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Principal Financial Group, Inc. (NYSE:PFG)

Q1 2014 Results Earnings Conference Call

April 25, 2014 10:00 AM ET

Executives

John Egan - VP of Investor Relations

Larry Zimpleman - Chief Executive Officer

Terry Lillis - Chief Financial Officer

Dan Houston - Retirement Investor Services and U.S. Insurance Solutions

Jim McCaughan - Principal Global Investors

Luis Valdes - Principal International

Analysts

John Nadel - Sterne Agee

Erik Bass - Citigroup

Seth Weiss - Bank of America

Christopher Giovanni - Goldman Sachs

Ryan Krueger - KBW

Mark Finkelstein - Evercore

Eric Berg - RBC Capital

Steven Schwartz - Raymond James & Associates

Operator

Good morning, and welcome to the Principal Financial Group First Quarter 2014 Financial Results Conference Call. There will be a question-and-answer period after the speakers have completed their prepared remarks. (Operator Instructions). I'd now like to turn the conference call over to John Egan, Vice President of Investor Relations.

John Egan

Thank you, and good morning. Welcome to the Principal Financial Group's first 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.

Following the 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 today 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. Risks 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 filed by the company with the Securities and Exchange Commission.

Now I'd like to turn the call over to Larry.

Larry Zimpleman

Thanks, John, and welcome to everyone on the call. As usual, I'll comment on 3 areas. First I will discuss first quarter results. Second I will provide an update on the continued successful execution and long-term benefits of our strategy and I will close with some comments on capital management. As John mentioned, slides related to today’s call are on our website, slide four outlines the themes for the call.

The Principal achieved strong results across our businesses in the first quarter with record total company operating earnings of $317 million. Coming off record operating earnings in 2013 the momentum in our businesses continues despite persistent headwinds including a low interest rate environment and a strengthening U.S. dollar. The ongoing success proves our ability to execute the relevancy of our strategy and the power of our diversified business model. Strong earnings growth is continuing to increase return on equity which expanded to 13% at quarter end a 90 basis point increase year-to-date. As we’ve communicated we expect to once again achieve at least a 15% return on equity within the next few years despite the impact of historically low interest rates in the U.S.

Results this quarter continue to reflect strong underlying fundamentals as momentum continues across our businesses. We continue to win and retain business because of our strong investment performance, our ability to provide outcome oriented solutions, excellent customer service and the diversity and strength of our distribution partnerships. Total company assets under management were a record $496 billion at quarter end and total company quarterly net cash flows were $4.8 billion. Following our additional key growth metrics from the quarter, full service accumulation sales were $2.7 billion and net cash flows were $1.8 billion. Margins in this business continue to improve in part because of our efforts to achieve better balance across all plan sizes. We are achieving the combination of good growth and attractive margins that reflect our leadership in this business.

Principal Funds sales were $4.5 billion for the quarter, net cash flows were $760 million, this is the 17th straight quarter of positive net cash flows in Principal Funds reflecting strong investment performance and our ability to offer solutions that financial advisors and retail investors seek.

Principal Global investors ended first quarter with record total assets under management of $298 billion including record unaffiliated assets under management of $112 billion. First quarter total net cash flows were $1.1 billion and unaffiliated net cash flows were $100 million. Principal International, assets under management of $109 billion at the end of first quarter was also a record. Net cash flows for the quarter were $2 billion.

Suppress market conditions in Brazil negatively impacted net cash flows at the beginning of first quarter, but flows rebounded to normal levels by the end of the quarter, Individual Life’s business market focus continues to be a differentiator for us with 58% of full year sales from non-qualified deferred compensation and business owner and executive solutions.

The increased activity in a non-qualified market reflects enhanced confidence among business owners as the economy recovers. Specialty benefits premium and fees were up 5% from the year ago quarter and loss ratios continue to stay within our desired range.

In total we had a strong start to 2014 and we remained optimistic for the full year as leading indicators such as investment performance and sales pipeline continue to be very solid. Next I’ll provide a few updates on the continued execution of our strategy. Our diversified business model is extremely well suited for the world aging population and emerging market middle class growth.

We remain committed to helping business owners, individuals and investors around the world achieve financial security and success. In full service accumulation, we’ve added nearly 1,500 plans in the past 12 months. This not only helps drive growth in recurring deposits, which increase 10% on a trailing 12 months basis, but we also have the opportunity to educate more plan participants about the importance of preparing for retirement. With more than 1 billion people over the age of 60 worldwide and that number expected to double by 2025, there has never been a more critical time to promote financial literacy and retirement readiness.

Our new Principal Plan Works program was introduced to help plan sponsors and advisors improve participant retirement outcomes. Through this program we have delivered thousands of retirement readiness reports to help raise awareness about income replacement needs, encourage effective plan design and positively impact participant savings behavior.

As mentioned earlier and as slide five shows, investment performance remains strong and is a leading indicator of growth for our retirement and investment management businesses. Principal Funds currently has 17, four and five star funds as ranked by Morningstar and we expect that number to increase over the next six months. Principal Funds was once again recognized by Lipper in March.

The Principal Global Real Estate Securities Fund ranked number 1 for its consistently strong performance. This important third party recognition validates our ability to offer high quality investment options to investors.

REITs will continue to attract assets in the future due to their above average yield. Principal International had record operating earnings in the quarter. Cuprum continues to be a meaningful contributor to earnings and as we said last quarter, we consider the acquisition complete and are now moving into the second stage of integration. With regular deposits from the mandatory retirement markets in Chile and Mexico, combined with upside potential from growing voluntary savings opportunities, our Latin America businesses remain in excellent position for continued growth.

