Principal Financial Group, Inc. — FY2013 Form 10-K
Business context and reporting period. This 10-K covers the fiscal year ended December 31, 2013; the filing also reports fourth-quarter results. Principal is a diversified financial services company with retirement, asset management, international and U.S. insurance operations. It reported $483.2 billion of assets under management (AUM) and approximately 19.4 million customers at year-end.
Financial performance and position
| Metric | 2013 | 2012 | Change / context |
|---|---|---|---|
| Total revenue | $9.29 billion | $9.22 billion | Up $74 million |
| Net income | $936.1 million | $825.4 million | Up 13% |
| Net income available to common stockholders | $879.7 million | $773.6 million | Up $106.1 million |
| Diluted EPS | $2.95 | $2.58 | Up 14% |
| Net investment income | $3.14 billion | $3.25 billion | Down $116.5 million |
| Net realized capital gains (losses) | $(225.2) million | $114.1 million | Driven in part by derivative losses and the absence of a 2012 Catalyst gain |
| Operating cash flow | $2.22 billion | $3.08 billion | Down $859.6 million |
| Total assets | $208.19 billion | $161.83 billion | Increase largely reflects Cuprum and consolidation of its separate-account assets and liabilities |
| Total stockholders’ equity | $9.78 billion | $9.70 billion | Up modestly; AOCI declined |
| Total debt | $2.75 billion | $2.71 billion | Debt-to-capitalization, excluding AOCI, was 22% versus 23% |
| Cash and cash equivalents | $2.37 billion | $4.18 billion | Down $1.81 billion |
| AUM | $483.2 billion | $403.0 billion | Up $80.2 billion |
Fourth quarter. Q4 2013 revenue was $2.67 billion, net income was $250.4 million, net income available to common stockholders was $233.4 million, and diluted EPS was $0.78. In Q4 2012, these measures were $2.30 billion, $226.7 million, $214.9 million and $0.72, respectively.
Segment operating earnings. Retirement and Investor Services (RIS) earned $694.4 million, up $119.3 million; Principal Global Investors earned $102.6 million, up $21.4 million; Principal International earned $215.2 million, up $61.1 million; U.S. Insurance Solutions earned $196.6 million, up $58.4 million. Corporate reported a $148.9 million operating loss, versus a $139.8 million loss. Total segment operating earnings were $1.06 billion, up from $808.8 million.
The filing does not provide a single consolidated operating margin measure. RIS accumulation net revenue increased to $2.34 billion from $2.04 billion; guaranteed net revenue rose to $184.2 million from $155.1 million.
Material changes versus the prior period
- Common-stockholder earnings improved primarily on higher RIS earnings, supported by positive equity-market performance and business growth. Fees and other revenues rose $595.5 million, while premiums fell $65.3 million and net investment income fell $116.5 million.
- Cuprum, a Chilean pension manager, was acquired in February 2013 for approximately $1.3 billion. It added $34.3 billion of AUM at acquisition and contributed $186.4 million of revenue and $87.0 million of net income from acquisition through year-end. Principal International AUM increased to $104.5 billion, including the acquisition, positive flows and market performance, partly offset by currency translation.
- Principal Global Investors AUM rose to $292.1 billion from $263.2 billion, reflecting $26.3 billion of investment performance and $4.2 billion of net inflows, partly offset by other reductions.
- Cash from operations declined, primarily due to settlement timing and lower cash flows from trading securities. Investing cash outflow was $1.23 billion; financing cash outflow was $2.80 billion, including debt repayments and net investment-contract withdrawals.
- Net unrealized gains on available-for-sale securities and derivatives declined by $1.38 billion, largely as interest rates rose approximately 79 basis points. Other comprehensive income was a loss of $471.9 million, compared with income of $370.1 million in 2012.
Outlook, risks, contingencies and unusual items
- Outlook: Management provided no specific consolidated earnings or revenue guidance. It said sustained low interest rates would reduce net-income growth and continue to pressure spreads, reserves and actuarial balances. Management noted that market gains and positive customer flows supported 2013 accumulation and asset-management results.
- Interest rates and markets: Low rates may compress investment spreads, increase reserves and hedging costs, and affect deferred acquisition costs (DAC). Rising rates can reduce bond values and contribute to surrenders and realized losses. A hypothetical 100-basis-point rate increase implied a $1.85 billion net fair-value loss at year-end; this is a sensitivity scenario, not a forecast.
- Investments and guarantees: U.S. fixed maturities totaled $46.0 billion, with approximately 7% below investment grade. Gross unrealized losses on available-for-sale fixed maturities were $806.6 million. Commercial mortgage loans totaled approximately $10.3 billion; California represented 21%. Variable-annuity living-benefit guarantees and hedging effectiveness remain earnings and liquidity risks.
- Liquidity and capital: Management said available cash, securities, operating inflows and committed facilities were sufficient for anticipated needs. Credit facilities totaled $1.105 billion, with $150.6 million outstanding. Parent-company cash and highly liquid assets were $353.7 million. Principal Life’s estimated 2014 ordinary dividend capacity was $687.2 million, subject to insurance regulation and approvals.
- Ratings and regulatory exposure: Principal Life retained A+ ratings from A.M. Best and S&P, AA- from Fitch and A1 from Moody’s. Fitch’s outlook was negative, citing Cuprum integration risk and leverage; Moody’s downgraded the insurer rating to A1 in November 2013. Changes to regulation of affiliated captive reinsurance could affect capital and product economics.
- Contingencies: The filing identifies litigation and regulatory matters, including a Lehman-related claim seeking approximately $500 million, an excessive-fee claim concerning target-date funds, and litigation involving a property separate account. No loss was accrued for the matters discussed because management said losses were not probable and estimable; management generally could not estimate possible losses. Guarantees to third parties had maximum exposure of approximately $251 million, with management assessing material payment as remote.
- Other items: The Closed Block had $4.28 billion of designated assets and $4.95 billion of liabilities; Principal Life may need to fund any shortfall. A $100 million Principal Life surplus-note redemption was approved after year-end, for March 1, 2014, at 102.3% of par. In 2012, a Catalyst transaction generated a $141.2 million after-tax realized gain; 2012 also included an $85.2 million net-income reduction from actuarial assumption updates.
- Audit and controls: Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management reported effective disclosure controls and no material control changes during Q4.
Most important facts for investors to verify
- Whether Cuprum integration, local-currency performance and customer flows support continued Principal International earnings growth.
- How much of 2013 earnings growth reflects recurring fees and segment operations versus market performance, acquisitions and volatile realized gains or losses.
- Exposure to interest-rate changes, guaranteed product spreads, variable-annuity benefits, DAC assumptions and the effectiveness and cost of hedging.
- Fixed-maturity impairments, below-investment-grade holdings, mortgage-credit performance, California concentration and the significance of unrealized losses.
- Holding-company liquidity, regulatory limits on subsidiary dividends, debt service and the effect of rating changes or captive-reinsurance regulation.
- Developments in the disclosed litigation and tax matters, and any potential Closed Block funding needs.