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

So we'll get things kicked off here. Deanna, thank you for being here, Deanna Strable-Soethout of Principal.

Thanks, Alex.

Very nice to have you. So this will be a fireside chat format, so I'll fire away with questions. And is there anything you'd like to say to get it started?

Yes, I'll just make a couple of comments. So obviously, 2021 has been a pretty big year for Principal. We did have a pretty impactful Investor Day, where we communicated kind of our go-forward path that also caused some changes in our product portfolio. We're narrowing our focus on the annuity line of business and the life insurance business and ultimately are focused on transacting on a few of those blocks as we go forward. Probably more importantly, I think we really did have our business leaders focus on the path forward in our core growth areas: retirement in the U.S. and emerging markets, global asset management and also emerging markets. And then our benefits business focused on the U.S. small-to-medium type business. And then we really did confirm our capital deployment plan and really returning quite a bit of our excess capital to shareholders over the next -- by the end of 2022. And I feel like we're on a great path relative to that as well as meeting our financial objectives we laid out. So with that, I'll turn it back to you to ask some questions relative to that strategy on where things are playing out at this point.

Yes. The first question I can ask, I guess, falls in the lines of what you're just discussing, I guess the EPS growth you've rolled out, the ROE targets you've rolled out. Can you talk about some of the underlying drivers of what you're expecting to get you up to that 9% to 12% and 15% ROE?

Yes. So obviously, as we deploy our excess capital, that will be positive to both the ROE level as well as the EPS level. So that is a driver for both of those. Specifically to the ROE, as of third quarter, our run rate ROE is right at 14%. So we're well on our way to that 15% target. And I think that does really reflect our underlying business mix. We have been more fee focused, less capital intensive, and some of the actions that we are undertaking will continue to propel that. Relative to the earnings growth, obviously, COVID had some pressure on earnings. But if you look historically, we've been in that 9% to 12% range with a high proportion of that coming from earnings growth. We do think there'll be a little bit of lift from some additional share buybacks, but we still think there's a lot of earnings growth potential from our underlying businesses, as we are focused in those areas where we have differentiation and where we have proven the ability to grow. So I think it's a combination of continued execution, investing in new areas of growth and then making sure we get right size our excess capital that again helps both of those metrics.

That's helpful. And maybe digging into the capital returns that you mentioned there. You've already committed to $3 billion through 2022, that's already big amount. But could you talk about the potential upside in that number?

It's never good in our business. So a couple of things I would say there is we're at $1.1 billion already relative to that $3 billion. And ultimately, we think we're well on the way of that. Two things that could help that. Obviously, that $3 billion did not include any proceeds from the transaction, so that would be additive of that. And we really are down the path that, that will happen and be able to benefit that over that time period. The other thing I would say is, even since we announced that at Investor Day, macro factors have been a tailwind and that tends to flow to the ability to deploy that. So I do think there is upside to that for both of those factors as we think about that over the next couple of years.

With COVID variants continuing to come up here, what's your expectation working towards 2022? Are you seeing a normalization in trends at all?

Yes. So I think we'd all want to understand how that might play out. I'd start with the fact that our sensitivity to COVID, I think, is one of the smallest that I've seen in the industry. And I think there's 3 probable factors to why that is. So our rule of thumb is $10 million of after-tax impact for every 100,000 of COVID U.S. deaths. And since the onset, we've actually -- we're right on that rule of thumb. We've had some quarters above, some quarters below. One, our Life Insurance business is smaller than some of our peers. Two, we tend on the individual life side to likely reinsure a higher percentage of that risk. And then we do have a pretty good offset with our annuity and CRT business. And so obviously, you never want to have an impact from that, but it does benefit those businesses when mortality happens since you can release the reserves. So we think fourth quarter is likely going to be pretty similar to third quarter. And then we're following kind of the forecast for 2022, which I think is in the 150,000 to 200,000 range at this point in time. But I think that's going to continue to change, and we'll update you as we go forward. But I think that rule of thumb it's pretty good. What we have found with the Delta variant is it's doing more to the younger population. And that one puts more of the impact in our Group Life line of business and actually reduces some of the annuity offset. So we may be slightly higher than the rule of thumb if it continues to focus more on those cases.

I guess the next question is just on the labors markets and wage growth. When I think across your businesses, what does some of the impacts I should think about there?

