Principal Financial Group, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; balance-sheet comparisons are against December 31, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and reporting period
Principal provides retirement and income products, asset management, international savings and insurance solutions through Retirement and Income Solutions, Principal Global Investors, Principal International, and U.S. Insurance Solutions, alongside Corporate activities. Results are unaudited interim results and may not indicate full-year performance.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $3,234.9 | $3,178.3 | $6,118.5 | $6,227.7 |
| Income before tax | $515.4 | $365.6 | $972.4 | $779.6 |
| Net income attributable to Principal | $456.6 | $309.5 | $853.7 | $658.4 |
| Diluted EPS | $1.58 | $1.06 | $2.93 | $2.25 |
| Operating cash flow | — | — | $1,638.2 | $1,829.1 |
- Margins: GAAP pre-tax margin was approximately 15.9% in Q2 2018 versus 11.5% in Q2 2017, and 15.9% for the first half versus 12.5%. These comparisons include volatile realized investment gains and losses.
- Balance sheet: Total assets were $252,104.0 at June 30, versus $253,941.2 at year-end. Total investments were $82,404.8; cash and cash equivalents were $2,342.0.
- Debt and equity: Total debt was $3,284.4 ($64.5 short-term; $3,219.9 long-term), up from $3,217.9. Debt to capitalization excluding AOCI was 20%, unchanged; debt to equity excluding AOCI rose to 26% from 25%. Stockholders’ equity was $11,706.5, down from $12,921.9.
- Liquidity and capital returns: Management said cash, securities, operations and available borrowing sources were adequate for anticipated obligations. Holding companies and other subsidiaries held $1,820.4 of cash and liquid assets available for corporate purposes. First-half dividends and share repurchases returned $692.3 to common shareholders.
Material changes versus the prior comparable period
- Q2 revenue rose 1.8%, while first-half revenue declined 1.8%. Premiums and other considerations fell $186.9 in Q2 and $439.7 for the first half, principally reflecting lower sales of single-premium group and individual annuities in Retirement and Income Solutions.
- Net income attributable to Principal increased 47.5% in Q2 and 29.7% for the first half. Management attributed much of the increase to the shift from realized capital losses to gains, including a gain from selling an equity-method investment and lower derivative losses. The gain makes reported earnings less representative of underlying operating trends.
- Segment pre-tax operating earnings were $485.7 in Q2, down from $494.5; first-half earnings were $982.2, up from $967.3. First-half improvement at Global Investors and U.S. Insurance Solutions was partly offset by Retirement and Income Solutions and Latin America.
- First-half operating cash flow decreased to $1,638.2 from $1,829.1. Cash declined by $128.8 during the period. Financing cash flow was $574.5 provided, compared with $38.0 used in the prior-year period.
- Other comprehensive loss was $672.3 in Q2 and $1,408.4 for the first half, driven largely by unrealized losses on available-for-sale securities and foreign-currency translation. AOCI moved from $165.5 of income at year-end to a $1,137.9 loss at June 30; this reduced reported equity but is distinct from net income.
Outlook, commentary, risks and unusual items
- Guidance: The filing provides no specific earnings or revenue guidance. Management stated that an immediate parallel 100-basis-point rate decrease would reduce segment pre-tax operating earnings by less than 1% over the next 12 months, excluding potential DAC and actuarial-balance unlocking; adverse effects could grow as assets mature and are reinvested.
- Market sensitivity: A hypothetical 100-basis-point rate increase was estimated to reduce the net reported fair value of financial assets and derivatives by $3,789.5. 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%. These are scenarios, not forecasts.
- Operating and investment risks: Management cited interest rates and credit spreads, equity and real estate markets, investment and reserve assumptions, customer withdrawals, derivatives and hedging effectiveness, foreign exchange, regulation, competition, cyber and operational disruption, litigation, reinsurer performance, acquisitions, and ratings downgrades as risks. Gross unrealized losses on available-for-sale securities increased, primarily from higher rates and wider credit spreads; management said it did not intend, and was not more likely than not required, to sell the affected securities before cost recovery.
- Acquisitions and ownership: The company acquired INTERNOS, adding $3.5 billion of AUM, and MetLife’s Mexican pension business, adding $3.8 billion of AUM at closing. It increased its ownership of two CIMB joint ventures to 60%, while continuing equity-method accounting. RobustWealth was acquired on July 2, after quarter-end.
- Financing and contingencies: Two contingent funding agreements provide options to issue up to $400 million and $350 million of senior notes; the notes are not issued unless the options are exercised. The company disclosed $135 million maximum exposure under certain guarantees, plus $750 million under the P-Caps arrangements. The future maximum exposure under Chilean pension-fund minimum-return guarantees is indeterminable.
- Legal and regulatory: The company reported no litigation or regulatory contingencies for which it believed disclosure was appropriate. It said the Fifth Circuit’s June 2018 mandate vacated the DOL fiduciary rule; proposed SEC standards remained under consideration. Management did not expect adjustment of provisional U.S. tax-reform amounts during the first half.
- Accounting and tax items: The effective tax rate was 11% in both 2018 periods versus 14% in 2017, reflecting U.S. tax reform and other factors. Adoption of revenue-recognition guidance reduced opening equity by $39.7 and was not material to the income statement or EPS.
Important facts for investors to verify
- How much of the earnings increase reflects recurring segment performance versus the investment-sale gain and changes in derivative results.
- Whether Retirement and Income Solutions’ lower annuity premiums and spread earnings persist, and how market and mortality assumptions affect DAC amortization and reserves.
- Trends in unrealized investment losses, credit quality, foreign-currency translation and the company’s ability to hold securities through recovery.
- Liquidity at the parent and insurance-subsidiary levels, dividend capacity under Iowa regulation, and any exercise or triggering conditions for the $750 million contingent funding arrangements.
- Performance and integration of the acquisitions, foreign-exchange effects, and risks related to international pension guarantees.
- Whether capital returns, including the newly authorized $300 million repurchase program, remain consistent with capital needs and operating cash generation.