Principal Financial Group, Inc. (PFG) Earnings Call Transcript & Summary

[Audio Gap] and CEO of Principal Financial. Dan has been with Principal since 1984.

Correct.

Right out of college?

Right out of school.

Wow, you were more boring than I am.

My wife would confirm that.

He's been CEO since 2015, Chairman for almost 4 years. Since Dan took over as CEO, Principal has had an average ROE of 14%, bought back more than $1.6 billion worth of common stock. The company has also made a number of key acquisitions during that time. It's always a pleasure to have you here, Dan. Thanks for coming

Thank you, Jay.

I want to start maybe having you, just take a look back to -- not that far, just 2019 and give us a summary of how you thought the year went.

It was interesting because I think all of us were concerned about 2019 coming off '18. And what the equity markets and interest rate markets might do. And I don't think anyone was sitting there thinking that the equity markets would be terrible. But we would have thought that our underlying assumptions would have been more close to what the markets actually produce. So it was a nice, frankly, windfall entailed to our backs as related to equity markets. Now on the interest rates, they are probably 50 basis points lower than what we would have expected. And that was a bit of a surprise. As you know, we've got a significant part of our operations outside the U.S. And it was nice to see some of those equity markets, like the BOVESPA down in Brazil, actually turn around and be quite positive as well. So we did get some nice tailwinds internationally, although currency didn't help. But all in all, '19 will go down as a very solid year for the company, and those are effectively kind of the main, sort of, macro drivers. Obviously, we announced on April 9 the acquisition of Wells Fargo's Investment Retirement & Trust businesses. We closed on July 1, and we are very much in the midst of the integration, and we couldn't be more pleased about bringing that, not only the block of business on, but the advisers and the employees of the organization, very, very similar cultures.

So that was '19. Let's take again big picture, still, 2020. What are some of the goals you have for the company?

Well, there's really -- there's probably 3 or 4 that I would hit on. The first of which is, we need good, clean execution on the full integration of the Wells Fargo IRT business. And we have a lot of resources going at it. We are going to do it right. And Jay, this is where it probably worth noting, in previous instances of large acquisitions from many of our competitors, they never did bring the systems together. They operated them separately. We made the decision back in the due diligence phase of the project that we would integrate as quickly as we possibly can and get on to a single system. It's harder, it's more expensive. It takes more time, but I have no doubt, 18 months down the road, we will be very happy. In 3 and 5 years down the road, we're going to be thrilled. So that was number one. The second thing, and we've talked about this with investors, we had a deliberate spend on a digital portfolio. This is to advance our strategy on the digital front, on a number of different venues. The internal rate of return on that portfolio is about 20%. We're hitting stride on each of those and look forward to seeing those materialize in terms of driving revenues and taking out expense for the organization. And then the third thing I would say is, internationally, we are going to spend a fair amount of time better understanding how we can advance our strategy, both India and in China. We -- as you know, we've been in China for a very long time, over 15 years. We have a great working relationship with China Construction Bank. Now with the trade agreements behind us, we're more optimistic about getting traction on enterprise annuity license and advancing our retirement efforts in China. India is a bigger lift, and we need to sort that out. So those are the sort of 3 top-of-mind big initiatives for 2020.

On the digital portfolio, you mentioned the IRR, you think it's about -- will be about 20%. How do you measure that? Is that a challenge to measure that?

Well, it is. And -- but I would tell you, we put a lot of science behind it. About 60% to 65% of that portfolio is driving top line revenue, which is where I think you get the most bang for the buck because it's reoccurring again through '21 and '22 and '23. And the remaining portion is around expense takeout. We have already seen, for example, in one of the digital initiatives, it has a profound impact on the ability to have stronger take-up of our products. Because of convenience and ease of use, people are deferring more. More people are participating. All of those things are very compounding. As you know, last year, our reoccurring deposits were up just short of 10%. And anything you can do across your existing customer base to drive additional deposits is a very positive thing. And there's 2 big levers. One is getting more participants to join the plans. The second is, are those people in the plan to increase their contributions. And it's a tight labor market. You're starting to see a strengthening of employer matching contributions. They need to retain their talent. And so there's just a lot of positive momentum in leveraging our 401(k) plan to attract employees.

That business looks like it should be reasonably good even in '20 and '21?

My -- certainly, my hope is.

Yes.

