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

And we're live again. If you're just joining us, for this moment, this is the Bank of America U.S. Financial Services Conference. I should say, the Bank of America U.S. Insurance Conference. There will be other financial services conferences. We're doing this from New York in the Bank of America Tower. Right now is the track for Principal Financial and we hope that you're joining us. If you want to ask a question, you should be logged into the Veracast app. You'll see there's a dialogue box for Q&A. You can type that in. It will come to me. I won't be able to get a video feed to you, but I will ask Dan the question. And so you should be -- feel free to use it. And with that said, we're very proud to have Dan Houston, the CEO of Principal Financial here. If I'm right, you've been at for 35 years and...

37, yes.

37. And CEO for 5 years. I mean, everyone knows, Dan. I don't have to give an introduction, but Dan is going to say a few remarks in the beginning. We'll go through my questions, but I hope that you'll help us by asking some questions, too. And so I'm going to give the mic to Dan, and then we'll move on from there. Thank you very much for coming, Dan.

Thanks, Josh, and thanks to our friends at Bank of America for putting on this virtual investor conference. I'll make my comments brief. And the reason I make 5 minutes worth of comments is to perhaps stimulate some questions from the investors. So when I think about COVID, our plan of attack was, frankly, never to close our corporate center here. That's where I'm speaking from, and it's been where I've been from day 1. We have not exited the buildings. We have 500 or 600 folks here every day conducting business. Obviously, we're in the midst of a large acquisition, with the acquisition of Wells Fargo's retirement business and trust business, and we're integrating that well. We've made some significant concessions to our customers in 2020 to make sure that they understood how much we care about their business, and so premium concessions and hardship withdrawal concessions. And then so with that as a backdrop, I think about what are the growth drivers for Principal going forward in a post-COVID environment? The one thing we know for sure is the SMB market has held up remarkably well. Hospitality got beat up, restaurants, some of those really small employers really had a tough go of it. But the steps that the federal government took and the Fed, along with the PPP program, has really provided an incredible backstop for small- to medium-sized business. So we see recurring deposits recovering. We see matches recovering, et cetera. So feel good about that. The second area I would cite is around the U.S. retirement growth. Again, recurring deposits are strong. Interest in qualified retirement plans and establishing them for the first time still is positive. So not only takeover business, but new business of startups still very much intact. And the idea of providing your employees with financial security is top of mind in addition to health insurance for employers of all size. Our integrated model still works well, integrating asset management. Our total retirement solutions with defined benefit, defined contribution, deferred comp and ESOPs really holds well. 60%, again, of all of our business falls into this category. It's in demand. People are looking for those comprehensive solutions as opposed to trying to net those together. And then I'd be remiss if I didn't cite the emerging market opportunities with -- for Principal, Latin America, Asia, so big markets in Chile, Mexico, Brazil and then our joint venture with China Construction Bank in China, operations in Hong Kong and our good partner in Southeast Asia is CIMB Group, of which now we own 60%. They have 40%, and we're really finding great ways to partner with our asset management franchise to really make things work well in Southeast Asia. I should have mentioned our partner, Banco do Brasil, in Latin America. These emerging markets have been challenged in the last few years. If you just looked at 2020 alone, we had $56 million of headwinds relative to just currency. But again, as the dollar loses strength, as these currencies strengthen, we should see a nice rebound. And then the group benefits business still very much intact. The group life, dental, disability, top 4 player. Life insurance, Individual Life insurance sales, up about 7% for us this past year. And then our business owner executive solutions and deferred comp. And then last comment is great capital position, great liquidity position, still have a dividend payout ratio in excess of 40% is what we told investors was our target. We continue to maintain that. We started purchasing shares again in the fourth quarter, and we'll give more of an update on these important capital matters at our outlook call, Josh, on February 25. So those are really my prepared comments. And hopefully, that creates some interest and some additional questions for investors.

So Dan, you referenced the integrated solution. I'm not going to say that there's only one way. When I think about history of companies like Ameriprise or Lincoln, that competed with you in multiple lines over time. They've just aggregated their value proposition to grow their focus on certain lines of business. When I think about the enterprise value of bring all these things together in Principal, why does it work? Why may have it not worked for some others? And why are the lines you're in a wholesome sort of basket that is going to drive growth over the long term?

