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PFG > SEC Filings for PFG > Form 10-Q on 31-Jul-2013All Recent SEC Filings

Show all filings for PRINCIPAL FINANCIAL GROUP INC

Form 10-Q for PRINCIPAL FINANCIAL GROUP INC


31-Jul-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following analysis discusses our financial condition as of June 30, 2013, compared with December 31, 2012, and our consolidated results of operations for the three and six months ended June 30, 2013 and 2012, prepared in conformity with U.S. GAAP. The discussion and analysis includes, where appropriate, factors that may affect our future financial performance. The discussion should be read in conjunction with our Form 10-K, for the year ended December 31, 2012, filed with the SEC and the unaudited consolidated financial statements and the related notes to the financial statements and the other financial information included elsewhere in this Form 10-Q.

Forward-Looking Information

Our narrative analysis below contains forward-looking statements intended to enhance the reader's ability to assess our future financial performance. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and similar expressions. Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects on us. Such forward-looking statements are not guarantees of future performance.

Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties including, but not limited to, the following: (1) adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, as well as our access to capital and cost of capital; (2) continued difficult conditions in the global capital markets and the economy generally may materially and adversely affect our business and results of operations; (3) continued volatility or declines in the equity markets could reduce our assets under management ("AUM") and may result in investors withdrawing from the markets or decreasing their rates of investment, all of which could reduce our revenues and net income; (4) changes in interest rates or credit spreads may adversely affect our results of operations, financial condition and liquidity, and our net income can vary from period-to-period; (5) our investment portfolio is subject to several risks that may diminish the value of our invested assets and the investment returns credited to customers, which could reduce our sales, revenues, AUM and net income; (6) our valuation of fixed maturities, equity securities and derivatives may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition; (7) the determination of the amount of allowances and impairments taken on our investments requires estimations and assumptions which are subject to differing interpretations and could materially impact our results of operations or financial position; (8) any impairments of or valuation allowances against our deferred tax assets could adversely affect our results of operations and financial condition; (9) gross unrealized losses may be realized or result in future impairments, resulting in a reduction in our net income;
(10) competition from companies that may have greater financial resources, broader arrays of products, higher ratings and stronger financial performance may impair our ability to retain existing customers, attract new customers and maintain our profitability; (11) we may not be able to protect our intellectual property and may be subject to infringement claims; (12) a downgrade in our financial strength or credit ratings may increase policy surrenders and withdrawals, reduce new sales and terminate relationships with distributors, impact existing liabilities and increase our cost of capital, any of which could adversely affect our profitability and financial condition; (13) our efforts to reduce the impact of interest rate changes on our profitability and retained earnings may not be effective; (14) guarantees within certain of our products that protect policyholders may decrease our earnings or increase the volatility of our results of operations or financial position under U.S. GAAP if our hedging or risk management strategies prove ineffective or insufficient; (15) if we are unable to attract and retain qualified employees and sales representatives and develop new distribution sources, our results of operations, financial condition and sales of our products may be adversely impacted; (16) our international businesses face political, legal, operational and other risks that could reduce our profitability in those businesses; (17) we may face losses if our actual experience differs significantly from our pricing and reserving assumptions; (18) our ability to pay stockholder dividends and meet our obligations may be constrained by the limitations on dividends Iowa insurance laws impose on Principal Life; (19) the pattern of amortizing our DAC and other actuarial balances on our universal life-type insurance contracts, participating life insurance policies and certain investment contracts may change, impacting both the level of the DAC and other actuarial balances and the timing of our net income; (20) we may need to fund deficiencies in our Closed Block assets; (21) a pandemic, terrorist attack or other catastrophic event could adversely affect our net income; (22) our reinsurers could default on their obligations or increase their rates, which could adversely impact our net income and financial condition; (23) we face risk arising from acquisition of businesses; (24) we face risks arising from the acquisition of Cuprum; (25) changes in laws, regulations or accounting standards may reduce our profitability; (26) we may be unable to mitigate the impact of Regulation XXX and Actuarial Guideline 38, potentially resulting in a negative impact to our capital position and/or a reduction in sales of term and universal life insurance products; (27) a computer system failure or security breach could disrupt our business, damage our reputation and adversely impact our profitability; (28) loss of key vendor relationships or failure of a vendor to protect information of our customers or employees could adversely affect our business or result in losses; (29) results of litigation and regulatory investigations may affect our financial strength or reduce our profitability; (30) from time to time we may become subject to tax audits, tax litigation or similar proceedings, and as a result we may owe additional taxes, interest and penalties in amounts that may be material; (31) fluctuations in foreign currency exchange rates could reduce our profitability;
(32) applicable laws and our certificate of incorporation and by-laws may


