Principal Financial Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Comparisons are with the corresponding 2017 periods unless otherwise noted. Principal operates retirement and income solutions, asset management, international financial services, and U.S. insurance businesses.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $4.348B | $4.628B | $10.467B | $10.856B |
| Income before tax | $569.1M | $1.158B | $1.542B | $1.937B |
| Net income attributable to Principal | $456.3M | $810.2M | $1.310B | $1.469B |
| Diluted earnings per share | $1.59 | $2.76 | $4.52 | $5.02 |
| Segment pre-tax operating earnings | $593.4M | $452.9M | $1.576B | $1.420B |
Revenue and GAAP earnings declined year over year, while segment pre-tax operating earnings increased. The filing does not provide a directly comparable consolidated operating margin; reported GAAP results include significant investment gains and losses.
Cash flow, nine months: Operating cash flow was $3.714B, investing cash flow was $(4.409)B, and financing cash flow was $1.151B. Cash and cash equivalents rose to $2.927B from $2.471B at year-end 2017.
Balance sheet at September 30: Total assets were $258.758B and total liabilities $246.841B. Total debt was $3.282B ($36.1M short-term; $3.246B long-term). Debt was 25% of equity excluding AOCI and 20% of capitalization excluding AOCI, both unchanged from year-end. Stockholders’ equity was $11.769B, down from $12.922B; AOCI moved from positive $165.5M to negative $1.348B, primarily reflecting unrealized investment losses and foreign currency translation. Cash and separate-account assets are not equivalent to unrestricted parent-company liquidity.
Changes and significant drivers
- Q3 revenue included a $253.1M accelerated performance fee following a real estate investment-team realignment; $151.9M of related revenue-sharing expenses left a $101.2M increase in Principal Global Investors’ pre-tax operating earnings. The firm no longer manages $9.2B of the client’s assets, and management did not expect material ongoing earnings effects.
- Q3 actuarial assumption updates and model refinements increased consolidated net income by $32.1M. The comparable 2017 updates decreased net income by $26.6M.
- The prior-year comparison includes a $690.9M pre-tax ($410.8M after-tax) gain from 2017 real estate transactions. This was the principal reason net realized capital gains and consolidated net income were much lower in 2018; Q3 2018 had a $5.5M net realized capital loss versus a $676.6M gain in Q3 2017.
- Nine-month operating revenue in Retirement and Income Solutions fell, mainly on lower single-premium group and individual annuity sales. Principal Global Investors’ AUM ended at $426.5B, including a $9.2B outflow related to the team realignment; the $3.5B INTERNOS acquisition added AUM. Principal International AUM ended at $156.6B, affected by foreign exchange movements.
- U.S. tax reform lowered the statutory federal corporate tax rate to 21%; effective tax rates were 19% for Q3 and 14% for nine months, versus 30% and 24% in 2017.
Liquidity, outlook, risks, and unusual items
- Management said cash flows and available funding were adequate for current and reasonably foreseeable liquidity needs. Holding companies and other subsidiaries held $2.034B of cash and liquid assets available for corporate purposes. Credit facilities totaled approximately $996M, with $36.1M drawn at quarter-end.
- Management reported no material change in contractual obligations or guarantees since year-end 2017 and gave no specific earnings or revenue guidance in the provided filing text. It noted that results are not necessarily indicative of full-year results.
- In March 2018, the company entered contingent funding agreements that can provide access to $400M of 2028 notes and $350M of 2048 notes. The notes are not issued unless the put options are exercised; specified events can require exercise. The company also may have to purchase up to $750M of Treasury securities from the trusts if due and unpaid.
- Interest-rate, credit, equity, foreign-exchange, investment valuation, policyholder behavior, and asset-liability risks are significant. A hypothetical 100-basis-point rate decrease was estimated to reduce segment pre-tax operating earnings by less than 1% over the next 12 months, excluding possible DAC and actuarial-balance unlocking; management said adverse effects may grow as assets mature. A modeled 10% equity-market decline followed by 2% quarterly increases would reduce annual segment pre-tax operating earnings by approximately 4%–6%.
- Gross unrealized losses on available-for-sale fixed maturities increased to $1.140B from $267M at year-end, primarily due to higher interest rates. The company said it did not intend, and was not more likely than not required, to sell these securities before recovering amortized cost; 97% of Principal Life’s securities in unrealized-loss positions were investment grade.
- The Chilean mandatory retirement fund relative-return guarantee has no stated cap on duration or amount, so maximum future exposure is indeterminable. Other disclosed guarantees had approximately $131M maximum exposure; management considered material payments remote. The filing reported no litigation or regulatory contingencies for which disclosure was considered appropriate.
- Acquisitions during 2018 included RobustWealth, INTERNOS, and MetLife Afore’s Mexican pension business. The company is evaluating a new long-duration insurance accounting standard expected to be adopted in 2021 and anticipates significant changes to accounting for many insurance and annuity products.
Important facts for investors to verify
- How much of current earnings and fee growth is recurring after the $253.1M accelerated performance fee and the $32.1M actuarial-update benefit?
- Whether asset flows, market performance, and foreign exchange movements support future AUM and fee revenue, particularly after the $9.2B real-estate mandate departure.
- How rising rates, unrealized fixed-maturity losses, credit spreads, and policyholder withdrawals affect statutory capital, liquidity, and realized results.
- The availability and restrictions on subsidiary dividends and holding-company liquidity, and the triggers and costs associated with the $750M contingent funding arrangements.
- Developments in the uncapped Chilean fund guarantee, insurance-reserve assumptions, and implementation of the long-duration insurance accounting standard.