Business context and reporting period
Principal Financial Group, Inc. (PFG) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. Its businesses include retirement and income solutions, asset management, international operations, and U.S. insurance. Comparisons below are against the corresponding 2016 periods unless otherwise noted. Amounts are in U.S. dollars.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $4,627.8 million | $2,818.0 million | $10,855.5 million | $8,880.3 million |
| Net income attributable to PFG | $810.2 million | $308.2 million | $1,468.6 million | $998.5 million |
| Diluted earnings per share | $2.76 | $1.06 | $5.02 | $3.41 |
| Net cash provided by operating activities | Not reported by quarter | $3,628.7 million | $2,927.3 million |
Quarterly revenue and earnings rose sharply, primarily because of a $690.9 million pretax gain on real estate transactions ($410.8 million after tax). For the nine months, reported revenue increased 22% and PFG-attributable net income increased 47%; those figures also reflect the real estate gain and volatile derivative results. The filing does not provide a comparable adjusted consolidated net income measure that removes all unusual items.
- Net realized capital gains were $676.6 million in Q3 and $564.1 million for the nine months. The real estate gain was partly offset by derivative losses; for the nine months, derivatives and related hedge activities generated $157.5 million in losses versus $153.8 million in gains in 2016.
- Segment pretax operating earnings, management’s measure of ongoing segment performance, were $452.9 million for Q3, up from $416.4 million, and $1,420.2 million for nine months, up from $1,203.9 million.
- Q3 segment pretax operating earnings were $210.1 million in Retirement and Income Solutions, $130.2 million in Principal Global Investors, $72.4 million in Principal International, $83.2 million in U.S. Insurance Solutions, and a $43.0 million Corporate loss.
- Net investment income was $838.0 million in Q3, down $18.1 million year over year, and $2,581.8 million for nine months, up $164.8 million. The nine-month annualized net investment yield was 4.3%, compared with 4.4% in 2016.
At September 30, total assets were $247.9 billion, up from $228.0 billion at year-end 2016; separate account assets and matching liabilities were $154.1 billion. Total stockholders’ equity was $12.1 billion, including $12.0 billion attributable to PFG. Short- and long-term debt totaled $3.23 billion. Debt to equity excluding accumulated other comprehensive income was 27%, versus 29% at year-end.
Consolidated cash and cash equivalents were $2.80 billion. PFG reported $1.81 billion of cash and liquid assets held in holding companies and other subsidiaries and stated that available sources were sufficient for current and reasonably foreseeable liquidity needs. Operating cash flow increased year over year; investing activities used $3.32 billion, and financing activities used $235.6 million. The company paid $398.5 million in common dividends and repurchased $218.1 million of stock during the nine months. Declared dividends were $0.47 per share for Q3 and $1.38 per share year to date.
Material changes and management commentary
- Retirement and Income Solutions revenue growth was led by higher single-premium group and individual annuity sales, which also increased related benefit and reserve expenses. Segment pretax operating earnings rose to $698.1 million for nine months from $583.0 million.
- Principal Global Investors ended Q3 with $423.3 billion of AUM, up from $397.3 billion a year earlier. Nine-month net cash flow was negative $0.5 billion, while investment performance added $33.4 billion.
- Principal International ended Q3 with $158.6 billion of AUM, up from $136.3 billion. Nine-month segment earnings improved to $251.7 million from $222.1 million, supported by growth in Asia, Latin American currency effects, and higher earnings from the Brazil equity-method investment.
- U.S. Insurance Solutions nine-month pretax operating earnings increased to $273.8 million from $254.3 million, with business growth partly offset by higher expenses and claims.
- Third-quarter actuarial assumption updates and model refinements reduced total company net income by $26.6 million, compared with a $68.8 million reduction in Q3 2016.
- In September, PFG exchanged interests in certain real estate joint ventures and sold some properties, citing portfolio concentration, liquidity, and control objectives. The transactions also changed real estate, other investments, cash, debt, and tax balances.
- After quarter-end, PFG announced an agreement to acquire MetLife’s Mexican AFORE pension business. Closing was expected in Q1 2018, subject to regulatory approval; the company estimated the deal would add about $3.9 billion of AUM and 0.7 million customers.
Outlook, risks and contingencies
The filing gives no specific earnings or revenue guidance. Management described liquidity as adequate and noted that 99% of institutional GICs and funding agreements, approximately $9.5 billion, could not be redeemed before maturity. Principal Life’s 2017 ordinary dividend capacity without prior regulatory approval was approximately $1.14 billion; it paid $1.22 billion in dividends to its parent through September, all extraordinary and regulator-approved.
- Key exposures include interest rates, equity markets, credit spreads, investment valuation and impairment judgments, policyholder behavior, foreign exchange, and counterparty risk. Management estimated a hypothetical 100-basis-point rate decrease would reduce segment pretax operating earnings by less than 1% over the next 12 months, excluding possible DAC and actuarial unlocking. A hypothetical 10% S&P 500 decline followed by 2% quarterly increases was estimated to reduce annual segment pretax operating earnings by about 4%–6%.
- Fixed maturities had $246.1 million of gross unrealized losses at September 30, down from $615.6 million at year-end 2016. Management attributed the improvement mainly to tighter credit spreads and lower interest rates and said it did not intend, nor expect to be required, to sell affected securities before recovery.
- Commercial mortgage loans on non-accrual status increased to $64.1 million from none at year-end; the filing also reports $20.9 million of non-performing residential mortgages. Management maintains allowances for estimated credit losses.
- Legal matters include an appeal in the Lehman bankruptcy litigation, where the estate’s claim against Principal Life was approximately $600 million; the company had no accrual for the discussed matters, stating losses were not probable and could not be reasonably estimated. A separate investment-fund fee lawsuit was dismissed with prejudice in October 2017, and another dismissal was affirmed on appeal.
- Guarantees to third parties had a stated maximum exposure of approximately $149 million. The future maximum exposure under Chilean mandatory pension fund relative-return guarantees is indeterminable. Management considered material payments under these guarantees and indemnifications remote.
- The DOL fiduciary rule remained subject to a changing implementation timetable; management did not expect its costs to materially affect financial condition or results. PFG was evaluating several future accounting standards, including CECL, and said expected revenue-recognition changes were not material.
Important facts for investors to verify
- How much of reported earnings growth is attributable to the one-time real estate gain, actuarial assumption changes, and derivative mark-to-market results, versus recurring segment operating performance.
- Whether the expected MetLife AFORE acquisition closes on the announced terms and how it affects AUM, customers, earnings, and capital.
- Trends in annuity sales and associated reserve/benefit costs, asset-management net flows, and segment margins.
- Mortgage portfolio delinquencies, non-accrual balances, credit impairments, and the adequacy of loan-loss allowances.
- Holding-company liquidity, Principal Life dividend restrictions, debt ratings, and sensitivity to market movements and policyholder withdrawals.