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PFG > SEC Filings for PFG > Form 10-Q on 30-Apr-2014All Recent SEC Filings

Show all filings for PRINCIPAL FINANCIAL GROUP INC

Form 10-Q for PRINCIPAL FINANCIAL GROUP INC


30-Apr-2014

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 March 31, 2014, compared with December 31, 2013, and our consolidated results of operations for the three months ended March 31, 2014 and 2013, 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, 2013, 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) 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, bond or real estate markets could reduce our 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 or a sustained low interest rate environment 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) 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; (14) 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; (15) our international businesses face political, legal, operational and other risks that could reduce our profitability in those businesses; (16) we may face losses if our actual experience differs significantly from our pricing and reserving assumptions;
(17) 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; (18) 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; (19) we may need to fund deficiencies in our Closed Block assets; (20) a pandemic, terrorist attack, military action or other catastrophic event could adversely affect our net income; (21) our reinsurers could default on their obligations or increase their rates, which could adversely impact our net income and financial condition; (22) we face risk arising from acquisition of businesses; (23) changes in laws or regulations may reduce our profitability;
(24) 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; (25) changes in accounting standards may reduce the transparency of our reported profitability and financial condition; (26) a computer system failure or security breach could disrupt our business, damage our reputation and adversely impact our profitability; (27) 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; (28) results of litigation and regulatory investigations may affect our financial strength or reduce our profitability; (29) 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; (30) fluctuations in foreign currency exchange rates could adversely impact our profitability and financial condition; (31) applicable laws and our certificate of incorporation and by-laws may discourage takeovers and business


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combinations that some stockholders might consider in their best interests; and
(32) 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 is organized into the Accumulation business, which includes full service accumulation, Principal Funds (our mutual fund business), individual annuities and bank and trust services; and the Guaranteed business, which includes investment only and full service payout. We offer a comprehensive portfolio of asset accumulation products and services for retirement savings and investment:

To businesses of all sizes with a concentration on small and medium sized businesses, we offer products and services for defined contribution pension plans, including 401(k) and 403(b) plans, defined benefit pension plans, nonqualified executive benefit plans and ESOP consulting services. For more basic investment needs, we offer SIMPLE IRA and payroll deduction plans;

To large institutional clients, we also offer investment-only products, including GICs and funding agreements and

To employees of businesses and other individuals, we offer the ability to accumulate savings for retirement and other purposes through mutual funds, individual annuities and bank products.

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, real estate investments and other alternative investments. Principal Global Investors also has experience in 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 Special Administrative Region, 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 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, U.S. 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 2014 and 2013.

Liongate Capital Management LLP and Liongate Limited. On May 1, 2013, we finalized the purchase of a 55% interest in Liongate Capital Management LLP and Liongate Limited ("Liongate"), a global alternative investment boutique based in London and New York. Liongate is focused on managing portfolios of hedge funds. The purchase price was $44.0 million. Liongate 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.

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 negatively impacted by $9.0


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million for the three months ended March 31, 2014 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 11, Stock-Based Compensation Plans."

Employee and Agent Benefits Expense

The 2014 annual defined benefit pension expense for substantially all of our employees and certain agents is expected to be $85.1 million pre-tax, which is a $58.2 million decrease from the 2013 pre-tax pension expense of $ 143.3 million. This decrease is primarily due to an increase in the discount rate from 4.00% for 2013 to 4.90% for 2014, and to better than expected asset returns during 2013. Also, the expected long-term return on plan assets used to develop the 2014 expense decreased to 6.75 % from 7.50 % used in 2013. Pre-tax pension expense of $21.4 million and $35.7 million was reflected in the determination of net income for the three months ended March 31, 2014 and 2013, respectively.

The 2014 annual other postemployment benefit ("OPEB") plan expense (income) for employees and certain agents is expected to be $(48.3) million pre-tax, which is a $1.3 million difference from the 2013 pre-tax OPEB income of $(47.0) million. The weighted average expected long-term return on plan assets used to develop the expense (income) in 2014 decreased to 5.36% from 5.62%, 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%, 5.00% and 5.85%, respectively. The discount rate used to develop the 2014 expense (income) increased to 4.90%, up from the 4.00% discount rate used in 2013. The pre-tax expense (income) of $(12.1) million and $(11.7) million was reflected in the determination of net income for the three months ended March 31, 2014 and 2013, respectively.