As another example of our strong position in Latin America, in April assets under management in BrazilPrev, our joint venture with Banco Brasil reached R$90 billion, which equates to approximately $41 billion in U.S. dollars.

On a local basis, the compound annual growth rate of BrazilPrev assets under management has been 32% for the past five years, because of their focus on asset retention BrazilPrev is the market leader with more than 60% of total net flows in the Brazilian retirement market over the past 12 months.

It is important to understand that due to the expertise of our team in Principal International businesses in our select emerging markets are performing well on a local level. The strong fundamentals of these businesses, our proven ability to execute and our relationship with premier partners allow us to weather short-term volatility including foreign currency movements to achieve long-term growth.

Principal Global Investors continues to build scale in the business which is driving margin expansion. Trailing 12 month pretax margin was 25.2%, an increase of 180 basis points over the same period last year. Principal Global Investors’ multi-boutique business model with our diversified investment platforms combined with the strength of a share distribution capability allows us to maintain positive net cash flows as client demands shift. This along with our strong investment performance and a robust pipeline, gives us confidence for continued growth and margin expansion.

An important part of our overall strategy is to provide a better experience for advisors and customers to increase operational efficiency and to drive productivity through innovative uses of technology. The Principal was recently recognized in this regard by InformationWeek for the 17th year as a top business technology innovator in the U.S.

I’ll close with some comments on capital management. With record operating earnings and strong net income, we remain well positioned to increase shareholder value through a variety of capital deployment options. In the first quarter, we paid a $0.28 per share common stock dividend and bought back more than $72 million of shares outstanding.

Additionally last night, we announced a $0.32 per share a common stock dividend payable in the second quarter of 2014. This 14% increase over the first quarter dividend demonstrates confidence in our ability to grow fee based earnings and generate higher percentages of deployable capital. We remain focused on increasing our dividend payout ratio to our target of 40% on a growing net income base.

Finally, there is an active M&A pipeline that includes opportunities to further enhance our global investment management expertise. Our fee based business model allows us to generate deployable capital and strategically deploy it to create long-term value for shareholders.

Before I close, I want to mention one other recognition that Principal recently received. For the 12th consecutive year, Principal Financial Group was named one of the top companies for executive women by the National Association for Female Executives. We share their commitment to women succeeding in their careers and we are honored to receive this recognition.

In closing, we are very confident that the execution of our strategy and diversified business model will continue to enhance shareholder value. Terry?

Terry Lillis

Thanks Larry. The first quarter results were a strong start to the year. While earnings were aided by one-time items that I will address shortly, our strong business fundamentals and proven ability to execute are driving continued momentum. This morning I will focus my comments on operating earnings for the quarter, net income including performance on the investment portfolio, and I will close with an update on capital deployment.

Total operating earnings of $317 million for the quarter were up 36% over first quarter 2013 results. Net revenues increased 13% over the year ago quarter while operating expenses only increased 4%. This led to strong earnings growth and margin expansion. Total company assets under management increased to $496 billion at quarter end.

Excluding the corporate segment, 67% of the company’s earnings in the quarter were from our fee based business. These fee based earnings come from higher multiple businesses that put less pressure on our balance sheet and provide more free cash flow.

We strongly believe that our current business mix provides the right diversification for continued growth. At quarter end, our returning on equity excluding AOCI was 13%, this is a 320 basis point improvement compared to a year ago. Organic growth contributed a 130 basis points of that increase. The remainder came from the addition of Cuprum and the negative impact of the actuarial assumption review in 2012. We believe that an ROE of 13% driven mostly by operating earning expansion rather than just capital deployment is a strong result. We continue to expect 50 to 80 basis points of annual ROE expansion into the future.

Looking at slide six, first quarter 2014 operating earnings per share was a $1.06, a 34% increase when compared to a year ago quarter. As noted on the slide, we normalized first quarter 2014 earnings for three items.

In Full Service Accumulation results benefited by $15 million, predominantly from a true up of a prior year dividend accrual. In addition, RIS Guaranteed operating earnings were helped by $6 million from higher than expected variable investment income.

These benefits were partially offset by higher than expected claims in Individual Life which hurt earnings by $4 million in the quarter. Combining these items, we believe that the normalized earnings per share for the quarter was approximately $1, a 28% increase on an adjusted basis.

Now I’ll discuss business unit results. Starting with the accumulation businesses within retirement investor services, operating earnings were $185 million, an increase of 30% over the year ago quarter.

As shown on slide seven, net revenue was up 12% over first quarter 2013 and 14% on a trailing 12-month basis. Trailing 12-month pre-tax return on net revenue improved to 33%. Quarterly operating earnings for Full Service Accumulation at $119 million were up 38% from a year ago quarter.

As I mentioned, the current period was helped by $15 million most of which was a true-up on a prior year dividend accrual. As a reminder, the year ago quarter benefited from an $8 million dividend accrual true-up. Excluding the true-ups from both quarters, earnings were still up more than 30%.

Net revenue was up 13% due to the growth in the business and the strong equity market performance, while operating expenses were only up 4%. As a result, the trailing 12-month pretax return on net revenue for the business unit improved to 33%.

Full Service Accumulation sales at $2.7 billion for the quarter were strong as we continue to focus on striking the appropriate balance of growth and profitability. Net cash flows for Full Service Accumulation were $1.8 billion for the quarter. Large case withdrawals can be lumpy and we did not have any in the first quarter.

We still expect net flows for the year to be 1% to 3% at beginning of year account value. Principal Funds operating earnings were $25 million for the quarter, a 31% increase from the year ago quarter as the strong sales over the last several years are translating into bottom line results.