Yes. So obviously, as an employer with 15,000 to 18,000 employees, we are facing some of that in having to understand how do we continue to attract and retain our employee base. So you won't probably see some of that weave into our expense base. But I'd actually say we have natural revenue offset to that. And particularly in our U.S. retirement business, if you think about the recurring revenue that comes from our import retirement plan, if someone hires a new person, that usually leads to contributions to the 401(k). And if their salaries are increasing, that leads to higher levels of recurring deposits well. We've also seen employers increase their assets as that war for talent comes. And so I think if you looked at our third quarter recurring deposits, even if you took out the kind of noise from our IRT Wells Fargo acquisition from the legacy block, those were up 20% quarter-over-quarter, somewhat pressured in the year ago quarter but strong in the current quarter to go over into our Group Benefits business. And we focus on dental, life and disability in the small to medium-size business. So our average case size is 40 employers. We saw record employment growth and probably 1% higher wage growth than what we have seen historically. And that was the strongest in the smaller end of our employee case size. And so that's going to help premium growth. There's no acquisition costs for any of that. And obviously, it helps our growth in that business as well.

The next topic is just on some of the strategy we've embarked on where you've kind of gone through and work in your businesses, and you're very focused on some of the areas where you see good growth potential. You made harder decisions where we feel like the U.S. Life and the -- particularly the universal [indiscernible] and the fixed annuities or maybe the claims which you can divest. Could you update us on what some of the drivers were behind that decision-making and then also just how the process has gone?

Yes. So in addition to being the CFO, I run enterprise strategy, so I was very involved in our strategic review earlier this year. And it was really driven by strategy and where we felt we had the ability to differentiate. We have the ability to grow and ultimately have the ability to earn the returns that we thought our shareholders deserve. And so that led us to those difficult decisions. We're still in the individual life business. We're still in the retail annuity business. But on the annuity side, we're going to focus more on the variable, exiting the fixed retail. And on the life insurance side, we'll be very focused on the business owner market because we feel that our differentiation in some of those businesses, we feel, have become commoditized and less able to have the returns that we think, again, our shareholders deserve. Process is well underway. The fact that we're in second round bids, interest has been strong. I think there is a positive path to executing on those and optimistic. Probably before our next earnings call at the end of January, we'll be able to update the market on those transactions.

Any way to help us think through how much capital you contribute freeze up in those transactions and how do you kind of rank order the uses of the proceeds?

Yes. It's -- they're complicated transactions, and so obviously, we had some estimate as we went through the strategic review. But we're also at [Audio Gap]

It's been a notable area of change in the margins coming in at 45%. I think year-to-date, recent last quarter have been quite strong relative to the 37% to 40% guidance that you guys put out there. Can you talk about sort of that performance, what's the sustainability of that [indiscernible] over time?

Yes. So obviously, PDI is our Global Asset Management arm. It's having a really, really strong year. We came in targeting a 37% to 40% margin, were, as you just mentioned, closer to 45%. Two things that have driven that, obviously, strong market has helped in terms of increased management fees on that business and the expenses aren't tracking at that same level of growth. And then we've also benefited from some higher-than-normal performance fees. Our general account has benefited some higher variable investment income. A portion of that is from real estate. And obviously, there'll be investor there and get some performance fees relative to that. And so if I take out what I would consider more abnormally large positive impact from performance fees, we're probably more in that 42% range. And I do think as we invest in the business, as some of the expenses catch up, we'll probably be at the top end of that 37% and the 40% range. And I do think that margin compared very favorable to others in that space.

Next is moving to specialty benefits. That's an area where I can achieve the guidance around the growth in that business has kind of been taken up a little bit there. Can you talk us through some of the drivers of that?

Yes. So for those of you that don't know my background, I ran that business for a number of years. And since we went public, I would say that we have grown the top line of that business in that 6% to 10% range pretty consistently other than when it got hit by COVID, and that had a negative impact on employment. And we also gave some premium relief to some of our dental customers because they weren't using those benefits. And so we had, what has normally been in that 7% to 9% range, drop closer to 3% to 5%. And I'd say what we're now projecting is somewhat just getting back to what we had experienced pre-COVID. I think what drives that growth is we are focused on that small- to medium-sized business. That's been a very attractive business for us. We've built our business model to scale in that market. And actually, we see a large percentage of our new sales every year actually being new market. So 40% of our new business year-to-date this year are actually customers putting that benefit in for the first time. So we may have their life insurance, but they decided to add a short-term disability business. And so we've been able to cross-sell and attract new business there as well. The other thing we've been very much investing in is the digital interaction with both -- actually all 3 of the people that we need to work in successfully [indiscernible] that business: the adviser broker community, the employer as well as the participant. And so the key to success in the small business is the ability to transact a lot of transactions. And so we install 10,000 cases every month. We renew 10,000-plus cases every month. And we've invested in the technology to make that work very smooth with the broker community as well as the employer community. And then employment growth will be a tailwind to that business as well.

