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

All right. We'll go ahead and get the session kicked off here. Thanks, everybody, for being here, and a special welcome to Dan Houston, CEO of Principal Financial Group. Thank you for being with us.

Honored to be here.

Thank you for the invitation. So I'll start with a high-level question. You've gone through this process of refining the business mix, and you've talked about that allowing you to get to a 15% ROE in '22 and '23. And I thought I would just get the update on what are some of those things you've done? What are the drivers that are going to allow that to happen? And can it still happen in a somewhat uncertain environment as we look into '23?

Yes, I appreciate the question, Alex. So I think about it in the context of we're sort of 18 months into the launch of our strategic review and what we had come out and told investors we were going to focus on. And again, for those of you less free at the Principal Financial Group is really to focus on 3 things: Global Asset Management. Secondly was retirement in the U.S. and emerging markets, and I stress select emerging markets. And then third was business insurance for life insurance and group benefits because we had interrogated every single business, every single product to solve for how do we get to a 15% return on equity. Our trailing 12 months is 14%. So you can see that from here. Now recession, no recession, hell, I don't know, that's coin toss. But the steps that we're taking underlying is expense management. We're certainly eliminating sales. As you know, we divested ourselves through a reinsurance treaty with Talcott for the universal life of Sectary guarantees as well as our retail fixed annuities. And so the portfolio has just fundamentally changed both from a capital perspective and expense perspective as well as the new businesses being added. So when we look at new business valuations, we're just incredibly stinging about that next new piece of business that we're putting on the books.

Got it. So you've completed a lot of reposition in terms of some of the business mix changes. Where are we with that? Do you feel like you've gotten past a lot of that work? Or is that still a focal point as you kind of look into 2023?

I don't think it's ever over. And I say that in the context of the big buckets that I just mentioned are very much anchored down within those buckets, you have to take a very close look at the portfolio. And I'll use one just literally for illustrative purposes. In the international markets, it's a different perspective today than maybe it was 30 years ago, certainly when we opened up those emerging markets, it's different than a decade ago, and it's different than 5 years ago. And so we need to make sure that country by country, Mexico, Chile, Indonesia, Thailand, Hong Kong, Brazil, that the products within those countries that we're selling, we're looking at those from a long-term historical perspective and what they can do for us in the future. The other part of that, Alex, which I think is interesting, is stronger alignment between Principal Global Investors or Principal Asset Management and Principal International. Again, if you go back 10, 15, 20 years ago, if you were a good sovereign debt manager in Brazil, that was the box you were checking. Today, they want more than sovereign debt. They want multi [indiscernible] funds. They want other investments that are not only local, but regional as well as global. And so we're wanting to make sure that our product lineup, our set has good alignment between our asset management, global asset management franchise and Principal International. Just one of those examples of how you would refine that message.

Got it. So the next one will be a macro question, then I'm going to jump into some of the specifics around on your businesses. So when we think through equities, interest rates, employment levels, et cetera, what are the ways in which we should think about a recession impacting your business? What have you done to sort of position yourself to weather the storm, if that's what we get here?

Yes. Interesting question. I was coming in from the airport last night and I'm still a relationship manager on 6 very large accounts. I do that in part, so I never lose touch with what's really on the minds of trustees and large employers. And we had talked to this large employer. They have roughly 40,000 employees in their retirement plan, 80,000 total employees. And we've talked to them about a nonqualified deferred compensation program for probably a decade, and maybe it shows you how lousy the salesperson I am because I just got the call last night that they're now ready to move forward. And why did they want to put it in place? Talent retention. So here's an organization that's retail oriented, and they're even faced with being able to retain that top executive team. So the environment, I would describe it as small- to medium-sized employers, they're still hiring. If you look at some of the underlying fundamentals in our Group Benefits business, we know that our 100,000 installed base of small to medium-sized customers grew by about 2% from an employment perspective. We know that if you look at our retirement business, our fee business, full-service retirement, we saw an increase in matching contributions, increase in deferrals, increasing percentage of people participating and a 10% reoccurring deposit on a trailing 12 months through the third quarter. So as much conversation we read on and here on CNBC in the journal, the growth among our businesses still remains quite strong. The question around, so what are we doing about that? Well, the one thing we want to make sure is we don't starve the business. We have to still invest in technology. At the same time, we're making sure that we're managing our expenses. And to the degree the markets are down in those 3 businesses, we have to make those adjustments. And Cardinal roll around our place is to align our expenses with our revenues without starving the business.

