10-Q 1 a13-19451_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 


 

1-16725

(Commission file number)

 

PRINCIPAL FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

42-1520346

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

711 High Street, Des Moines, Iowa 50392

(Address of principal executive offices)

 

(515) 247-5111

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

The total number of shares of the registrant’s Common Stock, $0.01 par value, outstanding as of October 23, 2013, was 294,370,290.

 

 

 



Table of Contents

 

PRINCIPAL FINANCIAL GROUP, INC.

 

TABLE OF CONTENTS

 

 

 

 

Page

Part I - FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

Consolidated Statements of Financial Position at September 30, 2013 (Unaudited) and December 31, 2012

3

 

 

 

 

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012

4

 

 

 

 

Unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012

5

 

 

 

 

Unaudited Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2013 and 2012

6

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012

7

 

 

 

 

Notes to Unaudited Consolidated Financial Statements — September 30, 2013

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

91

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

129

 

 

 

Item 4.

Controls and Procedures

135

 

 

 

Part II — OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

136

 

 

 

Item 1A.

Risk Factors

136

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

137

 

 

 

Item 6.

Exhibits

138

 

 

 

Signature

 

139

 

2


 


Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Principal Financial Group, Inc.

Consolidated Statements of Financial Position

 

 

 

September 30,
2013

 

December 31,
2012

 

 

 

(Unaudited)

 

(As adjusted)

 

 

 

(in millions)

 

Assets

 

 

 

 

 

Fixed maturities, available-for-sale (2013 and 2012 include $243.3 million and $194.6 million related to consolidated variable interest entities)

 

$

48,914.9

 

$

50,939.3

 

Fixed maturities, trading (2013 and 2012 both include $110.4 million related to consolidated variable interest entities)

 

572.9

 

626.7

 

Equity securities, available-for-sale

 

114.0

 

136.5

 

Equity securities, trading

 

666.2

 

252.8

 

Mortgage loans

 

11,868.1

 

11,519.7

 

Real estate

 

1,278.6

 

1,180.3

 

Policy loans

 

859.6

 

864.9

 

Other investments (2013 and 2012 include $72.6 million and $80.3 million related to consolidated variable interest entities and $140.5 million and $113.9 million measured at fair value under the fair value option)

 

2,994.0

 

3,291.1

 

Total investments

 

67,268.3

 

68,811.3

 

Cash and cash equivalents

 

1,707.1

 

4,177.2

 

Accrued investment income

 

571.2

 

584.4

 

Premiums due and other receivables

 

1,160.7

 

1,084.4

 

Deferred acquisition costs

 

3,007.6

 

2,590.0

 

Property and equipment

 

479.1

 

464.2

 

Goodwill

 

1,127.5

 

543.4

 

Other intangibles

 

1,497.4

 

914.7

 

Separate account assets (2013 includes $31,999.2 million related to consolidated variable interest entities)

 

123,800.5

 

81,653.8

 

Other assets

 

1,068.0

 

1,006.8

 

Total assets

 

$

201,687.4

 

$

161,830.2

 

Liabilities

 

 

 

 

 

Contractholder funds

 

$

36,402.7

 

$

37,786.5

 

Future policy benefits and claims

 

22,324.2

 

22,436.2

 

Other policyholder funds

 

753.6

 

716.4

 

Short-term debt

 

175.5

 

40.8

 

Long-term debt

 

2,593.3

 

2,671.3

 

Income taxes currently payable

 

7.9

 

15.3

 

Deferred income taxes

 

634.6

 

600.0

 

Separate account liabilities (2013 includes $31,999.2 million related to consolidated variable interest entities)

 

123,800.5

 

81,653.8

 

Other liabilities (2013 and 2012 include $320.6 million and $302.9 million related to consolidated variable interest entities, of which $102.2 million and $85.0 million are measured at fair value under the fair value option)

 

5,387.2

 

6,146.1

 

Total liabilities

 

192,079.5

 

152,066.4

 

 

 

 

 

 

 

Redeemable noncontrolling interest

 

234.5

 

60.4

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Series A preferred stock, par value $.01 per share with liquidation preference of $100 per share — 3.0 million shares authorized, issued and outstanding in 2013 and 2012

 

 

 

Series B preferred stock, par value $.01 per share with liquidation preference of $25 per share — 10.0 million shares authorized, issued and outstanding in 2013 and 2012

 

0.1

 

0.1

 

Common stock, par value $.01 per share — 2,500.0 million shares authorized, 458.0 million and 453.5 million shares issued, and 293.9 million and 293.8 million shares outstanding in 2013 and 2012

 

4.6

 

4.5

 

Additional paid-in capital

 

9,749.3

 

9,730.9

 

Retained earnings

 

5,249.9

 

4,862.0

 

Accumulated other comprehensive income (loss)

 

(17.7

)

640.3

 

Treasury stock, at cost (164.1 million and 159.7 million shares in 2013 and 2012)

 

(5,707.8

)

(5,554.4

)

Total stockholders’ equity attributable to Principal Financial Group, Inc.

 

9,278.4

 

9,683.4

 

Noncontrolling interest

 

95.0

 

20.0

 

Total stockholders’ equity

 

9,373.4

 

9,703.4

 

Total liabilities and stockholders’ equity

 

$

201,687.4

 

$

161,830.2

 

 

See accompanying notes.

 

3



Table of Contents

 

Principal Financial Group, Inc.

Consolidated Statements of Operations

(Unaudited)

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions, except per share data)

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums and other considerations

 

$

703.0

 

$

1,158.2

 

$

2,134.9

 

$

2,519.3

 

Fees and other revenues

 

803.0

 

675.0

 

2,340.4

 

1,909.1

 

Net investment income

 

784.5

 

783.8

 

2,323.5

 

2,409.6

 

Net realized capital gains (losses), excluding impairment losses on available-for-sale securities

 

(29.7

)

122.1

 

(109.5

)

176.4

 

Total other-than-temporary impairment losses on available-for-sale securities

 

(11.9

)

(43.6

)

(81.2

)

(126.4

)

Other-than-temporary impairment losses on fixed maturities, available-for-sale reclassified to (from) other comprehensive income

 

(9.3

)

9.2

 

8.8

 

31.2

 

Net impairment losses on available-for-sale securities

 

(21.2

)

(34.4

)

(72.4

)

(95.2

)

Net realized capital gains (losses)

 

(50.9

)

87.7

 

(181.9

)

81.2

 

Total revenues

 

2,239.6

 

2,704.7

 

6,616.9

 

6,919.2

 

Expenses

 

 

 

 

 

 

 

 

 

Benefits, claims and settlement expenses

 

1,096.2

 

1,647.0

 

3,286.4

 

3,969.5

 

Dividends to policyholders

 

48.5

 

49.7

 

144.3

 

149.5

 

Operating expenses

 

774.6

 

816.4

 

2,372.1

 

2,101.1

 

Total expenses

 

1,919.3

 

2,513.1

 

5,802.8

 

6,220.1

 

Income before income taxes

 

320.3

 

191.6

 

814.1

 

699.1

 

Income taxes (benefits)

 

61.2

 

(7.2

)

128.4

 

100.4

 

Net income

 

259.1

 

198.8

 

685.7

 

598.7

 

Net income attributable to noncontrolling interest

 

5.2

 

3.4

 

14.7

 

15.3

 

Net income attributable to Principal Financial Group, Inc.

