Principal Financial Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; balance sheet compared with December 31, 2015. Amounts are in millions unless noted. PFG provides retirement and insurance products, asset management, and international financial services. Separate-account assets and liabilities largely represent customer-directed investments, with investment risk borne by clients.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $2,818.0 | $3,240.9 | $8,880.3 | $9,157.4 |
| Income before taxes | $370.7 | $369.2 | $1,210.4 | $1,121.8 |
| Net income attributable to PFG | $308.2 | $300.4 | $998.5 | $980.4 |
| Net income available to common stockholders | $308.2 | $300.4 | $998.5 | $955.7 |
| Diluted earnings per common share | $1.06 | $1.01 | $3.41 | $3.20 |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $2,927.3 | $3,323.0 |
- Q3 revenue: Down $422.9 year over year, chiefly because premiums and other considerations fell $554.4, primarily reflecting lower sales of single-premium group and individual annuities with life contingencies. Net investment income rose $102.6; fees and other revenues rose $23.1.
- Nine-month revenue: Down $277.1. Net investment income increased $149.7, but premiums declined $594.8 and fees and other revenues declined $56.5.
- Profit: Q3 PFG-attributable net income increased $7.8; nine-month net income attributable to PFG increased $18.1. Nine-month common-stockholder income also reflects the absence of 2015 preferred dividends and a preferred-share redemption adjustment.
- Investment results: Net investment income was $856.1 in Q3 and $2,417.0 for nine months. Net realized capital gains were $44.2 and $214.5, respectively, versus $38.4 and a $10.0 loss in the comparable 2015 periods. Nine-month other-than-temporary impairment losses, net of recoveries, were $81.0, compared with $6.9 of recoveries in 2015.
- Margins and segments: The filing reports segment pre-tax operating earnings rather than a consolidated operating margin. Q3 / nine-month segment earnings were: Retirement and Income Solutions $206.9 / $583.0; Principal Global Investors $112.9 / $310.1; Principal International $84.2 / $222.1; U.S. Insurance Solutions $70.2 / $254.3; Corporate losses $(57.8) / $(165.6).
- Balance sheet at September 30: Total assets were $230,367.6, including $77,758.5 of investments and $141,120.3 of separate-account assets. Total liabilities were $219,313.9; stockholders’ equity was $10,863.8, including $10,794.6 attributable to PFG. Assets and liabilities grew from year-end, including separate accounts.
- Debt and capitalization: Total debt was $3,318.1 ($39.9 short-term and $3,278.2 long-term), versus $3,446.3 at year-end. Debt-to-equity excluding accumulated other comprehensive income was 31%, down from 34%; debt-to-capitalization on that basis was 24%, down from 25%.
- Cash flows and liquidity: Nine-month operating cash flow was $2,927.3, investing cash use was $4,497.6, and financing cash flow was $1,223.7. Cash and cash equivalents ended at $2,218.2, down $346.6 from year-end. Management stated that available cash, securities, operations, borrowing facilities, and capital access were expected to meet current and reasonably foreseeable liquidity needs. The holding companies and other subsidiaries had $1,113.0 of cash and liquid assets available for corporate purposes.
Material changes versus comparable periods
- Q3 pre-tax operating earnings increased in Retirement and Income Solutions, Principal Global Investors, and Principal International, but U.S. Insurance Solutions earnings fell to $70.2 from $172.9. The latter decline was primarily driven by unfavorable actuarial assumption updates in individual life insurance.
- Nine-month segment operating earnings declined at U.S. Insurance Solutions to $254.3 from $342.9, while Retirement and Income Solutions, Principal Global Investors, and Principal International increased earnings.
- Actuarial assumption updates and model refinements in Q3 reduced 2016 net income by $68.8; the comparable 2015 updates increased net income by $26.2. Management described a $95.0 after-tax adverse comparison between the periods.