On a trialing 12-month basis, revenue was up 21% and operating margins continue to improve due to the scale based nature of the business. For the quarter, Principal Funds’ sales were $4.5 billion, contributing to $760 million of net cash flows. While down from very strong year ago quarter, these results were solid relative to the industry.

Individual Annuities first quarter operating earnings were up 17% to $34 million. Increased fee revenue in our variable annuity business due to market appreciation has more than offset spread compression on our fixed deferred block of business. As macroeconomic factors improve, we expect Individual Annuities earnings to be around this level going forward.

Slide eight covers the guaranteed businesses within Retirement and Investor Services. First quarter operating earnings of $32 million were up 13% over the year-ago quarter. On a trailing 12-month basis, pretax return on net revenue was 81%. Investment-only operating earnings improved 15% from the prior year quarter to $17 million. In addition to the benefit from variable investment income this quarter, business rolling off the books is being replaced with higher margin new business.

Full Service Payout operating earnings were $50 million for the quarter, a 12% increase over the year ago quarter, aided by variable investment income. We continue to approach these guaranteed businesses opportunistically.

Slide nine shows Principal Global Investors' operating earnings for the quarter were $27 million, up 33% from the year-ago quarter. Total net cash flows for the segment were $1.1 billion for the quarter. Assets under management increased 9% to $298 billion, leading to revenue growth of 11% over first quarter 2013.

Unaffiliated assets under management ended the quarter at a $112 billion, with $6.5 billion of deposits coming in during the quarter. There is continued demand for our diversified investment options especially as investors seek yield. The percentage of our assets under management in equity investment options which generated higher revenues has increased to 38% of the total up from 31% compared to the year ago quarter. Diligent expense control resulted in expenses only growing 6% over that timeframe. Trailing 12 month pretax margin for the segment improved to 25%.

Slide 10 shows first quarter 2014 operating earnings for Principal International of $63 million. These record earnings were a strong result especially considering the impact of the strengthening U.S. dollar. Adjusting for Cuprum operating earnings were 14% over the prior year quarter on a local currency basis, this highlights the strength of our businesses in the local markets.

While exchange rates have negatively impacted our U.S. dollar financial results, we feel very confident in the growth prospects for the markets where we do business. [Importantly] net cash flows for the segment were $2 billion contributing to an increase in assets under management to a record $109 billion at quarter end.

Turning to U.S. insurance solutions, our operating earnings up $43 million were up 22% from the year ago quarter. As shown on slide 11, Individual Life operating earnings were $17 million for the quarter, results in the quarter were negatively impacted by alleviated claims severity.

When compared to the prior year quarter sales in first quarter 2014 excluding universal life with secondary guarantees were up 11%. We continue to intentionally change our desired sales mix to be less focused on universal life with secondary guarantees thus improving the risk profile of our sales portfolio.

As shown on slide 12, specialty benefits operating earnings of $26 million were up 25% from the year ago quarter. The loss ratio for the quarter was 68% right in the middle of our 65% to 71% expected range. For the quarter total company net income was $294 million, a 65% increase over prior year quarter. Realized capital losses continue to trend down at $23 million for the quarter. Credit related losses continue to improve and at $12 million for the quarter or down 39% from the year ago quarter.

Turning now to capital deployment. As outlined on slide 13, we’ve announced plans to deploy more than $475 million of capital so far in 2014. This includes a 14% increase to our second quarter common stock dividend that we announced last night and the $100 million debt reduction that was executed on March 1st.

In addition during the first quarter our Board authorized a $200 million share buyback program. This is an addition to the $55 million remaining from last year’s authorization. Year-to-date we have spent $100 million on share buybacks leaving a $155 million of authorization for additional buybacks.

Our capital deployment strategy is fluid with multiple options available to enhance shareholder value. We believe that we will end the year on the top end of the $500 million to $700 million capital deployment range that we discussed on our outlook call.

In closing we are extremely pleased with the strong results in the quarter. We are well positioned for future growth across all of our businesses and our business diversification enabled us to be successful in various economic environments.

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

Question-and-Answer Session

Operator

Okay. (Operator Instructions). Your first question comes from the line of John Nadel with Sterne Agee.

John Nadel - Sterne Agee

Hey good morning everybody. Hey Larry, I am not -- I guess I am not too shy to admit that I am very surprised that the level of expense control in the quarter and maybe I shouldn’t be so surprised by it, but I am. Can you give us some sense, you hit on the operating leverage but you didn’t really go into any details on what’s sort of driving the expense controls here? I just want to get a sense for is there anything in the first quarter level of overall general expenses I am not talking about debt or amortization that you think with sort of one-time in nature where we expected to pick back up as we look throughout the year?

Larry Zimpleman

Good morning John. This is Larry.

John Nadel - Sterne Agee

Good morning.

Larry Zimpleman

I think in response to your question John, what I would say is that the years sort of 2010, ‘11, ‘12 were very, very challenging relative to the issues around expense control and some of that was because, it was a good news thing, because we were having a lot of growth, we were bringing on a lot of assets, so obviously there is an acquisition cost associated with that. And as I have said before, I mean I think to some extent we were emphasizing a little bit too much growth and a little too much at the expense of profitability. And I think that the team did a great job in 2013 of doing a much, a good balance between growth and profitability. So we started to see some improvement in margin expansion in 2013.

I think when you roll into 2014 and when you look at the first quarter John, it’s probably two things there that are worth mentioning. One is sustainable which is that as the kind of interest rates begin to move up a little bit as your discount rate moves up for all of employee benefits that has a positive and sustainable element to expense control and then the other one which is a little bit more one-time was again in the asset management business. We had sort of higher expenses in the fourth quarter associated with essentially, employee compensation particularly within the asset management group that doesn’t necessarily recur in the first quarter.

