The following analysis discusses our financial condition as of June 30, 2012,
compared with December 31, 2011, and our consolidated results of operations for
the three and six months ended June 30, 2012 and 2011, 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, 2011, filed
with the SEC and the unaudited consolidated financial statements and the related
notes to the financial statements and the other financial information included
elsewhere in this Form 10-Q.
Forward-Looking Information
Our narrative analysis below contains forward-looking statements intended to
enhance the reader's ability to assess our future financial performance.
Forward-looking statements include, but are not limited to, statements that
represent our beliefs concerning future operations, strategies, financial
results or other developments, and contain words and phrases such as
"anticipate," "believe," "plan," "estimate," "expect," "intend" and similar
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects on us. Such forward-looking statements are not guarantees of future
performance.
Actual results may differ materially from those included in the forward-looking
statements as a result of risks and uncertainties including, but not limited to,
the following: (1) adverse capital and credit market conditions may
significantly affect our ability to meet liquidity needs, as well as our access
to capital and cost of capital; (2) continued difficult conditions in the global
capital markets and the economy generally may materially and adversely affect
our business and results of operations; (3) continued volatility or further
declines in the equity markets could reduce our assets under management ("AUM")
and may result in investors withdrawing from the markets or decreasing their
rates of investment, all of which could reduce our revenues and net income;
(4) changes in interest rates or credit spreads may adversely affect our results
of operations, financial condition and liquidity, and our net income can vary
from period-to-period; (5) our investment portfolio is subject to several risks
that may diminish the value of our invested assets and the investment returns
credited to customers, which could reduce our sales, revenues, AUM and net
income; (6) our valuation of fixed maturities and equity securities 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) gross unrealized losses may be realized or result in
future impairments, resulting in a reduction in our net income; (9) 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; (10) 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; (11) our efforts to reduce the impact of interest rate
changes on our profitability and retained earnings may not be effective; (12) if
we are unable to attract and retain sales representatives and develop new
distribution sources, sales of our products and services may be reduced; (13)
our international businesses face political, legal, operational and other risks
that could reduce our profitability in those businesses; (14) we may face losses
if our actual experience differs significantly from our pricing and reserving
assumptions; (15) our ability to pay stockholder dividends and meet our
obligations may be constrained by the limitations on dividends or distributions
Iowa insurance laws impose on Principal Life; (16) the pattern of amortizing our
DPAC 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 asset and the timing of
our net income; (17) we may need to fund deficiencies in our "Closed Block"
assets that support participating ordinary life insurance policies that had a
dividend scale in force at the time of Principal Life's 1998 conversion into a
stock life insurance company; (18) a pandemic, terrorist attack or other
catastrophic event could adversely affect our net income; (19) our reinsurers
could default on their obligations or increase their rates, which could
adversely impact our net income and profitability; (20) we face risks arising
from acquisitions of businesses; (21) changes in laws, regulations or accounting
standards may reduce our profitability; (22) 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; (23) a computer system failure or security
breach could disrupt our business, damage our reputation and adversely impact
our profitability; (24) results of litigation and regulatory investigations may
affect our financial strength or reduce our profitability; (25) 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; (26) fluctuations in foreign currency exchange rates could
reduce our profitability; (27) applicable laws and our certificate of
incorporation and by-laws may discourage takeovers and business combinations
that some stockholders might consider in their best interests and (28) our
financial results may be adversely impacted by global climate changes.
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Overview
We provide financial products and services through the following reportable
segments:
† Retirement and Investor Services, which consists of our asset
accumulation operations that provide retirement savings and related investment
products and services. We provide a comprehensive portfolio of asset
accumulation products and services to businesses and individuals in the U.S.,
with a concentration on small and medium-sized businesses. We offer to
businesses products and services for defined contribution pension plans,
including 401(k) and 403(b) plans, defined benefit pension plans, nonqualified
executive benefit plans and employee stock ownership plan consulting services.
We also offer annuities, mutual funds and bank products and services to the
employees of our business customers and other individuals.
† Principal Global Investors, which consists of our asset management
operations, manages assets for sophisticated investors around the world, using a
multi-boutique strategy that enables the segment to provide an expanded range of
diverse investment capabilities including equity, fixed income and real estate
investments. Principal Global Investors also has experience in currency
management, asset allocation, stable value management and other structured
investment strategies.
† Principal International, which offers retirement products and
services, annuities, mutual funds, institutional asset management and life
insurance accumulation products through operations in Brazil, Chile, China, Hong
Kong SAR, India, Mexico and Southeast Asia.
† U.S. Insurance Solutions, which provides individual life insurance as
well as specialty benefits in the U.S. Our individual life insurance products
include universal and variable universal life insurance and traditional life
insurance. Our specialty benefit products include group dental and vision
insurance, individual and group disability insurance, group life insurance,
wellness services and non-medical fee-for-service claims administration.
† Corporate, which manages the assets representing capital that has not
been allocated to any other segment. Financial results of the Corporate segment
primarily reflect our financing activities (including interest expense and
preferred stock dividends), income on capital not allocated to other segments,
inter-segment eliminations, income tax risks and certain income, expenses and
other after-tax adjustments not allocated to the segments based on the nature of
such items.
Critical Accounting Policies and Estimates
Deferred Policy Acquisition Costs and Other Actuarial Balances
Incremental direct costs of contract acquisition as well as certain costs
directly related to acquisition activities (underwriting, policy issuance and
processing, medical and inspection and sales force contract selling) for the
successful acquisition of new and renewal insurance policies and investment
contract business are capitalized to the extent recoverable. Maintenance costs
and acquisition costs that are not deferrable are charged to net income as
incurred.
Amortization Based on Estimated Gross Profits. DPAC for universal life-type
insurance contracts, participating life insurance policies and certain
investment contracts are amortized over the expected lifetime of the policies in
relation to EGPs. In addition to DPAC, the following actuarial balances are also
amortized in relation to EGPs.
† Sales inducement asset - Sales inducements are amounts that are
credited to the contractholder's account balance as an inducement to purchase
the contract. Like DPAC, the cost of the sales inducement is capitalized and
amortized over the expected life of the contract, in proportion to EGPs.
† Unearned revenue liability - An unearned revenue liability is
established when we collect fees or other policyholder assessments that
represent compensation for services to be provided in future periods. These
revenues are deferred and then amortized over the expected life of the contract,
in proportion to EGPs.
† Reinsurance asset or liability - For universal-life type products
that are reinsured, a reinsurance asset or liability is established to spread
the expected net reinsurance costs or profits in proportion to the EGPs on the
underlying business.
† Present value of future profits (''PVFP'') - This is an intangible
asset that arises in connection with the acquisition of a life insurance company
or a block of insurance business. PVFP for universal life-type insurance
contracts, participating life insurance policies and certain investment
contracts is amortized over the expected life of the contracts acquired, in
proportion to EGPs.
We also have additional benefit reserves that are established for annuity or
universal life-type contracts that provide benefit guarantees, or for contracts
that are expected to produce profits followed by losses. The liabilities are
accrued in relation to estimated contract assessments.
We define EGPs to include assumptions relating to mortality, morbidity, lapses,
investment yield and expenses as well as the change in our liability for certain
guarantees and the difference between actual and expected reinsurance premiums
and recoveries,
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depending on the nature of the contract. We develop an estimate of EGPs at issue
and each valuation date. As actual experience emerges, the gross profits may
vary from those expected either in magnitude or timing, in which case a true-up
to actual occurs as a charge or credit to current net income. In addition, we
are required to revise our assumptions regarding future experience if actual
experience or other evidence suggests that earlier estimates should be revised.
Both actions, reflecting actual experience and changing future estimates, can
change both the current amount and the future amortization pattern of the DPAC
asset and related actuarial balances.
For individual variable life insurance, individual variable annuities and group
annuities that have separate account U.S. equity investment options, we utilize
a mean reversion methodology (reversion to the mean assumption), a common
industry practice, to determine the future domestic equity market growth rate
assumption used for the calculation of EGPs. If actual annualized U.S. equity
market performance varies from our 8% long-term assumption, we assume different
performance levels in the short-term such that the mean return is equal to the
long-term assumption over the mean reversion period. However, our mean reversion
process generally limits assumed returns to a range of 4-12% during the mean
reversion period. The 12% cap was reached during the third quarter of 2008, and
the mean reversion rate has remained at the 12% cap since then. Therefore, until
the mean reversion rate falls below the 12% cap, we will not adjust the equity
return assumption by the amount needed to result in a mean return equal to the
long-term assumption.
In limited circumstances, DPAC and certain of the actuarial balances noted above
are amortized in proportion to estimated gross revenues rather than EGPs.
Estimated gross revenues include similar assumptions as EGPs and the changes of
future estimates and reflection of actual experience is done in the same manner
as EGPs discussed above.
Amortization Based on Premium-Paying Period. DPAC of non-participating term life
insurance and individual disability policies are amortized over the
premium-paying period of the related policies using assumptions consistent with
those used in computing policyholder liabilities. Once these assumptions are
made for a given policy or group of policies, they will not be changed over the
life of the policy unless a loss recognition event occurs. As of March 31, 2012,
these policies accounted for 13% of our total DPAC balance.
Internal Replacements. We review policies for modifications that result in the
exchange of an existing contract for a new contract. If the new contract is
determined to be an internal replacement that is substantially changed from the
replaced contract, any unamortized DPAC and related actuarial balances are
written off and acquisition costs related to the new contract are capitalized as
appropriate. If the new contract is substantially unchanged, we continue to
amortize the existing DPAC and related actuarial balances.
Recoverability. DPAC and sales inducement assets are subject to recoverability
testing at the time of policy issue and loss recognition testing on an annual
basis, or when an event occurs that may warrant loss recognition. Likewise, PVFP
is subject to impairment testing on an annual basis, or when an event occurs
that may warrant impairment. If loss recognition or impairment is necessary, the
asset balances are written off to the extent that it is determined that future
policy premiums and investment income or gross profits are not adequate to cover
related losses and expenses.
Sensitivities. We perform sensitivity analyses to assess the impact that certain
assumptions have on our DPAC and related actuarial balances. The following table
shows the estimated immediate impact of various assumption changes on our DPAC
and related actuarial balances as of March 31, 2012. The net balance of DPAC and
related actuarial balances, excluding balances affected by changes in other
comprehensive income, was a $2,508.2 million asset.
Estimated impact to
net income (1)
(in millions)
Reducing the future equity return assumption by 1% $ (5 )
Reducing the long-term general account net investment returns
assumption by 0.5% (2)
(45 )
A one-time, 10% drop in equity market values (13 )
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(1) Reflects the net impact of changes to the DPAC asset, sales inducement
asset, unearned revenue liability, reinsurance sset or liability, PVFP and
additional benefit reserves. Includes the impact on net income of changes in
DPAC and related balances for our equity method subsidiaries. The DPAC and
related balances of the equity method subsidiaries are not included in the total
DPAC balance listed above as they are not fully consolidated.
(2) Net investment return represents net investment income plus net realized
capital gains (losses).
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Recent Event
Catalyst Health Solutions, Inc.
In July 2012, Catalyst Health Solutions, Inc. merged with a wholly-owned
subsidiary of SXC Health Solutions Corp. As a shareholder of Catalyst Health
Solutions, Inc., we realized an after-tax gain of approximately $126.0 million.
The gain will be reported as a net realized capital gain in the third quarter of
2012.
Transactions Affecting Comparability of Results of Operations
Acquisitions
We entered into acquisition agreements for the following businesses during 2012
and 2011.
Claritas Administração de Recursos Ltda./Claritas Investments, Ltd. On April 2,
2012, we finalized the purchase of a 60% indirect ownership in Claritas
Administração de Recursos Ltda./Claritas Investments, Ltd. ("Claritas"), a
leading Brazilian mutual fund and asset management company. The Sao Paulo-based
company manages equity funds, balanced funds, managed accounts and other
strategies for affluent clients and institutions through its multi-channel
distribution network. Claritas had $1.8 billion in AUM at the time of
acquisition and is consolidated within the Principal International segment.
Origin Asset Management LLP. On October 3, 2011, we finalized the purchase of a
74% interest in Origin Asset Management LLP ("Origin"), a global equity
specialist based in London. The initial payment was $63.6 million. Origin had
$2.6 billion in AUM in global and international equities at the time of the
acquisition and is consolidated within the Principal Global Investors segment.
HSBC AFORE, S.A. de C.V. On August 8, 2011, we finalized the purchase of our
100% interest in HSBC AFORE, S.A. de C.V. ("HSBC AFORE"), a Mexican pension
business, from HSBC Bank for $206.1 million. In addition, we and HSBC Bank have
established a distribution arrangement for the distribution of Principal AFORE's
products through HSBC Bank's extensive network in Mexico. HSBC AFORE was merged
into our Principal AFORE pension company, which is consolidated within the
Principal International segment.
Finisterre Capital LLP and Finisterre Holdings Limited. On July 1, 2011, we
finalized the purchase of a 51% interest in Finisterre Capital LLP and
Finisterre Holdings Limited, (together "Finisterre Capital"), an emerging
markets debt investor based in London. The initial payment was $84.6 million,
with a possible additional contingent payment of up to $30.0 million in 2013,
dependent upon performance targets. Finisterre Capital had $1.7 billion in AUM
at the time of acquisition and is accounted for on the equity method within the
Principal Global Investors segment.
Other
Individual Life Insurance Amortization. During the first quarter of 2012, our
individual life insurance business changed its basis for amortizing DPAC and
other actuarial balances on a portion of our universal life insurance products.
The actuarial balances for these products are now amortized based on estimated
gross revenues instead of EGPs. This change required an unlocking of the
actuarial balances to reflect the pattern of estimated gross revenues, which
resulted in volatility within certain income statement line items. Specifically,
fee revenues decreased $46.6 million; benefits, claims and settlement expenses
increased $87.9 million; and operating expenses decreased $139.6 million.
However, on a net basis the impact was a net gain of $3.3 million after-tax,
which is not material.
Individual Life Insurance Assumption Changes. During the second quarter of 2011,
we updated premium assumptions in our individual life insurance business, which
impacts comparability between reported time periods. Specifically, fee revenues
increased $4.9 million; benefits, claims and settlement expenses increased $43.1
million; and operating expenses increased $14.9 million. Given the large
magnitude of the assumption changes, we removed the after-tax impact of $(34.5)
million from operating earnings and reported it as an other after-tax adjustment
in order to aid in comparability at the segment level.
Catalyst Health Solutions, Inc. In early April 2011, we sold a portion of our
interest in Catalyst Health Solutions, Inc., which is accounted for on the
equity method. The $46.0 million after-tax gain was reported as a net realized
capital gain in the second quarter of 2011. The remaining portion of the
investment continued to be accounted for as an equity method investment.
Group Medical Insurance Business. On September 30, 2010, we announced our
decision to exit the group medical insurance business (insured and
administrative services only) and entered into an agreement with United
Healthcare Services, Inc. to renew group medical insurance coverage for our
customers as the business transitions. The exiting of the group medical
insurance business
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does not yet qualify for discontinued operations treatment under U.S. GAAP.
Therefore, the results of operations for the group medical insurance business
are still included in our consolidated income from continuing operations.
With the exception of corporate overhead, amounts related to our group medical
insurance business previously included in segment operating earnings have been
removed from operating earnings for all periods presented and are reported as
other after-tax adjustments. The operating revenues associated with our exited
group medical insurance business were $4.0 million and $180.8 million for the
three months ended June 30, 2012 and 2011, respectively, and $22.9 million and
$435.7 million for the six months ended June 30, 2012 and 2011, respectively.
The other after-tax adjustments associated with the after-tax earnings (loss) of
our exited group medical insurance business were $(4.0) million and $18.8
million for the three months ended June 30, 2012 and 2011, respectively, and
$(5.5) million and $35.9 million for the six months ended June 30, 2012 and
2011, respectively.
Fluctuations in Foreign Currency to U.S. Dollar Exchange Rates
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in
which we have operations can affect reported financial results. In years when
foreign currencies weaken against the U.S. dollar, translating foreign
currencies into U.S. dollars results in fewer U.S. dollars to be reported. When
foreign currencies strengthen, translating foreign currencies into U.S. dollars
results in more U.S. dollars to be reported.