- Other comprehensive income was $989.0 for the first nine months of 2016, versus a loss of $583.5 in 2015, largely reflecting the change in unrealized gains on available-for-sale securities and foreign-currency translation.
- Adoption of revised consolidation guidance on January 1, 2016 deconsolidated $8.6 billion of assets and liabilities from certain Chilean mandatory retirement funds and consolidated certain sponsored investment funds. The adoption did not materially affect operations or retained earnings.
- During the first nine months, PFG paid $341.1 in common dividends and acquired $245.2 of treasury stock. The common dividend declared per share was $0.41 in Q3, versus $0.38 a year earlier.
Outlook, management commentary, risks and unusual items
- Outlook: The filing provides no specific numerical earnings or revenue guidance. Management said operating results for the nine months are not necessarily indicative of full-year results and described liquidity as adequate for current and reasonably foreseeable needs.
- Interest rates and markets: Management identified sustained low rates as a risk to investment spreads, reserves, and actuarial balances; rising rates may increase surrenders and withdrawals and could require asset sales. A hypothetical 25-basis-point rate decrease was estimated to have an immaterial domestic margin effect over the following 12 months and a $5–$7 pre-tax reduction over the subsequent 12 months for the specified in-force contracts. A hypothetical 100-basis-point rate increase implied a $2,982.8 net estimated potential fair-value loss at September 30, compared with $2,482.6 at year-end.
- Market and currency sensitivity: A hypothetical 10% equity-market decline followed by 2% quarterly increases was estimated to reduce annual pre-tax operating earnings by approximately 4%–6%. A 10% unfavorable currency move was estimated to reduce nine-month international pre-tax operating earnings by $27.5 and international equity by $322.3; these are scenario estimates, not forecasts.
- Portfolio and credit: Fixed maturities were $52,834.3 by carrying amount, with 93% in NAIC designations 1 or 2. Fixed-maturity problem, potential-problem, and restructured securities totaled $205.7, or 0.39% of the portfolio. Nine-month credit impairment losses on available-for-sale securities were higher than in 2015; management cited energy and structured-security impairments.
- Derivatives: Net derivative credit exposure was $722.3 after collateral received. If specified credit-rating triggers were activated, the company estimated it would need to post an additional $65.4 of collateral. Derivative values and hedge results can be volatile.
- Regulation: Management was assessing the DOL fiduciary-rule package issued in April 2016 and said its preliminary assessment indicated no significant effect on financial condition or results, while noting business implications remained under review.
- Legal and contingent exposures: PFG reported investment-adviser fee litigation and an appeal in the ACE matter; it said no losses were accrued for the discussed legal matters because loss was not considered probable and estimable. The Lehman bankruptcy court dismissed with prejudice all claims against Principal Life in June 2016. Separately, guarantees to third parties had a stated maximum exposure of approximately $168.0; the future maximum exposure under Chile’s minimum-return guarantee was indeterminable.
- Ratings and controls: Fitch affirmed Principal Life’s AA- financial-strength rating with a stable outlook in October 2016; S&P and A.M. Best ratings were also affirmed with stable outlooks. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the $68.8 actuarial-assumption impact and adverse year-over-year comparison are nonrecurring, and how assumptions affect future DAC amortization, reserves, and earnings.
- Whether lower annuity premiums and challenging equity markets persist, and whether fee-based, spread-based, and insurance businesses sustain segment earnings trends.
- Credit performance and impairment exposure in energy, structured securities, mortgages, and real estate, including movements in unrealized losses and valuation allowances.
- Ability to maintain investment margins and liquidity under prolonged low rates, rising-rate-driven surrenders, and the disclosed interest-rate and equity stress scenarios.
- Potential collateral needs, derivative counterparty exposure, legal outcomes, the Chilean minimum-return guarantee, and the effects of the DOL fiduciary rule.
- Cash available at the parent and regulated subsidiaries, statutory dividend capacity, and the sustainability of dividends and share repurchases.