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 caption, "Recent Accounting Pronouncements."


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Results of Operations



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



                                                 For the three months ended March 31,
                                                                               Increase
                                                 2014            2013         (decrease)
                                                            (in millions)
Revenues:
Premiums and other considerations            $      803.6    $      694.7    $      108.9
Fees and other revenues                             829.7           733.6            96.1
Net investment income                               844.7           789.3            55.4
Net realized capital gains (losses),
excluding impairment losses on
available-for-sale securities                        19.8           (26.4 )          46.2
Net other-than-temporary impairment
(losses) recoveries on available-for-sale
securities                                           10.9           (44.7 )          55.6
Other-than-temporary impairment losses on
fixed maturities, available-for-sale
reclassified to (from) other
comprehensive income                                (30.1 )          20.2           (50.3 )
Net impairment losses on
available-for-sale securities                       (19.2 )         (24.5 )           5.3
Net realized capital gains (losses)                   0.6           (50.9 )          51.5
Total revenues                                    2,478.6         2,166.7           311.9
Expenses:
Benefits, claims and settlement expenses          1,227.5         1,094.5           133.0
Dividends to policyholders                           45.7            48.3            (2.6 )
Operating expenses                                  829.0           795.7            33.3
Total expenses                                    2,102.2         1,938.5           163.7
Income before income taxes                          376.4           228.2           148.2
Income taxes                                         52.3            38.2            14.1
Net income                                          324.1           190.0           134.1
Net income attributable to noncontrolling
interest                                             22.2             3.5            18.7
Net income attributable to Principal
Financial Group, Inc.                               301.9           186.5           115.4
Preferred stock dividends                             8.2             8.2               -
Net income available to common
stockholders                                 $      293.7    $      178.3    $      115.4

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

Net Income Available to Common Stockholders

Net income available to common stockholders increased primarily due to higher earnings in all of our segments. In addition, net realized capital gains (losses) improved largely due to foreign currency translation losses on cash held for the Cuprum acquisition in 2013 with no corresponding activity in 2014 and lower credit-related losses.

Total Revenues

Premiums increased $118.2 million for the Retirement and Investor Services segment primarily due to growth in our payout annuity block of business.

Fee revenues increased $66.0 million for the Retirement and Investor Services segment primarily due to higher fees stemming from generally positive equity market performance and growth in the business. In addition, fee revenues increased $27.3 million for the Principal International segment primarily due to the Cuprum acquisition.

Net investment income increased primarily due to higher inflation-based investment returns on average invested assets and cash as a result of higher inflation in Chile coupled with the Cuprum acquisition, which was partially offset by the weakening of the Latin American currencies against the U.S. dollar. For additional information, see "Investments - Investment Results."


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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 gains (losses) improved largely due to foreign currency translation losses on cash held for the Cuprum acquisition in 2013 with no corresponding activity in 2014 and lower credit-related losses. For additional information, see "Investments - Investment Results."

Total Expenses

Benefits, claims and settlement expenses increased $85.6 million for the Retirement and Investor Services segment primarily due to an increase in reserves resulting from growth in our payout annuity block of business. In addition, benefits, claims and settlement expenses increased $22.0 million for the U.S. Insurance Solutions segment primarily due to growth in our specialty benefits insurance business.

Operating expenses increased $37.6 million for the Retirement and Investor Services segment primarily due to an increase in non-deferrable distribution costs and higher sub-advisory fees stemming from positive equity market performance. The increase in segment operating expenses was partially offset by a decrease in staff related costs resulting from lower pension and other postretirement benefits.

Income Taxes

The effective income tax rates were 14% and 17% for the three months ended March 31, 2014 and 2013, respectively. The effective income tax rate for the three months ended March 31, 2014, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, tax credits 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 March 31, 2013, 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 lower tax rates of foreign jurisdictions. The effective income tax rate decreased to 14% from 17% for the three months ended March 31, 2014 and 2013, respectively, primarily due to increased income tax deductions allowed for corporate dividends received and tax credits in 2014.