Got it. That all makes sense. Maybe shifting over to retirement fee specifically. I think you touched on this a little bit just on what you've seen with the strength of your customers at the moment. But are you feeling any negative impacts from the environment yet in terms of activity and flows? Or is that still coming in pretty strong? And could you help us think through just the outlook for that kind of flow activity?

So as I said earlier, 10% recurring deposit growth. That's strong. It's really strong. When you see increases in deferrals and matches, I think back to the wage freezes from the Nixon-era of where benefits really got sort of its jet fuel for growth, it's because they have put a cap on wages. Well, the same thing sort of applies here. People are attracted to good health insurance benefits, good group benefits, and that's dental, life, vision, disability, and, of course, retirement. So the fundamentals of those businesses are still very much intact. On the retirement side, the example I just used you with you on nonqualified ESOPs increasingly, very popular. We're the leader there, deferred compensation. That's a big one. How do you retain key talent for the organization? And I've said this for the 38 years I've been with the company, defined benefits are not going away. And when they do go away, we're in the pension risk transfer business, a lot of these plans are 100% funded. So they're sort of ripe for the conversation to say, what do you want to do about your defined benefit line? You want to freeze it, you freeze it, you still have actuarial services, you still have record-keeping services, you still have ALM strategies that you're deploying against those assets. Monday afternoon, I was speaking to our retirees at their Christmas function. So 300 more employees who have now retired top of mind for them once the defined benefit plan. And we know the importance of that defined benefit plan. That's one Christmas party for one company that has a defined benefit plan. Whether it's frozen or not for the next 30, 40 years, people are going to be drawing down on defined benefit plans and someone is going to have to provide the services, that's us.

Got it. So one of the things you've talked about over time is the power of the record-keeping 401(k) platform you have and the access that gives you to cross-selling a lot of other products that you specialize in. Could you talk about some of the things you're doing there? And I guess, particularly with the Wells Fargo transaction being more fully integrated now, what kind of opportunity does that look like?

Well, there's really sort of 2 tracks, Alex. And when I think about it, it's the employer track. It's those 2,500 plans that we have to engage with. And then there, we're talking about TRS, introducing deferred comp, introducing ESOP, introducing defined benefit and looking at additional opportunities to put our asset management capabilities into those plans. As you know, they had a lower percentage of proprietary than our book of business. And so there's a pretty rich environment that we're going out there. Now the first thing you have to remind yourself is when you're moving record keepers and there's been an acquisition, first, they have to gain confidence in you that you're going to provide those wraparound comprehensive services. The participants are happy, communications package is good. Now they're starting to entertain those questions about what else can you do for those customers. The other side of this equation is the participant over 2 million new participants added to our opportunity set. So that's roll-ins, that's rollovers, and that's a benefit event opportunities for either maintaining those assets inside the plan or putting them in a pension role over a higher rate. So all of those are the levers that we were looking at in terms of when we made this acquisition and when it was such a good fit for Principal. And we're definitely activating on every single one of those opportunities. Remember that when we acquired the Wells Fargo retirement business, we brought over the vast majority of those relationship managers. They're very skilled. They're very capable, and they're distributed around the country. And so we've leveraged that talent not only across the Wells Fargo business, but also large principal retirement business. We have roughly 48 plans to have over $1 billion of assets. A lot of -- we talk a lot about the SMB franchise, but it's those really large plans to give us the scale the scale up as it relation to whether it's marketing or technology, digital investments really does require a large installed base of participants.

Got it. Next one I have for you is on margins. You guys over the last couple of years, improved margins pretty significantly, whether it's in fee or particularly in PGI. And as you've had revenue pressure, they've held up really well, a lot better than I would have expected. And I guess the question for you is what are some of the things you're doing to be able to achieve that? Do you think you can continue that into '23 despite some of the inflationary pressures you face?

