The Principal Financial Group (PFG) Daniel Joseph Houston on Q4 2015 Results - Earnings Call Transcript

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The Principal Financial Group, Inc. (NYSE:PFG)

Q4 2015 Earnings Call

February 02, 2016 10:00 am ET

Executives

John Egan - Vice President-Investor Relations

Daniel Joseph Houston - President and Chief Executive Officer

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

Timothy Mark Dunbar - Chief Investment Officer & Executive VP

James Patrick McCaughan - President, Global Asset Management and Chief Executive Officer, Principal Global Investors

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

Luis Valdés - President-Principal International

Deanna D. Strable-Soethout - President-US Insurance Solutions

Analysts

Steven D. Schwartz - Raymond James & Associates, Inc.

Kenneth S. Lee - RBC Capital Markets LLC

Yaron J. Kinar - Deutsche Bank Securities, Inc.

John M. Nadel - Piper Jaffray & Co (Broker)

Ryan Krueger - Keefe, Bruyette & Woods, Inc.

Mike Kovac - Goldman Sachs & Co.

Sean Dargan - Macquarie Capital (NYSE:USA), Inc.

Jamminder Singh Bhullar - JPMorgan Securities LLC

Operator

Good morning and welcome to the Principal Financial Group Fourth Quarter 2015 Financial Results Conference Call. There will be a question-and-answer period after the speakers have completed their prepared remarks.

I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.

John Egan - Vice President-Investor Relations

Thank you and good morning. Welcome to the Principal Financial Group's fourth quarter and full year 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 remind you that all the results follow the new format we outlined on our November 6 investor event. Following the reading of the Safe Harbor provision, CEO, Dan Houston; CFO, Terry Lillis will deliver some prepared remarks, then we will open up the call for questions.

Others available on the Q&A are Nora Everett, Retirement Income Solutions; Jim McCaughan, Principal Global Investors; Luis Valdés, Principal International; Deanna Strable, U.S. Insurance Solutions and Tim Dunbar, our Chief Investment Officer.

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 U.S. Securities and Exchange Commission.

I'll now turn the call over to Dan.

Daniel Joseph Houston - President and Chief Executive Officer

Thanks, John; and welcome to everyone on the call. Today I'll briefly comment on our financial results and certain accomplishments that position us for continued growth in 2016 and beyond. I'll turn the call over to Terry who will provide additional details on results.

As John mentioned, slides related to today's call are available on our website. The key themes are outlined on slide four. I'd characterize 2015 as a good year. We delivered after-tax operating earnings of nearly $1.3 billion despite challenging conditions, such as the strengthening of the U.S. dollar and underperformance of the U.S. equity markets. And we returned more than $700 million to shareholders in the form of common stock dividends and share repurchases. This demonstrates the benefit of our broad diversification by business, by geography, by investment platforms and by asset class.

In 2015, Principal continued to build momentum through outstanding investment performance and expansion of distribution and our solutions based product set. Full year 2015 total company net cash flows of $23 billion were 4% of beginning of year assets under management. As we continue to attract and retain retail, retirement and institutional investors, this helped drive assets under management to $527 billion at year-end, despite a $28 billion drag from foreign exchange.

As other major growth highlights for 2015, I'd point to Principal International's 29th consecutive quarter of positive net cash flows with $9 billion of flows for the year, plus another $21 billion of positive flows from our joint venture with China Construction Bank. On a constant currency basis, Principal International grew reported assets under management by 20% in 2015; double-digit earnings growth for Principal Global Investors and nearly $16 billion in positive net cash flows; record earnings for Specialty Benefits on record sales and a 9% growth in premium and fees; continued traction delivering mutual funds, separately managed accounts and annuity-based income solutions; strong underlying growth in plans, participants and reoccurring deposits for our U.S. retirement businesses and strong Individual Life full-year results as claims returned to expected levels.

As I said, outstanding investment performance continues to be a differentiator and is a foundation for future growth. For example, 44 of our rated mutual funds, or 76%, have a four-star or five-star Morningstar rating. Additionally, as slide five shows, 88%, 89% and 93% of our investment options were in the top two Morningstar quartiles on a one-year, three-year and five-year basis, respectively. And 100% of our target date funds remain in the top two quartiles across all time periods and year-end, driving sales and retention in this key asset class and enabling us to help more individuals achieve financial success. From the strong competitive position, we remain confident in our ability to drive growth in 2016 and beyond.

Next I'll provide some examples of how we continue to execute on our strategy and further position ourselves for long-term growth. The U.S. remains the largest retirement market in the world and Principal has maintained its leadership position for decades through exceptional service, product innovation and strong multi-channel distribution.

With the retail mutual funds business now reporting through Principal Global Investors, Full Service Accumulation is now the majority of Retirement and Income Solutions Fee or RIS Fee. To be clear, the underlying fundamentals of this business remain strong. We continue to grow plan count across plan sizes, adding nearly 1,300 net new plans in 2015 and we continue to be a leader in start-up plans as we focus on expanding employee coverage. The Principal's core target market of small-sized and medium-sized businesses is underserved, creating an ongoing opportunity for us to uniquely serve this market through our network of local offices and drive consistent growth in this segment.

Full year reoccurring deposits grew $1.1 billion, up 7% versus 2014. These growth trends highlight the power of the payroll deduction component of this business. But, more importantly, the work we're doing to advocate best practice plan design with employers and advisers to increase participation in savings rates to better prepare their employees for retirement. Strong alliance firm relationships continue to be a key driver of sales for Retirement Income Solutions, Principal Global Investors, as well as U.S. Insurance Solutions.

In 2015, seven different advisory firms sold more than $1 billion across our offerings, with those firms averaging more than six products per platform. In 2015 we continue to do business with more advisers and get our investments added to recommended lists, platforms and model portfolios. In 2015, we had good traction of plan sponsors adopting our retirement readiness plan design. The primary features of these plans are automatic enrollment and automatic savings rate increases.

Additionally, we launched an innovative income option in the fourth quarter, which offers an in-plan guaranteed annuity to provide more income security for plan participants. While this business remains under pressure from volatile markets, we expect good growth in sales and flows in 2016 and getting meaningful growth in the pipeline.