So that one we hope is actually going to be back later in the year, because every time, we're paying high performance fees, it’s because the funds did well and they were good flow. So a good chunk of it is sustainable, some of it is a bit of seasonality. I hope that helps a little bit.

John Nadel - Sterne Agee

Yes, that’s helpful. Any chance to give us some sense for how much the corporate pension and benefit plan costs maybe down in 2014 versus ‘13 my sense is it’s actually a pretty reasonable tailwind?

Larry Zimpleman

Yes. It’s probably in the range of about $60 million pre-tax.

John Nadel - Sterne Agee

Okay. That’s very helpful. Thank you very much.

Larry Zimpleman

You bet.

Operator

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

Erik Bass - Citigroup

Hi thank you. Could you provide a little bit more detail on the results in the international business at a country level? And then in particular, can you comment about the local currency flow and earnings dynamics in Brazil, Chile and Mexico and how those compared to your expectations?

Larry Zimpleman

Yes, I’ll let Luis to comment on that. I would just say again, we would emphasize that Principal International had a really nice quarter and nice quarter not just in terms of earnings but a nice quarter in terms of flows, in terms of sales, in terms of expenses control. As Terry said in his earlier comments, if you look at our PI local companies operating in their local markets and their performance in local currencies, you’ve seen a 14% increase year-over-year, aggregate across all the PI member companies in local term. So, I think that validates very much, that the issues here to the extent investors have concerns around emerging markets, what they should not have concern about, is the performance of the companies in local terms When you translate that back to USD, you may see some diminishment due to the strength of U.S. dollar, but at the local market level, I think it's really important that investors understand, these companies continue to grow at double-digits. And so with that, I'll forward over to Luis.

Luis Valdes

Yes, thanks. Eric, as Larry said year-over-year in local currency we are showing a double-digit 14% growth year-over-year. But if you are paying attention to quarter-over-quarter and you are paying attention to our last quarter 2013 and in terms of USD. We are showing a growth of equal to 3%, which is a pretty interesting, but in local currency is then 8%. So, we continue showing a very, very dynamic growth in our companies in PI.

Having said that, this is proven that, this proves that we have a very resilient business model in our market. And certainly we are not just working in emerging market. We are working again, again in select emerging markets, which is the main difference. So, it's a very resilient model and again repeating in a very interesting number of select emerging markets.

About FX, we paid a very important headwind in the last year, 14% on average in Brazil and Chile, a kind of 5%, 6% in Mexico. What we are being able to see in the last quarter that the situation is much more stable for these emerging markets and our expectation is that going forward FX for emerging markets are going to fly probably about in same level that they are today. Does that help, Eric.

Erik Bass - Citigroup

Yes. And then maybe if you could just add a little bit more in terms of the flow dynamics where I think you commented for Brazil that if I have this right, January was the pretty weak period when you saw kind of the height of the turmoil but flows have recovered in February and March and assume that’s continued probably through April. And then is it fair to assume that Chile and Mexico, the activity levels are little bit more stable since it’s a mandatory system?

Larry Zimpleman

Yes. I think all of that is very, very accurate. And again, we have seen the situation in Brazil sort of return to what you would consider to be normal in March and April.

Erik Bass - Citigroup

Okay. And I mean as we look year-over-year in terms of the earnings comparisons on a local currency basis, are there any sort of unusual things that we should kind of factor in, in making the comparison? I know you had some tax changes as well as the accounting changes in Brazil that may kind of affect the year-over-year?

Larry Zimpleman

Right, this is Larry. I don’t think there is anything unusual, we had the fourth quarter commentary around Mexico tax changes and we also had the change that we opted to make that greater amortization of the intangible relative to the prev but that was in fourth quarter, nothing in first quarter and nothing that we can see going forward, although of course one never knows.

Erik Bass - Citigroup

Okay, thank you for the color.

Larry Zimpleman

You are welcome.

Operator

Your next question comes from the line of Seth Weiss with Bank of America.

Seth Weiss - Bank of America

Hi, good morning, thank you. If we could talk a little bit about accumulation and the run rate implied by this quarter in terms of how it fits in with your margin guidance of 30% to 32% for the full year. Even after sort of normalizing for the items you mentioned, if we run rate this out, the full year will I believe significantly outperform what your guidance was. So maybe you could just help us think about run rate earnings. Terry, you had spoken about this being a decent run rate for individual annuities, if you could touch on that say which on a normalized basis was running over $100 million that would be helpful as well? Thank you.

Larry Zimpleman

This is Larry, Seth. I suspect both Dan and Terry want to comment. I will just again for those maybe not quite as familiar, I want to drop back and maybe remind everybody that in the outlook call we had at the end of last year looking into 2014, we talked about net revenue growth for the accumulation businesses in that 6% to 8% range and we talked about pretax return on revenue in that sort of 30% to 32% range. Obviously at the moment, the higher equity markets from 2013 give us a if you will a tailwind coming into 2014. So net revenue at least in the first quarter was growing above the top-end of that range.

In our outlook call what we assume is that you have 2% per quarter equity market growth going forward. So if in fact that’s what you have then that 12% net revenue growth going to start to come down a little bit and when that happens I think we are also going to start to come down towards the top end of that range. So that’s a general set of comments looking forward. Terry, do you want to make any further comment on that?