Yes. So maybe we just sort of take it by business and give you maybe the top driver in each one of those. When I think about the asset management business, and we're a little bit different than other franchises and our global asset management because if you think about whether it's private debt when you think about the 4 quadrants of real estate or if you think about preferred securities or high yield or even some of our emerging market debt and equities. We're still able to maintain a high fee for those capabilities. Number one, performance is good. And number two, there's a limited number of people that do that really well. And so as it turns out in our global asset management franchise, we just so happen to be in asset classes that have held up under a lot of pressure in that industry. And the retirement space, as you very well know, you've covered us for a long time, Alex, there's been a bit of an arms race on driving margins down. And we've pushed back and we have a lot of levers to do that, one of which is the SMB area. It's a little bit -- I got to hate to use the word easy, but there's been so much work done in the last 10 years. I think there's a lot of stability that's taking place at the SMB level. The second is on the very large plant, a lot of that's locked in on a per-participant charge. And so a larger percentage of the revenue is more predictable because it's not subject to the vagaries of the market and then the cross-selling opportunities that I mentioned. Group benefits, small to medium-sized businesses, those margins, again, have held up incredibly well. In large part, you saw a 10% increase in premium and fees on -- through the third quarter. And again, this is in part by our strong dominant position in that marketplace, strong underwriting and very strong use of technology. I'll give you just like a snippet just because I think it's so interesting. Dental, used to review all those X-rays through a doctor, dentist on staff, looking through those, making determinations on benefits and so forth. We put a lot of technology in place that read those X-rays 90% of the time. It's being done in an automated format to look at that, and it's almost nearly instantaneous approval for those dental records for doctors. That means the customer -- our customer isn't disadvantaged by having to come back and wait. It's done in a very rapid fashion. So key points. And then as you know, on our pension risk transfer and investment only, we think of that business as being opportunistic and if it doesn't meet our thresholds, then we don't sell it. So my business, the last one I should have mentioned is Principal International. Margins are quite good there. But as you know, it's the challenges in the marketplace, whether it's high inflation impact on encaje and FX is what creates the challenge. It is a lack of our ability to maintain sort of a run rate of good margins on those businesses.

Right. Okay. Maybe shifting to PGI. Could you take us through some of the things you're doing there to achieve the positive flows? And what are some of the strategic focal points to do there?

So the way we think about PGI is the asset classes that I mentioned earlier that are differentiated in the marketplace. And again, the performance on a long-term basis has held remarkably well. And then we think about the 3 buckets when we go to market. The first bucket is the most important one, which is to support our general account, which is, you went from $100 billion down to $70 billion with our transactions. But again, that $70 billion has to be managed by Principal Asset Management. And in addition to all of the opportunities within full service retirement. So there is, I'll call a build-in mechanism to help drive flows into PGI that's quite predictable. Think about all those reoccurring deposits, right? The second one is around institutional asset management. And again, we know institutional investors in this group. You know them all too well. They do take a very long-term view. And a lot of these real estate opportunities have a long-term view. And so therefore, flows remain good and margins maintain good. And then the last one is around our ability to leverage this capability for international opportunities. And again, there's more and more principal global asset management strategies being sold through Principal International around the world. Part of that institutional partner, should have backed up for a second, are those retail flows going through the wire houses, getting on those platforms. A lot of our principal asset management product sits on our biggest competitors platforms for distribution within their qualified retirement plans, including our target date funds.

Got it. You mentioned the international base of institutional investors you have. Do we need to think about the change in interest rates at all there and hedge costs and U.S. dollar-denominated back other currencies become pretty punitive, particularly for Japan. I mean do you have enough for that, that we need to be considering some impact there?

I don't think there's enough of it to be a huge distraction. It's enough to probably get a mention on an earnings call, if you will, right? But here's the one thing, Alex, I would say about that. those institutional relationships are really strong. So even though the money may go out of one of our strategies into some sort of liquid investment money market, those relationships are still in play. And so you mentioned Japan specifically. That U.S. dollar-denominated trade is not working today, but it could very well come back in vogue. And when it does, we're there with those relationships. We've actually, in Japan on a very large retirement plan there. They shifted some of their strategies away from us that were, in fact, being negatively impacted by the changes in currency, moved a generous portion of those assets into a different fixed income structure and the margins were about 4x or greater. So retain the client, different strategy, still good for PFG.