Two other points I'd like to emphasize, our U.S. retirement business continues to be one of the highest performing businesses in the industry and continues to create tremendous value for the enterprise overall.

Slide six provides an update on fiduciary regulations. With the Department of Labor's fiduciary regulation advancing to the Office of Management and Budget last week, final regulations could be issued as early as March or April. The Principal remains fully engaged to help ensure the final regulations work in favor of individuals trying to save for retirement.

We also remain focused on scenario planning and potential changes to business models with a particular focus on education and guidance, compliance and oversight, provision of investment information, distribution and asset retention. Absent clarity around the final rule, we're not providing a cost estimate at this time. But, based on what we know today, we do not expect a significant increase in our run rate expenses. The Principal has a long history of successfully adapting to complex regulations, our track record reflects the benefit of scale, products and service breadth and top tier investments; all critical to meeting the needs of the market and diverse adviser business models. As with prior regulatory developments, we're well positioned and confident we'll emerge among the winners.

Despite volatility in emerging markets, Principal International continues to demonstrate that we're in the right target markets with marquee distribution partners. As an example, our long-term exclusive distribution partnership with Banco do Brasil, the largest bank in Latin America, provides our joint venture, Brasilprev, access to more than 61 million customers. Customers' confidence in Banco do Brasil and our tax-advantaged individual retirement products helped drive Brasilprev's full year net cash flows to $7 billion. This growth further strengthened Brasilprev's position as the number one private retirement provider in Brazil in terms of net cash flow and assets.

Additionally, we continue to gain traction in the voluntary savings market. For example, on a constant currency basis with Chile, volunteer assets under management increased 17% and voluntary fee income increased 25% in 2015. We remain confident in the long-term growth opportunities of our international operations.

Principal Global Investors, which now includes retail and institutional asset management, ended 2015 with $361 billion in assets under management. Institutional sales were strong in 2015 and the pipeline is robust. To counter the broader shift in demand to more passive or low-cost investment options, Principal Global Investors launched solutions in areas where demand for active strategies remained strong, including multiple new real estate offerings and fixed income strategies. We'll continue to add to our ETF suite in 2016 and beyond, as well as our portfolio of Income Solutions, which will include both funds and guaranteed income options.

In December, the Principal earned the top spot in the category in Pension & Investments' (sic) [Pensions & Investments'] annual survey of Best Places to Work in Money Management for the fourth consecutive year. This award highlights the Principal's strong investment management culture and teams that successfully work to meet client needs every day, and position us to attract and retain top investment talent.

Moving now to our insurance businesses, our focus on small and medium-sized business markets remain a key differentiator, and we continue to find ways to improve the customer experience. In 2015, we piloted our Easy Elect (11:06) group benefits enrollment tool in seven markets with meaningful improvement in voluntary participation, as we continue to help individuals understand the importance of protection to broader financial security.

In closing, I'm optimistic about 2016 and our long-term future despite the continued global macroeconomic volatility. Strong business fundamentals and our ability to focus on things we can control will continue to drive momentum and generate long-term profitable growth.

Terry?

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

Thanks, Dan. This morning I'll focus my comments on operating earnings for the quarter and full year, net income, including performance of the investment portfolio, and I'll close with an update on capital deployment.

The fourth quarter was a solid end to a good year. On a reported basis, total company after-tax operating earnings were $303 million, a 6% decrease from the prior year period, reflecting macroeconomic volatility.

On slide seven you'll see that fourth quarter 2015 earnings per share were $1.02 compared to a normalized fourth quarter 2014 earnings per share of $1.07, down 5%. However, on a constant currency basis, earnings per share increased 1% quarter-over-quarter. For full year 2015, reported total company after-tax earnings were nearly $1.3 billion, a 4% decrease from a record 2014. The lower reported earnings in 2015 were primarily driven by lower variable investment income and the impact from currency translation.

Year-end 2015 return on equity, excluding AOCI other than the foreign currency translation adjustment, was 14.2%. The daily average change in equity markets is an important driver of the revenue for our fee businesses. In fourth quarter 2015, despite a 6.5% point-to-point increase in the S&P 500, the daily average change for the quarter was slightly higher than 1% compared to third quarter 2015. On a full-year basis, the S&P 500 daily average increased approximately 7% in 2015 compared to a 17.5% increase in 2014.

As we look ahead to 2016, if the macroeconomic volatility continues as it has in January, we anticipate a slowdown in revenues in our fee-based businesses. Therefore, we'll focus on things we can control and continue to manage expenses to ensure revenue and expense are aligned. With that said, we will continue to make the necessary investments to keep our competitive edge and drive long-term shareholder value. The fundamentals of our business are strong, and our teams remain focused on execution regardless of the macroeconomic environment.

Now I'll discuss business unit results, starting on slide eight with RIS Fee businesses. Fourth quarter pre-tax operating earnings of $125 million were down 10% from the year-ago quarter. Net revenue decreased 2% from the prior year quarter, primarily due to flat average account values and a decline in variable investment income. Full-year 2015 net revenue increased 1% over 2014. Net investment income decreased due to lower variable investment income in 2015 compared to the higher than expected levels in 2014. On a reported basis, trailing 12-month pre-tax return on net revenue was 31%. After normalizing for the third quarter actuarial assumption review, it was 34%.

RIS Fee had net outflows of $1.6 billion in fourth quarter 2015, despite strong sales of $3.1 billion. Fourth quarter net cash flows reflect exit of a few large cases, due to M&A activity and continued pricing discipline, as well as the timing of funding for new sales. As a result, we anticipate strong net cash flows in first quarter 2016 and full year 2016 net cash flows to be 1% to 3% of beginning of period account values as we maintain our focus on balancing growth and profitability.

Turning to slide nine, RIS Spread quarterly pre-tax operating earnings were $62 million, a 4% increase over the year-ago quarter, primarily due to growth in account values. On a trailing 12-month basis, pre-tax return on net revenue was 56%. The pension closeout business had record full-year sales of $1.8 billion, which are double 2014 sales. The pipeline remains strong and opportunities in 2016 look promising.