Terry Lillis

No, not on that one Larry, but I think on the what you talk about Seth also was on the variable annuity block business being a little bit higher than we had seen in the past, $34 million this quarter. We see that the variable annuity block has benefited from some higher fees because of the equity market run up and this more than offsetting some of fixed deferred annuities spread compression that we’re seeing. We see that this is very a pretty good run rate on a go forward basis. So that observation of it being a bigger block of business for us on a go forward basis is a good observation.

Larry Zimpleman

And then I’ll ask Dan maybe to comment a little bit for you Seth on full service accum.

Dan Houston

Yes, good morning Seth. On full service accum, it’s refreshing because although we’ve had some benefit from the equity markets, a lot of things we’re working down in the tranches of business itself, you know that we had good retention of existing plans, we also had -- we’ve added roughly 1,500 new plans in the last 12 months. And if you don’t lose many, you are able to add those new plans, you get that flywheel going relative to deposit which all contribute to improving on your margins.

The other note I would make is we’re continuing to see strong investment performance from Principal Global Investors; it’s giving us more product to sell more competitive product which means a higher percentage of our sales going towards proprietary and then as mentioned in Larry’s prepared comments, on the mutual fund side which also is just a very leverageable business, we have really strong investment performance with 17 funds now with 4 and 5-star ratings from Morningstar. So again very, very strong margins and again over the course of the year, I think the best way to look at whether it’s net cash flow or sales or margins is to look on a trailing 12 month basis and I am still very comfortable in that 30% to 32% for RIS accum.

Seth Weiss - Bank of America

Okay, thanks a lot. And Dan maybe just a follow-up on FSA because even assuming kind of that 2% normalized run rate, I am still getting very strong earnings growth there. Should we assume that if markets stay as favorable as they are, there may be a higher reinvest in terms of the expense line in FSA?

Dan Houston

Yes. The demands there are always high, so we constantly are making investments in distribution and technology and of course the mobile technology is a big part of that. We know that we are on the top quartile relative to margin and profitability for full service accumulation, so there is what I’ll call some restrictions in the marketplace.

But again don’t lose sight side of the fact that we are very deliberately focusing on that mid to small size market plan as opposed to the jumble plan, which is going to just naturally contribute to having higher margins than maybe what we had two or three years ago.

Does that help?

Seth Weiss - Bank of America

Okay, thanks a lot.

Larry Zimpleman

Yes.

Operator

Your next question comes from the line of Christopher Giovanni with Goldman Sachs.

Christopher Giovanni - Goldman Sachs

Thank so much. Good morning.

Larry Zimpleman

Hi Chris.

Christopher Giovanni - Goldman Sachs

I wanted to see you could comment on few regulatory areas which thankfully for you guys haven’t been much of a focus, but first at the federal level, given your size and the disposal of the bank, maybe not an issue, but certainly a lot of focus not just in insurers but asset managers as well. So anything you guys are participating in or preparing for from that regards? And then two, at the state level, it’s hard to ignore kind of the influx of the insurers moving into Iowa, and just wondering if that’s having any impact on either trying to approach or talent or issues in terms of how you run new business?

Larry Zimpleman

Yes, those are interesting questions Chris, I appreciate that. This is Larry. Let me again just kind of backup because I think your question is interesting. And one of the things that I think has differentiated Principal over the period since the financial crisis because we’ve had within the industry and across all of financial services, we’ve had very significant, both legislative and regulatory change that has gone on. And the two most noteworthy ones I think would be the Affordable Care Act and Dodd Frank.

And I think to the credit of this management team, I think they’ve done an excellent job in managing and maneuvering around the substantial change that both of those pieces of legislation are going bring to broadly to financial services. So the very effective wind down, a very successful financial wind down of our medical business, difficult as the decision was, I think really position us well.

And then as you noted, the deregistration of the bank, again we're still in the banking business, but we’ve changed the charter of the bank, so that we no longer have Federal Reserve oversight Principal Holding Company. Those are really significant items that may not get full credit for those who maybe aren’t as close to our industry or our businesses.

I’d say going forward, so most of the regulatory things that could snag us for the most part, we’ve maneuvered around. There is still, as you know, there is still the potential around, we don’t know what systemically important definitions are going to be around asset managers. I would say, we’re sort of in the range of somewhere between 25 and 30th largest global asset management company. And I’ll let Jim comment in a minute. So, it’s kind of hard to see that we would be in -- anything approaching the first phase of any definitions of systemically significant.

So, I don’t really worry too much about that. Again, I’ll let Jim comment. On your point about Iowa, that’s an interesting question. Actually to dig into that, what you’ll find is that the company is re-domesticating, but in many cases, and I think this is true both of Symetra and Fidelity & Guaranty Life, they are re-domesticating, but if you actually look at the jobs that they are going to bring here, it sort of numbers in the 100s, it certainly, and they’re going to keep many of their existing -- they’re going to keep their locations and their existing employees. So maybe overtime in 5 or 10 years it has some impact, but we are talking maybe 100 to 200 jobs that they will be bringing here over the next year or two, so I don’t see it as a big factor. with that maybe I will forward over to Jim.

Jim McCaughan

Yes. Thanks Larry. In terms of regulations of assets managers, if you go back to the financial crises, the one piece of the asset management business that was really at the center of the troubles of those money market funds and whether they could preserve the buck. I think appropriately if one looking to what regulators are doing related to asset managers their focus is on money market funds and that’s where the systemic risk might be.

But fortunately and deliberately that’s a pretty small business for us. And we handle client’s cash in appropriate ways. And Larry, talked about our bank in the insurance separate accounts. So money market funds is something we are not at the center of.

If I look at regulation and how it affects our asset management activities, it’s much more the second order affect, how it affects the parties we trade with. So we had new market system came in, in 2007 with a lot of controversy about equity trading. Like all big equity houses we have much more sophisticated metrics and controls now than we used to have to cope with those competitive markets.

