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

Welcome back, everyone, for day 2 of the Annual Bank of America Insurance Conference, the last virtual conference we're going to have for insurance. Pleased to say. We're very pleased to start today with Dan Houston, CEO and Chairman and President of Principal Financial. Dan has been there for 38 years. I think this is year 7 of his CEO, of managerial roles. And he's been in a number of positions at the company, including running Retirement and Income Solutions. We're going to do mostly fireside chat. I want to give Dan some minutes to set the stage for what he wants the world to understand about Principal. And so, Dan, I'll give it to you, and we'll go from there.

Yes. Thanks, Josh, and thanks for the invitation this morning to be part of your conference. I hope yesterday went well for all of your customers and investors. So we feel very good where we're ended 2021. It was a very solid year, but frankly, it even gives us an even better platform, as we think about 2022 and beyond. Here, in the first week of March, we'll provide all the investors with our outlook call. So I may defer a few of the comments today to the first week of March there. But we were excited on a number of fronts this past year, the first of which was one that investors got us used to talking about quarter-by-quarter, but was the successful integration of the Wells Fargo IRT retirement business on our platform. That was a very key part of our puzzle to get scale, to get capabilities, access to new markets, and that has now successfully brought over. Here in the next few weeks, we'll finish the final touches. The retirement's already successfully migrated. The second part is just standing up the trust and custody with the final migration. That should be a very seamless transaction. The other course is the strategic review that we undertook throughout 2021 in the midst of a pandemic, I might add, that led us to the conclusions to divest of our ULSG and retail fixed annuity business. We have successfully vetted that for potential investors. We got what we think is a very fair price with a counterparty that we look forward to working with, while retaining those servicing rights. And we'll get the final closure here over the course -- hopefully before the end of the second quarter. So we feel very good about the review and the subsequent repositioning of those 2 portfolios. And that really leads us to the go-forward strategy. And we'll have a chance with Josh to talk about a lot of different things today. I'm quite sure of that. But the portfolio today that focuses and emphasizes our U.S. and emerging markets retirement business; secondly, around our global asset management business; and thirdly, our U.S. protections business with group benefits and business owner solutions, we really battle tested that. We looked at that by geography, by product, by capabilities. And frankly, we feel very good. And we worked with world-class advisers to look at the financial dynamics, not only backwards, not only currently but on the go-forward part of our strategy, and now it's about execution. We've got a long track record of doing that. We'll continue to deploy a lot of technology that will better enable us to meet the needs of plan participants, of plan sponsors and, of course, the advisory community. So with that, Josh, very much look forward to Q&A this morning and jump into anything that might be top of mind for you and your clients.

Well, let's start with a question you can kind of take anyway, but trying to understand what the Principal culture is. You have a bunch of businesses that are different businesses necessarily or maybe you feel that they all have some sort of rhythm that works together. But what makes a Principal business a Principal business? What is the sort of guiding tenets behind what you do in your operations?

I like your comment about rhythm because the way I think about it, we're not a holding company, and I know some more organizations do manage these businesses independently. You could organize, if you will, if you were by product. You could think about USIS, RIS, PGI and then PI and think of those as 4 stand-alone verticals. I think you'd be missing a huge value creation for investors because when I think about it, if that's the case, that I don't believe is a winning proposition. I think the cross-fertilization and having porous lines between those 4 business units is critical. And I'll give you a good example. When I think about our Retirement and Investor Services, they work constantly across borders to work with Principal global asset management, and they also work with USIS for solutions for business owners and nonqualified deferred compensation. We try to use common systems. We try to use a common go-to-market strategy. We use the same client management systems. So the porousness across those lines of businesses, I think, is critically important. And frankly, that's where we can create differentiation. Back to your sort of original thesis around culture, our culture is focused on doing what's in the best interest of the enterprise in total. For example, we capture a lot of earnings that are generated out of the retirement business, but we capture them in PGI. We capture those in USIS. And I think it's just over $0.30 additional on a dollar than we capture in other parts of the organization, which is why we still have a very strong fundamental belief that the 401(k) asset accumulation, retirement recordkeeping business is such a powerful engine for the entire organization, not just a stand-alone business.