 

253.9

 

195.4

 

671.0

 

583.4

 

Preferred stock dividends

 

8.2

 

8.2

 

24.7

 

24.7

 

Net income available to common stockholders

 

$

245.7

 

$

187.2

 

$

646.3

 

$

558.7

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.83

 

$

0.64

 

$

2.20

 

$

1.87

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.82

 

$

0.63

 

$

2.17

 

$

1.85

 

 

See accompanying notes.

 

4



Table of Contents

 

Principal Financial Group, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

259.1

 

$

198.8

 

$

685.7

 

$

598.7

 

Other comprehensive income (loss), net:

 

 

 

 

 

 

 

 

 

Net unrealized gains (losses) on available-for-sale securities

 

29.3

 

296.0

 

(523.7

)

558.0

 

Noncredit component of impairment losses on fixed maturities, available-for-sale

 

(2.5

)

(4.0

)

(13.1

)

(14.8

)

Net unrealized gains (losses) on derivative instruments

 

(25.1

)

(18.2

)

(3.4

)

27.2

 

Foreign currency translation adjustment

 

(33.5

)

45.4

 

(169.5

)

21.5

 

Net unrecognized postretirement benefit obligation

 

13.8

 

8.7

 

41.4

 

26.2

 

Other comprehensive income (loss)

 

(18.0

)

327.9

 

(668.3

)

618.1

 

Comprehensive income

 

241.1

 

526.7

 

17.4

 

1,216.8

 

Comprehensive income attributable to noncontrolling interest

 

4.4

 

4.2

 

4.4

 

16.3

 

Comprehensive income attributable to Principal Financial Group, Inc.

 

$

236.7

 

$

522.5

 

$

13.0

 

$

1,200.5

 

 

See accompanying notes.

 

5



Table of Contents

 

Principal Financial Group, Inc.

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Series A

 

Series B

 

 

 

Additional

 

 

 

other

 

 

 

 

 

Total

 

 

 

preferred

 

preferred

 

Common

 

paid-in

 

Retained

 

comprehensive

 

Treasury

 

Noncontrolling

 

stockholders’

 

 

 

stock

 

stock

 

stock

 

capital

 

earnings

 

income (loss)

 

stock

 

interest

 

equity

 

 

 

(in millions)

 

Balances at January 1, 2012
(as adjusted)

 

$

 

$

0.1

 

$

4.5

 

$

9,634.7

 

$

4,323.4

 

$

271.4

 

$

(5,281.7

)

$

353.8

 

$

9,306.2

 

Common stock issued

 

 

 

 

24.7

 

 

 

 

 

24.7

 

Stock-based compensation and additional related tax benefits

 

 

 

 

52.8

 

(2.7

)

 

 

 

50.1

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(272.7

)

 

(272.7

)

Dividends to common stockholders

 

 

 

 

 

(169.6

)

 

 

 

(169.6

)

Dividends to preferred stockholders

 

 

 

 

 

(24.7

)

 

 

 

(24.7

)

Distributions to noncontrolling interest

 

 

 

 

 

 

 

 

(8.1

)

(8.1

)

Contributions from noncontrolling interest

 

 

 

 

 

 

 

 

12.1

 

12.1

 

Deconsolidation of certain variable interest entities

 

 

 

 

 

 

 

 

(353.2

)

(353.2

)

Net income (excludes $1.6 million attributable to redeemable noncontrolling interest)

 

 

 

 

 

583.4

 

 

 

13.7

 

597.1

 

Other comprehensive income (excludes $0.9 million attributable to redeemable noncontrolling interest)

 

 

 

 

 

 

617.1

 

 

0.1

 

617.2

 

Balances at September 30, 2012

 

$

 

$

0.1

 

$

4.5

 

$

9,712.2

 

$

4,709.8

 

$

888.5

 

$

(5,554.4

)

$

18.4

 

$

9,779.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2013

 

$

 

$

0.1

 

$

4.5

 

$

9,730.9

 

$

4,862.0

 

$

640.3

 

$

(5,554.4

)

$

20.0

 

$

9,703.4

 

Common stock issued

 

 

 

0.1

 

80.1

 

 

 

 

 

80.2

 

Stock-based compensation and additional related tax benefits

 

 

 

 

54.7

 

(3.4

)

 

 

 

51.3

 

Treasury stock acquired, common

 

 

 

 

 

 

 

(153.4

)

 

(153.4

)

Dividends to common stockholders

 

 

 

 

 

(211.7

)

 

 

 

(211.7

)

Dividends to preferred stockholders

 

 

 

 

 

(24.7

)

 

 

 

(24.7

)

Contributions from noncontrolling interest

 

 

 

 

 

 

 

 

115.7

 

115.7

 

Purchase of subsidiary shares from noncontrolling interest

 

 

 

 

1.8

 

 

 

 

(53.2

)

(51.4

)

Sale of subsidiary shares to noncontrolling interest

 

 

 

 

11.5

 

 

 

 

20.3

 

31.8

 

Adjustments to redemption amount of redeemable noncontrolling interest

 

 

 

 

(129.7

)

(43.3

)

 

 

(6.5

)

(179.5

)

Net income (excludes $9.0 million attributable to redeemable noncontrolling interest)

 

 

 

 

 

671.0

 

 

 

5.7

 

676.7

 

Other comprehensive loss (excludes $(3.3) million attributable to redeemable noncontrolling interest)

 

 

 

 

 

 

(658.0

)

 

(7.0

)

(665.0

)

Balances at September 30, 2013

 

$

 

$

0.1

 

$

4.6

 

$

9,749.3

 

$

5,249.9

 

$

(17.7

)

$

(5,707.8

)

$

95.0

 

$

9,373.4

 

 

See accompanying notes.