Foreign currency exchange rate fluctuations create variances in our financial
statement line items but have not had a material impact on our consolidated
financial results. Principal International segment operating earnings were
negatively impacted by $6.4 million and $8.4 million for the three and six
months ended June 30, 2012, 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 2012 annual defined benefit pension expense for substantially all of our
employees and certain agents is expected to be $122.1 million pre-tax, which is
a $29.4 million increase from the 2011 pre-tax pension expense of $92.7 million.
This increase is primarily due to a decrease in the discount rates as of
December 31, 2011, increasing the service cost, interest cost, and gain/loss
amortization. Pre-tax pension expense of $30.8 million and $61.5 million was
reflected in the determination of net income for the three and six months ended
June 30, 2012, respectively. The expected long-term return on plan assets used
to develop the 2012 expense remained at the same 8.00% used to develop the 2011
expense. The discount rate as of December 31, 2011, used to develop the 2012
expense decreased to 5.15%, down from the 5.65% as of December 31, 2010, 5.80%
as of March 31, 2011, 5.70% as of June 30, 2011, and 5.25% as of September 30,
2011.
The 2012 annual other postretirement employee benefit ("OPEB") plan expense
(income) for retired employees is expected to be $(55.9) million pre-tax, which
is a $2.1 million decrease from the 2011 pre-tax OPEB plan income of $(58.0)
million. This decrease in income is primarily due to a reduction in the prior
service credit to be recognized. The 2011 expense included $(5.1) million in
one-time credits due to the curtailment from the group medical insurance
business exit. Pre-tax (income) of $(13.0) million and $(25.9) million was
reflected in the determination of net income for the three and six months ended
June 30, 2012, respectively. The expected long-term return on plan assets used
to develop the expense (income) in 2012 remained at the same 7.30% used to
develop the 2011 expense. The discount rate as of December 31, 2011, used to
develop the 2012 expense (income) decreased to 5.15%, down from the 5.65% as of
December 31, 2010, 5.80% as of March 31, 2011, 5.70% as of June 30, 2011 and
5.25% as of September 30, 2011.
Recent Accounting Changes
For recent accounting changes, see Item 1. "Financial Statements, Notes to
Unaudited Consolidated Financial Statements, Note 1, Nature of Operations and
Significant Accounting Policies" under the captions, "Accounting Changes" and
"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 June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Revenues:
Premiums and other
considerations $ 681.3 $ 751.9 $ (70.6 ) $ 1,361.1$ 1,549.0 $ (187.9 )
Fees and other revenues
636.1 633.2
2.9 1,234.1 1,256.2 (22.1 )
Net investment income
801.0 873.6 (72.6 ) 1,625.8 1,733.4 (107.6 )
Net realized capital gains,
excluding impairment losses on
available-for-sale securities 32.2 88.3 (56.1 ) 54.3 82.7 (28.4 )
Total other-than-temporary
impairment losses on
available-for-sale securities (49.1 ) (40.9 ) (8.2 ) (82.8 ) (54.9 ) (27.9 )
Other-than-temporary impairment
losses on fixed maturities,
available-for-sale reclassified
to (from) other comprehensive
income 17.1 (9.7 ) 26.8 22.0 (48.1 ) 70.1
Net impairment losses on
available-for-sale securities (32.0 ) (50.6 ) 18.6 (60.8 ) (103.0 ) 42.2
Net realized capital gains
(losses) 0.2 37.7 (37.5 ) (6.5 ) (20.3 ) 13.8
Total revenues 2,118.6 2,296.4 (177.8 ) 4,214.5 4,518.3 (303.8 )
Expenses:
Benefits, claims and settlement
expenses 1,110.0 1,193.9 (83.9 ) 2,322.5 2,382.8 (60.3 )
Dividends to policyholders 49.5 52.9 (3.4 ) 99.8 106.5 (6.7 )
Operating expenses 724.1 739.4 (15.3 ) 1,280.1 1,457.3 (177.2 )
Total expenses 1,883.6 1,986.2 (102.6 ) 3,702.4 3,946.6 (244.2 )
Income before income taxes 235.0 310.2 (75.2 ) 512.1 571.7 (59.6 )
Income taxes 50.9 61.0 (10.1 ) 109.1 113.7 (4.6 )
Net income 184.1 249.2 (65.1 ) 403.0 458.0 (55.0 )
Net income attributable to
noncontrolling interest 2.7 23.6 (20.9 ) 11.9 42.2 (30.3 )
Net income attributable to
Principal Financial Group, Inc. 181.4 225.6 (44.2 ) 391.1 415.8 (24.7 )
Preferred stock dividends 8.3 8.3 - 16.5 16.5 -
Net income available to common
stockholders $ 173.1 $ 217.3 $ (44.2 ) $ 374.6 $ 399.3 $ (24.7 )
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Net Income Available to Common Stockholders
Net income available to common stockholders decreased primarily due to a $46.0
million after-tax gain associated with the sale of a portion of our interest in
Catalyst Health Solutions, Inc. in the second quarter of 2011 with no
corresponding activity in the second quarter of 2012.
Total Revenues
Premiums decreased $157.7 million for the Corporate segment primarily due to a
reduction in average covered medical members in our exited group medical
insurance business. Partially offsetting this decrease was a $70.2 million
increase in Retirement and Investor Services segment premiums primarily due to
an increase in sales of single premium group annuities with life contingencies
in our full service payout business.
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Net investment income decreased primarily due to lower investment yields in our
U.S. operations and lower inflation-based investment returns on average invested
assets and cash as a result of lower inflation in Chile. For additional
information, see "Investments - Investment Results."
Net realized capital gains (losses) can be volatile due to other-than-temporary
impairments of invested assets, mark-to-market adjustments of certain invested
assets and our decision to sell invested assets. Net realized capital gains
decreased primarily due to a gain in the second quarter of 2011 associated with
the sale of a portion of our interest in Catalyst Health Solutions, Inc. and
equity market losses versus gains, which were partially offset by gains versus
losses on the GMWB embedded derivative and related hedging instruments. For
additional information, see "Investments - Investment Results."
Total Expenses
Benefits, claims and settlement expenses decreased $119.2 million for the
Corporate segment primarily due to a reduction in average covered medical
members in our exited group medical insurance business. In addition, U.S.
Insurance Solutions segment benefits, claims and settlement expenses decreased
$37.6 million primarily due to updated premium assumptions in our individual
life insurance business in second quarter of 2011. Principal International
segment benefits, claims and settlement expenses also decreased $27.4 million
primarily due to lower inflation-based interest crediting rates to customers and
the weakening of the Chilean peso against the U.S. dollar. Partially offsetting
these decreases was a $100.3 million increase in benefits, claims and settlement
expenses for the Retirement and Investor Services segment primarily due to an
increase in change in reserves resulting from an increase in sales of single
premium group annuities with life contingencies in our full service payout
business.
Operating expenses decreased $67.5 million for the Corporate segment primarily
due to a prior year contribution made to The Principal Financial Group
Foundation, Inc. and a reduction in corporate overhead expenses needed to
support the exited group medical insurance business. Partially offsetting this
decrease was a $30.7 million increase for the Retirement and Investor Services
segment primarily due to higher staff related costs, including pension and other
postretirement benefits. In addition, Principal Global Investors segment
operating expenses increased $8.8 million primarily due to higher compensation
and operating costs resulting from continued investment in the global business
model and other one-time costs during the period. Principal International
segment operating expenses also increased $8.5 million primarily due to
transaction costs related to the Claritas acquisition in Brazil and higher
compensation costs across the segment.
Income Taxes
The effective income tax rates were 22% and 20% for the three months ended
June 30, 2012 and 2011, respectively. The effective income tax rate for the
three months ended June 30, 2012, was lower than the U.S. statutory rate
primarily due to income tax deductions allowed for corporate dividends received,
the presentation of taxes on our share of earnings generated from equity method
investments in net investment income and the interest exclusion from taxable
income. The effective income tax rate for the three months ended June 30, 2011,
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 in net investment income
and the inclusion of income attributable to noncontrolling interest in income
before income taxes with no corresponding change in income taxes reported by us
as the controlling interest.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Net Income Available to Common Stockholders
Net income available to common stockholders decreased primarily due to a $46.0
million after-tax gain associated with the sale of a portion of our interest in
Catalyst Health Solutions, Inc. in the second quarter of 2011 with no
corresponding activity through the first six months of 2012, which was partially
offset by lower other-than-temporary impairments on fixed maturities,
available-for-sale.
Total Revenues
Premiums decreased $382.9 million for the Corporate segment primarily due to a
reduction in average covered medical members in our exited group medical
insurance business. Partially offsetting this decrease was a $149.9 million
increase in Retirement and Investor Services segment premiums primarily due to
an increase in sales of single premium group annuities with life contingencies
in our full service payout business.
Fees decreased $36.5 million for our U.S. Insurance Solutions segment primarily
due to unlocking of unearned revenue associated with the change in basis for
amortizing DPAC and other actuarial balances in the first quarter of 2012 offset
by growth in the universal life and variable universal life lines of business.
In addition, fees decreased $35.6 million for our Corporate segment primarily
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due to a reduction in average fee-for-service members in our exited group
medical insurance business. Partially offsetting these decreases was a $25.2
million increase in fees for our Principal International segment primarily due
to higher investment management fees driven by higher average AUM in Mexico as a
result of the HSBC AFORE acquisition. In addition, fees for our Principal Global
Investors segment increased $18.9 million primarily due to an increase in
average AUM and higher real estate transaction fees resulting from higher
transaction volumes.
Net investment income decreased primarily due to lower investment yields in our
U.S. operations. For additional information, see "Investments - Investment
Results."
Net realized capital gains (losses) can be volatile due to other-than-temporary
impairments of invested assets, mark-to-market adjustments of certain invested
assets and our decision to sell invested assets. Net realized capital losses
decreased primarily due to gains on the GMWB embedded derivative and related
hedging instruments and lower other-than-temporary impairments on fixed
maturities, available-for-sale, which were partially offset by a gain associated
with the sale of a portion of our interest in Catalyst Health Solutions, Inc.in
2011 with no corresponding activity in 2012. For additional information, see
"Investments - Investment Results."
Total Expenses
Benefits, claims and settlement expenses decreased $292.7 million for the
Corporate segment primarily due to a reduction in average covered medical
members in our exited group medical insurance business. Partially offsetting
this decrease was a $142.8 million increase in benefits, claims and settlement
expenses for the Retirement and Investor Services segment primarily due to an
increase in change in reserves resulting from an increase in sales of single
premium group annuities with life contingencies in our full service payout
business. In addition, benefits, claims and settlement expenses for our U.S.
Insurance Solutions segment increased $78.5 million primarily due to unlocking
associated with the change in basis for amortizing DPAC and other actuarial
balances in the first quarter of 2012.
U.S. Insurance Solutions operating expenses decreased $140.2 million primarily
due to unlocking associated with the change in basis for amortizing DPAC and
other actuarial balances in the first quarter of 2012. In addition, operating
expenses for our Corporate segment decreased $106.7 million primarily due to a
reduction in corporate overhead expenses needed to support the exited group
medical insurance business and a prior year contribution made to The Principal
Financial Group Foundation, Inc. Partially offsetting these decreases was a
$34.6 million increase in operating expenses for our Retirement and Investor
Services segment primarily due to higher staff related costs, including pension
and other postretirement benefits.
Income Taxes
The effective income tax rates were 21% and 20% for the six months ended
June 30, 2012 and 2011, respectively. The effective income tax rate for the six
months ended June 30, 2012, was lower than the U.S. statutory rate primarily due
to income tax deductions allowed for corporate dividends received, the
presentation of taxes on our share of earnings generated from equity method
investments in net investment income and the interest exclusion from taxable
income. The effective income tax rate for the six months ended June 30, 2011,
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 in net investment income
and the inclusion of income attributable to noncontrolling interest in income
before income taxes with no corresponding change in income taxes reported by us
as the controlling interest.
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
Growth in earnings of the segment should generally track with, yet will
typically be less than, the percentage growth in account values. This trend may
vary due to changes in business and/or product mix. Net cash flow and market
performance are the two main drivers of account value growth. Net cash flow
reflects the segment's ability to attract and retain client deposits. Market
performance reflects not only the equity market performance, but also the
investment performance of fixed income investments supporting our spread
business.
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The following table presents the Retirement and Investor Services account value
rollforward for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
2012 2011 2012 2011
(in billions)
Account values, beginning of period $ 197.9 $ 184.6 $ 183.3 $ 178.3
Net cash flow 2.4 1.2 4.9 1.5
Credited investment performance (2.5 ) 1.4 9.8 7.4
Other - (0.1 ) (0.2 ) (0.1 )
Account values, end of period $ 197.8 $ 187.1 $ 197.8 $ 187.1
The following table presents certain summary financial data relating to the
Retirement and Investor Services segment for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Operating revenues:
Premiums and other
considerations $ 173.2 $ 103.0 $ 70.2 $ 326.7 $ 176.8 $ 149.9
Fees and other revenues 368.5 370.3 (1.8 ) 739.2 733.4 5.8
Net investment income 539.5 570.9 (31.4 ) 1,070.4 1,151.9 (81.5 )
Total operating revenues 1,081.2 1,044.2 37.0 2,136.3 2,062.1 74.2
Expenses:
Benefits, claims and
settlement expenses,
including dividends to
policy holders 543.2 504.0 39.2 1,063.6 985.8 77.8
Operating expenses 356.6 337.4 19.2 704.2 670.5 33.7
Total expenses 899.8 841.4 58.4 1,767.8 1,656.3 111.5
Operating earnings before
income taxes 181.4 202.8 (21.4 ) 368.5 405.8 (37.3 )
Income taxes 39.7 48.1 (8.4 ) 83.2 97.0 (13.8 )
Operating earnings $ 141.7 $ 154.7 $ (13.0 ) $ 285.3 $ 308.8 $ (23.5 )
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Operating Earnings
Operating earnings decreased $5.2 million in our individual annuities business
primarily due to a decrease in investment income stemming from lower asset
prepayment fee income and investment yields and an increase in DPAC amortization
expense resulting from declining equity markets in the second quarter of 2012.
In addition, operating earnings decreased $4.5 million in our full service
accumulation business primarily due to shifts in mix of business, economic
pressures on fee revenue and higher staff related costs, including pension and
other postretirement benefits. Furthermore, operating earnings decreased $1.0
million in our Principal Funds business primarily due to higher staff related
costs, including pension and other postretirement benefits, and to a lesser
extent, higher distribution expenses resulting from an increase in sales.
Operating Revenues
Premiums increased $59.8 million in our full service payout business primarily
due to an increase in sales of single premium group annuities with life
contingencies. The single premium product, which is typically used to fund
defined benefit plan terminations, can generate large premiums from very few
customers and therefore tends to vary from period to period. In addition,
premiums increased $10.4 million in our individual annuities business primarily
due to an increase in sales of annuities with life contingencies stemming from
expanding opportunities with our bank distribution partners.
Fees decreased $7.5 million in our full service accumulation business primarily
due to shifts in mix of business and economic pressures. Partially offsetting
the decrease in fees were $4.5 million and $1.5 million increases in our
Principal Funds and individual annuities businesses, respectively, primarily due
to higher fee income stemming from an increase in average account values.
Net investment income decreased primarily due to lower investment yields.
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Total Expenses
Benefits, claims and settlement expenses increased $58.3 million in our full
service payout business primarily due to an increase in change in reserves
resulting from an increase in sales of single premium group annuities with life
contingencies. Partially offsetting the increase in benefits, claims and
settlement expenses was an $18.5 million decrease in our investment only
business primarily due to a decrease in cost of interest credited stemming from
lower variable crediting rates and a decline in average account values resulting
from scheduled maturities of medium-term notes.
Operating expenses increased $7.1 million and $4.2 million in our full service
accumulation and individual annuities businesses, respectively, primarily due to
higher staff related costs, including pension and other postretirement benefits.