Slide 10 shows Principal Global Investors' fourth quarter pre-tax operating earnings were $102 million, a 2% increase over the prior year quarter. On a trailing 12-month basis, adjusted revenue increased 7% to $1.2 billion and pre-tax operating earnings grew 11% compared to the prior year period. Pre-tax return on adjusted revenue increased to 34%.

Despite the industry's bias towards passive investment strategies, Principal Global Investors generated full-year net cash flows of nearly $16 billion, with $8 billion coming from institutional clients. This is a result of outstanding investment performance, and outcome-oriented solutions that are in demand. Additionally, full-year management fees increased 9% over 2014, above the 6% growth in average assets under management, demonstrating client preference for higher fee capabilities that, combined with increased scale, led to margin improvement.

Slide 11 shows quarterly pre-tax operating earnings for Principal International of $67 million. On a constant currency basis, Principal International continues to drive mid-teen earnings growth. On a trailing 12-month basis, Principal International's pre-tax return on net revenue was 38% after normalizing for the third quarter 2015 impairment of intangible assets in Claritas.

Moving to slide 12, Specialty Benefits' quarterly pre-tax operating earnings were $57 million, a 29% increase over the year-ago quarter. Fourth quarter premium and fees grew 8% compared to the prior year quarter, and the overall loss ratio remained favorable at 62%. These are very strong results, even in a seasonally high fourth quarter, due to our focus on the small-sized and medium-sized business market and disciplined profitable growth.

As shown in slide 13, Individual Life pre-tax operating earnings were $30 million for the quarter. Despite the claims experience that was in line with expectation, this is at the low end of our expected range for the quarter, partially due to lower variable revenue. However, full-year pre-tax operating earnings growth was strong year-over-year. For the quarter, total company net income was $254 million, which includes realized capital losses of $48 million. After-tax net credit related losses of $5 million were slightly better than expected. The losses related to the hedging activities were predominantly due to interest rate and equity market changes. Full-year credit-related losses were $20 million, a 65% improvement over 2014 results. Unrealized gains were $1.9 billion, and the portfolio ended the year with a net gain of $1.1 billion.

Our investment portfolio is high quality and diversified by industry, geography, property type and individual credit exposures. In addition, we have always had a disciplined approach to asset liability management, and therefore, we're not forced sellers during stressed times.

At year-end 2015 our energy portfolio carrying value was 95% of par value. Our overall exposure to the energy sector represents 5.7% of our total fixed maturity portfolio and 4.2% of our total U.S. invested assets as of December 31, 2015. Our market value exposure in high-yield energy companies as of year-end 2015 was $280 million, or less than one half of 1% of total U.S. invested assets.

Despite the continued market volatility in the beginning of 2016, we remain confident about the strength of our investment portfolio. As outlined on slide 14, our capital management strategy remains balanced and is focused on building long-term value for shareholders. Our fee-based businesses drove nearly 70% of 2015 normalized earnings, which generates higher levels of deployable capital and provides greater financial flexibility. In 2015, we deployed $1.1 billion of capital, which represented nearly 90% of net income.

Our balanced capital deployment includes $441 million in common stock dividends, $355 million in strategic acquisitions, and $275 million in share repurchases. The full year common stock dividend was $1.50 per share. This is a 17% increase over full-year 2014 as we continue to increase our payout ratio. Additionally, last night we announced a $0.38 per share common stock dividend payable in first quarter 2016.

While we continue to explore strategic acquisition opportunities, the current equity market volatility is also providing an opportunity to enhance shareholder value through execution of the remainder of our share buyback authorization. In 2016, we expect to deploy $800 million to $1 billion of capital in a strategic and balanced manner to enhance long-term value for shareholders.

In closing, despite ongoing macroeconomic volatility, we remain confident that our diversified business model positions us well for future growth.

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

Question-and-Answer Session

Operator

The first question will come from Steven Schwartz with Raymond James & Associates.

Steven D. Schwartz - Raymond James & Associates, Inc.

Hey. Good morning, everybody. I wanted to follow up actually, Terry, on your last statement with regards to acquisitions. And maybe you can give us a sense of what the tone is out there. Obviously, your stock is cheaper. That's more attractive. On the other hand, public valuations are down, but then I wonder if private sellers look at those valuations and say, no way, and you're finding that they're pulling back.

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, Steven, this is Dan. Thanks for the question this morning. And, of course, this has a lot to do with how we're going to deploy our capital for the best interest of our long-term shareholders. And with that maybe I'll ask Terry speak specifically to valuations on potential acquisitions.

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

Yeah. Thanks for the question, Steven. As we talked about this before, we always look at it as a balanced approach to our capital deployment strategy to enhance long-term shareholder value. As we've stated before, we have more fee-based businesses. Predominantly pretty close to 70% of our earnings are coming from fee-based businesses, which is less capital-intensive. As a result of that, we have an opportunity to deploy more capital. And if you look at what we talked about historically, only about 35% of our capital's needed on organic basis, that leaving close to 65% available for other deployment opportunities.

Now, that said, we think that we need to have a balanced approach. We are on track to increase our dividend as a percent of that total net income percentage, closer to 40% over the longer period here. But, as you look at share buybacks, and you look at M&A opportunities, the M&A opportunities are still very important to us. We want to have an active pipeline. We want to continue to look at that. But, as you say, with the valuations as low as they currently are, it makes sense for us to actually deploy capital in terms of buying back our shares, because we do believe that they're undervalued at this point in time. It's a very volatile market, so we have to have that disciplined approach. But, again, we're going to continue to look at capital deployment strategies, and we said $800 million to $1 billion this year. We expect to have a very balanced approach as we've done in the past. But, as you said, the opportunities right now are very enticing for the buyback program. We actually have $75 million of authorization that's outstanding at this point in time.

Daniel Joseph Houston - President and Chief Executive Officer

Steven, was that helpful?

Steven D. Schwartz - Raymond James & Associates, Inc.

Yes, it was. Thank you, a little nuance there. And then just one more quick one, Terry, do you know what the unrealized losses on the energy BEIG (24:55) portfolio?

