Principal Financial Group Inc. NYSE:PFG

Transcription

1 CONTENTS CALL PARTICIPANTS 2 PRESENTATION 3 QUESTION AND ANSWER 8 Principal Financial Group Inc. NYSE:PFG FQ Earnings Call Transcripts Friday, January 30, :00 PM GMT... S&P Capital IQ Estimates -FQ FQ FY FY CONSENSUS ACTUAL SURPRISE CONSENSUS CONSENSUS ACTUAL SURPRISE CONSENSUS EPS Normalized Revenue (mm) Currency: USD Consensus as of Jan :53 PM GMT - EPS NORMALIZED - CONSENSUS ACTUAL SURPRISE FQ % FQ % FQ %

2 PRINCIPAL FINANCIAL GROUP INC. FQ EARNINGS CALL JAN 30, 2015 FQ %

3 Call Participants... EXECUTIVES Daniel J. Houston President, Chief Operating Officer and Director Sean Dargan Macquarie Research Seth Weiss BofA Merrill Lynch, Research Division James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management John Egan Vice President of Investor Relations Chairman, Chief Executive Officer, Chairman of Executive Committee, Chairman of The Principal Life and Chief Executive Officer Steven D. Schwartz Raymond James & Associates, Inc., Research Division Yaron Kinar Deutsche Bank AG, Research Division Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President Timothy Mark Dunbar Executive Director, Senior Vice President, Chief Investment Officer, and Chairman of Investment Committee ANALYSTS Jamminder S. Bhullar JP Morgan Chase & Co, Research Division John M. Nadel Sterne Agee & Leach Inc., Research Division Ryan Krueger Keefe, Bruyette, & Woods, Inc., Research Division 1

4 Presentation... Operator Good morning, and welcome to the Principal Financial Group Fourth Quarter 2014 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference call over to John Egan, Vice President of Investor Relations. John Egan Vice President of Investor Relations Thank you, and good morning. Welcome to the Principal Financial Group's Fourth Quarter Earnings Conference Call. As always, our earnings release, financial supplement and slides related to today's call are available on our website at Following a reading of the safe harbor provision, CEO, Larry Zimpleman; COO, Dan Houston; and CFO, Terry Lillis, will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A are Jim McCaughan, Principal Global Investors; Luis Valdés, Principal International; and Tim Dunbar, our Chief Investment Officer. Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risk and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent Annual Report on Form 10-K and quarterly report on Form 10-Q filed by the company with the Securities and Exchange Commission. Before we get to the prepared remarks, I'd like to remind you of an upcoming investor event in Santiago, Chile on March 10 and 11. Executives from our Latin American business will provide an update. This is a great opportunity to learn more about these businesses and we hope you can make it. Information can be found on our Investor Relations website. Now I'd like to turn the call over to Larry. Thanks, John, and welcome to everyone on the call. This morning I'll comment on 3 areas: First, I'll discuss 2014 results; second, I'll provide an update on the execution of our strategy; and I'll close with some comments on capital management. I'll then turn the call over to our newly appointed President and Chief Operating Officer, Dan Houston, for some comments on key growth metrics for 2014, followed by Terry, with his normal CFO report was an outstanding year for the Principal, with record total company operating earnings of $1.3 billion, a 24% increase over full year 2013 results. Full year net income was $1.1 billion, a 26% increase over Perhaps even more impressive than the record total company operating earnings is that each of our 4 operating segments had record earnings for the year. Our ability to achieve the strong results while still facing continued macroeconomic volatility reflects our scale in each business segment, the strength of our diversified business model and the ongoing momentum in our businesses. Since 2009, we've grown earnings per share at a compounded annual growth rate of 15%. We've done that predominantly through operating earnings growth, which drives a long-term increase in shareholder value and not relying on share buybacks to increase earnings per share, which can only have an impact for a few years. In addition, 2/3 of our earnings are now generated from our fee-based businesses compared to roughly half, 5 years ago. Our strong financial position has created a great foundation from which to grow for years to come. Total company net cash flows of $18 billion for the year contributed to record assets under management of $519 billion, which increased 7% over 2013, despite a $14 billion negative impact from foreign exchange rates. These outstanding results position 2