Yes. It's a great question, Josh. And I start with what our targeted market is. It's small- to medium-sized employers, large employers, their -- principles of those companies and, obviously, their employees. And we've oriented our product set to go after these very specific markets. There are some products that I consider to be natural bundles. Natural would be DB, DC, ESOP and deferred comp. They fit together, they knit together really well. And they're also generally sold by the same adviser. One of the reasons we divested ourselves of our health insurance business back to 2010 was because it wasn't necessarily a natural fit. We had lost the critical mass that we needed, didn't have the scale. And believe it or not, even then, only 5% of our health insurance customers had dental, disability and life. And so even the decision around group benefits and health insurance was bifurcated into 2 different bundles. So that's the approach that we've taken. We have tried to leverage the enterprise's ability to create great product and then feed our targeted market segments. I can't speak for the other companies that you mentioned. I don't know if they are effectively product manufacturers, trying to take a product to market or they're trying to target a specific target market and provide comprehensive solutions to them. One of the reasons, Josh, that we made a very difficult decision to instantly integrate the IRT business from Wells Fargo was we didn't want to have 2 dual systems, where it created confusion in call centers or product offering or branding or technology. And yes, we spent the last 18 months putting in 1 million hours of coding to make this transition. And 2 of the 5 waves have now rolled over. But again, the focus was on satisfying the customer, not trying to satisfy for a product sale. Hopefully, that helps.

So let's talk about the contents of IRT. I mean, I was looking at the retirement services of our group retirement. And I think you're now maybe the fifth or maybe the fourth biggest player in the market, but it still feels fairly fragmented to me. I counted there were about -- out of the top 500, 10 competitors were about half your size. But still, I don't know if it's critical mass. But definitely, they have a share in the market overall. And it does seem like from there, there's a lot of players in that marketplace, and it's still quite fragmented. I'm actually surprised, given the economies of scale associated with that business that it's as fragmented as it is. Some people have made this argument, which is popular that in the long term, there's only 2 to 4 competitors in every market, as sort of a general rule. Is this is a market on the verge of mass consolidation? And how -- you can go take that anywhere you want, but how should we think about it?

It's an industry that is slowly migrating into a handful of what I'd consider to be mega players in this marketplace. I mean, we'll be roughly 10 million planned participants. And you mentioned there's a lot that are kind of 0.5 million to 1 million. I lived through the consolidation of the health insurance industry. I saw what the likes of the Blue Cross and Blue Shield organizations did. You can put certainly UnitedHealthcare into that mix, and we can talk about Aetna and Cigna and Kaiser. But I do think that over a longer period of time, these industries will have a tendency to coalesce into some really mega players and Principal's going to be and is one of those players today. To the extent that you're committed to this business, the investment that you make around IT, IT security, participant website, employer, websites and support, it's a big deal. And so critical mass matters when you're trying to spread the cost out of these significant multi-million, tens of millions dollar investments to your technology infrastructure. So I think it will happen. But again, I come back to -- with the focus on the customer, I think the TRS element, which again, as I said, 60%, I think that's going to be a great differentiator. We already, for example, can provide services for emergency savings or HSAs. They're not as natural as some of these others. The distribution partners tend not to promote those as often. But we'll see what a post-COVID environment with more remote workers looks like and what their expectations will be from their services provider such as provider retirement plans and group benefits. But we are certainly poised in a positive manner to take advantage of that.

And with the technology initiatives that you're doing with IRT transaction. Look, I don't want to imply that there's more M&A to come, there might be. But is it easy to integrate a bolt-on, if you want to acquire a smaller book of business, not of the nature of the IRT transaction, but one of your smaller competitors. Can you do the technology that's easy to do going forward [indiscernible] transaction?

