美國信安金融集團 (PFG) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Principal Financial Group third quarter 2014 financial results conference call.

(Operator Instructions)

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

Thank you, and good morning. Welcome to the Principal Financial Group's third quarter earnings conference call. As always, our earnings release, financial supplement, and slides related to today's call are available on our website at www.principal.com/investor.

Following our 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 US Insurance Solutions; Jim McCaughan, Principal Global Investors; Luis Valdes, Principal International; and Dennis Menken, Vice President of our investment team.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company does not revise them or update them to reflect new information, subsequent events, or changes in strategy. Risk and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the Company's most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q filed by the Company with the Securities and Exchange Commission.

Before we get to the prepared remarks, I'd like to announce some upcoming investor events. First, on the afternoon of November 21, we will host an event in New York City to provide an update on Principal Global Investors, our asset management business. Details are available on our website.

We are also planning an update in the spring on Principal International's Latin American businesses. That event will be hold in Santiago, Chile on March 11. We hope that many of you are able to attend these events.

Finally, our 2015 outlook call will be held on the morning of December 8. We'll provide call-in information closer to that date. Now I'd like to turn the call over to Larry.

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

As John mentioned, slides related to today's call are on our website. As you can see on slide 4, total Company quarterly operating earnings of $354 million made this our third straight quarter of record earnings.

As Terry will discuss, the results included a $39 million benefit from our annual review of actuarial assumptions and methodology. However, even adjusting for this, we consider third quarter to be another strong quarter.

Third quarter results, combined with a strong first-half, resulted in year-to-date 2014 operating earnings of $994 million. This is a 28% improvement over year-to-date 2013 results on a reported basis, and a 23% improvement when adjusting for the actuarial assumption review. This is an outstanding result despite continued macroeconomic volatility, and reflects the strength of our diversified business model and the ongoing momentum in our businesses.

Assets under management were $514 billion at quarter end, down 1% from mid-year. The strengthening of the US dollar reduced assets under management by $9 billion for the quarter.

Solid sales and retention contributed to $3.7 billion of total company net cash flows for the quarter, and $18 billion over the trailing 12 months. This demonstrates the competitiveness of our businesses, the outstanding investment performance we are generating, and the strength of our distribution partnerships across the organization.

Following are additional key growth metrics from the quarter. Full Service Accumulation quarterly sales were $1.8 billion. We continue to strike the right balance between growth and profitability. Third quarter recurring deposits increased 9% over the prior year period, reflecting the recovering economy and improving deferral rates, as our retirement readiness initiatives start to take hold.

Principal Funds had strong sales of $5.2 billion for the quarter. Net cash flows were $1.4 billion; this is Principal Funds' 19th straight quarter of positive net cash flows. At 8% of account value, Principal Funds' net cash flows were almost 3 times the industry.

Principal Global Investors had $500 million of unaffiliated net cash flows, which contributed to unaffiliated assets under management of $114 billion at the end of the third quarter. Total assets under management in Principal Global Investors were $307 billion.

Principal International's assets under management increased 13% over the prior year quarter to $116 billion, despite the strengthening of the dollar. Coming off record net cash flows in the second quarter, Principal International delivered strong third quarter net cash flows of $2.5 billion, driven by continued strength in Brazil.

Specialty benefits, premium, and fees increased 9% over third quarter 2013 as a result of record third-quarter sales and strong persistency. In-plan growth over the past 12 months was 1.5%, the highest level since 2006, signaling more sustainable job growth.

We continue to deliver products and solutions that are in demand, with a focus on providing financial security to business owners, individuals, and investors around the globe. We remain confident about our competitive positioning and our ability to continue to grow our businesses into the future.

Next, I'll provide a few updates on the continued execution of our strategy. Many of you had the opportunity to attend our investor event in September with members of our US retirement leadership team.

As they discussed, the Principal remains competitive, and is a retirement leader with key differentiators like Principal Total Retirement Suite, and Retire Secure. These innovative approaches build stronger relationships with advisors, plan sponsors, and participants, driving better persistency.

We're also focused on addressing retirement income gaps through our retirement readiness program called Principal PlanWorks. PlanWorks encourages plan-level features, such as auto enrollment and auto escalation, to drive improved participation and deferral rates. Additionally, we recently rolled out a new participant website designed to provide participants a quick view of their retirement savings and drive them to take action to improve their retirement readiness.

As slide 5 shows, investment performance continues to be very strong, and is a leading indicator of growth for our retirement and investment management businesses. At least 85% of Principal Funds' investment options were in the top half of Morningstar rankings on a one-, three-, and five-year basis at quarter end.

Principal Funds continues to perform very well. Funds had record operating earnings in the third quarter, demonstrating our ability to turn the strong growth in recent years into bottom-line results.

Principal Funds continues to have great success executing on a strategy focused on asset allocation multi-manager funds that address risk and income needs. 65% of Principal Funds' assets under management are in Morningstar-ranked 4 and 5 Star Funds.

We continue to expand on our outcome-based funds lineup, and enhance our investment platform. Through the third quarter, we've launched four new fund products this year and anticipate launching three more in December, and up to five more in 2015.