 

6



Table of Contents

 

Principal Financial Group, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

For the nine months ended

 

 

 

September 30,

 

 

 

2013

 

2012

 

 

 

(in millions)

 

Operating activities

 

 

 

 

 

Net income

 

$

685.7

 

$

598.7

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Amortization of deferred acquisition costs

 

136.0

 

27.6

 

Additions to deferred acquisition costs

 

(338.5

)

(298.9

)

Accrued investment income

 

13.2

 

0.8

 

Net cash flows for trading securities

 

(40.5

)

135.3

 

Premiums due and other receivables

 

(43.8

)

65.7

 

Contractholder and policyholder liabilities and dividends

 

993.0

 

1,578.8

 

Current and deferred income taxes (benefits)

 

175.6

 

(29.6

)

Net realized capital (gains) losses

 

181.9

 

(81.2

)

Depreciation and amortization expense

 

114.5

 

99.1

 

Mortgage loans held for sale, acquired or originated

 

 

(48.2

)

Mortgage loans held for sale, sold or repaid, net of gain

 

0.2

 

90.1

 

Real estate acquired through operating activities

 

(81.5

)

(25.5

)

Real estate sold through operating activities

 

12.2

 

4.1

 

Stock-based compensation

 

51.7

 

50.2

 

Other

 

(461.8

)

206.7

 

Net adjustments

 

712.2

 

1,775.0

 

Net cash provided by operating activities

 

1,397.9

 

2,373.7

 

Investing activities

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

Purchases

 

(7,012.3

)

(6,467.5

)

Sales

 

1,626.7

 

946.5

 

Maturities

 

5,783.2

 

4,702.7

 

Mortgage loans acquired or originated

 

(2,020.0

)

(1,811.8

)

Mortgage loans sold or repaid

 

1,570.8

 

1,166.7

 

Real estate acquired

 

(59.0

)

(114.8

)

Net purchases of property and equipment

 

(22.7

)

(35.6

)

Purchase of interests in subsidiaries, net of cash acquired

 

(1,268.3

)

(62.5

)

Net change in other investments

 

(31.2

)

(42.9

)

Net cash used in investing activities

 

(1,432.8

)

(1,719.2

)

Financing activities

 

 

 

 

 

Issuance of common stock

 

80.2

 

24.7

 

Acquisition of treasury stock

 

(153.4

)

(272.7

)

Proceeds from financing element derivatives

 

46.7

 

51.6

 

Payments for financing element derivatives

 

(36.9

)

(38.3

)

Excess tax benefits from share-based payment arrangements

 

8.6

 

9.8

 

Purchase of subsidiary shares from noncontrolling interest

 

(51.7

)

 

Sale of subsidiary shares to noncontrolling interest

 

32.1

 

 

Dividends to common stockholders

 

(211.7

)

(169.6

)

Dividends to preferred stockholders

 

(24.7

)

(16.5

)

Issuance of long-term debt

 

24.1

 

602.9

 

Principal repayments of long-term debt

 

(212.2

)

(2.1

)

Net proceeds from (repayments of) short-term borrowings

 

131.6

 

(81.0

)

Investment contract deposits

 

5,270.2

 

4,798.7

 

Investment contract withdrawals

 

(7,055.6

)

(6,126.0

)

Net increase (decrease) in banking operation deposits

 

(276.2

)

14.9

 

Other

 

(6.3

)

(5.8

)

Net cash used in financing activities

 

(2,435.2

)

(1,209.4

)

Net decrease in cash and cash equivalents

 

(2,470.1

)

(554.9

)

Cash and cash equivalents at beginning of period

 

4,177.2

 

2,833.9

 

Cash and cash equivalents at end of period

 

$

1,707.1

 

$

2,279.0

 

 

See accompanying notes.

 

7



Table of Contents

 

Principal Financial Group, Inc.

Notes to Consolidated Financial Statements

September 30, 2013

(Unaudited)

 

1. Nature of Operations and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Principal Financial Group, Inc. (“PFG”), its majority-owned subsidiaries and its consolidated variable interest entities (“VIEs”), have been prepared in conformity with accounting principles generally accepted in the U.S. (“U.S. GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2013, are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2012, included in our Form 10-K for the year ended December 31, 2012, filed with the United States Securities and Exchange Commission (“SEC”). The accompanying consolidated statement of financial position as of December 31, 2012, has been derived from the audited consolidated statement of financial position but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

 

Revisions of Previously Issued Financial Statements

 

In conjunction with our first quarter 2013 acquisition of AFP Cuprum S.A. (“Cuprum”) in Chile, we re-evaluated the accounting treatment for similar products offered in other foreign jurisdictions, including the AFORE retirement accumulation business in Mexico. As a result of this re-evaluation, we have concluded that the AFORE product, which was previously accounted for under Accounting Standards Codification 944, Financial Services — Insurance, should be accounted for as a long-term service contract, consistent with the accounting requirements for our recently acquired retirement accumulation business in Chile. The revision to the accounting treatment for the AFORE product in Mexico resulted in the following changes:

 

(a)                                 Fewer acquisition costs are capitalized. Specifically, we expense as incurred salary and related costs associated with the successful efforts of our proprietary sales force and sales support staff. All direct and incremental costs such as commissions will continue to be deferred.

(b)                                 Deferred costs are amortized on a straight line basis over the expected contract life rather than based on estimated gross profits. The amortization method change also impacts purchased customer intangible assets.

 

We have revised our prior period consolidated financial statements accordinglyThese revisions, inclusive of any other potential adjustments, are not material in any prior period based on an analysis of quantitative and qualitative factors in accordance with SEC Staff Accounting Bulletins 99 and 108, and, as a result, amendment of previously filed periodic reports is not required. Rather, these revisions will be made the next time we file the prior period consolidated financial statements. See our March 31, 2013, Form 10-Q filed with the SEC on May 1, 2013, for historical impacts of this revision.

 

Recent Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance that requires the liability related to certain unrecognized benefits to be offset against a deferred tax asset from operating loss carryforwards. This guidance will be effective for us beginning January 1, 2014, and is not expected to have a material impact on our consolidated financial statements.

 

In June 2013, the FASB issued authoritative guidance that formalizes the definition of an investment company. This guidance will be effective for us beginning January 1, 2014, and is not expected to have a material impact on our consolidated financial statements.

