PRINCIPAL FINANCIAL GROUP INC, 10-Q filed on 5/2/2019
Quarterly Report
v3.19.1
Document and Entity Information - shares
3 Months Ended
Mar. 31, 2019
Apr. 24, 2019
Document and Entity Information    
Entity Registrant Name PRINCIPAL FINANCIAL GROUP INC  
Entity Central Index Key 0001126328  
Document Type 10-Q  
Document Period End Date Mar. 31, 2019  
Amendment Flag false  
Current Fiscal Year End Date --12-31  
Entity Current Reporting Status Yes  
Entity Filer Category Large Accelerated Filer  
Entity Small Business false  
Entity Emerging Growth Company false  
Entity Common Stock, Shares Outstanding   278,548,135
Document Fiscal Year Focus 2019  
Document Fiscal Period Focus Q1  
v3.19.1
Consolidated Statements of Financial Position - USD ($)
$ in Millions
Mar. 31, 2019
Dec. 31, 2018
Assets    
Fixed maturities, available-for-sale (2019 and 2018 include $98.9 million and $94.5 million related to consolidated variable interest entities) $ 63,123.0 $ 60,108.5
Fixed maturities, trading 668.9 636.1
Equity securities (2019 and 2018 include $811.3 million and $774.8 million related to consolidated variable interest entities) 1,864.1 1,843.7
Mortgage loans 15,597.5 15,336.9
Real estate (2019 and 2018 include $376.1 million and $364.0 million related to consolidated variable interest entities) 1,736.7 1,729.7
Policy loans 798.5 801.4
Other investments (2019 and 2018 include $590.7 million and $457.9 million related to consolidated variable interest entities and $25.3 million and $23.6 million measured at fair value under the fair value option) 4,755.2 4,310.3
Total investments 88,543.9 84,766.6
Cash and cash equivalents 2,259.7 2,977.5
Accrued investment income 679.6 636.2
Premiums due and other receivables 1,641.1 1,413.1
Deferred acquisition costs 3,616.5 3,693.5
Property and equipment 933.2 767.3
Goodwill 1,110.6 1,100.0
Other intangibles 1,310.3 1,315.1
Separate account assets (2019 and 2018 include $39,544.7 million and $37,183.3 million related to consolidated variable interest entities) 157,942.8 144,987.9
Other assets 1,382.2 1,378.9
Total assets 259,419.9 243,036.1
Liabilities    
Contractholder funds (2019 and 2018 include $395.8 million and $396.0 million related to consolidated variable interest entities) 39,649.3 39,699.7
Future policy benefits and claims 36,891.2 35,664.8
Other policyholder funds 939.1 888.4
Short-term debt 43.9 42.9
Long-term debt (2019 and 2018 include $62.9 million and $58.4 million related to consolidated variable interest entities) 3,266.4 3,259.6
Income taxes currently payable 22.3 25.3
Deferred income taxes 1,318.7 958.4
Separate account liabilities (2019 and 2018 include $39,544.7 million and $37,183.3 million related to consolidated variable interest entities) 157,942.8 144,987.9
Other liabilities (2019 and 2018 include $154.8 million and $104.9 million related to consolidated variable interest entities) 6,046.3 5,661.9
Total liabilities 246,120.0 231,188.9
Redeemable noncontrolling interest (2019 and 2018 include $460.2 million and $325.7 million related to consolidated variable interest entities) 537.7 391.2
Stockholders' equity    
Common stock, par value $0.01 per share - 2,500.0 million shares authorized, 478.5 million and 476.7 million shares issued, and 278.2 million and 279.5 million shares outstanding in 2019 and 2018 4.8 4.8
Additional paid-in capital 10,090.8 10,060.7
Retained earnings (accumulated deficit) 10,571.9 10,290.2
Accumulated other comprehensive income (loss) (418.9) (1,565.1)
Treasury stock, at cost (200.3 million and 197.2 million shares in 2019 and 2018) (7,554.2) (7,400.6)
Total stockholders' equity attributable to Principal Financial Group, Inc. 12,694.4 11,390.0
Noncontrolling interest 67.8 66.0
Total stockholders' equity 12,762.2 11,456.0
Total liabilities and stockholders' equity $ 259,419.9 $ 243,036.1
v3.19.1
Consolidated Statements of Financial Position (Parenthetical) - USD ($)
shares in Millions, $ in Millions
Mar. 31, 2019
Dec. 31, 2018
Fixed maturities, available-for-sale $ 63,123.0 $ 60,108.5
Equity securities 1,864.1 1,843.7
Real estate 1,736.7 1,729.7
Other investments 4,755.2 4,310.3
Other investments measured at fair value under fair value option 25.3 23.6
Separate account assets 157,942.8 144,987.9
Contractholder funds 39,649.3 39,699.7
Long-term debt 3,266.4 3,259.6
Separate account liabilities 157,942.8 144,987.9
Other liabilities 6,046.3 5,661.9
Redeemable noncontrolling interest $ 537.7 $ 391.2
Common stock, par value (in dollars per share) $ 0.01 $ 0.01
Common stock, authorized (in shares) 2,500.0 2,500.0
Common stock, issued (in shares) 478.5 476.7
Common stock, outstanding (in shares) 278.2 279.5
Treasury stock (in shares) 200.3 197.2
Aggregate consolidated variable interest entities    
Fixed maturities, available-for-sale $ 98.9 $ 94.5
Equity securities 811.3 774.8
Real estate 376.1 364.0
Other investments 590.7 457.9
Separate account assets 39,544.7 37,183.3
Contractholder funds 395.8 396.0
Long-term debt 62.9 58.4
Separate account liabilities 39,544.7 37,183.3
Other liabilities 154.8 104.9
Redeemable noncontrolling interest $ 460.2 $ 325.7
v3.19.1
Consolidated Statements of Operations - USD ($)
$ in Millions
3 Months Ended
Mar. 31, 2019
Mar. 31, 2018
Revenues    
Premiums and other considerations $ 1,724.9 $ 995.2
Fees and other revenues 973.5 1,011.3
Net investment income (loss) 961.0 902.2
Net realized capital gains (losses), excluding impairment losses on available-for-sale securities 91.3 (15.2)
Net other-than-temporary impairment (losses) recoveries on available-for-sale securities (9.6) 1.3
Other-than-temporary impairment losses on fixed maturities, available-for-sale reclassified to (from) other comprehensive income 2.8 (11.2)
Net impairment (losses) recoveries on fixed maturities, available-for-sale (6.8) (9.9)
Net realized capital gains (losses) 84.5 (25.1)
Total revenues 3,743.9 2,883.6
Expenses    
Benefits, claims and settlement expenses 2,195.1 1,411.1
Dividends to policyholders 30.1 30.5
Operating expenses 992.7 985.0
Total expenses 3,217.9 2,426.6
Income (loss) before income taxes 526.0 457.0
Income taxes (benefits) 73.9 54.5
Net income (loss) 452.1 402.5
Net income (loss) attributable to noncontrolling interest 22.2 5.4
Net income (loss) attributable to Principal Financial Group, Inc. $ 429.9 $ 397.1
Earnings per common share    
Basic earnings per common share (in dollars per share) $ 1.54 $ 1.37
Diluted earnings per common share (in dollars per share) $ 1.53 $ 1.36
