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

Good morning, and welcome to the Principal Financial Group Conference Call on the agreement announcement. [Operator Instructions] I would now like to turn the conference over to John Egan, Vice President of Investor Relations.

Thank you for joining us on short notice. We recently issued a press release announcing an agreement for our in-force blocks as well as an increased share repurchase authorization. The press release and slide presentation are available on our website at principal.com/investor. Following the reading of the safe harbor provision, CEO, Dan Houston; and CFO, Deanna Strable, will deliver some prepared remarks. Then we will open up the call for questions. Chief Risk Officer, Ken McCullum, will also be available for a Q&A session. Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K filed by the company with the U.S. Securities and Exchange Commission. Additionally, some of the comments made during this conference call may refer to non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures may be found in our most recent financial supplement. The focus of today's call will be on today's announcement. Our fourth quarter and full year 2021 earnings call is scheduled for Tuesday, February 8. Additionally, we'll provide updated guidance for 2022 on our outlook call scheduled for Wednesday, March 2. Dan?

Thanks, John, and thanks, everyone, for joining the call. I'm excited to announce that we've entered into an agreement to reinsure our in-force U.S. retail fixed annuity and universal life insurance with secondary guarantee blocks of business to an affiliate of Sixth Street and Talcott Resolution. We conducted a comprehensive and competitive process and received strong interest from multiple parties. This transaction optimizes the value of these blocks while improving our overall risk profile and reducing the capital requirements of our portfolio. Following the close of this transaction, which is expected in the second quarter, Principal will retain the policy administration and servicing responsibilities for these blocks. PGI will manage approximately $4 billion of commercial mortgage loans and private credit assets on behalf of Talcott as part of the agreement. We have secured several counterparty protections in this agreement, including agreed-upon investment guidelines and over collateralization of the coinsurance agreement through a supplemental trust. Importantly, this announcement delivers on our June Investor Day commitments, which followed a deep and thorough strategic review process, focused on realigning our business model to drive higher growth, higher returns and greater capital efficiency. As we move forward, we will continue to focus on further strengthening Principal to win in growing markets and create long-term shareholder value. The results of this review and the intense focus on our go-forward strategy are paying off, enabling us to confidently affirm our financial targets and return more capital to shareholders. Today's announcement builds on the intentional evolution of our portfolio, positions us for further financial success and enables us to better serve and meet the needs of our nearly 50 million customers. Dan will now share more details on today's announcement. Deanna?

Thanks, Dan, and good morning to everyone on the call. I'll share important financial details of the agreement and provide an update on our capital deployment strategy. We expect today's announcement to create value for both our customers and shareholders. It is a key milestone that reinforces our strategic focus on evolving into a higher growth, higher return, more capital-efficient enterprise while also reducing our risk profile and freeing up capital. Starting on Slide 5, we expect deployable proceeds of approximately $800 million upon closing and through additional transactions designed to improve the capital efficiency of our in-force individual life insurance business including our regulatory closed block. We plan to return the proceeds to shareholders through share repurchases in 2022. At close, Principal will reinsure approximately $25 billion of U.S. retail fixed annuity and ULSG statutory reserves to Talcott. Turning to Slide 7. We now plan to return up to $4.6 billion to shareholders between 2021 and 2022 through share repurchases and common stock dividends, more than 50% higher than the $3 billion announced at Investor Day. In 2021, we returned nearly $1.6 billion of capital to shareholders including more than $650 million of common stock dividends and approximately $920 million through share repurchases. This includes approximately $350 million of repurchases in the fourth quarter and is higher than the $600 million to $800 million 2021 guided range for repurchases. Additionally, our Board of Directors has approved a $1.6 billion increase to our existing share repurchase authorization, bringing the total available authorization to $2.7 billion. We deployed approximately $100 million from the existing authorization in 2021. In 2022, we now plan to return between $2.5 billion and $3 billion of capital to shareholders, reflecting a 40% dividend payout ratio and $2 billion to $2.3 billion of share repurchases. This is a significant increase from the $800 million to $1 billion repurchase range we shared at Investor Day, reflecting higher free cash flow from our more capital-efficient business portfolio, the more favorable macroeconomic environment as well as the estimated $800 million of deployable proceeds from these transactions. These transactions significantly enhance our future financial profile. We are expecting accretion to non-GAAP operating earnings per diluted share starting in 2023. It will also improve our ROE and allow us to achieve our targeted 15% in 2023. Finally, upon close, our enterprise free capital flow conversion will increase by approximately 10 percentage points annually. As a result, we've increased our targeted free capital flow range to 75% to 85% from the previous 70% to 80%. As we move forward with a refined focus and strengthened capital deployment strategy, we will continue to invest in our growth drivers of retirement in the U.S. in selected emerging markets, global asset management and U.S. benefits and protection, all with an aim to drive long-term shareholder value. With our continued strategic execution, we are well positioned to achieve the financial targets laid out at our June Investor Day. Today's announcement delivers on the transactions contemplated at Investor Day is in line with our expectations around deployable proceeds and demonstrates our continued focus on execution and improving our capital efficiency and overall risk profile. This concludes our prepared remarks.