Daniel Joseph Houston - President and Chief Executive Officer

Maybe we'll have Tim Dunbar go ahead and take that, he's on the call as well, our Chief Investment Officer.

Timothy Mark Dunbar - Chief Investment Officer & Executive VP

Sure. So, Terry, I think mentioned that we had about $280 million of GAAP exposure in high-yield energy sector. And that's at about $0.70 on the dollar. So, our book carrying value would be around $400 million.

Steven D. Schwartz - Raymond James & Associates, Inc.

Okay. Thanks, guys.

Daniel Joseph Houston - President and Chief Executive Officer

Thank you. Appreciate it.

Operator

The next question will come from Eric Berg with Royal Bank of Canada.

Kenneth S. Lee - RBC Capital Markets LLC

Hi. This is Kenneth Lee on for Eric Berg. Just had a quick question in terms of the PGI institutional flows. It looks like there was a bit of a slowdown in the fourth quarter. Just want to get a better sense of what you're seeing in terms of the various boutique managers in terms of their flows, whether there's a risk (25:49) emerging market debt or whatnot. Thanks.

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, Kenneth. Thanks for the question. The one area that we look at that really had really strong results for the quarter clearly was around Principal Global Investors. I think about that in the context of Jim coalescing a mutual fund team along with the institutional team. When you look at the broader industry, we've seen actually a lot of declines, significant declines, negative net cash flow. So, frankly when we evaluate Principal Global Investors and Jim's leadership in this area, we think we've got a very strong result for the quarter and certainly for the year. But, Jim, uncertainly, you can add some color to that.

James Patrick McCaughan - President, Global Asset Management and Chief Executive Officer, Principal Global Investors

Yes, I'd add a couple of things to that. The first is that the decline in net flows in the second half of the year was really around some of the large cap equity strategies, particularly at Columbus Circle and Principal Global Equities, where our clients have been looking at the passive alternative and going for lower fee capabilities. Now, as you saw from our flows, though, we more than replaced that with the higher added-value strategies that we really specialize in, which range through high yield, real estate, small cap, areas that are less efficient markets. But, net-net, it was a slightly down but still positive fourth quarter. And I'd emphasize that because many of our peer group are seeing negative flows. One area where the peer group's seeing negative flows is sovereigns, particularly central banks and sovereign wealth funds in Asia and the Middle East, which are obviously under severe financial pressure. We have some business in those areas, and we have not seen those outflows yet, because we are seeing much stronger investment performance, and we've tended to be among the managers that got retained. We're hopeful that'll continue, but obviously, there are no guarantees.

If I look at the pipeline, which I think was partly where you were going, we have had a very active last two months, including over the holidays and in January. And that is unusual. Usually the institutional market globally quietens down during that period around the end and beginning of the year. But, we've seen quote activity and indeed funding looking really quite positive, and I have to say we're feeling pretty optimistic about the flow potential, and it's related to the investment performance that Dan and Terry both mentioned.

Kenneth S. Lee - RBC Capital Markets LLC

Okay. Great. And just a quick follow-up, just to clarify, it sounds as if, because of the outflows in relatively low fee rate products and inflows in high fee rate products, that means like on a revenue-adjusted basis, it sounds like it's a lot more positive than the flows would suggest. Would that be a fair statement?

James Patrick McCaughan - President, Global Asset Management and Chief Executive Officer, Principal Global Investors

Yeah. Yeah, I think that's right. And Terry identified some of the numbers that point to that. We're seeing – it's not universally so, but we're seeing moves towards some of our more high added-value strategies. And it is a very tough environment in terms of fee negotiation. We do not cut fees heavily because we are going to be eventually capacity-constrained a long way out and we need to get the business at attractive revenue rather than necessarily at all costs. We're much more driven by revenues than we are by AUM.

Kenneth S. Lee - RBC Capital Markets LLC

Understood. Thank you.

Daniel Joseph Houston - President and Chief Executive Officer

Kenneth, thanks for the question. Please give Eric our regards.

Kenneth S. Lee - RBC Capital Markets LLC

Will do.

Operator

The next question will come from Yaron Kinar with Deutsche Bank.

Yaron J. Kinar - Deutsche Bank Securities, Inc.

Good morning, everybody. I'm a little confused and was hoping to get some clarification. Terry, you had talked about the point-to-point increase in the S&P this quarter really averaging, I think, less than 1%. But, the way I thought I understood it last quarter was that you had compared the point-to-point decrease in the S&P as opposed to the daily average change relative to expectations. So, was I not thinking about this correctly last quarter, or how should I think about it going forward in terms of the impact of the S&P to normalized earnings?

Daniel Joseph Houston - President and Chief Executive Officer

Hey, Yaron. Thanks for the question. And clearly the daily average is what ultimately drives the revenue, but I'll have Terry go ahead and add to that.

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

Yeah, you're absolutely right, Yaron. As you look at the impact on the fees that occur, it's really more the daily average asset (30:18). And we use that as a proxy for what the movements and the impact to our account values. So, you really look at the average account value from one period to the next period.

Now, actual performance of those assets also come into play versus the proxy that we use. Last quarter we talked about a significant drop point-to-point in the S&P 500, that was down 6.7% third quarter over third quarter. That has an impact on the deferred acquisition costs and that's what we're referencing last quarter.

Now, we have an expectation that you'll have anywhere from a 2% to 3% positive impact in that point-to-point time. So, if you look at that 2% to 3% versus, say, down nearly 7%, you're talking a 9% to 10% drop that impacts the deferred acquisition model. Now, you go forward to this quarter, now, the point-to-point was up 6.5%, as you pointed out. Now, that has an impact on the expenses, but the differential between what the expectation and what the actual point-to-point was, was much smaller this quarter and didn't have as significant of an impact.

Again, that S&P 500 is a proxy for the movement in our actual assets. The actual asset movement was also impacted by – the domestic markets were strong in the fourth quarter. However, international markets and maybe some of the fixed income investments weren't quite as strong. But, I hope that helps. It is really two different things: an average account value and the average S&P go hand-in-hand, and that typically ties to the fee base. Whereas, the expenses associated with the acquisition are more of a point-to-point. Now, if you look at the deferred acquisition costs for this quarter, they were right in line with what our expectations would be for every one of our businesses. Hope that helps.