Principal Global Investors made two strategic announcements in the third quarter that enhanced our successful multi-boutique strategy. First, we announced that Principal Real Estate Investors, a dedicated real estate group of Principal Global Investors, partnered with Macquarie Group to create a nationwide commercial lending platform known as Principal Commercial Capital. Principal Real Estate Investors will provide its underwriting and loan origination expertise, but will not take on the balance sheet risk.

In addition, we announced that Principal Global Investors has increased its ownership stake in Columbus Circle Investors from 70% to 95%, with plans to acquire the remaining 5% over the next two years. Columbus Circle has performed exceptionally well since we first acquired a majority ownership in 2005, with assets under management quadrupling over that time.

Investment performance is strong, and we've retained all of the key investment staff. This boutique remains an important part of our overall investment management strategy, as it invests on behalf of all of our platforms.

Principal International had another quarter of record operating earnings, despite continued macroeconomic headwinds. On a local currency basis, operating earnings once again grew at a double-digit rate compared to the prior year quarter. The combination of our investment management expertise, our ability to effectively manage the business at a local level, and our relationships with marquee distribution partners, positions Principal International for continued long-term growth and success.

An example of our strong distribution partnerships is the success of our joint venture in Brazil, BrasilPrev. On a trailing 12-month basis, BrasilPrev garnered 58% of net deposits in the Brazilian open pension market, moving them into the number two spot for pension providers based on assets under management. This underscores the strength of Banco Brazil's distribution reach, and demonstrates the powerful long-term opportunities for BrasilPrev.

Additionally, we continue to focus on maximizing the voluntary savings opportunity in Chile. Cuprum voluntary sales increased 29%, and net cash flows for voluntary products were five times higher than the year ago quarter's results.

I also want to mention the continued strong performance from our Specialty Benefits division. Our team continues to do an excellent job of maintaining above market growth, with sound pricing discipline, resulting in better than expected loss ratios. Providing leading employee benefit solutions to small and medium-sized businesses continues to be an important part of our strategy in the United States.

Next, I'll comment on capital management. Our fee-based business model allows us to generate free cash flow and strategically deploy it to create long-term value for shareholders. We remain well positioned to deploy capital through a variety of options, in addition to supporting organic growth.

Last night, we announced a $0.34 per share common stock dividend payable in the fourth quarter. This brings the annual 2014 common stock dividend to $1.28, up 31% over full-year 2013. The merger and acquisition pipeline remains active, with opportunities to further enhance our global investment management platform.

In closing, I want to point out two third-party recognitions we received. I'm especially pleased because both of these recognized our commitment across the entire Company on corporate responsibility and sustainability.

First, Principal Real Estate Investors recently received the Green Star designation for three funds from the 2014 Global Real Estate Sustainability Benchmark Survey, including achieving the number one ranking out of 64 opportunistic investment strategy funds. Green Star is the highest ranking this organization provides.

In addition, Principal was recently recognized as a leader among S&P 500 companies by the environmental nonprofit organization CDP for its actions to reduce carbon emissions and mitigate the business risks of climate change. We take being a socially responsible company very seriously, and are proud of our recent recognitions of our efforts.

Before I turn it over to Terry, I just want to take a minute to note that yesterday was the 13th anniversary of our initial public offering. At that time we had approximately $100 billion in assets under management, and a solid position in the US insurance and retirement markets. Our aspiration was to become recognized as a global leader in the mutual funds and asset management areas.

Since going public, we've generated nearly $150 billion in net cash flows, and assets under management have grown to over $500 billion. That's a compounded annual growth rate of over 12%, which is 2 1/2 times the growth of the S&P 500. But, as pleased as we are about our results to-date, we are even more excited for the growth opportunities that lie ahead of us. Terry?

Thanks Larry.

This morning I'll focus my comments on operating earnings for the quarter; net income, including performance on the investment portfolio; and an update on capital deployment. Third quarter continued to build on our strong first half of 2014. Total company operating earnings of $354 million were up 31% over the prior year quarter.

On a reported basis, operating earnings per share were a record $1.19, a 32% increase over third quarter 2013 results. Total company operating earnings for 2013 were a record $1.1 billion. Year-to-date 2014 operating earnings of $994 million are already 94% of that amount.

We continue to successfully execute on our strategy, and momentum continues to build across all our businesses. With our continued shift towards a fee-based business model, we're increasingly well-positioned for long-term growth.

During the quarter, we completed our annual actuarial assumption and model review; the impact from the review was predominantly recognized in the Individual Life division. Individual Life had a net operating earnings benefit of $39 million or $0.13 per share.

In third quarter 2012, we made a significant change in our long-term interest rate assumption and glide path. Thus, the current year impact from the continued low interest rate environment was minimal. The benefit this quarter in Individual Life was driven by several updated assumptions and model enhancements, including refined coverage periods, and policy-specific premiums.

On slide 6, we normalized third quarter 2014 earnings for two additional items. First, the encaje return in Principal International was $12 million, or $0.04 per share better than expected. The higher than expected encaje returns are reflected in Street earnings expectations for the quarter, and are consistent with the encaje return information available on the websites we provided in the past.