 

In March 2013, the FASB issued authoritative guidance that clarifies how the cumulative translation adjustment (“CTA”) related to a parent’s investment in a foreign entity should be released when certain transactions related to the foreign entity occur. This guidance will be effective prospectively for us beginning January 1, 2014, and is not expected to have a material impact on our consolidated financial statements.

 

In February 2013, the FASB issued authoritative guidance that requires entities to disclose additional information about items reclassified out of accumulated other comprehensive income (“AOCI”). Entities are required to disclose information regarding changes in AOCI balances by component and significant items reclassified out of AOCI by component either on the face of the income statement or as a separate footnote to the financial statements. This guidance was effective for us beginning January 1, 2013,

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

and did not have a material impact on our consolidated financial statements. This guidance did not impact the requirements for reporting of comprehensive income under FASB guidance issued in June 2011, which changed the presentation of comprehensive income in the financial statements. The guidance eliminated the presentation options contained in previous guidance and instead required entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements that show the components of net income and other comprehensive income (“OCI”), including adjustments for items that are reclassified from OCI to net income. The guidance did not change the items that must be reported in OCI or when an item of OCI must be reclassified to net income. This guidance was effective for us on January 1, 2012, and did not have a material impact on our consolidated financial statements. See Note 9, Stockholders’ Equity, for further details.

 

In January 2013 and December 2011, the FASB issued authoritative guidance related to balance sheet offsetting. The 2011 guidance requires disclosures about assets and liabilities that are offset or have the potential to be offset. These disclosures are intended to address differences in the asset and liability offsetting requirements under U.S. GAAP and International Financial Reporting Standards. The 2013 guidance clarified that the disclosure requirements would apply to derivative instruments, including bifurcated embedded derivatives, repurchase and reverse repurchase agreements and securities borrowing and securities lending arrangements that are either offset on the balance sheet or subject to an enforceable master netting arrangement or similar agreement. Both pieces of guidance were effective for us beginning January 1, 2013, with retrospective application required and did not have a material impact on our consolidated financial statements. See Note 4, Investments, for further details.

 

In July 2012, the FASB issued authoritative guidance that amends how indefinite-lived intangible assets are tested for impairment. The amendments provide an option to perform a qualitative assessment to determine whether it is necessary to perform the annual fair value calculation impairment test. This new guidance is effective for our 2013 indefinite-lived intangible asset impairment testing and is not expected to have a material impact on our consolidated financial statements.

 

In December 2011, the FASB issued authoritative guidance that requires a reporting entity to follow the real estate sales guidance when the reporting entity ceases to have a controlling financial interest in a subsidiary that is in-substance real estate as a result of a default on the subsidiary’s nonrecourse debt. This guidance was effective for us on January 1, 2013, and did not have a material impact on our consolidated financial statements.

 

In September 2011, the FASB issued authoritative guidance that amends how goodwill is tested for impairment. The amendments provide an option to perform a qualitative assessment to determine whether it is necessary to perform the annual two-step quantitative goodwill impairment test. This guidance was effective for our 2012 goodwill impairment test and did not have a material impact on our consolidated financial statements.

 

In May 2011, the FASB issued authoritative guidance that clarifies and changes fair value measurement and disclosure requirements. This guidance expands existing disclosure requirements for fair value measurements and makes other amendments but does not require additional fair value measurements. This guidance was effective for us on January 1, 2012, and did not have a material impact on our consolidated financial statements. See Note 10, Fair Value Measurements, for further details.

 

In April 2011, the FASB issued authoritative guidance that modifies the criteria for determining when repurchase agreements would be accounted for as secured borrowings as opposed to sales. The guidance was effective for us on January 1, 2012, for new transfers and modifications to existing transactions and did not have a material impact on our consolidated financial statements.

 

Separate Accounts

 

The separate accounts are legally segregated and are not subject to the claims that arise out of any of our other business. The client, rather than us, directs the investments and bears the investment risk of these funds. The separate account assets represent the fair value of funds that are separately administered by us for contracts with equity, real estate and fixed income investments and are presented as a summary total within the consolidated statements of financial position. An equivalent amount is reported as separate account liabilities, which represent the obligation to return the monies to the client. We receive fees for mortality, withdrawal and expense risks, as well as administrative, maintenance and investment advisory services that are included in the consolidated statements of operations. Net deposits, net investment income and realized and unrealized capital gains and losses of the separate accounts are not reflected in the consolidated statements of operations. Separate account assets and separate account liabilities include certain non-domestic retirement accumulation products where the segregated funds and associated obligation to the client are consolidated within our financial statements. We have determined that summary totals are the most meaningful presentation for these funds.

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

At September 30, 2013 and December 31, 2012, the separate account assets include a separate account valued at $201.1 million and $148.3 million, respectively, which primarily includes shares of our stock that were allocated and issued to eligible participants of qualified employee benefit plans administered by us as part of the policy credits issued under our 2001 demutualization. These shares are included in both basic and diluted earnings per share calculations. In the consolidated statements of financial position, the separate account shares are recorded at fair value and are reported as separate account assets with a corresponding separate account liability to eligible participants of the qualified plan. Changes in fair value of the separate account shares are reflected in both the separate account assets and separate account liabilities and do not impact our results of operations.

 

2. Acquisition

 

On February 4, 2013, we completed the purchase of Cuprum, a premier pension manager in Chile that will grow our ability to offer customers in Chile unmatched pension savings and retirement solutions. Our acquisition agreement required Empresas Penta S.A. and Inversiones Banpenta Limitada to sell their 63% ownership in Cuprum pursuant to a public tender offer that also included the remaining 37% of publicly traded shares. 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 is consolidated within the Principal International segment on a one-month lag.

 

A summary of the fair values of the net assets acquired as of February 4, 2013, based upon current valuation estimates, is as follows (in millions):

 

Assets

 

 

 

Equity securities, available-for-sale

 

$

3.2

 

Equity securities, trading

 

340.5

 

Real estate

 

1.9

 

Other investments

 

24.2

 

Cash and cash equivalents

 

3.5

 

Premiums due and other receivables

 

1.4

 

Property and equipment

 

19.6

 

Goodwill

 

633.3

 

Other intangibles

 

671.3

 

Separate account assets

 

33,919.4

 

Other assets

 

27.3

 

Total assets

 

35,645.6

 

Liabilities

 

 

 

Short-term debt

 

5.0

 

Long-term debt

 

114.6

 

Separate account liabilities

 

33,919.4

 

Other liabilities

 

229.5

 

Total liabilities

 

34,268.5

 

Noncontrolling interest

 

113.6

 

Net assets acquired

 

$

1,263.5

 

 

Of the acquired intangible assets, $633.3 million was assigned to goodwill and is not subject to amortization. The goodwill is largely related to future sales anticipated from our internal workforce and entity-specific revenue synergies that will be generated by combining Cuprum with our existing businesses.