v3.19.1
Consolidated Statements of Comprehensive Income - USD ($)
$ in Millions
3 Months Ended
Mar. 31, 2019
Mar. 31, 2018
Consolidated Statements of Comprehensive Income    
Net income (loss) $ 452.1 $ 402.5
Other comprehensive income (loss), net:    
Net unrealized gains (losses) on available-for-sale securities 1,104.3 (805.5)
Noncredit component of impairment losses on fixed maturities, available-for-sale (2.5) 9.3
Net unrealized gains (losses) on derivative instruments (4.5) (14.4)
Foreign currency translation adjustment 37.9 65.8
Net unrecognized postretirement benefit obligation 11.5 8.7
Other comprehensive income (loss) 1,146.7 (736.1)
Comprehensive income (loss) 1,598.8 (333.6)
Comprehensive income (loss) attributable to noncontrolling interest 22.7 6.3
Comprehensive income (loss) attributable to Principal Financial Group, Inc. $ 1,576.1 $ (339.9)
v3.19.1
Consolidated Statements of Stockholders' Equity - USD ($)
$ in Millions
Common stock
Additional paid-in capital
Retained earnings (accumulated deficit)
Accumulated other comprehensive income (loss)
Treasury stock
Noncontrolling interest
Total
Balances at Dec. 31, 2017 $ 4.7 $ 9,925.2 $ 9,482.9 $ 165.5 $ (6,729.0) $ 72.6 $ 12,921.9
Increase (decrease) in stockholders' equity              
Common stock issued   32.5         32.5
Stock-based compensation   23.2 (1.5)     (0.6) 21.1
Treasury stock acquired, common         (199.6)   (199.6)
Dividends to common stockholders     (147.3)       (147.3)
Distributions to noncontrolling interest           (8.0) (8.0)
Contributions from noncontrolling interest           0.1 0.1
Adjustments to redemption amount of redeemable noncontrolling interest   0.9         0.9
Effects of implementation of accounting change | ASU 2016-01 - Equity investments     1.0 (1.0)      
Effects of implementation of accounting change | ASU 2014-09 - Revenue recognition     (65.0) 25.6   (0.3) (39.7)
Effects of implementation of accounting change | ASU 2018-02 - Reclassification of certain tax effects     (77.6) 77.6      
Effects of implementation of accounting change | ASU 2016-16 - Intra-entity asset transfer taxes     8.7       8.7
Net income (loss) [1]     397.1     4.6 401.7
Other comprehensive income (loss) [1]       (737.0)   0.5 (736.5)
Balances at Mar. 31, 2018 4.7 9,981.8 9,598.3 (469.3) (6,928.6) 68.9 12,255.8
Balances at Dec. 31, 2018 4.8 10,060.7 10,290.2 (1,565.1) (7,400.6) 66.0 11,456.0
Increase (decrease) in stockholders' equity              
Common stock issued   5.8         5.8
Stock-based compensation   26.8 (2.0)       24.8
Treasury stock acquired, common         (153.6)   (153.6)
Dividends to common stockholders     (150.2)       (150.2)
Distributions to noncontrolling interest           (1.3) (1.3)
Contributions from noncontrolling interest           0.8 0.8
Adjustments to redemption amount of redeemable noncontrolling interest   (2.5)         (2.5)
Effects of implementation of accounting change | ASU 2016-02 - Leases     4.0       4.0
Net income (loss) [1]     429.9     1.9 431.8
Other comprehensive income (loss) [1]       1,146.2   0.4 1,146.6
Balances at Mar. 31, 2019 $ 4.8 $ 10,090.8 $ 10,571.9 $ (418.9) $ (7,554.2) $ 67.8 $ 12,762.2
[1] Excludes amounts attributable to redeemable noncontrolling interest. See Note 9, Stockholders’ Equity, for further details.
v3.19.1
Consolidated Statements of Cash Flows - USD ($)
$ in Millions
3 Months Ended
Mar. 31, 2019
Mar. 31, 2018
Operating activities    
Net income (loss) $ 452.1 $ 402.5
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:    
Net realized capital (gains) losses (84.5) 25.1
Depreciation and amortization expense 51.0 50.6
Amortization of deferred acquisition costs and contract costs 58.9 73.0
Additions to deferred acquisition costs and contract costs (108.3) (107.3)
Stock-based compensation 24.9 21.6
(Income) loss from equity method investments, net of dividends received (8.8) (34.7)
Changes in:    
Accrued investment income (43.4) (25.4)
Net cash flows for trading securities and equity securities with operating intent 0.2 (107.0)
Premiums due and other receivables (189.8) (57.0)
Contractholder and policyholder liabilities and dividends 929.9 300.2
Current and deferred income taxes (benefits) 65.9 45.8
Real estate acquired through operating activities (9.2) (30.6)
Real estate sold through operating activities 1.5 46.4
Other assets and liabilities 28.6 143.6
Other 7.4 (0.3)
Net adjustments 724.3 344.0
Net cash provided by (used in) operating activities 1,176.4 746.5
Investing activities    
Fixed maturities available-for-sale and equity securities with intent to hold: Purchases (2,886.7) (3,330.8)
Fixed maturities available-for-sale and equity securities with intent to hold: Sales 342.6 1,273.5
Fixed maturities available-for-sale and equity securities with intent to hold: Maturities 1,548.9 1,555.0
Mortgage loans acquired or originated (625.1) (643.0)
Mortgage loans sold or repaid 382.4 331.8
Real estate acquired (10.5) (14.7)
Real estate sold   56.5
Net (purchases) sales of property and equipment (29.4) (26.0)
Purchase of interests in subsidiaries, net of cash acquired   (113.9)
Net change in other investments (213.3) (68.3)
Net cash provided by (used in) investing activities (1,491.1) (979.9)
Financing activities    
Issuance of common stock 5.8 32.5
Acquisition of treasury stock (153.6) (199.6)
Payments for financing element derivatives (6.5) (19.3)
Dividends to common stockholders (150.2) (147.3)
Issuance of long-term debt 6.7 18.0
Principal repayments of long-term debt (0.3) (0.3)
Net proceeds from (repayments of) short-term borrowings 0.1 38.0
Investment contract deposits 1,872.2 1,783.0
Investment contract withdrawals (1,947.4) (1,535.5)
Net increase (decrease) in banking operation deposits (35.4) 124.1
Other 5.5 4.7
Net cash provided by (used in) financing activities (403.1) 98.3
Net increase (decrease) in cash and cash equivalents (717.8) (135.1)
Cash and cash equivalents at beginning of period 2,977.5 2,470.8
Cash and cash equivalents at end of period 2,259.7 $ 2,335.7
Supplemental disclosure of non-cash activities:    
Lease assets established upon adoption of accounting guidance 168.8  
Lease liabilities established upon adoption of accounting guidance $ 164.0  
v3.19.1
Nature of Operations and Significant Accounting Policies
3 Months Ended
Mar. 31, 2019
Nature of Operations and Significant Accounting Policies  
Nature of Operations and Significant Accounting Policies