Next, Individual Life claims adversely impacted earnings by $10 million, or $0.03 on a per-share basis. Analysis of claims points to random volatility, which is inherent in risk-based businesses. Given what we have seen in the last few quarters, we continue to analyze the results, and will communicate any changes to our expectations if deemed necessary.

On a normalized basis, earnings per share were $1.05, up 13% over a normalized prior year quarter. At quarter end return on equity, excluding AOCI, was 14.1%; this is a 220 basis point improvement from a year ago. Organic growth contributed 145 basis points of the increase, as operating earnings improved 26%, while mean equity increased only 6%.

Operating earnings during this time period benefited from favorable equity markets and high variable investment income, which were partially offset by the strengthening of the US dollar and higher than expected mortality. We are still targeting 50 to 80 basis points of annual return on equity expansion, as the strength of our diversified business model continues to provide many growth opportunities both domestically and internationally.

Now, I'll discuss business unit results. Retirement and investor services delivered its eighth straight quarter of double-digit operating earnings growth. For the accumulation businesses, operating earnings were $180 million, an increase of 19% over the year ago quarter.

Slide 7 shows that the net revenue was up 11% over third quarter 2013, and up 12% on a trailing 12-month basis. Trailing 12-month pre-tax return on net revenue improved to 34%. Full Service Accumulation operating earnings were $113 million, a 24% increase over the year ago quarter.

Net revenue growth of 9%, combined with expense discipline, resulted in an improvement in the trailing 12-month pre-tax return on net revenue to 35%. This margin has been helped by the strong equity market returns over the past year, and some positive one-time items that we've discussed in previous calls. Net cash flow for full service accumulations were slightly negative for the quarter.

In light of our shift in focus on asset sales to new business revenue, we've become more selective on new sales, particularly at the large end of the market. We're increasingly focused on two measures.

First, on plan retention, which was very strong at 97% year-to-date, up 100 basis points from a year ago. And second, on capturing more assets to principal branded funds, which is up 5 percentage points to 73% year-to-date on new sales, reflecting strong investment performance.

Principal Funds' third-quarter operating earnings were up 25% from a year ago quarter, to a record $28 million. On a trailing 12-month basis, revenue was up 14%, and operating margins continue to improve due to the scale-based nature of the business.

For the quarter, Principal Funds' sales were $5.2 billion, contributing to $1.4 billion in net cash flows. Strong investment performance, and our focus on outcome-oriented products, have led to strong sales across multiple asset types.

Individual annuities operating earnings were $31 million for the quarter. Increased fee revenue on our variable annuity business, due to marked appreciation, continues to offset spread compression on our fix-deferred block of business.

Looking at slide 8, the guarantee businesses within Retirement Investor Services continued to perform as expected. We continue to approach these businesses opportunistically.

Turning to slide 9, Principal Global Investors' quarterly operating earnings were $25 million, a 10% improvement over the year ago quarter. Trailing 12-month pre-tax margin was 25%, slightly below our expectation of 26% to 28% for the year.

Fourth quarter 2013 benefited from large performance fees, which lowered the trailing 12-month pre-tax margin by approximately 100 basis points. We still anticipate increasing to a 30% pre-tax margin.

We expect 2014 revenue in this business to be similar to 2013 levels. While management fees should grow in line with assets under management, performance fees are less likely to reach 2013 levels.

Third-quarter net cash flows from our fee-based products were nearly $750 million, which is partially offset by our opportunistic approach to the guaranteed businesses. Net cash flows of post-advisory groups improved dramatically, with only modest outflows during the quarter, reflecting some rebalancing occurring in high-yield. Quarterly performance remained in the top quartile.

Assets under management for Principal Global Investors increased 9% over the prior year quarter to $307 billion. Unaffiliated assets under management ended the quarter at $114 billion, a 7% increase over the year ago quarter.

Slide 10 shows record quarterly operating earnings for Principal International of $74 million, a 46% increase on a reported basis. As pointed out earlier, results in the current quarter were helped by higher than expected encaje returns in Chile.

While the strengthening of the US dollar dampens growth when comparing prior period results, Principal International continues to perform well on a local currency basis. Operating earnings were up 12% over the prior year quarter, after adjusting for normalizing items.

On a trailing 12-month basis, combined net revenue was up 20%, above our 16% to 18% expectation, due to the strong encaje returns. Combined pre-tax return on net revenue was 52% on a trailing 12-month basis, at the top end of our range.

As shown on slide 11, individual life operating earnings were $52 million for the quarter, impacted by the items previously discussed.

Moving to slide 12, Specialty Benefits operating earnings of $31 million were roughly flat with the year ago quarter, while quarterly premiums and fees were up 9% over the year ago quarter. The loss ratio for the quarter remains strong at 64.5%, relative to our 65% to 71% targeted range. The more favorable claims and strong growth in the current quarter were offset by lower expenses in the prior year quarter.

On a trailing 12-month basis, premium and fees were up 6%. This is above our expectation of 3% to 5% growth for the year. Trailing 12-month pre-tax operating margin of 11% is in-line with our expectations.

For the quarter, total company net income was $241 million, including realized capital losses of $55 million. Net credit related losses continue to be in line with expectations. We saw improvement in the commercial mortgage-backed securities asset class, with impairments of only $15 million in the quarter.

Net income was negatively impacted by $58 million to the Chilean tax reform bill that was signed into law during the quarter. The tax rate will increase over time, so the impact to operating earnings will be gradual. However, we adjusted our deferred tax liability for the ultimate tax rate in the third quarter.

Unrealized gains were $2.8 billion at quarter end. As a reminder, because of our strong asset liability management, changes in net unrealized gains or losses due to interest rate movements did not result in an economic impact.

Our asset liability management expertise, combined with strong liquidity, allows us to avoid forced asset sales in periods of stress. In addition, our predominately fee-based business model limits our sensitivity to interest rate movements.

As outlined on slide 13, our approach to capital deployment is balanced and focused on increasing long-term value for shareholders. We've now announced plans to deploy more than $855 million of capital in 2014, well above our $500 million to $700 million stated range for the year.

In addition to the third quarter common stock dividend and increased ownership in Columbus Circle Investors, we repurchased $72 million of common stock during the quarter. We still have $50 million remaining from the previously announced share repurchase program.

In closing, there are some macroeconomic factors providing significant headwinds as we start the fourth quarter. However, we feel that our diversified business model positions us well for future growth in various economic environments.

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

(Operator Instructions)

Tom Gallagher, Credit Suisse.

Good morning.

First question is just on -- can you help us think through, and I guess it would either be for Jim or Terry, can you help us think through the valuation on the Columbus Circle buyout?

Was that just a contractual obligation? Was that negotiated? Because when I look at the implied valuation of $720 million, it looks pretty high relative to what I would expect that to be earning for the AUN. That's my first question.

Okay Tom. Good morning. This is Larry. I'll have Jim take that one for you.

Yes. Tom, I think you'll have to see that final payment in to the context to the incentive structure at Columbus Circle, and to take you through the whole story as quickly as I can. For the first 70% in -- at the end of 2004, we paid $60 million. Obviously the Company was way smaller then, and management's done a fine job growing it, and we've obviously supported that.

We paid a further $180 million -- $179 million for the next 25% share. What that means is we've effectively, for $240 million, bought a company that its current value must be around $500 million if you marked it to market. Now as you remark, the price we've paid for the 25% looks to be pretty clearly above market.

That was a contractual formula we settled on five or six years ago very deliberately to incent management to go strongly for growth and to build a very sound business. Management has delivered on that, so that's why they got a good price for the further 25%. And from a principal point of view, we've ended up with a very valuable asset.

We've also, by the way, in the 10 years we owned it, received almost $180 million of dividends from Columbus Circle, so if you add this all up, this has been a really tremendous acquisition. The return on the capital invested so far has been in the high teens. So, I think we are poised to make this very successful.

Okay. That's pretty clear Jim. Thanks. Just a follow-up on the mortality and individual life this quarter. Now I know the actuarial review had gains, and I presume those were non-mortality related.

Can you just address the issue of what has been, I guess, different quarters of weak mortality over the last two or three years and whether or not that was factored into the actuarial review and how would you think about that in the context of the balance sheet? Thanks.

Yes. Tom, this is Larry. I'll make a few comments and maybe ask Dan or Terry to comment as well. I think if you look back over about the last three or four years, I think the last sort of 15 quarters we've had a little higher mortality in about seven of those quarters.

So in the current quarter, Tom, the higher mortality really was more a matter of severity than it was of frequency. So, we are going to take a further look into that. I do think it's something that we do need to pay a little bit of attention to.

Having said that, the mortality was not really an issue in the actuarial assumption review. We took our appropriate steps a couple of years ago relative to interest rates and other economic factors. The adjustments this time were more related to lapse rates and reinsurance costs, and what I would call sort of maybe some secondary factors rather than basic mortality or interest rate. So, let me see if Dan wants to add anything.

Yes, maybe just a couple of data points, Larry.

The first is which on a year-to-date basis, if we look at large claims it's actually been about one less than we would have expected for that period of time, but to the comment that was made in the earlier comments, the severity of those large claims has been more significant. We would've expected maybe 380,000 or 400,000 versus 800,000. So this is a severity issue. We are taking a very hard look at this.

We've got a group of senior executives drilling down to take a very, very hard look at the business and make adjustments as necessary, but at this point in time, we do not think that we've got a systemic problem. This is all in the course of the volatility associated with a life block like this.

Dan, nothing -- because I remember several years ago you all had mentioned the IOLI issue. Is it -- so you're not tracing it back to that, per se, right now?

We are not. We can identify three or four very large claims. Had they not occurred, we wouldn't have had the mortality expense that we have.

As you know our business is bifurcated. Some has more reinsurance than others, and unfortunately in these instances they were just almost freakish sort of claims. So, again more validation that we don't think this is a systemic issue. It's more of a situational one, but again, that won't keep us from really digging into the details.

Okay. Thanks.

Thanks Tom.

Seth Weiss, Bank of America Merrill Lynch.

Hi. Thanks for taking the question.

If I could just follow-up on the actuarial review, and I believe you mentioned that the impact from interest rates was minimal for the quarter. Could you comment on how you reset the glidepath of interest rate improvements in the future and your assumptions?

Yes. Seth, this is Larry. I'll have Terry make a few comments.

I'd go back again -- I think to really understand this year, you sort of have to go back and look at what was done in the past. I know some comments have been written as to whether -- does this indicate other companies are going to have comparable sort of positive numbers or rather negative numbers. Of course there's no way to ever really make any conclusion on that unless you have a sense of what each company has done up to this point in time.

So sort of the trough at this point, and again it's up till now, the trough really was in 2012 where at that time the 10-year treasury was sort of give or take in the range of 1.75%. Today, it's give or take 2.20%. So, from the time we actually took the hit in 2012, which I think was around $90 million, interest rates are now actually up about 45 basis points. At that time we not only lowered the long-term interest rate, but we also changed the so-called glidepath that you referenced in your question.

So, we expected that the portfolio rate was going to continue to actually go down from that point for another three or four years, and that's kind of exactly what's happened. So what I'd say is, again, we took the adjustment in 2012. It has sort of trended or followed that path that we expected it to follow in 2012, so there's very little need to do any particular updating.

So Terry, you want to add anything?

Yes. This is Terry. Just a few additional comments on it. Each quarter we take a look at any significant items that may have changed, but in the third quarter of each year, we do an annual actuarial review of our models as well as our assumptions.

We look at interest rates. We look at mortality. We look at lapses, expenses, premiums, reinsurance. All the different drivers of those long-term actuarial models.

And as Dan said, we looked at mortality this quarter, decided that it was more of a few random isolated cases, so we did not adjust for the mortality at this point in time, but we will continue to look at it. As Larry said though, in 2012 we looked at the low interest rate environment as termed the ultimate rate, and lowered our ultimate rate down by 50 basis point at that point in time. But probably equally as important, or maybe even more so important, is the glidepath with which to get there.

Each company will have their own opinion as to this but I think one of ours is probably a little bit more conservative as to how long it takes us to get to that glidepath. A year ago, we looked at the rising interest rate environment or the environment at that point in time and decided -- you know, we are not seeing a significant change in the glidepath that we would warrant a positive unlocking a year ago, and it served us well this year.

We did, again, look at the trajectory out to that longer-term rate. We feel very comfortable with our ultimate rates for each of our businesses. We feel very comfortable in terms of the glidepath, but as we've mentioned before, these are just a couple of the components that impact the actuarial unlocking.

The last point I'd make on this actuarial unlocking for the $39 million that we called out impacting the life area was -- that was really the conservative assumptions that we've had over the last six or seven years, and so in a lot of cases, you'll see an unlocking will bring in profitability or losses from future years. This is all with respect to the last six or seven years of understating some profitability.

So we're very comfortable with the actuarial review this quarter and the unlocking that we called out.

That's very helpful.

And if I could just -- I suppose follow-up on that, and I know you haven't given specific quantitative landmarks in terms of where rates need to get to, but I believe that general commentary at least back in the third quarter of 2012, when you and some others changed the interest rate assumptions, was following the forward curve in the near term. Which rates have actually followed pretty closely what the forward curve suggested if you go back two years ago. But then I believe that it implied a faster improvement in interest rates if you look forward three to five years, going back to 2012 or coming up upon that.

So, the question is, if we just follow today's forward curve going forward, is that not going to be a fast enough rate of improvement in order to avoid balance sheet charges in future years?

No, Seth. This is Terry, again. No. I think what we're looking at right now is an ultimate rate that is probably -- and it varies based upon the product and the duration, obviously. But, if you are looking out 30 years or 25, 30 years out into the future, the forward rates are probably pretty close to where we would expect them to be at that point in time.

Seth, this is Larry. I'm just going to add one higher-level comment. The individual life business remains very important to us strategically, but I also think it's important that investors not lose sight of the fact of the substantial growth that's happened over the last few years is going to continue to happen with our fee-based businesses. So, what you're talking about there, again, is roughly give or take somewhere between 5% and 8% of our total Company earnings attributable to individual life.

So, we could talk about sort of the unlockings, and there is going to be some noise from time to time, but I don't want to let that obscure the real trend which is happening, which is really the growth in the fee-based businesses. So, just wanted to add that comment as background.

Understood. Thanks a lot for the comments.

Erik Bass, Citigroup.

Hi. Thank you. Can you talk about what drove the decline in the pre-tax margin at PGI this quarter? And it sounds like from your comments in the script, you still are comfortable getting to the 30% plus range for pre-tax margins over the next few years. So, if you could just talk about -- what are the key drivers there?

Yes, you bet. I'll have Jim cover that for you here.

Yes. Thanks Erik. Firstly there's always a lot of fluctuations quarter to quarter, so really better to look at the trailing 12 months to smooth it out to get the trend. First thing to say as a broad context, is the industry is suffering and has been suffering in the last two years, as assets have moved to passive and to liability driven investing.

We are in those businesses, but we're not big players, so in terms of flows though, the main point is those are very low fee businesses and that's put some pressure on industry margins. What that pressure is meaning is that we're going to take longer to get to that 30% we've talked about.

If I look to the current quarter, however, it was a pretty low quarter for both transaction fees on real estate and for performance fees generally. So that actually means that it was, if anything, a pretty low quarter if you look at the fluctuations quarter to quarter.

Secondly, in conjunction with the general churn in the industry, the net flow consists of some pretty big inflows and outflows. And the inflows of course are not cost free. There's cost, including commissions of putting that business on the books. So, that's actually one of the factors that brought the margins down a bit for this particular quarter.

Now, of course being able to take in assets in contrast to many in the industry because of our performance and our distribution reach is long-term good for the business, but short-term it does cause a bit of a margin impact. If you look at the trailing 12 months, which I encourage you to think of as the glidepath towards that 30%, firstly the fourth quarter of 2013 will fall off. That was a low margin quarter because of the particular set of incentive fees we had in that quarter.

We're pretty confident of the trailing 12 months will again show some progress. And be in, albeit at the lower level, of that 26% to 28% range we previously talked about. But, we are on course to continue improving margins.

The real reason I'm confident of that is that the business we are putting on the books at the moment is both very well priced and should be quite profitable looking forward. The margin on new business is very profitable, so that's really the root of our confidence that we are headed for 30%.

Thank you. That's helpful. Any sense of -- I mean at this point how quickly you would assume that piece of expansion kind of getting from that 26% to 28% to the 30%?

Yes. We'll get more formal about that in the guidance call Erik, but I think it's fair to say that the industry background makes it fair that it will take a year or two more than we perhaps thought when we first set it.

Okay. Thanks.

And if I could ask just one other margin question, this time on IRS accumulation. At Investor Day, you talked about continuing to target the 28% to 32% return on net revenue over time and outlined a couple of factors that could pressure margins other than just a market decline. I think you also suggested that margins could remain about that target near-term if the markets hold up.

So can you just help us think about how long it would take for margins to decline from the current level to that, and a 28% to 32% range if the market performs in-line with your expectations.

Okay, Erik. I'll have Dan cover that.

Hello Erik. This is Dan.

I would say over the course of the next couple of years, again we've had really nice tailwind's here in the last two years driving equity markets, and it's been really nice obviously.

But again, when we validate those long-term earnings rates we feel very confident that they -- we can hold up into those ranges, and the fact that they're up slightly, has a lot more to do with just how positive the markets are right now, as opposed to anything else.

Okay. Thank you.

Sean Dargan, Macquarie.

Thank you. Jim, in PGI typically in the fourth quarter of a good year you'll receive some performance fees that will flow through the income statement. I'm wondering if you could give us a directional sense of where they might shakeout this year.

That's a terribly hard thing to do given volatile markets. And even a well-managed hedge fund, which is where the big numbers tend to come from, can have individual month draw-downs in the low single digits and that can affect the amount we make.

As of the end of September, we were confident of a decent fourth quarter but not as big a performance fee as last year. And, I think that's probably about the best I can say right now because there is a high degree of uncertainty until you really get into the closing stretch.

But the other thing I'd point out though is we were a little unfortunate last year in that the big performance fee came through on a set of hedge funds where we have a very historical agreement -- a very legacy agreement with the team that will pay them a large proportion in incentive comp of the carry on the fund.

For the funds we've set up and developed more recently, we have a more market deal, so there won't be the adverse impact on margins if it flows through as expected.

Okay. Thank you. That's helpful.

And then just going back to the change in the tax law in Chile. The effective tax rate over time will creep up to 27%. Is that correct?

That's correct.

And how long will that take?

Five years. Four to five years.

Okay. And the charge was related to a deferred tax liability, which is why you put it below the line?

That's right. That's right. I mean, we sort of believe -- this is Larry, Sean.

We sort of believe that the operating earnings metric is best suited to sort of help to predict how the businesses themselves are doing, not some of the other balance sheet impacts. So to put -- at least in our thinking the way we construct operating earnings, to put a one-time item like a reset of the deferred tax asset into an operating earnings number would make it more difficult for you to try to understand and to get a reasonable estimate of what the run rate earnings of the business are.

So that's why, to us, it made sense to put it in the other after-tax adjustment.

Okay. Thank you very much.

You bet.

Jimmy Bhullar, JPMorgan.

Hi. The first question for Dan, just on FSA flows and deposits. They seemed a little weak this quarter. I think you were optimistic at the last call that things were going to improve in the second half, so maybe you could talk about how you are balancing margins and flows in that business, and how the competitive environment is and maybe talk about the pipeline as well?

Then secondly for Larry or Terry, you've spent more on buybacks and deals and dividends this year than you'd indicated previously, so should we assume that you're going to be active on buybacks through the remainder of the year as well, or not?

Okay. I'll have Dan take the FSA one first, Jimmy.

Yes. Jimmy. Good morning.

Good strong margins, good recurring deposits, good strong revenue growth, a little light in sales at $1.8 billion versus prior quarter $2.7 billion. We had one sale just this last -- a year ago quarter that was nearly $1 billion. So again, if you wanted to kind of compare the two, the numbers were closer to being on top of one another than perhaps you realize.

The large case market's more lumpy. That's a reality. When we validate the value proposition of TRS, working with our alliance partners, executing on our PlanWorks, that's all still very much resonating with our customers.

There's been a pickup here recently in terms of the size of the pipeline. I'd say the first half of the year, the pipeline is pretty light. Again, strong investment performance probably contributes to some of that. In terms of value proposition, again when I look at investment performance which we mentioned in the earlier comments, we've got very, very strong performance coming from Jim and his team.

For our principal branded funds, we got 88% of our funds at the five-year level that are in the top two quartiles, which makes our existing customers happy and prospective clients pleased. We got record retention during that period of time.

And the other item, and I've brought this up on previous calls, but when I look at our DCIO business, which again is taking advantage of our investment management capabilities without necessarily buying our record keeping. That's up double from where it was in 2011 at $3.3 billion.

In terms of the shift in net cash flow, a little bit light. Negative a couple hundred million dollars. Again, we are still coming in on top of that.

Net cash flow, which would be somewhere in that $1.5 billion in a year-to-date basis, which would put us at the low end of our range of 1% to 3% at beginning year account balance. So it's not performing that unlike what we would've expected and the difference is probably a few larger cases, but again we're going to stick to our focus on being disciplined on profitable growth and write businesses that are going to allow us to execute on all the business -- all the values that we bring as an asset manager in addition to being a provider of services to participants and plan sponsors.

So, hopefully that helps, Jimmy.

So on your other question let me -- just a quick comment, Jimmy, on your first one, which is if you had -- if you as an analyst or you as an investor had a choice between two different paths, one path would have higher sales and less retention, the other path would have lower sales and higher retention. 2014 represents that second path, and that second path is actually a better economic outcome to have somewhat lower sales and better retention. Because your most profitable business is the dollars that you have on the books, so actually of the two paths, we like this path better.

Now on your question on buybacks, again I think we have been more consistent on this issue, certainly, than many of our insurance peers, but even more I think than many other public companies. We have said now for some period of time we are less oriented towards share buyback.

We think we are among a very small set of companies that can organically grow our earnings and use that to grow EPS, and so we think about share buyback as simply a tool to offset dilution. And that's essentially what has happened over the last couple of years, is we've used share buybacks to offset dilution, we've allowed the businesses to grow organically, and that provides EPS.

I think as I sit here today, Jimmy and I look forward, I think that's going to continue to sort of be the formula. We have a lot of opportunities, as we've said before in the script. We have a lot of opportunities around M&A.

I think for those who are long-term shareholders, the best thing we can do is to use our capital, to deploy it to grow our businesses and grow shareholder value over the long term, and so that's what we're going to continue to do. We will continue to move the dividend up.

I think a 31% increase in our common stock dividend this year. should be viewed very positively by investors, but share buyback, while it is a REO stat, it's not something that we have to go to in order to grow EPS, which is what most companies end up having to do.

The deal focus primarily, I'm assuming, is asset management and international?

That is correct.

Okay. Thank you.

You bet.

Suneet Kamath, UBS.

Thanks and good morning. Just a couple quick ones.

First, on the asset management business and specifically the buy-ins of -- any future buy-ins of boutiques. Are there any more deals that were sort of structured like the Columbus Circle that we should be thinking about over the next couple years in terms of put options and the like?

Yes. I'll have Jim cover that. Good morning.

Thanks. The only one that's on a similar formulaic pattern is actually the further 5% of Columbus Circle, which there's no guarantees, but we expect to be able to buy that in from management over the next two or three years. So, that would be on the same sort of structure as I described.

Since about six or seven years ago, really the rules around put and call options have made it much more advantageous to go with pure market value assessments, and so the exact structure I described in Columbus Circle is not replicated on the other puts and calls. Where management have equity in the boutiques, we generally do have put rights for them, particularly if they want to retire, and call rights for us some years out in the future, but really the further 5% to Columbus Circle is the only one that's imminent in the next year or two.

Okay. Got it.

I guess for Dan on FSA. Just to follow-up on Jimmy's question, I guess at the beginning of the year you talked about flat sales. It looks like fourth quarter would have to be a pretty huge quarter for that to happen. So any sense on what your full-year outlook is now for sales? And given some of the market dynamics that you mentioned, how should we be thinking about 2015 sales growth?

Yes. So this is Larry. I'll just make a couple of high-level comments.

We're now a little bit more focused, Suneet, on sort of the revenue generated by the sales rather than the AUM generated by the sales, and so we have a certain target sort of thinking that 2014 was going to represent an FSA sales volume and net revenue new volume that would be comparable to 2013.

I think while we may fall a little bit short on the asset component, we do expect to be pretty close in terms of the revenue generated off of that sales volume being very comparable to 2013. So again, all in all in an era where there's less money in motion, I think that's actually a pretty good result. As I said, we are seeing retention at an all-time high, which again adds to the margin and to the profitability of the business.

Okay. And then just one last one -- just on that same topic. So I think, Dan, you had said earlier or somebody had said earlier that about 73% of new FSA sales are going into a principal fund. How high do you think that number could go?

I would imagine at some point you'll hit a ceiling but I just don't know if you have a sense of how high that number could go.

Yes. I think the ceiling's 100% and --

You could actually do 100%, do you think, at some point?

I'd like to think we could, because investment performance is good and in all seriousness the reality is, it really differs by the size of the plan. The smaller the plan, the higher probability you are going to have a higher percentage allocated to principal funds. And if I look at that emerging market which is under $5 million, that is north of 80%, 85%. If I look at that dynamic on a $5 million to $50 million, those numbers settle in the 70%s.

It's when you get to the really large cases were you get this volatility. If you wanted to, you could write a lot of plans where you didn't manage any of them of the assets, and you did 100% of the record-keeping. The economics on that are not very good.

The reality is that space is going to probably end up settling into that the 50% to 60% of principal managed accounts. The good news is we got a really good value proposition with the service package and investment performance is good. Which leads to being more selective, more disciplined.

We just finished an institutional client conference in September with some of our largest clients, had the opportunity to showcase what we are doing. Some of the new plan -- some of the new investment options, some of the new services in particular, about helping their future retirees do a better job for planning for retirement. It's called PlanWorks. The feedback could not have been more positive, so again it reinforces that we feel that our strategy very much on point.

We may say sales, as Larry pointed out, is measured by assets. Down say 5% or 10% on a full-year basis relative to a year ago. And at some point, maybe we can have more extended conversation about the difference in a model that values assets under management versus assets under administration, because those are two very different models and I suspect the industry will start bifurcating to some extent along those lines.

Yes. If I can add to reinforce Dan's points, Dan makes some excellent points. But I would emphasize that his team and mine -- in other words the retirement services people and the product people within Principal Global Investors -- work very, very closely together designing capabilities that provide outcomes that are attractive to the plan participant. That's why ultimately we're doing better in terms of the allocations that are coming both from the plan sponsor level and the plan participant level.

It's that as well as having, I would argue, the strongest suite of investment products in the industry that makes us so confident we can keep on in this direction.

Those large cases that you're talking about, where maybe you get a smaller than average percentage of the asset management mandates. Is that running about a third of your new business?

Yes. That's probably a good number. I think in years past it could've been as much as 50%. But if we settled in on a third small, third medium and a third large, and those large plans are ones that really value the entire suite of services, products and investment lineup, that's probably not a bad place for us to end up.

Terrific. Thank you.

Steven Schwartz, Raymond James.

Hi. Good morning everybody.

Hi Steve.

Mostly asked and answered, but I am interested in any update you might be willing to give on expansion in Asia and of course particularly in China. Anything happen in the quarter?

Okay. This is Larry, Steven.

So, as you know we've had a very successful -- I'll talk about China first and then make a few comments on Asia and see if Luis wants to add anything. We've had a successful mutual fund company in China since 2006, and again for those not as familiar with our businesses, our partner there is China Construction Bank, which is a very large state-owned bank, today probably the third or fourth largest bank in the world.

And that's been a very successful effort in the mutual fund and asset management space but the desire is to hopefully someday get into the retirement business in China. That business exists today. It's called Enterprise Annuity, but it's been limited to local companies.

So we continue to travel over there to visit with regulators. Recognizing their need to deal with aging, which in China is one of the most aged populations on the earth because of the one child policy. So we remain hopeful, although I don't think we'll have anything to announce in the near-term on that particular project. But we do remain hopeful that over time we think if and when they expand that industry we'll be one of the first ones allowed in.

More broadly across Asia, Steven -- it's a great question, and what I would say is, and I mentioned this in the opening comments, there is more activity and some of that is in Asia. And most of that is coming out of banks, primarily European banks, but some US banks who are in the process as I think everyone knows, of having to get out of geographic markets that are not meaningful, and having to get out of tangential businesses that are not meaningful.

So the regulatory pressure on the larger banks continues to be pretty severe. That gives companies like Principal, I think, a great opportunity, and we've done a number of acquisitions in Asia, although they've been pretty small.

You may remember, last quarter we announced an acquisition in Thailand. That's kind of small on one hand, but it actually doubled the size of that Thailand business. So again, it's a matter of trying to sort of get to scale within each of the seven countries in Asia where we operate. So anything you want to add, Luis?

No.

Okay. I hope that helps, Steven.

Yes. I appreciate it. Thanks, guys.

All right. Take care.

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

I just wanted to say thanks to all of you for joining us on the call this morning. We're very pleased with our results to date in 2014 and we look forward to a strong finish to the year. And so with that, thanks for joining us.

I hope to see many of you on the road in the coming months. Have a great day.

Thank you for participating in today's conference.

This call will be available for replay beginning at approximately 12 PM Eastern time today until end-of-day October 31, 2014. 8844037 is the access code for the replay. The number to dial for the replay is 855-859-2056 US and Canadian callers, or 404-537-3406 international callers. Ladies and gentlemen, thank you for participating. You may now disconnect.