To a lesser extent, operating expenses increased in our individual annuities
business due to an increase in DPAC amortization expense resulting from
declining equity markets in the second quarter of 2012. In addition, operating
expenses increased $6.1 million in our Principal Funds business primarily due to
higher staff related costs, including pension and other postretirement benefits,
and to a lesser extent, higher distribution expenses resulting from an increase
in sales.
Income Taxes
The effective income tax rates for the segment were 22% and 24% for the three
months ended June 30, 2012 and 2011, respectively. The effective income tax
rates were 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.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Operating Earnings
Operating earnings decreased $8.1 million in our individual annuities business
primarily due to lower investment yields and, to a lesser extent, a favorable
separate account dividend received deduction true-up in 2011 compared to a
negative separate account dividend received deduction true-up in 2012. In
addition, operating earnings decreased $7.1 million in our full service
accumulation business primarily due to shifts in mix of business, economic
pressures on fee revenue and higher staff related costs, including pension and
other postretirement benefits. Furthermore, operating earnings decreased $3.6
million in our bank and trust services business primarily due to an estimated
expense for a legal settlement accrual in 2012.
Operating Revenues
Premiums increased $129.9 million in our full service payout business primarily
due to an increase in sales of single premium group annuities with life
contingencies. The single premium product, which is typically used to fund
defined benefit plan terminations, can generate large premiums from very few
customers and therefore tends to vary from period to period. In addition,
premiums increased $20.0 million in our individual annuities business primarily
due to an increase in sales of annuities with life contingencies stemming from
expanding opportunities with our bank distribution partners.
Fees increased $10.1 million and $4.2 million in our Principal Funds and
individual annuities businesses, respectively, primarily due to higher fee
income stemming from an increase in average account values. Partially offsetting
the increase in fees was an $8.9 million decrease in our full service
accumulation business primarily due to shifts in mix of business and economic
pressures.
Net investment income decreased primarily due to lower investment yields.
Total Expenses
Benefits, claims and settlement expenses increased $123.6 million in our full
service payout business primarily due to an increase in change in reserves
resulting from an increase in sales of single premium group annuities with life
contingencies. Partially offsetting the increase in benefits, claims and
settlement expenses was a $35.7 million decrease in our investment only business
primarily due to a decrease in cost of interest credited stemming from lower
variable crediting rates and a decline in average account values resulting from
scheduled maturities of medium-term notes.
Operating expenses increased $12.7 million in our Principal Funds business
primarily due to higher staff related costs and higher distribution expenses
resulting from an increase in sales. In addition, operating expenses increased
$8.8 million and $7.5 million in our full service accumulation and individual
annuities businesses, respectively, primarily due to higher staff related costs,
including pension and other postretirement benefits.
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Income Taxes
The effective income tax rates for the segment were 23% and 24% for the six
months ended June 30, 2012 and 2011, respectively. The effective income tax
rates were 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.
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 earnings 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 June 30, For the six months ended June 30,
2012 2011 2012 2011
(in billions)
AUM, beginning of period $ 242.2 $ 222.9 $ 227.8 $ 220.1
Net cash flow 2.9 0.7 6.6 (3.2 )
Investment performance (0.9 ) 3.0 11.3 10.1
Other (0.3 ) (0.6 ) (1.8 ) (1.0 )
AUM, end of period $ 243.9 $ 226.0 $ 243.9 $ 226.0
The following table presents certain summary financial data relating to the
Principal Global Investors segment for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Operating revenues:
Fees and other revenues $ 138.5 $ 132.2 $ 6.3 $ 272.6 $ 253.7 $ 18.9
Net investment income 2.6 4.1 (1.5 ) 6.6 7.9 (1.3 )
Total operating revenues 141.1 136.3 4.8 279.2 261.6 17.6
Expenses:
Total expenses 111.4 102.6 8.8 222.1 201.6 20.5
Operating earnings before income
taxes and noncontrolling
interest 29.7 33.7 (4.0 ) 57.1 60.0 (2.9 )
Income taxes 8.9 11.5 (2.6 ) 18.9 20.1 (1.2 )
Operating earnings attributable
to noncontrolling interest 2.6 1.4 1.2 3.8 2.5 1.3
Operating earnings $ 18.2 $ 20.8 $ (2.6 ) $ 34.4 $ 37.4 $ (3.0 )
Three and Six Months Ended June 30, 2012 Compared to Three and Six Months Ended
June 30, 2011
Operating Earnings
Operating earnings decreased primarily due to higher compensation and operating
costs resulting from continued investment in the global business model and other
one-time costs during the current period. These increases in expenses were
partially offset by higher fee revenues driven by an increase in average AUM, as
well as increased real estate transaction fees resulting from higher transaction
volumes.
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Income Taxes
The effective income tax rates for the segment were 30% and 33% for the three
and six months ended June 30, 2012, respectively, and 34% for both the three and
six months ended June 30, 2011. The effective income tax rates for the three and
six months ended June 30, 2012 and 2011, were lower than the U.S. statutory
rate, primarily due to the inclusion of income attributable to noncontrolling
interest in operating earnings before income taxes with no corresponding change
in income taxes reported by us as the controlling interest.
Principal International Segment
Principal International Segment Summary Financial Data
AUM is a key indicator of earnings growth for the segment, as AUM is the base by
which we can generate local currency profits. Net customer cash flow and market
performance are the two main drivers of local currency AUM growth. Net customer
cash flow reflects our ability to attract and retain client deposits. Market
performance reflects the investment returns on our underlying AUM. The
percentage growth or decline in the earnings of our Principal International
segment will generally track with the percentage growth or decline in AUM. This
trend may vary due to changes in business and/or product mix. Our financial
results are also impacted by fluctuations of the foreign currency to U.S. dollar
exchange rates for the countries in which we have business. AUM of our foreign
subsidiaries is translated into U.S. dollar equivalents at the end of the
reporting period using the spot foreign exchange rates. Revenue and expenses for
our foreign subsidiaries are translated into U.S. dollar equivalents at the
average foreign exchange rates for the reporting period.
The following table presents the Principal International segment AUM rollforward
for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
2012 2011 2012 2011
(in billions)
AUM, beginning of period $ 59.2 $ 48.5 $ 52.8 $ 45.8
Net cash flow 2.3 1.8 4.6 3.1
Investment performance 1.4 1.1 3.6 1.7
Operations acquired (1) 1.8 - 1.8 -
Effect of exchange rates (4.3 ) 1.7 (2.3 ) 2.7
Other (0.1 ) (0.1 ) (0.2 ) (0.3 )
AUM, end of period $ 60.3 $ 53.0 $ 60.3 $ 53.0
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(1) Reflects the acquisition of Claritas in Brazil in April 2012.
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The following table presents certain summary financial data of the Principal
International segment for the periods indicated.
For the three months ended June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Operating revenues:
Premiums and other considerations $ 64.5 $ 57.0 $ 7.5 $ 148.3 $ 123.8 $ 24.5
Fees and other revenues 50.5 38.2 12.3 100.7 75.5 25.2
Net investment income 95.6 132.0 (36.4 ) 224.1 234.0 (9.9 )
Total operating revenues 210.6 227.2 (16.6 ) 473.1 433.3 39.8
Expenses:
Benefits, claims, and settlement
expenses 122.1 149.1 (27.0 ) 292.4 281.6 10.8
Operating expenses 50.5 41.4 9.1 100.8 86.0 14.8
Total expenses 172.6 190.5 (17.9 ) 393.2 367.6 25.6
Operating earnings before income
taxes and noncontrolling interest 38.0 36.7 1.3 79.9 65.7 14.2
Income taxes 1.0 0.4 0.6 1.2 1.6 (0.4 )
Operating earnings attributable
to noncontrolling interest 0.1 - 0.1 - - -
Operating earnings $ 36.9 $ 36.3 $ 0.6 $ 78.7 $ 64.1 $ 14.6
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Operating Earnings
Operating earnings increased primarily due to higher fees driven by higher
average AUM in Mexico as a result of the HSBC AFORE acquisition, which was
partially offset by the weakening of the Latin American currencies against the
U.S. dollar and lower investment returns on assets not backing segment insurance
products as a result of lower inflation in Chile.
Operating Revenues
Premiums increased $7.4 million in Chile primarily due to higher sales of single
premium annuities with life contingencies, which was partially offset by the
weakening of the Chilean peso against the U.S. dollar.
Fees and other revenues increased primarily due to higher investment management
fees driven by higher average AUM in Mexico as a result of the HSBC AFORE
acquisition, which was partially offset by the weakening of the Mexican peso
against the U.S. dollar.
Net investment income decreased primarily due to lower inflation-based
investment returns on average invested assets and cash as a result of lower
inflation in Chile.
Total Expenses
Benefits, claims and settlement expenses decreased $26.5 million in Chile
primarily due to lower inflation-based interest crediting rates to customers and
the weakening of the Chilean peso against the U.S. dollar, which were partially
offset by an increase in the change in reserves related to higher sales of
single premium annuities with life contingencies.
Operating expenses increased primarily due to transaction costs related to the
Claritas acquisition in Brazil and higher compensation expenses across the
segment.
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Income Taxes
The effective income tax rates for the segment were 3% and 1% for the three
months ended June 30, 2012 and 2011, respectively. The effective income tax
rates were lower than the U.S. statutory rate primarily due to the presentation
of taxes on our share of earnings generated from our equity method investments.
Specifically, our share of earnings generated from equity method investments,
net of foreign taxes incurred, are reported within net investment income whereas
any residual U.S. tax expense or benefit related to equity method investments is
reported in income taxes. Lower tax rates of foreign jurisdictions also
contributed to the lower effective income tax rates.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Operating Earnings
Operating earnings increased primarily due to higher fees driven by higher
average AUM in Mexico as a result of the HSBC AFORE acquisition and higher
earnings in our equity method investment in Brazil. These increases were
partially offset by the weakening of the Latin American currencies against the
U.S. dollar and higher compensation expenses across the segment.
Operating Revenues
Premiums increased $24.4 million in Chile primarily due to higher sales of
single premium annuities with life contingencies.
Fees and other revenues increased primarily due to higher investment management
fees driven by higher average AUM in Mexico as a result of the HSBC AFORE
acquisition, which was partially offset by the weakening of the Mexican peso
against the U.S. dollar.
Net investment income decreased primarily due to lower inflation-based
investment returns on average invested assets and cash as a result of lower
inflation in Chile, which was partially offset by higher average invested assets
in Chile.
Total Expenses
Benefits, claims and settlement expenses increased $10.8 million in Chile
primarily due to an increase in the change in reserves related to higher sales
of single premium annuities with life contingencies, which was partially offset
by lower inflation-based interest crediting rates to customers.
Operating expenses increased primarily due to higher compensation expenses
across the segment, transaction costs related to the Claritas acquisition in
Brazil and higher present value of future profits and DPAC amortization and as a
result of net unlocking and true-up adjustments in Mexico.
Income Taxes
The effective income tax rate for the segment was 2% for both the six months
ended June 30, 2012 and 2011. The effective income tax rate was lower than the
U.S. statutory rate primarily due to taxes on our share of earnings generated
from our equity method investments. Specifically, our share of earnings
generated from equity method investments, net of foreign taxes incurred, are
reported within net investment income whereas any residual U.S. tax expense or
benefit related to equity method investments is reported in income taxes. Lower
tax rates of foreign jurisdictions also contributed to the lower effective
income tax rates.
U.S. Insurance Solutions Segment
Individual Life Insurance Trends
Our life insurance premiums and fees are influenced by both economic and
industry trends. We have been primarily focused on marketing our universal and
variable universal life insurance products. As such, premiums related to our
traditional life insurance products continued to decline. To address recent
economic and industry trends, we introduced new term products in 2011.
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The following table provides a summary of our individual universal and variable
universal life insurance fee revenues and our individual traditional life
insurance premiums for the periods indicated:
For the three months ended For the six months ended
June 30, June 30,
2012 2011 2012 2011
(in millions)
Universal and variable universal
life insurance fee revenues (1) $ 120.5 $ 110.6 $ 193.2 $ 226.1
Traditional life insurance premiums 125.8 128.7 249.0 253.4
--------------------------------------------------------------------------------
(1) Fee revenues reflects a $46.6 million reduction due to unlocking of
unearned revenue associated with the change in basis for amortizing DPAC and
other actuarial balances for the six months ended June 30, 2012.
Specialty Benefits Insurance Trends
Premium and fees in our specialty benefits insurance business are also
influenced by economic and industry trends. Premium and fees have risen more
slowly in recent years due to more moderate increases in underlying salaries and
lower membership in existing group contracts. Over the past year, we are seeing
signs of improvement in both areas.
The following table provides a summary of our specialty benefits insurance
premium and fees for the periods indicated:
For the three months ended For the six months ended
June 30, June 30,
2012 2011 2012 2011
(in millions)
Premium and fees:
Group dental and vision insurance $ 144.2 $ 139.0 $ 287.8 $ 274.2
Group life insurance 82.9 80.9 163.8 161.0
Group disability insurance 74.3 68.8 143.6 137.1
Individual disability insurance 57.9 53.3 115.0 105.5
Wellness 2.2 2.6 5.0 5.2
U.S. Insurance Solutions Segment Summary Financial Data
There are several key indicators for earnings growth in our U.S. Insurance
Solutions segment. The ability of our distribution channels to generate new
sales and retain existing business drives growth in our block of business,
premium revenue and fee revenues. Our earnings growth also depends on our
ability to price our products at a level that enables us to earn a margin over
the cost of providing benefits and the expense of acquiring and administering
those products. Factors impacting pricing decisions include competitive
conditions, persistency, our ability to assess and manage trends in mortality
and morbidity and our ability to manage operating expenses.
The following table presents certain summary financial data relating to the U.S.
Insurance Solutions segment for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Operating revenues:
Premiums and other considerations $ 443.6 $ 434.2 $ 9.4 $ 883.4 $ 862.8 $ 20.6
Fees and other revenues (1) 134.1 123.8 10.3 221.4 253.2 (31.8 )
Net investment income 173.8 172.7 1.1 343.7 346.7 (3.0 )
Total operating revenues 751.5 730.7 20.8 1,448.5 1,462.7 (14.2 )
Expenses:
Benefits, claims and settlement
expenses (1) 443.3 439.3 4.0 970.5 849.3 121.2
Dividends to policyholders 49.0 52.3 (3.3 ) 98.8 105.4 (6.6 )
Operating expenses (1) 185.8 167.2 18.6 231.6 358.2 (126.6 )
Total expenses 678.1 658.8 19.3 1,300.9 1,312.9 (12.0 )
Operating earnings before income
taxes 73.4 71.9 1.5 147.6 149.8 (2.2 )
Income taxes 23.2 22.9 0.3 47.2 47.4 (0.2 )
Operating earnings $ 50.2 $ 49.0 $ 1.2 $ 100.4 $ 102.4 $ (2.0 )
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(1) For further details related to the impact associated with the change in
basis for amortizing DPAC and other actuarial balances on results for the six
months ended June 30, 2012 see, "Transactions Affecting Comparability of Results
of Operations - Individual Life Insurance Amortization."
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Operating Earnings
Operating earnings in our individual life insurance business increased $3.9
million due to lower claims. Operating earnings decreased $2.7 million in our
specialty benefits insurance business primarily due to lower investment yields
and higher staff related costs, including pension and other postretirement
benefits.
Operating Revenues
Premiums increased $16.9 million in our specialty benefits insurance business
due to growth in the block of business. Premiums decreased $7.5 million in our
individual life insurance business due to higher reinsurance premiums in the
universal life and variable universal life lines of business and the expected
continued decline from our traditional life insurance business.
Fees and other revenues increased $10.3 million in our individual life insurance
business due to growth in the universal life and variable universal life lines
of business.
Total Expenses
Benefits, claims and settlement expenses increased $14.2 million in our
specialty benefits insurance business primarily due to growth in the block of
business. Benefits, claims and settlement expenses decreased $10.2 million in
our individual life insurance business due to lower claims.
Operating expenses increased $13.1 million in our individual life insurance
business primarily due to higher DPAC amortization related to lower claims.
Operating expenses increased $5.5 million in our specialty benefits insurance
business due primarily due to growth in the block of business and higher staff
related costs, including pension and other postretirement benefits.
