating earnings increased to $59.5 million from $44.1 million, reflecting improved claims experience. Principal Global Investors operating earnings rose to $16.6 million from $12.0 million, supported by higher average AUM and fees.
- Principal International operating earnings declined to $28.5 million from $37.9 million, primarily because of reduced economic interest in Brazil and higher PVFP/DPAC amortization in Mexico. Retirement and Investor Services operating earnings were $159.3 million versus $157.0 million.
- Net realized capital losses were $58.0 million versus $45.5 million. Lower investment impairment losses were offset by weaker derivative and trading-security results. The effective tax rate was 21% in both periods.
- Total assets rose from $145.631 billion at year-end 2010; total equity increased from $9.885 billion. AOCI increased to $525.5 million from $272.4 million, while cash rose to $1.984 billion from $1.877 billion.
Outlook, risks and unusual items
- Outlook: The filing gives no consolidated earnings or revenue guidance. Management cautions that quarterly results are not necessarily indicative of full-year results. As of March 31, estimated 2011 pension expense was $81.2 million and OPEB income was $55.0 million; management said actual full-year amounts could differ. The company stated its investment strategy and cash flows were intended to support policyholder obligations.
- Acquisitions and subsequent events: In April, Principal agreed to acquire Mexican pension business HSBC AFORE for approximately $198 million, subject to regulatory approval, with closing expected by early Q3 2011. It also agreed to acquire a majority stake in Finisterre Capital for $84.6 million initially, with up to $30 million contingent consideration, also subject to approval and expected to close by early Q3. An early-April partial sale of Catalyst Health Solutions was expected to generate an approximately $46 million after-tax gain in Q2, excluded from operating earnings.
- Exited group medical business: Included revenue was $254.9 million in Q1 2011 versus $361.3 million in Q1 2010. Its after-tax earnings are treated as an adjustment outside segment operating earnings. The business exit also affects employee benefit expense and comparability.
- Investment and credit exposures: Commercial mortgage loans were $9.515 billion; non-accrual mortgage loans increased to $200.8 million from $97.1 million, primarily because some commercial loans matured without payoff or extension. Commercial mortgage loans classified as problem, potential problem or restructured increased to $421.1 million (4.47% of the portfolio) from $360.9 million (3.76%). Management cited increased vacancies and rollover risk. The mortgage valuation allowance was $124.7 million.
- Market and valuation risks: Management identifies interest rates, credit spreads, equity markets, foreign exchange, investment valuation and policyholder behavior as material sensitivities. The primary duration-managed portfolio’s duration gap was -0.43, outside the stated +/-0.25 guideline, attributed to temporary asset-liability spread mismatches. A hypothetical 100-basis-point rate increase was estimated to raise portfolio net fair value by $748.4 million; this is a scenario, not a forecast.
- Legal and contingent matters: The company described ongoing ERISA and investment-fund fee litigation and regulatory inquiries; management did not expect pending matters to materially affect business or financial position, while acknowledging uncertain outcomes. Guarantees had maximum exposure of approximately $216 million, with management assessing material payment as remote. Certain derivatives could require additional collateral if credit ratings fell below investment grade; the filing estimated $41.2 million of additional collateral under the specified trigger scenario.
- Controls and accounting: Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting. The filing notes that new accounting guidance on troubled debt restructurings was under evaluation.
Key facts for investors to verify
- Whether operating earnings and claims trends in U.S. Insurance Solutions persist, and how the ongoing group medical exit affects reported results and comparability.
- Commercial mortgage delinquency, non-accrual and watch-list trends, including the resolution of matured loans and the adequacy of the $124.7 million mortgage valuation allowance.
- Investment portfolio impairment risk, including structured securities, commercial real estate exposure and the effect of interest-rate or credit-spread changes.
- Liquidity at the relevant legal entities, investment-contract withdrawals, access to facilities and any collateral needs if ratings or markets deteriorate.
- Regulatory approvals, final consideration and closing timing for HSBC AFORE and Finisterre, plus the realized Q2 Catalyst sale gain.
- Developments in the disclosed litigation and regulatory matters, and any change to management’s assessment of their financial impact.