1. Nature of Operations and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Principal Financial Group, Inc. (“PFG”) have been prepared in conformity with accounting principles generally accepted in the U.S. (“U.S. GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2019, are not necessarily indicative of the results that may be expected for the year ended December 31, 2019. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2018, included in our Form 10-K for the year ended December 31, 2018, filed with the United States Securities and Exchange Commission (“SEC”). The accompanying consolidated statement of financial position as of December 31, 2018, has been derived from the audited consolidated statement of financial position but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

 

Consolidation

 

We have relationships with various special purpose entities and other legal entities that must be evaluated to determine if the entities meet the criteria of a variable interest entity (“VIE”) or a voting interest entity (“VOE”). This assessment is performed by reviewing contractual, ownership and other rights, including involvement of related parties, and requires use of judgment. First, we determine if we hold a variable interest in an entity by assessing if we have the right to receive expected losses and expected residual returns of the entity. If we hold a variable interest, then the entity is assessed to determine if it is a VIE. An entity is a VIE if the equity at risk is not sufficient to support its activities, if the equity holders lack a controlling financial interest or if the entity is structured with non-substantive voting rights. In addition to the previous criteria, if the entity is a limited partnership or similar entity, it is a VIE if the limited partners do not have the power to direct the entity’s most significant activities through substantive kick-out rights or participating rights. A VIE is evaluated to determine the primary beneficiary. The primary beneficiary of a VIE is the enterprise with (1) the power to direct the activities of a VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. When we are the primary beneficiary, we are required to consolidate the entity in our financial statements. We reassess our involvement with VIEs on a quarterly basis. For further information about VIEs, refer to Note 2, Variable Interest Entities.

 

If an entity is not a VIE, it is considered a VOE. VOEs are generally consolidated if we own a greater than 50% voting interest. If we determine our involvement in an entity no longer meets the requirements for consolidation under either the VIE or VOE models, the entity is deconsolidated. Entities in which we have management influence over the operating and financing decisions but are not required to consolidate, other than investments accounted for at fair value under the fair value option, are reported using the equity method.

 

Recent Accounting Pronouncements

 

 

 

 

 

 

 

 

Description

  

  

Date of
adoption

  

  

Effect on our consolidated
financial statements or other
significant matters

Standards not yet adopted:

 

 

 

 

 

 

Targeted improvements to the accounting for long-duration insurance contracts

 

 

 

 

 

 

This authoritative guidance updates certain requirements in the accounting for long-duration insurance and annuity contracts.

 

1.    The assumptions used to calculate the liability for future policy benefits on traditional and limited-payment contracts will be reviewed and updated periodically. Cash flow assumptions will be reviewed at least annually and updated when necessary with the impact recognized in net income. Discount rate assumptions are prescribed as the current upper-medium grade (low credit risk) fixed income instrument yield and will be updated quarterly with the impact recognized in other comprehensive income (“OCI”).

2.    Market risk benefits, which are certain market-based options or guarantees associated with deposit or account balance contracts, will be measured at fair value. The periodic change in fair value related to instrument-specific credit risk will be recognized in OCI while the remaining change in fair value will be recognized in net income.

3.    Deferred acquisition costs (“DAC”) for all insurance and annuity contracts will be amortized on a constant basis over the expected term of the related contracts.

4.    Additional disclosures are required, including disaggregated rollforwards of significant insurance liabilities and other account balances and disclosures about significant inputs, judgments, assumptions and methods used in measurement.

 

The guidance for the liability for future policy benefits for traditional and limited-payment contracts and DAC will be applied on a modified retrospective basis; that is, to contracts in force as of the beginning of the earliest period presented based on their existing carrying amounts. An entity may elect to apply the changes retrospectively. The guidance for market risk benefits will be applied retrospectively. Early adoption is permitted.

 

 

January 1,
2021

 

 

Our implementation and evaluation process to date includes, but is not limited to, identifying and documenting contracts and contract features in scope of the guidance; identifying the actuarial models, systems and processes to be updated; evaluating our systems solutions for implementing the new guidance and evaluating our key accounting policies. As we progress through our implementation, we will be able to better assess the impact to our consolidated financial statements; however, we expect this guidance to significantly change how we account for many of our insurance and annuity products.

 

 

 

 

 

 

 

Goodwill impairment testing

 

 

 

 

 

 

This authoritative guidance simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 (which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill to the carrying amount of that goodwill) from the goodwill impairment test. A goodwill impairment loss will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. Early adoption is permitted.

 

 

January 1,
2020

 

 

We are currently evaluating the impact this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements. We expect the guidance will reduce complexity and costs associated with performing a Step 2 test, should one be needed in the future. However, the impact on the outcome of any such future impairment assessment will be dependent on modeling factors that are not currently determinable.

Credit losses

 

 

 

 

 

 

This authoritative guidance requires entities to use a current expected credit loss (“CECL”) model to measure impairment for most financial assets that are not recorded at fair value through net income. Under the CECL model, an entity will estimate lifetime expected credit losses considering available relevant information about historical events, current conditions and reasonable and supportable forecasts. The CECL model does not apply to available-for-sale debt securities. This guidance also expands the required credit loss disclosures and will be applied using a modified retrospective approach by recording a cumulative effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Early adoption is permitted.

 

 

January 1,
2020

 

 

Our implementation and evaluation process to date includes, but is not limited to, identifying financial assets within scope of the guidance, developing and refining CECL models for the relevant assets, preparing quarterly estimates of the cumulative effect of adoption, and drafting the required financial statement disclosures. We believe estimated credit losses under the CECL model will generally result in earlier loss recognition for loans and other receivables.