Well, I'm going to get to the 401(k) in a second. Let's just start with another asset retirement, the pension risk transfer.

Yes.

When you are competing for a pension risk transfer business, what is the different business proposition that Principal comes with that some others may not have? I mean it feels from the outside -- is it just price? Is there something that can be done in service that makes a difference overall that wins even if it's not the best price?

Yes. And this is a business I've been around for 38 years. And so I think I know the pension risk transfer business very well, and I won't get into all the unique aspects of it. But I think about all the legislative changes of TEFRA and DEFRA, the Retirement Act, that all of these changes in the legislative system cause a recordkeeper for a defined benefit plan to have to recognize that anyone, plan participant, having gone through a 30-, 35-, 40-year career, the calculating of those benefits is not an easy task. We know exactly how that works even if it's a transfer piece of business that comes to Principal. We also know this isn't just a financial transaction for anybody laying off the risk. They want certainty those retirees are serviced in an appropriate manner, which means availability. It means having the right technology to support individual inquiries from a participant under a pension risk transfer situation and then understanding how the dynamics of these deferred versus active retirees will draw down on their benefits and what that looks like. And so it does get down to understanding exactly how the plan operates, understanding how to price it, understanding how to service it, and we've been doing that for literally decades. We all want to sort of short arm it into thinking it's something that you engage in some sort of financial transaction, but there's frankly a lot of work behind the scenes. And that's what allowed us to not only differentiate but also make this a very financially strong contributor to Principal's overall bottom line.

And in the life cycle of this part of the business, where are we in terms of having fully satisfied the pension holders' need to transfer risk to somebody else? Are there any other blocks we won in 10 years? Or are we at the tail end of having converted all the pensions that want to take risk off the corporate balance sheets?

I really love baseball and played a lot of it in my youth. And I'd say we're in the third inning of a 9-inning game and may go into extra innings. There's $3 trillion that are sitting out there today, and we know that tens of billions of that come to the market every single year. And so there is going to continue to be a lot of interest. There's going to be a lot of balance sheet capacity that's going to be required. I think as new players enter into this business, everyone will sort of have a good understanding of how their investment portfolios have allowed them to either achieve or not achieve their stated investment objectives. And so I think we're early on, Josh, and this is a very promising. It's a very serious business, one that shouldn't be taken lightly. And again, we consider it as such. And we are very -- we use it as a variable part of our business. We don't have a specified target that we're trying to hit. As long as we can achieve more than our cost of capital and it makes financial sense to do so, we want to be in that marketplace. And again, I think, this is where good discipline is just critical.

For those watching this presentation, if you want me to ask a question, you can type it into the Veracast app and shoot it over to me. I have plenty of questions, but would be happy also to ask yours. Let's shift to the retail retirement space. There's -- obviously there's been a lot of M&A certainly coming from Canada into the U.S. markets and whatnot. Is this a business that we're going to look 5, 8 years on into 2 to 4 competitor business that economies of scale is going to be a dominant factor in who are the leaders for tomorrow? Do you need to increase scale in order to be competitive?

Josh, we've had this same conversation with analysts and investors for more than a decade now. So maybe the way I think about answering the question has to do with what has changed in the last 3 to 5 years that would cause me to think that the consolidation will come quicker than not. And I think it really boils down to technology. And technology is not only an incredible tool for introducing efficiencies and cost efficiencies and operational excellence in terms of more precision and more accuracy. But now the application demand, so what's expected of a plan sponsor, what's expected of a plan participant and even, frankly, what you're expected to provide to the adviser community is they build out their retirement platforms, the tech stack is increasingly becoming important. The question is, do you want to spread that out over 45,000, 50,000 plans? Can you do it over 10,000 plans? Can you spread that out over 10 million participants more efficiently than 1 million participants? So I do think we've probably reached an era where having scale and having tech that allows you to be more efficient but also provide a differentiated customer experiences is going to be important. I think being an asset manager is also a very important part of this. Customers are looking for comprehensive solutions, our total retirement solutions, and I've talked about that. I talked about that a year ago on this call. But having ESOP capabilities, deferred compensation, defined benefit, knowledge and expertise, still about 50% of our business hits those marks in providing a more comprehensive set of services. And that's all expected. And I can assure you that customers want that to be seamless. They don't want clunky and they want to see comprehensive outcomes. And then the last point I would make, and you hit on it earlier, but it's the rollover benefit event opportunities to provide ongoing services to those participants. And I do think, for those reasons, we'll continue to see a roll-up of the industry, and Principal is going to make sure that it's very much part of that.