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discourage takeovers and business combinations that some stockholders might consider in their best interests and (33) our financial results may be adversely impacted by global climate changes.

Overview

We provide financial products and services through the following reportable segments:

† Retirement and Investor Services, which consists of our asset accumulation operations that provide retirement savings and related investment products and services. We provide a comprehensive portfolio of asset accumulation products and services to businesses and individuals in the U.S., with a concentration on small and medium-sized businesses. We offer to businesses products and services for defined contribution pension plans, including 401(k) and 403(b) plans, defined benefit pension plans, nonqualified executive benefit plans and employee stock ownership plan consulting services. We also offer annuities, mutual funds and bank products and services to the employees of our business customers and other individuals.

† Principal Global Investors, which consists of our asset management operations, manages assets for sophisticated investors around the world, using a multi-boutique strategy that enables the segment to provide an expanded range of diverse investment capabilities including equity, fixed income and real estate investments. Principal Global Investors also has experience in currency management, asset allocation, stable value management and other structured investment strategies.

† Principal International, which offers retirement products and services, annuities, mutual funds, institutional asset management and life insurance accumulation products through operations in Brazil, Chile, China, Hong Kong SAR, India, Mexico and Southeast Asia.

† U.S. Insurance Solutions, which provides individual life insurance as well as specialty benefits in the U.S. Our individual life insurance products include universal and variable universal life insurance and traditional life insurance. Our specialty benefit products include group dental and vision insurance, individual and group disability insurance, group life insurance, wellness services and non-medical fee-for-service claims administration.

† Corporate, which manages the assets representing capital that has not been allocated to any other segment. Financial results of the Corporate segment primarily reflect our financing activities (including interest expense and preferred stock dividends), income on capital not allocated to other segments, inter-segment eliminations, income tax risks and certain income, expenses and other after-tax adjustments not allocated to the segments based on the nature of such items.

Transactions Affecting Comparability of Results of Operations

Acquisitions

We entered into acquisition agreements for the following businesses during 2013 and 2012.

Liongate Capital Management. On May 1, 2013, we finalized the purchase of a 55% interest in Liongate Capital Management ("Liongate"), a global alternative investment boutique based in London and New York. Liongate is focused on managing portfolios of hedge funds and had $1.4 billion in AUM at the time of acquisition. Liongate is accounted for on the equity method within the Principal Global Investors segment.

AFP Cuprum S.A. On February 4, 2013, we finalized the purchase of Cuprum, a premier pension manager in Chile. As a result of the public tender offer, we initially acquired a 91.55% ownership stake in Cuprum for a purchase price of $1.3 billion. Cuprum had $34.3 billion in AUM at the time of acquisition and is consolidated within the Principal International segment on a one-month lag. For additional information, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 2, Acquisitions."

First Dental Health. On November 1, 2012, we finalized the purchase of a 100% interest in First Dental Health, a California based independent dental preferred provider organization. First Dental Health is consolidated within the U.S. Insurance Solutions segment.

Claritas Administração de Recursos Ltda./Claritas Investments, Ltd. On April 2, 2012, we finalized the purchase of a 60% indirect ownership in Claritas, a leading Brazilian mutual fund and asset management company. The Sao Paulo-based company manages equity funds, balanced funds, managed accounts and other strategies for affluent clients and institutions through its multi-channel distribution network. Claritas had $1.8 billion in AUM at the time of acquisition and is consolidated within the Principal International segment.