We absolutely can. Yes, Josh. So one of the things that we -- that we said to ourselves, and so I'll make up a number, 800,000 to 1 million hours to onboard this acquisition. Maybe you could have done it for half the hours, 500,000 to 600,000 maybe or 400,000 to 500,000 hours. But what we've done is created the infrastructure to receive the next acquisition without having to do a lot of reprogramming. And so as it turns out a number measured in dozens of the employees that will be transferring over to principal from Wells Fargo had already had a really good playbook. Wells had been an acquirer and a consolidator of platforms. And so we took a lot of their playbook, their insights, their knowledge and codified that to be a more robust engine, to receive the next acquisition. So directly answering your question, it would be a fraction of the effort to onboard the next big one or even medium-sized one than what has taken place here as it relates to the IRT transition.

I want to remind -- there's currently 70 people listening that you can ask a question, just type the -- your question to the Veracast window and send it over to me. You don't have to be shy, but you can be if you want. So a little bit deeper. I cover Voya. I cover Prudential, I cover a few others. And just once, for no good reason, I was looking at the fund flows over the last 4, 5 years, I was mapping them over and they're very similar. I didn't think that they would have to be, maybe there's a reason there, but fund flow percentages generally have been in line. But with those companies, I mentioned, you could be in different areas, 401(k) versus 403(b) versus 457. Can you talk about some [ disruptive ] behaviors in those subgroups a little bit. And how, I guess, different books of business will behave differently. Are older books of business attractive for people? Are their withdrawals straight -- stage? I guess, if you want to skew younger, were there still growth? How should we think about sort of the different opportunities in different sort of classes of business within that retirement business?

Excellent. So one of what we know to be an obvious differentiator between 401(k) and 403(b) and to some extent, even 457, is a higher utilization of the general account guaranteed returns in spite of even low rates. Those generally can produce -- although it uses up more capital, there is more revenue generated from those sorts of investment options. I do think that if you think about the overall differentiators, it gets down into things like TRS, it gets to the participant website. It's how you go to market. We enjoy literally relationships with tens of thousands of advisers that sell our products. We like that. It's highly diversified. Technology is a huge differentiator. One of what I think will be a big outcome with our relationship with a third-party, that is allowing us to onboard a new, small plan without any human interaction. So it is a 100% automated onboarding of a small plan. That's a very powerful tool for small employers that know what they want. And again, we'll work with advisers and using that to try it again, take out cost where customization is not necessary. But TRS is probably among the competitors you mentioned, is a huge differentiator. And they're hard to do. I mean there's a lot of complexity in deferred compensation. There's a lot of expertise that you need around ESOP and working with valuation firms and having the proper communications because the way you communicate with corporate employee, a W2 worker as opposed to a W2 worker working for a privately owned, smally-held organization in which the appreciation of the underlying stock is a huge contributor to their retirement program. Those are 2 very, very extreme examples of how you'd communicate differently. And then remember that once you get a plan greater than a couple of hundred employees. There is no way that the highly compensated individuals can save enough for retirement. Matter of fact, I'm sure many of the people on this call find themselves in that same position. So a deferred compensation program, people don't want different investment options. They don't want a different website. They don't want the complexity that trying to take 2 unaffiliated firms together to produce that and the confusion that it can create. So that bringing together a deferred comp funded either with mutual funds or unfunded or using life insurance because of its tax efficiencies, those are all other ways, Josh, as you say, getting down into the details. Those are ways to truly differentiate our offering from the competition. Of course, that's even before we get to investment options. We've known that it's been open architecture for a long time, whether it's a brokerage option, a target date, proprietary, nonproprietary. The best way to go to the market there is having choice. The good news is we've got really strong asset management at Principal Global Investors, good target date funds. And so it's allowed us to disproportionately capture those assets not because how we go to market, but rather the investment standing on their own for having strong long-term competitive performance.

Let's move over, I guess, we'll do a nice bridge to investment management, I guess. And, by bridge, by saying, I haven't really seen any company's throughput a lot of their retirement funds into the investment management business. It's always maybe been a dream or maybe it's my dream. Man, I'd say, "Oh, you can put these 2 things and marry them, that will not only will manage your portfolios, but will also manage the risk as well." Why hasn't it been more successful? Is there things you can do to drive greater participation in Principal funds in the retirement business?