Standards  adopted:

 

 

 

 

 

 

Implementation costs in a cloud computing arrangement that is a service contract

 

 

 

 

 

 

This authoritative guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.  This guidance can be applied either retrospectively or prospectively and early adoption is permitted.

 

 

January 1,
2019

 

 

The effective date of the guidance is January 1, 2020; however, we elected to early-adopt this guidance on a prospective basis, effective January 1, 2019. This guidance did not have a material impact on our consolidated financial statements.

Leases

 

 

 

 

 

 

This authoritative guidance requires lessee recognition of lease assets and lease liabilities on the balance sheet. The concept of an operating lease, where the lease assets and liabilities are off balance sheet, is eliminated under the new guidance. For lessors, the guidance modifies lease classification criteria and accounting for certain types of leases. Other key aspects of the guidance relate to the removal of the current real estate-specific guidance and new presentation and disclosure requirements. Lessees and lessors are required to recognize and measure leases using a modified retrospective approach, which includes certain optional practical expedients that may be elected. We elected the alternative transition method, which allows entities to initially apply the new standard at the adoption date and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption.

 

 

January 1,
2019

 

 

We adopted the guidance using the modified retrospective approach and comparative periods were not restated.  Further details are included under the caption “Adoption of Lease Guidance” and in Note 8, Contingencies, Guarantees, Indemnifications and Leases.

Targeted improvements to accounting for hedging activities

 

 

 

 

 

 

This authoritative guidance updated certain recognition and measurement requirements for hedge accounting. The objective of the guidance is to more closely align the economics of a company’s risk management activities in its financial results and reduce the complexity of applying hedge accounting. The updates included the expansion of hedging strategies that are eligible for hedge accounting, elimination of the separate measurement and reporting of hedge ineffectiveness, presentation of the changes in the fair value of the hedging instrument in the same consolidated statement of operations line as the earnings effect of the hedged item and simplification of hedge effectiveness assessments. This guidance also included new disclosures.

 

 

January 1,
2019

 

 

This guidance did not have a material impact on our consolidated financial statements. See Note 4, Derivative Financial Instruments, for further details.

Premium amortization on purchased callable debt securities

 

 

 

 

 

 

This authoritative guidance applies to entities that hold certain non-contingently callable debt securities, where the amortized cost basis is at a premium to the price repayable by the issuer at the earliest call date. Under the guidance the premium will be amortized to the first call date.

 

 

January 1,
2019

 

 

This guidance did not have a material impact on our consolidated financial statements.

 

 

 

 

 

 

 

Reclassification of certain tax effects from accumulated other comprehensive income

 

 

 

 

 

 

This authoritative guidance permits a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for the stranded tax effects resulting from U.S. tax legislation enacted on December 22, 2017, which is referred to as the ‘‘Tax Cuts and Jobs Act’’ (‘‘U.S. tax reform’’). The amount of that reclassification includes the change in corporate income tax rate, as well as an election to include other income tax effects related to the application of U.S. tax reform. The guidance also requires disclosures about stranded tax effects.

 

 

January 1,
2018

 

 

The effective date of the guidance was January 1, 2019; however, we elected to early adopt the guidance. The guidance was applied at the beginning of the period of adoption and comparative periods were not restated. We reclassified the stranded tax effects in AOCI resulting from U.S. tax reform, which includes the change in corporate income tax rate and an election to reclassify the tax effects of the one-time deemed repatriation tax. A reclassification of $77.6 million was recorded as an increase to AOCI and a decrease to retained earnings.

Revenue recognition

 

 

 

 

 

 

This authoritative guidance replaces all general and most industry specific revenue recognition guidance currently prescribed by U.S. GAAP. The core principle is that an entity recognizes revenue to reflect the transfer of a promised good or service to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for that good or service. This guidance also provides clarification on when an entity is a principal or an agent in a transaction. In addition, the guidance updates the accounting for certain costs associated with obtaining and fulfilling a customer contract. The guidance may be applied using one of the following two methods: (1) retrospectively to each prior reporting period presented, or (2) retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application.

 

 

January 1, 2018

 

 

We adopted the guidance using the modified retrospective approach. The guidance did not have a material impact on our consolidated financial statements. A cumulative effect adjustment of $39.7 million was recorded as a decrease to total stockholders’ equity. See Note 12, Revenues from Contracts with Customers, for further details.

Income tax - intra-entity transfers of assets

 

 

 

 

 

 

This authoritative guidance requires entities to recognize current and deferred income tax resulting from an intra-entity asset transfer when the transfer occurs. Prior to issuance of this guidance, U.S. GAAP did not allow recognition of income tax consequences until the asset had been sold to a third party. This guidance requires adoption through a cumulative effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.

 

 

January 1, 2018

 

 

We adopted the guidance using the modified retrospective approach. A cumulative effect adjustment of $8.7 million was recorded as an increase to retained earnings. In addition, other assets and deferred income taxes decreased $21.1 million and $29.8 million, respectively, due to the adoption of this guidance.

Financial instruments - recognition and measurement

 

 

 

 

 

 

This authoritative guidance addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The guidance eliminated the classification of equity securities into different categories (trading or available-for-sale) and requires equity investments to be measured at fair value with changes in the fair value recognized through net income. The guidance also updated certain financial instrument disclosures and eliminated the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments that are measured at amortized cost on the balance sheet.

 

 

January 1, 2018

 

 

We adopted this guidance using the modified retrospective approach. A cumulative effect adjustment of $1.0 million was recorded as a decrease to AOCI and a corresponding increase to retained earnings. The guidance did not have a material impact on our consolidated financial statements. See Note 3, Investments, for further details.

Nonfinancial asset derecognition and partial sales of nonfinancial assets

 

 

 

 

 

 

This authoritative guidance clarifies the scope of the recently established guidance on nonfinancial asset derecognition and the accounting for partial sales of nonfinancial assets. The guidance conforms the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue recognition standard.

 

 

January 1,
2018

 

 

The guidance did not have a material impact on our consolidated financial statements.

Presentation of net periodic pension cost and net periodic postretirement benefit cost

 

 

 

 

 

 

This authoritative guidance requires that an employer disaggregate the service cost component from the other components of net benefit cost. The guidance also provides explicit guidance on the presentation of the service cost component and the other components of net benefit cost in the consolidated statement of operations and allows only the service cost component of net benefit cost to be eligible for capitalization.

 

 

January 1,
2018

 

 

The guidance did not have a material impact on our consolidated financial statements.