Income Taxes
The effective income tax rate for the segment was 32% for both the three months
ended June 30, 2012 and 2011. The effective income tax rate was lower than the
U.S. statutory rate primarily due to interest exclusion from taxable income and
income tax deductions allowed for corporate dividends received.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Operating earnings decreased $6.7 million in our specialty benefits insurance
business primarily due to lower investment yields and higher staff related
costs, including pension and other postretirement benefits. Operating earnings
in our individual life insurance business increased $4.7 million primarily due
to the favorable net impact of the unlocking associated with the change in basis
for amortizing DPAC and other actuarial balances in the first quarter of 2012.
Operating Revenues
Premiums increased $31.6 million in our specialty benefits insurance business
due to growth in the block of business. Premiums decreased $11.0 million in our
individual life insurance business due to higher reinsurance premiums in the
universal life and variable universal life lines of business and the expected
continued decline from our traditional life insurance business.
Fees and other revenues decreased $32.4 million in our individual life insurance
business primarily due to the unlocking of unearned revenue associated with the
change in basis for amortizing DPAC and other actuarial balances in the first
quarter of 2012 offset by growth in the universal life and variable universal
life lines of business.
Total Expenses
Total expenses decreased $47.4 million in our individual life insurance business
primarily due to unlocking associated with the change in basis for amortizing
DPAC and other actuarial balances in the first quarter of 2012. Total expenses
increased $35.4 million in
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our specialty benefits insurance business due to growth in the block of business
and higher staff related costs, including pension and other postretirement
benefits.
Income Taxes
The effective income tax rate for the segment was 32% for both the six months
ended June 30, 2012 and 2011. The effective income tax rate was lower than the
U.S. statutory rate primarily due to interest exclusion from taxable income and
income tax deductions allowed for corporate dividends received.
Corporate Segment
Corporate Segment Summary Financial Data
The following table presents certain summary financial data relating to the
Corporate segment for the periods indicated:
For the three months ended June 30, For the six months ended June 30,
Increase Increase
2012 2011 (decrease) 2012 2011 (decrease)
(in millions)
Operating revenues:
Total operating revenues $ (48.1 ) $ (39.9 ) $ (8.2 ) $ (93.4 ) $ (73.7 ) $ (19.7 )
Expenses:
Total expenses (11.1 ) (3.9 ) (7.2 ) (12.0 ) (1.8 ) (10.2 )
Operating losses before income
taxes, preferred stock dividends
and noncontrolling interest (37.0 ) (36.0 ) (1.0 ) (81.4 ) (71.9 ) (9.5 )
Income tax benefits (14.5 ) (15.4 ) 0.9 (28.3 ) (27.4 ) (0.9 )
Preferred stock dividends 8.3 8.3 - 16.5 16.5 -
Operating earnings (losses)
attributable to noncontrolling
interest (0.1 ) 2.9 (3.0 ) (0.1 ) 2.9 (3.0 )
Operating losses $ (30.7 ) $ (31.8 ) $ 1.1 $ (69.5 ) $ (63.9 ) $ (5.6 )
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Operating Losses
Operating losses decreased primarily due to a reduction in corporate overhead
expenses needed to support the exited group medical insurance business.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Operating Losses
Operating losses increased due a decrease in earnings on average invested assets
for the segment, representing capital that has not been allocated to any other
segment and a change in income tax reserves established for IRS tax matters.
Partially offsetting these increases was a reduction in corporate overhead
expenses needed to support the exited group medical insurance business.
Liquidity and Capital Resources
Liquidity and capital resources represent the overall strength of a company and
its ability to generate strong cash flows, borrow funds at a competitive rate
and raise new capital to meet operating and growth needs. Our legal entity
structure has an impact on our ability to meet cash flow needs as an
organization. Following is a simplified organizational structure.
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[[Image Removed]]
Our liquidity requirements have been and will continue to be met by funds from
consolidated operations as well as the issuance of commercial paper, common
stock, debt or other capital securities and borrowings from credit facilities.
We believe that cash flows from these sources are sufficient to satisfy the
current liquidity requirements of our operations, including reasonably
foreseeable contingencies.
We maintain a level of cash and securities which, combined with expected cash
inflows from investments and operations, is believed to be adequate to meet
anticipated short-term and long-term payment obligations. We will continue our
prudent capital management practice of regularly exploring options available to
us to maximize capital flexibility, including accessing the capital markets and
careful attention to and management of expenses.
Our liquidity is supported by a portfolio of U.S. government and agency and
residential pass-through government-backed securities, of which we held $4.4
billion as of June 30, 2012, that may be utilized to bolster our liquidity
position, as collateral for secured borrowing transactions with various third
parties or by disposing of the securities in the open market, if needed. As of
June 30, 2012, approximately $10.1 billion, or 98%, of our institutional
guaranteed investment contracts and funding agreements cannot be redeemed by
contractholders prior to maturity. Our life insurance and annuity liabilities
contain provisions limiting early surrenders.
As of June 30, 2012 and December 31, 2011, we had short-term credit facilities
with various financial institutions in an aggregate amount of $914.7 million and
$725.0 million, respectively. As of June 30, 2012 and December 31, 2011, we had
$262.9 million and $105.2 million, respectively, of outstanding borrowings
related to our credit facilities, with $15.7 million of assets pledged as
support as of June 30, 2012. None of these credit arrangements, other than our
commercial paper back-stop facility, are committed facilities. Due to the
financial strength and the strong relationships we have with these providers, as
well as the small size of these facilities, we are comfortable that there is a
very low risk that the financial institutions would not be able to fund these
facilities. During the first quarter of 2012, we refinanced our $579.0 million
revolving credit agreement that serves as a back-stop to our commercial paper
program. The new facility, effective March 30, 2012, was increased to $800.0
million. This facility provides 100% back-stop support for our commercial paper
program. The credit agreement is broken into two tranches, a $500.0 million four
year facility that matures in March 2016, and a $300 million 364 day facility.
The four year facility is set up with PFG, PFS and Principal Life as
co-borrowers, the 364-day facility is for Principal Life only. The facility is
supported by eighteen banks, most if not all of which have other relationships
with us. We have no reason to believe that our current providers would be unable
or unwilling to fund the facility if necessary. As of June 30, 2012 and
December 31, 2011, commercial paper outstanding was $222.0 million and $50.0
million, respectively.
The Holding Companies: Principal Financial Group, Inc. and Principal Financial
Services, Inc. The principal sources of funds available to our parent holding
company, PFG, to meet its obligations, including the payments of dividends on
common stock, debt service and the repurchase of stock, are dividends from
subsidiaries as well as its ability to borrow funds at competitive rates and
raise capital to meet operating and growth needs. Dividends from Principal Life,
our primary subsidiary, are limited by Iowa law. Under Iowa laws, Principal Life
may pay dividends only from the earned surplus arising from its business and
must receive the prior approval of the Insurance Commissioner of the State of
Iowa ("the Commissioner") to pay stockholder dividends or make any other
distribution if such distributions would exceed certain statutory limitations.
Iowa law gives the Commissioner discretion to disapprove requests for
distributions in excess of these limits. In general, the current statutory
limitations are the greater of (i) 10% of Principal Life's statutory
policyholder surplus as of the previous year-end or (ii) the statutory net gain
from operations from the previous calendar year. Based on these limitations,
Principal Life could distribute approximately $507.7 million in 2012. Total
stockholder dividends paid by Principal Life to its parent as of June 30, 2012,
were $350.0 million.
Operations. Our primary consolidated cash flow sources are premiums from
insurance products, pension and annuity deposits, asset management fee revenues,
administrative services fee revenues, income from investments and proceeds from
the sales or maturity of investments. Cash outflows consist primarily of payment
of benefits to policyholders and beneficiaries, income and other taxes, current
operating expenses, payment of dividends to policyholders, payments in
connection with investments acquired, payments made to acquire subsidiaries,
payments relating to policy and contract surrenders, withdrawals, policy loans,
interest expense and repayment of short-term
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debt and long-term debt. Our investment strategies are generally intended to
provide adequate funds to pay benefits without forced sales of investments. For
a discussion of our investment objectives, strategies and a discussion of
duration matching, see "Investments" as well as Item 3. "Quantitative and
Qualitative Disclosures About Market Risk - Interest Rate Risk."
Cash Flows. Activity, as reported in our consolidated statements of cash flows,
provides relevant information regarding our sources and uses of cash.
Net cash provided by operating activities was $ 1,502.0 million and
$1,785.5 million for the six months ended June 30, 2012, and 2011, respectively.
From our insurance business, we typically generate positive cash flows from
operating activities, as premiums collected from our insurance products and
income received from our investments exceed policy acquisition costs, benefits
paid, redemptions and operating expenses. These positive cash flows are then
invested to support the obligations of our insurance and investment products and
required capital supporting these products. Our cash flows from operating
activities are affected by the timing of premiums, fees and investment income
received and benefits and expenses paid. The decrease in cash provided by
operating activities in 2012 compared to 2011 was primarily due to fluctuations
in receivables and payables associated with the timing of settlement as well as
a decrease in sales of development real estate properties in the current year
compared to 2011.
Net cash used in investing activities was $826.8 million for the six months
ended June 30, 2012, compared to net cash provided by investing activities of
$793.9 million for the six months ended June 30, 2011. The increase in cash used
in investing activities in 2012 compared to 2011 was primarily the result of an
increase in net purchases of investments in 2012 compared to net sales and
maturities of investments in 2011.
Net cash used in financing activities was $1,862.5 million and $2,287.2 million
for the six months ended June 30, 2012 and 2011, respectively. The decrease in
cash used in financing activities was primarily due to a decrease in net
withdrawals of investment contracts, for which we have had net withdrawals in
both 2012 and 2011 primarily due to our decision to scale back our investment
only business as well as an increase in proceeds from short-term borrowings in
2012. These were partially offset by an increase in common stock dividends in
2012 as a result of moving to a quarterly dividend beginning in 2012.
Shelf Registration. On May 24, 2011, our shelf registration statement was filed
with the SEC and became effective. The shelf registration replaces the shelf
registration that had been in effect since June 2008. Under our current shelf
registration, we have the ability to issue in unlimited amounts, unsecured
senior debt securities or subordinated debt securities, junior subordinated
debt, preferred stock, common stock, warrants, depository shares, stock purchase
contracts and stock purchase units of PFG, trust preferred securities of three
subsidiary trusts and guarantees by PFG of these trust preferred securities. Our
wholly owned subsidiary, PFS, may guarantee, fully and unconditionally or
otherwise, our obligations with respect to any non-convertible securities, other
than common stock, described in the shelf registration.
Preferred Stock Dividend Restrictions and Payments. The certificates of
designation for the Series A and B Preferred Stock restrict the declaration of
preferred dividends if we fail to meet specified capital adequacy, net income or
stockholders' equity levels. As of June 30, 2012, we have no preferred dividend
restrictions. The dividend payments on our preferred stock are not mandatory or
cumulative, as our Board of Directors approves each quarterly dividend payment.
Short-Term Debt. The components of short-term debt as of June 30, 2012 and
December 31, 2011, were as follows:
June 30, 2012 December 31, 2011
(in millions)
Commercial paper $ 222.0 $ 50.0
Other recourse short-term debt 40.9 55.2
Total short-term debt $ 262.9 $ 105.2
Long-Term Debt. As of June 30, 2012, there have been no significant changes to
long-term debt since December 31, 2011.
Stockholders' Equity. The following table summarizes our return of capital to
common stockholders.
June 30, 2012 December 31, 2011
(in millions)
Dividends to stockholders $ (108.0 ) $ (213.7 )
Repurchase of common stock (203.2 ) (556.4 )
Total cash returned to stockholders $ (311.2 ) $ (770.1 )
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For additional stockholders' equity information, see Item 1. "Financial
Statements, Notes to Unaudited Consolidated Financial Statements, Note 8,
Stockholders' Equity."
Capitalization
Our capital structure as of June 30, 2012 and December 31, 2011, consisted of
debt and equity summarized as follows:
June 30, 2012 December 31, 2011
(in millions)
Debt:
Short-term debt $ 262.9 $ 105.2
Long-term debt 1,576.9 1,564.8
Total debt 1,839.8 1,670.0
Stockholders' equity:
Equity excluding AOCI 8,872.2 8,759.9Total capitalization excluding AOCI $ 10,712.0 $ 10,429.9
Debt to equity excluding AOCI
21 % 19 %
Debt to capitalization excluding AOCI 17 % 16 %
As of June 30, 2012, we had $527.9 million of excess capital in the holding
companies, consisting of cash and highly liquid assets available for debt
maturities, interest, preferred stock dividends and other holding company
obligations. In addition, we continue to maintain sufficient capital levels in
Principal Life based on our current financial strength ratings.
Contractual Obligations and Contractual Commitments
As of June 30, 2012, there have been no significant changes to contractual
obligations and contractual commitments since December 31, 2011.
Off-Balance Sheet Arrangements
Variable Interest Entities. We have relationships with various types of special
purpose entities and other entities where we have a variable interest as
described in Item 1. "Financial Statements, Notes to Unaudited Consolidated
Financial Statements, Note 2, Variable Interest Entities."
Guarantees and Indemnifications. As of June 30, 2012, there have been no
significant changes to guarantees and indemnifications since December 31, 2011.
For guarantee and indemnification information, see Item 1. "Financial
Statements, Notes to Unaudited Consolidated Financial Statements, Note 7,
Contingencies, Guarantees and Indemnifications" under the caption, "Guarantees
and Indemnifications."
Financial Strength Rating and Credit Ratings
Our ratings are influenced by the relative ratings of our peers/competitors as
well as many other factors including our operating and financial performance,
asset quality, liquidity, asset/liability management, overall portfolio mix,
financial leverage (i.e., debt), risk exposures, operating leverage, ratings and
other factors.
A.M. Best Company, Inc., Fitch Rating Ltd., Moody's Investors Service and S&P
publish financial strength ratings on U.S. life insurance companies that are
indicators of an insurance company's ability to meet contractholder and
policyholder obligations. These rating agencies also assign credit ratings on
non-life insurance entities, such as PFG and PFS. Credit ratings are indicators
of a debt issuer's ability to meet the terms of debt obligations in a timely
manner, and are important factors in overall funding profile and ability to
access external capital. Such ratings are not a recommendation to buy, sell or
hold securities. Ratings are subject to revision or withdrawal at any time by
the assigning rating agency.
A.M. Best, Fitch, Moody's and S&P maintain a stable outlook on the U.S. life
insurance sector. However, these rating agencies note that current challenges
for the industry such as global sovereign uncertainty, equity market volatility,
impact of sustained low interest rates, weakness in the real estate market,
lingering unemployment and weak consumer confidence are putting pressure on the
stable outlook.
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The financial strength ratings of Principal Life and Principal National Life
Insurance Company were upgraded by S&P from A with a positive outlook to A+ with
a stable outlook in June 2012, and were affirmed with no change in outlook by
Fitch in June 2012, by Moody's in August 2011 and by A.M. Best in December 2011.
The following table summarizes our significant financial strength and debt
ratings from the major independent rating organizations. The debt ratings shown
are indicative ratings. Outstanding issuances are rated the same as indicative
ratings unless otherwise noted. Actual ratings can differ from indicative
ratings based on contractual terms.
Standard &
A.M. Best Fitch Poor's Moody's
Principal Financial Group
Senior Unsecured Debt (1) a- BBB+ Baa1
Preferred Stock (2) bbb BBB- Baa3
Principal Financial Services
Senior Unsecured Debt a- BBB+
Commercial Paper AMB-1 A-2 P-2
Principal Life Insurance Company
Insurer Financial Strength A+ AA- A+ Aa3
Commercial Paper AMB-1+ A-1 P-1
Surplus Notes a A- A2
Enterprise Risk Management Rating Strong
Principal National Life Insurance Company
Insurer Financial Strength A+ AA- A+ Aa3
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(1) Moody's has rated Principal Financial Group's senior debt issuance "A3"
(2) S&P has rated Principal Financial Group's preferred stock issuance "BB"
Fair Value Measurement
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date (an exit price). The fair value hierarchy prioritizes the
inputs to valuation techniques used to measure fair value into three levels for
disclosure purposes. The fair value hierarchy gives the highest priority (Level
1) to quoted prices in active markets for identical assets or liabilities and
gives the lowest priority (Level 3) to unobservable inputs. An asset or
liability's classification within the fair value hierarchy is based on the
lowest level of significant input to its valuation. See Item 1. "Financial
Statements, Notes to Unaudited Consolidated Financial Statements, Note 9, Fair
Value Measurements" for further details, including a reconciliation of changes
in Level 3 fair value measurements.