I don't see a reason -- we did a strategic debrief and retreat back in September with our full Board of Directors. And we do a deep dive every year. But this year, we had a special emphasis on the retirement business. And we were really sort of looking out the next 10 and 20 and 30 years around the world, what would be the deposits growth look like. And there's one thing we came away with. Our diversified business model focusing on global asset management, global retirement and domestic protection coverage group benefits and et cetera, life insurance, really has the potential, a market that we are not changing our strategy, it's very much on the right track.

Let's talk about the retirement business. Let's start with, I guess, the competitive environment. It's always competitive. Have you seen any changes in the environment?

Yes, ironically enough, I got in town yesterday, spent time with a number of the media outlets, including the Wall Street Journal and then spent time last evening -- early evening with the Head of our New York Operations and Retirement space. And so this is as fresh the last 12 hours. Allison Smith is our sales leader here in the New York vicinity. And I ask her about investment performance. Dan, it's great. How is the technology? It's great. How is the pricing? It's great. I've never seen her more enthusiastic about her ability to compete. Scale is going to matter in this business. Total Retirement Solutions, TRS, it matters in a big way. About 60% of our business, again is some combination of DB, DC deferred comp and ESOP. ESOP, if you think about it, is become increasingly a popular way -- and we have 3,000 of these at Principal, a very popular way to engage employees. And if you think about the sort of delaying of IPOs and you think about the use of sort of that 100,000 life employer, being public isn't necessarily the right alternative. ESOP and engaging your employees is a very, very positive ownership structure. And again, if you think about baby boomers, who may own 2/3 of a company or a 100% of a company, how do they get out of there in a tax-efficient manner, certainly ESOPs can play an important role. So from her perspective, TRS is a very powerful component. The other part of TRS that I mentioned is defined benefit. There are trillions of dollars in defined benefit. And yes, a lot of those plans are frozen. But someone still has to do the record keeping, they have to do the administration, they have to do the asset management. And most employers say, if they've got one, and it is frozen, they still want it record keep-administered with the 401(k) plan. So that when you receive your benefit statement, you're seeing whatever frozen benefit that you've accrued plus your 401(k) contributions. So again, those are all very alive and well. Last comment on that would be the deferred comp. You got key executives making more than the social security wage limit. How do you go about ensuring that they are funding 85% income replacement at retirement. Deferred comp funded with life insurance or mutual funds or unfunded is still a very popular choice. I mean it is truly a great way to ensure that you have some retentive benefits in place for your key executives.

On the Wells Fargo IRT transaction, you answered some of the questions that I had. But it's a question I have, how should investors judge this deal over time? What metrics?

Great question. So remember that business is made up of really 2 businesses: One is the trust and custody business, and that's a lower-margin business, but think of it as a utility that help support the 401(k) and the defined contribution and the defined benefit businesses. We'll try to make that as transparent as we can as time goes on, and we'll produce that in our supplement. But it is an important part of the business. There's really 3 key takeaways as you think about why the Wells Fargo IRT business was so important. One, had everything to do with scale. If you're going to have to invest truly hundreds of millions of dollars with applications to support a participant or a plan sponsor, we want to be able to spread that over all of them, more than 10 million here -- nearly 10 million in the U.S. and just maybe to set that -- set the table here, 33 million customers around the world, nearly 200,000 small-to-medium sized businesses in 80 different countries and we want to leverage that platform globally. So the ideas that are being generated around our digital innovation labs in São Paulo, Brazil or in Santiago, Chile, we're using those right back here in the U.S. to leverage that. So one would be the scale component. The second is it tapped into a larger case market, and it brought with us advisers that otherwise we would not have worked with. So it's a different cohort of advisers that we're able to tap into as a result of this transaction. And then capabilities, we will extract from their existing systems, the applications that Wells Fargo large institutional customers found of great value. And the point I raised -- the reason I raised that point, Jay, is because on those larger plans, think about plans greater than a couple of billion dollars. There's a lot of unique coding that takes place for those really large plans. And to be able to scrape that and not have to have an available operation, creating those capabilities and taking the code, putting it on our platform, that's important. So the 3 things I just described don't happen overnight. It will take us all of 2020 to get that successfully integrated. It'll take us partially 2021 to sort of round it out, but I think it sets us up, I think -- I know it sets us up for tremendous success going forward with the company.

So is it really a margin play more than a revenue?