Definition of a business

 

 

 

 

 

 

This authoritative guidance clarifies the definition of a business to assist with evaluating when transactions involving an integrated set of assets and activities (a “set”) should be accounted for as acquisitions or disposals of assets or businesses. The guidance requires that when substantially all of the fair value of the gross assets acquired or disposed of is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The guidance also requires a set to include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output to be considered a business. Lastly, the guidance removes the evaluation of whether a market participant could replace missing elements and narrows the definition of outputs by more closely aligning it with how outputs are described in the revenue recognition guidance. The guidance will be applied prospectively.

 

 

January 1,
2018

 

 

The guidance did not have a material impact on our consolidated financial statements.

 

When we adopt new accounting standards, we have a process in place to perform a thorough review of the pronouncement, identify the financial statement and system impacts and create an implementation plan among our impacted business units to ensure we are compliant with the pronouncement on the date of adoption. This includes having effective processes and controls in place to support the reported amounts. Each of the standards listed above is in varying stages in our implementation process based on its issuance and adoption dates. We are on track to implement guidance by the respective effective dates.

 

Adoption of Lease Guidance

 

On January 1, 2019, we adopted the guidance using the modified retrospective approach with the cumulative effect of initially applying the standard recognized at the date of adoption. We elected the package of practical expedients permitted under the transition guidance. In addition, we elected the hindsight practical expedient to determine the lease term for existing leases. We have agreements with lease and non-lease components, which we account for as a combined unit of account for all classes.

 

The impact of the guidance to our consolidated financial statements primarily related to the establishment of additional assets and liabilities of $168.8 million and $164.0 million, respectively. The difference between the additional assets and liabilities, net of deferred tax impacts, was recorded as a cumulative effect adjustment to retained earnings and increased total stockholders’ equity by $4.0 million.

 

Results of reporting periods beginning January 1, 2019, are presented under the new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with our prior accounting. The guidance did not have a material impact on our consolidated statements of operations and did not impact earnings per common share.

 

Derivatives

 

Overview

 

Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities. Derivatives generally used by us include swaps, options, futures and forwards. Derivative positions are either assets or liabilities in the consolidated statements of financial position and are measured at fair value, generally by obtaining quoted market prices or through the use of pricing models. See Note 10, Fair Value Measurements, for policies related to the determination of fair value. Fair values can be affected by changes in interest rates, foreign exchange rates, financial indices, values of securities, credit spreads, and market volatility and liquidity.

 

Accounting and Financial Statement Presentation

 

We designate derivatives as either:

 

(a)a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, including those denominated in a foreign currency ("fair value hedge");

(b)a hedge of a forecasted transaction or the exposure to variability of cash flows to be received or paid related to a recognized asset or liability, including those denominated in a foreign currency ("cash flow hedge");

(c)a hedge of a net investment in a foreign operation or

(d)a derivative not designated as a hedging instrument.

 

Our accounting for the ongoing changes in fair value of a derivative depends on the intended use of the derivative and the designation, as described above, and is determined when the derivative contract is entered into or at the time of redesignation. Hedge accounting is used for derivatives that are specifically designated in advance as hedges and that reduce our exposure to an indicated risk by having a high correlation between changes in the value of the derivatives and the items being hedged at both the inception of the hedge and throughout the hedge period.

 

Fair Value Hedges. When a derivative is designated as a fair value hedge and is determined to be highly effective, changes in its fair value, along with changes in the fair value of the hedged asset, liability or firm commitment attributable to the hedged risk, are reported in the same income statement line item that is used to report the earnings effect of the hedged item. For fair value hedges of fixed maturities, available-for-sale, these changes in fair value are reported in net investment income. Prior to 2019, these changes in fair value were recorded in net realized capital gains (losses). A fair value hedge determined to be highly effective may still result in a mismatch between the change in the fair value of the hedging instrument and the change in the fair value of the hedged item attributable to the hedged risk.

 

Cash Flow Hedges. When a derivative is designated as a cash flow hedge and is determined to be highly effective, changes in its fair value are recorded as a component of OCI. At the time the variability of cash flows being hedged impacts net income, the related portion of deferred gains or losses on the derivative instrument is reclassified and reported in net income.

 

Net Investment in a Foreign Operation Hedge. When a derivative is used as a hedge of a net investment in a foreign operation, its change in fair value, to the extent effective as a hedge, is recorded as a component of OCI. If the foreign operation is sold or upon complete or substantially complete liquidation, the deferred gains or losses on the derivative instrument are reclassified into net income.

 

Non-Hedge Derivatives. If a derivative does not qualify or is not designated for hedge accounting, all changes in fair value are reported in net income without considering the changes in the fair value of the economically associated assets or liabilities.

 

Hedge Documentation and Effectiveness Testing. At inception, we formally document all relationships between hedging instruments and hedged items, as well as our risk management objective and strategy for undertaking various hedge transactions. This process includes associating all derivatives designated as fair value or cash flow hedges with specific assets or liabilities on the consolidated statements of financial position or with specific firm commitments or forecasted transactions. Effectiveness of the hedge is formally assessed at inception and throughout the life of the hedging relationship. Even if a hedge is determined to be highly effective, the hedge may still result in a mismatch between the change in the fair value of the hedging instrument and the change in the fair value of the hedged item attributable to the hedged risk.

 

We use qualitative and quantitative methods to assess hedge effectiveness. Qualitative methods may include monitoring changes to terms and conditions and counterparty credit ratings. Quantitative methods may include statistical tests including regression analysis and minimum variance and dollar offset techniques.

 

Termination of Hedge Accounting. We prospectively discontinue hedge accounting when (1) the criteria to qualify for hedge accounting is no longer met, e.g., a derivative is determined to no longer be highly effective in offsetting the change in fair value or cash flows of a hedged item; (2) the derivative expires, is sold, terminated or exercised or (3) we remove the designation of the derivative being the hedging instrument for a fair value or cash flow hedge.

 

If it is determined that a derivative no longer qualifies as an effective hedge, the derivative will continue to be carried on the consolidated statements of financial position at its fair value, with changes in fair value recognized prospectively in net realized capital gains (losses). The asset or liability under a fair value hedge will no longer be adjusted for changes in fair value pursuant to hedging rules and the existing basis adjustment is amortized to the consolidated statements of operations line associated with the asset or liability. The component of AOCI related to discontinued cash flow hedges that are no longer highly effective is amortized to the consolidated statements of operations consistent with the net income impacts of the original hedged cash flows. If a cash flow hedge is discontinued because it is probable the hedged forecasted transaction will not occur, the deferred gain or loss is immediately reclassified from AOCI into net income.