Shifting gears to the Specialty Benefits segment. There are some players who are dominant in life and disability. There are other players who are, like yourself, expanding shelf space by offering more products. Is the future of being a multiproduct distributor in order to get that shelf space? Or in talking to the human resources and risk managers at the firms where you're providing these benefits to, what are they looking for? And how do you stay competitive? And what your offerings are?

I still find myself on phone calls with customers on a routine basis, and I try to make it a point of doing it and also being very connected with the adviser community. So you've got a number of questions that are embedded in your sort of broad-based thesis there. The first one I would start with is, we still think the group benefits business is a very good business. And as you know, whether it's dental or vision or group life or STD or LTD, Principal is a top 5 player. And our calling card has been in large part around small to medium-sized businesses and differentiated capabilities, and that has really worked well. And you saw from our most recent year and quarter that our underwriting results were quite good, even in spite of a very challenging environment with COVID. We feel very good about that business. Secondly, even though advisers and brokers have had the tendency to more narrowly focus their practice on health or group benefits or retirement, the benefits firms still want to be broad in scope. And so what we find is when we're in there talking to our partners -- and these are large brokerage platforms. These are large entities. You'd know the names quite well. They're looking for deeper relationships with single companies that bring a broader array of products and solutions because there are licensing issues. There's relationship issues. And they're trying to do this in a more comprehensive and more holistic way. And the more connection we have to small- to medium-sized employers and being able to serve the needs of large employers, it really does put us in a more favorable light in providing these solutions to their advisers, especially when we think about our ability to support that adviser. And we still believe strongly that this is an adviser-dominated marketplace, whether it's group benefits or in the retirement space. Does that help, Josh?

To some extent. One thing I noticed, though, the more traditional group benefits lines, life and disability, I mean, I think your sales look really strong, stronger than they were prepandemic.

Right.

Dental and vision, weaker than prepandemic. In terms of the expansion of those products, do they grow and decline in harmony? Or is there a decoupling here? Or am I just reading too much into the numbers?

I think you're reading too much into the numbers. I think that, number one, dental is sort of the 800-pound gorilla. That's a big part of the business, which -- where a lot of the revenues and premiums comes in. Obviously, group term life is also a very important component. But I think you have to look at these at longer periods of time, 3-, 4-, 5-year cycles. We underwrite to be profitable. We underwrite to be in business another 10 years down the road, 20, 30, 40, 50 years. So we do apply a lot of discipline. And I think at any given times, there's companies that will enter into the marketplace that might be more aggressive than at other times. And so we don't look at any 1 year or a couple years as an indication of our viability. We want to make sure that we are being disciplined in how we are pricing our products, how we are designing our products and how we're going to market and how we differentiate. And so the little bit of sales volatility is not something I'm terribly concerned about.

PGI, obviously, having inflows for a very long time, very successful. You've guided to about a 37% to 40% range in terms of your margins on that business, but you're consistently doing better than that. On the one hand, does that mean that I should be more skeptical that the future is going to look like the past? Or does that mean that you're in the business of under-promising and over-delivering?

Well, it's not intentional. What we try to do, and we'll provide, Josh, with you and the other investors more information here on our outlook call and refine that, is Principal is a little bit unique in that we cut across so many of the different asset classes, whether it's fixed income, high-yield, preferreds, real estate, whether it's the public or the private market in real estate, international, small-cap, equities. And I think what comes with that is, at any given time, these products come in and out of favor and they can generate quite a different range of margins for the organization. And it's probably the mix of our sales that's creating, at least in the current environment, a margin higher than what we have guided you to. But if you'd be patient here for a couple of weeks, we'll provide more insights with Pat Halter and framing that for you on the go forward and where we think that, that mix might end up for 2022 and beyond. Hopefully, that's helpful.

That's helpful. 10 years over 2%, up about 150 basis points from where it was 18 months ago. Has this caused a shift or a change in where your clients are wanting to park their money in certain products in the PGI arsenal becoming something more favorable to be purchased?