As of June 30, 2012, 39% of our net assets (liabilities) were Level 1, 57% were
Level 2 and 4% were Level 3. Excluding separate account assets as of June 30,
2012, 1% of our net assets (liabilities) were Level 1, 98% were Level 2 and 1%
were Level 3.
As of December 31, 2011, 41% of our net assets (liabilities) were Level 1, 55%
were Level 2 and 4% were Level 3. Excluding separate account assets as of
December 31, 2011, 3% of our net assets (liabilities) were Level 1, 96% were
Level 2 and 1% were Level 3.
Changes in Level 3 fair value measurements
Net assets (liabilities) measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) as of June 30, 2012, were $4,747.5
million as compared to $4,647.3 million as of December 31, 2011. The increase
was primarily related to gains on other invested assets and real estate included
in our separate account assets. This increase was largely offset by transfers
out of Level 3 into Level 2 for certain fixed maturities, available-for-sale due
to our obtaining prices from third party pricing vendors or using internal
models based on substantially observable market information versus relying on
broker quotes or utilizing significant unobservable inputs.
Net assets (liabilities) measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) as of June 30, 2011, were $4,625.8
million as compared to $4,691.4 million as of December 31, 2010. The decrease
was primarily due to settlements of fixed maturities, available-for-sale and
fixed maturities, trading and net sales and settlements of separate account
assets. To a lesser extent, the decrease was due to net transfers out of Level 3
into Level 2 for certain long-term bonds in our separate accounts due to our
obtaining prices from third party vendors versus relying on broker quotes or
internal pricing models. These decreases in Level 3 assets were largely offset
by gains on other invested assets and real estate included in our separate
accounts assets.
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Investments
We had total consolidated assets as of June 30, 2012, of $152.1 billion, of
which $67.2 billion were invested assets. The rest of our total consolidated
assets are comprised primarily of separate account assets for which we do not
bear investment risk. Because we generally do not bear any investment risk on
assets held in separate accounts, the discussion and financial information below
does not include such assets.
Overall Composition of Invested Assets
Invested assets as of June 30, 2012, were predominantly high quality and broadly
diversified across asset class, individual credit, industry and geographic
location. Asset allocation is determined based on cash flow and the risk/return
requirements of our products. As shown in the following table, the major
categories of invested assets are fixed maturities and commercial mortgage
loans. The remainder is invested in other investments, residential mortgage
loans, real estate and equity securities. In addition, policy loans are included
in our invested assets.
June 30, 2012 December 31, 2011
Carrying amount % of total Carrying amount % of total
($ in millions)
Fixed maturities:
Public $ 35,613.9 53 % $ 35,350.3 53 %
Private 14,956.2 22 14,628.1 22
Equity securities 363.3 1 481.9 1
Mortgage loans:
Commercial 9,824.7 14 9,396.6 14
Residential 1,333.9 2 1,330.6 2
Real estate held for sale 58.6 - 44.8 -
Real estate held for investment 1,115.5 2 1,048.1 2
Policy loans 867.8 1 885.1 1
Other investments 3,096.8 5 2,985.8 5
Total invested assets 67,230.7 100 % 66,151.3 100 %
Cash and cash equivalents 1,646.6 2,833.9
Total invested assets and cash $ 68,877.3 $ 68,985.2
Investment Results
Net Investment Income
The following table presents the yield and investment income, excluding net
realized capital gains and losses, for our invested assets for the periods
indicated. We calculate annualized yields using a simple average of asset
classes at the beginning and end of the reporting period. The yields for fixed
maturities and equity securities are calculated using amortized cost and cost,
respectively. All other yields are calculated using carrying amounts.
For the three months ended June 30, Increase (decrease) For the six months ended June 30, Increase (decrease)
2012 2011 2012 vs. 2011 2012 2011 2012 vs. 2011
Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount
($ in millions)
Fixed maturities 5.1 % $ 617.5 5.7 % $ 683.0 (0.6 )% $ (65.5 ) 5.2 % $ 1,258.5 5.6 % $ 1,350.1 (0.4 )% $ (91.6 )
Equity securities 2.5 3.3 2.8 4.0 (0.3 ) (0.7 ) 4.0 8.4 2.9 7.9 1.1 0.5
Mortgage loans -
commercial 5.7 140.5 6.0 140.9 (0.3 ) (0.4 ) 5.8 279.7 5.9 280.7 (0.1 ) (1.0 )
Mortgage loans -
residential 5.4 18.1 7.2 26.3 (1.8 ) (8.2 ) 6.0 40.1 6.4 47.2 (0.4 ) (7.1 )
Real estate 4.8 13.6 7.2 18.2 (2.4 ) (4.6 ) 4.3 24.6 9.0 46.7 (4.7 ) (22.1 )
Policy loans 6.2 13.6 6.5 14.5 (0.3 ) (0.9 ) 6.3 27.6 6.5 28.9 (0.2 ) (1.3 )
Cash and cash
equivalents 0.5 2.1 0.4 2.0 0.1 0.1 0.4 4.3 0.3 3.4 0.1 0.9
Other investments 1.7 12.8 0.8 5.7 0.9 7.1 1.6 24.2 0.8 10.3 0.8 13.9
Total before investment
expenses 4.9 821.5 5.4 894.6 (0.5 ) (73.1 ) 5.0 1,667.4 5.3 1,775.2 (0.3 ) (107.8 )
Investment expenses (0.1 ) (20.5 ) (0.1 ) (21.0 ) - 0.5 (0.1 ) (41.6 ) (0.1 ) (41.8 ) - 0.2
Net investment income 4.8 % $ 801.0 5.3 % $ 873.6 (0.5 )% $ (72.6 ) 4.9 % $ 1,625.8 5.2 % $ 1,733.4 (0.3 )% $ (107.6 )
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Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Net investment income decreased due to lower reinvestment yields within our
fixed maturities portfolio as well as lower inflation-based investment returns
on average invested assets and cash, most notably fixed maturities as a result
of lower inflation in Chile.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Net investment income decreased due to lower reinvestment yields within our
fixed maturities portfolio as well as a decrease due to gains on the sale of
development real estate in the prior year with no corresponding activity in the
current year.
Net Realized Capital Gains (Losses)
The following table presents the contributors to net realized capital gains and
losses for our invested assets for the periods indicated.
For the three months ended Increase For the six months ended Increase
June 30, (decrease) June 30, (decrease)
2012 2011 2012 vs. 2011 2012 2011 2012 vs. 2011
(in millions)
Fixed maturities,
available-for-sale - credit
impairments (1) $ (32.0 ) $ (43.5 ) $ 11.5 $ (60.8 ) $ (93.7 ) $ 32.9
Fixed maturities,
available-for-sale - other 2.7 1.6 1.1 15.6 2.6 13.0
Fixed maturities, trading (2.0 ) 3.3 (5.3 ) 1.0 (1.3 ) 2.3
Equity securities - credit
impairments - (4.5 ) 4.5 - (2.4 ) 2.4
Derivatives and related hedge
activities (2) 48.2 (9.3 ) 57.5 44.7 (34.5 ) 79.2
Commercial mortgages (3.4 ) (4.4 ) 1.0 (7.9 ) (12.2 ) 4.3
Other gains (losses) (13.3 ) 94.5 (107.8 ) 0.9 121.2 (120.3 )
Net realized capital gains
(losses) $ 0.2 $ 37.7 $ (37.5 ) $ (6.5 ) $ (20.3 ) $ 13.8
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(1) Includes credit impairments as well as losses on sales
of
fixed maturities to reduce credit risk, net of realized credit recoveries on the
sale of previously impaired securities. Credit gains on sales, excluding
associated foreign currency fluctuations that are included in derivatives and
related hedging activities, were a net gain of $0.0 million and $2.6 million for
the three months ended June 30, 2012 and 2011, respectively and $0.0 million and
$7.3 million for the six months ended June 30, 2012 and 2011, respectively.
(2) Includes fixed maturities, available-for-sale
impairment-related net gains of $0.0 million and $0.4 for the six months ended
June 30, 2012 and 2011, respectively, which were hedged by derivatives reflected
in this line. There were no fixed maturities available-for-sale
impairment-related net gains in this line for the three months ended June 30,
2012 and 2011.
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Net realized capital losses on fixed maturities, available-for-sale - credit
impairments decreased primarily due to lower impairments on commercial
mortgage-backed and other asset-backed securities as a result of improved market
conditions.
Net realized capital gains on derivatives and related hedge activities increased
due to gains versus losses on the GMWB embedded derivatives, including increased
gains from changes in the spread reflecting our own creditworthiness, and
related hedging instruments. These gains were partially offset by losses versus
gains on currency forwards and currency swaps not designated as hedging
instruments due to changes in exchange rates.
Other net realized capital losses increased due to equity market losses versus
gains and a $70.9 million gain in the second quarter of 2011 resulting from the
sale of a portion of our interest in Catalyst Health Solutions, Inc., which is
accounted for on the equity method.
Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011
Net realized capital losses on fixed maturities, available-for-sale - credit
impairments decreased primarily due to lower impairments on commercial
mortgage-backed and other asset-backed securities as a result of improved market
conditions.
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Net realized capital gains on derivatives and related hedge activities increased
due to gains versus losses on the GMWB embedded derivatives and related hedging
instruments.
Other net realized capital gains decreased due to lower equity market gains and
a $70.9 million gain in the second quarter of 2011 resulting from the sale of a
portion of our interest in Catalyst Health Solutions, Inc., which is accounted
for on the equity method.
U.S. Investment Operations
Of our invested assets, $61.7 billion were held by our U.S. operations as of
June 30, 2012. Our U.S. invested assets are managed primarily by our Principal
Global Investors segment. Our primary investment objective is to maximize
after-tax returns consistent with acceptable risk parameters. We seek to protect
policyholders' benefits by optimizing the risk/return relationship on an ongoing
basis, through asset/liability matching, reducing the credit risk, avoiding high
levels of investments that may be redeemed by the issuer, maintaining
sufficiently liquid investments and avoiding undue asset concentrations through
diversification. We are exposed to two primary sources of investment risk:
† credit risk, relating to the uncertainty associated with the
continued ability of a given obligor to make timely payments of principal and
interest and
† interest rate risk, relating to the market price and/or cash flow
variability associated with changes in market yield curves.
Our ability to manage credit risk is essential to our business and our
profitability. We devote considerable resources to the credit analysis of each
new investment. We manage credit risk through industry, issuer and asset class
diversification. Our Investment Committee, appointed by our Board of Directors,
is responsible for establishing all investment policies and approving or
authorizing all investments, except the Executive Committee of the Board must
approve any investment transaction exceeding $500.0 million. As of June 30,
2012, there are twelve members on the Investment Committee, one of whom is a
member of our Board of Directors. The remaining members are senior management
members representing various areas of our company.
We also seek to reduce call or prepayment risk arising from changes in interest
rates in individual investments. We limit our exposure to investments that are
prepayable without penalty prior to maturity at the option of the issuer and we
require additional yield on these investments to compensate for the risk that
the issuer will exercise such option. We assess option risk in all investments
we make and, when we take that risk, we price for it accordingly.
Our Fixed Income Securities Committee, consisting of fixed income securities
senior management members, approves the credit rating for the fixed maturities
we purchase. Teams of security analysts, organized by industry, analyze and
monitor these investments. In addition, we have teams who specialize in RMBS,
CMBS, ABS, municipals and below investment grade securities. Our analysts
monitor issuers held in the portfolio on a continuous basis with a formal review
documented annually or more frequently if material events affect the issuer. The
analysis includes both fundamental and technical factors. The fundamental
analysis encompasses both quantitative and qualitative analysis of the issuer.
The qualitative analysis includes an assessment of both accounting and
management aggressiveness of the issuer. In addition, technical indicators such
as stock price volatility and credit default swap levels are monitored.
Our Fixed Income Securities Committee also reviews private transactions on a
continuous basis to assess the quality ratings of our privately placed
investments. We regularly review our investments to determine whether we should
re-rate them, employing the following criteria:
† material declines in the issuer's revenues or margins;
† significant management or organizational changes;
† significant uncertainty regarding the issuer's industry;
† debt service coverage or cash flow ratios that fall below
industry-specific thresholds;
† violation of financial covenants and
† other business factors that relate to the issuer.
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A dedicated risk management team is responsible for centralized monitoring of
the commercial mortgage loan portfolio. We apply a variety of strategies to
minimize credit risk in our commercial mortgage loan portfolio. When considering
the origination of new commercial mortgage loans, we review the cash flow
fundamentals of the property, make a physical assessment of the underlying
security, conduct a comprehensive market analysis and compare against industry
lending practices. We use a proprietary risk rating model to evaluate all new
and substantially all existing loans within the portfolio. The proprietary risk
model is designed to stress projected cash flows under simulated economic and
market downturns. Our lending guidelines are typically 65% or less loan-to-value
ratio and a debt service coverage ratio of at least 1.5 times. We analyze
investments outside of these guidelines based on cash flow quality, tenancy and
other factors. The following table presents loan-to-value and debt service
coverage ratios for our brick and mortar commercial mortgages, excluding
Principal Global Investors segment mortgages:
Weighted average loan-to-value ratio Debt service coverage ratio
June 30, 2012 December 31, 2011 June 30,
2012 December 31, 2011
New mortgages 48 % 45 % 3.1x 3.3x
Entire mortgage
portfolio 57 % 60 % 2.1x 2.0x
Our investment decisions and objectives are a function of the underlying risks
and product profiles of each primary business operation. In addition, we
diversify our product portfolio offerings to include products that contain
features that will protect us against fluctuations in interest rates. Those
features include adjustable crediting rates, policy surrender charges and market
value adjustments on liquidations. For further information on our management of
interest rate risk, see Item 3. "Quantitative and Qualitative Disclosures About
Market Risk - Interest Rate Risk."
Overall Composition of U.S. Invested Assets
As shown in the following table, the major categories of U.S. invested assets
are fixed maturities and commercial mortgage loans. The remainder is invested in
other investments, real estate, residential mortgage loans and equity
securities. In addition, policy loans are included in our invested assets. The
following discussion analyzes the composition of U.S. invested assets, but
excludes invested assets of the separate accounts.
June 30, 2012 December 31, 2011
Carrying amount % of total Carrying amount % of total
($ in millions)
Fixed maturities:
Public $ 32,147.1 52 % $ 32,081.2 53 %
Private 14,956.2 24 14,628.1 24
Equity securities 259.1 1 395.9 1
Mortgage loans:
Commercial 9,814.0 16 9,386.0 15
Residential 713.3 1 746.0 1
Real estate held for sale 51.2 - 36.6 -
Real estate held for investment 1,114.7 2 1,047.3 2
Policy loans 843.2 1 861.6 1
Other investments 1,807.5 3 1,783.5 3
Total invested assets 61,706.3 100 % 60,966.2 100 %
Cash and cash equivalents 1,491.4 2,741.7
Total invested assets and cash $ 63,197.7 $ 63,707.9
Fixed Maturities
Fixed maturities consist of publicly traded and privately placed bonds,
asset-backed securities, redeemable preferred stock and certain nonredeemable
preferred stock. Included in the privately placed category as of June 30, 2012
and December 31, 2011, were $9.6 billion and $9.1 billion, respectively, of
securities subject to certain holding periods and resale restrictions pursuant
to Rule 144A of the Securities Act of 1933. Fixed maturities include trading
portfolios that support investment strategies that involve the active and
frequent purchase and sale of fixed maturities. We held $152.2 million and
$279.1 million of these trading securities as of June 30, 2012 and December 31,
2011, respectively.
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Fixed maturities were diversified by category of issuer, as shown in the
following table for the periods indicated.