[Operator Instructions] And your first question will come from John Barnidge with Piper Sandler.

Yes. I just wanted to follow up on the comment about intentional evolution of Principal. Did the process make you think about how the market may be receptive in possible other blocks as well?

John, so what I would say as it relates to where we're at in the strategic review is that we took the better half, as you know, of 2021, work with the Board Finance Committee and we did an extensive and exhaustive review of the portfolio. Frankly, today's announcement is very consistent with what we said we were going to do, which was to divest our U.S. retail fixed annuity and the ULSG block of business. And frankly, we're very excited about that and equally as excited about the go-forward strategy. Frankly, we've got a long track record of evolving our portfolio to meet our customers and market needs. We'll continue to take the right steps and align our business model to drive growth, support the active capital management program and create long-term shareholder value. And I'd be remiss if I didn't point out, again, recent examples of our commitment in evolving our portfolio, for example, includes divesting ourselves of our asset management mutual fund business in India as well as our divestiture of our life and annuity business in Mexico. So that's kind of a representative sampling of how we manage this portfolio. Was that helpful, John?

It was very helpful. And then my follow-up question, related to that $4 billion relationship that's established for PGI on the commercial and the private assets. Can you talk about any revenue loss related to PGI management of those assets.

Thanks, John. I'll have Deanna do that. Deanna?

Yes. So we are going to maintain. We're very happy to continue to allow PGI to manage $4 billion of that $25 billion of assets, but PGI will lose the revenue on the remaining $21 billion. That's factored into all of the impacts that you saw that we announced and we'll further refine that as we get into outlook call, but there will be some lost revenue, and we'll work quickly to refine our expenses in PGI to match that lost revenue.

The next question is from Ryan Krueger with KBW.

I guess could you give more detail now that the transaction has been announced on your final expectation for the lost earnings from these blocks, any stranded overhead? And as well as any impact from PGI. I guess, altogether, I think you had talked about $110 million pretax last time around.

Yes, absolutely. Deanna, please?

Yes. So we had previously talked about $110 million pretax, and that was really the loss operating earnings from the 2 blocks that we are divesting on. We hadn't included any estimate of stranded costs. We haven't -- didn't at that time include any estimates of PGI revenue because ultimately, some of that was very much impacted by the deal that we executed on. If you take that forward to today, as you mentioned, there's 3 elements. We do still have an estimate, the lost earnings at about that same level. We are estimating our stranded costs to be approximately $75 million pretax out of the gates with plans to immediately start working through that and eliminating it over the next 24 months. And then we'll have -- like I just mentioned, lost PGI revenue on a $20 billion of assets that they will no longer manage. All in, my current estimate is $125 million to $150 million post tax in 2022 and then decreasing from there. But we will continue to refine that number. And if it changes, we'll update that at our outlook call on March 2.

That's helpful. And then I know you announced the transaction together. Is there anything you can do to help us think about the, I guess, the capital freed up in the 2 pieces, the fixed annuities versus the ULSG blocks?

Yes, I appreciate the question, Ryan. As we shared at Investor Day, all along is our intention to sell both blocks. Frankly, we consider several options on how to get it done and ran a robust and comprehensive process. And frankly, we have very competitive bids for the blocks -- for each block separately and combined. For this transaction, the ceding commission was negotiated to a single amount. It was not split between ULSG and the fixed annuity block. We believe to generate the best total outcome for Principal as well as for our long-term shareholders. So again, hypercompetitive market, strong bid interest, and we feel very good about the outcome.

The next question is from Erik Bass with Autonomous.

Maybe first, just to follow up on Ryan's question. So for the $110 million or the $125 million to $150 million total impact, can you help us think about how to model that by segment? And I guess also for the stranded costs, will those be all in corporate or will they be spread across the segments?