Yaron J. Kinar - Deutsche Bank Securities, Inc.

Very much so. Thank you. And then I had one follow-up, and I apologize if I missed it in your prepared comments, but the G&A expenses and RIS Fees were a bit high. Was that a timing issue or are you investing more significantly in the platform? Could you maybe give us a little more color on that?

Daniel Joseph Houston - President and Chief Executive Officer

Yeah. I think there is just a little bit of noise there. And again, we make ongoing investments in the platform to make sure that we're viable. You may have seen that we've introduced a new in-plan annuity, which we're excited about. That's just one example of that sort of investment. But with that as a backdrop, Nora, do you have anything specific to add as it relates to the spike in...

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

No, if you look at quarter-over-quarter, comp and other, if you see that line item, actually up only $5 million, 2.5%. So, that's the line I'd focus on. And certainly to Dan's point, we're going to continue to make investments in technology, but that's going to be an ongoing investment, not a point in time.

Yaron J. Kinar - Deutsche Bank Securities, Inc.

Got it. Okay. So there's just maybe a degree of seasonality there?

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, I think that's correct. Yeah, nothing to call out, certainly. Yaron, thanks for the question.

Yaron J. Kinar - Deutsche Bank Securities, Inc.

Thank you.

Operator

The next question will come from John Nadel with Piper Jaffray.

John M. Nadel - Piper Jaffray & Co (Broker)

Hey. Good morning, everybody. I've got one question on a data point and then a couple of bigger picture questions for you, if I could. The question that I have on the data point is variable investment income. On a consolidated basis, Terry, how much did that contribute to the fourth quarter results and how would that compare with a more typical quarter?

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

John, thanks for the question. As you talk about variable investment income, there is a lot of components that go into that. What I would talk about in terms of variable investment income is probably prepayment activity that occurs on our mortgages and fixed income investments, as well as some real estate sales that we have that also impact it.

And typically, I'd look at on a quarter-by-quarter basis that we benefit from this variable investment income activity by $0.03 to $0.07 a quarter. In 2014, it was well above average because as you're well aware, everybody was anticipating higher interest rates, and so the prepayment activity was really, really high. We try to call out the variable investment income when it distorts the run rate that is actually in any particular quarter.

Now, if you look at this particular quarter, the expectations were right in line with what we would have expected. We saw probably a benefit of variable investment income around $0.04, little over $0.04, so it's right in line with our expectations. So, there was no reason to call it out. Now, a year ago, it was slightly higher. And if you actually look out on a run rate basis, we called out probably close to $0.08 – probably $0.06 to $0.08 a year ago, which was well above our expectations for the year. Hopefully that helps, but I would expect it to be right in line with expectations this quarter.

John M. Nadel - Piper Jaffray & Co (Broker)

Okay. That is helpful. Thank you. And then I have a question on Brazil. In Principal International net flows remain very strong. But, they have slowed quite a bit, if you look at it versus the last – maybe even just a year ago. Net flows are about half the level as they were a year ago. I'm just so curious about what's your view of the economy there is, what your outlook is for ongoing growth there and whether we should expect that that continues to grow but at a much slower pace.

Daniel Joseph Houston - President and Chief Executive Officer

Yeah. John, thanks for that question, because if you think about Brazil and India and China and Southeast Asia, those are really our big growth engines for Luis and his team. As you noted from the script and other conversations, we think we have a excellent partner in Banco do Brasil. Brasilprev, as you know, has some very favorable tax treatment of the savings vehicle, and there is this flight to quality right now and so that's playing to our benefit. Having said that, you're correct, some of those flows are lower than they have been historically. And with that, maybe I'll have Luis provide some additional color on the specificity around those flows in Brazil. Luis?

John M. Nadel - Piper Jaffray & Co (Broker)

Thanks a lot.

Luis Valdés - President-Principal International

John, good morning. This is Luis.

John M. Nadel - Piper Jaffray & Co (Broker)

Good morning.

Luis Valdés - President-Principal International

Talking about total net customer cash flows for PI, during this year we put $9.3 billion in comparison with $13 billion last year. If you're putting this comparison in a constant currency basis, it's a minus 5%. And we're comparing with our record year in 2014. So I would say that the most important part of these differences at currency we had we were facing a 30% depreciation on average. Talking about Brazil, I mean, Brazil continues performing very well. We put a $6.9 billion in net customer cash flows. As Dan mentioned, our JV with Banco is going very well. We're going to continue facing some volatility and some headwinds, but all-in-all, all our companies and the fundamentals of our business out there continues very strong.

Daniel Joseph Houston - President and Chief Executive Officer

Hopefully that helps. Maybe I'll ask Jim to opine a bit on the Brazilian economy, maybe more broadly in its recovery and maybe where we stand. I think that was the latter half of your question, John.

John M. Nadel - Piper Jaffray & Co (Broker)

And if I could, my last question was actually going to be for Jim, and that's just what probability are you putting at this point, Jim, on a broader turn in the credit cycle beyond just energy? I'm just curious in your outlook.

James Patrick McCaughan - President, Global Asset Management and Chief Executive Officer, Principal Global Investors

Very good. Thanks. Okay. Now, thank you. On the last point, I would say this is one of the very important questions on the U.S. and the global economy. And at the moment we're seeing the problems in credit really associated with the energy companies, the miners and to an extent companies with very large leverage businesses in emerging markets as it's quite a tight little part of the credit market. The way that that would become contagion would be if banks have been foolish enough to get over-committed in those markets. If that happens, you're going to see a broader credit contagion, and indeed a lower flow of credit in even the U.S. economy.

Your question really was what probability do I see attached to that. We've discussed this at some length within our organization. We have people with a lot of different skills on this. But, if I can distill it, I would say in the next 12 months, that's probably a 20% probability, it's still a negative tail risk. It is most likely that the U.S. and global economy continue growing albeit at a slower pace than it was before, but we need to be ready to defend if contagion happens and you end up with a worse economy.