June 30, 2012 December 31, 2011
Carrying amount % of total Carrying amount % of total
($ in millions)
U.S. government and agencies $ 951.6 2 % $ 1,004.7 2 %
States and political subdivisions 3,019.4 6 3,041.1 7
Non-U.S. governments 692.9 2 676.1 1
Corporate - public 18,988.6 40 19,194.4 41
Corporate - private 12,414.3 26 11,920.7 26
Residential mortgage-backed
pass-through securities 3,374.3 7 3,421.3 7
Commercial mortgage-backed
securities 3,748.4 8 3,425.7 7
Residential collateralized mortgage
obligations 1,211.9 3 1,403.8 3
Asset-backed securities 2,701.9 6 2,621.5 6
Total fixed maturities $ 47,103.3 100 % $ 46,709.3 100 %
We believe that it is desirable to hold residential mortgage-backed pass-through
securities due to their credit quality and liquidity as well as portfolio
diversification characteristics. Our portfolio is comprised of Government
National Mortgage Association, Federal National Mortgage Association and Federal
Home Loan Mortgage Corporation pass-through securities. In addition, our
residential collateralized mortgage obligation portfolio offers structural
features that allow cash flows to be matched to our liabilities.
CMBS provide varying levels of credit protection, diversification and reduced
event risk depending on the securities owned and composition of the loan pool.
CMBS are predominantly comprised of large pool securitizations that are diverse
by property type, borrower and geographic dispersion. The risks to any CMBS deal
are determined by the credit quality of the underlying loans and how those loans
perform over time. Another key risk is the vintage of the underlying loans and
the state of the markets during a particular vintage. In the CMBS market, there
is a material difference in the outlook for the performance of loans originated
in 2005 and earlier relative to loans originated in 2006 through 2008. For loans
originated prior to 2006, underwriting assumptions were more conservative
regarding required debt service coverage and loan-to-value ratios. For the 2006
through 2008 vintages, real estate values peaked and the underwriting
expectations were that values would continue to increase, which makes those loan
values more sensitive to market declines. The 2009 through 2012 vintages
represent a return to debt service coverage ratios and loan-to-value ratios that
more closely resemble loans originated prior to 2006.
We purchase ABS to diversify the overall credit risks of the fixed maturities
portfolio and to provide attractive returns. The principal risks in holding ABS
are structural and credit risks. Structural risks include the security's
priority in the issuer's capital structure, the adequacy of and ability to
realize proceeds from the collateral and the potential for prepayments. Credit
risks involve issuer/servicer risk where collateral values can become impaired
in the event of servicer credit deterioration. Our ABS portfolio is diversified
both by type of asset and by issuer. We actively monitor holdings of ABS to
ensure that the risk profile of each security improves or remains consistent.
Prepayments in the ABS portfolio are, in general, insensitive to changes in
interest rates or are insulated from such changes by call protection features.
In the event that we are subject to prepayment risk, we monitor the factors that
impact the level of prepayment and prepayment speed for those ABS. In addition,
we diversify the risks of ABS by holding a diverse class of securities, which
limits our exposure to any one security.
The international exposure held in our U.S. operation's fixed maturities
portfolio was 26% and 26% of total fixed maturities as of June 30, 2012 and
December 31, 2011, respectively. It is comprised of corporate and foreign
government fixed maturities. The following table presents the carrying amount of
our international exposure for our U.S. operation's fixed maturities portfolio
for the periods indicated.
June 30, 2012 December 31, 2011
(in millions)
European Union $ 4,301.0 $ 4,132.1
United Kingdom 2,448.8 2,329.5
Australia/New Zealand 1,422.2 1,490.1
Asia-Pacific 1,212.1 1,172.3
Latin America 870.4 868.8
Other countries (1) 2,087.2 2,139.8
Total $ 12,341.7 $ 12,132.6
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(1) Includes exposure from 13 countries as of June 30, 2012 and 14 countries
as of December 31, 2011.
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International fixed maturities are determined by the country of domicile of the
parent entity of an individual asset. All international fixed maturities held by
our U.S. operations are either denominated in U.S. dollars or have been swapped
into U.S. dollar equivalents. Our international investments are analyzed
internally by country and industry credit investment professionals. We control
concentrations using issuer and country level exposure benchmarks, which are
based on the credit quality of the issuer and the country. Our investment policy
limits total international fixed maturities investments and we are within those
internal limits. Exposure to Canada is not included in our international
exposure. As of June 30, 2012 and December 31, 2011, our investments in Canada
totaled $1,775.9 million and $1,749.1 million, respectively.
Economic and fiscal conditions in select European countries, including
Greece, Ireland, Italy, Portugal and Spain, continue to cause credit concerns
particularly to financial institutions and banks with exposure to the European
periphery region. Our exposure to the region within our U.S. investment
operations fixed maturities portfolio is modest and manageable, representing
2.3% and 2.4% of total fixed maturities as of June 30, 2012 and December 31,
2011, respectively. Additionally, we did not hold any sovereign debt issuances
of the selected countries and had not bought or sold credit protection on
sovereign issuances as of June 30, 2012 and December 31, 2011.
The fixed maturities within our U.S. operations portfolio with exposure to the
region are primarily corporate credit issuances of large multinational companies
where the majority of revenues are coming from outside the country where the
parent company is domiciled. Our experience indicates multinational companies
have demonstrated better market price performance and credit ratings stability.
As of June 30, 2012, 94% of our total portfolio exposure consists of investment
grade bonds with an average price of 98 (carrying value/amortized cost) and a
weighted average time to maturity of 5 years.
The following table presents the carrying amount of our European periphery zone
fixed maturities exposure for the periods indicated:
June 30, 2012
Select European Exposure Greece Ireland Italy Portugal Spain Total
(in millions)
Non-Sovereign:
Financial institutions $ - $ 62.9 $ 57.4 $ - $ 162.3 $ 282.6
Non-financial institutions 7.6 261.9 224.6 21.6 272.1 787.8
Total $ 7.6 $ 324.8 $ 282.0 $ 21.6 $ 434.4 $ 1,070.4
December 31, 2011
Select European Exposure Greece Ireland Italy Portugal Spain Total
(in millions)
Non-Sovereign:
Financial institutions $ - $ 62.1 $ 53.7 $ - $ 152.2 $ 268.0
Non-financial institutions 7.1 295.5 223.9 19.9 284.5 830.9
Total $ 7.1 $ 357.6 $ 277.6 $ 19.9 $ 436.7 $ 1,098.9
For further details on our International investment operations exposure to these
European countries, see "International Investment Operations - Fixed Maturities
Exposure."
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Fixed Maturities Credit Concentrations. One aspect of managing credit risk is
through industry, issuer and asset class diversification. Our credit
concentrations are managed to established limits. The following table presents
our top ten exposures as of June 30, 2012.
Amortized cost
(in millions)
Berkshire Hathaway Inc. $ 209.1
General Electric Co. 205.1
AT&T Inc. 196.5
Wells Fargo & Co. 176.5
Bank of America Corp. 159.8
Rabobank Netherlands 158.4
JPMorgan Chase & Co. 156.0
Verizon Communications Inc. 154.5
Credit Suisse Group AG (1) 151.4
Republic of Korea 150.7
Total top ten exposures $ 1,718.0
--------------------------------------------------------------------------------
(1) Includes actual counterparty exposure.
Fixed Maturities Valuation and Credit Quality. Valuation techniques for the
fixed maturities portfolio vary by security type and the availability of market
data. The use of different pricing techniques and their assumptions could
produce different financial results. See Item 1. "Financial Statements, Notes to
Unaudited Consolidated Financial Statements, Note 9, Fair Value Measurements"
for further details regarding our pricing methodology. Once prices are
determined, they are reviewed by pricing analysts for reasonableness based on
asset class and observable market data. In addition, investment analysts who are
familiar with specific securities review prices for reasonableness through
direct interaction with external sources, review of recent trade activity or use
of internal models. All fixed maturities placed on the "watch list" are
periodically analyzed by investment analysts or analysts that focus on troubled
securities ("Workout Group"). This group then meets with the Chief Investment
Officer and the Portfolio Managers to determine reasonableness of prices. The
valuation of impaired bonds for which there is no quoted price is typically
based on the present value of the future cash flows expected to be received.
Although we believe these values reasonably reflect the fair value of those
securities, the key assumptions about risk premiums, performance of underlying
collateral (if any) and other market factors involve qualitative and
unobservable inputs.
The Securities Valuation Office (''SVO'') of the National Association of
Insurance Commissioners (''NAIC'') monitors the bond investments of insurers for
regulatory capital and reporting purposes and, when required, assigns securities
to one of six investment categories. For certain bonds, the NAIC designations
closely mirror the Nationally Recognized Statistical Rating Organizations'
("NRSRO") credit ratings. For most corporate bonds, NAIC designations 1 and 2
include bonds considered investment grade by such rating organizations. Bonds
are considered investment grade when rated ''Baa3'' or higher by Moody's, or
''BBB-'' or higher by S&P. NAIC designations 3 through 6 are referred to as
below investment grade. Bonds are considered below investment grade when rated
''Ba1'' or lower by Moody's, or ''BB+'' or lower by S&P.
However, for loan-backed and structured securities, as defined by the NAIC, the
NAIC rating is not always equivalent to an NRSRO rating as described below. For
non-agency RMBS, PIMCO Advisors models and assigns the NAIC ratings. For CMBS,
Blackrock Solutions undertakes the modeling and assignment of those NAIC
ratings. Other loan-backed and structured securities may be subject to an
intrinsic price matrix as provided by the NAIC. This may result in a final
designation being higher or lower than the NRSRO credit rating.
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The following table presents our total fixed maturities by NAIC designation and
the equivalent ratings of the NRSROs as of the periods indicated as well as the
percentage, based on fair value, that each designation comprises.
June 30, 2012 December 31, 2011
% of total % of total
NAIC Amortized Carrying carrying Carrying carrying
Rating Rating Agency Equivalent cost amount amount Amortized cost amount amount
($ in millions)
1 AAA/AA/A $ 26,683.4 $ 28,450.4 60 % $ 26,802.2 $ 28,115.1 60 %
2 BBB 14,450.3 15,288.1 33 14,570.4 15,195.9 33
3 BB 2,610.8 2,383.3 5 2,537.5 2,405.8 5
4 B 687.5 530.0 1 759.1 582.3 1
5 CCC and lower 398.9 319.4 1 329.4 255.5 1
6 In or near default 247.9 132.1 - 273.4 154.7 -
Total fixed maturities $ 45,078.8 $ 47,103.3 100 % $ 45,272.0 $ 46,709.3 100 %
Fixed maturities include 19 securities with an amortized cost of $220.9 million,
gross gains of $11.2 million, gross losses of $0.6 million and a carrying amount
of $231.5 million as of June 30, 2012, that are still pending a review and
assignment of a rating by the SVO. Due to the timing of when fixed maturities
are purchased, legal documents are filed and the review by the SVO is completed,
there will always be securities in our portfolio that are unrated over a
reporting period. In these instances, an equivalent rating is assigned based on
our fixed income analyst's assessment.
Commercial Mortgage-Backed Securities and Home Equity Asset-Backed Securities
Portfolios. As of June 30, 2012, based on amortized cost, 54% of our CMBS
portfolio had ratings of A or higher and 35% was issued in 2005 or before and
12% of our ABS home equity portfolio had ratings of A or higher and 87% was
issued in 2005 or before.
The following tables present our exposure by credit quality, based on the lowest
NRSRO designation, and year of issuance ("vintage") for our CMBS portfolio as of
the periods indicated.
June 30, 2012
AAA AA A BBB BB+ and Below Total
Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying
cost amount cost amount cost amount cost amount cost amount cost amount
(in millions)
2003 & Prior $ 55.6 $ 55.4 $ 75.1 $ 75.7 $ 43.2 $ 43.6 $ 73.5 $ 70.7 $ 144.0 $ 103.6 $ 391.4 $ 349.0
2004 86.0 89.5 56.9 58.3 46.8 45.7 23.2 18.2 117.1 93.2 330.0 304.9
2005 341.2 369.3 43.8 49.0 40.0 38.4 70.5 59.8 245.4 155.5 740.9 672.0
2006 152.3 160.6 4.8 5.6 90.4 96.8 37.7 38.8 177.6 116.4 462.8 418.2
2007 194.8 192.7 30.9 34.5 160.1 181.2 232.8 253.5 718.5 443.2 1,337.1 1,105.1
2008 11.3 11.9 15.0 17.0 28.4 33.1 15.0 15.6 31.4 29.3 101.1 106.9
2009 112.2 115.9 88.0 92.9 - - - - - - 200.2 208.8
2010 60.9 66.1 68.7 70.8 - - - - - - 129.6 136.9
2011 101.3 104.0 87.9 91.0 - - - - - - 189.2 195.0
2012 92.2 92.6 157.1 159.0 - - - - - - 249.3 251.6
Total $ 1,207.8 $ 1,258.0 $ 628.2 $ 653.8 $ 408.9 $ 438.8 $ 452.7 $ 456.6 $ 1,434.0 $ 941.2 $ 4,131.6 $ 3,748.4
December 31, 2011
AAA AA A BBB BB+ and Below Total
Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying
cost amount cost amount cost amount cost amount cost amount cost amount
(in millions)
2003 & Prior $ 147.0 $ 142.3 $ 81.3 $ 81.4 $ 72.2 $ 70.2 $ 94.6 $ 85.2 $ 117.8 $ 79.9 $ 512.9 $ 459.0
2004 146.5 149.6 56.8 56.9 45.2 41.6 25.1 18.8 79.4 54.7 353.0 321.6
2005 362.0 392.4 43.5 48.0 18.3 17.1 77.5 61.6 225.0 128.7 726.3 647.8
2006 203.4 209.2 4.8 5.6 58.6 62.9 14.6 14.5 151.9 89.9 433.3 382.1
2007 292.2 288.9 22.8 25.1 152.7 165.2 300.8 306.6 637.2 347.8 1,405.7 1,133.6
2008 - - 15.0 16.3 33.1 36.4 - - 38.1 32.7 86.2 85.4
2009 123.6 127.5 16.1 16.3 - - - - - - 139.7 143.8
2010 76.2 80.8 7.7 7.6 - - - - - - 83.9 88.4
2011 165.3 164.0 - - - - - - - - 165.3 164.0
Total $ 1,516.2 $ 1,554.7 $ 248.0 $ 257.2 $ 380.1 $ 393.4 $ 512.6 $ 486.7 $ 1,249.4 $ 733.7 $ 3,906.3 $ 3,425.7
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The following tables present our exposure by credit quality, based on the lowest
NRSRO designation, and vintage for our ABS home equity portfolio supported by
subprime first lien mortgages as of the periods indicated.
June 30, 2012
AAA AA A BBB BB+ and Below Total
Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying
cost amount cost amount cost amount cost amount cost amount cost amount
(in millions)
2003 & Prior $ 2.5 $ 2.5 $ 5.0 $ 5.0 $ 11.6 $ 11.1 $ 20.0 $ 19.3 $ 147.3 $ 118.0 $ 186.4 $ 155.9
2004 - - - - 22.6 21.7 3.3 3.3 45.3 37.5 71.2 62.5
2005 - - - - 3.0 3.1 - - 71.8 48.3 74.8 51.4
2006 - - - - - - - - 14.2 11.4 14.2 11.4
2007 - - - - - - - - 37.0 30.1 37.0 30.1
Total $ 2.5 $ 2.5 $ 5.0 $ 5.0 $ 37.2 $ 35.9 $ 23.3 $ 22.6 $ 315.6 $ 245.3 $ 383.6 $ 311.3
December 31, 2011
AAA AA A BBB BB+ and Below Total
Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying
cost amount cost amount cost amount cost amount cost amount cost amount
(in millions)
2003 & Prior $ 12.3 $ 12.3 $ 7.3 $ 7.0 $ 12.7 $ 12.0 $ 61.2 $ 54.8 $ 102.7 $ 77.1 $ 196.2 $ 163.2
2004 1.5 1.4 12.6 11.9 8.4 7.8 2.1 2.1 47.1 38.3 71.7 $ 61.5
2005 - - 3.0 3.1 - - - - 67.8 43.3 70.8 $ 46.4
2006 - - - - - - - - 14.9 9.5 14.9 $ 9.5
2007 - - - - - - - - 37.2 27.8 37.2 $ 27.8
Total $ 13.8 $ 13.7 $ 22.9 $ 22.0 $ 21.1 $ 19.8 $ 63.3 $ 56.9 $ 269.7 $ 196.0 $ 390.8 $ 308.4
Fixed Maturities Watch List. We monitor any decline in the credit quality of
fixed maturities through the designation of "problem securities," "potential
problem securities" and "restructured securities". We define problem securities
in our fixed maturity portfolio as securities: (i) as to which principal and/or
interest payments are in default or where default is perceived to be imminent in
the near term, or (ii) issued by a company that went into bankruptcy subsequent
to the acquisition of such securities. We define potential problem securities in
our fixed maturity portfolio as securities included on an internal "watch list"
for which management has concerns as to the ability of the issuer to comply with
the present debt payment terms and which may result in the security becoming a
problem or being restructured. The decision whether to classify a performing
fixed maturity security as a potential problem involves significant subjective
judgments by our management as to the likely future industry conditions and
developments with respect to the issuer. We define restructured securities in
our fixed maturity portfolio as securities where a concession has been granted
to the borrower related to the borrower's financial difficulties that would not
have otherwise been considered. We determine that restructures should occur in
those instances where greater economic value will be realized under the new
terms than through liquidation or other disposition and may involve a change in
contractual cash flows. If the present value of the restructured cash flows is
less than the current cost of the asset being restructured, a realized capital
loss is recorded in net income and a new cost basis is established.