And then of course in the bond market, as you know we’re a big high yield manager, we deal in a lot of relatively illiquid bonds like preferreds. I think that the consequences of Dodd-Frank and the fact that the banks are devoting less capital to bond trading are something that we have worked on, upgraded our trading capabilities and essentially we are able to work on it.

So I think, it’s more second order than the first order for us in terms of asset management regulation. And just to close, of course there is a lot going on in Europe. I think that may actually turnout for us with the alternative products we have in Europe and the new regulatory framework there it may turn into an opportunity.

Christopher Giovanni - Goldman Sachs

I appreciate the thoughts. And then one just quick follow-up in the past quarters you have talked about kind of RBC ratio as well as excess capital and didn’t see that in the first quarter press release, so Terry maybe if you could give us an update on where you stand in any changes in your targets there?

Terry Lillis

Sure, Chris. Our targets for long-term for the end of the year for the RBC are still in that 415% to 425% range, as we make estimates during the year and that’s still a pretty good range for us. We were up 439% at the end of the year and we have brought that down purposely because of the $100 million surplus note redemption. So we are back down into that range and expect to be there at the end of the year as well.

Christopher Giovanni - Goldman Sachs

Thank you.

Larry Zimpleman

Thanks Chris.

Operator

Your next question comes from the line of Ryan Krueger with KBW.

Ryan Krueger - KBW

Hey, good morning.

Larry Zimpleman

Hi Ryan.

Ryan Krueger - KBW

Question on the M&A pipeline I guess one thing I am wondering about is, does that comment include opportunities to buy an additional stakes from boutiques that you already own?

Larry Zimpleman

Yes. Ryan this is Larry. Our comment around M&A would be broadly inclusive of any deployment of capital. So if we were to buy a bigger ownership share of some of our existing boutique, obviously that would a deployment of capital. So yes that is part of our commentary when we talk about the kind of M&A pipeline.

Ryan Krueger - KBW

Okay. And then just my understanding was that you had to accrue as if you already own 100% of these boutiques under the statutory accounting regimes. So I guess one, am I right? And if I am would that suggest that when you do buy an additional stakes that actually doesn’t really impact your RBC ratio at all?

Larry Zimpleman

Right. I’ll let Terry to comment on that and then Jim may want to comment as well.

Terry Lillis

Yes, Ryan, this is Terry. The non-controlling interest that we have is reflected as mezzanine equity in both the GAAP and statutory basis. So we already have reflected the obligation that we have to acquire some of these boutiques that can be actually put back to us. So we’ve recognized that already, but as Larry says as we deploy that capital to buy a bigger share of that then we get the earnings in it and we’ll release it as well, but doesn’t have an impact on the RBC ratio.

Larry Zimpleman

Jim, maybe you want to comment about kind of how we view the relationship between what we own versus what each boutique management owns?

Jim McCaughan

Yes. There is two different types and the boutiques that are consolidated, you’re correct that we put in a 100% of the boutique into our income statement. But then we deduct for the minority interest, and so if we buy in some of that minority interest as a positive impact on earnings. The other sources where we’re on a smaller stick for their non-consolidated equity method accounting, in those cases if we buy in some more then we end up with a bigger share on the equity method. And eventually it will trip into consolidation at a point for debate with between our CFO and our auditor.

So that would be the technical side of it. In terms of the business side, we are keen eventually to buy in some of these minority interests, but when we have bought a stake in a boutique, particularly from a founder or an entrepreneurial manager we like them to keep some equity in the boutique for the rest of their careers in effect. And so buying in tends to be related to succession planning. So if a retired partner in a boutique, if he retires, he or she retires then we will buyback their stock and sometimes have limited recycling to the next generation, but that’s more difficult technically. So I think on balance, we view positively that evolution, but we take it in a measured way because we like to keep the equity for alignment.

Ryan Krueger - KBW

Understood. That’s very helpful.

Larry Zimpleman

Yes.

Ryan Krueger - KBW

And then just lastly on the PGI pipeline, you mentioned that was robust, just anymore color on how does it compare to recent quarters and what types of mandates are you currently seeing demand for?

Jim McCaughan

Yes, Jim McCaughan here. In terms of the pipeline, sales so far this year are up high single-digits percent from last year which was a record year for sales. So, so far this year, the sales are looking quite buoyant in the pipeline with its visibility as at least to good as it’s ever been for us. I think it’s the same story as it’s been for the last two years on sales which is increased demand for specialty product.

Terry mentioned yield in the script, and we have a remarkable array of yield buyers, investment capabilities from real estate, other alternatives through high yield equities, high yield bonds preferred securities and all the real estate products. So if you added up, we are really in good demand for investors seeking yield.

Also more broadly specialty products, things like small cap and emerging markets, emerging markets may not be this year’s theme, but they are coming back. And so we are well positioned we believe to continue building that pipeline which as I say has been quite strong this year.

Ryan Krueger - KBW

Great, thank you very much.

Larry Zimpleman

Thanks Ryan.

Operator

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

Mark Finkelstein - Evercore

Good morning.

Larry Zimpleman

Hi Mark.

Mark Finkelstein - Evercore

I guess I wanted to go back to Eric’s question, I think it was on, just looking at the earnings internationally. And I mean again if you look at the AUM growth in particularly in Brazil, very strong kind of outstanding. But it actually doesn't feel like when you adjust from a constant currency basis, it doesn't feel like the earnings are catching up with the AUM growth. And I understand there is amortization changes and there is other things going on. But I guess the real question is are there any dynamics that you are currently seeing particularly in Brazil to start that would suggest that going forward earnings shouldn't keep up with AUM. Are there any market dynamics, [case] sizes, anything that would keep pressures, anything that would influence that?