Maybe shifting to the IRT acquisition. The retirement piece came over in 2Q [indiscernible] year. What are some of the benefits that you're experiencing as you try to finalize that? Or what are the opportunities as we look into next year?

Yes. So first of all, we'll be very happy when that gets completed in the first quarter of '22. It's taken a little bit longer than we anticipated partially just as we focused on making sure we did it right for our customers, and we invested in really making sure we have a platform that could work and give advantages to the combined customer base, and we're seeing the benefits of that. So one thing that will have started and will accelerate as we get to the trust and custody integration is the realization of those expense synergies. We see -- when we announced the deal, we thought that would be in the $60 million range. We now think it's closer to $90 million. We've started to realize some of that, but that will really accelerate as we move past the transition in the first quarter. The other thing that we've seen is we now have a broader market reach. And so we have distribution outlets more in the consultant channel. So we didn't have strong relationships prior. And we've become more a player that is getting looked at plans in all size cases. And so we do think that -- some of that takes time to come to fruition, but we're seeing some opportunities there. The other thing we're seeing some opportunities is one of our key differentiators is our ability to offer multiple retirement plans for the same customer. We call that TRS, total retirement solutions. And so our ability to offer 401(k), record keeping, nonqualified deferred comp, stock purchase plan, PRT business, all within the same kind of administration platform. Many of those, well, customers did not have that broad range of capabilities, and so we're seeing access to that as well. And then I think the final one is just the additional opportunity we have to retain IRA rollover dollars at benefit event and retirement on a larger block of business. We added 2.4 million participants that are all going through those stages, and we have the ability to retain that. The economics of that don't show up in our retirement business. They tend to show up in either our bank or the asset management business, but a benefit that we're excited about as well.

Maybe moving back to the RIS-Fee business. And I think you guys guided to a margin that sort of started out at the lower end of your range, I think in the 27%. And we've seen seeing that our equity markets were strong. There was a little bit of pressure there. So I'd just be interested in any updated thoughts on where that could be as we think through the end of the year and into next year.

Yes. So the first thing I would say is that equity markets have been positive from our third quarter call, so there's probably a little bit of a tailwind relative to the commentary on that call. The other thing I would say is that trust and custody delay is moving some of that target margin out a couple of quarters. And so when we did our outlook in February, we thought we'd be fully transitioned in the third quarter. We now have a 2-quarter delay. And so we still see that same path to 27%. We think that's very plausible in the middle of next year and ultimately some upward trajectory even after that. So we feel good about it. Again, it's more when we're going to see it rather than if.

Got it. So I'd like to ask on the Chilean election. You've got a presidential election going on down there. And there's certainly some consideration for pension reform. You have the Cuprum business down there. Any thoughts -- any early indications of what that could look like as we learn more on the outcome?

Yes. I'd say that some of that changes every day kind of where that's going to go. But I think there has been some positive signs here recently. So most of you are probably not as opposed to the Chilean election than up until 6 months as opposed to the Chilean election, but we did have a runoff in November. That actual -- the actual election -- primary what happened in November, the runoff will actually happen, I think, next week. We're down to 2 candidates, but the 2 candidates couldn't be more different. One is very far left, one is far right, and we have the third place candidate that has not yet endorsed either of those 2 candidates. And I think that candidate has 12% of the vote. So I still think the election, it's too hard to call which way that's going to be. Two things I would say is, at the same time they did the primary elections, the Congressional election occurred. And the outcome of that was that more of Congress move center. And obviously, just like here in the U.S., the President can't get anything done without Congress also approving that. And so we do think that has probably lessened the probability that maybe something dramatic can get through both the President and the Congress. And then last week, the Congress did vote on whether they would allow a fourth withdrawal from the AFP system or the second withdrawal from the annuity system, and that was defeated. And so again, that -- it's not telling me where it's going to go, but there are some signs that maybe there can be more support on that system as we go forward.

Maybe talking about the PGI, I'd just be interested in what are some of the key areas you focus on if you think through growth opportunities there. Are there any capabilities you're wishing to build out in the U.S.?

