Good afternoon. We're gonna get going on our next session with Principal Financial. Want to introduce Deanna Strable, who is now the President and Chief Operating Officer, and also recognize Humphrey Lee from Investor Relations in the front. So, as many of you probably know, Deanna was recently promoted to President and COO of Principal. She was previously in her role as CFO since 2017, so I thought this would be a good opportunity. I don't expect you to have major changes in your new role, but I did wanna hear, you know, just given the new role, you know, what your key priorities are for it.
Yeah. Thank you, Ryan. So it's great to be here, and it's a privilege and an honor to be moving into this role. I've been at Principal for 34 years, and I've been privileged to work under some great leaders, and it's gonna be great, big shoes to fill as we move forward, but you know, we've been a strong company for a hundred and 45 years, and my priority will be how do we continue that as we go forward in the next few years as well? You know, when I think about priorities, I think the first thing I would say, Ryan, is you know, being the CFO for the last seven years, I also ran enterprise strategy for five of those seven years.
I don't think you would expect huge differences in our areas of focus and our strategies going forward, but I am very much looking forward to getting back, working closer with our businesses. Prior to being CFO, I ran our Benefits and Protection business, and now I'll be overseeing all of our lines of business, and so it's really making sure that we're starting with the customer and figuring out how we can best meet the needs of the customers across all of our businesses, and being able to connect the dots and leveraging that. Whether it's thinking about our broad capabilities in retirement, whether it's thinking about our broad capabilities and meeting the needs of our small to medium-sized business, which is our target market.
And then thinking through things such as AI and Generative AI, and how do we make sure we're putting our priorities around those largest opportunities versus thinking about them in individual businesses. So again, not big differences in strategy. We feel great about our growth prospects and our ability to meet them, but I think thinking holistically will be additive to the businesses as well.
Great. I believe I actually started writing my questions when you were still CFO, so I'm gonna make you answer some of the CFO questions still, too.
That's okay.
So, you know, one of the topics last quarter was, you know, you maintained the 9% to 12%-
Yeah
... EPS growth target for this year, which I think you went through. It implies about $2 or more of EPS per quarter in the second half of the year, and it was about $1.80 in the first half. Can you remind us of the key drivers of the difference between the first and the second half of the year? And also, just is that still your expectation as you sit here now?
Yeah. So, great question. You know, it was great coming into this year and being able to say our 2024 guidance really aligned with our long-term EPS guidance of 9% to 12%. And again, if you look at that delta between the first half and the second half, it's not dissimilar to what you would have saw in 2023, when there was about a $0.17 delta in the average quarter, and like you said, it's about a $0.20 delta as we sit here today. The primary driver is actually seasonality within a couple of our businesses, and so primarily, Principal Global Investors, which is the asset management side of the business, they do have seasonally high expenses, which we quantified at about $25 million in the first quarter.
And then within our group benefits business, mortality and morbidity and dental claims tend to be higher in the first half of the year, and we expect that to normalize in the second half of the year, and so we may be higher in our range in the first half, lower in our range in the second half, so seasonality is a big driver on that. Just a couple other things that do contribute to that in addition to seasonality, we have been deploying capital to buy back shares. So even with the same dollar amount of delta, it's actually gonna be a greater delta from an EPS perspective.
And then we did have some one-timers that pressured our earnings in the first half of the year, primarily taxes and severance. We don't expect them to continue at that same magnitude. Within our asset management business, we also had very limited, if any, performance fees, and we see a higher level in the second half as well. When you bring those all together, that confidence in the full year outlook of nine to twelve we still feel really good about.
Great. You mentioned the severance cost. Just, I guess, how should we think about and either savings from that or just your expenses broadly? You know, and I think you typically do have seasonally higher fourth quarter expenses, but I don't know if perhaps you expect a different pattern this year.
Yeah, if you went back three to five years ago, we did see fourth quarter be quite a bit higher than the average of the other three quarters. The last couple years, it's just been modestly higher, and I think that's probably more what to expect as we sit here today. You know, I think we've had a really good culture of always aligning our expenses with our revenue. But we did have elevated severance in the second quarter, primarily in our asset management and international businesses, as we upgraded talent or ultimately made some decisions to focus in different areas. So, you know, I wouldn't say that's gonna be a huge driver of expense savings. It's probably more reinvestment into other priority areas.