In particular, on Brazil, I think what's gone wrong in Brazil apart from the obvious political process and commodity prices is, like China, they kept growth going for quite a long time by expansion of credit, particularly to state-owned enterprises for infrastructure investment and so on. That expansion of credit has probably got to about the limit. So, you're into a bit of a debt deflation situation.

The IMF, I think it was, just brought down their growth estimate or their recession estimate this year to in excess of 3% from 1%. I think that's quite possible. I think you're going to see another year of pretty severe recession in Brazil, come what may, but this is part of a deleveraging process. And we've seen this with economies that slow a lot, because people are not spending, there's quite a lot of cash available. And Principal International is taking maximum advantage of that right now. This will pass, it's a phase. It could take a while, but it's one where our business can do, frankly, okay.

Daniel Joseph Houston - President and Chief Executive Officer

Very good. Thanks, Jim. Hopefully that helps, John.

John M. Nadel - Piper Jaffray & Co (Broker)

Thanks, no that...

Operator

The next question will come from Ryan Krueger with KBW.

Ryan Krueger - Keefe, Bruyette & Woods, Inc.

Hey. Thanks. Good morning. Can you give a little bit more underlying color on RIS Fee, both deposits and withdrawals? And specifically, recurring deposits, I guess, were down about 5% year-over-year. I'm sure part of that was impacted by lower asset values, so I'd appreciate any more color on kind of underlying activity.

Daniel Joseph Houston - President and Chief Executive Officer

My take on that, Ryan, is that FSA is in really good shape. When I think about Full Service Accumulation and the underlying drivers of that business, and when I think about it in the context of sales and net cash flow and ability just to grow that block of business, so we really, really feel strongly that it is a strong contributor to success. But, having said that, Nora is our resident expert, can speak specifically on some of these drivers. Nora?

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

Sure. Good morning, Ryan. So, again, total recurring deposits were up 7% year-over-year, that's $1 billion number that I think Dan mentioned in the script ahead of time. What you may be focused on is the quarter-over-quarter, which was up only about 3.2%. There's some noise there. We have some DB plan deposit noise there. If we strip that noise away and we don't expect that to recur, and we look at those core deferrals, so look at the core deferrals and match, that's actually up really strong quarter-over-quarter, closer to 11%, little bit north of 11%. So, both with regard to quarter-over-quarter and trailing 12 months, we're seeing very strong growth in those recurring deposits.

We're also seeing very strong growth with regard to the number of participants that are deferring. That percentage is up over 8%. So, when you look at the fundamentals of this business, whether you're looking at plan count, again, we saw that increase across all of the segments; whether you're looking at startup plans in the industry, we're now seeing startup plans 17% above pre-crisis levels. So a huge opportunity in that part of the market that is completely underserved because 50% or so of those smaller employers do not today have worksite access to retirement. We play in that space extremely well and one of the leaders in that startup plan market.

So the underlying fundamentals here are really, really strong. When you look at the fourth quarter lapses, handful of large cases, again, we're going to win and lose on an M&A basis, we happened to lose a couple where the plan went to the acquirer, but the good news there is the momentum we're seeing. I might add one other thing in Q4 that we saw is one plan that came in as a sale and a very large plan, north of $500 million, is not going to fund until 1Q. So, once in a while, as we've mentioned before, we're going to get those timing issues.

But if you strip out those timing issues and you look into Q1, we're seeing very significant momentum there both with regard to our sales pipeline, good momentum in the pipeline and we're also seeing good momentum with regard to retention. So, as we look into 2016, certainly we don't want to get into the prediction business, but we would anticipate a pretty strong, positive net cash flow in Q1. And we would look, as Terry said, to be back in that range of 1% to 3% of beginning of year account values with regard to net cash flow full year.

Daniel Joseph Houston - President and Chief Executive Officer

Ryan, just a couple of additional comments. When I think about just the America marching back, why do you look at group benefits or you look at our small-sized to medium-sized retirement businesses, low unemployment rates are causing – will start take an increase in wages, we start seeing an increase in matching contributions, we see employers competing for workers, which means they may strengthen, adding a dental benefit, adding a 401(k) match, all of those things contribute to growing long-term revenues for the organization. But, again, I'd highlight one of the statistics that Nora threw out. We are now seeing new plan formation at a higher level than we saw it in last – in that 2007/2008 timeframe, so a really good time for small business in the U.S.

Ryan Krueger - Keefe, Bruyette & Woods, Inc.

Very helpful. Thank you. And then just a separate question. I think, Dan, you mentioned this at one point. I just wanted to get an update. Do you still see a potential opportunity to free up some capital in your Closed Block within Individual Life?

Daniel Joseph Houston - President and Chief Executive Officer

We absolutely do see that as an opportunity. That's a lever that we could pull. And while I'll ask – Deanna Strable is here, and I'll ask her to tell opine on what the nature of that might look like.

Deanna D. Strable-Soethout - President-US Insurance Solutions

Yeah, just a couple of comments on Individual Life. Obviously, we've been very focused on making sure we're meeting our profitability targets both on a return basis and on earnings perspective. Even though earnings were a little bit soft in the fourth quarter, I think very strong growth when you look year-over-year.

Specific to capital, obviously, there's a number of things that we continue to look at to make sure that we're pulling those levers when and if they make sense. And the Closed Block is one that is currently does provide an opportunity, and we're just working together with Terry and Tim to determine when the right time might be to do that. Obviously, we want to have a place to deploy that. The rating agencies are more concerned on making sure we keep that within our life insurance company perspective. And so, again, I think it's probably more of a matter of when rather than if. But, we do think it's an opportunity that we could pull at some point in time.

Ryan Krueger - Keefe, Bruyette & Woods, Inc.

Can you help us – any sort of metric to help us size how big that could be?

Deanna D. Strable-Soethout - President-US Insurance Solutions

A lot of it depends on the timing of it. But, I would say it's multiple hundreds of millions of dollars that are really trapped up in that perspective.

Ryan Krueger - Keefe, Bruyette & Woods, Inc.

Okay. Great. Thank you.