Yes. So just to step back a little bit, when we look at the AUM of PGI, about half of it is forced internally, so again either the general accounts or the retirement business. The other half is really institutional or more broader retail. But we tend to use the capabilities that make us strong and general account in the retirement business and leverage those capabilities with third-party clients. So we're very strong in real estate. We're very strong in asset allocation products that some of that plays out in target date within the retirement business. We're very strong in mid-cap equity, international equity, preferred, high yield. So those have tended to be products that are less conducive to passive alternative. And I think all in all, that's allowed our fee levels to remain very resilient. If you go back to our President of Principal Global Investors, Pat Halter, in his Investor Day President -- presentation, he did talk about some areas we are building out. Private credit would be one that we are building out internally. We've expanded and hired 15 to 20 individuals in that area to organically grow that capability. And we're continuing to expand our real estate reach. And so we are a top 5 U.S. manager of real estate, but we recently, a couple of years ago, expanded that into Europe. And we're looking to build out some of that in Europe and Asia as well.

So on the RIS-Fee business, one of the questions that we get is just, over the last year, you think through how strong the equity markets have been, 30% [indiscernible]. And the segment earnings that are very much a few on the AUM business, we're not up. By the end of the day, we are rather down. And so it has some focus on this in the pricing, the fee rates, et cetera. And so any commentary you can provide on why you didn't necessarily see all that come through and what's the driver there?

Yes, so fully recognized where that is coming from it. And there has been equity market growth. There's also been some fee compression in that business. And then expenses were kept pretty low in 2020, and we're starting to see some of come back in 2021. And so I think those dynamics plus the delay in the IRP trust and custody integration has caused some pressure on that business. When I think going forward, there will continue to be fee compression and competitive nature in that business. We've quantified that to be about 2 to 3 basis points a year going forward. Some of that is just because of the strong market, you get customers saying I'm paying you a lot more for the same services. Can we negotiate that kind of down? So there is a little bit of an interplay between that and strong markets. But if I think about the next 2 to 3 years, I've seen a lot of tailwinds for that business despite some of that fee compression. I've talked about many of those already. So I talked about the realization of the synergies from the IRT transaction. I've talked about the strong wage and salary growth. I talked about us getting into new markets and being more -- our pipeline is up significantly just because we are getting the ability to quote on more business because we are a top 3 carrier in that business as well. And then the other thing to recognize is not all of the revenue that comes from us being a strong retirement record keeper doesn't all show up there. It's why PGI is having a strong year is because they get some of the benefits from that platform. So I think -- again, I feel good about what we've built. I feel good about how that's going to play out. And even though there will be continued fee pressure, I think we have what we need to do to propel that business forward.

And you mentioned some of the expense initiatives around IRT in there in that response. You've also had pressure on IRTs in this issues on excess variance coming down. And I know that you all worked hard on the expenses in the face of some of that. Can you talk a little bit about that and some of the benefits that you'll get as those earn in? And maybe you can just remind us the sensitivity to that.

So it was obviously challenging to have a pretty large portion of the revenue on that IRT transaction kind of go away when interest rates plummeted significantly in 2020. And I think we lost $70 million of annual run rate from that reduction. Obviously, we've looked to see if there's ways that we can offset some of that from expenses, but we also have been working with Wells Fargo to look and see if there's some different alternatives that could help offset of that. And we are going to be bringing some of those assets onto our balance sheet that will provide some natural offset to that probably to the nature of about half of that drag. That has started here just recently, and we'll continue to ramp as we go into 2022. That will reduce some of our ability to benefit from higher OER rates, but it gives us more control of the spread that we can earn on those assets going forward. So we're excited that, that will be a tailwind as we think about that going forward.

Got it. Another big thing in the industry has been consolidation. Can you comment on what your views are, what it means to be at scale in this business, the consolidations occurring and how you expect to be positioned in that?

Yes. I think we've been pretty clear that we're focused on executing the one in front of us. And obviously, the transactions are causing some bandwidth issues within Principal as well. And so I really want to get through the next 3 to 4 quarters and be able to test those things off before we really try to do anything significant. But it is important to have scale in the retirement business. And now that we're a top 3 provider, we're seeing the benefits of that scale just being able to compete and be on the page of what companies look at when they're considering selecting a retirement provider. You also get scale in that it allows you to have your unit costs go down, and that allows you to either be more competitive going forward or obviously continue to enhance or maintain your margins. And so it's going to be -- we think it's important to be in a top position, but I also think, ultimately, our ability to translate that into other revenues for the organization is pretty critical, whether that be in the form of asset management, in the form of rollover at benefit of that time. And we do think that, that economics is important to Wells. So we're going to look at those in all situations. I think we have to feel we were either getting a capability or we have the ability to better leverage our differentiators we have on that block of business. But we're also very, very focused on organically building that business as well.