Yes, Eric, those are great questions. That will be the further refinement we'll be working through between now and the outlook call. just as we -- we just think to deal, and we need to do some further modeling of that. And again, we'll continue to update that and really plan for that to be at the outlook call on March 2.

Okay. And then you mentioned some other actions beyond just the transaction that improved free cash flow going forward as well as I think contributed to some of the $800 million you're freeing up. So can you provide some more details there on what you're doing? And I guess, related -- the free cash flow range improved by about 5 points from what you were talking at the Investor Day. So is that just all related to the deal and the changes?

Yes. I think you had 2 questions there. So I want to clarify it. One was on the other actions we took and one was on a reconciliation of the difference between our $800 million of proceeds and the higher free cash flow that was contemplated as part of our increased share buybacks. Did I get that right, 2 parts of that question?

Yes, sorry. I think a little unclear. On the free cash flow is more the increase in the range, what was driving that? And if that was -- basically what drove the increase in the range?

Yes. So at Investor Day, we had talked about an estimate of 7% to 10% from these transactions. As we now sit here today, we think that's closer to 10. And that allowed us to increase our range from $70 to $80 million to $75 million to $85 million. There's 4 factors that we've been seeing that's increasing free cash flow, and all of that is contemplated as we got to the point of our authorization and the amount of deployments that you see in our release today. Really 4 components there. We have seen higher, just operating results partially due to the positive economic and market performance that we've seen since Investor Day. Also just due to the positive credit cycle, our estimates around credit drift have reduced since that time. We refined and incorporated the impact of ceasing sales on these businesses as of 9/30 of last year. And then obviously, as part of the strategic review, we have -- continued to have discipline around ensuring our organic capital that we do deploy can achieve our targeted returns. And so those would be the 4 components that are factored in. And again, happy that we were able to increase our range from $70 million to $80 million to $75 million to $85 million.

Did that help, Eric?

Yes. And just last, you mentioned in your prepared remarks to that, I think something with the regulatory closed block changes. What were those?

Yes. So incorporated in that $800 million of proceeds, obviously, many pluses and minuses in there. You have, obviously, the [ cede ], you have the release of the capital. We did -- and again, it was contemplated at the time of the strategic review. We had some -- we knew we had some opportunities to further optimize the capital that was backing the remaining life insurance business. That includes the regulatory closed block, which is an item that we have discussed with investors in the past as an opportunity that we knew was out there. So that's included in the $800 million. On the flip side, and I know you guys are all aware of this, there is some negatives that go into that net proceeds amount as well. We have lost covariance benefit in our risk-based capital calculation. We have some break fees from our current financing arrangements. And so again, those 2 items, all total, then get to -- along with the proceeds from the transaction, get to the total of $800 million of deployable proceeds.

The next question is from Tracy Benguigui with Barclays.

If you could just quantify for us the ceding commission, I believe in the past, you said that these blocks are supported by $1.5 billion of capital. And then at first glance, if you talk about $800 million of deployable capital, I guess, that would imply $700 million of ceding commission, but then you've also tagged on other transactions, which sounds like that would be completed in the future. So if you could just clarify specific to this deal, what the ceding commission is?

Yes. If you refer to our 8-K, our net ceding commission is approximately negative $190 million. .

Okay. Got it. And then if you could just help me understand some of the math because if you're saying that the free cash flow is going from $70 million to $80 million to $75 million to $85 million. How do I -- how do you explain the 10% point increase rather than 5 points? And then also just to tag on why wouldn't the ROE target change as well? .

Yes. So a couple of things there to help you with. And again, obviously, some complicated things going into all of this. If you go back to Investor Day, one of the things I had talked about is we were probably more confident at the lower end of the 70% to 80%, but we would continue to refine that and understand the impacts of these transactions. We now feel pretty confident we can be at the upper end of that range. So the delta there is 10%. But there is volatility year-by-year. And so we do feel the $75 million to the $85 million is the correct kind of delta and again excited that we were able to do that.

The ROE?

On the ROE, again, there is some that's just kind of math. It takes some time. We calculate ROE on a trailing 12-month basis. So it is dilutive to ROE in the first year, accretive thereafter. We will march north even after the 2023, but again, the 15% still holds for 2023.

We'll be talking more about that on the March 2 outlook call, as John mentioned in his earlier comments. .

Okay. If I could just -- sorry, just ask one more on the, I guess, the net result of your life reserves. If I just look at the Exhibit 5 in your stop link, it seems like the $9 billion from the ULSG, that's the majority of it. Could you quantify today where -- how much is remaining? .