Yes. And it's such a great question, right? And I think the million-dollar question is, is it 2% at the end of 2022 or is it 3% at the end of 2022? Or does something catastrophic happen and we end up at 1%? And as we sit here today, it's awfully difficult to project. There's a lot of potential disruption around supply chains and oil and political discord and challenges that we're up against. We've got high inflation. We've got an environment where uncertainty is sort of coming into a lot of decisions and making long-term investments. And so I think it's for all of those reasons. When I think about interest rates, it's why we're very careful to hedge those risks as we add those liabilities onto our books in the first place and try to immunize ourselves a bit as it relates to interest rate volatility. But I think the industry -- and I think that the marketplace would benefit from interest rates sort of more naturally finding their right level. And my guess is it's higher than where it's at today, but we manage that with a great deal of vigilance and a great deal of thought that goes into that. And again, I do think back to what is -- what would cause rates to go up, I think inflation is a big part of that. And I fall into the camp and again others at the firm have different views, but I do think inflation is going to continue to be a problem for the foreseeable future.

If I think about -- you have a lot of places you can put capital, I think, but in the annuity business. You can put them into doing pension risk transfers. You can sell life insurance. You can buy other asset managers. And that's not capital intensive, but obviously upfront, there's a big capital outlay for that. What are the different ROIs? I don't know if you can rank them enough to give numbers necessarily, but what's the best return on investor capital today in terms of what you can put money to work in?

I think it might be easier to answer the question what's the meaning of life than to answer that question, Josh. And I say it for this reason. It's with a lot of uncertainty, right? If we were having this call 5 years ago, there isn't a bad investment you could have made in the asset management space because the thought was it was going to go up into the right and that those margins wouldn't see downward pressure. But in fact, we have seen that the fee businesses have been subjected to margin compression. Likewise, if you look over longer periods of time, capital properly deployed against the risk transfer business or the retirement business or life insurance and annuity, it was dependent upon the cycle and the underlying policy provisions and the assumptions that went into that. And then lastly, of course, is the use of capital to either use in the form of a common stock dividend or stock repurchase. All of that goes into our mix, and our mix is to try to maximize shareholder value over long periods of time. So again, our strategy has been that the fee risk and spread business discipline -- with a lot of discipline applying across those businesses and making investments and making decisions for the long term. And we think that more singly focusing the organization in any one area isn't likely in the best interest of our long-term shareholders. When -- and again, I won't try to rank order the next dollar of capital and where they go, except to say that we do evaluate those before we deploy the next dollar of capital into a business, into a product or into a country and the long-term implications.

Without rank ordering, I mean you have made a decision to deemphasize some of the retail life business.

That's right.

And put more emphasis on corporate life. Is that ROI consideration driving that? Or is it strategic? What drove that decision?

Yes. That's a great question. So a couple of different things enter into that. Number one, if you're going to go out and just compete on individual life insurance, a lot of that business is decided on price. When you think about the structures that we use, either nonqualified deferred comp or business owner executive solutions and the consulting that goes with that and trying to solve problems for key person insurance or by sell structures or deferred comp, there's a lot of value added there and differentiation that allows us to get a margin that would be better than going out and selling the next retail life policy. We also think that a lot of what we're doing in group term life or the workplace is another good place for us to deploy capital. And that's where a lot of people do look to acquire their sort of life insurance for most -- many Americans. So that's a perfect example. Where we can differentiate and really add value, we want to continue making investments in that space, in that area. As I said earlier, when I was talking about TRS, that's another one of those enabling capabilities when we manufacture it internally. We can show those values in a single statement to an executive that's participating both in a qualified retirement plan. Maybe it's a frozen defined benefit and a deferred comp. They're going to see that rolled up into a single statement and have a very comprehensive view on how they're doing relative to their financial benchmark or retirement readiness.

I have a question coming in from the outside. And the question is, should we expect a closed block reinsurance transactions at the right price to be a regular part of the Principal story?