 

Of the remaining acquired intangible assets, $185.2 million was assigned to trade name, which is not subject to amortization, and $486.1 million was assigned to customer relationships, which is subject to amortization over a 15-year useful life.

 

See Note 3, Variable Interest Entities, for further information on Cuprum’s separate account assets and liabilities.

 

The following (unaudited) pro forma consolidated results of operations have been prepared to show the impact of the acquisition of Cuprum as if the acquisition had occurred January 1, 2013, for the three and nine months ended September 30, 2013, and on January 1, 2012, for the three and nine months ended September 30, 2012. This supplemental pro forma information has been prepared for comparative purposes and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

 

 

For the three months ended,

 

For the nine months ended,

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

2,239.6

 

$

2,756.8

 

$

6,666.9

 

$

7,073.6

 

Net income

 

259.1

 

224.1

 

706.4

 

679.8

 

Basic earnings per common share

 

0.83

 

0.76

 

2.40

 

2.28

 

Diluted earnings per common share

 

0.82

 

0.75

 

2.37

 

2.26

 

 

The (unaudited) total revenues and net income of Cuprum included in the consolidated statement of operations from the acquisition date to the period ended September 30, 2013, were as follows:

 

 

 

For the three months ended,

 

For the nine months ended,

 

 

 

September 30, 2013

 

September 30, 2013

 

 

 

(in millions)

 

Total revenues

 

$

44.1

 

$

120.8

 

Net income

 

17.3

 

52.7

 

 

3.  Variable Interest Entities

 

We have relationships with and may have a variable interest in various types of special purpose entities. Following is a discussion of our interest in entities that meet the definition of a VIE. When we are the primary beneficiary, we are required to consolidate the entity in our financial statements. The primary beneficiary of a VIE is defined as the enterprise with (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. On an ongoing basis, we assess whether we are the primary beneficiary of VIEs we have relationships with.

 

Consolidated Variable Interest Entities

 

Grantor Trusts

 

We contributed undated subordinated floating rate notes to three grantor trusts. The trusts separated the cash flows by issuing an interest-only certificate and a residual certificate related to each note contributed. Each interest-only certificate entitles the holder to interest on the stated note for a specified term, while the residual certificate entitles the holder to interest payments subsequent to the term of the interest-only certificate and to all principal payments. We retained the interest-only certificates and the residual certificates were subsequently sold to third parties. We have determined these grantor trusts are VIEs due to insufficient equity to sustain them. We determined we are the primary beneficiary as a result of our contribution of securities into the trusts and our continuing interest in the trusts.

 

Collateralized Private Investment Vehicle

 

We invest in synthetic collateralized debt obligations, collateralized bond obligations, collateralized loan obligations and other collateralized structures, which are VIEs due to insufficient equity to sustain the entities (collectively known as “collateralized private investment vehicles”). The performance of the notes of these structures is primarily linked to a synthetic portfolio by derivatives; each note has a specific loss attachment and detachment point. The notes and related derivatives are collateralized by a pool of permitted investments. The investments are held by a trustee and can only be liquidated to settle obligations of the trusts. These obligations primarily include derivatives and the notes due at maturity or termination of the trusts. We determined we are the primary beneficiary for one of these entities because we act as the investment manager of the underlying portfolio and we have an ownership interest.

 

Commercial Mortgage-Backed Securities

 

In September 2000, we sold commercial mortgage loans to a real estate mortgage investment conduit trust. The trust issued various commercial mortgage-backed securities (“CMBS”) certificates using the cash flows of the underlying commercial mortgages it purchased. This is considered a VIE due to insufficient equity to sustain itself. We have determined we are the primary beneficiary as we retained the special servicing role for the assets within the trust as well as the ownership of the bond class that controls the unilateral kick

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

out rights of the special servicer.

 

Mandatory Retirement Savings

 

As a result of our first quarter 2013 acquisition of Cuprum, we hold an equity interest in mandatory privatized social security funds in which we provide asset management services. We determined that the mandatory privatized social security funds, which include contributors for voluntary pension savings, voluntary non-pension savings and compensation savings accounts, are VIEs. This is because the equity holders as a group lack the power, due to voting rights or similar rights, to direct the activities of the entity that most significantly impact the entity’s economic performance and also because equity investors are protected from below-average market investment returns relative to the industry’s return, due to a regulatory guarantee that we provide. Further we concluded that we are the primary beneficiary through our power to make decisions and our variable interest in the funds. The purpose of the funds, which reside in legally segregated entities, is to provide long-term retirement savings. The obligation to the client is directly related to the assets held in the funds and, as such, we present the assets as separate account assets and the obligation as separate account liabilities within our consolidated statements of financial position.

 

The carrying amounts of our consolidated VIE assets, which can only be used to settle obligations of consolidated VIEs, and liabilities of consolidated VIEs for which creditors do not have recourse are as follows:

 

 

 

 

 

Collateralized

 

 

 

Mandatory

 

 

 

 

 

 

 

private investment

 

 

 

retirement

 

 

 

 

 

Grantor trusts

 

vehicle

 

CMBS

 

savings

 

Total

 

 

 

(in millions)

 

September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

243.3

 

$

 

$

 

$

 

$

243.3

 

Fixed maturities, trading

 

 

110.4

 

 

 

110.4

 

Other investments

 

 

 

72.6

 

 

72.6

 

Accrued investment income

 

0.4

 

 

0.4

 

 

0.8

 

Separate account assets

 

 

 

 

31,999.2

 

31,999.2

 

Total assets

 

$

243.7

 

$

110.4

 

$

73.0

 

$

31,999.2

 

$

32,426.3

 

Deferred income taxes

 

$

1.5

 

$

 

$

 

$

 

$

1.5

 

Separate account liabilities

 

 

 

 

31,999.2

 

31,999.2

 

Other liabilities (1)

 

190.3

 

94.9

 

35.4

 

 

320.6

 

Total liabilities

 

$

191.8

 

$

94.9

 

$

35.4

 

$

31,999.2

 

$

32,321.3

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale

 

$

194.6

 

$

 

$

 

$

 

$

194.6

 

Fixed maturities, trading

 

 

110.4

 

 

 

110.4

 

Other investments

 

 

 

80.3

 

 

80.3

 

Accrued investment income

 

0.5

 

 

0.6

 

 

1.1

 

Total assets

 

$

195.1

 

$

110.4

 

$

80.9

 

$

 

$

386.4

 

Deferred income taxes

 

$

1.8

 

$

 

$

 

$

 

$

1.8

 

Other liabilities (1)

 

152.4

 

104.8

 

45.7

 

 

302.9

 

Total liabilities

 

$

154.2

 

$

104.8

 

$

45.7

 

$

 

$

304.7

 

 


(1)            Grantor trusts contain an embedded derivative of a forecasted transaction to deliver the underlying securities; the collateralized private investment vehicle includes derivative liabilities and an obligation to redeem notes at maturity or termination of the trust; and CMBS includes an obligation to the bondholders.