Got it. The next one I wanted to ask you about on international is just pension reform is a broad topic. And part of it, I wanted to see if you could touch on the proposal that's going on in Chile and potential implications of that. But maybe also just broader on pensions. I know there's opportunities. It's not just about pension reform, potential pressure in fees here or there. There's also a lot of opportunities. And so if you can talk about China as well, that would be helpful.

Yes. So maybe I'll just give a little bit of context. Last week, I was one of the co-hosts for the employee benefit research institutes, symposium that was held at the U.S. Chamber of Commerce, and we had Secretary of Labor Welsh there presenting and I had a chance to engage with him on this very topic about the U.S. and the desire to enact retire 2.0, and there's a lot of support for that. The last 2 days, I spent a lot of time on the hill, 6 different members of the House and the Senate who have something to say about these topics. There is no debate around the U.S. retire 2.0 getting enacted. You hope it doesn't become a pawn in the process. But we will get sort of the next deliverable as it relates to pension reform in the U.S. and there's nothing in there that's negative towards principal for the rest of our industry. So set that one sort of aside. Let's go to Chile. In the case of Chile, as you know, President Boric had a very aggressive constitutional reform agenda. It failed. It did not gain traction. The people spoke and they said they're not signing up for that. My guess is there's still pension reform. And it will happen sometime this debate will go throughout sort of 2023, and we'll sort of see what happens towards the end. I would tell you we have a very constructive relationship with the finance minister, constructive relationship in the marketplace. But what we know for sure from all the pulling that takes place and believe me, we're not pulling back as an industry on making sure the message is getting out there. But individuals want to have their own account, and they want to make their own investment decisions as opposed to the government doing that. And so I would say that the market conditions in Chile are very tenuous. However, having said that, the backdrop for Principal in the industry to continue being an active player and maintaining our margins and growing that business is probably better intact today than it certainly was 18 months ago.

Interesting. Okay. And maybe quickly on China. I know there's a pension license you all have been out there for a while. Any update on where that stands and the possible you'll be able to kind of go into the JV a little bit more?

Yes. So number one, we remain very enthusiastic about the opportunity set in China. And as we all know, there's always the backdrop of China and supply chains and the issues that constantly hit the headline news. I can tell you that within the hallowed walls of an organization like China Construction Bank, we have a very close working relationship with them. They go to work, like we go to work every day and delivering great service to their large customers and their retail customers. And we've had that relationship with them for, I believe, 17 years now. And it's very strong and the asset management business there is really a healthy business and one we're really proud of. What you're referring to is the license that has now been approved on July 14 for Principal to be an owner in an existing retirement business owned by China Construction Bank. What we're waiting for right now is administrative process of the Articles of Association, and we expect that to happen very soon. It is, as you know, lockdown in China, it's hard to get into the office. A lot of things require wet signatures. It's a little bit more bureaucratic in terms of the check offs and the process, but we remain incredibly confident about our ability to do that. We also see this as being an accretive transaction and look forward to updating investors just as soon as we get the finality on the articles of association.

So I wanted to shift gears a little bit over to the specialty benefits. I was hoping maybe you could comment on just the competitive environment generally, what are you seeing in terms of pricing? And it seems like you've taken some share there. You mentioned the 10%, I think, post-growth rate recently. Do you think you can continue taking share in this niche you have in the small business?

Yes. Business Roundtable, I was in a van going over to the national archives building for a function for BRT and had the opportunity to sit across from an individual that runs a P&C company. And the only reason I sort of frame that in that context, they are one of the very few P&C companies that are underwriting for a gain in their personal lines business. And that led to a conversation around how are you doing that? And they're incredibly selective and they're using a lot of artificial intelligence to identify the best risk and not taking on the poor risk. I think that's analogous to Principal's small group business. We won't take all comers. We want to make sure we're underwriting industries and individuals, which we feel we have a higher than average chance of being profitable in that business. So we are more selective than some of our competitors. We anchor gets the SMB. We're sensitive to industry and risk associated with those industries. And I would tell you that, that started with our Chief Financial Officer, Deanna Strable, before she became the CFO. She ran that business. Amy Friedrich, who runs that business today and the discipline that they use with their underwriting around the use of technology around artificial intelligence, the use of segment -- market segmentation about where they're selling business is a huge contributor to our ability to grow that business by 10% premium fees.