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Other

Individual Life Insurance Amortization. During the first quarter of 2012, our individual life insurance business changed its basis for amortizing DAC and other actuarial balances on a portion of our universal life insurance products. The actuarial balances for these products are now amortized based on estimated gross revenues instead of estimated gross profits. This change required an unlocking of the actuarial balances to reflect the pattern of estimated gross revenues, which resulted in volatility within certain income statement line items. Specifically, fee revenues decreased $46.6 million; benefits, claims and settlement expenses increased $87.9 million; and operating expenses decreased $139.6 million. However, on a net basis the impact was a net gain of $3.3 million after-tax, which is not material.

Group Medical Insurance Business. On September 30, 2010, we announced our decision to exit the group medical insurance business (insured and administrative services only) and entered into an agreement with United Healthcare Services, Inc. to renew group medical insurance coverage for our customers. The exiting of the group medical insurance business does not qualify for discontinued operations treatment under U.S. GAAP. Therefore, the results of operations for the group medical insurance business are still included in our consolidated income from continuing operations.

With the exception of corporate overhead, amounts related to our group medical insurance business previously included in segment operating earnings have been removed from operating earnings for all periods presented and are reported as other after-tax adjustments. The operating revenues associated with our exited group medical insurance business were $0.4 million and $4.0 million for the three months ended June 30, 2013 and 2012, respectively, and $4.0 million and $22.9 million for the six months ended June 30, 2013 and 2012, respectively. The other after-tax adjustments associated with the after-tax earnings (loss) of our exited group medical insurance business were $(1.5) million and $(4.0) million for the three months ended June 30, 2013 and 2012, respectively, and $(0.1) million and $(5.5) million for the six months ended June 30, 2013 and 2012, respectively.

Fluctuations in Foreign Currency to U.S. Dollar Exchange Rates

Fluctuations in foreign currency to U.S. dollar exchange rates for countries in which we have operations can affect reported financial results. In years when foreign currencies weaken against the U.S. dollar, translating foreign currencies into U.S. dollars results in fewer U.S. dollars to be reported. When foreign currencies strengthen, translating foreign currencies into U.S. dollars results in more U.S. dollars to be reported.

Foreign currency exchange rate fluctuations create variances in our financial statement line items but have not had a material impact on our consolidated financial results. Principal International segment operating earnings were positively impacted by $0.1 million and negatively impacted by $1.5 million for the three and six months ended June 30, 2013, respectively, as a result of fluctuations in foreign currency to U.S. dollar exchange rates. For a discussion of our approaches to managing foreign currency exchange rate risk, see Item 3. "Quantitative and Qualitative Disclosures About Market Risk - Foreign Currency Risk."

Stock-Based Compensation Plans

For information related to our Stock-Based Compensation Plans, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 12, Stock-Based Compensation Plans."

Employee and Agent Benefits Expense

The 2013 annual defined benefit pension expense for substantially all of our employees and certain agents is expected to be $143.3 million pre-tax, which is a $21.0 million increase from the 2012 pre-tax pension expense of $122.3 million. This increase is primarily due to a decrease in the discount rate from 5.15% for 2012 to 4.00% for 2013. Also, the expected long-term return on plan assets used to develop the 2013 expense decreased to 7.50% from 8.00% used in 2012. Pre-tax pension expense of $35.8 million and $71.5 million was reflected in the determination of net income for the three and six months ended June 30, 2013, respectively.