Yes, I think it does a couple of things. I think you'll -- this industry, as you know, I mean, you just provided some statistics when we let off. This is an industry that's been under pressure. We've been doing a good job maintaining margins. But certainly, these kinds of capabilities and the sort of integration helps lock up those margins and protects the downside, gives enormous competitive advantage from a scale perspective, leveraging expenses. So yes, maybe there's some margin improvement as a result of this. But certainly adding $425 million of top line revenue to this block of business is a really good shot in the arm. When we announced the acquisition back on April 9, my comment was, we just picked up 10 years of organic growth by stroking a check for $1.9 billion -- $1.2 billion. And that's a really sort of smart way to think about deploying capital and we always take a very well-balanced approach to deploying the capital. And from my perspective, I get 10 years of organic growth and go through the -- and there is a challenge. There is pain. It's a lot of hard work to integrate these 2 platforms, but it certainly sets you up for success on the backside.

Before we leave the retirement area, pension risk transfer market. Talk about how you are competing there and your outlook for flows here.

So last year, sales were $3.9 billion in the pension risk transfer business that would have put us on the top 5, sort of, what league tables you look at, and some would show us at 3, some might show at 5. We see the pipeline is still healthy. I've used this example before, but I'll use it again. There are a lot of defined benefit plans out there. To the people that we're holding off that interest rates might rise, that's not materializing. There's -- what's the shelf life of the CEO, 7 years? Something like that. New CEO comes in, there's a big liability sitting on the balance sheet. What's one of the very first things they want to move off the balance sheet. Anything related to what was created prior to their getting there. And so there's continuing laying off of the liabilities off the balance sheet. And there are great companies like Principal that are in this business to be able to take on those liabilities. Now I will say this, it's not for the faint at heart. And you to -- they are underwriting you as a company. You have to be able to make good on all the promises that's stating the obvious. You have to be able to have a record-keeping system that pays people on a timely basis, whether it's a check or an electronic transfer. There are -- there's a lot of that goes into the pricing on were they deferred lives, were they active lives, what are the provisions within the contracts. The average defined benefit plan, if you go back to TEFRA and DEFRA and ERISA and RIA, et cetera, all the major tax law changes that have taken place since ERISA. Every one of those has a certain calculation that has to take place. There are anywhere from 6 to 9 cohorts. Every time you price every single participant in a pension risk transfer case, getting that right really, really matters. It's very technical, and we've been doing it for 75 years.

Yes, I don't think we have an appreciation for the in-depth work and the actuarial work that goes into it.

If they're all currently active retired, and they're drawing down on their benefits, and it's a stated amount. That's nirvana. But on deferreds, and those that are still active are far more difficult challenge.

So let me forward just for the PRT business. It sounds as if the flow is still out there, you'll get your share.

We'll get our unfair share, yes.

Let's talk about PGI because this was a business that the flows really seem to improve quite a bit and the performance improved over the course of the year. What were some of the changes that you made, whether it's product, distribution, investment process, because it really showed improvement last year?

Yes, the answer is D, all the above. And we had really good traction on a couple of different areas. Number one, remember, that the flows on the top side actually weren't terrible. They were actually pretty decent, if you think about our active strategy. But we had a leaky bucket on the bottom side. It was an agent-based client. We're on the record. We knew it was coming. We knew it was going to drawdown that yen trade, U.S. dollar to yen trade. It wasn't working. It's no one's fault, no hard feelings. We retained the client and a lot of other different strategies, but that one was going to get paid up. It was a fate at complete. It was going to happen. So that sort of ran its course. So that was a good thing. Fourth quarter of 2018 was not a good quarter, but they had a lot of conviction. They stayed with the strategies. And so we had a 1-year investment performance number that wasn't good. And it was drawdown from a single quarter. That one got took -- was now gone, and you saw in the most recent reporting for the fourth quarter results. One year performance numbers go up dramatically. So our 1, our 3 and our 5 are very much there. We did do some shifting around on some of our resources for sales under Tim Dunbar and Pat Halter and Kirk West, handling international and Tim Hill now handling the domestic business. And another area that's pretty quiet, and this -- I'm glad you raised this question, Jay. One area that we'll measure success this past year in that $5 billion to $6 billion of sales was the DCIO. So yes, we're not necessarily getting asset capture on our platform as rich as it once was, and that tends to happen when you write larger business. But you pick up another $5 billion to $6 billion in the DCIO, that's not reflected in the retirement business. It's being reflected in the asset management business. So we probably need to do a better job of helping educate investors on sort of that collective retirement flow, reoccurring deposits and ongoing asset management. So it's -- we're getting it one way or another within the organization. And the way we report, it could look as if it was struggling on one side, and we didn't provide the necessary details on the other.

And it all ends up in fees so it's...