The following table presents the total carrying amount of our fixed maturities
portfolio, as well as its problem, potential problem and restructured fixed
maturities for the periods indicated.
June 30, 2012 December 31, 2011
($ in millions)
Total fixed maturities (public and private) $ 47,103.3 $ 46,709.3
Problem fixed maturities (1) $ 357.2 $ 343.5
Potential problem fixed maturities 162.3 166.3
Restructured problem fixed maturities 15.3 14.6
Total problem, potential problem and restructured
fixed maturities $ 534.8 $ 524.4
Total problem, potential problem and restructured
fixed maturities as a percent of total fixed
maturities 1.14 % 1.12 %
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(1) The problem fixed maturities carrying amount is net of
other-than-temporary impairment losses.
Fixed Maturities Impairments. We have a process in place to identify 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.
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Each reporting period, a group of individuals including the Chief Investment
Officer, our Portfolio Managers, members of our Workout Group and
representatives from Investment Accounting review all securities to determine
whether an other-than-temporary decline in value exists and whether losses
should be recognized. The analysis focuses on each issuer's ability to service
its debts in a timely fashion. Formal documentation of the analysis and our
decision is prepared and approved by management.
We consider relevant facts and circumstances in evaluating whether a credit or
interest-rate 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 and (5) our intent to sell the security
or whether it is more likely than not we will be required to sell the security
before recovery of its amortized cost which, in some cases, may extend to
maturity. To the extent we determine that a security is deemed to be other than
temporarily impaired, an impairment loss is recognized. For additional details,
see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial
Statements, Note 3, Investments."
We would not consider a security with unrealized losses to be other than
temporarily impaired when it is not our intent to sell the security, it is not
more likely than not that we would be required to sell the security before
recovery of the amortized cost, which may be maturity, and we expect to recover
the amortized cost basis. However, we do sell securities under certain
circumstances, such as when we have evidence of a change in the issuer's
creditworthiness, when we anticipate poor relative future performance of
securities, when a change in regulatory requirements modifies what constitutes a
permissible investment or the maximum level of investments held or when there is
an increase in capital requirements or a change in risk weights of debt
securities. Sales generate both gains and losses.
There are a number of significant risks and uncertainties inherent in the
process of monitoring credit impairments and determining if an impairment is
other than temporary. These risks and uncertainties include: (1) the risk that
our assessment of an issuer's ability to meet all of its contractual obligations
will change based on changes in the credit characteristics of that issuer,
(2) the risk that the economic outlook will be worse than expected or have more
of an impact on the issuer than anticipated, (3) the risk that our investment
professionals are making decisions based on fraudulent or misstated information
in the financial statements provided by issuers and (4) the risk that new
information obtained by us or changes in other facts and circumstances lead us
to change our intent to not sell the security prior to recovery of its amortized
cost. Any of these situations could result in a charge to net income in a future
period.
The net realized loss relating to other-than-temporary credit impairments and
credit related sales of fixed maturities was $60.8 million and $97.2 million for
the six months ended June 30, 2012 and 2011, respectively.
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Fixed Maturities Available-for-Sale
The following tables present our fixed maturities available-for-sale by industry
category and the associated gross unrealized gains and losses, including
other-than-temporary impairment losses reported in AOCI, as of the periods
indicated.
June 30, 2012
Gross Gross Carrying
Amortized cost unrealized gains unrealized losses amount
(in millions)
Finance - Banking $ 4,584.4 $ 137.4 $ 350.7 $ 4,371.1
Finance - Brokerage 370.6 21.3 2.8 389.1
Finance - Finance Companies 221.4 10.9 1.2 231.1
Finance - Financial Other 536.6 74.3 0.3 610.6
Finance - Insurance 2,894.9 227.0 43.3 3,078.6
Finance - REITS 1,038.9 42.9 10.8 1,071.0
Industrial - Basic Industry 1,649.3 138.1 3.9 1,783.5
Industrial - Capital Goods 2,055.5 170.9 4.5 2,221.9
Industrial - Communications 2,174.0 196.1 23.4 2,346.7
Industrial - Consumer Cyclical 1,533.3 150.8 5.1 1,679.0
Industrial - Consumer Non-Cyclical 3,256.4 310.9 1.8 3,565.5
Industrial - Energy 1,917.3 227.5 1.8 2,143.0
Industrial - Other 469.3 32.8 1.4 500.7
Industrial - Technology 863.0 63.7 2.8 923.9
Industrial - Transportation 613.0 52.3 6.9 658.4
Utility - Electric 2,766.0 291.3 20.0 3,037.3
Utility - Natural Gas 990.8 117.7 1.5 1,107.0
Utility - Other 249.9 27.4 - 277.3
FDIC guaranteed 5.0 - - 5.0
Government guaranteed 1,143.5 127.1 3.6 1,267.0
Total corporate securities 29,333.1 2,420.4 485.8 31,267.7
Residential mortgage-backed
pass-through securities 3,070.7 200.5 0.2 3,271.0
Commercial mortgage-backed
securities 4,128.1 161.1 544.3 3,744.9
Residential collateralized
mortgage obligations 1,199.3 30.8 32.1 1,198.0
Asset-backed securities - Home
equity (1) 383.6 0.5 72.8 311.3
Asset-backed securities - All
other 1,942.6 29.1 0.8 1,970.9
Collateralized debt obligations -
Credit 83.0 - 47.8 35.2
Collateralized debt obligations -
CMBS 95.3 2.1 20.8 76.6
Collateralized debt obligations -
Loans 245.1 0.8 4.8 241.1
Collateralized debt obligations -
ABS 15.0 - 1.8 13.2
Total mortgage-backed and other
asset-backed securities 11,162.7 424.9 725.4 10,862.2
U.S. government and agencies 790.9 34.1 0.9 824.1
States and political subdivisions 2,638.4 232.4 1.4 2,869.4
Non-U.S. governments 566.7 126.3 0.1 692.9
Total fixed maturities,
available-for-sale $ 44,491.8 $ 3,238.1 $ 1,213.6 $ 46,516.3
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(1) This exposure is all related to sub-prime mortgage loans.
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December 31, 2011
Gross Gross
Amortized unrealized unrealized Carrying
cost gains losses amount
(in millions)
Finance - Banking $ 4,520.7 $ 79.9 $ 445.5 $ 4,155.1
Finance - Brokerage 381.0 15.4 6.7 389.7
Finance - Finance Companies 216.2 8.9 4.7 220.4
Finance - Financial Other 532.4 55.5 1.1 586.8
Finance - Insurance 2,966.3 227.2 73.0 3,120.5
Finance - REITS 1,015.2 28.3 22.0 1,021.5
Industrial - Basic Industry 1,656.6 135.3 5.4 1,786.5
Industrial - Capital Goods 2,133.0 146.8 14.3 2,265.5
Industrial - Communications 2,033.2 179.9 23.8 2,189.3
Industrial - Consumer Cyclical 1,606.7 130.5 12.4 1,724.8
Industrial - Consumer
Non-Cyclical 3,084.0 286.3 3.7 3,366.6
Industrial - Energy 1,978.4 220.9 1.2 2,198.1
Industrial - Other 596.1 32.5 3.9 624.7
Industrial - Technology 851.3 57.7 9.3 899.7
Industrial - Transportation 626.2 45.7 10.3 661.6
Utility - Electric 2,709.6 276.0 18.9 2,966.7
Utility - Natural Gas 1,034.2 100.2 1.8 1,132.6
Utility - Other 197.1 20.1 - 217.2
FDIC guaranteed 80.0 0.6 - 80.6
Government guaranteed 1,219.0 107.8 7.8 1,319.0
Total corporate securities 29,437.2 2,155.5 665.8 30,926.9
Residential mortgage-backed
pass-through securities 3,130.8 185.6 0.7 3,315.7
Commercial mortgage-backed
securities 3,894.3 117.0 597.6 3,413.7
Residential collateralized
mortgage obligations 1,408.1 32.0 51.5 1,388.6
Asset-backed securities - Home
equity (1) 390.8 0.2 82.6 308.4
Asset-backed securities - All
other 1,808.0 68.1 2.9 1,873.2
Collateralized debt obligations
- Credit 82.8 - 34.4 48.4
Collateralized debt obligations
- CMBS 98.7 1.6 18.5 81.8
Collateralized debt obligations
- Loans 203.2 0.3 8.8 194.7
Collateralized debt obligations
- ABS 15.0 - 1.1 13.9
Total mortgage-backed and other
asset-backed securities 11,031.7 404.8 798.1 10,638.4
U.S. government and agencies 772.3 32.8 - 805.1
States and political
subdivisions 2,670.0 218.2 5.5 2,882.7
Non-U.S. governments 580.7 96.3 0.9 676.1
Total fixed maturities,
available-for-sale $ 44,491.9 $ 2,907.6 $ 1,470.3 $ 45,929.2
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(1) This exposure is all related to sub-prime mortgage loans.
Of the $1,213.6 million in gross unrealized losses as of June 30, 2012, there
were $4.9 million in losses attributed to securities scheduled to mature in one
year or less, $68.9 million attributed to securities scheduled to mature between
one to five years, $35.8 million attributed to securities scheduled to mature
between five to ten years, $378.6 million attributed to securities scheduled to
mature after ten years and $725.4 million related to mortgage-backed and other
ABS that are not classified by maturity year. As of June 30, 2012, we were in a
$2,024.5 million net unrealized gain position as compared to a $1,437.3 million
net unrealized gain position as of December 31, 2011. Of the $587.2 million
increase in net unrealized gains for the six months ended June 30, 2012, an
approximate $0.2 billion of the increase can be attributed to an approximate 7
basis points decrease in interest rates in addition to other market factors that
increased unrealized gains.
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Fixed Maturities Available-for-Sale Unrealized Losses. We believe that our
long-term fixed maturities portfolio is well diversified among industry types
and between publicly traded and privately placed securities. Each year, we
direct the majority of our net cash inflows into investment grade fixed
maturities. Our current policy is to limit the percentage of cash flow invested
in below investment grade assets to 10% of cash flow. During the first half of
2012, we did not actively increase our investment in available-for-sale below
investment grade assets. While Principal Life's general account investment
returns have improved due to the below investment grade asset class, we manage
its growth strategically by limiting it to no more than 10% of the total fixed
maturities portfolios.
We invest in privately placed fixed maturities to enhance the overall value of
the portfolio, increase diversification and obtain higher yields than are
possible with comparable quality public market securities. Generally, private
placements provide broader access to management information, strengthened
negotiated protective covenants, call protection features and, where applicable,
a higher level of collateral. They are, however, generally not freely tradable
because of restrictions imposed by federal and state securities laws and
illiquid trading markets.
The following table presents our fixed maturities available-for-sale by
investment grade and below investment grade and the associated gross unrealized
gains and losses, including the other-than-temporary impairment losses reported
in OCI, as of the periods indicated.
June 30, 2012 December 31, 2011
Gross Gross Gross Gross
Amortized unrealized unrealized Carrying Amortized unrealized unrealized Carrying
cost gains losses amount cost gains losses amount
(in millions)
Investment grade:
Public $ 28,251.8 $ 2,258.5 $ 312.6 $ 30,197.7 $ 28,497.9$ 1,989.8 $ 435.0 $ 30,052.7
Private
12,463.2 895.1 236.2 13,122.1 12,298.2 757.4 373.8 12,681.8
Below investment
grade:
Public 1,871.8 27.9 348.0 1,551.7 1,834.4 21.3 365.1 1,490.6
Private 1,905.0 56.6 316.8 1,644.8 1,861.4 139.1 296.4 1,704.1
Total fixed
maturities,
available-for-sale $ 44,491.8 $ 3,238.1 $ 1,213.6 $ 46,516.3 $ 44,491.9 $ 2,907.6 $ 1,470.3 $ 45,929.2
The following tables present the carrying amount and the gross unrealized
losses, including other-than-temporary impairment losses reported in OCI, on
investment grade fixed maturities available-for-sale by aging category as of the
periods indicated.
June 30, 2012
Public Private Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 576.6 $ 5.8 $ 345.0 $ 6.0 $ 921.6 $ 11.8
Greater than three to six
months 147.5 7.6 145.2 2.2 292.7 9.8
Greater than six to nine
months 116.3 3.3 36.8 0.6 153.1 3.9
Greater than nine to
twelve months 321.1 12.1 236.1 9.7 557.2 21.8
Greater than twelve to
twenty-four months 445.0 40.1 374.6 22.4 819.6 62.5
Greater than twenty-four
to thirty-six months 93.9 14.8 5.4 1.0 99.3 15.8
Greater than thirty-six
months 933.4 228.9 886.2 194.3 1,819.6 423.2
Total fixed maturities,
available-for-sale $ 2,633.8 $ 312.6 $ 2,029.3 $ 236.2 $ 4,663.1 $ 548.8
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December 31, 2011
Public Private Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 897.5 $ 14.1 $ 472.0 $ 4.9 $ 1,369.5 $ 19.0
Greater than three
to six months 1,022.9 33.7 747.1 24.0 1,770.0 57.7
Greater than six to
nine months 420.3 40.7 337.4 20.2 757.7 60.9
Greater than nine to
twelve months 61.8 5.5 65.2 3.4 127.0 8.9
Greater than twelve
to twenty-four
months 135.0 15.8 184.5 20.5 319.5 36.3
Greater than
twenty-four to
thirty-six months 65.7 16.3 30.0 5.5 95.7 21.8
Greater than
thirty-six months 1,122.5 308.9 1,138.0 295.3 2,260.5 604.2
Total fixed
maturities,
available-for-sale $ 3,725.7 $ 435.0 $ 2,974.2 $ 373.8 $ 6,699.9 $ 808.8
The following tables present the carrying amount and the gross unrealized
losses, including other-than-temporary impairment losses reported in OCI, on
below investment grade fixed maturities available-for-sale by aging category as
of the periods indicated.