Got it. So moving into your retirement business, I want to start with the fee-based side. Can you talk about the dynamics that are impacting flows in that business, at this point in time? And then can you give some thoughts on or how trends look different, I guess, between your SMB market and the large case market?
... So, when you think about our US retirement business, there's primarily a lot of focus comes on more of our defined contribution and defined benefit side, which again drives quite a bit of fee revenue. I think we've reiterated a number of times that net cash flow is a metric we look at, but it's not the primary metric we manage the business with. We're really trying to drive revenue growth, and what we found over time, both in honestly PGI and RIS, is there's a broad range of revenue for the same amount of account value, and we want to make sure we're prioritizing those with broad revenue, sometimes fee-based, sometimes spread-based, sometimes revenue and PGI.
But specifically to your question, you know, if underneath that net cash flow, which has run average more negative in the last few quarters, there's a few things that are going really well and a few things that are pressuring that. One thing that's going really well is our recurring deposit growth. That's been in that high single-digit growth range, and honestly is probably the metric I look at more than any to see what's the health of the business. So are you getting more participants? Are they contributing to the plan at a high participation? Are they increasing their deferral? Are you increasing matches? And that's all showing some very strong growth. We've also saw some very strong contract lapse, or retention, both in small and large case, and so that's helping as well.
The places where we've had some pressure that's leading it to negative net cash flows in total is, first of all, from a new transfer deposits in, even though it's up from last year, we have seen less plan movement in the large case market. That's benefiting us from a retention perspective, but as you're aware, you know, we're more of a newer entrant in that larger case market with our acquisition of the Wells business. And so with less plan movement, we're being hurt more on transfer deposit than we're gaining in the lapse perspective.
And then the other piece that is hindering our net cash flow and actually has been a trend in the industry is just higher participant withdrawals. That trend is not different, small or large. Two things I'd say there is, first of all, because of strong markets, even with the withdrawal rate being the same, you're gonna see higher outs coming out of that. But then we are also seeing higher retirements. And it is a little bit of phenomenon when participants' 401 balances are higher, it gives them a little bit more emphasis on thinking about retirement.
And so I'm not sure that trend is going to change in the near future, but those are really the ins and outs relative to net cash flow.
Got it. I guess on the guaranteed side of the business, I mean, it does seem like, yeah, as the population is aging, you mentioned seeing higher participant withdrawals. And I think one of the, you know, one of the things the industry is clearly trying to figure out is, are there other decumulation options-
Yeah
... that can be provided? I guess, do you see opportunities for Principal to focus, you know, more on that type of product, whether it be an in-plan annuity or something else?
Yeah. You know, within our retirement business, we have a number of spread solutions, both at the plan level and the participant level, and so maybe just going through those real quick, and then we can get to your specific question. So we do, for example, offer guaranteed products within the 401 plan, and we actually have a focus to increase that. And so then, again, that's a broader way to get economics from the plan, but shifts a little bit from fee to spread. We also have a very strong PRT business, pension risk transfer, and some of those customers that buy our pension risk transfer solution actually move from defined benefit record-keeping into PRT. That's actually another way it goes from fee revenue to spread.
We also have a bank that is utilized almost entirely to help the participants of our 401 plan. So whether it's a small amount to take out or when they do retire, being a place where they want to put money for safety, and so all those things, I think, are things that contribute to that spread. And then we do have some annuity solutions, variable and RILA, as well as institutional annuities, that can be there for both in plan as well as, as they transition out of the plan. I do think over time and Secure 2.0, obviously, allowed for some additional avenues for that. If we can find ways to make it easy, I think there will be opportunities to increase the ability to do that. We have the product set to do it.
We are under development on a new product that would more embed it within the target date. I do think that'll be a slower build, and something that will be an opportunity over time.
Would that be you providing an in-plan annuity within your own target date fund? Would that be the idea?
So it's that. We would probably use some third party more from a managing that glide path-
Okay
... and how it transitioned between the two of them.