 

We did not provide financial or other support to investees designated as VIEs for the nine months ended September 30, 2013 and 2012.

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

Unconsolidated Variable Interest Entities

 

Invested Securities

 

We hold a variable interest in a number of VIEs where we are not the primary beneficiary. Our investments in these VIEs are reported in fixed maturities, available-for-sale; fixed maturities, trading and other investments in the consolidated statements of financial position and are described below.

 

VIEs include CMBS, residential mortgage-backed pass-through securities (“RMBS”) and other asset-backed securities (“ABS”). All of these entities were deemed VIEs because the equity within these entities is insufficient to sustain them. We determined we are not the primary beneficiary in any of the entities within these categories of investments. This determination was based primarily on the fact we do not own the class of security that controls the unilateral right to replace the special servicer or equivalent function.

 

As previously discussed, we invest in several types of collateralized private investment vehicles, which are VIEs. These include cash and synthetic structures that we do not manage. We have determined we are not the primary beneficiary of these collateralized private investment vehicles primarily because we do not control the economic performance of the entities and were not involved with the design of the entities.

 

We have invested in various VIE trusts as a debt holder. All of these entities are classified as VIEs due to insufficient equity to sustain them. We have determined we are not the primary beneficiary primarily because we do not control the economic performance of the entities and were not involved with the design of the entities.

 

We have invested in partnerships, some of which are classified as VIEs. The returns of the partnership are in the form of income tax credits and investment income. These entities are classified as VIEs as the general partner does not have an equity investment at risk in the entity. We have determined we are not the primary beneficiary because we are not the general partner, who makes all the significant decisions for the entity.

 

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Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

The carrying value and maximum loss exposure for our unconsolidated VIEs were as follows:

 

 

 

 

 

Maximum exposure to

 

 

 

Asset carrying value

 

loss (1)

 

 

 

(in millions)

 

September 30, 2013

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

Corporate

 

$

500.5

 

$

417.7

 

Residential mortgage-backed pass-through securities

 

2,758.5

 

2,680.0

 

Commercial mortgage-backed securities

 

3,983.5

 

4,076.8

 

Collateralized debt obligations

 

332.3

 

358.5

 

Other debt obligations

 

4,045.1

 

4,040.3

 

Fixed maturities, trading:

 

 

 

 

 

Residential mortgage-backed pass-through securities

 

52.1

 

52.1

 

Commercial mortgage-backed securities

 

1.9

 

1.9

 

Collateralized debt obligations

 

62.5

 

62.5

 

Other debt obligations

 

1.5

 

1.5

 

Other investments:

 

 

 

 

 

Other limited partnership interests

 

126.9

 

126.9

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

Corporate

 

$

523.2

 

$

403.7

 

Residential mortgage-backed pass-through securities

 

3,226.7

 

3,022.7

 

Commercial mortgage-backed securities

 

3,897.4

 

4,094.8

 

Collateralized debt obligations

 

379.2

 

428.8

 

Other debt obligations

 

3,779.2

 

3,756.9

 

Fixed maturities, trading:

 

 

 

 

 

Residential mortgage-backed pass-through securities

 

77.7

 

77.7

 

Commercial mortgage-backed securities

 

2.8

 

2.8

 

Collateralized debt obligations

 

56.4

 

56.4

 

Other debt obligations

 

3.2

 

3.2

 

Other investments:

 

 

 

 

 

Other limited partnership interests

 

136.2

 

136.2

 

 


(1)         Our risk of loss is limited to our initial investment measured at amortized cost for fixed maturities, available-for-sale and other investments. Our risk of loss is limited to our investment measured at fair value for our fixed maturities, trading.

 

Sponsored Investment Funds

 

We are the investment manager for certain money market mutual funds that are deemed to be VIEs. We are not the primary beneficiary of these VIEs since our involvement is limited primarily to being a service provider, and our variable interest does not absorb the majority of the variability of the entities’ net assets. As of September 30, 2013 and December 31, 2012, these VIEs held $1.4 billion and $1.5 billion in total assets, respectively. We have no contractual obligation to contribute to the funds.

 

We provide asset management and other services to certain investment structures that are considered VIEs as we generally earn performance-based management fees. We are not the primary beneficiary of these entities as we do not have the obligation to absorb losses of the entities that could be potentially significant to the VIE or the right to receive benefits from these entities that could be potentially significant.

 

14


 


Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

4.  Investments

 

Fixed Maturities and Equity Securities

 

Fixed maturities include bonds, ABS, redeemable preferred stock and certain nonredeemable preferred stock. Equity securities include mutual funds, common stock, nonredeemable preferred stock and mandatory regulatory required investments. We classify fixed maturities and equity securities as either available-for-sale or trading at the time of the purchase and, accordingly, carry them at fair value. See Note 10, Fair Value Measurements, for methodologies related to the determination of fair value. Unrealized gains and losses related to available-for-sale securities, excluding those in fair value hedging relationships, are reflected in stockholders’ equity, net of adjustments related to deferred acquisition costs (“DAC”), sales inducements, unearned revenue reserves, policyholder liabilities, derivatives in cash flow hedge relationships and applicable income taxes. Unrealized gains and losses related to hedged portions of available-for-sale securities in fair value hedging relationships and mark-to-market adjustments on certain trading securities are reflected in net realized capital gains (losses). We also have a minimal amount of assets within trading securities portfolios that support investment strategies that involve the active and frequent purchase and sale of fixed maturities. In addition, we have assets within the trading securities portfolio that represent mandatory regulatory required investments. Mark-to-market adjustments related to these trading securities are reflected in net investment income.

 

The cost of fixed maturities is adjusted for amortization of premiums and accrual of discounts, both computed using the interest method. The cost of fixed maturities and equity securities classified as available-for-sale is adjusted for declines in value that are other than temporary. Impairments in value deemed to be other than temporary are primarily reported in net income as a component of net realized capital gains (losses), with noncredit impairment losses for certain fixed maturities, available-for-sale reported in OCI. For loan-backed and structured securities, we recognize income using a constant effective yield based on currently anticipated cash flows.