The 2013 annual other postemployment benefit ("OPEB") plan expense (income) for employees and certain agents is expected to be $(47.0) million pre-tax, which is an $8.2 million decrease from the 2012 pre-tax OPEB income of $(55.2) million. The weighted average expected long-term return on plan assets used to develop the expense (income) in 2013 decreased to 5.62% from 7.30%, which was based on weighted average expected long-term asset returns for the medical, life and long-term care plans. The expected long-term rates for the medical, life and long-term care plans were 5.40%, 7.75% and 5.85%, respectively. The expected rate of return for the medical plans was reduced to 5.40% to reflect the after-tax return on the plan assets resulting from the decision to have taxes paid by the trust instead of Principal Life. The discount rate used to develop the 2013 expense (income) decreased to 4.00%, down from the 5.15% discount rate used in 2012. The pre-tax expense (income) of $(11.7) million and $(23.4) million was reflected in the determination of net income for the three and six months ended June 30, 2013, respectively.


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Recent Accounting Changes

For recent accounting changes, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 1, Nature of Operations and Significant Accounting Policies" under the captions, "Revisions of Previously Issued Financial Statements" and "Recent Accounting Pronouncements."

Results of Operations



The following table presents summary consolidated financial information for the
periods indicated:



                                    For the three months ended June 30,                For the six months ended June 30,
                                                                  Increase                                            Increase
                                   2013             2012         (decrease)          2013              2012          (decrease)
                                                                         (in millions)
Revenues:
Premiums and other
considerations                 $       737.2    $       681.3    $      55.9    $      1,431.9    $      1,361.1    $       70.8
Fees and other revenues                803.8            636.1          167.7           1,537.4           1,234.1           303.3
Net investment income                  749.7            801.0          (51.3 )         1,539.0           1,625.8           (86.8 )
Net realized capital gains
(losses), excluding
impairment losses on
available-for-sale
securities                             (53.4 )           32.2          (85.6 )           (79.8 )            54.3          (134.1 )
Total other-than-temporary
impairment losses on
available-for-sale
securities                             (24.6 )          (49.1 )         24.5             (69.3 )           (82.8 )          13.5
Other-than-temporary
impairment losses on fixed
maturities,
available-for-sale
reclassified to (from)
other comprehensive income              (2.1 )           17.1          (19.2 )            18.1              22.0            (3.9 )
Net impairment losses on
available-for-sale
securities                             (26.7 )          (32.0 )          5.3             (51.2 )           (60.8 )           9.6
Net realized capital gains
(losses)                               (80.1 )            0.2          (80.3 )          (131.0 )            (6.5 )        (124.5 )
Total revenues                       2,210.6          2,118.6           92.0           4,377.3           4,214.5           162.8
Expenses:
Benefits, claims and
settlement expenses                  1,095.7          1,110.0          (14.3 )         2,190.2           2,322.5          (132.3 )
Dividends to policyholders              47.5             49.5           (2.0 )            95.8              99.8            (4.0 )
Operating expenses                     801.8            729.6           72.2           1,597.5           1,284.7           312.8
Total expenses                       1,945.0          1,889.1           55.9           3,883.5           3,707.0           176.5
Income before income taxes             265.6            229.5           36.1             493.8             507.5           (13.7 )
Income taxes                            29.0             50.9          (21.9 )            67.2             107.6           (40.4 )
Net income                             236.6            178.6           58.0             426.6             399.9            26.7
Net income attributable to
noncontrolling interest                  6.0              2.7            3.3               9.5              11.9            (2.4 )
Net income attributable to
Principal Financial
Group, Inc.                            230.6            175.9           54.7             417.1             388.0            29.1
Preferred stock dividends                8.3              8.3              -              16.5              16.5               -
Net income available to
common stockholders            $       222.3    $       167.6    $      54.7    $        400.6    $        371.5    $       29.1

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012

Net Income Available to Common Stockholders

Net income available to common stockholders increased primarily due to higher earnings in our Retirement and Investor Services segment stemming from an increase in fees as a result of positive equity market performance and growth in the business. In addition, net income available to common stockholders increased due to the Cuprum acquisition in Chile. These increases in net income available to common stockholders were partially offset by an after-tax increase in net realized capital losses.