And then, you know, sticking with guaranteed products, you have seen pretty good growth in general in the overall business. I guess what's your outlook there? And I guess it seems like you've kind of seemed to have kind of a budget on how much capital you're willing to allocate to those. You know, as you see more growth opportunities, you know, would you increase that budget?
Yeah. So, you know, in addition to our EPS target, we've also targeted that 75% to 85% free cash flow, and, you know, that was something we increased when we did exit the retail fixed annuity and the retail life insurance business. And so now it allows us to more strategically utilize that capital budget. But we do think it's an optimization of, you don't want to use too much capital upfront, which could, you know, impact that ability to return capital to our shareholders, have a strong growing dividend, and ultimately continue to contribute to that shareholder return in. But that is a pretty wide budget-
Yeah
... between 75 and 85, and so if we are seeing more attractive opportunities, you might find us more on the lower end of that. Whereas, if we aren't seeing those, we might go toward the upper end of that.
So there's been industry kind of secular pressure on 401 fee rates for as long as I can remember. But you've obviously have strategies that you've used to combat that. Can you talk about what some of those strategies?
Yeah
... have been, you know, and also just, like, to what extent are synergies with your other businesses, other opportunities to offset that?
Yeah. So if you just look at pure record-keeping fees, there is competitive pressure on that. We have. You know, we'll see that average fee rate go down two to three basis points a year. It is interesting that a portion of that decline is driven by, for example, investment lineup changes to cheaper investment lineups. So the fee goes down, but your management fees on the investment side go down as well. So it's not as impactful when you look at bottom-line earnings. And so some of it is that, some of it is, as we go more into the medium and large cases, you're gonna see lower fees there. So there's business mix and those would tend to have lower expenses as well.
So some of them are pressuring just that fee rate, but not as much, kind of, bottom-line impact, and others is just pure competitive. The other thing is, you know, that benefit benefits from macro and equity market increases, and so even when the fee rate goes down, you get a natural offset there as well. Having said that, now pivoting, you know, the first thing I would say is all of our metrics, whether it be 2% to 5% revenue growth, in RIS or overall EPS factors in that continuation of fee compression, and so we have the ability to overcome that and grow the business despite that.
I'd say really what we're trying to do is making sure we're maximizing revenue, in all the places that we have capabilities, both at the plan level and at the participant level. So at the plan level, it'd be thinking through things like putting more attractive options on the guaranteed funds that, again, offer spread income for that same thing that potentially would've been fee in the past. If you look at our guaranteed penetration into our 401 plans, we have room to grow that, and think it's a good way to use our balance sheet in conjunction with our record-keeping capabilities, and then it's also continuing to take what we also think today is a strength, which is our proprietary asset management, and making sure we're leveraging that to all of our plans as well.
And so I'd say those would be two things that, you know, we're gonna continue to use that to offset that, and then how do we retain those and monetize those participants into broader solutions over time?
Got it. So moving into Principal Global Investors, your asset management-
Yep
... business. You've had improved flows, but still ultimately negative in the first half of the year.
Right.
But again, as kind of we dig underneath the surface, can you talk about areas where you are seeing better momentum?
Yeah.
And then in other areas where you're still seeing challenges.
Yeah. So, I think there's been some one-off customer withdrawals that, you know, either the client's looking to bring the money in-house, one client that needed liquidity for general purposes, some rebalancing, so some things that probably aren't as driven by either performance issues or those types of things that has had some pressures on flows. I'd say the other thing that has had some pressure is Stable Value, so that is a something we use both within our retirement plans and other people's retirement plans.
Tends to be lower fee, but in times of higher interest rates and higher markets, there's just natural outflows and we are seeing some negative impact from that. On the plus side, we are still seeing positive flows into our real estate asset management capabilities. Again, at a lower rate than maybe we saw pre-2023, but still are continuing to see quarter after quarter positive flows. We've also seen our retail mutual fund flows improve as both quarters this year, and then we're seeing a lot of interest in things like high yield, specialty equity, such as midcap international.
Really starting to see some interest in fixed income as kind of that line of sight to lower kind of risk-free rates come down, and then emerging markets capabilities would be another one as well.