5 us going into 2015 with a much higher asset base from which to continue to grow revenue and operating earnings even during periods of macroeconomic volatility. Next, I'll comment briefly on the long-term power of our strategy and some positive developments we see contributing to our growing momentum. Though we refined and evolved our strategy over time to remain competitive and take advantage of longterm growth opportunities, we've never wavered from our core goal of helping individuals around the world achieve financial security. Our strategy was built around 3 core trends that today are more relevant than ever: First, aging populations around the world; second, financially constrained employers who want to provide affordable and attractive benefits to attract and retain global talent; and finally, financially constrained governments that can no longer support government provider retirement programs causing individuals to look to their own resources for financial security. Across the globe, we've achieved a market leadership position that enables us to meet the needs of individuals looking to save, invest and protect their assets over the long term. Improving macroeconomic and employment conditions in the U.S. are making it easier for individuals to take control of their financial futures with help from the Principal. As the employment picture improves, more individuals can say for retirement and participate in benefit programs that protect their income. We're seeing this trend in Full Service Accumulation, where the number of people making a deferral increased 7% compared to a year ago. And Specialty Benefits had the highest ever full year in-group growth of 1.5% in Principal Funds continues to have great success, executing on a strategy focused on asset allocation, multi-manager funds that address risk, inflation and income needs. Principal Funds is now the 16th largest adviser-sold firm, up from 17th in In 2014, we launched 7 new funds as we continued to expand on our outcome-based solutions. Many of you had the opportunity to hear from several executives from Principal Global Investors at our Investor Event in November. Jim and his team discussed the increasing demand for tailored solutions among retirement, retail and institutional investors. Our diverse group of specialized investment boutiques, coupled with multi-asset expertise, positions us to customize solutions and capitalize on this trend. Principal International's recent announcement of our planned acquisition of AXA's Pension business in Hong Kong is 1 of 8 strategic acquisitions we've done since 2008, totaling over $2.5 billion in capital deployed. The acquisition, which we expect to close in the second half of 2015, will add scale to our current business, making us the fifth largest mandatory pension provider in Hong Kong. Importantly, the deal also includes a 15-year exclusive distribution agreement with AXA, which has 4,500 agents in Hong Kong. This gives us additional opportunities to grow market share as the mandatory and voluntary pension markets continue to grow. Finally, I'll provide an update on capital management for Our fee-based business model allows us to generate free cash flow and strategically deploy it to create long-term value for shareholders. We remain well positioned to deploy capital through a variety of options in addition to supporting organic growth. In 2015, we expect to deploy $800 million to $1 billion of capital beyond the capital needed for organic growth, including the $335 million already announced for the AXA acquisition. Last night, we announced a $0.36 per share common stock dividend payable in the first quarter, which is a 6% increase over the dividend paid in fourth quarter As a reminder, our 2014 common stock dividend was up 31% over Additionally, the merger and acquisition pipeline remains active with opportunities to further enhance our global retirement and investment management platform. We will continue to look for strategic acquisitions as a good way to build long-term value for shareholders. In closing, I remain confident in our ability to deliver sustainable, profitable growth in 2015 and beyond. The Principal is in a strong competitive position with proven success and a unique business model that positions us to provide long-term value for our customers and our shareholders. Now I will turn the call over to Dan Houston. Dan's 30-year career and proven leadership give him a clear view of where the company will go in the future. I look forward to working with him in his new capacity. Dan? Daniel J. Houston 3

6 President, Chief Operating Officer and Director Thanks, Larry. I'm excited about my expanded role and look forward to working with the teams on continued implementation of our strategy. The fundamentals of our business remained strong and we continue to build our leading positions, providing continued momentum going forward. Following are some of the key growth metrics that contributed to the outstanding results in 2014: Full Service Accumulation full year sales were $8.7 billion. We continue to focus on striking the right balance of growth and profitability in this business. We have fewer large plan sales in 2014 than we've had in previous years, which led to a decrease in transfer deposits and net cash flows for the full year. To demonstrate that point, net cash flows from our small to midsize markets were 2% of beginning year account values in that space, in line with our expectations, with strong investment performance and key differentiators, like Principal Total Retirement Suite, we remain confident in our ongoing competitiveness of the Full Service Accumulation business. Principal Funds had a record sales of $20 billion in 2014 and the fourth quarter was the 20th consecutive quarter of positive net cash flows. At 8% of beginning of year account values, Principal Funds' full year net cash flows were more than 3x the industry average. Principal Global Investors had record total assets under management of $314 billion as of year end, driven by continuous strong investment performance and full year total net cash flows of $2.4 billion. Principal International reported assets under management of $115 billion at year end. Record full year net cash flows of $13 billion were up 54% over 2013 and 68% on a local currency basis. We continue to see momentum build in our Asian businesses with 15% of full year net cash flows from this region, up from 6% in the We're also executing on our full product suite strategy in Chile, with full year voluntary net cash flows doubling from In Individual Life, the business market strategy continues to be a differentiator for us with 2014 being the second highest year of nonqualified deferred compensation sales. Specialty Benefits had a record full year sales of nearly $300 million, up 10% over These strong sales, combined with strong persistency, drove premium and fees up 7% over Our solutions remained very attractive in the small and midsize employer market. With a competitive environment that is constantly changing, we remain laser-focused on meeting evolving customer needs and demands and ways that differentiate us in the marketplace. Top tier investment performance is clearly critical. 71% of our rated mutual funds have a 4- or 5-star Morningstar rating. And as Slide 5 shows, at least 85% of Principal's investment options were in the top half of Morningstar rankings on a 1-, 3- and 5-year basis at quarter end. Additionally, 2 of our Mandatory Provident Funds in Hong Kong were recently awarded the Gold Rating by the MPF rating agency. Exceptional service matters as well. In 2014, we retained 95% of Full Service Accumulation customers, our second best year on record, and Specialty Benefits division retention rate in 2014 were the highest they've been since In addition, we continue to garner recognition for our Latin American businesses. Cuprum received customer satisfaction and investment performance recognition from the Chilean pension regulator throughout And BrazilPrev, our joint venture with Banco do Brasil, was once again recognized as the most admired private pension company in Brazil. The last point I'll highlight is the importance of attracting and retaining best-in-class employees who have specialized expertise. During the fourth quarter, the Principal earned the top spot in its category in Pension & Investments Annual survey of the Best Places to Work in Money Management for third year in a row. We view this as a significant accomplishment and one that evidences our ability to attract and retain top investment talent. Terry? Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President 4