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Total Revenues

Premiums increased $30.8 million for the Retirement and Investor Services segment primarily due to an increase in sales of single premium group annuities with life contingencies. The single premium product, which is typically used to fund defined benefit plan terminations, can generate large premiums from very few customers and therefore tends to vary from period to period. In addition, premiums increased $13.8 million for the Principal International segment primarily due to higher sales of single premium annuities with life contingencies in Chile. Furthermore, premiums increased $11.1 million for the U.S. Insurance Solutions segment primarily due to growth in our specialty benefits insurance business.

Fee revenues increased $78.2 million for the Retirement and Investor Services segment primarily due to an increase in average account values, which resulted from positive equity market performance and growth in the business. In addition, fee revenues increased $61.9 million for the Principal International segment primarily due to the Cuprum acquisition in Chile. Furthermore, fee revenues increased $28.5 million for the Principal Global Investors segment largely due to higher fee revenues as a result of increased AUM.

Net investment income decreased primarily due to lower investment yields in our U.S. operations. For additional information, see "Investments - Investment Results."

Net realized capital gains (losses) can be volatile due to other-than-temporary impairments of invested assets, mark-to-market adjustments of certain invested assets and our decision to sell invested assets. Net realized capital losses increased primarily due to losses versus gains on the GMWB embedded derivatives, including losses versus gains from changes in the spread reflecting our own creditworthiness, and related hedging instruments, and due to losses versus gains on derivatives not designated as hedging instruments. For additional information, see "Investments - Investment Results."

Total Expenses

Benefits, claims and settlement expenses decreased $25.8 million for the Retirement and Investor Services segment primarily due to a decrease in cost of interest credited in our investment only business and resulting from a lower interest rate environment. Partially offsetting this decrease was a $9.4 million increase in benefits, claims and settlement expenses for the U.S. Insurance Solutions segment primarily due to an increase in reserves resulting from a lower interest rate environment.

Operating expenses increased $31.2 million for the Principal International segment primarily due to the acquisition of Cuprum in Chile. In addition, operating expenses increased $16.2 million for the Retirement and Investor Services segment primarily due to an increase in non-deferrable distribution costs resulting from growth in the business and higher sub-advisory fees stemming from positive equity market performance. Furthermore, operating expenses increased $10.0 million for the Corporate segment primarily due to litigation expenses and higher interest expense on corporate debt.

Income Taxes

The effective income tax rates were 11% and 22% for the three months ended June 30, 2013 and 2012, respectively. The effective income tax rate for the three months ended June 30, 2013, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, a Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan and the presentation of taxes on our share of earnings generated from equity method investments reflected in net investment income. The effective income tax rate for the three months ended June 30, 2012, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, the presentation of taxes on our share of earnings generated from equity method investments reflected in net investment income and the interest exclusion from taxable income. The effective income tax rate decreased to 11% from 22% for the three months ended June 30, 2013 and 2012, respectively, primarily due to a 2013 Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan and increased income tax deductions allowed for corporate dividends received.

Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

Net Income Available to Common Stockholders

Net income available to common stockholders increased primarily due to higher earnings in our Retirement and Investor Services segment stemming from an increase in fees as a result of positive equity market performance and growth in the business. In addition, net income available to common stockholders increased due to the Cuprum acquisition in Chile. These increases in net income available to common stockholders were partially offset by an after-tax increase in net realized capital losses.


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Total Revenues

Premiums increased $43.4 million for the Retirement and Investor Services segment primarily due to an increase in sales of single premium group annuities with life contingencies. In addition, premiums increased $25.4 million for the U.S. Insurance Solutions segment primarily due to growth as a result of strong sales and continued recovery in employment and salary trends.

Fee revenues increased $128.0 million for the Retirement and Investor Services segment primarily due to an increase in average account values, which resulted from positive equity market performance and growth in the business. In addition, fee revenues increased $88.5 million for the Principal International segment primarily due to the Cuprum acquisition in Chile and higher investment management fees driven by higher average AUM in Mexico. Furthermore, fee revenues increased $73.5 million for the U.S. Insurance Solutions segment . . .

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