Larry Zimpleman

This is Larry, Mark. I'll offer a few opening comments and then Luis can comment as well. As I said in my opening comments, if you look at AUM, assets under management, when you look at assets under management over the past five years in BrazilPrev, what you'd see is about a 32% compound annual growth. So, we're at, again as we've said we're at R$90 billion, when we, which is US$40 billion, when we bought into that joint venture in 1999, it had less than a $1 billion in assets. So, I'd say that's a pretty amazing growth rate.

In terms of operating earnings, I think that we're in the range in terms of again five year compound annual growth, we're in the range of 25% per year compound annual growth rate. So, they correlate, but similarly to say full service accumulation, you're not going to see your AUM growth rate be, your OE growth rate be parallel with your AUM, but they're going to be in the same zip code, would be the way that I think about it.

Now on your question about, is there anything in the market that could disrupt change that, there are competitive pressures in Brazil just like any other market, although there is a fewer number of players, basically the significant players are the four -- are the banks, particularly the private banks Bradesco, Itaú.

The thing that might enter into it in the long term is that Brasilprev for the most part has pursued the retail market. And one of the real opportunities that is there to even further the growth of that company, if that seems even likely when it grows to 30% would be to be more active in the corporate pension market in Brazil, as compared to just the retail pension market.

So again, we are only going to do that, but makes sense financially, but that would be an example of where you might see increased growth. But if you try to measure it profits for dollar, you might be able to compromise because again it’s the corporate market as compared to the retail market. But this is an amazing company. And again for those who maybe aren’t quite as familiar, if you want to hear more or see more about the performance of this company, it is part of a publically traded company in Brazil called BB Seguridade. And you can get some great insight into this very fast growing, very profitable company

So Luis, anything you’d like to add?

Luis Valdes

Mark, this is Luis. And truly what you have to keep in mind also, if you are looking the trend of Brasilprev which is a very, very interesting company and as Larry said, the company that is having a very interesting performance in the last five years, just certain things are happening also in Brazil. So first, the interest rate is going down that has been the trend for last five to six years. The market is getting a little bit more competitive. So we have seen a very moderate as well margin compression in Brasilprev but that is a totally normal in that kind of environment going forward.

Does that help?

Mark Finkelstein - Evercore

Yes, it does, thank you. One quick question maybe for Dan. There have been some recent actions Dan, largely kind of on the fiduciary standard, largely directed towards Plan Sponsors relate to sub account options, investment options for participants, it sounds like it’s largely directed at Plan Sponsors in terms of kind of the responsibility, but I am just curious if you see any impact towards your business and the fee structures that you are able collect or PGI is able to collect from on 401(k) accounts?

Dan Houston

Yes, thanks Mark for the question. So really, there is a couple of issues, first is around the appropriateness of the fees; the second is whether or not there is adequate investment options available to the plant participants. And as you know we’ve run a multi-manager, multi-asset class, multi-style approach for over a decade, and that’s even true within our target date funds as it turns out, Principal Global Investors does manage a generous portion of those.

But we have always taken the approach that we are going to put best in class investment managers into those respective line-ups. So you could go right through our target date funds, you can go through many of our standalone investment options and find that we have a mixer of both proprietary and non-proprietary.

As far as fee disclosure and fee reasonableness goes, that gets scrutinized by the advisor and the Plan Sponsor every year, most of those discussions take place annually. And so I don’t see any sort of issues that we are up against that the rest of the industry isn’t, matter of fact, I think we are well positioned because of our willingness to go multi-manager and our willingness to have very adaptable fee schedules depending upon what the Plan Sponsors looking for in terms of services for their participants. Does that help?

Mark Finkelstein - Evercore

Yes, thank you.

Larry Zimpleman

Thanks Mark.

Operator

Your next question comes from the line of Eric Berg with RBC Capital.

Eric Berg - RBC Capital

Thanks very much and good morning to everyone in Iowa.

Larry Zimpleman

Hi Eric.

Eric Berg - RBC Capital

Good morning. My first question is directed to either Larry or Dan whoever feels best suited to answer it. It seems like there continues to be a lot of commentary about how the 401(k) business is going to change in a big way, with some people who are self proclaimed experts and some people are genuine experts I suppose, saying that we’re going to see all sorts of new options, private equity, liquid alts, hedge funds, ETFs, this that it boggles to mind all the choices.

I consider you guys absolutely to be experts on the 401(k) business. If there anyone who knows sort of whether this can happen and to what degree would be you. Where is the business headed from this regard?

Larry Zimpleman

Yes. That’s interesting, this is Larry. That’s a really interesting question. What I would say is that we often forget that the average participant in a 401(k) plan likely doesn’t read the Wall Street Journal every day and they don’t turn on CNBC, Squawk Box or Bloomberg or FOX Business channel or any of the other media that probably many of us on this call look at multiple times each and every day. And so therefore we forget that the average 401(k) investor is in a very, very different world. They are middle income sort of person focused on their job and their family and they know they need to say but they’re clearly not an investment expert.

And I think one of the unique elements of our business model and the platform that we put together including the investment platform is that we get that, we understand that, and we understand that our role is to construct very solid, but also easy, able to understand sort of investment offset. So when people start talking about ETFs and liquid alts and private equity and all of that stuff, I too chuckle a little bit, because it’s really hard to see, how that is something that can be easily explained in a way that the average 401(k) participant is going to have the interest in.