 

Embedded Derivatives. We purchase and issue certain financial instruments and products that contain a derivative that is embedded in the financial instrument or product. We assess whether this embedded derivative is clearly and closely related to the asset or liability that serves as its host contract. If we deem that the embedded derivative's terms are not clearly and closely related to the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the derivative is bifurcated from that contract and held at fair value on the consolidated statements of financial position, with changes in fair value reported in net income.

 

Separate Accounts

 

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

 

Separate account assets and separate account liabilities include certain international retirement accumulation products where the segregated funds and associated obligation to the client are consolidated within our financial statements. We have determined that summary totals are the most meaningful presentation for these funds.

 

As of March 31, 2019 and December 31, 2018, the separate accounts included a separate account valued at $102.7 million and $94.9 million, respectively, which primarily included shares of our stock that were allocated and issued to eligible participants of qualified employee benefit plans administered by us as part of the policy credits issued under our 2001 demutualization. These shares are included in both basic and diluted earnings per share calculations. In the consolidated statements of financial position, the separate account shares are recorded at fair value and are reported as separate account assets with a corresponding separate account liability to eligible participants of the qualified plan. Changes in fair value of the separate account shares are reflected in both the separate account assets and separate account liabilities and do not impact our results of operations.

v3.19.1
Variable Interest Entities
3 Months Ended
Mar. 31, 2019
Variable Interest Entities  
Variable Interest Entities

2. Variable Interest Entities

 

We have relationships with various types of entities which may be VIEs. Certain VIEs are consolidated in our financial results. See Note 1, Nature of Operations and Significant Accounting Policies, under the caption “Consolidation” for further details of our consolidation accounting policies. We did not provide financial or other support to investees designated as VIEs for the periods ended March 31, 2019 and December 31, 2018.

 

Consolidated Variable Interest Entities

 

Grantor Trust

 

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

 

Commercial Mortgage-Backed Securities

 

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

 

Mandatory Retirement Savings Funds

 

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

 

Principal International Hong Kong offers retirement pension schemes in which we provide trustee, administration and asset management services to employers and employees under the Hong Kong Mandatory Provident Fund and Occupational Retirement Schemes Ordinance pension schemes. Each pension scheme has various guaranteed and non-guaranteed constituent funds, or investment options, in which customers can invest their money. The guaranteed funds provide either a guaranteed rate of return to the customer or a minimum guarantee on withdrawals under certain qualifying events. We determined the guaranteed funds are VIEs due to the fact the equity holders, as a group, lack the obligation to absorb expected losses due to the guarantee we provide. We concluded we are the primary beneficiary because we have the power to make decisions and to receive benefits and the obligation to absorb losses that could be potentially significant to the VIE. Therefore, we consolidate the underlying assets and liabilities of the funds and present as separate accounts or within the general account, depending on the terms of the guarantee.

 

Real Estate

 

We invest in several real estate limited partnerships and limited liability companies. The entities invest in real estate properties. Certain of these entities are VIEs based on the combination of our significant economic interest and related voting rights. We determined we are the primary beneficiary as a result of our power to control the entities through our significant ownership. Due to the nature of these real estate investments, the investment balance will fluctuate as we purchase and sell interests in the entities and as capital expenditures are made to improve the underlying real estate.

 

Sponsored Investment Funds

 

We sponsor and invest in certain investment funds for which we provide asset management services. Although our asset management fee is commensurate with the services provided and consistent with fees for similar services negotiated at arms-length, we have a variable interest for funds where our other interests are more than insignificant. The funds are VIEs as the equity holders lack power through voting rights to direct the activities of the entity that most significantly impact its economic performance. We determined we are the primary beneficiary of the VIEs where our interest in the entity is more than insignificant and we are the asset manager.

 

We also invest in certain series of another investment fund. These series are VIEs as the equity holders of each series lack the power to direct the most significant activities of the VIE. We determined we are the primary beneficiary of these series as our interest is more than insignificant and collectively we have the power to direct the most significant activities of the fund.

 

Assets and Liabilities of Consolidated Variable Interest Entities

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

December 31, 2018

 

 

Total

 

Total

 

Total

 

Total

 

    

assets

    

liabilities

    

assets

    

liabilities

 

 

(in millions)

Grantor trust (1)

 

$

99.6

 

$

94.9

 

$

95.0

 

$

89.4

CMBS

 

 

5.9

 

 

 

 

6.4

 

 

Mandatory retirement savings funds (2)

 

 

40,311.8

 

 

39,940.5

 

 

37,915.7

 

 

37,579.3

Real estate (3)

 

 

389.9

 

 

70.7

 

 

379.2

 

 

70.6

Sponsored investment funds (4)

 

 

697.8

 

 

52.4

 

 

526.5

 

 

3.6

Total

 

$

41,505.0

 

$

40,158.5

 

$

38,922.8

 

$

37,742.9

 

(1)The assets of grantor trusts are primarily fixed maturities, available-for-sale. The liabilities are primarily other liabilities that reflect an embedded derivative of the forecasted transaction to deliver the underlying securities.

(2)The assets of the mandatory retirement savings funds include separate account assets and equity securities. The liabilities include separate account liabilities and contractholder funds.

(3)The assets of the real estate VIEs primarily include real estate and cash. Liabilities primarily include long-term debt and other liabilities.

(4)The assets of sponsored investment funds are primarily fixed maturities and equity securities, certain of which are reported with other investments, and cash. The consolidated statements of financial position included a $460.2 million and $325.7 million redeemable noncontrolling interest for sponsored investment funds as of March 31, 2019 and December 31, 2018, respectively.

 

Unconsolidated Variable Interest Entities

 

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

 

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

 

We invest in cash collateralized debt obligations, collateralized bond obligations, collateralized loan obligations and other collateralized structures, which are VIEs due to insufficient equity to sustain the entities. We have determined we are not the primary beneficiary of these entities primarily because we do not control the economic performance of the entities and were not involved with the design of the entities or because we do not have a potentially significant variable interest in the entities for which we are the asset manager.

 

We have invested in various VIE trusts and similar entities as a debt holder. Most of these entities are classified as VIEs due to insufficient equity to sustain them. In addition, we have an entity classified as a VIE based on the combination of our significant economic interest and lack of voting rights. We have determined we are not the primary beneficiary primarily because we do not control the economic performance of the entities and were not involved with the design of the entities.

 

We have invested in partnerships and other funds, which are classified as VIEs. The entities are VIEs as equity holders lack the power to control the most significant activities of the entities because the equity holders do not have either the ability by a simple majority to exercise substantive kick-out rights or substantive participating rights. We have determined we are not the primary beneficiary because we do not have the power to direct the most significant activities of the entities.

 

As previously discussed, we sponsor, invest in and have other interests in certain investment funds that are VIEs. We determined we are not the primary beneficiary of the VIEs for which we are the asset manager but do not have a potentially significant variable interest in the funds.

