PRINCIPAL FINANCIAL GROUP INC quarterly report, Q3 FY2012

Principal Financial Group, Inc. — Q3 2012 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2012. Figures are unaudited and in U.S. dollars; financial amounts are in millions unless stated otherwise. Principal provides retirement and investment services, asset management, international financial products, and U.S. insurance.

Financial performance

MetricQ3 2012Q3 2011Nine months 2012Nine months 2011
Total revenue$2,704.7$2,093.6$6,919.2$6,611.9
Income before taxes$181.4$151.1$693.5$722.8
Net income$191.3$74.5$594.3$532.5
Net income available to common stockholders$179.7$71.9$554.3$471.2
Diluted EPS$0.60$0.23$1.84$1.47
Segment operating earnings$134.8$193.2$564.1$642.0
  • Q3 revenue rose about 29%, chiefly reflecting higher premiums from single-premium group annuities and higher net realized gains. Nine-month revenue rose about 5%; lower investment income partly offset growth in premiums and fees.
  • Q3 and nine-month common earnings increased year over year, but segment operating earnings declined. Reported net income included a $141.2 million after-tax gain related to the Catalyst Health Solutions merger and disposition of Principal’s remaining interest. Higher gains and the prior-year tax ruling also aided comparisons.
  • Net investment income was $783.8 million in Q3 and $2,409.6 million for nine months, down from $815.2 million and $2,548.6 million, respectively. Management cited lower U.S. reinvestment yields and lower Chilean inflation-related returns.
  • Net realized capital gains were $87.7 million in Q3 and $81.2 million for nine months, versus losses of $30.7 million and $51.0 million in the comparable 2011 periods. These results include volatile investment, impairment, derivative and hedging items.
  • The effective tax rate was negative 5% for Q3 and 14% for nine months, compared with 51% and 26% in 2011. Q3 tax benefits included deductions and a contribution of appreciated stock; the prior-year quarter included an unfavorable tax ruling.

Financial position, cash flow and liquidity

  • At September 30, total assets were $159.2 billion, total liabilities $149.3 billion and total stockholders’ equity $9.8 billion. Assets increased from $147.4 billion at December 31, 2011; separate-account assets and matching liabilities were $80.2 billion.
  • Invested assets were $69.3 billion, including $51.5 billion of available-for-sale fixed maturities and $11.3 billion of mortgage loans. Cash and cash equivalents were $2.3 billion, down from $2.8 billion at year-end.
  • Nine-month operating cash flow was $2.374 billion, versus $1.885 billion in 2011. Investing activities used $1.719 billion, while financing activities used $1.209 billion. Cash decreased $554.9 million over the period.
  • Total debt was $2.209 billion: $28.5 million short-term and $2.180 billion long-term, compared with $1.670 billion at year-end. The company issued $600 million of senior notes in September. Debt to equity excluding AOCI was 25%, versus 19% at year-end.
  • Management reported $1.227 billion of excess capital in the holding companies and said available liquidity, operating cash flows and borrowing sources were adequate for current and reasonably foreseeable needs. The $800 million revolving facility supports the commercial-paper program; no commercial paper was outstanding at September 30.
  • Common dividends paid during the first nine months totaled $169.6 million, and share repurchases totaled $272.7 million. A quarterly dividend of $0.21 per share was paid in September.

Material changes, outlook and risks

  • Actuarial assumption updates and model refinements in Q3 reduced total-company net income by $96.7 million. Lower long-term interest-rate assumptions negatively affected operating earnings; increased expected persistency in individual annuities partly offset the impact. Segment operating earnings were reduced by $66.3 million from interest-rate-related updates and by a further $24.4 million from other assumption and model changes.
  • Retirement and Investor Services operating earnings were $137.5 million in Q3 and $422.8 million for nine months. U.S. Insurance Solutions recorded a Q3 operating loss of $21.6 million, largely due to actuarial unlocking; nine-month operating earnings were $78.8 million. Principal International earned $29.5 million in Q3 and $108.2 million for nine months; Principal Global Investors earned $20.6 million and $55.0 million, respectively.
  • Accounting changes adopted retrospectively affected acquisition-cost capitalization and reinsurance accounting. Comparative periods were adjusted; the filing states the revised reinsurance method reduced nine-month 2012 net income by $11.2 million versus the former method.
  • After quarter-end, Principal announced an agreement to acquire Chilean pension manager AFP Cuprum for approximately $1.5 billion, subject to regulatory approval and expected to close in Q1 2013. Following the announcement, Fitch, Moody’s and S&P affirmed ratings but changed outlooks from stable to negative; A.M. Best maintained a stable outlook.
  • The company reported $1.033 billion of gross unrealized losses on available-for-sale fixed maturities, down from $1.524 billion at year-end. It said it expected to recover amortized cost and did not intend, nor expect to be required, to sell the securities before recovery; future impairments remain possible.
  • Key risks include low interest rates, credit spreads and investment losses, equity-market declines affecting assets under management and guarantees, valuation and actuarial-estimate uncertainty, foreign-exchange exposure, counterparty risk, policyholder behavior, regulatory or tax changes, and acquisition execution. The filing reported no material changes to the prior Form 10-K risk factors.
  • Several litigation and regulatory matters remain pending, including claims involving retirement-plan fees, a property-account withdrawal queue and Lehman-related transactions. No losses were accrued for the discussed matters because management considered losses not probable and not reasonably estimable; possible outcomes remain uncertain. Guarantees had a maximum exposure of approximately $270 million, with material payment considered remote.
  • No formal earnings guidance is provided in the supplied filing text. Management estimated 2012 pension expense of $122.1 million and noted that the minimum required qualified-plan contribution for 2012 was zero; contributions to qualified and nonqualified plans totaled $69.0 million through September.

Important facts for investors to verify

  • Separate the $141.2 million after-tax Catalyst gain and other market-related items from recurring segment operating earnings.
  • Review the assumptions, timing and potential future effects of the $96.7 million actuarial unlocking and the retrospective accounting changes.
  • Assess the quality and liquidity of the investment portfolio, including unrealized losses, mortgage credit performance and derivative exposures.
  • Confirm the financing, regulatory approvals, rating implications and integration risks of the proposed Cuprum acquisition.
  • Monitor debt growth, holding-company capital and dividend capacity, as well as the unresolved litigation, tax matters and guarantee exposures.