Now I will say, on the other hand Eric, I will say the area where it’s possible those types of options could make some inroads would be to be a part inside some sort of target date structure. So for example, taking 5% of an investment allocation inside of target date fund and then deciding whether some alternative investments like the ones you describe might be a piece of that as a way to perhaps have higher investment performance or more stable investment performance. But that’s something where the participant really doesn’t need to be involved in that and frankly wouldn’t be involved in that.

Terry Lillis

[This is Terry, Eric]. (Inaudible) just a couple of comments and that is remember that we still make available a brokerage window on plans where the advisor or the plan sponsor is keen on providing additional investment options, but most of these plans as said, a lot of trusties meeting 10 to 15 options, 30% of these dollars generally flow to a target date or target risk like fund, there is 30 minute group employee meetings if you got to get that message other too complicated, my last prove point even if we look at non-qualified deferred compensation, which often times funded with life insurance, on those that are funded with, mutual fund options, they are not asking in that target market for exchange traded funds or hedge funds in that place as well.

So I do think it’s more of a after-tax investment option for many of the high wage earners.

Eric Berg - RBC Capital

Last question, second last question is for Jim. Jim, I would have thought given the strength of sales in 2013 that your first quarter 2014 cash flows would have been better than they were. What were the dynamics in the quarter that held back the cash flows?

Jim McCaughan

Yes, thank you for that question Eric. There is a very rapid set of changes going on in clients’ desires and needs. And we’ve talked before about the move by clients away from active core products. That actually wasn't a big factor this quarter, but it's one that we must be vigilant about looking forward.

Our challenge by the way with clients or inactive core products, which may be less attractive in future is to offer them some of these more in demand products that I talked about earlier in the call. That's one element, but in the particular quarter, they are a lot of moving parts and some of this is to do with these kind of inevitable losses of clients’ requirements change.

So, for example, there's no one big theme, but for example we had a withdrawal in our currency group, which was really related to the changed hedging policy of the client. We had withdrawals from stable value, which was I think well known move more into equities, more into target date funds as people gain confidence. We had some profit taking in real estate that leads to an outflow, but it also leads to a happy client who hopefully will come back for more when we’ve got propositions to offer them.

So, I think this will continue to be a theme. The fact that we have the attractive products to replace it with that’s why structurally we feel confident that we'll continue to have positive flows in the institutional space. But I do think it's very important that we beat continued diligence and vigilance about dealing with those clients.

Eric Berg - RBC Capital

Thank you.

Larry Zimpleman

Does that help, Eric.

Operator

Your next question comes from the line of Steven Schwartz with Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

Hey, everybody. Actually the last part was something I wanted to ask about. Jim the clients that you referenced, these changes that you referenced, this is all on the PGI direct side, right?

Jim McCaughan

Yes, that's correct.

Steven Schwartz - Raymond James & Associates

Okay, I just wanted to make sure, that was correct. All right, just a couple, Terry, early on you talked about the pension expense, there was some discussion with regards to the net revenue margin for FSA and others in FSA being very, very high. The guidance that you gave late last year, did that incorporate this lower level of pension expense in it?

Terry Lillis

Steven, this is Terry. Yes it did, it factored in. Now that will come in all year long. In fact, one of the things that we talked about the guidance is that it will also reflect some other changes such as variable income, it's somewhat spotty throughout the year as well. But over the long period as Dan talked about that you'll see this revenue and expense get back to that higher end of that 30% to 32% return on that revenue range.

Steven Schwartz - Raymond James & Associates

Okay. And then on the variable investment income, it's correct that it was all real estate, it was all allocated to guarantee and in individual annuity there is nothing else out there, there is nothing accounted for?

Terry Lillis

Yes, Steven, this is Terry. The variable annuity that we called out was a little bit bigger in the guaranteed businesses, the investment-only, the full service payout, you can actually reflect it there. But there was also some variable income that was spread among all the other businesses, and what we found in those other businesses that there were some partial offsets to that. For example the individual annuity, it got some variable income as well, but that plus a lower effective tax rate somewhat offset some of the higher amortizations of tax. So, we kind of looked at it as what was a good number for each of the businesses and called those numbers out.

Steven Schwartz - Raymond James & Associates

Okay. And then one more if I may, on China, I don’t believe that you are participating in the RQFII process yet, are you intending and I guess if not, why not?

Larry Zimpleman

I’ll let Jim to maybe answer that one Steven.

Jim McCaughan

I think the answer to that is yes, we're looking at it. We have QFII capacity through our joint venture, so it happens to CCB Principal Asset Management which is part of Principal International but we have Principal Global Investors are managing or advising rather on those QFII assets. RQFII is expanding, it's relatively modest as far as global asset managers are concerned, but we do expect to be involved.

Larry Zimpleman

I think one of the -- this is Larry Steven, I think one of the interesting things is that the challenges have been so significant in the Chinese equity market that I think many of the more sophisticated investors are now actually starting to think that we're getting closer to maybe an interesting opportunity relative to Chinese equity A shares. So it will be interesting to see what happens over the next couple of years basically with us.

Steven Schwartz - Raymond James & Associates

Okay. Thank you guys.

Larry Zimpleman

You bet.

Operator

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

Larry Zimpleman

Well, thanks everybody for joining us for our call this morning. As we said, we're very pleased with our strong start to the year and we're really pleased with the ongoing momentum of our businesses. And we look forward to visiting with many of you on the road in the coming months. So, 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 O'clock pm Eastern Time until end of day, May 2, 2014. 18044564 is the access code for the replay. The number to dial for the replay is (855) 859-2056 for U.S. and Canadian callers or (404) 537-3406 for international callers. This concludes today’s conference call. You may now disconnect.

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