We'll have to follow up on that one with you, Tracy. I don't have that one right in front of me, but we will follow up.

Is it fair to say it's a majority, though?

There was $7 billion of capital backing the ULSG business.

Let's follow up on that one, Tracy. We'll come back to you. Yes. Appreciate the question.

The next question will come from Alex Scott with Goldman Sachs.

A number of my questions have been answered. But I guess just a follow-up on Tracy's question on the SGUL. I think you guys had talked about $7 billion in the past, and I saw $9 billion in this presentation. So I'd just be interested in what that delta was. And I guess, just high level on the transaction, I mean, the fixed income has been getting a pretty robust price in the market. So clearly, getting rid of SGUL is tough. I'd just be interested in -- from a risk reduction standpoint, I mean, how important is this to the business? And why did you feel like it was necessary to get rid of the SGUL even at I think a price that is relatively less attractive when compared to the fixed?

When I think about that, it's frankly consistent with the decisions we made during the strategic review around divesting the blocks and reduce exposure to Principal's interest rates and credit risk and the volatility on both earnings and capital. The ULSG block is capital-intensive. It was generating low returns on capital due to persistently low interest rates. And when we looked at it, reinsuring the ULSG block enables us to really reduce future uncertainties of our results and more clearly demonstrates the value of our ongoing business in that life area. And remember, we very much believe that business of life insurance and supporting our business owner executive solutions and nonqualified deferred comp really holds up well. We just did not see that -- we saw this as the best path forward for long-term shareholders as we worked with our Board strategic -- with our strategic review with our Board. And maybe I'll have Ken McCullum provide a few additional thoughts on that, Kenny? .

Yes. Dan, you did frame that well. It is proven to be a challenging block for us and there's an industry to manage due to the low interest rate environment that we've been in and stayed in now for quite some time as those rates have come down and stayed down as you well know. In addition, as those guarantees got more and more in the money, the policyholder behavior with lapses and premium persistency became increasingly sensitive, and you saw this in our annual actuarial assumption reviews virtually every year as we made adjustments to those and dealt with that. So we did get to the point as Dan pointed out, where it was capital intensive, it was volatile, and it was generating unacceptably low returns on that capital. And we felt like these new owners would be better suited to take on the investment requirements of a block like this and deal with those challenges. And as Dan mentioned, it liberates us to focus on the businesses that we're profitably growing and remove some of the distortion on our financial statements and balance sheets and risk profile that this oversized block was creating.

Alex, does that help?

Yes, that's very helpful. And then just on the first part of my question, any thoughts on I think you'd quoted $7 billion of reserves in the past, and I think it was $9 billion. I might not be comparing apples to apples, but I'd just be interested if that reserve did sort of increase if there was something statutory financials or something that caused that? .

Yes. We'll get -- we'll take a look at that and hopefully, we should be able to update you on our earnings call next week.

Yes. We'll definitely -- we'll lead off to make sure that our prepared comments include that. Appreciate that. Sorry we didn't have the answer for you today, Alex.

The next question will come from Andrew Kligerman with Credit Suisse.

Question following up on the $800 million of freed up capital. And I know somebody was touching on it earlier that at the time, it was mentioned $1.5 billion of capital to be freed up from the transactions. Can you help me through the math on that initial thinking of $1.5 billion to $800 million right now? .

Yes. There are a lot of components to that. I'm not going to quantify each component. The first thing I would say is the $800 million is very aligned with what we felt. The proceeds from this combination of things would be back in Investor Day. So again, everything is in alignment with that. There is a $1.5 billion of capital. There is the negative [ cede ] of negative $200 million. They are the onetime negative impacts, lots of covariance, the break fees. We did release a little bit from the remaining. And then the only other item there is we did have a reserve financing on that ULSG block that we had to unwind at time of close. And so that would be the other piece in there relative to that.

Do you have a follow-up, Andrew?

Yes. Follow-up would be around other transactions. I kind of -- it was nice to see this deal get completed, but I had kind of hoped that some of the other blocks of business, maybe life insurance, pension, risk transfer, variable annuities that don't seem, at least in my view to be core, could be announced as another potential transaction. Could you comment a little bit on the outlook for the potential to do other block deals going forward? .

