PRINCIPAL FINANCIAL GROUP INC quarterly report, Q2 FY2019

Principal Financial Group, Inc. — Q2 2019 Form 10-Q

Business context and reporting period

Quarterly report for the three and six months ended June 30, 2019. Principal provides retirement and income products, asset management, international savings and insurance products. Results are unaudited and presented under U.S. GAAP. Amounts below are in millions of dollars except per-share data, percentages and AUM.

Key financial metrics

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Total revenue	$3,972.6	$3,234.9	$7,716.5	$6,118.5
Income before tax	$450.3	$515.4	$976.3	$972.4
Net income attributable to Principal	$386.3	$456.6	$816.2	$853.7
Diluted EPS	$1.37	$1.58	$2.90	$2.93
Net cash from operating activities	Not separately stated for quarter	Not separately stated for quarter	$2,678.4	$1,638.2

Q2 revenue rose 22.8%, while attributable net income fell 15.4% and diluted EPS fell 13.3%. The effective tax rate was 13%, versus 11%.
For the first half, revenue increased 26.1%, pretax income was nearly flat, and attributable net income fell 4.4%; diluted EPS declined from $2.93 to $2.90. The effective tax rate was 14%, versus 11%.
Net investment income was $1,037.1 in Q2 and $1,998.1 for the first half, up 16.6% and 11.5%, respectively. Management cited higher average invested assets, yields and variable investment income.
Net realized capital results were a $4.0 loss in Q2 2019 versus a $67.4 gain in Q2 2018; first-half gains were $80.5 versus $42.3. Investment gains and losses are volatile and include market movements and derivative effects.
Q2 segment pretax operating earnings: Retirement and Income Solutions $256.2; Principal Global Investors $115.6; Principal International $93.2; U.S. Insurance Solutions $146.3; Corporate loss $98.1. Total segment operating earnings were $513.2, compared with $485.7 a year earlier; this is a non-GAAP measure.
Principal Global Investors AUM ended Q2 at $431.8 billion, up from $423.1 billion at quarter start, with $13.5 billion investment performance offset by $5.0 billion net outflows. Principal International AUM was $168.0 billion.

Balance sheet, cash flow and liquidity

At June 30, total assets were $267,918.0 and total liabilities $253,511.5. Assets included $162,848.6 of separate-account assets, matched by equal liabilities; these accounts are legally segregated and investment risk is generally borne by clients.
Investments totaled $91,195.2; cash and cash equivalents were $3,315.9, up from $2,977.5 at year-end 2018. Stockholders’ equity was $14,102.0, including $14,034.7 attributable to Principal.
Total debt was $3,839.2, up from $3,302.5 at December 31, 2018: $76.8 short-term and $3,762.4 long-term. Debt-to-equity was 27%, versus 29%; debt-to-capitalization was 21%, versus 22%.
First-half operating cash flow was $2,678.4, investing cash outflow $2,344.0 and financing cash flow $4.0; cash increased $338.4. Operating cash flow rose from $1,638.2 in 2018, primarily reflecting higher pension risk-transfer and individual fixed-annuity sales and related reserves.
Management reported $2,463.4 of cash and liquid assets at holding companies and other subsidiaries available for corporate purposes. Committed credit facilities had $1,007.1 capacity, of which $76.8 was outstanding.

Material changes versus prior periods

The large increase in premiums and benefits largely reflects higher sales of single-premium group and individual annuities with life contingencies. These products can produce substantial period-to-period swings in both premiums and reserve-related expenses.
Q2 earnings were pressured by the absence of a 2018 gain on sale of an equity-method investment; this was partly offset by improved derivative results. First-half earnings also lacked the prior-year $27.9 tax-reform benefit.
Net unrealized gains on available-for-sale investments lifted other comprehensive income: first-half OCI was $2,219.0, versus a $1,408.4 loss in 2018. AOCI shifted from a $1,565.1 deficit at year-end to $647.7 positive at June 30, largely reflecting market-value movements; this is distinct from net income.
Long-term debt increased following issuance of $500.0 of 3.7% senior notes due 2029 on May 7, 2019. Proceeds and available cash were intended to fund the Wells Fargo transaction.
Principal suspended repurchases under its remaining $295.3 million authorization in Q1. First-half cash returned to common shareholders was $454.3, including $300.6 of dividends and $153.7 of repurchases.

Outlook, commentary, risks and unusual items

No numerical full-year earnings or revenue guidance is provided in the supplied filing text. Management states interim results are not necessarily indicative of full-year results. It expects lower interest rates to weigh more on profitability over time as assets mature and are reinvested at lower yields.
On July 1, 2019, after the reporting date, Principal closed its acquisition of Wells Fargo’s Institutional Retirement & Trust business for $1.2 billion cash, with a potential earn-out of up to $150.0 million based on fee-revenue retention through December 31, 2020. The purchase was funded with available cash and debt financing. Integration, customer retention, delayed asset transfers, regulatory approvals and realizing expected benefits are identified risks.
The filing estimates an immediate 100-basis-point parallel rate decline would reduce segment pretax operating earnings by less than 1% over the next 12 months, excluding potential DAC and actuarial-balance unlocking. An immediate 10% S&P 500 decline followed by quarterly recovery was estimated to reduce annual segment pretax operating earnings by approximately 4%–6%, excluding such unlocking.
Key exposures include interest-rate and reinvestment risk, equity and AUM declines, credit and valuation risk, insurance claims and reserving assumptions, foreign currency movements, regulatory and technology risks, and acquisition execution. The filing estimates a 100-basis-point rate increase would reduce the net reported fair value of covered financial assets and derivatives by $4,490.6; the sensitivity excludes important liabilities and is not an estimate of total economic impact.
Management disclosed no litigation or regulatory contingencies for which disclosure was considered appropriate. Certain guarantees have maximum stated exposures of $118.0 and $750.0, while the Chilean minimum-return guarantee has an indeterminable maximum exposure; management considers material payment unlikely. The filing notes outcomes could nevertheless materially affect a particular period’s net income.
A pension-plan amendment ended traditional benefit accruals after 2022 and begins cash-balance accruals in 2023. Remeasurement generated a $59.0 net actuarial loss and a $122.4 plan-amendment gain recorded in AOCI, with the gain to be amortized over future working lifetimes.
Principal adopted lease guidance in 2019, recording $168.8 of lease assets and $164.0 of liabilities at adoption; the filing says the effect on operations and EPS was not material. The company expects long-duration insurance accounting changes to significantly alter accounting for many insurance and annuity products; adoption was tentatively planned for January 1, 2022.

Most important facts for investors to verify

How much of premium growth and earnings reflects pension risk-transfer and other single-premium annuity sales, and how will their reserve and capital requirements develop?
Whether ongoing earnings trends support the reported segment operating results after volatile realized investment gains and losses, prior-year one-time gains and tax items.
The funding, integration costs, transferred assets and liabilities, customer retention, earn-out likelihood and financial contribution of the Wells Fargo acquisition.
How lower rates, equity-market movements, credit spreads and policyholder behavior affect investment income, guarantees, reserves, DAC and statutory capital.
Whether cash available at holding companies, subsidiary dividend capacity and debt levels remain adequate alongside dividends, acquisition funding and other capital needs.