On just that fixed income point, like, do you think we actually need to see rates actually come down? I mean, we have had rates come down-
Yeah
... but short-term rates come down before there's more action. Like, are we more in the discussion phase of interest, or do you think things can happen before there's, like, full clarity?
Yeah, I think the fact that we saw mutual retail fund flows much more actually slightly positive. The first half shows that for some investors, they're already starting to make that move. I think in other areas, like real estate, I think we may need to see the rates come down.
Mm-hmm.
I don't think it's as much how much they come down, it's more people see that they are gonna come down, and it makes them think about other asset classes that might be of interest.
You mentioned higher PGI performance fees as one driver of seasonality.
Yeah.
Can you expand on that at all, just in terms of, like, what would-- It sounds like you have some line of sight on the performance fees in the second half of the year. What would be-- what's driving that?
Yeah. So our, just, education-wise, our performance fees in PGI tend to be more real estate transaction-driven than they are kinda hedge fund type of that. And again, some of that is for us as a general account, and so you'll see a performance fee in PGI, but you'll actually also see benefit with variable investment income within either our retirement or benefits business. But it also could be for a third-party client, where we have equity real estate that they've invested in, and we honestly have seen a good opportunity to transact on that property. And so again, those aren't things that we don't know about.
Yeah.
And so there will be some that we see a line of sight to in the second half of the year. We've kind of pointed to about a $30 to 35 million, kinda run rate. I expect we'll probably be below that, but the second half of the year will be higher than the first half of the year.
Got it. The fee rate at PGI has pretty consistently been, like, the 28
8 to 29
... to 29 basis points range.
Yeah.
It's been closer to 28 more recently, but is that, is that kinda the right range to expect going forward? And I guess what are the positives and negatives influencing it?
Yeah. So, the first thing to keep in mind for PGI is half of our assets are internally sourced, so either the retirement business or the general account. Those tend to be sticky. They seem to have stable rates. That's kind of embedded in there, and I think helps to kinda offer that stability for that rate perspective. The other thing is, even though we average 28 to 29 we have quite a few things that are above that and quite a few things that are below that, and I think, again, that stability of rate is something when you compare us to other asset manager, it does look like a much better performance from where a lot of our peers have seen much more dramatic drops in average fee rates.
I think the things that really help that is, again, a lot of our real estate capabilities. You know, obviously, those are higher fee rates. That has probably caused us to drift down a little bit because the amount of positive flows in real estate is lower than what it used to be. And then it's things such as high-yield emerging markets. Those things that aren't easily replicable by passive things, that's where we're seeing flows that can really help drive that stability of rates.
Moving over to international, you've seen kind of a general trend of improving-
Yeah
... flows, and you're in several different markets there, but can you talk about what you're seeing?
Yeah. So, you know, if you think of our international business, one, it is focused in emerging markets, and it really is a combination of retirement assets within a few countries, namely Brazil, Chile, China, and then it's really global asset management in other parts of those emerging markets. And so we did bring the management of that under common leadership with PGI, and ultimately, I think we're gonna continue to see some advantages of that, where either global clients are interested in our local equity capabilities and fixed income capabilities in some of these countries.
But on the other end, some of these local customers will have interest in our global capabilities. Probably, the most significant drivers of flows is honestly the recovery of Brazil and our pension business there. I'd say Latin America was one to two years behind the US in kind of getting out of the COVID pressure, and Asia's probably one to two years behind Latin America and still seeing some downward pressure, but 2023 was a great year for Latin America. We saw Brazil flows come back to a higher level.
We still see good line of sight for increases there as well, and then we've seen again some of those other asset management capabilities, whether that be in Southeast Asia, Mexico, Chile, also drive some good flows as well.
So I think most of your international businesses really began as retirement businesses.
Mm-hmm.
Like, do you see more... Is asset management the bigger opportunity now, do you think, longer term in these international businesses, or is it a combination of both?
I think it's a combination of both. I think, you know, you've seen us get out of a few of the pension markets because we found that it wasn't worth the effort that we were putting into it. And so it's probably gonna see us very much focused in a few select areas on the retirement side, but then leveraging that brand and capabilities to have broader global asset management capabilities on top of that.