Well, as you know, our number that goes to Principal funds is about 60% of the total. The larger the plan is going to have a smaller percentage of the funds to Principal funds. The smaller plans have a tendency to look for more comprehensive solutions. The reality is, for the most part, all plans today work with an adviser. There's usually a group of trustees, fiduciaries, making decisions, evaluating fund performance, evaluating the underlying expense structures, making sure that there's good choice on the platform. But at the end of the day, you got to have competitively priced funds, and you need to make sure that you've got strong performance. The good news is we continue to evolve our platform to be able to do that. We have passive funds from Principal and non-Principal funds available. We have target dates that are 100% Principal funds and a hybrid that is a mix of multi manager. All of those become choices to small, medium and large employers to see if it's a good fit for them. And -- but long ago, the decision was made, for the most part, by advisers to split the decision between the record keeper administrator and who is going to be the asset manager. And the other sort of significant contributor to Principal's retirement success isn't even captured in what we call FSA or WSRS, the worksite retirement and full-service accumulation. But it's captured rather in our DCIO, where we have put our PGI investment options on the platforms of our competitors and gone to large plan sponsors directly. So when I look at our franchise, I know there are some organizations that never break it out. We have a tendency to break it out into fairly small components. But I think about our PRT business, the income annuity business, the traditional retirement business and of course, the DCIO and the institutional mandates that come directly out of PGI, and we've really held our own with our ability to gain market share across those segments.

Obviously, there's many layers to the investment management business and Principal has been extremely successful in the emerging market class of businesses. Can we talk about fee structure a little bit. I mean, if we talk about domestic investment management, obviously, fee compression is a huge worry for investors and whatnot, but emerging markets where it's underpenetrated, there may be less pressure and there might be growth there. I guess there's 2 sort of angles I want to go. One is, why should we think that companies that are currently in the emerging market class of investments are going to be winners compared to, I guess, companies that are just starting out now? What's the advantage of incumbency? And on the other hand, how should we think about the fee pressure from emerging markets businesses compared to what's going on in domestic invest management?

Yes. Okay. So really 2 very different things, but they sound a lot similar, right? And so let me just take first. I think emerging markets are oftentimes misunderstood, and the reason they're misunderstood is because if I just looked at last year's results, as I said at the top of my comments, we had a $56 million bad guy last year just on currency alone across those international businesses. But if you look at the growth rates of the middle class in places like Chile and Mexico and Brazil and Southeast Asia and China, they're much larger than what we're going to enjoy for middle class growth here for the targeted market in the U.S. And so we still have a high degree of confidence in spite of regulatory changes and there will be fee pressures outside the U.S. If you just try to distill and understand the formulating of employer-sponsored or state-sponsored but publicly-supported retirement schemes, whether it's an AFP or a foray or mandatory provident fund. Whatever the particular model is in those respective countries, we think there's still a lot of growth outside of the U.S. We pulled back from India recently. You saw us exit there our back office. We have a large back office there, but as an ongoing business in retail mutual funds, we made the decision to divest to Sundaram. So a good strategic decision from my perspective. So we still have a lot of confidence. Net out FX some of the noise in Brazil on inflation, some of the encaje implications on down years. We're seeing good solid growth in the emerging markets in which we do business. As for the second part of your question, we do have good insights. We have a really nice set of international investment options for our domestic customers. We have a lot of niche investment strategies, whether it's real estate, emerging market debt, emerging market equities, high yield, certainly preferred securities. These are all really good stand-alone components to go into a qualified retirement plan or be part of a target date series, be part of a general account. And the investment performances held up. These are highly differentiated asset classes. Pricing has held up better than large-cap value, blender growth, but we recognize there will continue to be downward pressure, which means we need to create more scale, more size. And Pat Halter and his team have done a really good job doing that. And hopefully, Josh, I've answered your question, but if not, we can go back and clean that one up, however you'd like.

Yes. That's a little bit more feature pressure type. Is the pressure on fees? I -- And truly, maybe I'm wrong, but it seems it's greater in the saturated domestic markets than it is in the...

Yes.

Emerging markets where you still offer differentiated product. And I guess where I'm going is, is there a certain scale that you can get to, where you can offset the general trend of fee compression because the pool that's getting bigger, faster has a higher fee take than the pool of, I guess, assets with greater competition?