I think what you've seen us execute on most recently was the result of a very intense strategic review of every business, every country, every product. It was vetted with third-party advisers, and they just did an exemplary job in helping us navigate our way through there. And the conclusion was we had 2 blocks of business, one starting with our universal life of secondary guarantees, the other, which was the fixed individual retail annuity business. And again, the thought was that, on a go-forward basis, those were not good assets to be holding on our portfolio. Having said that, we looked at all of the other businesses, those that are capital-light, those that were using capital and came to the conclusions at the current time they're meeting our appropriate thresholds for profitability and their prospects long term look very favorable. We're going to manage the company in accordance to that outcome.

Okay. Let's shift to emerging markets. You've just sold your Indian investment management business. I'm assuming that deal is coming because you got a good price and it's a good buyer and it just made sense necessarily. It's not your own view of the Indian market. But when we look at where you are, you have positions in Southeast Asia, Brazil, Mexico. How do you pick which emerging markets are winners in the future? There's a lot of options. And is first-mover advantage important? If you want to be successful, do you have to already be there right now?

Yes. So a couple of questions there, the first of which is we have been in India for some time, Josh. And the thought when we first entered that market that an employer-based retirement model would emerge, and it didn't emerge. And we don't think it's going to emerge in the short term here in the next 3 to 5 years. So we made the decision to exit India as an underwriter of products and services. We do have -- and ironically, just this morning, I just gotten off a phone call with 1,000 of our associates in Southeast Asia, including India. We have roughly 2,000 employees there that are doing exemplary work for the organization. We -- when we evaluate countries, we're looking for rule of law. We're looking for the emergence of small- to medium-sized businesses, and we're looking where we can capitalize on our current capabilities, global asset management and global retirement knowledge, skill sets and capabilities. And if you look across whether it was Chile, Brazil, Mexico, Thailand, Indonesia, Malaysia, Hong Kong and China, they all hit the mark in terms of they are good places for us to manage global assets, regional assets and local assets. They're good markets as it relates to distribution partners and capabilities. There is strong demand for these products. And at any given time, just like we're experiencing in Chile, there can be political changes that will cause you to hit the pause button and reevaluate and make sure that, that market has a good upside. And again, what's going on in Chile, as we speak, is one that it's serious in nature with the change of the political wins, and we continue to evaluate those opportunities. As I said on the call, for those of you who listened in, in addition to the divestiture of our Indian operations, we also divested our life and annuity business in Mexico. Again, we didn't see that as adding value long term. Having said that, we still look at the Afore business in Mexico as being a good business, even in spite of some changes relative to fee structures on a go-forward basis.

You mentioned Chile, and you did talk about it on the call a little bit, but I think it's worth sort of scaling, what does the Boric presidency seem to want? I mean they may want a political win of some sort. We're -- obviously, there's a lot of money tied up in the pension system there. So there are a lot of concerned Chileans about what's going to happen to their monies. Can you frame what the outcome -- range of outcomes could be in terms of what's going on? And do you and your peers who are large multinational life insurance companies -- do you have a seat at the table in discussing about what might be a good option for -- to make everyone happy?

That's a great question, Josh. And the first thing I would say is our local leadership with Roberto Walker and his team have just done an exemplary job in helping navigate these political wins. And this is a country that has done extraordinarily well the last 30, 35 years to have a very credible and strong capital markets capability. And in large part, it's because of these AFP assets have helped really establish a very durable capital markets. I think, as that information continues to become more prevalent among the new political ranks and President Boric elect as he takes on these challenges and understands the importance of AFPs, I think, we'll continue to see hopefully some moderation towards some of the views about AFP. AFP, as I said on the call, there are over $50 billion that were distributed to Chileans, I think roughly 29.5 million Chileans during the peak of the COVID infection. And in Chile, where they had access, there were a number of withdrawals that were made. And so they saw firsthand how these reserves, these retirement assets could be used in the short run to help mitigate some of the financial challenges of Chilean. To the original part of your question, the ranges, if you completely were to privatize the retirement system and make it a corporate capability, the others if you went to the public sector, which today we're certainly a heavy participant and leader in that space, and everything that ranges in between. And again, those are ongoing conversations with the administration, the incoming administration, the outgoing administration. But I would just note this, and that is the system of AFP has had a very strong and profound favorable impact on Chileans. And when you take the surveys, what the surveys tell Chileans is, they actually like the AFP system, number one, an overwhelming majority. And secondly, they say they want to have choice. And so I think as the fact pattern emerges on what Chileans want and as they look to rewrite the constitution of Chile this summer, they're going to take a lot of this information into consideration as they continue to evolve. I do think, and lastly, as you know, there's now a universal pension plan that has been proposed. And I think we'll for sure be codified here as a way to make sure that the lowest quartile of Chileans from an income perspective have a baseline retirement income that is again demonstrating that the government is listening to what the people are saying, and they need some level of certainty in their retirement. Hopefully, that answer wasn't too long, Josh.