 

We hold an equity interest in Mexican mandatory privatized social security funds in which we provide asset management services. Our equity interest in the funds is considered a variable interest. We concluded the funds are VIEs because the equity holders as a group lack decision-making ability through their voting rights. We are not the primary beneficiary of the VIEs because although we, as the asset manager, have the power to direct the activities of the VIEs, we do not have a potentially significant variable interest in the funds.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Maximum exposure to

 

    

Asset carrying value

    

loss (1)

 

 

(in millions)

March 31, 2019

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

Corporate

 

$

239.3

 

$

224.9

Residential mortgage-backed pass-through securities

 

 

2,484.5

 

 

2,471.5

Commercial mortgage-backed securities

 

 

4,242.1

 

 

4,234.0

Collateralized debt obligations (2)

 

 

2,765.7

 

 

2,786.7

Other debt obligations

 

 

7,545.3

 

 

7,523.3

Fixed maturities, trading:

 

 

 

 

 

 

Residential mortgage-backed pass-through securities

 

 

318.8

 

 

318.8

Commercial mortgage-backed securities

 

 

18.5

 

 

18.5

Collateralized debt obligations (2)

 

 

20.3

 

 

20.3

Other debt obligations

 

 

12.3

 

 

12.3

Equity securities

 

 

110.0

 

 

110.0

Other investments:

 

 

 

 

 

 

Other limited partnership and fund interests (3)

 

 

802.3

 

 

1,428.9

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

Corporate

 

$

235.3

 

$

222.6

Residential mortgage-backed pass-through securities

 

 

2,460.6

 

 

2,488.5

Commercial mortgage-backed securities

 

 

3,945.6

 

 

4,023.1

Collateralized debt obligations (2)

 

 

2,420.8

 

 

2,451.3

Other debt obligations

 

 

7,153.2

 

 

7,196.6

Fixed maturities, trading:

 

 

 

 

 

 

Residential mortgage-backed pass-through securities

 

 

322.6

 

 

322.6

Commercial mortgage-backed securities

 

 

13.8

 

 

13.8

Collateralized debt obligations (2)

 

 

11.8

 

 

11.8

Other debt obligations

 

 

9.7

 

 

9.7

Equity securities

 

 

103.9

 

 

103.9

Other investments:

 

 

 

 

 

 

Other limited partnership and fund interests (3)

 

 

737.5

 

 

1,432.2

 

(1)

Our risk of loss is limited to our initial investment measured at amortized cost for fixed maturities, available-for-sale. Our risk of loss is limited to our investment measured at fair value for our fixed maturities, trading and equity securities. Our risk of loss is limited to our carrying value plus any unfunded commitments and/or guarantees and similar provisions for our other investments. Unfunded commitments are not liabilities on our consolidated statements of financial position because we are only required to fund additional equity when called upon to do so by the general partner or investment manager.

(2)

Primarily consists of collateralized loan obligations backed by secured corporate loans.

(3)

As of March 31, 2019 and December 31, 2018, the maximum exposure to loss for other limited partnership and fund interests includes $129.7 million and $132.2 million, respectively, of debt within certain of our managed international real estate funds that is fully secured by assets whose value exceeds the amount of the debt, but also includes recourse to the investment manager.

 

Money Market Funds

 

We are the investment manager for certain money market mutual funds. These types of funds are exempt from assessment under any consolidation model due to a scope exception for money market funds registered under Rule 2a-7 of the Investment Company Act of 1940 or similar funds. As of March 31, 2019 and December 31, 2018, money market mutual funds we manage held $3.6 billion and $3.0 billion in total assets, respectively. We have no contractual obligation to contribute to these funds; however, we provide support through the waiver of fees and through expense reimbursements. The amount of fees waived and expenses reimbursed was insignificant.

v3.19.1
Investments
3 Months Ended
Mar. 31, 2019
Investments  
Investments

3. Investments

 

Fixed Maturities and Equity Securities

 

Fixed maturities include bonds, ABS, redeemable preferred stock and certain non-redeemable preferred securities. Equity securities include mutual funds, common stock, non-redeemable preferred stock and required regulatory investments. We classify fixed maturities as either available-for-sale or trading at the time of the purchase and, accordingly, carry them at fair value. Equity securities are also carried at fair value. See Note 10, Fair Value Measurements, for methodologies related to the determination of fair value. Unrealized gains and losses related to fixed maturities, available-for-sale, excluding those in fair value hedging relationships, are reflected in stockholders' equity, net of adjustments associated with DAC and related actuarial balances, derivatives in cash flow hedge relationships and applicable income taxes. Mark-to-market adjustments on equity securities, unrealized gains and losses related to hedged portions of fixed maturities, available-for-sale in fair value hedging relationships prior to 2019 and mark-to-market adjustments on certain fixed maturities, trading are reflected in net realized capital gains (losses). Beginning in 2019, unrealized gains and losses related to hedged portions of fixed maturities, available-for-sale in fair value hedging relationships are reflected in net investment income. Mark-to-market adjustments related to certain securities carried at fair value with an investment objective to realize economic value through mark-to-market changes are reflected in net investment income.

 

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

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

Gross

 

Gross

 

 

 

 

temporary

 

 

Amortized

 

unrealized

 

unrealized

 

 

 

 

impairments in

 

    

cost

    

gains

    

losses

    

Fair value

    

AOCI (1)

 

 

(in millions)

March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

1,467.0

 

$

40.6

 

$

9.2

 

$

1,498.4

 

$

 —

Non-U.S. governments

 

 

876.4

 

 

90.9

 

 

3.9

 

 

963.4

 

 

 —

States and political subdivisions

 

 

6,301.7

 

 

351.8

 

 

27.2

 

 

6,626.3

 

 

 —

Corporate

 

 

35,242.7

 

 

1,985.4

 

 

258.9

 

 

36,969.2

 

 

0.5

Residential mortgage-backed pass-through securities

 

 

2,471.5

 

 

38.1

 

 

25.1

 

 

2,484.5

 

 

Commercial mortgage-backed securities

 

 

4,234.0

 

 

51.6

 

 

43.5

 

 

4,242.1

 

 

19.2

Collateralized debt obligations (2)

 

 

2,786.7

 

 

0.2

 

 

21.2

 

 

2,765.7

 

 

1.4

Other debt obligations

 

 

7,551.3

 

 

69.1

 

 

47.0

 

 

7,573.4

 

 

35.3

Total fixed maturities, available-for-sale

 

$

60,931.3

 

$

2,627.7

 

$

436.0

 

$

63,123.0

 

$

56.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities, available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

1,441.6

 