Results of Operations by Segment

For results of operations by segment see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 10, Segment Information."

Retirement and Investor Services Segment

Retirement and Investor Services Segment Summary Financial Data

Net revenue is a key metric used to understand Retirement and Investor Services ("RIS") earnings growth. Net revenue is defined as operating revenues less benefits, claims and settlement expenses less dividends to policyholders. Net revenue from our Accumulation products is primarily fee based and is impacted by changes in the equity markets. Net revenue from our Guaranteed products is driven by our ability to earn an investment spread. Accumulation net revenue has grown due to improvement in the equity markets as well as growth in the block of business. Guaranteed net revenue has increased due to improving returns on new business as well as an improvement in variable investment income.

The following table presents the RIS net revenue for the periods indicated:

                                             For the three months ended March 31,
                                                                            Increase
                                             2014             2013         (decrease)
                                                         (in millions)
Net revenue:
Accumulation                             $       628.4    $       559.9    $      68.5
Guaranteed                                        54.4             48.7            5.7
Total Retirement and Investor Services   $       682.8    $       608.6    $      74.2


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Retirement and Investor Services Segment Summary Financial Data



The following table presents certain summary financial data relating to the RIS
segment for the periods indicated:



                                               For the three months ended March 31
                                                                             Increase
                                               2014            2013         (decrease)
                                                          (in millions)
Operating revenues:
Premiums and other considerations          $      284.3    $      166.1    $      118.2
Fees and other revenues                           486.5           420.5            66.0
Net investment income                             490.4           515.7           (25.3 )
Total operating revenues                        1,261.2         1,102.3           158.9
Expenses:
Benefits, claims and settlement expenses          578.4           493.7            84.7
Operating expenses                                422.8           394.4            28.4
Total expenses                                  1,001.2           888.1           113.1
Operating earnings before income taxes            260.0           214.2            45.8
Income taxes                                       43.5            44.2            (0.7 )
Operating earnings                         $      216.5    $      170.0    $       46.5

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

Operating Earnings

Operating earnings increased $42.7 million in our Accumulation business primarily due to higher fees stemming from generally positive equity market performance and growth in the business.

Net Revenue

Net revenue increased $68.5 million in our Accumulation business primarily due to higher fees stemming from an increase in average account values, which resulted from generally positive equity market performance, and growth in the business.

Operating Expenses

Operating expenses increased $28.6 million in our Accumulation business primarily due to an increase in non-deferrable distribution costs and higher sub-advisory fees costs stemming from positive equity market performance. The increase in operating expenses was partially offset by a decrease in staff related costs resulting from lower pension and other postretirement benefits.

Income Taxes

The effective income tax rates for the segment were 17% and 21% for the three months ended March 31, 2014 and 2013, respectively. The effective income tax rate for the three months ended March 31, 2014, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, tax credits and the interest exclusion from taxable income. The effective income tax rate for the three months ended March 31, 2013, was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received and the interest exclusion from taxable income. The effective tax rate decreased to 17% from 21% for the three months ended March 31, 2014 and 2013, respectively, primarily due to increased income tax deductions allowed for corporate dividends received and tax credits in 2014.


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Principal Global Investors Segment

Principal Global Investors Segment Summary Financial Data

AUM is a key indicator of earnings growth for our Principal Global Investors segment, as AUM is the base by which we generate revenues. Net cash flow and market performance are the two main drivers of AUM growth. Net cash flow reflects our ability to attract and retain client deposits. Market performance reflects equity, fixed income and real estate market performance. The percentage growth in revenues of the segment will generally track with the percentage growth in AUM. This trend may vary due to changes in business and/or product mix.

The following table presents the AUM rollforward for assets managed by Principal Global Investors for the periods indicated:

                               For the three months ended March 31,
                                    2014                   2013
                                           (in billions)
AUM, beginning of period     $            292.1     $            263.2
Net cash flow                               1.1                    2.3
Investment performance (1)                  5.4                    9.9
Other                                      (0.7 )                 (2.4 )
AUM, end of period           $            297.9     $            273.0
. . .
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