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
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine 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.