 

The amortized cost, gross unrealized gains and losses, other-than-temporary impairments in AOCI and fair value of fixed maturities and equity securities available-for-sale are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

Gross

 

Gross

 

 

 

temporary

 

 

 

Amortized

 

unrealized

 

unrealized

 

 

 

impairments in

 

 

 

cost

 

gains

 

losses

 

Fair value

 

AOCI (1)

 

 

 

(in millions)

 

September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

741.1

 

$

15.9

 

$

36.4

 

$

720.6

 

$

 

Non-U.S. government and agencies

 

843.1

 

175.3

 

3.8

 

1,014.6

 

 

States and political subdivisions

 

3,557.7

 

129.5

 

70.6

 

3,616.6

 

 

Corporate

 

30,805.8

 

2,021.7

 

383.8

 

32,443.7

 

17.0

 

Residential mortgage-backed pass-through securities

 

2,680.0

 

106.4

 

27.9

 

2,758.5

 

 

Commercial mortgage-backed securities

 

4,076.8

 

188.0

 

281.3

 

3,983.5

 

214.6

 

Collateralized debt obligations

 

358.5

 

7.3

 

33.5

 

332.3

 

0.6

 

Other debt obligations

 

4,040.3

 

51.2

 

46.4

 

4,045.1

 

78.6

 

Total fixed maturities, available-for-sale

 

$

47,103.3

 

$

2,695.3

 

$

883.7

 

$

48,914.9

 

$

310.8

 

Total equity securities, available-for-sale

 

$

116.8

 

$

10.1

 

$

12.9

 

$

114.0

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

911.4

 

$

33.2

 

$

0.3

 

$

944.3

 

$

 

Non-U.S. government and agencies

 

944.9

 

264.3

 

0.9

 

1,208.3

 

 

States and political subdivisions

 

2,940.4

 

241.1

 

2.7

 

3,178.8

 

 

Corporate

 

31,615.4

 

3,029.9

 

319.9

 

34,325.4

 

19.5

 

Residential mortgage-backed pass-through securities

 

3,022.7

 

204.4

 

0.4

 

3,226.7

 

 

Commercial mortgage-backed securities

 

4,094.8

 

241.7

 

439.1

 

3,897.4

 

195.4

 

Collateralized debt obligations

 

428.8

 

7.0

 

56.6

 

379.2

 

4.3

 

Other debt obligations

 

3,756.9

 

73.5

 

51.2

 

3,779.2

 

82.8

 

Total fixed maturities, available-for-sale

 

$

47,715.3

 

$

4,095.1

 

$

871.1

 

$

50,939.3

 

$

302.0

 

Total equity securities, available-for-sale

 

$

132.4

 

$

12.6

 

$

8.5

 

$

136.5

 

 

 

 

15



Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 


(1)         Excludes $145.4 million and $95.0 million as of September 30, 2013 and December 31, 2012, respectively, of net unrealized gains on impaired fixed maturities, available-for-sale related to changes in fair value subsequent to the impairment date, which are included in gross unrealized gains and gross unrealized losses.

 

The amortized cost and fair value of fixed maturities available-for-sale at September 30, 2013, by expected maturity, were as follows:

 

 

 

Amortized cost

 

Fair value

 

 

 

(in millions)

 

Due in one year or less

 

$

2,929.8

 

$

2,973.1

 

Due after one year through five years

 

13,024.2

 

13,658.8

 

Due after five years through ten years

 

8,659.6

 

9,127.7

 

Due after ten years

 

11,334.1

 

12,035.9

 

Subtotal

 

35,947.7

 

37,795.5

 

Mortgage-backed and other asset-backed securities

 

11,155.6

 

11,119.4

 

Total

 

$

47,103.3

 

$

48,914.9

 

 

Actual maturities may differ because borrowers may have the right to call or prepay obligations. Our portfolio is diversified by industry, issuer and asset class. Credit concentrations are managed to established limits.

 

Net Realized Capital Gains and Losses

 

Net realized capital gains and losses on sales of investments are determined on the basis of specific identification. In general, in addition to realized capital gains and losses on investment sales and periodic settlements on derivatives not designated as hedges, we report gains and losses related to the following in net realized capital gains (losses): other-than-temporary impairments of securities and subsequent realized recoveries, mark-to-market adjustments on certain trading securities, mark-to-market adjustments on certain seed money investments, fair value hedge and cash flow hedge ineffectiveness, mark-to-market adjustments on derivatives not designated as hedges, changes in the mortgage loan valuation allowance provision and impairments of real estate held for investment. Investment gains and losses on sales of certain real estate held for sale, which do not meet the criteria for classification as a discontinued operation and mark-to-market adjustments on trading securities that support investment strategies that involve the active and frequent purchase and sale of fixed maturities and on trading securities that represent mandatory required investments are reported as net investment income and are excluded from net realized capital gains (losses). The major components of net realized capital gains (losses) on investments are summarized as follows:

 

 

 

For the three months ended September 30,

 

For the nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions)

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

Gross gains

 

$

5.8

 

$

3.0

 

$

27.6

 

$

22.7

 

Gross losses

 

(18.2

)

(44.1

)

(98.6

)

(131.0

)

Other-than-temporary impairment losses reclassified to (from) OCI

 

(9.3

)

9.2

 

8.8

 

31.2

 

Hedging, net

 

(9.6

)

1.0

 

(99.4

)

7.7

 

Fixed maturities, trading

 

2.1

 

4.7

 

(4.1

)

5.7

 

Equity securities, available-for-sale:

 

 

 

 

 

 

 

 

 

Gross gains

 

0.7

 

0.5

 

0.8

 

0.6

 

Gross losses

 

 

(0.6

)

(0.1

)

(0.6

)

Equity securities, trading

 

0.1

 

(0.1

)

11.6

 

30.6

 

Mortgage loans

 

(3.3

)

(23.3

)

(20.3

)

(44.6

)

Derivatives

 

(34.8

)

(50.5

)

(4.8

)

(20.1

)

Other

 

15.6

 

187.9

 

(3.4

)

179.0

 

Net realized capital gains (losses)

 

$

(50.9

)

$

87.7

 

$

(181.9

)

$

81.2

 

 

16



Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

Proceeds from sales of investments (excluding call and maturity proceeds) in fixed maturities, available-for-sale were $415.7 million and $236.1 million for the three months ended September 30, 2013 and 2012, and $1,516.0 million and $952.2 million for the nine months ended September 30, 2013 and 2012, respectively.