7 Thanks, Dan. This morning, I'll focus my comments on: Operating earnings for the quarter and full year; net income, including performance in the investment portfolio; and I'll close with an update on capital deployment. The fourth quarter was a strong end to an outstanding year. Total company operating earnings were $324 million, up 13% over the prior year quarter. Operating earnings per share of $1.09 were up 14% increase over fourth quarter 2013 results. Moving to Slide 6, you'll see that we normalized fourth quarter 2014 earnings by $0.02 or onetime tax items in our Corporate segment. On a normalized basis, earnings per share were $1.07, up 11% over the year ago quarter. We also removed the 1- month lag from reporting of Cuprum results during the quarter. The earnings from the additional month were reduced by lowerthan-expected encaje returns and additional investments in the business to support future growth. For the year, return on equity, excluding AOCI, was 14.2%. This is a 210-basis-point improvement from a year ago. Organic growth contributed 150 basis points of the increase as operating earnings growth outpaced mean equity growth of 6%. Our current return on equity, excluding AOCI, includes exchange rate movements in earnings, but not in the equity calculations. If, similar to other companies with large international operations, we adjusted the average equity for the exchange rate movements, the return on equity would be 15.1%. Now I'll discuss business unit results, starting on Slide 7, with the accumulation businesses within Retirement and Investor Services. Operating earnings of $168 million were up 12% over the adjusted fourth quarter 2013 results. Net revenue was up 5% over the prior year quarter and up 10% for the year. Full year pretax return on net revenue improved to 34%. Full Service Accumulation operating earnings were $106 million, up 14% increase over the year ago quarter. For the year, net revenue grew 9% and the pretax return on net revenue was 35%. As previously discussed, we expect margins come down in 2015 due to expense growth outpacing net revenue growth, primarily due to investments in the business. In addition, 2014 benefited from higher-than-expected variable investment income. Full Service Accumulation had net outflows for the quarter of $850 million. Quarterly results can be lumpy, so it's important to focus on the longer term. For the full year, while dollars of lapses were up 6% in 2014 due to account value growth, the withdrawal rate was 100 basis points lower than the prior year. Importantly, as we look at all key metrics for Full Service Accumulation, it's clear the business remained strong and competitive. Recurring deposits grew 7% in 2014 and we added nearly 1,000 net new plans and 135,000 net new participants. In addition, as a result of strong investment performance, customers and advisers directed approximately 75% of the 2014 new sale assets into Principal-branded investments. Principal Funds fourth quarter operating earnings were up 20% from the year ago quarter to $26 million. For the full year, operating earnings surpassed $100 million for the first time, up 30% over Principal Funds' sales were the second highest quarterly result ever at $5.6 billion. Individual Annuity operating earnings were $29 million for the quarter. Increased fee revenue on our variable annuity business due to market appreciation continues to offset spread compression in our fixed deferred block of business. Slide 8 highlights the guaranteed businesses within Retirement and Investor Services. Fourth quarter operating earnings of $27 million were up 4% over fourth quarter 2013 results. Net revenue was up 3% over the prior year quarter and up 8% for the year. The 2014 pretax return on net revenue improved to 82%. Full service payout fourth quarter sales of $464 million were higher than full year 2013 sales, as we continue to see opportunities in the small to midsized pension closeout market. Turning to Slide 9, Principal Global Investors' quarterly operating earnings were a record $36 million. Earnings benefited this quarter from seasonal performance fees and an increased stake in Columbus Circle Investors. The full year pretax margin increased to 26.5% as we continue to improve margins by gaining scale and providing investment options that are in demand. 5

8 As a reminder, earnings in Principal Global Investors are impacted by seasonality with first quarter typically the lowest due to the timing of certain expenses and fourth quarter typically the highest due to performance fees. Slide 10 shows quarterly operating earnings for Principal International of $63 million. As I mentioned earlier, we removed the month reporting lag for Cuprum, which was reduced by lower-than-expected encaje returns as well as additional marketingrelated expenses. Principal International continues to perform well on a local basis. Operating earnings were up 16% over the prior year quarter after adjusting for foreign exchange rates. For the year, combined net revenue was up 14% on a reported basis and up 24% on a local currency basis. Combined pretax return on net revenue was 51% for the year. As shown on Slide 11, Individual Life operating earnings were $28 million for the quarter. Claims experience for the quarter was in line with expectations. We mentioned on our previous call that we are doing an in-depth review of the recent elevated claims experience. The analysis reinforced our ongoing belief that the elevated claims experienced in recent quarters was random fluctuation, associated with risk-based business and not a systemic issue. Moving to Slide 12. Specialty Benefits' operating earnings of $28 million were up 3% from the year ago quarter. The overall loss ratio for the quarter remained favorable at 65%, better than our expected range. For the full year, premium and fees were up 7% and full year pretax operating margin was 11%. Seasonality also impacts operating earnings in U.S. insurance solutions with the highest results typically in the fourth quarter and the lowest in the first quarter. The Corporate segment reported operating losses for the quarter of $26 million, better than our forecasted range of $32 million to $37 million of operating losses. Results this quarter benefited from some onetime tax adjustments in the Corporate segment. For the quarter, total company net income was $270 million, including realized capital losses of $53 million. Net credit-related losses of $8 million were a strong result, improving 67% from the year ago quarter. Net income was negatively impacted by $44 million due to the impairment of Liongate, our hedge fund of funds boutique during the quarter. Full year credit-related losses were $56 million, a 33% improvement over 2013 results. Unrealized gains were $2.9 billion at quarter end. Due to our asset/liability management expertise and strong liquidity, changes in unrealized gains or losses due to interest rate movements do not result in forced asset sales in periods of stress. In addition, our predominantly fee-based business model limits our sensitivity to interest rate movements. As outlined in Slide 13, our approach to capital deployment is balanced and focused on increasing long-term value for shareholders. We deployed $855 million of capital in This is more than 3/4 of our net income for the year, demonstrating our ability to generate capital and strategically deploy it. The full year common stock dividend was $1.28. This is a 31% increase over full year 2013 and we continue to increase our payout ratio. Our capital deployment in 2014 also included, $200 million of share repurchase, $100 million surplus note redemption and $180 million increase in our ownership percentage of Columbus Circle Investors. In 2015, we expect to deploy $800 million to $1 billion of capital in a strategic and balanced manner. In closing, while macroeconomic factors, such as the strengthening U.S. dollar and low interest rates are providing near-term pressure, we remain confident that our diversified business model positions us well for future growth across various macroeconomic environments. This concludes our prepared remarks. Operator, please open the call for questions. 6

9 Question and Answer... Operator [Operator Instructions] Our first question comes from the line of Sean Dargan with Macquarie. Sean Dargan Macquarie Research Terry, I have a question about Slide 6 in that the normalized items. If I add back $0.02 per share for tax adjustments, it still implies a tax rate in the high teens, which is below your 2015 guidance of 21% to 23%. Can you just discuss what was going on with the tax rate? And if the 2015 guidance still stands? Sean, this is Larry. I'll just have Terry take that. Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President You're absolutely right, it's a little bit lower than what we had anticipated in our outlook call. We still feel that the 20% to 22% is good effective rate -- tax rate for the overall organization. However, if you look at what happened at the early part of this year, we had some true-ups in prior years. So if you were to adjust for that, you'd be at the -- around closer to 20% for the year. So we still think that, that's a very good rate and taking into consideration, the adjustments that we had in the fourth quarter in the Corporate segment. Sean Dargan Macquarie Research Okay. And then if I could just ask one follow-up about Liongate, I'm just wondering what the thought process in impairing this was. And considering that you seem committed to doing further M&A to deploying capital in that manner, how can we have confidence that we're not going to see more impairments in these acquisitions you're making? Sure, this is Larry, Sean, I'll make a couple of general comments and then have Jim comment specifically as it relates to Liongate. First of all, again, if you go back and look over the longer course of history, I think that our success with our asset management boutique acquisitions has been really second to none. For example, we mentioned last quarter, the additional purchase of an interest from 70% to 95% in Columbus Circle Investors. And that's a boutique that we've grown from under $4 billion to $16 billion over the point in time that we've had it. I could give you similar statistics around spectrum and other asset management boutiques. So the challenge as it relates to goodwill often is actually in the early years after you acquire a boutique because if the macro environment changes, the way accounting rules work, you run closer to the edge, so to speak. And in fact, the hedge fund of funds business has been a bit of a troubled space in recent months, as there's been a lot of volatility and kind of a lot of churning around in the hedge funds space. So again, my emphasis here, Sean, would be to say that, I think, Jim and his team have done an outstanding job over the longer term and Liongate is actually more of the one off circumstance. So I'll ask Jim to cover that for you now. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management 7

10 Yes, Sean. As Larry said, this is a portfolio. And the IRR on the portfolio of boutiques ranges most -- almost all of them from low teens to high teens. So it's been one of the best ways of deploying capital that we have had available to us. The hedge fund of funds space has had headwinds, as Larry described. And that's -- that together, with some performance glitches in 2013, which since have been fixed, the performance since then is pretty strong, led to some losses of assets and revenues. And that's what led us to impair this particular asset. In terms of the process of impairment, thinking of how this might affect other boutiques, this one is -- it's just over 50% stake and so it was accounted for on the equity method rather than consolidated. That means from an impairment, it's looked at at the legal entity level and that was really the background to the impairment we had on Liongate. With the growth in all the other boutiques and with -- the only other equity method boutique being Finisterre, which actually has grown very strongly has almost doubled in assets in the 3 years we've been associated with them. So I think I'm pretty confident that the strategy remains sound, and we don't see any other impairments on the horizon on the evidence at the moment. Operator Your next question comes from the line of Yaron Kinar with Deutsche Bank. Yaron Kinar Deutsche Bank AG, Research Division I want to go back to the comments on withdrawals and sales in FSA, and maybe got a little more color as to what's driving -- what seems to be a little bit of weakness there, at least so seasonally speaking. I understand there is more pressure from the large showcase market. But at the end of the day, I thought that pressure was already there in the last few quarters. So I was a little surprised to see numbers maybe a little bit below expectation. Yaron, this is Larry. I'll make a few comments and again, I'm sure Dan will want to add. So -- first of all, as it relates to fourth quarter, recognize that sales results in fourth quarter for FSA were actually quite good, they were at $2.8 billion, bringing the year-to-date to $8.7 billion. Now while that $8.7 billion is a little bit below what we might have expected going into the year, I would also say that there has been, as a general perspective, there has been a little less money moving in the marketplace. And I can tell you, as somebody who has been involved in the Full Service Accumulation business for more than 30 years, we'll just leave it at that, this is something that you always see. When you have a very strong equity market, like we had in 2013, there will be fewer assets in motion. It just inevitably turns out that way. I can't -- I think, it's more of a psychological factor among plan sponsors and advisers than anything else. So on the flip side, 2014 was the second best year for retention of existing Full Service Accumulation cases that we've ever had. So you do have sort of parallel dynamics that have been kind of going on within the FSA market. I think, it's my judgment and Dan can offer his opinion here in a sec, it's my judgment, that actually, the kind of competitive environment and the kind of pricing environment has actually been more rational, more rational in 2014 than it has been in prior periods. I think in prior periods, coming out of the financial crisis, everybody was sort of scrambling, given the depth and pain of the financial crisis, everybody was kind of scrambling to rebuild their retirement business. And frankly, we were part of that as well. But I think post 2013 and '14, things have now sort of settled down and the dynamics of the Full Service Accumulation business have sort of gone back to normal. We're seeing salary growth, we're seeing new participants added, we're seeing increased deferral rates. So the normal factors that drive FSA revenue increases are more solidly in place. So I wouldn't want you to get too distracted by a quarter or a year. I think as we said in our comments, all the elements of HELP are very, very strong in FSA. So with that, I'll ask Dan to comment. Daniel J. Houston President, Chief Operating Officer and Director Yes, Larry, I'll give comments and -- I'm sorry... Yaron Kinar Deutsche Bank AG, Research Division 8

11 And maybe just before that, just to clarify, when I talk about weak sales, I'm talking for fourth quarter not relative to other quarters of the year, so seasonally adjusted. Daniel J. Houston President, Chief Operating Officer and Director Yes, I would say the fourth quarter sales actually relatively strong compared to a year ago. I think you can identify this to -- identify a couple of areas. One is that for the full year, we ended up having 11 large plans over $100 million a year ago versus 6 this year. So again, disciplined underwriting on those plans. The other area where we saw some withdrawals was relative to large M&A where we may have had a smaller piece of the pie, the acquiring company was maybe 2x or 3x our size. Larry spoke specifically to the issue of second best retention year ever. Recurring deposits of 10%, we had good matching contributions, strong profit sharing contributions, new hires are in that mix. Whenever you can hold withdrawals to 6% on a 12% increase in account values and still retain your in force business, and be more selective on choosing new plans. I think it speaks to the strength of the product line. And lastly, as we said in the script, we did have net cash flow for that SMB market right at 2%, right? Well within the range and that -- where the shortfall really falls is in that large $100 million market which we know is volatile. Last comment I'd make is you could sell 2 or 3 large plans in the fourth quarter of this year and we probably wouldn't be sitting here today having the conversation about sales or net cash flow. And so it really does boil down to being selective and more particular about the plans we want to underwrite. Hopefully, that helps. Yaron Kinar Deutsche Bank AG, Research Division Yes, it does. And then my second question, probably best start for Terry. Just looking at the 10-year yields today, about 100 basis points below of the year-end assumption that you came out with at the time of the outlook, and I realize during the prepared commentary, you said that overall the fee business is quite sensitive to rates, but at the end of the day, there is some sensitivity. Maybe you can help us think about the sensitivity, what's the balance sheet and income statement? Okay, I'll have Terry going to make some comments. Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President Yes. As we've talked about in the past, the sensitivity that the Principal has to the lower interest rate environment is probably a little bit less than what we've seen in some of our insurance peers because of the strong asset/liability management. As you said, our fee-based businesses are 60% to 65% of our earnings. Albeit, there are some businesses that are affected by this in the Life business, or spread businesses, it does have a little bit of a drag as the interest rate environment goes down. What we've seen on the 10-year treasury, although the 10-year treasury is not necessarily the only point that we'd look at it, it's across the yield curve. And so as that yield curve flattens out, it will have some other impact on us as well. So I guess, I would say that we say that the drag that we'd have from a current interest rate environment, maybe in that little less than 1% or so in terms of earnings for next year, in Now that being said, the other part of that is the impact that it would have on sales. As you can see, it could have some drag on future sales in the fixed deferred annuity area, which we've considered somewhat opportunistic. But one of the things that's encumbered to that is our Full Service Payout business that taking over that closeout business. We actually had our highest quarter ever in the fourth quarter with $464 million of earnings. And so that's an intra-sensitive business as well. So we do see that the low-interest rate environment will have an impact on us, albeit it'll be a little bit lower than what you would see in some of our insurance peers. Operator Your next question comes from the line of Ryan Krueger with KBW. Ryan Krueger Keefe, Bruyette, & Woods, Inc., Research Division 9

12 First, on FSA, I was hoping to clarify one thing. It looks like the rate of transfer deposits relative to sales was lower than normal. Was there some aspect of timing where some sales and hit transfer deposits that you'd normally expect this quarter? Yes. Ryan, this is Larry. There was, so I'll have Dan cover that. Daniel J. Houston President, Chief Operating Officer and Director Yes, Ryan, good catch. Yes, we did have a sale that was reported late in the fourth quarter 2014 here. It will fund in So as you point out, it's just a little bit lumpy, it's just a matter of which quarter it fell into. Ryan Krueger Keefe, Bruyette, & Woods, Inc., Research Division Can you quantify how big that sale was? Daniel J. Houston President, Chief Operating Officer and Director I don't think it's -- I'd probably just as soon not try to quantify that at this point in time. But it was a decent size plan, well in excess of $100 million. Yes. And the other one I would say, Ryan, is that I think, again, when you're interpreting, therefore, when people kind of try to interpret and to some degree over interpret the net cash flow in the business like Full Service Accumulation. I mean, literally, it can be the decision on plan sponsors. Do I send Principal their money on the transfer deposit on December 28, versus January 2. And that can be the difference in whether net cash flow is negative or positive. So that's why again, the real way to think about this business is to look at and on sort of either at trailing 12-month basis or some sort of calendar year basis and not try to assess whether some trend in a particular quarter represents a new trend. I would caution anyone against trying to do that for this kind of a business. Ryan Krueger Keefe, Bruyette, & Woods, Inc., Research Division Okay, got it. And then I wanted to revisit the preferred stock that you can call in mid-2015, which seems to be pretty likely to be a good economic decision to do that. But was curious how you're thinking about the potential funding for doing that? Yes, I may be ask Tim. Tim not only oversees the investment portfolio, but also heads up capital markets, and works with Terry on all of our capital structures. So I'm going to have Tim cover that for you. Timothy Mark Dunbar Executive Director, Senior Vice President, Chief Investment Officer, and Chairman of Investment Committee Yes, right now we are reviewing plans for the preferred securities that as you said, are open to prepayment or open to payment in mid-year. We look at that just in terms of what the after-tax cost to the organization is and different ways that we can fund that. And so while we haven't made our plan specifically for those yet, we're looking at that in view that we have a fair amount of 10

13 flexibility. We don't need to call them, but we certainly can if we want to. Ryan Krueger Keefe, Bruyette, & Woods, Inc., Research Division And am I correct that in your outlook guidance that, that did not contemplate doing anything with those? Timothy Mark Dunbar Executive Director, Senior Vice President, Chief Investment Officer, and Chairman of Investment Committee That is correct, we did not contemplate paying those off. Ryan, this is Larry, just to add a really quick comment to that. Again, the existence of preferred stock in our capital structure is really goes back again to the days when we were far more of an insurance company than a sort of investment management company that we are today. And I think when you look at capital structures from those that are asset management or investment management, you wouldn't see -- typically wouldn't see preferred stock in their capital structure. So that just to note that and that's another part of our thinking as we have that opportunity to take those out. Operator Our next question comes from the line of Seth Weiss with Bank of America. Seth Weiss BofA Merrill Lynch, Research Division My question is for Dan, and you commented about the strong fund flows in Principal Funds 3x industry average, I believe, for How long do you think that pace could continue for, in terms of outperformance that is? Sure, Seth, this is Larry. Again -- I'm sure Dan will want to add comments. Again, I -- the job that has been done by our team around the mutual fund business over the time since we bought Washington Mutual in 2007 has been really, really extraordinary. And I think we're now in our 20th quarter, maybe this is our 22nd quarter of positive net cash flows. And what's really been interesting is to see that we've actually been -- maybe not only continuing to outperform but maybe increasing a level of outperformance. And it's a combination of really 2 things, one is, I think, it's great product development. And in general, again, we commented on our outcome-based strategy for our retail funds. And secondly, of course, it's based on having outstanding investment performance, which is predominantly for -- to the credit of Principal Global Investors. So we do have a number of new product launches, we've launched 7 new products in We're going to launch a number of new products in So I would have a full expectation for a sales in 2015 that we're going to see, at least, a decent increase in sales, albeit, when you get to the level of $20 billion sales, sometimes it can be a little bit difficult to put up big increases against that. But I certainly have every expectation that we're going to continue to see very strong flows there and having put enough pressure on Dan, I'll let him comment. Daniel J. Houston President, Chief Operating Officer and Director Yes, I share your enthusiasm, Larry, we'll have a strong lineup. And is Larry pointed out -- we did have a very strong year for net cash flow, that's it is 20 consecutive quarters. What's probably most exciting to me about the success we enjoyed this past year, it wasn't one fund, it wasn't any one asset class. So it was collectively across the board with real estate, fixed income, equities, asset allocations and the hybrids and that is with the existing portfolio. And again, Nora Everett and her team have worked very closely with Jim and his team to develop this outcomes-oriented strategy, solving for problems related to income and growth 11

14 and waiting in the wings inflation solutions. This is very a popular among advisers, they look at this as being very favorable in terms of bringing to their customers, which is why you noticed that maybe we got one notch among the advisers-sold funds. As Larry point out, we've got 7 new products rolled out throughout 2014 across real estate, emerging market, credit opportunities, additional lifetime hybrid as well as small-company stock. So again, across the whole range of asset classes, and so I remain very enthusiastic about our ability to grow our funds business. And I know Jim wants to add a comment too. So... James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management Yes, this is really just a comment about what happens next since you're asking why have we been so strong and where does it go next. I would point out that in the last year or 2, the market has had very little appetite for active equity strategies in general. We have been in that time, developed, what I would argue, is one of the best ranges of active equity strategies in the industry. So as appetite changes, perhaps towards emerging equities at some point or towards Small and MidCap equities, I think we have a very good range to actually pick up the momentum rather than lose it as client attitudes and preferences shift. I hope that helps. Seth Weiss BofA Merrill Lynch, Research Division That's very helpful. And if I could just ask one question and then, the expense side of FSA. Margins are likely to come down in FSA as expense growth outpaces the net revenue growth. Can you give any granularity on that? And if this should be a little bit of a multi-year phenomenon? Or if we should just expect '15 to be a higher expense year and then level off from there? Well, again, I think, we spoke to that, Seth, a little bit, certainly, in the outlook call. And I will have Dan comment in a minute. I want to again, just take a step back and kind of remind everybody on the call about the high level of performance that is already embedded, if we're talking about a, sort of, 30% to 32% kind of a pretax return on revenue. That is in and of itself a really outstanding result when you think about it. I mean, that's again, the equivalent, if you were to put that in ROE, return on equity terms, I mean, that's an ROE that's in that mid- to high-30% range. And there is an upper limit, there is an upper limit as to how far you can drive margins. So I think that any of our shareholders would be very, very happy if we have of 5-, 10-, 15-, 20-year period where we can demonstrate a 30% to 32% return on net revenue over that period of time. That is simply outstanding performance, so probably can't be really matched by any other type of business within financial services. So that's just a sort of a background comment. And again, looking at trends from 2014 to 2015, or whatever, whatever, are going to be influenced by DAC and other things that are a bit variable and nonrecurring. So again, don't read too much into that, think broadly and more longer-term about the return that is coming out of that business. So Dan, you want to comment? Daniel J. Houston President, Chief Operating Officer and Director Yes, Seth think about FSA, I think it's probably one of our strongest areas for process improvement and driving cost out of the business and at the same time, maintaining strong customer service scores by both our advisers, participants and plan sponsors. Fourth quarter was a little bit lumpy, it had some expenses in there. When you parse it out, you find out if you take for 12

15 the quarter, comp and other less management fees, we're actually down by about 2%. So again, good expense management. When you look at the one-offs here and again, I do not view these as systemic. It's around some of the true-ups around DAC, some commission, printing, postage, security benefit, sales comp. We rolled out a new mobile application and promoted that. We had a new launch or a landing page for participant education, both launched in the latter half of 2014, which showed up as a little bit higher expense. But overall, as Larry points out, very, very expense minded and disciplined about making sure that we manage these very aggressively. We'll always have some higher variable costs as sales increase, you saw that in the mutual fund line, you also saw that in Specialty Benefits where you don't have the DAC-ing capabilities that we do in most of our Full Service Accumulation. Hopefully, that helps. Operator Your next question comes from the line of Jimmy Bhullar with JPMorgan. Jamminder S. Bhullar JP Morgan Chase & Co, Research Division So first question on the PGI business. The unaffiliated flows, I think, were negative this quarter and part of that might have been Columbus Circle. But maybe if you could just, Jim, could give us a little bit more detail on that? And then secondly on share buybacks, you outlined the $800 million to $1 billion in deployment goal. And I think your dividends, based on the present rate, are going to be close to $430 million or so this year. And then the AXA deal is $335 million. So it implies that what's left for deals and share buybacks is less than $250 million and then you've got the preferred stock potentially being called as well. So my question was you didn't buyback any stock in the fourth quarter, is it possible that you don't do any buybacks in 2015, if you do find any -- find additional deals and/or if you retire the preferred stock? Yes. So I'll try to give you a little bit of insight on the first one. I'll have Jim cover the unaffiliated, and then if Terry wants to or Tim wants to add something, they can certainly do that. First of all, I think on our second one, Jimmy, I mean, I think, I certainly -- first of all, I agree with all of your math. And so I think what you would expect for share buybacks is that's the specific question for Generally speaking, I think what you would expect would be and we've said this many, many, many times, our first priority is, in terms of share buybacks, is to try to make sure we cover the anti-dilutive portion. So we would do share buybacks, generally speaking, with the idea that it would, at least keep our share count flat and we gave outlook in early December on what we expected the share count to be. As I said in my comment, Jimmy, we are seeing, have been and continue to see more opportunities for the kind of M&A that we like, either within the asset management space, maybe within the international space, maybe within the retirement space, we're actually seeing more of that than we have seen in a very long time. And again, a lot of that is coming from the restructuring that is having to go on by some very, very large financial services companies as they, sort of, remake their strategy post the financial crisis. So I think it's in the interest of building long-term shareholder value for us to make sure that we're looking at every one of those opportunities and when we can make the very nice accretive acquisitions, like we think we will do with the AXA Hong Kong acquisition, we remain very, very interested in that. So I would expect again, kind of limited share buyback, certainly want to do the anti-dilutive. Whether we do anything beyond that, probably really will depend on our success kind of in the M&A space. And so with that, I'll let Jim comment on unaffiliated. James P. McCaughan Chief Executive Officer of Principal Global Investors and President of Global Asset Management In the quarter, the main negative on the unaffiliated flow was in our equity boutiques. If you add up Columbus Circle, Origin and Principal Global Equities, you had a net outflow of a bit over $1.5 billion. Most of that is client allocation away from active equity strategies, and particularly, active core equity strategies. There was one particular piece which you allude to in Columbus Circle, where about half of Columbus Circle's lost assets were related to a portfolio manager departure and, in fact, a hedge fund portfolio manager. And the clients were taking some really quite big profits that they've made over the last 2 or 3 years. Sometimes, you get a few hundred million flowing out with a big profit and it's hard to say that was bad for the clients, they're locking in profits. Our challenge is to find the next idea to make clients money with, so that's the outflows. In terms of the inflows, I'm delighted with, for example, Finisterre Capital, who just this week, got an award in London from the industry for the 13

16 Best Emerging Market Hedge Fund they're -- of the year. They're in emerging debt and they're seeing quite strong growth. Other high-yielding strategies, including Spectrum, with preferred post with high yield. Real estate has been a very much in demand area. So it's a balance of some pretty big outflows on the active equity side and some inflows elsewhere. I think if I were to sum up the year as a whole though, I would say that I'm very pleased with our new sales that were once again over $16 billion in these active specialty strategies for the non-affiliate business, very similar to the previous year. So sales are not the issue. I am a little disappointed or somewhat disappointed in our retention. It's fair that the clients take the money out of these, particularly, active core strategies. Our challenge and our management is very much on it, it to make sure that those same clients look at our high added value specialties. So we're making vigorous efforts to improve the net flows, and really the focus is on retention and making sure that those clients are coming out of active core strategies and see the interesting stuff in the high-performing things we're doing. Jamminder S. Bhullar JP Morgan Chase & Co, Research Division And Larry, just following up on your optimism about the M&A pipeline, can you just briefly discuss the businesses and regions that you're targeting and where you see the most opportunity? Sure, Jimmy. Well again, as I said, I think that we are -- there is opportunity in the U.S. But I think we are seeing more opportunity in asset management and in international. And the other thing that I would say, and by the way, within international, I think it is a little bit at the moment, I think, the trend has been, it's a little bit more in Asia. And again, this is often times coming much like the AXA acquisition, Jimmy, this is coming more from European financial services companies who are, as I said earlier, still sort of re-crafting their strategy post the financial crisis. And again, often, from the standpoint of pressure from regulators trying to kind of simplify their business model, which again can be -- which can be a benefit for us. So -- again, that's going to continue to be an opportunity and we're going to continue to prioritize that. The last thing I'll say is there is also, of course, the opportunity, Jimmy, that we can much as we did with Columbus Circle in terms of buying a bigger percentage of an asset management boutique, we also have potentially, the same opportunity with some of our other international joint ventures as well. So that's another one that sometimes we don't mention as much, but that's a great opportunity because these are already high-performing, highly profitable companies where the incremental return on capital is very, very high. So we also continue to look at that opportunity. Operator Your next question will come from the line of John Nadel with Sterne Agee. John M. Nadel Sterne Agee & Leach Inc., Research Division I had one quick follow-up for Terry. There was a question about the tax rate. And just thinking about the 21% to 23% range that, I think you provided in your outlook for I believe you mentioned in response, 20% to 22%, I just want to make sure that, that was a 2014 comment? Does that -- or has the outlook changed a little bit for the better? Terrance J. Lillis Chief Financial Officer, Chief Accounting Officer and Executive Vice President No, John. This is Terry. I think the 20% to 22% now is probably the run rate that we would see for '14 as well as going into '15. As you take an effective tax rate, a federal rate of 35%, to get down there, you have a benefit from some dividends what we receive, we also have equity method of accounting that has a play on that. We have tax-free investments, we also have foreign tax credits as well. And then the redeemable noncontrolling interest impact on our business, so that last one is what drove down that 1%, from that 21% to 23%. And that's somewhat volatile as we go into the year. Now as we talk about effective tax rate, each -- first quarter of each year, we have to true-up for what happens in the prior year. And that the -- and that's goes positive and negative adjustments to taxes. But we do adjust our accruals. So to the point that we're making earlier, the lower effective tax rate that we're seeing at this point in time, in large part, is due to a true-up positive, a lower tax rate, impact on -- from