Daniel Joseph Houston - President and Chief Executive Officer

Thanks for the question, Ryan.

Operator

The next question will come from Michael Kovac with Goldman Sachs.

Mike Kovac - Goldman Sachs & Co.

Hi. Thanks. As you discussed within the retirement fee-based business, because expenses were really only up 2% year-over-year, the topline brusher obviously drove margin pressure. Can you talk about some of the specific drivers that you see going forward in 2016 in order to sort of slow that margin compression, specifically thinking about the expense side?

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, that's a good question. Frankly, I wouldn't limit that to just a conversation about full-service accumulation or RIS. That's a company-wide item for us. We're trying to constantly strive the right differential between our growth in revenues and our growth in expenses. We review that on a constant basis; a lot of company-wide initiatives to go right at that specific point. So, again, not limited to RIS, but I know that's where your question was. So I'll ask Nora to maybe fill in some of the blanks in your question. Nora?

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

Sure. And this is not going to surprise you, but one of our priorities is to make sure that we actually do continue to invest for long-term growth. So, we're going to continue to balance the need for efficiencies, which we are gaining. We're going to continue to focus on operational efficiencies. But, we've got an equal focus on making sure that we're investing for that long-term growth. So, what you're going to see is, and we've given guidance on margin, and that guidance on margin gives us the ability to, what we believe, strike the right balance between those two things, because the last thing we want to do is shrink to greatness. We've got a very sharp focus on a lot of – when you think about digital, when you then about self-serve, when you think about the opportunities in the small to medium business market, that's our sweet spot. So, we're going to play there, and we're going to play there in a way that balances growth and profitability.

Daniel Joseph Houston - President and Chief Executive Officer

It's a really good question. The other area I think about, the investment we're making in technology well beyond cyber security controls, but it gets into having a digital strategy that better enables our customers to do business with us, better support our adviser community, better support our participants, that's an investment we can't afford not to make. And the good news is we can take that same investment and leverage it throughout the organization. So something that works in retirement is something that we'll likely deploy internationally with Luis and his team. And we've also demonstrated we can leverage that across Deanna Strable's U.S. Insurance Solutions. So, a good question. We appreciate that, Michael. Did you have a follow-up?

Mike Kovac - Goldman Sachs & Co.

Yeah. If I could, a follow-up here, on the Department of Labor, I know you're not giving any sort of large updates to the compliance cost in terms of sizing. But, have you begun spending some of that today? And I'm wondering sort of further beyond compliance costs if you're preparing anything in terms of product shifts or conversations you're having with your distribution partners in terms of sort of preparing for it in the coming months.

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, it's a question that I'm surprised it took this long today to get into this question. We know it's top of mind for investors, and we fully appreciate that. I guess where I start on this question is, we've been very active with the trades, we're active with DOL and Congress in better understanding the implications it has as it relates to this fiduciary definition. But, from our perspective, job one is to protect the interest of the American savers without taking away very valuable education and guidance, which frankly most workers are very dependent on. So, we've looked at it at basically three different inflection points.

One is that initial selection of the investments. We think that we've got that appropriately identified and the steps that we'll have to take in order to work with advisers. And so, again, we think that that's very manageable. The second is the routine inquiries that we have among our plan participants, they're inquiring about a hardship loan or a standard loan or trying to get some investor education and understand perhaps better the target date investment options. Again, we think that within the definition there's a way to work with that, we think there's viable solutions.

The third is around those job changers and retirees. Again, we all know they have three options. One is to leave it in the plan. Our reading of the understanding of the rule today would cause perhaps more people to leave it in the plan. There are some benefits from that to the participant, perhaps fewer investment options, but at the same time, they may very well find that the expenses are lower because it's been aggregated with a large pool of dollars. The second is the rollover IRA, either with Principal or another third-party. And then, lastly, is a cash-out, which we think is a bad idea for all the obvious reasons. Again, we come back to mapping what that scenario looks like as people are faced with those decisions. And we think there are going to be necessary disclosure and additional steps that will have to be taken. But, we've got that fairly well triangulated in terms of the impact.

So, we know there's more guidance, there's more education, there's more disclosure. We have a large team of people that are hammering away on this issue. We don't think it's a material change to our run rate related to expenses. And like you we're very anxious about the next 60 days to 90 days to see what OMB produces and back to the DOL and what that might start looking like. And I kept that at a fairly high strategic level. But, with that as a backdrop, I'll throw it over to Nora to see if she's got any additional color.

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

Yeah, just a quick comment. You asked about third-party distribution, and as you well know, our model is hugely diverse. We go across all the channels, all the firms, so we're out there. We actually have a very large group, a team that's been working on this for a number of months doing scenario planning and engaging with our third-party distribution partners. And the one result of those discussions is it's pretty clear to us, and again, we're speculating on a preliminary reg here, but it's pretty clear to us that there's going to be an array of adviser business models coming out of this change if and when this reg becomes final.

Because between ERISA and this new reg what you see is a huge amount of optionality, many exceptions, many exemptions, and so various firms and various advisers and various broker dealers are going to take different routes from our perspective, whether they go the fiduciary route with a third-party advisory service or the non-fiduciary route with a third-party advisory service, whether they use the best interest contract, there's a lot of optionality. What we're doing is working with them and making sure that we're putting the systems in place to be able to service those diverse operating models across our various channels, firms and advisers. And we feel pretty optimistic that at the end of the day somebody like us who's got the scale and the expertise and the discipline to really work channel-by-channel, firm-by-firm, is going to have a really elegant solution to an unbelievably complex set of regulations.

James Patrick McCaughan - President, Global Asset Management and Chief Executive Officer, Principal Global Investors

And can I just add something? It's Jim here. Jim McCaughan. Can I add that with our investment performance and our multi-asset capabilities, if in the market generally platforms find it harder to offer in proprietary products, we have some very strong substitutes there that we can sell into other platforms. We would see this as an opportunity, depending on how it all develops, to expand our defined contribution investment only business.

Daniel Joseph Houston - President and Chief Executive Officer

Very good. Michael, hopefully that helps.

Mike Kovac - Goldman Sachs & Co.

Thank you.