Absolutely not, very, very thorough. So I'm going to betray my own ignorance and ask a Brazilian inflation question. So I mean you have provided some noncash economic coverage for the spread between 2 different measures of Brazilian inflation. And over the long term, I guess they're supposed to move in harmony, but sometimes they don't. And that, I think, 3 quarters ago, that showed up as a charge to the P&L. Can you update us as to whether the macroeconomists focus about how these things are supposed to operate -- actually are operating as they should and do investors need to be concerned about this gap?

Yes. On a product that hasn't been sold in 20 years, which is the painful part of this discussion, but without getting into all the laborious details, when these products were first structured, the liabilities were keyed off of the -- effectively the institutional or industrial inflation rate. And as that economy has emerged, those industrial bonds are no longer available. And the proxy for those industrial bonds has been effectively the retail bonds and, therefore, using the inflation associated with those retail bonds. And for the most part, over a long period of time, they have actually tracked pretty closely. We found a period of time here in 2021 where that blew out by a considerable amount, and it created that dislocation in the marketplace. As we saw in the fourth quarter, it's come back together. We continue to have conversations with the government officials about this block of business and the need to have more flexibility for using a different proxy. Those conversations are ongoing. And again -- I think, again, long term, they should stay closer together, but we certainly saw a disruption this past year.

And one last inflation question. I keep telling people that the life insurers are very well positioned in suitable investments for an inflationary environment. I can't find anyone smarter than me to taking up my offer and explain why. I have my own theories, but maybe you want to take a 2-minute stab at the -- at explaining this.

Yes. It may not be someone smarter. It may be somebody who's maybe just more wiser that it takes into consideration that this inflation question can't be captured in a single sentence because we know that there are extenuating circumstances and roll-on effects of inflation starting with interest rates and does it lead to a recession. When I step back from it, Josh, I first think about it in our benefits business where there's wage inflation. My guess is as inflation takes hold and wages go up, we're going to see it. We've already seen it, more coverages and so higher revenue and premiums in our group benefits lines of business. We've already seen sort of the vulnerability of people recognizing that you can become disabled. You can die during a global pandemic. And so interest in those kinds of products has gone up. Same way for retirement and you think about higher wages, leads to higher deferrals and leads to larger payrolls and companies matches in order to retain talent, sort of gets caught up in this debate as well. And then just the impact on inflation causing fixed income investment pricing to improve and we see yields go up. And to the extent that you can capture some of that spread, I see that as being a very positive impact on our businesses. So I do think the net effect when we're all done, barring any sort of catastrophic recession, if we can thread the needle here and work our way through this next cycle over the next couple of years, I do think inflation is generally a tailwind for the insurance industry, and I look at as a tailwind for Principal. When I think about Pat Halter and his portfolio of products, whether it's equities, fixed income or commercial real estate, I think about the historical impact inflation has had on real estate, and that's been generally more favorable. But yet again, we haven't come out of a pandemic where we don't know the use of office building is going to land. I think it's going to recover in large part, but that's another one of those variables that we just don't know. So rambling here a bit, but I think inflation or cat of it is actually good. And if appropriately managed, but there are so many different sort of contingencies that could derail that or, frankly, put more wind in the sales of that driver.

Well, I could go on. We are out of time. You have a busy day ahead of you. So let me thank you, everyone, who's listening right now. And if you have any questions for Principal, you can send them to me or in your meetings discuss them with Dan directly. Dan, thank you, and have a wonderful day, and we'll see you in person next year.

Sounds great, Josh. Thanks again for the invitation. It's an honor.

Thank you. Be well. Bye-bye.

Bye.