Got it. On the capital front. On the capital front, we've seen some volatility across the insurance industry from capital ratios at some companies. And we've heard some of your peers that are a little heavier in different insurance businesses, talk about asymmetric impacts, different things that happen as rates go up, that it's not always a straight line to rates helping the balance sheet. Do you expect any kind of volatility like that around your year-end process?

One of the benefits of being around a long time as a company and as an individual, you go through literally '08 and '09 when that became such an issue. You think about back at 911, you think about 2001, you on all the way back to 1987 and some of the disruptions that took place in these marketplaces. Principal has always been disciplined around ensuring that we're properly capitalized in all seasons. And I would tell you, we find ourselves in a very favorable position today. And it comes from underwriting smartly in the first place. So I think about our commercial mortgage portfolio, our loan-to-value criteria, the quality of those underlying commercial mortgages, all of those contribute, Alex, to doing all the things right on the front end, so you don't put a lot of capital strain on the organization on the back end. We all know in this industry, if we get interest rates rising up and to the right, now it's been a little bit more dramatic than any of us would have liked. And if we can get stronger -- higher interest rates than what we had historically been running the last decade, that's going to be good for our industry. It's good for the capital position. That's good for the customers ultimately. But -- and remember, we've derisked the company. We have less exposure to capital-intensive businesses. That was a very deliberate strategy. And we have a very diversified portfolio of businesses between fee, spread and risk. So I would argue Principal is one of those companies that is more all-season prepared to deal with more volatility in the marketplace. But one thing I'm not worried about at night is whether or not we've got proper capital. We meet every single Friday morning with investment committee, have this conversation with the actuaries with risk management, with the investment professionals and the economists to ensure that we've got this thing downed in properly.

Next, I wanted to ask you about capital and deployment in general. And could you update us on what you have left as part of the capital plan around the repositioning of your businesses as well as how we should think about capital as we look forward to '23?

Yes. So I think the best way to think about it is through year-to-date through the third quarter, we've deployed $2.2 billion over that period of time, $1.9 billion through stock buyback and common stock dividend, the common stock kind of $450 million, give or take. And then the balance of that $300 million was eliminating some long-term debt. So there's $.2.2 billion. We still see a path to get to that low end of the $2.5 billion to $3 billion. I feel good about our ability to do that, especially as a percentage, right, which we said would be 75% to 85%. So we see a path there. The macro-environment doesn't help. As you know, we've got equity still down on any given day, call it, 15% fixed income market is kind of 15% to 20%. Those are certainly not strong and conducive contributors to those metrics.

And on the RBC ratio, you've got a lot of work, as you mentioned, to shed capital-intensive businesses. At this point, I mean, are we at a place where you could start to consider a lower RBC target?

I think it would be absolutely the worst time to think about covering a 400 basis point RBC ratio. And the reason I say it is, I think you just have to be smart. We want to make sure that investors who invest with Principal that they're not worried about capital. I mean -- and it's fine. In certain periods of time, every investor wants to talk about returns and margins, and growth. And then you get these periods where they want to go to the other side of the fulcrum and talk about capital adequacy. And it's a good variable to sort of take out of the equation. Yes, it's really smooth sailing, and everything up into the right and you could take that capital below your $400 million and certain investors would be pleased. But frankly, our long-term investors probably be uncomfortable. And we don't think that's a good place for the company to operate. And again, we look very closely at what our liabilities are and what our appropriate risk-based capital should be. And I would tell you that we're very confident that the capital position we have is more than adequate with a bit of cushion and that we can make good on all these long-term promises. And frankly, we want to make sure the industry is in that same sort of position. And so again, we want to be very vocal that we don't let capital ratios fall to the point where it puts this industry at risk.

So next, I wanted to ask you about M&A. You obviously had some appetite in the past. You're in the industry that I think there's still a good amount of consolidation going on. Where do you currently stand in terms of how you feel about the Wells Fargo transaction? And did that cause you to be motivated one way to the other to try to replicate that type of transaction in the future?