 

Other-Than-Temporary Impairments

 

We have a process in place to identify fixed maturity and equity securities that could potentially have a credit impairment that is other than temporary. This process involves monitoring market events that could impact issuers’ credit ratings, business climate, management changes, litigation and government actions and other similar factors. This process also involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.

 

Each reporting period, all securities are reviewed to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. We consider relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a security is other than temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events; (4) for structured securities, the adequacy of the expected cash flows; (5) for fixed maturities, our intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and (6) for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value. To the extent we determine that a security is deemed to be other than temporarily impaired, an impairment loss is recognized.

 

Impairment losses on equity securities are recognized in net income and are measured as the difference between amortized cost and fair value. The way in which impairment losses on fixed maturities are recognized in the financial statements is dependent on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, we recognize an other-than-temporary impairment in net income for the difference between amortized cost and fair value. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated. We recognize the credit loss portion in net income and the noncredit loss portion in OCI (“bifurcated OTTI”).

 

Total other-than-temporary impairment losses, net of recoveries from the sale of previously impaired securities, were as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions)

 

Fixed maturities, available-for-sale

 

$

(11.9

)

$

(43.5

)

$

(81.1

)

$

(126.3

)

Equity securities, available-for-sale

 

 

(0.1

)

(0.1

)

(0.1

)

Total other-than-temporary impairment losses, net of recoveries from the sale of previously impaired securities

 

(11.9

)

(43.6

)

(81.2

)

(126.4

)

Other-than-temporary impairment losses on fixed maturities, available-for-sale reclassified to (from) OCI (1)

 

(9.3

)

9.2

 

8.8

 

31.2

 

Net impairment losses on available-for-sale securities

 

$

(21.2

)

$

(34.4

)

$

(72.4

)

$

(95.2

)

 


(1)         Represents the net impact of (a) gains resulting from reclassification of noncredit impairment losses for fixed maturities with bifurcated OTTI from net realized capital gains (losses) to OCI and (b) losses resulting from reclassification of previously recognized noncredit impairment losses from OCI to net realized capital gains (losses) for fixed maturities with bifurcated OTTI that had additional credit losses or fixed maturities that previously had bifurcated OTTI that have now been sold or are intended to be sold.

 

17



Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

We estimate the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The ABS cash flow estimates are based on security specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate security cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or liquidations using bond specific facts and circumstances including timing, security interests and loss severity.

 

The following table provides a rollforward of accumulated credit losses for fixed maturities with bifurcated credit losses. The purpose of the table is to provide detail of (1) additions to the bifurcated credit loss amounts recognized in net realized capital gains (losses) during the period and (2) decrements for previously recognized bifurcated credit losses where the loss is no longer bifurcated and/or there has been a positive change in expected cash flows or accretion of the bifurcated credit loss amount.

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in millions)

 

Beginning balance

 

$

(301.5

)

$

(375.5

)

$

(335.2

)

$

(434.8

)

Credit losses for which an other-than-temporary impairment was not previously recognized

 

(4.9

)

(2.2

)

(11.1

)

(19.1

)

Credit losses for which an other-than-temporary impairment was previously recognized

 

(18.9

)

(20.9

)

(54.0

)

(60.8

)

Reduction for credit losses previously recognized on fixed maturities now sold, paid down or intended to be sold

 

14.6

 

32.4

 

83.1

 

146.2

 

Net reduction for positive changes in cash flows expected to be collected and amortization (1)

 

2.7

 

2.8

 

9.2

 

5.1

 

Ending balance

 

$

(308.0

)

$

(363.4

)

$

(308.0

)

$

(363.4

)

 


(1)         Amounts are recognized in net investment income.

 

Gross Unrealized Losses for Fixed Maturities and Equity Securities

 

For fixed maturities and equity securities available-for-sale with unrealized losses, including other-than-temporary impairment losses reported in OCI, the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are summarized as follows:

 

18



Table of Contents

 

Principal Financial Group, Inc.
Notes to Consolidated Financial Statements

September 30, 2013
(Unaudited)

 

 

 

September 30, 2013

 

 

 

Less than

 

Greater than or

 

 

 

 

 

 

 

twelve months

 

equal to twelve months

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

Fair

 

unrealized

 

Fair

 

unrealized

 

Fair

 

unrealized

 

 

 

value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in millions)

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

399.5

 

$

36.4

 

$

 

$

 

$

399.5

 

$

36.4

 

Non-U.S. governments

 

79.6

 

3.7

 

4.3

 

0.1

 

83.9

 

3.8

 

States and political subdivisions

 

1,221.6

 

61.2

 

45.0

 

9.4

 

1,266.6

 

70.6

 

Corporate

 

4,189.8

 

163.3

 

1,369.5

 

220.5

 

5,559.3

 

383.8

 

Residential mortgage-backed pass- through securities

 

795.6

 

27.8

 

3.0

 

0.1

 

798.6

 

27.9

 

Commercial mortgage-backed securities

 

563.2

 

12.9

 

543.2

 

268.4

 

1,106.4

 

281.3

 

Collateralized debt obligations

 

53.2

 

0.6

 

47.3

 

32.9

 

100.5

 

33.5

 

Other debt obligations

 

1,273.2

 

16.8

 

252.0

 

29.6

 

1,525.2

 

46.4

 

Total fixed maturities, available-for-sale

 

$

8,575.7

 

$

322.7

 

$

2,264.3

 

$

561.0

 

$

10,840.0

 

$

883.7

 

Total equity securities, available-for-sale

 

$

27.3

 

$

0.1

 

$

48.5

 

$

12.8

 

$

75.8

 

$

12.9

 

 

Of the total amounts, Principal Life Insurance Company’s (“Principal Life”) consolidated portfolio represented $10,197.8 million in available-for-sale fixed maturities with gross unrealized losses of $827.8 million. Of those fixed maturity securities in Principal Life’s consolidated portfolio with a gross unrealized loss position, 84% were investment grade (rated AAA through BBB-) with an average price of 92 (carrying value/amortized cost) at September 30, 2013. Gross unrealized losses in our fixed maturities portfolio increased slightly during the nine months ended September 30, 2013, due to an increase in interest rates.

 

For those securities that had been in a continuous unrealized loss position for less than twelve months, Principal Life’s consolidated portfolio held 1,102 securities with a carrying value of $8,186.9 million and unrealized losses of $305.8 million reflecting an average price of 96 at