I had one more on international, which is: You have a longer-term margin target of 34% to 38%, and I think you're around 32% now. What are the key reasons you expect margin expansion?
Yeah. I think at its growth in China-
Right
... and it's continued growth in Brazil. Those tend to be higher-margin products, but the AUM decline in China has had pretty significant impacts on margin, just because of the fixed cost and the scale there. So I think as we grow those, that will help drive the continual expansion of margins.
... Got it. In moving over to the US insurance businesses. So in the life insurance business, you fully shifted to the business market?
Yeah.
Which is probably a little less familiar to people.
Yeah.
Can you talk about, you know, what you like about that market? You know, are the returns better than your legacy in force? And how has that overall transition gone?
Yeah. So, if you would've looked at our life insurance business, again, on the more of the pure individual side, prior to our exit of the retail life, we were trying to meet the needs of retail customers, business owner customers, and in some situations, employer customers. For example, we use life insurance to fund non-qualified, deferred comp retirement. What we were finding is, the retail life had become much more commoditized. Really, you're competing on price, you're competing on underwriting requirements, versus really being able to differentiate. And so we made the... You know, that was- that's what-- how we started.
So it was a difficult decision to exit that, but we really felt our ability to focus and differentiate and meet the returns that our shareholders and we desire, was much stronger in the business and business owner market. So again, some of those solutions are very much offered to the employer, but many of those offerings are being offered to a business owner. So a couple examples would be, you know, if Ryan and I owned a business, I'm older than him, I'm getting ready to retire, Ryan wants to buy out the business, we can use life insurance to help fund that succession planning of the business. And so the good news is, we have seen the advantage of that focus.
We thought it might take three to four years to replicate the lost sales in retail, and I think it took about 12 to 18 months. And what we're hearing from our distributors are: "I have 20 companies I can use to put retail life with. You're my top provider of solutions when I think of the business owner and employer." So our ability to differentiate, and really, you're not talking about price, you're not talking about underwriting, you're talking about a solution, which then allows the returns over time to be higher as we think about the value add that we can bring to that customer base. It also ties very much into our SMB franchise across the enterprise, so the connectivity to the group benefits business, the retirement business, is much stronger than it was in the past.
Are there many other companies that focus on the business market? I don't personally hear a lot from other companies I-
Yeah
... I follow.
You know, I'd say their products get used for the market, but they're not focusing-
Okay
... their development on that market.
Got it. Want to shift to Specialty benefits. So, I mean, you guys have very consistently hit your targets in this business of 7% to 10% premium-
Yeah
... and fee growth and 12% to 16% margins. So it's like, it's admittedly, it's almost hard to even know what to ask. But maybe just what... Like, what-- how do you feel-- what do you think differentiates your group benefits business from maybe the broader market, and what are the key risks to continuing to achieve these metrics?
Yeah. So I think if you look at our premium, compared to our peers, it's probably 200 to 400 basis points above what the rest of the market has been able to deliver. And then margin also shows a premium as well, but probably more important, that consistency. And it really, I think, comes back to the fact that we are solely focused on the small to medium-sized business market. Our average customer is forty employees. Most of those customers don't have a sophisticated HR department. They might not even have a head of HR. And so our ability to design very simplified products, that has the technology, the distribution, and the service that is built for that market, has been, something that has been very important to our growth.
There's a lot of new market that's created, so we're not just, you know, taking business away from other companies. We're actually getting employers that are thinking of offering these products for the first time. And again, that helps to drive growth as well. Again, we're dental, life, disability, but then we've added a fuller suite of supplemental products, so accident, critical illness, supplemental health. Paid family medical leave would be another one that we've added. And so really, it's about how do we obtain customers and then grow those customers. And so one of the things I think that's different is, for every customer we have, they on average have three products with us within that group benefit suite.
You know, that's probably up over 10% in the last year, as we continue to not cross-sell and think of those broader solution sets. We're also able to reprice those much more frequently than cases in the small, medium and large case. Almost, you know, 80% to 90% of our business is annual renewable. So when we start to see some claim either outperformance or underperformance, we can reflect that in the prices and have more stable rates over time, and I think that's been a differentiator as well. From a risk perspective, you know, it's not a risk that's unique for us, and actually, we find it more resilient in the small case market, but if you have broad-based unemployment decline, that is gonna have some impact on your premium growth.
