Principal Financial Group, Inc. — Q1 2016 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2016, compared with the three months ended March 31, 2015; balance-sheet figures are compared with December 31, 2015. Principal provides retirement and income solutions, asset management, international financial products, and U.S. insurance through four operating segments, plus Corporate.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Total revenues | $3,036.6 million | $2,657.3 million |
| Income before income taxes | $439.8 million | $458.1 million |
| Net income attributable to Principal | $368.0 million | $422.4 million |
| Net income available to common stockholders | $368.0 million | $414.2 million |
| Diluted EPS | $1.25 | $1.39 |
| Dividends declared per common share | $0.38 | $0.36 |
| Net cash provided by operating activities | $895.5 million | $630.9 million |
| Net cash used in investing activities | $1,853.3 million | $229.5 million |
| Net cash from (used in) financing activities | $535.9 million | $(813.3) million |
| Total assets | $217,570.0 million | $218,660.3 million at Dec. 31, 2015 |
| Cash and cash equivalents | $2,142.9 million | $2,564.8 million at Dec. 31, 2015 |
| Total debt | $3,391.7 million | $3,446.3 million at Dec. 31, 2015 |
| Stockholders’ equity | $10,109.6 million | $9,377.4 million at Dec. 31, 2015 |
Net investment income was $761.7 million versus $723.9 million; the reported annualized net investment yield was 4.2% versus 4.3%. Consolidated operating or profit margins are not separately provided. Separate-account assets and liabilities were each $132.3 billion; these are substantially pass-through funds for which clients bear investment risk.
Material changes versus the prior comparable period
- Revenue increased $379.3 million, led by higher premiums and other considerations, up $366.0 million. Retirement and Income Solutions premiums rose largely due to single-premium group and individual annuities with life contingencies; these sales can vary materially by quarter.
- Benefits, claims and settlement expenses increased $422.2 million, mainly reflecting higher reserves associated with those annuity sales. Consequently, income before tax declined $18.3 million and net income attributable to Principal fell $54.4 million.
- Results included $136.6 million of net realized capital gains versus $66.2 million. Higher derivative gains were partly offset by increased available-for-sale security impairments and losses on trading equities and sponsored funds. Net impairment losses on available-for-sale securities were $48.1 million, compared with $7.5 million.
- The 2015 comparison benefited from a $105.2 million deferred-tax benefit related to a Chilean legal-entity merger and a $66.9 million tax-indemnification-related revenue item. The 2016 effective tax rate was 16%, compared with 6% in 2015; 2016 included a tax benefit from a Brazilian entity merger.
- Segment pre-tax operating earnings were $356.3 million versus $420.9 million. Retirement and Income Solutions reported $181.4 million (down from $202.9 million); Principal Global Investors $79.7 million (down from $92.6 million); Principal International $68.0 million (down from $80.8 million); U.S. Insurance Solutions $80.5 million (down from $81.9 million); and Corporate a $53.3 million loss (versus a $37.3 million loss).
- Principal Global Investors AUM ended at $368.3 billion, versus $355.2 billion a year earlier; quarterly net cash flow was $0.7 billion versus $6.9 billion. Principal International AUM was $121.0 billion versus $110.9 billion, with exchange-rate movements contributing $8.2 billion to the Q1 2016 total.
- Operating cash flow increased, while investing cash use rose with greater purchases of available-for-sale securities. Financing cash flow improved primarily because investment-contract deposits exceeded withdrawals in 2016; the prior-year period had net withdrawals.
- Q1 2016 cash returned to common stockholders was $216.0 million: $110.4 million of dividends and $105.6 million of share repurchases. The Board authorized a new $400 million repurchase program in February 2016.
Outlook, management commentary, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management said available cash flows and liquidity resources were expected to meet current needs and reasonably foreseeable contingencies; it also described ongoing liquidity stress testing and prudent capital management.
- Management attributed lower fee earnings in Retirement and Income Solutions to weaker average equity markets and lower account values. Principal International earnings faced currency headwinds: foreign-exchange movements reduced segment pre-tax operating earnings by $16.2 million in Q1 2016.
- Management highlighted persistent low interest rates as a risk to investment margins, reserve adequacy, and deferred acquisition cost assumptions; rising rates could increase surrenders and require asset sales. A hypothetical immediate 25-basis-point rate decline was estimated to reduce domestic investment margins by an immaterial amount over the next 12 months and $4–$6 million pre-tax over the following 12 months. These are scenarios, not forecasts.
- Other principal risks include credit and investment valuation losses, equity-market declines and lower AUM/fees, product guarantees and hedge effectiveness, foreign-exchange exposure, regulatory or tax changes, litigation, ratings downgrades, catastrophe, cybersecurity, and reinsurer or counterparty failure.
- In January 2016 the company adopted revised consolidation guidance. It deconsolidated $8.6 billion of assets and liabilities of certain Chilean mandatory privatized social-security funds, and consolidated sponsored investment funds with $180.1 million of assets, $0.6 million of liabilities, and $179.5 million of redeemable noncontrolling interest. The filing says these changes had no material operating-income or retained-earnings effect.
- The Department of Labor issued a final fiduciary-definition regulation package on April 6, 2016; the company was assessing its impact. S&P affirmed relevant ratings at A+ with stable outlook in April 2016; A.M. Best and Fitch ratings were also reported as affirmed with stable outlooks.
- Legal matters include an investment-fund fee lawsuit against Principal Management Corporation and the Lehman bankruptcy estate’s disputed claim against Principal Life of approximately $550 million, including disputed interest through November 2014. The company reported no accrual for the matters discussed because losses were not considered probable and reasonably estimable; the Lehman motion hearing was scheduled for May 4, 2016.
- Guarantees to third parties had maximum stated exposure of approximately $204 million, with management viewing material payment as remote. The future maximum exposure under the Chilean pension-fund relative-return guarantee is indeterminable.
Important facts for investors to verify
- How much of Q1 earnings and revenue reflects recurring segment performance versus volatile derivative gains, impairments, tax items, and variable single-premium annuity sales.
- Whether AUM flows, equity-market levels, and foreign-exchange trends support improvement in fee income and international earnings.
- Credit quality and impairment trends in the investment portfolio, especially energy-sector corporate debt, structured securities, and mortgage exposures; also review the assumptions behind unrealized-loss recovery.
- Liquidity and capital at the parent and regulated insurance subsidiaries: the filing reports $953 million of cash and liquid assets at holding companies and other subsidiaries, $1.005 billion of short-term credit facilities, and $300 million of Q1 dividends from Principal Life to its parent. Principal Life’s 2016 dividend limit was approximately $937 million, subject to applicable approval requirements.
- Progress and potential financial impact of the cited litigation, the DOL fiduciary rule, and guarantees, including the uncapped Chilean pension-fund guarantee.