June 30, 2012
Public Private Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 69.5 $ 1.1 $ 184.3 $ 3.1 $ 253.8 $ 4.2
Greater than three
to six months 4.9 - 53.0 4.5 57.9 4.5
Greater than six to
nine months 26.4 1.1 17.4 1.0 43.8 2.1
Greater than nine to
twelve months 57.2 2.8 45.5 1.9 102.7 4.7
Greater than twelve
to twenty-four
months 79.9 17.9 46.2 10.6 126.1 28.5
Greater than
twenty-four to
thirty-six months 3.6 0.3 18.3 4.4 21.9 4.7
Greater than
thirty-six months 702.0 324.8 433.7 291.3 1,135.7 616.1
Total fixed
maturities,
available-for-sale $ 943.5 $ 348.0 $ 798.4 $ 316.8 $ 1,741.9 $ 664.8
December 31, 2011
Public Private Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 123.4 $ 3.6 $ 72.3 $ 6.3
$ 195.7 $ 9.9
Greater than three
to six months 71.3 8.1 165.4 12.4 236.7 20.5
Greater than six to
nine months 74.3 11.5 30.8 1.9 105.1 13.4
Greater than nine to
twelve months 16.9 9.5 29.5 1.6 46.4 11.1
Greater than twelve
to twenty-four
months 42.2 11.8 18.9 4.4 61.1 16.2
Greater than
twenty-four to
thirty-six months 17.9 3.6 1.3 0.3 19.2 3.9
Greater than
thirty-six months 693.0 317.0 483.5 269.5 1,176.5 586.5
Total fixed
maturities,
available-for-sale $ 1,039.0 $ 365.1 $ 801.7 $ 296.4 $ 1,840.7 $ 661.5
The following tables present the carrying amount and the gross unrealized
losses, including other-than-temporary impairment losses reported in OCI, on
fixed maturities available-for-sale where the estimated fair value had declined
and remained below amortized cost by 20% or more as of the periods indicated.
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June 30, 2012
Problem, potential problem, All other fixed maturity
and restructured securities Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 5.2 $ 1.3 $ 133.0 $ 42.8 $ 138.2 $ 44.1
Greater than three to
six months
7.2 6.9 24.1 10.3 31.3 17.2
Greater than six to
nine months - - 28.6 14.1 28.6 14.1
Greater than nine to
twelve months 42.0 24.1 264.5 139.1 306.5 163.2
Greater than twelve
months 178.5 278.7 428.1 407.1 606.6 685.8
Total fixed
maturities,
available-for-sale $ 232.9 $ 311.0 $ 878.3 $ 613.4 $ 1,111.2 $ 924.4
December 31, 2011
Problem, potential problem, All other fixed maturity
and restructured securities Total
Gross Gross Gross
Carrying unrealized Carrying unrealized Carrying unrealized
amount losses amount losses amount losses
(in millions)
Three months or less $ 42.4 $ 14.0 $ 231.7 $ 75.5 $ 274.1 $ 89.5
Greater than three to
six months 74.4 32.2 587.3 263.9 661.7 296.1
Greater than six to
nine months 18.2 11.6 77.6 47.2 95.8 58.8
Greater than nine to
twelve months 3.5 1.6 6.9 8.5 10.4 10.1
Greater than twelve
months 171.9 262.4 452.8 387.6 624.7 650.0
Total fixed
maturities,
available-for-sale $ 310.4 $ 321.8 $ 1,356.3 $ 782.7 $ 1,666.7 $ 1,104.5
Mortgage Loans
Mortgage loans consist of commercial mortgage loans on real estate and
residential mortgage loans. The carrying amount of our commercial mortgage loan
portfolio was $9,814.0 million and $9,386.0 million as of June 30, 2012 and
December 31, 2011, respectively. The carrying amount of our residential mortgage
loan portfolio was $713.3 million and $746.0 million as of June 30, 2012 and
December 31, 2011, respectively.
Commercial Mortgage Loans. We generally report commercial mortgage loans on real
estate at cost adjusted for amortization of premiums and accrual of discounts,
computed using the interest method and net of valuation allowances.
Commercial mortgage loans play an important role in our investment strategy by:
† providing strong risk-adjusted relative value in comparison to other
investment alternatives;
† enhancing total returns and
† providing strategic portfolio diversification.
As a result, we have focused on constructing a solid, high quality portfolio of
mortgages. Our portfolio is generally comprised of mortgages originated with
conservative loan-to-value ratios, high debt service coverages and general
purpose property types with a strong credit tenancy.
Our commercial mortgage loan portfolio consists primarily of non-recourse, fixed
rate mortgages on fully or near fully leased properties. The mortgage portfolio
is comprised primarily of credit oriented retail properties, office properties
and general-purpose industrial properties.
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Our commercial mortgage loan portfolio is diversified by geography and specific
collateral property type. Commercial mortgage lending in the state of California
accounted for 19% and 22% of our commercial mortgage loan portfolio as of
June 30, 2012 and December 31, 2011, respectively. We are, therefore, exposed to
potential losses resulting from the risk of catastrophes, such as earthquakes,
that may affect the region. Like other lenders, we generally do not require
earthquake insurance for properties on which we make commercial mortgage loans.
With respect to California properties, however, we obtain an engineering report
specific to each property. The report assesses the building's design
specifications, whether it has been upgraded to meet seismic building codes and
the maximum loss that is likely to result from a variety of different seismic
events. We also obtain a report that assesses, by building and geographic fault
lines, the amount of loss our commercial mortgage loan portfolio might suffer
under a variety of seismic events.
The typical borrower in our commercial loan portfolio is a single purpose entity
or single asset entity. As of June 30, 2012 and December 31, 2011, the total
number of commercial mortgage loans outstanding was 973 and 975, of which 70%
and 71% were for loans with principal balances less than $10 million,
respectively. The average loan size of our commercial mortgage portfolio was
$10.1 million and $9.7 million as of June 30, 2012 and December 31, 2011,
respectively.
Commercial Mortgage Loan Credit Monitoring. For further details on monitoring
and management of our commercial mortgage loan portfolio, see Item 1. "Financial
Statements, Notes to Unaudited Consolidated Financial Statements, Note
3, Investments - Mortgage Loan Credit Monitoring."
We categorize loans that are 60 days or more delinquent, loans in process of
foreclosure and loans with borrowers or credit tenants in bankruptcy that are
delinquent as "problem" loans. Valuation allowances or charge-offs have been
recognized on most problem loans. We categorize loans that are delinquent less
than 60 days where the default is expected to be cured and loans with borrowers
or credit tenants in bankruptcy that are current as "potential problem" loans.
The decision whether to classify a loan delinquent less than 60 days as a
potential problem involves significant subjective judgments by management as to
the likely future economic conditions and developments with respect to the
borrower. We categorize loans for which the original note rate has been reduced
below market and loans for which the principal has been reduced as
"restructured" loans. We also consider loans that are refinanced more than one
year beyond the original maturity or call date at below market rates as
restructured.
There has been a decrease in the total level of problem, potential problem and
restructured commercial mortgages during 2012 primarily due to loan payoffs,
foreclosures, and improvement in collateral occupancies and values. The South
Atlantic regions account for over 80% of the problem, potential problem and
restructured commercial mortgages as of June 30, 2012. The South Atlantic,
Pacific, and East North Central regions accounted for over 90% of the problem,
potential problem, and restructured commercial mortgages as of December 31,
2011. Office properties accounted for over half of the problem, potential
problem and restructured commercial mortgages as of June 30, 2012. Office and
apartment properties accounted for over half of the problem, potential problem
and restructured commercial mortgages as of December 31, 2011.
The following table presents the carrying amounts of problem, potential problem
and restructured commercial mortgages relative to the carrying amount of all
commercial mortgages for the periods indicated.
June 30, 2012 December 31, 2011
($ in millions)
Total commercial mortgages $ 9,814.0 $ 9,386.0
Problem commercial mortgages $ 44.6 $ 112.7
Potential problem commercial mortgages 134.0 152.8
Restructured problem commercial mortgages 6.8 7.5
Total problem, potential problem and restructured
commercial mortgages $ 185.4 $ 273.0
Total problem, potential problem and restructured
commercial mortgages as a percent of total
commercial mortgages 1.89 % 2.91 %
Commercial Mortgage Loan Valuation Allowance. The valuation allowance for
commercial mortgage loans includes loan specific reserves for loans that are
deemed to be impaired as well as reserves for pools of loans with similar
characteristics where a property risk or market specific risk has not been
identified but for which we anticipate a loss may occur. For further details on
the commercial mortgage valuation allowance, see Item 1. "Financial Statements,
Notes to Unaudited Consolidated Financial Statements, Note 3, Investments -
Mortgage Loan Valuation Allowance."
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The valuation allowance decreased $15.5 million for the six months ended
June 30, 2012, and decreased $15.8 million for the year ended December 31, 2011.
The decrease in the level of valuation allowance during 2012 and 2011 was
related to the same market factors as those causing the decrease in the level of
problem, potential problem and restructured commercial mortgages during the six
months ended June 30, 2012. The South Atlantic region accounts for the highest
level of reserves at both June 30, 2012 and December 31, 2011.
The following table represents our commercial mortgage valuation allowance for
the periods indicated.
June 30, 2012 December 31, 2011
($ in millions)
Balance, beginning of period $ 64.8 $ 80.6
Provision 10.4 17.0
Charge-offs (25.9 ) (32.9 )
Recoveries - 0.1
Balance, end of period $ 49.3 $ 64.8
Valuation allowance as % of carrying value before
reserves 0.50 % 0.69 %
Residential Mortgage Loans. The residential mortgage loan portfolio is composed
of home equity mortgages with an amortized cost of $552.7 million and $611.0
million and first lien mortgages with an amortized cost of $196.3 million and
$171.0 million as of June 30, 2012 and December 31, 2011, respectively,
primarily held by our Bank and Trust Services business. The home equity loans
are generally second lien mortgages made up of closed-end loans and lines of
credit. Non-performing residential mortgage loans, which are defined as loans 90
days or greater delinquent plus non-accrual loans, totaled $37.7 million and
$24.0 million as of June 30, 2012 and December 31, 2011, respectively. We
establish the residential mortgage loan valuation allowance at levels considered
adequate to absorb probable losses within the portfolio based on management's
evaluation of the size and current risk characteristics of the portfolio. Such
evaluation considers numerous factors, including, but not limited to net
charge-off trends, loss forecasts, collateral values, geographic location,
borrower credit scores, delinquency rates, industry condition and economic
trends. The changes in the valuation allowance are reported in net realized
capital gains (losses) on our consolidated statements of operations.
Our residential mortgage loan portfolio, and in particular our home equity loan
portfolio, experienced an increase in loss severity from sustained elevated
levels of unemployment along with continued depressed collateral values
beginning in 2010. While these factors continue to drive charge-offs, loss rates
are showing signs of stabilization and the portfolio balance is declining. The
following table represents our residential mortgage valuation allowance for the
periods indicated.
June 30, 2012 December 31, 2011
($ in millions)
Balance, beginning of period $ 36.0 $ 37.7
Provision 13.3 28.5
Charge-offs (15.6 ) (33.4 )
Recoveries 2.0 3.2
Balance, end of period $ 35.7 $ 36.0
Valuation allowance as % of carrying value before
reserves 4.8 % 4.6 %
Real Estate
Real estate consists primarily of commercial equity real estate. As of June 30,
2012 and December 31, 2011, the carrying amount of our equity real estate
investment was $1,165.9 million, or 2%, and $1,083.9 million, or 2%, of U.S.
invested assets, respectively. Our commercial equity real estate is held in the
form of wholly owned real estate, real estate acquired upon foreclosure of
commercial mortgage loans and majority owned interests in real estate joint
ventures.
Equity real estate is categorized as either "real estate held for investment" or
"real estate held for sale." Real estate held for investment totaled $1,114.7
million and $1,047.3 million as of June 30, 2012 and December 31, 2011,
respectively. The carrying value of real estate held for investment is generally
adjusted for impairment whenever events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. Such impairment
adjustments are recorded as net realized losses and, accordingly, are reflected
in our consolidated results of operations. For the six months ended June 30,
2012 and year ended December 31, 2011, there were no such impairment
adjustments.
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The carrying amount of real estate held for sale was $51.2 million and $36.6
million as of June 30, 2012 and December 31, 2011, respectively. There were no
valuation allowances as of June 30, 2012 or December 31, 2011. Once we identify
a real estate property to be sold and commence a plan for marketing the
property, we classify the property as held for sale. We establish a valuation
allowance subject to periodic revisions, if necessary, to adjust the carrying
value of the property to reflect the lower of its current carrying value or the
fair value, less associated selling costs.
We use research, both internal and external, to recommend appropriate product
and geographic allocations and changes to the equity real estate portfolio. We
monitor product, geographic and industry diversification separately and together
to determine the most appropriate mix.
Equity real estate is distributed across geographic regions of the country with
larger concentrations in the South Atlantic, West South Central, and Pacific
regions of the United States as of June 30, 2012. By property type, there is a
concentration in office, industrial, and retail that represented approximately
78% of the equity real estate portfolio as of June 30, 2012.
Other Investments
Our other investments totaled $1,807.5 million as of June 30, 2012, compared to
$1,783.5 million as of December 31, 2011. Derivative assets accounted for
$1,115.7 million and $1,156.5 million in other investments as of June 30, 2012
and December 31, 2011, respectively. The remaining invested assets include
equity method investments, which include real estate properties owned jointly
with venture partners and operated by the partners.
International Investment Operations
Of our invested assets, $5.5 billion were held by our Principal International
segment as of June 30, 2012. The assets are managed by either our Principal
Global Investors segment or by the local Principal International affiliate. Due
to the regulatory constraints in each country, each company maintains its own
investment policies. As shown in the following table, the major categories of
international invested assets as of June 30, 2012 and December 31, 2011, were
fixed maturities, other investments, residential mortgage loans and equity
securities. In addition, policy loans are included in our invested assets. The
following table excludes invested assets of the separate accounts.
June 30, 2012December 31, 2011
Carrying amount % of total
Carrying amount % of total
($ in millions)
Fixed maturities - Public $ 3,466.8 63 % $ 3,269.1 63 %
Equity securities 104.2 2 86.0 2
Mortgage loans:
Commercial 10.7 - 10.6 -
Residential 620.6 11 584.6 11
Real estate held for sale 7.4 - 8.2 -
Real estate held for investment 0.8 - 0.8 -
Policy loans 24.6 1 23.5 1
Other investments 1,289.3 23 1,202.3 23
Total invested assets 5,524.4 100 % 5,185.1 100 %
Cash and cash equivalents 155.2
92.2
Total invested assets and cash $ 5,679.6 $ 5,277.3
Investments in equity method subsidiaries and direct financing leases accounted
for $663.9 million and $565.7 million, respectively, of other investments as of
June 30, 2012, and $667.5 million and $507.5 million, respectively, of other
investments as of December 31, 2011. The remaining other investments as of both
June 30, 2012 and December 31, 2011, are primarily related to derivative assets
and other short-term investments.
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Fixed Maturities Exposure
Economic and fiscal conditions in select European countries, including
Greece, Ireland, Italy, Portugal and Spain, continue to cause credit concerns
particularly to financial institutions and banks with exposure to the European
periphery region. Our exposure to the region within our International investment
operations fixed maturities portfolio is manageable, representing 7.1% and 7.7%
of our total International invested assets as of June 30, 2012 and December 31,
2011, respectively. Portfolio holdings with exposure to this region consist of
fixed maturities issued in the same countries as our International operations by
local subsidiaries of the European parent. Nearly all of the exposure is to
bonds issued in Chile. In addition, we did not hold any sovereign debt issuances
of the selected countries and had not bought or sold credit protection on
sovereign issuances as of June 30, 2012 and December 31, 2011.
Financial sector exposure is to local subsidiary banks, subject to local capital
requirements and banking regulation. The current financial exposure carries an
average AA local rating from S&P and the average time to maturity is 18 years.
Non-financial sector exposure consists primarily of infrastructure bonds, which
are backed by the project itself, often with minimum revenue guarantees from the
government. The current non-financial exposure carries an average AA- local
rating from S&P. The current Italian exposure has an average time to maturity of
14 years. In addition, the current Spanish exposure has an average time to
maturity of 14 years. As of June 30, 2012, our total portfolio exposure had an
average price of 108 (carrying value/amortized cost).
The following table presents the carrying amount of our European periphery zone
fixed maturities exposure for the periods indicated.
June 30, 2012 December 31, 2011
Select European Exposure Italy Spain Total Italy Spain Total
(in millions)
Non-Sovereign:
Financial institutions $ - $ 252.7 $ 252.7 $ - $ 241.5 $ 241.5
Non-financial institutions 28.7 123.0 151.7 52.5 112.4 164.9
Total $ 28.7 $ 375.7 $ 404.4 $ 52.5 $ 353.9 $ 406.4
For further details on our U.S. investment operations exposure to these European
countries, see "U.S. Investment Operations - Fixed Maturities."