Yes. The first thing I would say is all acquisitions are hard period. And I've said this before publicly, I wish I would have had the foresight in 2019 that there'd be a global pandemic, and we had just made the acquisition of Wells Fargo's retirement business, and we would do the complete conversion in a remote environment with people who were new to the organization. But that's the way it turned out. I'm thrilled the fact that we did it. It took a year longer than we would have liked. But I look at the installed customer base. I look at the new capabilities. I look at what we've built during that period of time, and we're in an incredibly strong position relative to our peers to compete in the retirement space. So that answers your question relative to, would you do it again? Yes, we'd do that again. We're #3 when it comes to 401(k) recordkeeping in our space. We think that's a very strong position to fight from. And again, we've already -- I was heavily involved in the acquisition of the ESOP capability, the building out of our deep defined benefit capability and, of course, our nonqualified deferred compensation. So Principal really has those capabilities. We also have a stock administration capability at Principal, and that's again as a result of having made the acquisition of Wells Fargo. So I would tell you, at this point in time, we'd be opportunistic only if it were accretive very quickly and that it gave us new capabilities because we're sitting in a very favorable position on scale. As it relates to the asset management business, again, we've got a nice spectrum. I share those and I frame those earlier. But on the margin, we still know that real asset opportunities are interesting to us, and we'd still be looking for the right sort of opportunity there. Having said that, as you know, our private lending, we're building that out fixed income team. They've done just a magnificent job. I think about Bill Nolen, who's done an amazing job on our mid-cap strategy. He has a fixed blue-chip strategy. So even our CLO operations that were built off the back of our post advisory. So inside the organization itself, we've had a lot of organic build-out of strategies that are meaningful to the organization. And then we didn't have to work on that cultural challenge that you have whenever you make these larger acquisitions. So I feel really good about where we're at today.

Got it. Maybe a broad sort of outlook question. Looking ahead, what do you see as the biggest opportunities and challenges for the organization?

I still think the U.S. is going to be the greatest opportunity. I don't think it's just unique to Principal, but there is so -- there are so many baby boomers marching towards retirement. And everything the baby boomers have touched, they've blown up, the number of elementary schools, the number of shopping malls, the number of colleges and the number of seats to colleges and apartments and housing, they're marking in on retirement now. And we already know that first baby boomers then there's another 15 years to go. Income and retirement is going to be a big deal. -- rollover opportunities are going to be a big deal, asset management that's differentiated. So I think right here in our backyard at the U.S., huge upside opportunity because of just the demographics of where we're at. Having said that, and again, we just completed and signed, as you know, our agreement with CIMB. We had a virtual closing where I joined by video conference at 5 in the morning recently formally signing our extension of our agreement with CIB, which we've discussed. It's a great partnership. And when you look at the underlying demographics, of the Greater Bay Area, it is really significant. So I expect a lot of growth from there. We just had our partners from Banco do Brasil in Des Moines, great partnership there. Latin America always goes, as you know, through the cycle. But I would tell you, I think Brazil, because of its macroeconomic drivers in agriculture and mining and its positioning in the marketplace on food, and it's a big economy. So I think of Brazil is also being a very good opportunity. So I think China, I think Brazil, Greater Bay Area and the United States as being really strong economic growth drivers for Principal.

Got it. Maybe to cap it off, I wanted to ask at least one question on credit. It's on everybody's mind. How do you view your investment portfolio? What are some of the opportunities with rates going up? But how are you kind of balancing that with positioning yourself for a potential recession?

Yes. As you know, we're over-indexed on commercial mortgages. And the reason we like commercial mortgages, as you think about it as a component around income and as price appreciation. Having said -- and we know that over long periods of time in long cycles, that asset class performs very well. In the last decade, we moved away from some of the office buildings and more focused on and certainly never were in the retail mall business as an example. So the portfolio, Alex, has really set up well in this new economy, whether it's medical services, whether it's data farms, whether it's apartment buildings, those guys running that real estate portfolio do a great job. Back to your question on relative to credit, we feel we're in a very strong position from a capital perspective. We think these loans have been underwriting in a very favorable basis. So -- and then frankly, as you know, from the reset that we have with the reinsurance counterparty, what we retained, we were very pleased with how the breakdown occurred on what we retained and what we divested to the buyer, and we're in a really, really healthy position from a credit perspective.

Okay. Well, I think we're at time. So thank you very much for being here. Thanks, everybody.

Appreciate your time. Thank you, Alex.