Daniel Joseph Houston - President and Chief Executive Officer

Very good.

Operator

The next question will come from Sean Dargan with Macquarie.

Sean Dargan - Macquarie Capital (USA), Inc.

Thanks, and good morning. Just one housekeeping item. Terry, forgive me if you said this already, but did you say if you've bought any stock year-to-date; and if so, how much?

Terrance J. Lillis - Chief Financial Officer & Executive Vice President

Sean, we did not state that. I just said that we had an authorization still outstanding of $75 million. But, I did also say that the valuations are pretty attractive at this point in time, unfortunately, but it does look like there's an outstanding authorization – we do have an outstanding authorization of $75 million and we'll also talk with the board of directors about any future authorizations that may occur.

Sean Dargan - Macquarie Capital (USA), Inc.

Okay. Thanks. And then, going back to the DOL but away from fiduciary duty, there's a proposal, I believe it's from the DOL, to allow small employers to pool together to offer 401(k) plans to their employees. Is that a net benefit to PFG or is that a challenge for you guys, because the size of the plans would then be bigger than the SMB kind of niche that you have?

Daniel Joseph Houston - President and Chief Executive Officer

Thanks for the question, Sean. We're actually on the record. We would support that multiple-employer plan model. We have plans in order to support that. The other part that came out of the White House was to provide some additional tax credits and some additional incentives for small-sized to medium-sized employers to adopt a plan. So, I think clearly this is an example where the administration is recognizing that an employer-based retirement approach is the right approach, and delivered through the private sector. So, again, we like seeing those. Now, having said that, I'll have Nora add any additional comments.

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

No, well said. We've been part of the movement to get those two very things on the agenda and we were really pleased to see that come out of the White House a couple of weeks ago.

Sean Dargan - Macquarie Capital (USA), Inc.

Okay. Thank you.

Daniel Joseph Houston - President and Chief Executive Officer

Thanks, Sean.

Operator

The next question will come from the Jimmy Bhullar with JPMorgan.

Jamminder Singh Bhullar - JPMorgan Securities LLC

Hi. So, the first question's just on the operating environment in the 401(k) business and just your outlook for flows. Obviously, your commentary seemed pretty positive, but withdrawals picked up a lot in the fourth quarter, and you mentioned M&A, but how much of this was because of competition and just competitor behavior on fees and other things?

Daniel Joseph Houston - President and Chief Executive Officer

Sure, Jimmy. So, thanks for the question. Nora had commented on those earlier. I'll have her repeat her comments relative to the operating environment and flows and withdrawals and some of the color around that. The M&A environment is always there. But, equally as important to M&A, I think about half of those withdrawals actually were attributable to plan terminations, and that means they just no longer have a plan. And that's going to happen in the small-size to medium-size employer space and you can't be as vibrant as we are in that marketplace and not have a few plans terminate after year two, three, four or maybe five. But, with that, maybe I'll have Nora go ahead and add some additional color.

Nora Mary Everett - President of Retirement and Investor Services and Chairman of Principal Funds

Sure. No doubt, it's competitive. It's always been competitive. What we're seeing in that small to medium business space, the core SMB space for us is that if we actually peel that back on a net cash flow basis for 2015, we were actually well within our beginning of year 1% to 3% net cash flow. So within that space that we've been talking about, stripping out some of the larger plans from a net cash flow perspective, we are proving up that we're extremely competitive. And there are two things going on there. One is we've got tremendous investment performance in that target date suite, and we've got a huge lineup with regard to target date, whether you want primarily passive, whether you want primarily active, whether you want it in a funds form or a CIT form. So, between the choice in the investment performance, we are highly competitive in that space. And then you add to that the fact that we're price competitive, and that's why we're seeing those kind of positive net cash flows year-over-year in that core small to medium business segment of the industry.

Jamminder Singh Bhullar - JPMorgan Securities LLC

Then on group benefits, the margins are pretty good. To what extent do you think that'll sustain? I think your margins, especially in group life and disability were just very strong this quarter.

Daniel Joseph Houston - President and Chief Executive Officer

Yeah, what did I tell you? It didn't happen by accident. Deanna and her team have just done a superb job managing that group benefits business. Deanna, some additional comments?

Deanna D. Strable-Soethout - President-US Insurance Solutions

Yeah. I think I'd make a comment. I think you can't just look at the fourth quarter. Obviously, we have some seasonality that makes the margin in the fourth quarter a little bit higher because of dental results. And you're right our Group life loss ratio was probably at an unsustainable level. So I'd say probably if you just look at the fourth quarter margins, probably not sustainable, but I think if you look at the full-year margins, we feel good about those results, and ultimately can see that there's fundamentals that can carry that into 2016.

I think as Dan says, I think the team's done a really, really good job with this business. We had record sales in both group benefits and individual disability record retention, record premium, record earnings. And I think when you look at that relative to some of our peers in this business, I think we really do have the fundamentals to drive not just growth but profitable growth, which is really important in this business. So, hopefully that helps give you a little bit of color on the margin, but I think full-year margin we feel good about that sustaining.

Jamminder Singh Bhullar - JPMorgan Securities LLC

Thank you.

Daniel Joseph Houston - President and Chief Executive Officer

Thanks, Jimmy.

Operator

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

Daniel Joseph Houston - President and Chief Executive Officer

Well, first I'd like to just thank everyone for joining the call today. As I said in the beginning, we felt like we had a very solid quarter. We think we had in overall a good year. We, frankly, are very optimistic about the future. We found 2015 to be challenging in a number of different areas including the headwinds created by the equity markets, sustaining low interest rates, and certainly FX was not playing to our strength in 2015.

2016, as we evaluate it, we think the fundamentals are very strong. We think the strategy is still spot-on. We'll continue to rigorously analyze our capital deployment in interest of long-term shareholders. And, again, appreciate your continued support and look forward to seeing you on the road here in the next few weeks. Thank you.

Operator

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 1:00 PM Eastern Time until end of day, February 9th, 2016. 12710878 is the access code for the replay. The number to dial for the replay is 855-859-2056, U.S. and Canadian callers; or 404-537-3406, international callers.

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