$

16.4

 

$

17.0

 

$

1,441.0

 

$

 —

Non-U.S. governments

 

 

833.4

 

 

71.7

 

 

14.6

 

 

890.5

 

 

 —

States and political subdivisions

 

 

6,125.0

 

 

196.0

 

 

95.3

 

 

6,225.7

 

 

 —

Corporate

 

 

35,134.6

 

 

1,249.9

 

 

845.2

 

 

35,539.3

 

 

 —

Residential mortgage-backed pass-through securities

 

 

2,488.5

 

 

21.9

 

 

49.8

 

 

2,460.6

 

 

 —

Commercial mortgage-backed securities

 

 

4,023.1

 

 

17.1

 

 

94.6

 

 

3,945.6

 

 

16.3

Collateralized debt obligations (2)

 

 

2,451.3

 

 

 

 

30.5

 

 

2,420.8

 

 

1.2

Other debt obligations

 

 

7,228.3

 

 

39.4

 

 

82.7

 

 

7,185.0

 

 

36.1

Total fixed maturities, available-for-sale

 

$

59,725.8

 

$

1,612.4

 

$

1,229.7

 

$

60,108.5

 

$

53.6

 

(1)

Excludes $65.1 million and $64.2 million as of March 31, 2019 and December 31, 2018, respectively, of net unrealized gains on impaired fixed maturities, available-for-sale related to changes in fair value subsequent to the impairment date, which are included in gross unrealized gains and gross unrealized losses.

(2)

Primarily consists of collateralized loan obligations backed by secured corporate loans.

 

The amortized cost and fair value of fixed maturities, available-for-sale as of March 31, 2019, by expected maturity, were as follows:

 

 

 

 

 

 

 

 

 

    

Amortized cost

    

Fair value

 

 

(in millions)

Due in one year or less

 

$

2,659.9

 

$

2,676.8

Due after one year through five years

 

 

10,451.4

 

 

10,643.0

Due after five years through ten years

 

 

10,617.3

 

 

10,899.6

Due after ten years

 

 

20,159.2

 

 

21,837.9

Subtotal

 

 

43,887.8

 

 

46,057.3

Mortgage-backed and other asset-backed securities

 

 

17,043.5

 

 

17,065.7

Total

 

$

60,931.3

 

$

63,123.0

 

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

 

Net Realized Capital Gains and Losses

 

Net realized capital gains and losses on sales of investments are determined on the basis of specific identification. In general, in addition to realized capital gains and losses on investment sales and periodic settlements on derivatives not designated as hedges, we report gains and losses related to the following in net realized capital gains (losses): other-than-temporary impairments of securities and subsequent realized recoveries, mark-to-market adjustments on equity securities, mark-to-market adjustments on certain fixed maturities, trading, mark-to-market adjustments on sponsored investment funds, mark-to-market adjustments on derivatives not designated as hedges, changes in the mortgage loan valuation allowance provision, impairments of real estate held for investment and impairments on equity method investments. Investment gains and losses on sales of certain real estate held for sale due to investment strategy and mark-to-market adjustments on certain securities carried at fair value with an investment objective to realize economic value through mark-to-market changes are reported as net investment income and are excluded from net realized capital gains (losses). The major components of net realized capital gains (losses) on investments were as follows:

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

March 31, 

 

    

2019

    

2018

 

 

(in millions)

Fixed maturities, available-for-sale:

 

 

 

 

 

 

Gross gains

 

$

2.5

 

$

4.3

Gross losses

 

 

(1.5)

 

 

(26.7)

Net impairment  losses

 

 

(6.8)

 

 

(9.9)

Hedging, net (1)

 

 

 —

 

 

(5.1)

Fixed maturities, trading (2)

 

 

14.2

 

 

(10.7)

Equity securities (3)

 

 

21.0

 

 

(2.0)

Mortgage loans

 

 

0.3

 

 

0.4

Derivatives (1)

 

 

5.0

 

 

9.4

Other

 

 

49.8

 

 

15.2

Net realized capital gains (losses)

 

$

84.5

 

$

(25.1)

 

(1)

Upon adoption of authoritative guidance effective January 1, 2019, the change in fair value of fixed maturities, available-for-sale and the change in fair value of derivative hedging instruments in fair value hedging relationships are reported in net investment income with the earnings effect of fixed maturities, available-for-sale. Prior to 2019, the change in fair value of fixed maturities, available-for-sale and the change in fair value of derivative hedging instruments in fair value hedging relationships were reported in net realized capital gains (losses). See Note 4, Derivative Financial Instruments, for further details.

(2)

Unrealized gains (losses) on fixed maturities, trading still held at the reporting date were $14.2 million and $(10.7) million for the three months ended March 31, 2019 and 2018, respectively.

(3)

Unrealized gains (losses) on equity securities still held at the reporting date were $19.8 million and $(5.0) million for the three months ended March 31, 2019 and 2018, respectively. This excludes $22.5 million and $0.0 million of unrealized gains (losses) on equity securities still held at the reporting date for the three months ended March 31, 2019 and 2018, respectively, that were reported in net investment income.

 

Proceeds from sales of investments (excluding call and maturity proceeds) in fixed maturities, available-for-sale were $163.0 million and $1,211.8 million for the three months ended March 31, 2019 and 2018, respectively.

 

Other-Than-Temporary Impairments

 

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

 

Each reporting period, all securities are reviewed to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. We consider relevant facts and circumstances in evaluating whether a credit or interest 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 a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent we determine a security is deemed to be other than temporarily impaired, an impairment loss is recognized.

 

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

 

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

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

March 31, 

 

    

2019

    

2018

 

 

(in millions)

Net other-than-temporary impairment losses (recoveries)

 

$

(9.6)

 

$

1.3

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

 

 

2.8

 

 

(11.2)

Net impairment losses on fixed maturities, available-for-sale

 

$

(6.8)

 

$

(9.9)

 

(1)

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

 

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

 

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

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

March 31, 

 

    

2019

    

2018

 

 

(in millions)

Beginning balance

 

$

(117.5)

 

$

(124.3)

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

 

 

(2.0)

 

 

(4.6)

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

 

 

(4.3)

 

 

(9.8)

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

 

 

20.4

 

 

7.3

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

 

 

1.1

 

 

2.2

Ending balance

 

$

(102.3)

 

$

(129.2)

 

(1)

Amounts are recognized in net investment income.

 

Gross Unrealized Losses for Available-for-Sale Securities

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

Less than

 

Greater than or

 

 

 

 

 

 

 

 

twelve months

 

equal to twelve months

 

Total

 

    

 

    

Gross

    

 

    

Gross

    

 

    

Gross