Principal Financial Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; balance-sheet figures are as of June 30, 2017, compared with December 31, 2016. The filing is unaudited. PFG provides retirement and income products, asset management, international financial services and U.S. insurance.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenues | $3,178.3 million | $3,025.7 million | $6,227.7 million | $6,062.3 million |
| Income before income taxes | $365.6 million | $399.9 million | $779.6 million | $839.7 million |
| Net income attributable to PFG | $309.5 million | $322.3 million | $658.4 million | $690.3 million |
| Diluted earnings per share | $1.06 | $1.10 | $2.25 | $2.35 |
| Dividends declared per common share | $0.46 | $0.39 | $0.91 | $0.77 |
- Revenue mix and earnings: First-half premiums and other considerations were $2,700.7 million, fees and other revenues $1,895.7 million, and net investment income $1,743.8 million. Net realized capital losses were $112.5 million, versus gains of $170.3 million in the first half of 2016.
- Segment operating results: First-half pre-tax operating earnings rose to $967.3 million from $787.5 million. Retirement and Income Solutions contributed $488.0 million; Principal Global Investors $215.4 million; Principal International $179.3 million; U.S. Insurance Solutions $190.6 million; Corporate recorded a $106.0 million loss. Segment operating earnings are a management-defined measure and do not equal GAAP pre-tax income.
- Assets and equity: Total assets were $240.2 billion, up from $228.0 billion at year-end; total stockholders’ equity was $11.2 billion, up from $10.3 billion. Separate-account assets and matching liabilities were each $149.3 billion; the filing says clients direct these investments and bear their investment risk.
- Debt and capitalization: Total debt was $3.17 billion, nearly unchanged from year-end. Debt-to-equity excluding accumulated other comprehensive income was 28%, versus 29%; debt-to-capitalization on the same basis was 22%, versus 23%.
- Cash flow and liquidity: First-half operating cash flow was $1.83 billion, investing cash flow was negative $2.50 billion, and financing cash flow was negative $38.0 million. Cash and cash equivalents fell to $2.01 billion from $2.72 billion. PFG reported $1.30 billion of cash and liquid assets in holding companies and other subsidiaries available for corporate purposes; committed credit facilities totaled $905 million, with $42 million drawn.
Material changes versus comparable periods
- First-half GAAP net income attributable to PFG declined $31.9 million year over year, despite higher revenue, as results shifted from realized capital gains to losses. Management attributed the change chiefly to a $289.0 million year-over-year deterioration in derivatives and related hedge activities. Higher segment operating earnings partly offset this effect.
- Q2 GAAP net income attributable to PFG fell $12.8 million year over year; management cited derivative losses and a shift in fixed-maturity results, partly offset by $63.3 million of higher segment pre-tax operating earnings.
- First-half operating cash flow decreased $296.5 million year over year. Management attributed the decrease to timing-related fluctuations in receivables and payables. Investing cash use was lower than in 2016, while financing cash flow moved from a $1.24 billion inflow to a $38 million outflow, primarily due to lower net investment-contract deposits.
- Assets under management at Principal Global Investors ended Q2 at $410.4 billion, up from $382.8 billion a year earlier; first-half net cash flow was negative $3.0 billion, while investment performance added $23.0 billion. Principal International AUM was $147.7 billion, up from $130.9 billion.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance is provided in the supplied filing text. Management said liquidity sources and available assets are believed sufficient for current needs and reasonably foreseeable contingencies, supported by liquidity stress testing and committed facilities.
- Management noted that lower interest rates generally reduce long-term profitability. A hypothetical immediate 100-basis-point rate decline was estimated to reduce segment pre-tax operating earnings by less than 1% over the next 12 months, excluding potential DAC and actuarial-balance unlocking; management expects the adverse effect to grow over time as assets mature and are reinvested at lower yields. A hypothetical 10% S&P 500 decline followed by quarterly 2% increases was estimated to reduce annual segment pre-tax operating earnings by approximately 4%–6%.
- Principal Life sold its ownership interest in Principal Global Investors, LLC to its parent, Principal Financial Services, Inc., on May 1 as part of a capital-allocation reorganization. Principal Life then paid an extraordinary dividend of $1,068.4 million to its parent, approved by the Iowa insurance commissioner. The transaction included $35.5 million of discontinued-operations income at Principal Life; the consolidated filing does not present this as a sale of the consolidated business.
- Net realized capital losses were volatile and included mark-to-market effects on derivatives, including guarantees on variable annuity products. The filing describes market, credit, currency, policyholder behavior, investment valuation, regulatory, litigation, tax, cyber and other risks. A downgrade below investment grade could trigger additional derivative collateral or payment obligations; the filing estimated an additional $42.5 million of collateral would have been required if specified rating-related triggers had been activated at quarter-end.
- Legal matters include investment-fund fee litigation and the appealed Lehman bankruptcy-estate case, which asserted an approximately $600 million claim against Principal Life. No loss was accrued for the discussed matters; management said the outcomes were uncertain and that possible losses generally could not be estimated. Guarantees to third parties had a stated maximum exposure of approximately $146 million; the future maximum exposure for Chilean mandatory-fund return guarantees is indeterminable.
- A $20.0 million fee related to ending an arrangement with a financing counterparty contributed to first-half operating-expense growth. A January 2017 CME rule change altered presentation of cleared-derivative variation margin, reducing certain balance-sheet assets and liabilities by about $528 million each, with no net-income effect.
- The DOL fiduciary rule became applicable June 9, 2017; full applicability was then scheduled for January 1, 2018. Management expected no significant effect on financial condition or results, while noting the business implications remained fluid. The filing reports no material changes to previously disclosed risk factors and no material change in internal control over financial reporting.
Important facts for investors to verify
- Review the drivers, duration and potential reversal of derivative-related realized losses, and distinguish GAAP results from segment operating earnings.
- Assess whether segment earnings growth, AUM trends and investment income can persist, including the effects of markets, client flows, claims and foreign exchange.
- Confirm holding-company liquidity, subsidiary dividend capacity and regulatory restrictions. Principal Life’s $1,068.4 million extraordinary dividend required regulatory approval.
- Evaluate exposure to interest-rate and equity-market shocks, policyholder surrenders, guarantees and potential collateral calls; test the filing’s hypothetical sensitivities against current exposures.
- Track investment credit quality, unrealized losses, mortgage and real-estate concentrations, reserve assumptions, litigation and guarantees, and implementation of upcoming accounting and regulatory changes.