And we did see that back in 2008, 2009. But, you know, other than that, I feel really good about our capabilities and our ability to continue to have that strong performance.
... How about, how about on the, sometimes there's thought of, you know, a worse economy also affecting claims, but it's not consistent. Is your view that that would not likely have much of an impact, and it's mostly just the top line?
I think it's more the top line. I think where you've seen that in the past has been really disability claim related. You know, I think all carriers, such as us, have gotten much better with our claim management so that, you know, you're not having a negative impact. So I don't think it'd be as much on the claim side. I think it'd be more on the top line.
Are there any other capabilities that you feel like you want to add to this business, or do you have what you really need? And then probably somewhat related to that, I assume the answer to this is you want to stick with your core market-
Yeah.
- but I guess to what, have you ever considered going a little bit upmarket to expand the addressable size of the business?
Yeah, I think we'll probably talk a little bit more about that in Investor Day. I think we feel really good about our product set. I think we are now seeing potentially the ability to, you know, where historically we've probably been the strongest on, say, the under 50 life. How do we make sure we're stretching that a little bit? So, you know, it's not saying we're gonna go after large or jumbo, but could we be more competitive in the 100 to 250 market, and how do we take advantage of that? It's probably been less a capability issue, but more how do you make sure you do that in a way that's profitable and additive to your margin, and leverage those strong capabilities that we have in the small market.
I think there'll be a little bit of extension to a slightly larger cases, but I do feel good about the capabilities and the product set that we have today.
And shifting to capital, can you give an update on how your free cash flow has developed throughout the year?
Sure.
You know, update us on your full year expectations and then, what your key capital deployment priorities are.
Yeah. So again, I feel really good about our ability to meet our 75% to 85% free cash flow, but also deliver on both our dividend payout as well as our share buyback plans that we went into the year. Again, our priorities really are about 15% to 25% goes back to fund organic growth, and then beyond that, it's about half share buybacks and half dividends. We really have targeted a 40% dividend payout ratio. We picked that ratio because it really reflected that we are a hybrid company. Insurance companies tend to have lower payout ratios. Asset management companies tend to have higher, but we have been able to have stable dividends as well.
We are fortunate that we've been able to grow that dividend the last five quarters after the divestitures of some of our businesses, and continue to see a path to continuing to grow that, so our yield looks very attractive relative to our peers, and the ability to continue to grow that will be there as well, so again, I think we're on path for a number the CFO would know, that the COO does not know. But you know, again, probably about $1.5 to $1.8 billion, and then that's split between dividends and share buybacks.
I guess just one on M and A. You, it seems like it's been kind of somewhat de-emphasized in your priorities in the last few years. But there is consolidation-
Yeah
particularly in the 401(k) industry. What would be your potential interest in M&A? How are you thinking about it?
Yeah. So we've, you know, earmarked kind of 0 to 10% of annual free cash flow to... That could go toward M and A. We also have a very low leverage ratio at 2 to 22%, so you have other abilities to fund acquisitions as well. We did do a small acquisition early this year, where we bought an ESOP business that put us in the top provider of ESOP in the US, and is a great complement to the rest of our retirement. And so again, small, modest, but I think on the front foot of finding properties that are strategic, meet our financial objectives, and ultimately see long prospects for growth. If it's just scale play, you know, I think we would look at any probably group benefits and retirement opportunity in play.
But acquisitions are hard, right? And so I think you'd have to get other capabilities or other, strategic advantages that you could apply across, your broader base versus an entire scale play. And then I do think the other place we might look for is continuing on the asset management side. But where we are interested in, everyone's interested in, which is really private capabilities. And so again, we'll scan the market, we'll see if something's there. If we don't see it, we've actually pivoted to more organic build, whether it's building that from the ground up or doing talent, acquisition to build capabilities as well.
So, we will be inquisitive about acquisitions, but I'd say it has a pretty high bar strategically and financially relative to organic growth.
Before we end, I wanted to just open it, see if there's any questions in the audience.