Can you talk about some of the investments you're making in the business as we think through some of those segments? Like what are some of the key areas and investments that you're doing?

Yes. So it's probably similar to many other companies. Our ability to provide a compelling customer experience, those -- the demands of our customers are different today than they were 5 years ago. And so our ability to have whether it be app capabilities or abilities within our call centers to not take those calls personally but automate the answers of those, so there's a lot around customer experience that were focused on digital. The other thing we've really been focused on, has been important is better segmenting our understanding our customers at a segment level. And so I think it's no longer -- we're no longer capable of just have a one-size approach for all of our customers. And so we did, for example, an extreme segmentation on our SMB customer base. We've done a segmentation on the participants of our retirement plan and better understanding how we can better target how we interact with them based on the specifics of those. And we've also done some of that in our Mexico operation. So building out our ability to segment and then activate on the insights we're learning from those, using artificial intelligence within our asset management business to become more efficient relative to how we understand, whether it be real estate, [indiscernible] assets or fixed income assets or equity assets have been something we've invested in as well. So I think it's more around customer experience, insights to the customer and then ultimately being as efficient as we can be in delivering that.

And maybe we can go back to Principal International. I asked you about the Chilean election and you sort of set that aside for a minute. But help us think through what are some of the key drivers of the earnings potential there? I mean when we think through Mexico, some pension reform going on there. Brazil is I think -- the economic outlook has been a little choppier there in Brazil. When we kind of take that all together, how should I think about that earning stream?

Yes. So we've had some -- since we went public, that has been a big growth in Principal. When we went public, it was basically not making any money. And obviously, if you fast forward to today, it's 15% of our company. And if FX did not happen, it'd probably be closer to 20%. And so we've had some macro headwinds that is offsetting some stronger performance if you actually look at it as a local country basis. I come back to we offer either retirement or mutual funds within those countries that we've selected. And we've selected them because they have growing middle class. And in many situations, they have countries that are accepting that they need to provide more retirement benefits to their consumers. And so that is going to be a driver of growth, whether it be emerging markets or the need for personal retirement. Some of the dynamics of how the countries are embracing those is changing. So Mexico would be an example. They have -- went through some pension reform. Short term, it's going to pressure our fees as part of that reform once they lowered the fees that we can charge our customers. But long term, it's going to require every participant to put more within their retirement plans. So you're going to have a crossover point at some point that long term, that's going to be very beneficial to our growth. In other situations, maybe the mandatory pension isn't getting as much focus, but we see the voluntary or mutual funds to be an arena that you need to focus in on. And we have strong partners that we work with in Brazil and China and Southeast Asia. It gives us access to customers and brands. And then we are looking to see can we expand in some areas. And so China would be an opportunity where we have a very strong mutual funds franchise, but we are looking to see can we get into China from a pension and even a real estate perspective to add to our scale within that market. So I still think it is a good diversifier, probably has more natural customer growth opportunities than some of our more mature markets. But it can be lumpy, and you need to be a little bit patient relative to how those come through.

Maybe I'll end with just a higher-level question. Yes, what are some of the biggest challenges but also what are some of the biggest opportunities you see for the company over the next couple of years?

Yes. So challenges is how -- it is making sure we're keeping up with our customer demand, right? I think people have asked which competitor do you worry about? And I actually don't worry much about our competitors. I worry about how do we continue to make what we offer resonate with our current and potential customers. And how the younger generation thinks about some of these products is different than how maybe we think about it. We're not the same age. But ultimately, how different generations think or different cultures, and so I think understanding that dynamic is a challenge we can't ignore. From an opportunity perspective, I actually think us doubling down our focus and making some difficult decisions is actually going to help us propel growth and where we are focused on. And I'm excited about that even though those were hard decisions to make. I also think that we became fee -- capital light many, many years ago. And so that's been a trend we've been focused on. We're not afraid of investing our capital, but we're going to invest it where it makes sense for our customers and also for our shareholders. And I think we're in businesses with strong prospects for growth, and we're focused on continuing to fulfill that. So those would be what come up to my mind.

Okay. Well, thank you very much for being here today. Really appreciate it. Thank you to everybody. All right.