The outlook, frankly, Andrew, is consistent with what I had mentioned just earlier as a result of the Board's Finance Committee. After having completed it to review, we reported that out mid-year and framed what is not only the businesses we are going to divest up, including ULSG and fixed annuity, but we also reaffirmed our other businesses that we were going to continue to grow, which is inclusive of the portfolio we have today. And as I mentioned, we can constantly look at evolving the portfolio. We look for opportunities to ensure that the capital is being deployed in the most efficient manner. And I gave you the examples a few minutes ago with regards to both India and Mexico. Again, we continue to look for opportunities, but right now, we feel very confident that our go-forward strategy is inclusive of our current businesses as previously discussed. Thanks for the question.

The next question is from Suneet Kamath with Jefferies.

Deanna, could you remind us what your equity market sensitivity is now pro forma for this transaction? I'm assuming it's -- what you're selling is not very equity sensitive so that there would probably be an impact on overall corporate sensitivity.

Yes. So previously, we had talked about for every 10% change, it was a 5% to 7% impact to total company. I think in our upcoming release of the 10-K, that will be increased to 5% to 8% because what you said is the remaining business is more equity market sensitive and then probably more impactful as PGI just given the incredible results that they have had is a larger percentage of our overall operating earnings. So 5% to 8% is the current. We do need to step back kind of post review and evaluate all of our rules of thumb. And obviously, we'll update you if any of those change as we go forward.

Got it. And then I guess, Dan, on the capital walk, you have this $200 million to $400 million placeholder for M&A or additional share buybacks. Should we think about that range is sort of the -- what you would -- the size of M&A that you'd be interested in, meaning the sort of $1 billion plus deals that you guys have announced in the past is not really part of what you'd be pursuing going forward? Or is that not the right interpretation of that range?

Yes. When I think of that range, I think about how much of our free capital flow will use for M&A. And as we talked about on Investor Day, 0 to 10. We obviously have made a strategic decision and really confirm that with our Board that we do have a fairly low leverage ratio, actually much lower than many of our peers. And so that is another currency that we can use. But I'd also say, one, we're digesting the IRT transaction, and we will continue to be very disciplined on any M&A that does come our way to make sure that it fits our financial targets and strategic targets. So that's how I would think of it as, obviously, we can fund those in different ways. But really are looking probably more to use our leverage, but there always could be some incremental usage within our free capital flow.

Got it. Can I just sneak one more in, just a quick math one. Deanna, are the interest on required reserves related to the IRT transaction, is that driven off of Fed funds or some other interest rate?

It's driven off the IOER, and we'll get more into that at the earnings call next week. So it's off of the IOER rate.

The final question is from Josh Shanker with Bank of America.

You talked about a robust process. I was just interested in -- I don't know what sort of detail you can give, but how many bidders, how lively is the market searching for these transactions right now? How long does it take? Can you talk about process at all? .

Yes. The way I would say it, number one, we had strong interest in these blocks of business. It was a very comprehensive process. We look at all the proposals. We had very strong interest in it. And frankly, we're very confident in the counterpart of it was identified here. The process took a long time as they generally do. I won't get into quantifying it exactly, except to say that it is -- it was deep. It was thorough, and we are well advised with Goldman and KPMG as well as having the benefit of [indiscernible] as our legal counsel. So again, we feel really good about not only the process but more importantly, the outcome of this divestiture of risk. .

And it's not a -- whether there's half dozen interested parties, dozen interest parties that you're not willing to say? .

Yes. My guess is if you talk to the bankers out there, they can help quantify that, what the interest is in these kinds of businesses and how many people might be interested. .

And then I have to go over the Investor Day presentation again and look at some of the outlook guidance. Are there any percentage growth numbers that you gave during the Investor Day that need to be reined in for having realized the earnings power of something currently that's going to reduce the growth rate going forward? .

No, I don't think so. We'll obviously spend time looking at that. Our EPS lock had contemplated the lost earnings, but did not contemplate any of the proceeds being deployed, and obviously, our free capital flow is a little bit stronger. So again, I think there could -- we'll need to continue to do it, but nothing at this point that we'd want to update other than what we did on the call.

We have reached the end of our Q&A session, Mr. Houston, your closing comments, please.

Yes. First and foremost, I apologize for the late notice. We know that it came quickly. And so for that, I apologize. Hopefully, you got your questions answered this morning, as Deanna and as pointed out by John, we've got an earnings call next Tuesday, February 8, and the outlook call on March 2. We will make sure and follow up specifically on the life question that was raised and handle that next week at the earnings call. So again, thank you, I appreciate and look forward to further conversations. Have a great day.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 p.m. Eastern Time until end of day, February 7, 2022. 439-4754 is the access code for the replay. The number to dial for the replay is (855) 859-2056 U.S. and Canadian callers or (404) 537-3406 international callers. Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect.