Principal Financial Group Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.25.13 | About: Principal Financial (PFG)

Principal Financial Group (NYSE:PFG)

Q3 2013 Earnings Call

October 25, 2013 10:00 am ET

Executives

John Egan - Vice President of Investor Relations

Larry D. Zimpleman - Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Chairman of Principal Life, Chief Executive Officer of the Principal Life and President of Principal Life

Terrance J. Lillis - Chief Financial Officer and Senior Vice President

Luis E. Valdés - Chief Executive Officer of Principal International and President of Principal International

Daniel J. Houston - President of Retirement, Insurance & Financial Services

James P. McCaughan - Chief Executive Officer of Principal Global Investors and President of Principal Global Investors

Analysts

Randy Binner - FBR Capital Markets & Co., Research Division

Erik James Bass - Citigroup Inc, Research Division

Ryan Krueger - Dowling & Partners Securities, LLC

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Sean Dargan - Macquarie Research

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Operator

Good morning, and welcome to the Principal Financial Group Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to John Egan, Vice President of Investor Relations.

John Egan

Thank you, and good morning. Welcome to the Principal Financial Group's Third Quarter Earnings Conference Call.

As always, our earnings release, financial supplement and slides related to today's call are available on our website at www.principal.com/investor.

I'd like to point out that we made several enhancements to our financial supplement this quarter to better reflect the drivers of our earnings and to add clarity in comparing quarterly results.

Following a reading of the Safe Harbor provision, CEO, Larry Zimpleman; 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: Dan Houston, Retirement Investor Services and U.S. Insurance Solutions; Jim McCaughan, Principal Global Investors; Luis Valdes, 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 begin, I'd like to announce that our 2014 outlook call will be on December 9. We'll provide additional details as we get closer to the date. Now I'd like to turn the call over to Larry.

Larry D. Zimpleman

Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas. First, I'll discuss third quarter and year-to-date results. Second, I'll provide an update on the continued successful execution of our strategy, and I'll close with some comments on capital management.

As John mentioned, slides related to today's call are on our website. Slide 4 outlines the themes for the quarter.

The total company operating earnings for the quarter were $269 million, a 22% increase over an adjusted third quarter 2012. As a reminder, third quarter 2012 was negatively impacted by $79 million due to an actuarial assumption review.

The strong results this quarter, combined with the first half of the year, resulted in total company year-to-date operating earnings of $774 million, a 19% increase over the adjusted 2012 year-to-date results.

Return on equity, at 12%, is up from the year-ago quarter, as well as sequentially. As we said on our Investor Day last month, this is an important metric, and we continue to believe that we'll achieve an annual increase of 50 to 80 basis points, resulting in a 15% return on equity within the next few years. These remarkable results demonstrate the benefit of our diversified and durable business model.

Though macroeconomic challenges remain, such as continued low interest rates, the strengthening U.S. dollar and uncertainty in emerging markets, our unique business mix allows us to achieve consistent performance and a balance of profitability and growth.

In addition, results this quarter reflect strong underlying fundamentals as momentum continues across our businesses. Total company net cash flows of $4.2 billion helped drive assets under management to a record $466 billion at quarter end.

As I have said many times, assets under management is the best single indicator of future revenue and operating earnings.

Business level growth metrics include: solid net cash flows of $1.2 billion in Full Service Accumulation, reflecting double-digit growth in both recurring and transferred deposits.

While assets sales were flat compared to the year-ago quarter, margins in this business continue to improve as we focus on a better balance across plan sizes.

Principal Funds' account value increased 25% to a record $61 billion, reflecting continued demand for our outcome-oriented products and solid investment performance.

Sales of $4.7 billion contributed to net cash flows of $550 million. Record unaffiliated assets under management of $106 billion for Principal Global Investors, up 8% from the year-ago quarter.

Net cash flows were $1.5 billion for the quarter. Assets under management of $103 billion in Principal International, with positive net cash flows of $1.1 billion despite a quarter in which the macroeconomic conditions in emerging markets were as difficult as they've been in years. Those conditions have improved in October.

U.S. Insurance Solutions year-to-date sales up 11% over the prior year period, with nearly $100 million of sales in the current quarter as we continue to balance growth and profitability. Our business model is extremely well-suited for the world's aging challenges and emerging market middle-class growth.

In this era of personal responsibility, we have the right solutions to meet the financial needs of our customers around the world, and we remain confident in our ability to continue to grow our businesses at above-market rates.

Next, I'll comment on our success in further implementing our strategy in the third quarter.

At our recent Investor Day, we had the opportunity to present an update on our Investment Management Plus strategy. It's a strategy we've had in place for more than a decade, and has created a unique business model with diverse revenue sources, yet with a highly integrated set of businesses.

This approach sets us apart for a couple of reasons. First, as I mentioned earlier, our diversified set of businesses allows us to weather challenging economic environments, as we demonstrated during the financial crisis. Our durable model enabled us to emerge from the recent crisis in a position of strength, allowing us to complete 7 strategic acquisitions since 2010.

Additionally, what makes our business model really powerful is the synergy and collaboration between the businesses, which results in a valuation that's greater than the sum of the parts. This leads to higher margins, continued long-term growth opportunities and a higher return on equity over time.

In Principal International, the on-boarding of Cuprum is complete. We are now focused on maximizing the value of this acquisition by creating the only fully integrated platform in Chile.

The acquisition made us the #2 retirement provider in Latin America, and created a retirement franchise to meet the savings and investing needs of people in the 3 key countries of Brazil, Chile and Mexico, that will be difficult for competitors to replicate.

The need for long-term savings by individuals in emerging markets continues to grow, and Principal is capitalizing on these opportunities.

In Full Service Accumulation, we will continue to focus our resources on advisors, plan sponsors and plan participants to deliver work site solutions with strong investment capabilities and performance. The fundamentals of this business remains strong. Recurring deposits were $3.7 billion for the quarter, a 13% increase over the prior year quarter.

This was driven by an 8% increase in both the number of people making a deferral and the number of people receiving a match. We'll see additional upside to recurring deposits as the job market recovers, and as our greater focus on engaging plan participants to save at appropriate levels begins to gather momentum.

At our recent Investor Day, we focused on the growth and success of Principal Funds which, along with Principal Global Investors and Principal International, was an aspirational business when we became a public company in 2001.

At the end of the third quarter, total Principal Funds complex account value was $103 billion. This is remarkable growth, and reflects our ability to offer outcome-oriented products focused on meeting the long-term needs of investors.

Turning now to Principal Global Investors. We continue to benefit from our well diversified multi-boutique strategy. Our strategy is distinctive because the successful boutiques that we've built and acquired are able to remain focused yet nimble to meet changing client demands, while having access to shared resources, such as a world-class distribution and operational platform.

This allows our investment teams to focus on what they do best while realizing the benefits of scale in areas like distribution, technology and compliance.

As shown on Slide 5, investment performance remains competitive. Solid investment performance is a good leading indicator of future sales and net cash flows. The pipeline in Principal Global Investors remains strong, and as investor appetite swings to equities and alternative investments, we remain in an excellent position to retain and attract clients because of our investment expertise across multiple boutiques.

Next, a quick update on Principal Bank. As of September 30, we've liquidated or transferred all required noncustodial deposits, including those that were part of our strategic agreement with Bank of the Internet. We have retained all individual retirement account deposit products which complement our U.S. Retirement and asset accumulation businesses and help us retain assets from job changers and retirees.

As part of the deregistration process, Principal Bank also sold its $390 million of commercial mortgage loans, predominantly to Principal Life Insurance Company.

These actions had minimal financial impact to the company and further our process to deregister as a savings and loan holding company. We still expect to complete the process by year end.

I'll close with some comments on capital management. As announced last night, we'll pay a $0.26 per share common stock dividend in the fourth quarter, bringing our 2013 total to a record $0.98 per share. This reinforces our commitment to return capital to shareholders by increasing the dividend payout ratio over time.

So far, in 2013, we've allocated more than $480 million of capital for common stock dividends, strategic acquisitions and share repurchases. We continue to look for the best and most accretive ways to deploy capital and increase long-term value for shareholders. We'll provide more detail on our 2014 capital management plans at our outlook call in December.

In closing, we're pleased with our team's ability to grow our businesses while maintaining expense discipline, which resulted in another strong quarter. Despite volatility that will likely continue, I'm confident that our business model and proven ability to execute will continue our momentum into next year and beyond. Terry?

Terrance J. Lillis

Thanks, Larry. Third quarter was another strong quarter on top of an already strong first half of 2013, as our businesses continued to grow.

This morning, I'll focus my comments on 3 items: operating earnings for the quarter; net income, including performance in the investment portfolio; and the strength of the capital position and the balance sheet.

Total company operating earnings of $269 million were up 89% over a reported third quarter 2012, but up 22% after adjusting for last year's actuarial assumption review. Excluding Cuprum, third quarter 2013 earnings were up 15% over the adjusted prior year quarter.

Earnings from our fee-based businesses remained in the 60% to 65% range of the total operating earnings, excluding the Corporate segment. The composition of our earnings continues to shift away from products that put pressure on our balance sheet. Our current business profile is more aligned with asset managers, and should warrant a higher-than-historical multiple over time.

Third quarter 2013 earnings per share were $0.90, a 22% increase compared to the adjusted year-ago quarter. This reflects strong organic growth, the addition of Cuprum, favorable equity markets and disciplined expense management.

Our annual actuarial assumption review in third quarter 2013 had an immaterial impact on total company operating earnings.

Looking at Slide 6, you'll see that third quarter 2013 earnings were impacted by one normalizing item. As we introduced last quarter, Principal International earnings are impacted by returns on the encaje investment in Chile and Mexico.

Adjusted results this quarter were negatively impacted by $10 million due to lower-than-expected returns in Chile. Results will vary quarter-to-quarter. In fact, the encaje returns in Chile is positively impacting the fourth quarter results at this point. There's more background information on the encaje investment on Slide 7, along with publicly available information on how to track the encaje performance throughout the quarter.

Now I'll discuss business unit results. Starting with the Accumulation businesses within the Retirement and Investor Services. Operating earnings were $151 million, an increase of 15% over the adjusted third quarter 2012.

As shown on Slide 8, net revenue was up 13% over the year-ago quarter. Trailing 12-month, pretax return on net revenue improved to 31%.

Quarterly operating earnings for Full Service Accumulation at $91 million were up 21% over the adjusted year-ago quarter. This reflects a 15% increase in net revenue due to strong growth in the business and positive equity market performance.

Operating expenses have grown slower than net revenue, resulting in improved margins. The pretax return on net revenue for the quarter was 32%.

Sales, at $2.7 billion for the quarter, were in line with the year-ago quarter. Net cash flow for Full Service Accumulation were $1.2 billion for the quarter. We will continue to be disciplined in attracting and retaining clients that value our comprehensive products and services as we strike the appropriate balance of growth and profitability.

Principal Funds' operating earnings were $22 million for the quarter, a very strong 66% increase from the year-ago quarter.

On a trailing 12-month basis, revenue was up 24% and operating margins continue to improve due to the scale-based nature of the business.

For the quarter, sales were $4.7 billion, leading to $550 million of net cash flow. While down sequentially, these results were solid relative to the industry. Sales continued to come in across multiple asset types as we focus on outcome-oriented products.

The individual annuity operating earnings were $30 million, reflecting flat net revenues in the quarter and a continued expense management. This is a good result in this low interest rate environment.

Our retirement income strategy continues to resonate in the marketplace, and we saw a nice momentum in payout annuity sales.

On a trailing 12-month basis, pretax return on net revenue improved to 44%, driven by strong growth in fee revenues.

Slide 9 covers the guaranteed businesses within Retirement and Investor Services. Third quarter operating earnings of $22 million were up 6% over the year-ago quarter. On a trailing 12-month basis, pretax return on net revenue was 80%, at the upper end of our expected range. Investment-only earnings improved 24% from the prior year quarter to $15 million due to increasing spreads on a lower asset base.

During the quarter, we sold a $350 million, 5-year medium-term note. We continue to approach this business opportunistically, and we'll write business when market conditions generate attractive returns.

Full Service payout earnings of $8 million were negatively impacted by a mortality fluctuation of approximately $3 million, after tax. This was the first negative fluctuation we've seen in this business in more than 2 years. We believe that the rising interest rate environment will allow us to add small- to mid-sized pension closeout business at attractive returns.

Slide 10 shows Principal Global Investors' operating earnings were $23 million, up 12% from the year-ago quarter. Third quarter revenues grew 12% over the prior year quarter, driven largely by higher average assets under management. Earnings were down on a sequential basis due to performance fees and front-end loaded real estate borrower fees.

On a trailing 12-month basis, pretax margin improved to 26% as Principal Global Investors continues to build scale.

Unaffiliated assets under management ended the quarter at a record $106 billion. The unaffiliated net cash flow for the quarter was $1.5 billion. We have a robust pipeline which, when paired with strong investment performance, bodes well for future growth.

Slide 11 shows third quarter 2013 operating earnings for Principal International of $51 million. Adjusting for the lower-than-expected return on the encaje, operating earnings were up 64% from the year-ago quarter.

After adjusting for Cuprum and the foreign exchange headwinds, Principal International is up 2% over the year-ago quarter.

As Larry mentioned, this was a challenging quarter for our Latin American operation. On a trailing 12-month basis, combined pretax return on net revenue for Principal International was 55%, slightly below our range reflecting the macroeconomic pressures.

In light of these pressures, we're pleased with the results of our Principal International businesses in the quarter and continue to invest for growth.

Quarterly net cash flows for the segment were $1.1 billion. Principal International ended the quarter with $103 billion of assets under management despite the strengthening U.S. dollar and volatility, particularly in Brazil.

As a sign of our leading position in Brazil, BrazilPrev was the only meaningful provider with positive net cash flows in the quarter.

U.S. Insurance Solutions' earnings were $54 million for the quarter, an increase of 25% from the adjusted year-ago quarter.

And as shown on Slide 12, Individual Life operating earnings were $22 million. This was a decrease of $3 million from an adjusted year-ago quarter, driven by adverse mortality due to a higher severity in the quarter, as well as the low interest rate environment.

On a trailing 12-month basis, pretax operating margin was 13%, below the range of 15% to 17% communicated for 2013. Higher-than-expected mortality, thus far this year negatively impacted our results. We continue to believe this is normal quarterly volatility.

As shown on Slide 13, Specialty Benefits operating earnings of $32 million, were up 74% from the adjusted year-ago quarter. The current period loss ratio of 65% compared favorably to the 72% result in the year-ago quarter, and was a large contributor to the earnings gain. We continue to expect our quarterly loss ratios to be in that 65% to 71% range.

Trailing 12-month pretax operating margins of 11% is slightly above our expectations due to the favorable claims experienced this year.

Specialty Benefits premium and fees grew 3% over a year-ago quarter. On a trailing 12-month basis, premium and fees were up 4%, relative to our 6% to 8% target, reflecting our focus on profitable growth.

The Corporate segment reported an operating loss for the quarter of $32 million, better than our forecasted range of $35 million to $40 million operating losses. This is primarily due to favorable debt-related expenses in 2013.

For the quarter, total company net income was $246 million. Realized capital losses for the quarter were $23 million, with improving credit-related losses making up $16 million of the total, which were at the lowest point since before the financial crisis.

Looking now at capital adequacy. We estimate our third quarter risk-based capital ratio to be in the 400% to 405% range. We expect to end the year in the 415% to 425% range, relative to a 350% RBC ratio at the Life company, and including cash at the holding company, we have approximately $800 million of excess capital.

Book value per share, excluding AOCI at $29.79, increased 5% over the prior year quarter. Our return on equity, excluding AOCI, was 11.9%, a strong improvement even taking into account rolling off the prior year quarter.

Trailing 12 months earnings grew 20% over an adjusted prior year, while the average equity, excluding AOCI, only increased 3%.

And as I mentioned at Investor Day, growing earnings 10% to 12%, while managing the equity growth to a lower rate, will deliver a 50- to 80-basis-point annual increase in return on equity.

Regarding capital management, in the quarter, we repurchased $62 million of company stock. We still have $55 million remaining from the $150 million previously announced share repurchase program.

As outlined on Slide 14, we allocated more than $480 million of our expected $400 million to $600 million of capital to be deployed for the year.

Last night, we announced our fourth quarter 2013 common stock dividend of $0.26, bringing our full-year dividend to a record $0.98. We continue to focus on increasing our dividend payout ratio on a growing net income base.

We're extremely pleased with the continued momentum of our businesses and feel that we are well positioned for future growth.

Before we close, I want to take a moment to recognize our CEO, Larry Zimpleman, on recently receiving a prestigious industry Award. Larry was named the winner of the 2013 Lillywhite Award. The Employee Benefit Research Institute sponsors the award, which recognizes outstanding lifetime contributions to Americans' economic security. Congratulations to Larry for this recognition of his contributions to the financial services industry.

This concludes our prepared remarks. Operator, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Randy Binner with FBR Capital Markets.

Randy Binner - FBR Capital Markets & Co., Research Division

Just wanted to start on International on the earnings. Even after kind of adding back to the callout for the encaje business in Chile, it seems like we were a little bit light there. And I guess, I'd ask kind of a 2-part question. One, was it light relative to initial expectations from your perspective it would be in the Cuprum business? And two, could you just elaborate a little bit on kind of the comments about kind of FX environment being challenging? Obviously, that's currency, but just wondering if there's interest rates and other pieces of those comments that might have affected International earnings this quarter.

Larry D. Zimpleman

Okay. This is Larry, Randy. I appreciate the question. I'll start, and I'm sure, Terry and Luis might want to add. First of all, as I said in my earlier comments, the conditions in emerging markets started to deteriorate in June, and I would say that deterioration sort of continued through most of the third quarter. But as I also noted in my comments, the situation has begun to reverse a little bit in October. So it feels -- in general, it feels like the macroeconomic environment is settling down a little bit. In your question about were PI earnings light, I would say, it was actually a very good quarter for PI from a local market perspective. So what you saw in the local markets was positive flows, generally good performance, but when you translate those back to the U.S., we took a hit on that because of currency. So the $51 million, in my view, represents sort of almost like a worst-case scenario which, from my perspective, really, if that represents the worst-case scenario, I can live with that all day long. So I think the normalized number for that segment is probably more in that $63 million to $65 million a quarter range, with $51 million kind of representing this worst-case scenario this quarter. So Luis, anything you like to add to that?

Luis E. Valdés

Yes. I mean, and again, the $51 million for this quarter, we consider that as a good number for PI, considering the macroeconomic conditions and certainly, normalized by our encaje, $10 million -- that's $61 million for the quarter. And concerning the headwinds, FX and market behavior and total AUMs -- and concerning even our total margin, it's a good number, it's a good number. We consider that as a good number.

Larry D. Zimpleman

Does that help, Randy?

Randy Binner - FBR Capital Markets & Co., Research Division

Yes, it's perfect. I mean, I'm trying to get to your run rate and I just want to amplify one thing. It sounds like -- if I'm just thinking about my P&L here, it sounds like most of it's FX and not necessarily kind of interest rates or other growth issues in those markets. It's mostly just the FX impact that's kind of clearly laid out and something we can track in the market.

Larry D. Zimpleman

Yes, that's right, Randy. The final comment I would make is I think inflation was a little bit lower in Latin America in the quarter, which has also got a very modest effect. But you've got the main factors with what you've mentioned there a minute ago.

Randy Binner - FBR Capital Markets & Co., Research Division

And then, finally, I mean -- and this is something we talked about at the Investor Day, but there's no -- given the diversity of your, kind of, your business base and variety of countries and your continued growth plans there. I mean, you're going to continue to kind of let this FX come through unhedged just because it will be too expensive and kind of complicated to hedge it. There should be kind of natural offsets in it going forward. Is that right? We accept this FX risk in these earnings?

Larry D. Zimpleman

Yes, that's exactly right. And again, we've looked at this any number of times. Even if we were to try to do some economic hedge, Randy, it wouldn't necessarily work for accounting purposes. But we believe that the best thing is just to let the natural diversification of the businesses carry us quarter-to-quarter.

Operator

Your next question comes from the line of Erik Bass with Citigroup.

Erik James Bass - Citigroup Inc, Research Division

Can you talk a little bit about the level of activity in the 401(k) market in the U.S. in terms of both RFPs for existing cases, as well as new case formation? And is health care reform still a distraction or are you seeing the disruption from that starting to ease?

Larry D. Zimpleman

Yes, again, I'll take -- make a few high-level comments on that Erik, and have Dan comment. I would describe the 401(k) environment as sort of "steady she goes," I would say, not a lot of change going on either positively or negatively. I think that the competitive pressures, which have always been a factor in this market, continue to be there. There may be slightly less competitive factors, say, than right after the financial crisis when, I think, a lot of retirement providers, a lot of 401(k) providers were all sort scrambling around, trying to find ways to at least continue -- if not absorb too much of a hit, at least try to continue the revenue in the AUM number. So those things seem like they've settled down. And our pipeline, it's pretty consistent with what it's been the last several quarters. So I'll let Dan make comments on that in health care.

Daniel J. Houston

Yes, that's right, Larry. Just a couple more comments. Within the last couple of weeks, I was down with some of our very largest clients. We have a client council. So that's 15 clients around a room with management discussing some of the issues relative to challenges they're facing within their benefits package. And as you might expect, health care reform compliance is top of mind for them. But I'd say, the shift in the conversation quickly goes to the issue of retirement readiness and income solutions. There's less emphasis around plan expenses, more time and attention now being focused on what can we do to better prepare our future retirees for retirement. So I would say, our product package with TRS and our product packaging around Retire Secure supports that in the marketplace today. And we're winning a lot of business because of that.

Erik James Bass - Citigroup Inc, Research Division

Okay, that's helpful. And then, if I could just ask one on Specialty Benefits, where your results have been -- it's a very strong year-to-date with favorable claims experience. You've also seen some modest sales growth. Just could you talk a little bit about what you're seeing in the group market in terms of both claims trends, as well as the competitive environment?

Larry D. Zimpleman

Yes, this is Larry, Erik. I mean I think you actually summarized it pretty well. I would just want to -- before I ask Dan to comment, I would just -- want to give our team that manages that business a lot of credit. For many companies, the story, historically, around this kind of business has been cycles of sort of boom and bust. And I think that when you look at our performance in this area of the business, I think our performance is really superior and far more consistent, kind of, quarter-to-quarter and year-to-year than many of our competitors. So I think we have a very experienced team with a strong track record, and I'm very proud of the trends they have going.

Daniel J. Houston

A lot of discipline on the part of the team to achieve nice growth and, at the same time, be profitable. Remember that our average size plan for Specialty Benefits is approximately 40 employees. It's diversified by industry and, frankly, by geography. And we have -- we've done a good job kind of balancing growth and profitability. In terms of health care reform and how it might impact Specialty Benefits, there's a pediatric benefit that comes out of the dental component that has to be included in health care reform on the medical plans. So Principal continues to monitor that. In most states, what most carriers are doing is, even though they have the pediatric benefit within the health insurance program, they're still purchasing dental insurance. It is a comprehensive solution. It's a best practice on the part of the advisor. So we don't see health care reform derailing our model of distribution today for Specialty Benefits. Having said that, we'll continue to evaluate the -- both the public and the private platforms for our products being on those products -- on those platforms.

Erik James Bass - Citigroup Inc, Research Division

Okay. And any comments on just the pricing environment? Or it seems to have been -- you've had a tailwind in the past couple of years as most people in the market have been raising prices. Are you still seeing that? Are you seeing any signs of increased competition?

Daniel J. Houston

Yes. It's a competitive marketplace, and our rates tend to always be -- we're top 5 provider in Specialty Benefits. And so there are new entrants from time to time that can be disruptive to the industry, but I would say that it's no more or any less competitive than it's been in the last few years. So it's game as usual, I suspect.

Operator

Your next question comes from the line of Ryan Krueger with Dowling & Partners.

Ryan Krueger - Dowling & Partners Securities, LLC

I had a question about your legal entity structure. Principal Global Investors is owned by Principal Life Insurance Company. I was wondering if you've ever considered moving PGI out from under the insurance subs. I'm not sure if that would be a positive, negative or neutral event for your capital structure or if it would maybe have any impact on the way rating agencies evaluate your access to subsidiary dividends. So was just interested in your perspective on that.

Larry D. Zimpleman

Yes. This is Larry, Ryan. That's a very interesting and sort of timely question. I think I'll make a couple of high-level comments, and Terry is going to want to add a little more specificity to it. But very high-level, if you go back a little bit in history, even back before we became a public company, it's true that when some of the legal structures were set up, of course, you have a holding company, but then you had the life company. And at that point in our strategy implementation, sort of in our history, the life company was kind of the center of the business units. I mean, that was just kind of the way it was done because the life insurance was the legacy business going back 134 years. And so as we began to develop these other businesses, including Principal Global Investors, many of them just sort of naturally ended up under that life company. As we've evolved and as we become a more multifaceted and global organization, your question is really spot-on because I think we continue to evaluate both for capital efficiency, tax efficiency, et cetera, whether that sort of structure makes sense. And we are beginning to evolve that structure. We talked about that, I think, at different investor days as we are a more global company and we need to move capital around to various companies around the globe. As we have expanded into other areas like International and mutual funds, we put those companies outside the life company and the legacy, really, is PGI is still under the life company. So that's a real set-up for Terry to sort of take it from there. But that's kind of the background and the history of it.

Terrance J. Lillis

Yes, Ryan, this is Terry. The strategic focus of our execution on our strategy is really evolving towards more of that Investment Management Plus-type company. And part of that is the breakdown of those businesses, as Larry said, between the life insurance companies and those legacy businesses there, as well as the sister companies, the mutual fund, as well as Principal International. And it makes sense as we grow the business from PGI being the aspirational business to a very meaningful part of our organization, there is a limitation as to the size of any nonlife subsidiaries within the life company. So because of that, there was eventually going to be a need to move that out. So we are exploring that at this point in time. We're looking to move the earnings of Principal Global Investors outside of the life company as part of our long-term strategy. And as Larry mentioned, we've looked at more of a global holding company structure, whereas, we can move a capital efficiently and effectively around the globe. So yes, that is one of our near-term views as well.

Larry D. Zimpleman

Does that help, Ryan?

Ryan Krueger - Dowling & Partners Securities, LLC

Yes, very helpful. I just have a follow-up. Do you think that if you do move PGI out from under the insurance subs, that it would have any -- would it have any impact on your RBC ratio, either positive or negative?

Larry D. Zimpleman

Well, I guess, what I would say to that, Ryan, is that we would manage that and do that in a way that will not have a substantial impact to the RBC ratios of the life company.

Ryan Krueger - Dowling & Partners Securities, LLC

Okay. And then just -- actually, one more follow-up on the same thing. I think from a rating agency standpoint, could doing -- could making this change -- do you think that would positively impact their view of access to capital and, perhaps, help your ratings?

Larry D. Zimpleman

Yes. I'm not sure I got all that question, but I think, essentially, you were asking about how the rating agencies would view that. And I guess, again, my general comment there would be that, of course, the rating agencies don't all have a unified or single view around these types of things. So we've begun that discussion with the rating agencies. I think, so far, I would certainly describe all of our conversations as very constructive. And we don't -- again, we don't see significant hurdles that we have to overcome, but we want to continue to work very proactively with them as we do it, and we want to take account of whatever concerns they have. But I don't think it will be an impediment at the end of the day. We'll just have to have those individual discussions to get their point of view.

Operator

Your next question comes from the line of Jimmy Bhullar with JPMorgan.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Overall, I thought the results were pretty strong, but the one that's sort of negative was that your flows in many of the businesses were weak. And you mentioned the environment in Latin America being challenging, but even PGI and mutual funds loans seemed a little weak. So maybe, if you could address that? And then, one for Luis on -- there's been a lot of talk about pension reform in Chile with the upcoming election. And just wondering what you see or is there anything that might seem like a threat to the Cuprum business, given the proposals that the various candidates have made?

Larry D. Zimpleman

Jimmy, this is Larry. Thanks for the questions. I would frankly take a little bit of exception to the comment on flows. I think that sometimes, your toughest competitor is yourself, and that's kind of a nice problem to have. And I think that your comment or your observation is really in relationship to Principal's flows. But I think the better measuring stick is, really, to sort of look at our flows as compared to competitors'. And I'm highly confident that if you look at -- within any of those businesses, particularly, the mutual fund business and the institutional business, you would find that our flows are really as strong as anyone's. So for example, yesterday, T. Rowe, Franklin, Janus and Federated reported, and they all reported pretty significant negative flows. This morning or last night, Legg Mason reported. They reported significant negative flows. That's as compared to $1.5 billion positive flows for PGI. So ours is a very strong story, and I would encourage you to look at kind of the industry flows and not necessarily make the comparison singularly or directly against what we might have done in the prior quarter. Because, once again, we would have been among the leading performers in those prior quarters. So with that, let me ask Jim to comment on institutional. And I'll have Luis comment on International.

James P. McCaughan

Yes, Jimmy. Thanks for the question. I think to comment on institutional -- and this actually has some impact on mutual funds and Full Service as well. I would point out that we at Principal have a product platform that is extremely strong relative to where client demand is going. If you want to understand the negative flows from competitors that Larry has described, you just need to look at the diminishing appetite that investors have for active core strategies. And that's something we do, but more importantly for us, there is increasing demand for specialty strategies, highly focused, high added value. So if you take the institutional flows during the quarter, $1.5 billion net inflow, that included losing a single account of more than $1.5 billion, which was in active core global equities. So in other words, the $1.5 billion plus making up for those losses of core mandates were in specialty strategies, which includes real estate, includes high-yield of various sorts, particularly, limited duration high yield, includes specialty equity strategies, including yield biased and regional strategies. So we are strong in those areas where client demand is moving, and that more than makes up for the losses we have in active core strategies. And that general theme -- I illustrated it with reference to Principal Global Investors, but that is one of the explanations as to why the Principal Financial Group platform is seeing pretty strong positive flows compared with our investment management competitors.

Luis E. Valdés

Jimmy, this is Luis. Let me comment briefly before going to -- into the pension reforms in Chile. About our net customer cash flows in PI, certainly, we reported $1.1 billion. Our normal run rate was about $2.2 billion, $2.3 billion per quarter. If you look at your supplement in the Page 31, 32, you're going to realize 2 things. First, we didn't have any country with negative net customer cash flows. All our countries are showing positive net customer cash flows. And then we have India, which is even. But the most important thing here is to realize that the country where we had serious problems was in Brazil. Brazil was showing $400 million in net customer cash flows, positive. And our normal run rate in Brazil was about $2 billion per quarter. So that is where we have the main shortfall, it's in one country, which is Brazil. The second quarter, particularly, the second quarter -- I'm talking about the market in Brazil, was very challenging in Brazil. Almost, we had that stock market down 20%. Almost, we had bad FX rate down to 20%, so that market was, in USD, almost 40% down at some given moment. So we had a very difficult entry into the third quarter. If you're looking those number, you will figure that the main part of that shortfall is coming because we have low deposit but we didn't have a very important amount of withdrawals. So we circled the wagons around our customers and our assets, and we were able to retain all those assets. And you could see that we didn't have any important fluctuation about our withdrawals. It's very important fluctuations about new deposit. This situation is changing during the third quarter. The third quarter has been much more, much better than the second quarter, so we think that the moods in Brazil are much better and moods around emerging markets are much better starting in the third quarter. So we think that we have had a much better entry in the fourth quarter of 2013. Going into the pension reforms in Chile. It's almost a fact, Jimmy, that Mrs. Michelle Bachelet is going to be the next president in Chile. And we were able to review when she released her program, and the only thing that has been said in her program -- and this was kind of -- we were talking about the -- about the AFPs and the pension reform. It's about the creation of a state-owned AFP in Chile in order to address 2 things: first, to extend the coverage under the low-income segment; and second, to extend and have a much more extended geographical reach, in particular, in some places that you don't have enough market or enough size in order to really cover those particular places in Chile. So it's pretty much more in the same way that we anticipated in the last earnings call, which is a kind of state-owned. If that AFP is going to exist as a state-owned AFP, that is going to go after the low -- going after the low-income segment and in those places that you don't have a very meaningful presence of other private AFPs. In particular, in Cuprum, we continue saying that Cuprum is not going to be affected because Cuprum is the premier pension provider pretty much more focused on the middle- and high-income segment in Chile. That is very well-attended, and we don't see any particular reason in order to make any meaningful change, rather than to continue increasing the incentives in order to add more long-term savings into our AFP and pension system in Chile.

Larry D. Zimpleman

This is Larry, Jimmy. I just want to make just 2 quick points. One is that the discussion in Chile is more around how to get the replacement ratios up. And so the discussion is more on how to generate additional contributions. So I actually think this discussion around pension reform in Chile is going to be a positive, not a negative. So that would be Point 1. Point 2 is just to make -- just to illustrate, I would say, the influence that we have -- "we" is a collective we. So for example, if you look at the independent chair of Cuprum's board, he happens to have been the Minister of Economy when Michelle Bachelet was the President previously. So that shows, I think, the sort of influence that we will have if and when any of these proposals get to a legislative state. You can bet that we'll be providing our views and commenting on the strengths of the AFP system over the 30-year period.

Operator

Your next question comes from the line of Sean Dargan with Macquarie.

Sean Dargan - Macquarie Research

I have a question about the FSA pipeline. Last quarter, I think it was said that things were looking better over the second half of the year. Now I'm sure this is tied to the margins that you're targeting, but should we assume that FSA sales will be down full year 2013 over 2012?

Larry D. Zimpleman

Yes, I'll let Dan handle that. But Sean, thanks.

Daniel J. Houston

Yes. Yes, Sean, this is Dan. I think that's right. I mean, I would fully anticipate, at this point in time, we could see our sales, as measured by assets under management, down by, say, 10%. And I'd say, at the same time, that our new case revenues will stay about flat with last year. So again, nicer revenue on roughly 10% fewer asset sales. We are getting good sales, though, across all the segments: small, medium and large. And I would just call your attention to the fact that we've got 2,200 new plans this year that we didn't have 12 months ago. And then if I were to look closely at the thousand plus life market, we've increased that by roughly 10%. The difference is, those aren't jumbo cases, they're smaller cases. So that pipeline that we historically talk about has all those large jumbo cases in there as well. So I think we have a higher quality pipeline today and we've maintained roughly the same sorts of close ratios, albeit on a smaller overall assets under management, but stronger revenue. So we feel very good about the mix of business going into 2014.

Larry D. Zimpleman

Sean, this is Larry, I just want to add one quick point. Having been around this business for a very, very long time, I certainly have to make the observation that from 2011 to 2012, we grew the sales by 1/3. So we went from roughly $8.4 billion to $11.2 billion. So when we say that we don't know whether 2013 sales are going to hit the level of 2012, we really need to sort of remember that we had a 30% increase the prior year. And so the notion that you're going to have a 30% increase and then, put another increase on top of that, becomes a little bit challenging. So this is the normal pattern that you sort of see in this business, is you'll see jumps along the way, and then you'll see it sort of plateau off and then -- for a year or so, then you'll see it jump again. And that's been the trend, really, over the longer term.

Sean Dargan - Macquarie Research

Great. And it seems that part of the -- or a big part of the margin expansion story in your accumulation businesses has been expense reduction. When I look at over the last few years, the fourth quarter tends to have elevated comp expenses. I mean, should we expect the fourth quarter to continue the trend that we've seen in the second and third quarters?

Larry D. Zimpleman

Yes. I think the story is really around expense control, not necessarily expense reductions because, in fact, we think it's really important to invest in the businesses. And we've made that comment many, many different times. Dan was just commenting earlier in response to a question. Employers today expect us to be very visible and active with our participants, and that's what our Retire Secure and Worksite platform is. So we've actually been investing in the business but we've been doing it wisely and in relationship to revenue growth. So that's really the strategy that we'll continue to pursue. And I don't know, Dan, any comments on Q4?

Daniel J. Houston

Yes. It's just -- to kind of boil it down into 3 buckets for Q4. The first is, we're going to continue to be disciplined about operational costs and holding those tight as we possibly can. The second bucket is around investing in the business, so that's expanding on TRS and the TPA business and also deploying some investment resources out into the marketplace. And then the third one is just a reminder that when we look at commissions and we look at asset management fees, those do stay current. They on the same pace as account value growth. And so some of the fourth quarter compensation increases are because of bonuses towards the end of the year. So hopefully, that helps explain the answer, Sean.

Sean Dargan - Macquarie Research

Okay, great. Just one more. Typically, PGI benefits in the fourth quarter from performance fees. How are they tracking year-to-date?

Larry D. Zimpleman

Jim, go ahead. Yes.

James P. McCaughan

Yes. Thanks, Sean. It's dangerous to say how they're tracking because things can change in the last 2 months of the year. We know the market can move and we know our relative performance can move. But if we were to draw the line right now, we're looking at a slightly better yield than last year. The 2 key boutiques in this and -- or 2 that have substantial hedge funds, and that includes Columbus Circle. It's maybe not surprising that they're having a good year because of the opportunities in the equity market, particularly, tech and health care, which are 2 of their specialties. So they're having a good year, better than last year. The one that's maybe more counterintuitive is Finisterre, with substantial hedge funds. They're in emerging debt, which as in another context, we described that as macroeconomic headwinds. However, Finisterre, being long/short in emerging debt, have been very thoughtful and very adroit at managing it and are seeing some good returns, actually better than last year. So I don't want to talk it up too much, but maybe if their line was drawn at the moment, we might be $1 million or $2 million better than last year. But it's all still there to play for.

Operator

Your next question comes from the line of Mark Finkelstein with Evercore Partners.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Question on FSA, and maybe this is a question for Dan. If I look at the AUM per plan, it's up about 13% year-over-year, which makes sense, given kind of how equity markets have performed, offset by some debt. And then, if I look at fees to AUM, it's actually held very steady over the trailing several quarters, which is obviously a good thing. And I guess what I'm curious about is, as AUM has gone up with markets higher, how do we think about the reaction of the plan sponsor in that scenario? I mean, are they going to let you kind of keep those increased revenue dollars? Do you put them back into service? Will they want to negotiate down? How do we see this playing out?

Larry D. Zimpleman

Yes. This is Larry, that's a very good question and I will have Dan provide some detail. But to your point -- and again, I think our team has done a really nice job on this in -- generally speaking, it was a little bit more difficult post the financial crisis. And as I said earlier, things are settling down a little bit. So if you look at FSA, trailing 12 months, account value is up 17%, revenue is up 15%, expense is up 10%, and that's why you grow pretax earnings. So that 2% differential, I would tell you, might be a little narrower than what we can sustain over the long term because, to your point, plan sponsors -- and I would say also advisors, because that's an important constituent in this whole equation, typically, you are resetting expenses every year on these plans. And so as AUM grows, there is some ability to lower the per AUM fee and frankly, plan sponsors and advisors expect you to do that. So we've talked about the differential between account value and revenue growth that's in that sort of 2% to 4% range. But that's broad and general, and I'll have Dan give you a little color on the current environment.

Daniel J. Houston

Yes, that's right. And to answer your question, it's true on all of those cases. We'll have to take a portion, invest in the business. On any plan of over $5 million, there is a detailed discussion that's occurring each year on the value of that piece of business. And we know what our margins are on that piece of business, and if there's room, then, we'll work with the client on that. Sometimes, clients want additional services, which can be reflected in the pricing. But for the most part, like Larry said, this is an annual review. A lot of these are 3-year guarantees, and so our relationship managers and service reps are doing a very nice job, striking the right balance on the service that we're going to deliver and at what price those are going to be. Hopefully, that helps.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Okay. And then, maybe just one last question, going back to international a little bit. Maybe going back to a prior question but specific to Brazil. If you look at currency-adjusted earnings in Brazil over the last 4 quarters, they haven't really moved that much, up a tad bit. AUM, on a currency-adjusted basis, obviously, is up a lot. And I'm just curious, why aren't you seeing a little bit stronger earnings? Has there been any structural changes in terms of how you collect fees, what is the impact of the volatility and how does that emanate in earnings?

Larry D. Zimpleman

Yes, this is Larry. I'll have Luis comment. It is, for the most part, it is. As Luis mentioned earlier, it is the FX impact. So again, you are typically seeing, at the local market level -- at the local market level, Mark, your are typically seeing growth in that -- for Brazil. You're seeing growth in that sort of 20% to 25% annual range, and it just so happens that FX -- over the 12-month period, FX evaporates much of that away. But the long trend on a local market, local currency basis would show you that BrazilPrev has again been among the leaders in terms of growth, both AUM and earnings and profitability. There's been no real structural change in that market relative to fees being collected in a different way or different sorts of investment options being offered or things like that. It's really been the impact of the macroeconomic conditions. So Luis, your comment?

Luis E. Valdés

Yes. In light of Larry's comments, we -- at some given point, we had the real kind of 20% down during this year. Right now it's between 8% to 9% down, so it's coming back. And it's running about -- BRL 2.18. And putting this in perspective, nothing is being changed. We have had this kind of a headwind in Brazil, which is a little softer right now. But putting this in perspective, the current spot grade that we have today is exactly the same spot grade that we had in Brazil in 2006. So flying around BRL 2.2, BRL 2 per dollar is pretty much more above the average for the last 15 years for Brazil. So we have had, in the last year, kind of a strong headwind. But again, around BRL 2 per $1 is -- BRL 2.2 per dollar should be the average for the last 10 years for that particular market.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Yes. I was kind of adjusting for the foreign exchange impact and what we see -- so I was just trying to normalize for that, but I can follow up, if that's better.

Larry D. Zimpleman

Yes, that's fine. Okay. Thanks, Mark.

Operator

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

Larry D. Zimpleman

Well, thanks to everybody for joining us for our call today. Despite the macroeconomic challenges, as I said earlier, we're pleased with the momentum of our businesses, and our 2013 results. As John mentioned in the opening commentary, our 2014 outlook call will be on December 9.

At Investor Day in September, we noted that we expect 2014 revenue growth rates and pretax returns to be similar to the 2013 outlook, but we will start from a much higher asset base as a result of our strong results this year.

So while we do expect the global macroeconomic picture to remain challenging, we think our unique business mix and our very experienced management team will allow us to achieve an ongoing balance of profitability and growth.

So thanks, again. I look forward to seeing many of you in the coming months. And I hope everybody has a great day.

Operator

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 8:00 p.m. Eastern Time until end of day, November 1, 2013. 69950446 is the access code for the replay. The number to dial for the replay is (855) 859-2056 or (404) 537-3406. Once again, thank you for your participation. You may now disconnect.

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